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Difficulty: HardInter-departmental Transfers and Provision for Unrealized Profit

Calabar Crafts Limited operates two departments: Spinning and Garment. The Spinning Department transfers yarn to the Garment Department at cost plus a mark-up of 25%25\%. At the end of the accounting period, the Garment Department holds closing inventory valued at N40,000\text{N}40,000, which includes N30,000\text{N}30,000 worth of yarn transferred from the Spinning Department. What is the amount of provision for unrealized profit to be debited to the General Profit and Loss Account?

  1. N6,000\text{N}6,000Answer
  2. B
    N7,500\text{N}7,500
  3. C
    N8,000\text{N}8,000
  4. D
    N10,000\text{N}10,000

Answer

N6,000\text{N}6,000
The transfer price includes a 25%25\% mark-up on cost, which corresponds to a profit margin of 20%20\% (or 15\frac{1}{5}) on the transfer price. Since the Garment Department holds N30,000\text{N}30,000 worth of transferred stock at the end of the period, the unrealized profit embedded in closing inventory is 20% of N30,000=N6,00020\% \text{ of } \text{N}30,000 = \text{N}6,000. This amount must be debited to the General Profit and Loss Account to eliminate internal unrealized profit.

Step-by-Step Solution

1
Convert the mark-up on cost to profit margin on transfer price (selling 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 transfer price represents the selling price from the perspective of the transferring department. Unrealized profit must be calculated as a percentage of this transfer price.
2
Identify the portion of closing inventory containing transferred goods.
Transferred Stock Element=N30,000\text{Transferred Stock Element} = \text{N}30,000
Only goods originating from internal transfers contain an unrealized profit element, not goods purchased externally.
3
Calculate the provision for unrealized profit.
Provision for Unrealized Profit=20%×N30,000=N6,000\text{Provision for Unrealized Profit} = 20\% \times \text{N}30,000 = \text{N}6,000
Multiplying the profit margin by the transfer value of remaining stock isolates the profit element that has not yet been realized through external sales.

Key Concept

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

Inter-departmental Transfers and Provision for Unrealized Profit

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