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    • Profile photo of John Moffat says

      Because by removing the PURP from the closing inventory we are valuing it at cost to the group. Reducing the closing inventory increases the cost of sales and gives the cost of sales from outside the group.

      (In addition, we have to do it this way because the accounting standard tells us to :-) )

  1. avatar says

    Good day sir, if I understand properly we can get the answer using a different method from yours?
    40/140=0.285714285*(28000)=8000
    28000+8000=36000
    36000-28000=8000 profit.
    8000*1/4=2000 unrealised profit which is in the inventory.

    Revenue:(120+110-36)= 194000
    C.O.S: (55+50-36+2)= (71000)
    Gross profit: 123000
    Expenses: (19000)
    PBT 104000
    Income Tax: (34000)
    Profit for the year: 70000

    • Profile photo of John Moffat says

      But what you have done is wrong (even though the final profit is the same).

      The question says that the goods were sold from S to P for 28,000 including the mark-up.
      Therefore the total revenue and the total cost of sales both should be reduced by 28,000 (the sale price) and not by 36,000 as you have done.

  2. avatar says

    Maybe it’s just me who doesn’t get it. Sorry in advance if this is the case. However, if we have to calculate a 40% mark-up (on cost) from 28,000 sales, isn’t the gross profit equal 8,000 instead of 7,000.

    Sales (140%) 28,000
    Cost of sales (100%) 20,000
    Gross profit (40%) 8,000

    Unrealized profit = 8,000 x 40% = 3,200

    • Profile photo of John Moffat says

      I do not say anywhere that the profit is 7,000 – you were not watching carefully enough!

      I said that 1/4 of the sales is sales of 7,000 and that the profit included in the 7,000 is 2,000.

      You worked out the profit first, which would have been fine except that 1/4 of profit of $8,000 does not equal $3,200 – it equals $2,000.

    • avatar says

      It was a bit late and I was a little tired. Apologize for taking your time and thank you for a quick reply. Yes, I thought I read that it was 40% of inventories that remained unsold. However, the question clearly states it was one quarter instead. My mistake! Thank you!

  3. Profile photo of Liza says

    Hi!

    If we are preparing both the consolidated balance sheet and income statement, how are we going to reflect the unrealized profit on the inventory(inter entity transaction)? Because if we already adjusted the unrealized profit on the consolidated income statement, the consolidated balance sheet would automatically be adusted (retained earnings). But how about the inventory account? Because our procedure in reflecting the unrealized profit was to increase COS?

    Many thanks!

    Liza

    • Profile photo of John Moffat says

      In the Statement of financial position, the PURP is removed from the value of the inventory and removed from the retained earnings of the company that sold the goods to the company holding them at the year end.

      In the Statement of profit or loss, the profit is reduced by the PURP (and achieved by increasing the cost of sales), which automatically reduces the retained earnings (and therefore ‘matches’ with the Statement of financial position.

      There is no consolidated inventory account. There are only two companies with t-accounts – the parent and the subsidiary. There is no such thing as a consolidated company with its own t-accounts. The preparation of consolidated statements is simply an exercise at the end of the year using the statements of the two individual companies.
      The inventory accounts in the individual companies are not affected by PURP and their individual statements are not changed in any sense.

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