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Difficulty: HardInter-departmental Transfers and Provision for Unrealized Profit

Delta Enterprises operates two departments: Department P and Department Q. Department P transfers goods to Department Q at cost plus a mark-up of 25%25\%. At the end of the financial year, Department Q's total closing stock was valued at N90,000\text{N}90,000, of which N60,000\text{N}60,000 represents goods transferred from Department P. The provision for unrealized profit brought forward from the previous year was N7,000\text{N}7,000. What amount should be charged to the General Profit and Loss Account as the net provision for unrealized profit?

  1. N5,000\text{N}5,000Answer
  2. B
    N8,000\text{N}8,000
  3. C
    N11,000\text{N}11,000
  4. D
    N12,000\text{N}12,000

Answer

The net amount to be charged to the General Profit and Loss Account is N5,000\text{N}5,000.
To eliminate internal unrealized profit, we first convert the 25%25\% mark-up on cost to a 20%20\% margin on transfer price using 25100+25=20%\frac{25}{100 + 25} = 20\%. We then calculate the unrealized profit in the transferred portion of closing inventory: 20%×N60,000=N12,00020\% \times \text{N}60,000 = \text{N}12,000. Finally, subtracting the existing opening provision of N7,000\text{N}7,000 yields a net increase of N5,000\text{N}5,000 to be debited to the General Profit and Loss Account.

Step-by-Step Solution

1
Convert mark-up percentage on cost to profit margin percentage on transfer price.
Margin=Mark-up100+Mark-up=25125=15=20%\text{Margin} = \frac{\text{Mark-up}}{100 + \text{Mark-up}} = \frac{25}{125} = \frac{1}{5} = 20\%.
Inter-departmental transfers are recorded at transfer price, so the profit proportion must be calculated relative to transfer price (margin).
2
Calculate the closing provision required on the transferred portion of inventory.
Closing Provision=20%×N60,000=N12,000\text{Closing Provision} = 20\% \times \text{N}60,000 = \text{N}12,000.
Only the transferred portion (N60,000\text{N}60,000) contains unrealized inter-departmental profit.
3
Determine the net adjustment to the General Profit and Loss Account.
Net Increase=Required Closing Provision−Opening Provision=N12,000−N7,000=N5,000\text{Net Increase} = \text{Required Closing Provision} - \text{Opening Provision} = \text{N}12,000 - \text{N}7,000 = \text{N}5,000.
The General Profit and Loss Account is debited with the increase in provision required for the year.

Key Concept

Provision for Unrealized Profit on Inter-departmental Inventory
Estimated Time:2m 0s
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Topics

Inter-departmental Transfers and Provision for Unrealized Profit

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