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Difficulty: HardProvision for Unrealized Profit on Closing Inventory

A manufacturing enterprise transfers finished goods to its retail department at a price that includes a mark-up of 25%25\% on manufacturing cost. At the end of the trading period on 31 December 2025, the opening inventory of finished goods at transfer price was ₦18,000\text{₦}18,000 (with an existing provision for unrealized profit of ₦3,600\text{₦}3,600), while the closing inventory of finished goods at transfer price was ₦25,000\text{₦}25,000. What is the amount to be charged to the Profit and Loss Account as an adjustment for unrealized profit?

  1. ₦1,400\text{₦}1,400Answer
  2. B
    ₦2,650\text{₦}2,650
  3. C
    ₦5,000\text{₦}5,000
  4. D
    ₦1,750\text{₦}1,750

Answer

The amount to be charged to the Profit and Loss Account as an adjustment for unrealized profit is ₦1,400\text{₦}1,400.
To find the adjustment to the Profit and Loss Account, first convert the 25%25\% mark-up on cost to a margin on transfer price: 25100+25=15\frac{25}{100 + 25} = \frac{1}{5}. Next, compute the required closing provision on unrealized profit: 15×₦25,000=₦5,000\frac{1}{5} \times \text{₦}25,000 = \text{₦}5,000. Finally, calculate the net increase in provision by subtracting the existing opening provision from the required closing provision: ₦5,000−₦3,600=₦1,400\text{₦}5,000 - \text{₦}3,600 = \text{₦}1,400.

Step-by-Step Solution

1
Convert the percentage mark-up on cost into a margin on transfer price.
Margin fraction = Mark-up100+Mark-up=25125=15\frac{\text{Mark-up}}{100 + \text{Mark-up}} = \frac{25}{125} = \frac{1}{5} (or 20%20\%).
Unrealized profit contained in inventory stated at transfer price must be calculated using margin rather than mark-up.
2
Calculate the required closing provision for unrealized profit on closing finished goods inventory.
Closing Provision = 15×₦25,000=₦5,000\frac{1}{5} \times \text{₦}25,000 = \text{₦}5,000.
This isolates the profit element embedded in the closing inventory valued at transfer price.
3
Determine the net adjustment (increase) to be charged to the Profit and Loss Account.
Increase in Provision = Required Closing Provision (₦5,000\text{₦}5,000) - Opening Provision (₦3,600\text{₦}3,600) = ₦1,400\text{₦}1,400.
Only the net change in provision between the beginning and end of the accounting period is recognized in the Profit and Loss Account.

Key Concept

Provision for Unrealized Profit on Closing Inventory
Estimated Time:2m 0s
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Provision for Unrealized Profit on Closing Inventory

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