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Difficulty: HardInter-departmental Transfers and Provision for Unrealized Profit

Department P transfers goods to Department Q at cost plus 20%20\%. At the end of the accounting year, Department Q held closing inventory valued at N45,000\text{N}45,000, of which 80%80\% represents goods transferred from Department P. If the Provision for Unrealized Profit Account had an opening balance of N2,500\text{N}2,500, what amount should be charged to the General Profit and Loss Account as the net provision for unrealized profit at year end?

  1. N3,500\text{N}3,500Answer
  2. B
    N6,000\text{N}6,000
  3. C
    N4,700\text{N}4,700
  4. D
    N5,000\text{N}5,000

Answer

N3,500\text{N}3,500 is the net amount to be charged to the General Profit and Loss Account.
The transferred portion of Department Q's closing inventory is 80%×N45,000=N36,00080\% \times \text{N}45,000 = \text{N}36,000. Since Department P transfers goods at cost plus 20%20\% (mark-up), the profit margin fraction on invoice price is 20100+20=16\frac{20}{100+20} = \frac{1}{6}. The total unrealized profit contained in closing stock is N36,000×16=N6,000\text{N}36,000 \times \frac{1}{6} = \text{N}6,000. Subtracting the existing opening provision balance of N2,500\text{N}2,500 gives a net increase of N3,500\text{N}3,500 to be debited to the General Profit and Loss Account.

Step-by-Step Solution

1
Calculate the value of transferred goods contained in Department Q's closing inventory.
Transferred goods =80%×N45,000=N36,000= 80\% \times \text{N}45,000 = \text{N}36,000.
Only the transferred portion of inventory contains unrealized departmental profit.
2
Convert mark-up on cost (20%20\%) to profit margin on invoice price to compute unrealized profit.
Profit margin =Mark-up100+Mark-up=20120=16= \frac{\text{Mark-up}}{100 + \text{Mark-up}} = \frac{20}{120} = \frac{1}{6}. Unrealized profit required =N36,000×16=N6,000= \text{N}36,000 \times \frac{1}{6} = \text{N}6,000.
Inter-departmental transfers are valued at invoice price, so mark-up must be converted to margin rate.
3
Determine the net adjustment required in the General Profit and Loss Account.
Net adjustment =Required Provision−Opening Provision=N6,000−N2,500=N3,500= \text{Required Provision} - \text{Opening Provision} = \text{N}6,000 - \text{N}2,500 = \text{N}3,500.
Only the increase in provision is debited to the General Profit and Loss Account.

Key Concept

Inter-departmental provision for unrealized profit requires removing the profit loading from closing inventory transferred above cost, adjusted for any existing provision balance.
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Topics

Inter-departmental Transfers and Provision for Unrealized Profit

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