Unrealised manufacturing profit from unsold stock

If we allow for factory profit then this will mean that the value of any closing stock would actually include an amount of factory profit in its valuation. The prudence concept disallows any anticipation of future profits - how can we say that the value of stock includes profits when we have yet to sell the stock? - and therefore we would need to deduct this profit by making a provision for any profits on unsold stock.

This provision for unrealised profit on unsold stock should be treated in the same way as any other provision. This means that the change in the provision should appear in the profit and loss account as a debit (if it is increased) or as a credit (if it is decreased) which means this would be added on to the gross profit.

Increasing the provision Increasing the provision Debit Profit & loss with the increase Credit Provision account with the increase Decreasing the provision Decreasing the provision Debit Provision account with the decrease Credit Profit & loss with the decrease

The adjustment for unrealised profit on stock should only be made if implied in the question.

Balance sheet
Once the factory profit on the closing stock has been calculated then the adjustment would have to be made on the balance sheet. In our previous example, the stock would appear as follows:

Current assets Stock 30000 Less provision for unrealised profit 6000 24000

Unrealised manufacturing profit from unsold stock

Example 3
The following balances have been extracted from the books of Bohanna Company Ltd as at 30 June 2003.

Stocks at 1 July 2002: Raw materials 6,500 Work in progress 7,900 Finished goods 18,430 Factory wages: Direct 143,000 Indirect 54,600 Royalties 1,290 Electricity and power 13,000 General factory expenses 27,000 Maintenance expenses 17,540 General office expenses 28,950 Purchases of raw materials 124,000 Sales 565,000 Depreciation of plant and machinery 9,000 Provision for unrealised profit 4,500

Additional information 1. At 30 June 2003 stocks were as follows:

Raw materials 4,980 Work in progress 6,950 Finished goods 21,500

2. Electricity and power and Maintenance expenses are to be apportioned 80% to the factory and 20% to the company's offices. 3. At 30 June 2003 an electricity bill of 800 remained unpaid and maintenance costs paid in advance amounted to 760. 4. The company always transfers finished goods from the factory to the warehouse at factory cost plus 25%.