DipIFR Syllabus D. Preparation of external financial reports - Unrealised Profit - Notes ^{2 / 2}

The key to understanding this - is the fact that when we make group accounts - we are pretending P & S are the same entity.

Therefore you cannot make a profit by selling to yourself!

So any profits made between two group companies (and still in group inventory) need removing - this is what we call ‘unrealised profit’.

Unrealised profit - more detail

Profit is only ‘unrealised’ if it remains within the group. If the stock leaves the group it has become realised.

So ‘Unrealised profit” is profit made between group companies and REMAINS IN STOCK.

Example

P buys goods for 100 and sells them to S for 150. S has sold 2/5 of this stock.

The Unrealised Profit is: Profit between group companies 50 x 3/5 (what remains in stock) = 30.

How do we then deal with Unrealised Profit

If P buys goods for 100 and sells them to S for 150. 

Thereby making a profit of 50 by selling to another group company. 

S sells 4/5 of them to 3rd parties.

Unrealised profit is 50 x 1/5 = 10

So why do we reduce inventory as well as profit?

Well let’s say that S buys goods for 100 and sells them to P for 150 and P still has them in stock.

How much did the stock actually cost the group? 

The answer is 100, as they are still in the group. 

However P will now have them in their stock at 150. 

So we need to reduce stock/inventory also with any unrealised profit.