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Difficulty: MediumInter-departmental Transfers and Provision for Unrealized Profit

Enugu Textile Company operates two departments: Weaving Department and Tailoring Department. During the year ended 31 December 2025, the Weaving Department transferred fabric to the Tailoring Department at a transfer price based on cost plus a 25%25\% mark-up. At the end of the year, the Tailoring Department had a closing stock valued at N20,000\text{N}20,000, of which 60%60\% comprised fabric transferred from the Weaving Department. What is the provision for unrealized profit required on the closing stock at the end of the year?

  1. A
    N3,000\text{N}3,000
  2. N2,400\text{N}2,400Answer
  3. C
    N4,000\text{N}4,000
  4. D
    N5,000\text{N}5,000

Answer

The provision for unrealized profit required on closing stock is N2,400\text{N}2,400.
The transferred portion of closing inventory is 60%60\% of N20,000\text{N}20,000, which equals N12,000\text{N}12,000. A mark-up of 25%25\% on cost represents a profit margin of 25100+25=15\frac{25}{100+25} = \frac{1}{5} or 20%20\% on transfer price. The unrealized profit is therefore 20%×N12,000=N2,40020\% \times \text{N}12,000 = \text{N}2,400.

Step-by-Step Solution

1
Determine the value of transferred goods in the closing inventory
Transferred Inventory = 60%×N20,000=N12,00060\% \times \text{N}20,000 = \text{N}12,000
Only the portion of closing inventory transferred from another department contains an unrealized profit element.
2
Convert the mark-up percentage on cost to margin percentage on selling/transfer price
Profit Margin = Mark-up100+Mark-up=25125=15=20%\frac{\text{Mark-up}}{100 + \text{Mark-up}} = \frac{25}{125} = \frac{1}{5} = 20\%
Since the transfer value is given at transfer price (selling price), the profit fraction must be expressed as a margin on transfer price.
3
Calculate the provision for unrealized profit
Provision = 20%×N12,000=N2,40020\% \times \text{N}12,000 = \text{N}2,400
Multiplying the profit margin by the transferred stock value isolates the unearned profit loading.

Key Concept

Provision for Unrealized Profit on Inter-departmental Transfers
Estimated Time:1m 30s
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Topics

Inter-departmental Transfers and Provision for Unrealized Profit

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