Sometimes, there are instances where companies in a
group carry out trading activities between themselves. If. For instance, A
acquires B and during the year, B sells some goods or an asset to A at a
profit. If the goods sold to A have been fully sold during the trading year,
there is no issue as “unrealized profit”. But where any of these goods remain
unsold at the end of the accounting year, then there is element of unrealized
profit. The reason being that the goods were sold at a mark-up or margin as the
case may be.
To address this, we need to establish the amount of
unrealized profit element involved in such transactions. The accounting
treatment will be to
Ø
Debit
reserves and
Ø
Credit
inventory (or current assets if inventory is not given)
Now, let’s take an example to demonstrate this.
Village Ltd sold goods worth N38million to Town Plc and
Village Ltd recorded a profit of N15.96million. Town Plc still held 60% of
these goods in its possession at the balance sheet date.
Solution
Amount of Unrealized profit - =N=15.96 * 60%
=N=9.576m or =N=9,576,000
Treatment
Debit Reserves with =N=9.576m (ie subtract =N=9.576m from reserves)
Credit Inventory with =N=9.576m
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