A level-readyAll subjects · Accounting · WAC11 The Accounting System and Costing
Factory profit and unrealised profit on manufactured goods
Edexcel IAL Accounting · WAC11 The Accounting System and Costing
Some manufacturers transfer goods from the factory to the sales department at a price above production cost, to show a factory profit. The part of that profit still in unsold inventory has not been earned and must be removed (spec 1.3.22).
Why transfer at more than cost
Transferring goods at a market value (or cost plus a mark-up) lets managers judge the factory as a profit centre: would it be cheaper to buy the goods in? The factory profit (manufacturing profit) = transfer price - production cost, and it is added to profit in the statement of profit or loss.
The finished goods inventory is then held at the transfer price, which includes profit not yet earned by the business as a whole.
Provision for unrealised profit
Under the realisation concept, profit is earned only when goods are sold to an outside customer; prudence says inventory must not be overstated. So:
- Provision for unrealised profit = finished goods inventory at transfer price x mark-up / (100 + mark-up).
- Only the change in the provision goes to the statement of profit or loss: an increase is deducted from the manufacturing profit; a decrease is added.
- In the statement of financial position, finished goods = transfer price - provision (that is, at cost).
| £ | |
|---|---|
| Production cost | 163,000 |
| Transfer price (cost + 20%) | 195,600 |
| Manufacturing profit | 32,600 |
| Provision on closing finished goods (18,000 x 20/120) | 3,000 |
| Provision on opening finished goods (15,600 x 20/120) | 2,600 |
| Increase in provision (deducted from profit) | 400 |
| Finished goods in statement of financial position (18,000 - 3,000) | 15,000 |
Common slips
- Use mark-up/(100 + mark-up), not the mark-up % of the transfer price: 20% of £18,000 would overstate the provision.
- The provision is deducted from finished goods only, not raw materials or WIP (which are at cost).
- The whole of the factory profit is not unrealised: only the part in unsold inventory.
Worked example
Production cost is £163,000; goods are transferred at cost plus 20%. Finished goods at transfer price were £15,600 at the start and £18,000 at the end. Find the manufacturing profit and the change in the provision.
- Transfer price = 163,000 x 1.2 = 195,600; manufacturing profit = 32,600.
- Closing provision = 18,000 x 20/120 = 3,000; opening = 15,600 x 20/120 = 2,600.
- Increase = 400, deducted from profit.
Answer: Manufacturing profit £32,600; increase in provision £400; net £32,200 added to profit.
Check yourself
- Closing finished goods are valued at a transfer price of £24,000, which includes a 25% mark-up on cost. Calculate the provision for unrealised profit.
Show answer
£4800. 24,000 x 25/125 = 4,800.
- The provision for unrealised profit should be £3,600; last year it was £4,100. By how much does profit change? (Enter an increase in profit as positive.)
Show answer
£500. The provision decreases by 500, which is added to profit.
- Production cost is £150,000 and goods are transferred at cost plus 15%. Calculate the manufacturing profit.
Show answer
£22500. 150,000 x 15% = 22,500.
- Finished goods at transfer price are £30,000, including a mark-up of 20% on cost. At what value are they shown in the statement of financial position?
Show answer
£25000. 30,000 x 100/120 = 25,000 (cost).
- Which concept requires the provision for unrealised profit?
- Business entity
- Realisation
- Going concern
- Money measurement
Show answer
Realisation. Profit is not earned until goods are sold to an outside customer.
- To which inventory is the provision for unrealised profit applied?
- Raw materials
- Work in progress
- All inventory equally
- Finished goods transferred from the factory
Show answer
Finished goods transferred from the factory. Only finished goods are held at transfer price.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.