1. 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!

  2. Profile photo of Liza says


    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!


    • 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.

    • Profile photo of John Moffat says

      You have not asked me for advice!!

      The exam will test the whole syllabus of Paper F3, and therefore you must work through all of the free lectures on here (together with the Course Notes that go with the lectures).

      You must also obtain a Revision/Exam Kit from one of the approved publishers. They contain lots of exam-standard questions to practice on, and practice is vital.

  3. avatar says

    Hi. I have a question when substracting 28k from revenue and cgs.
    I do understand why we are substracting 28k from revenue, but i dont get why we substract the same number from CGS. I dont understand why it isnt 20k (8k lesser, because of the profit)

    • Profile photo of John Moffat says

      Hi Martynas

      Remember that they are two separate companies and will have produced their own accounts separately.
      If one company sells to the other for 28,000, the the selling company will have recorded sales of 28,000. The buying company will have paid 28,000 and will have recorded a purchase of 28,000.

      When we consolidate, we only want to show sales outside the group, and so we subtract 28,000 from the total sales (and you are happy with this).
      However, we only want to show purchase from outside the group, so since the buying company has recorded purchases of 28,000, we need to subtract 28,000 from the total purchases.

      If you are still unsure, then imagine this. X buys goods for 10,000, sells them to Y for 15,000, and Y sells them outside for 18,000.
      In their own accounts, X has sales of 15,000 and cost of 10,000, so has made a profit of 5,000. Y has sales of 18,000 and cost of 15,000, so has made a profit of 3,000.
      When we consolidate, the total sales are 15,000 + 18,000 – 15,000 = 18,000
      Total costs are 10,000 + 15,000 – 15,000 = 10,000
      Total profit = 18,000 – 10,000 = 8,000

      (The only time the profit element in the transfer is relevant is if any of the goods sold from X to Y are still in Y’s inventory at the year end – then we have a provision for unrealised profit to deal with. However that is covered in the next lecture and so I will not confuse things by going into it now).

      • Profile photo of Muideen says

        Okay. I wanted to ask the same question asked by Martynas but you’ve answered my question clearly. Again, more grease to your elbow. I cherish your methodology

  4. avatar says

    Dear John, just wanted to check if i have understood inter entity transactions as intended in the lectures:-

    (i)All inter entity transactions are excluded to reflect profits from only outside the group.In a way, it reduces the problem of double counting which arises due to consolidation

    (ii)Cost of sales and inventory are adjusted only if there are any unsold inventory. Adjustment is made by increasing the cost of sales equal to the amount of unrealized profit which reduces the retained earnings. Accordingly, inventory is reduced by an equal amount . Assets and liabilities should match since inventory and retained earnings are reduced by an equal amount.

  5. avatar says

    Dear Mr. Moffat, since the unrealized profit on inventory was recorded by the selling company, would it not be easier (and the same effect) if we subtracted the profit from the sales revenue than adding it to the cost of sales? Arithmetically, it’s the same but I’m just wondering if it could be any different?

    • Profile photo of MikeLittle says

      Hi, although the end result would be arithmetically the same, your suggestion is not correct. The goods, when originally purchased, are in the buyer’s cost of sales (purchases) at say $10 and closing inventory at $10). The buyer sells for say $15 and the other group company includes $15 in its cost of sales (purchases) and closing inventory $15. So now it’s in revenue at $15 and in cost of sales at $10 (original purchase) and at $15 (intra-group sale / purchase) and in closing inventory at $15. To get to the correct position, we need to cancel the intra-group sale dollar for dollar. Thus we eliminate $15 from combined revenue and from combined cost of sales. That leaves us with +$10 in cost of sales (original purchase) and -$15 in cost of sales (closing inventory) To arrive at the correct position, we need to reduce that closing inventory by $5. Thus, we must ADD $5 to cost of sales and reduce combined closing inventory on the CSoFP.


  6. avatar says

    I would have a question concerning the following scenario:

    A parent company sells goods to a subsidiary, and a part of these goods is still in the inventory of the subsidiary at the end of the year. What do we do with the unrealised profit? Should we deduct it? Is it different if the sale is from the subsidiary to the parent company?

    I understand that we have to deduct the unrealised profit in any case. Am I right?

      • Profile photo of John Moffat says

        @Miss A.., Yes. Included in S’s sales is 28,000 of sales to P, and included in P’s cost of sales is 28,000 which is what they were charged by 3.

        In the consolidated income statement we only want to show sales and purchases outside the group, and so 28,000 needs removing from sales and from cost of sales.

  7. Profile photo of joeko91 says

    Fantastic! I really enjoyed the joke about those that would be exempted from F3. The lecture makes things that appear difficult at first quite easy to understand. It’s a remarkable experience for me.

  8. avatar says

    why is the profit 2000? as the inventory that was “left” was 1/4th.. which should mean that that 1/4th is the “not sold” inventory and so the profit should be taken as 28000-7000+21000, 21000/1.4(mark up)=15000
    so the profit should be 6,000. PLEASE TELL ME IF I’M WRONG.

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