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Difficulty: HardInter-departmental Transfers and Provision for Unrealized Profit

Zaria Textiles Plc operates two departments: Weaving and Garment. The Weaving Department transfers fabric to the Garment Department at cost plus a mark-up of 25%25\%. At the beginning of the year, the Provision for Unrealized Profit Account had a credit balance of N4,000\text{N}4,000. At the end of the year, the Garment Department held a total closing inventory valued at N75,000\text{N}75,000, of which 80%80\% represents transferred fabric from the Weaving Department. What is the net amount to be debited to the General Profit and Loss Account as an adjustment for provision for unrealized profit?

  1. N8,000\text{N}8,000Answer
  2. B
    N11,000\text{N}11,000
  3. C
    N12,000\text{N}12,000
  4. D
    N15,000\text{N}15,000

Answer

The net amount to be debited to the General Profit and Loss Account is N8,000\text{N}8,000.
To find the net charge to the General Profit and Loss Account, first calculate the transferred inventory element (N75,000×80%=N60,000\text{N}75,000 \times 80\% = \text{N}60,000). Convert the 25%25\% mark-up on cost to a 20%20\% margin on transfer price (25125=20%\frac{25}{125} = 20\%). Calculate the required closing provision as 20%×N60,000=N12,00020\% \times \text{N}60,000 = \text{N}12,000. Subtract the existing opening provision balance of N4,000\text{N}4,000 to get a net increase of N8,000\text{N}8,000.

Step-by-Step Solution

1
Calculate the value of transferred goods in the closing inventory
Transferred Portion=80%×N75,000=N60,000\text{Transferred Portion} = 80\% \times \text{N}75,000 = \text{N}60,000
Only the portion of closing stock supplied by the transferring department contains unrealized profit.
2
Convert the mark-up percentage on cost to margin on transfer price
Margin=Mark-up100+Mark-up=25125=15 or 20%\text{Margin} = \frac{\text{Mark-up}}{100 + \text{Mark-up}} = \frac{25}{125} = \frac{1}{5} \text{ or } 20\%
The transferred inventory value is stated at transfer price (cost + profit), so profit must be extracted using profit margin.
3
Calculate the required closing provision for unrealized profit
Required Provision=20%×N60,000=N12,000\text{Required Provision} = 20\% \times \text{N}60,000 = \text{N}12,000
This is the total unrealized profit contained in the year-end transferred inventory.
4
Determine the net adjustment to the General Profit and Loss Account
Net Increase=Required Provision−Opening Provision=N12,000−N4,000=N8,000\text{Net Increase} = \text{Required Provision} - \text{Opening Provision} = \text{N}12,000 - \text{N}4,000 = \text{N}8,000
Only the increase in provision is charged as an expense to the General Profit and Loss Account for the current period.

Key Concept

Provision for Unrealized Profit on Inter-departmental Transfers
Estimated Time:2m 30s
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Topics

Inter-departmental Transfers and Provision for Unrealized Profit

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