A company makes Product X and sells to customers. The per unit cost / profit structure is as below.
Material cost Rs. 35
Add: Labour and other direct costs (Process A) Rs. 15
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Cost of Process A output Rs. 50
Add: Labour and other direct costs (Process B) Rs. 20
Add: Overhead costs and profit Rs. 30
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Selling price of finished product X Rs. 100
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The company creates a new Division Z to cater to a certain geographical segment, and to save on outward transport cost.
The company transfers a part of its Process A output to Division Z at ten percent profit on cost, i.e., Rs. 50 + 10% = Rs. 55
Division Z's consequential per unit cost / profit structure is as below.
Material cost, transferred by Head office Rs. 55
Add: Labour and other direct costs (Process B) Rs. 20
Add: Overhead costs and profit Rs. 25
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Selling price of finished product X Rs. 100
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In consolidated profit and loss statement (and MIS), inter-unit transfer out / in are set-off. Unrealised profit in inventory carried by Division Z at end-of-period is also eliminated.
In standalone mode, Division Z's accounts should reflect material cost at Rs. 55.
However, my question is "in consolidation, should the material cost in Division Z's accounts be restated to have parity with 'true cost' at company level"?
To elaborate, the company's material cost is 35% of selling price, whereas Division Z reports material cost as 55% of selling price (for same finished product X).
In other words, should Division Z's "material cost" be split into "true company material cost Rs. 35", "labour and other direct costs Rs. 15", and "profit kept by company Rs. 5"?
This would show the correct revenue components at company level.
Please provide your views, for and against.
CAclubindia
