Examkin

Question

Difficulty: HardProvision for Unrealized Profit on Closing Inventory

A manufacturing enterprise transfers finished goods from its factory to the trading section at a mark-up of 25%25\% on manufacturing cost. For the financial year ended 31 December 2025, the opening inventory of finished goods at transfer price was ₦30,000\text{₦}30,000 with an existing provision for unrealized profit of ₦6,000\text{₦}6,000. The closing inventory of finished goods at transfer price was ₦45,000\text{₦}45,000. What is the amount of provision for unrealized profit to be debited to the Profit and Loss Account for the year?

  1. ₦3,000\text{₦}3,000Answer
  2. B
    ₦5,250\text{₦}5,250
  3. C
    ₦9,000\text{₦}9,000
  4. D
    ₦11,250\text{₦}11,250

Answer

The amount to be debited to the Profit and Loss Account as provision for unrealized profit is ₦3,000\text{₦}3,000.
To determine the provision for unrealized profit, convert the 25%25\% mark-up on cost to a margin on transfer value: 25125=20%\frac{25}{125} = 20\% (or 15\frac{1}{5}). Applying this fraction to the closing inventory transfer value of ₦45,000\text{₦}45,000 yields a closing provision of ₦9,000\text{₦}9,000. Subtracting the existing opening provision of ₦6,000\text{₦}6,000 gives a net increase of ₦3,000\text{₦}3,000, which is debited to the Profit and Loss Account.

Step-by-Step Solution

1
Convert mark-up on cost to profit 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\%.
Because inventory is valued at transfer price, the profit element contained within it must be determined using the margin ratio.
2
Calculate the total provision for unrealized profit required on closing inventory.
Closing Provision=15×₦45,000=₦9,000\text{Closing Provision} = \frac{1}{5} \times \text{₦}45,000 = \text{₦}9,000.
This isolates the profit element that remains unrealized in unsold inventory at year-end.
3
Determine the net adjustment required in the Profit and Loss Account.
Increase in Provision=₦9,000−₦6,000=₦3,000\text{Increase in Provision} = \text{₦}9,000 - \text{₦}6,000 = \text{₦}3,000.
Only the net increase in the provision from the opening balance (₦6,000\text{₦}6,000) is charged to the Profit and Loss Account.

Key Concept

Provision for Unrealized Profit on Closing Inventory
Rate this question

Topics

Provision for Unrealized Profit on Closing Inventory

More questions from this topic