09/19/2022

Cost of sales & Inventories

CHAPTER 7 Topic list:
Cost of sales and inventories 1. IAS 2 Inventories
2. Cost of sales (cost of goods sold) –
COS/COGS
3. Accounting for opening and closing
inventories
The regulation of accounting
4. Adjusting the trial balance
and ethical consideration
5. Counting inventories
Qualitative characteristic of information
6. Valuing inventories
7. Using mark-up/margin percentages to
establish cost
8. Inventory drawings
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Overview IAS 2 - Inventories

Accounting adjustments Inventories include assets

 held for sale in the ordinary course
Inventory
of business (finished goods/goods
purchased and held for resale),
Valuation Effects on profit
 in the process of production for
sale in the ordinary course of
Cost Net realisable value business (work in process-WIP),
 in the form of materials or supplies to
Methods of estimating cost be consumed in the production
process or in the rendering of
FIFO AVCO services (raw materials). [IAS 2.6]
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The objective of IAS 2 OVERVIEW OF INVENTORY

ACCOUNTING
Input of
• Prescribe the accounting treatment Inventory
• Indentify Inventory items for different
companies
(Accounting
for inventories. Provides guidance treatment when • Calculate the cost for Inventory ( u should
understand this is: INPUT COST)
purchasing Inv)
for determining the cost of
inventories and for subsequently Output of Inv
(accounting
• Identify the output cost by Costing methods
(or Cost flow assumptions: SI, FIFO, WAC)
treatment
recognising an expense, including when selling
• You should clearly understand: Output cost ≠
Selling price
Inv)
any write-down to net realisable • Physical flows ≠ Cost flows

value. At the end of • Lower of cost or NRV

the period
(accounting • Inventory adjustments
treatment for (additional)
Inv left on • Estimating Inventories
hand)

Cost of sales DELIVERY COST

 Formula for the cost of goods sold
 Delivery inwards: added to cost of
Opening inventory x purchases
Add cost of purchases x  Delivery outwards: is a distribution cost,
Add cost of delivery inwards x included in statement of profit or loss.
Less closing inventory (x)
Cost of sales x

Cost of sales is deducted from revenue to arrive at gross profit

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Interactive question 1 Inventory written off or written down

On 1 January 20X6, Grand Union Food Stores At the end of the period, trader might be
had goods in inventory valued at £6,000. unable to sell all inventories due to:
During 20X6 its owner purchased supplies  Lost or stolen
costing £50,000. Sales for the year to 31  Damaged or become worthless
December 20X6 amounted to £80,000. The
 Obsolete or out of date/fashion
cost of goods in inventory at 31 December
20X6 was £12,500. --- written off (thrown goods away)
Requirement --- written down to NRV (net realisable
value)
Calculate the business's gross profit for the
year.

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Inventory destroyed or stolen and

Worked example subject to an insurance claim

Lucas Wagg ends his financial year on 31 March. At 1

April 20X5 he had goods in inventory valued at Accounting
£8,800. During the year to 31 March 20X6, he treatment
purchased goods costing £48,000. Fashion goods Cost of goods Put out of
which cost £2,100 were held in inventory at 31 March
20X6, and Lucas Wagg believes that these can only
stolen or destroyed purchases and
now be sold at a sale price of £400. Goods still held in include in Other
inventory at 31 March 20X6 (including the fashion Expenses (title a/c:
goods) had an original purchase cost of £7,600. Sales Costs of goods
for the year were £81,400. stolen or
Requirement destroyed)
Calculate Lucas Wagg's gross profit for the year ended
Insurance claim Other income
31 March 20X6.
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Worked example Accounting for Opening & Closing inventories

Farita had £15,000 of inventory as at 1 January At the beginning of the year:

20X2. During the year to 31 December 20X2 she Dr COS Understand: this is the
approach of periodic system
purchased inventory for £98,000, incurring delivery Cr Inventory
inwards of £150. She made sales of £150,000, Entries during the year
incurring delivery costs to her customers of £2,400. During the year, purchases are recorded by the following entry.
At 31 December 20X2 she realises that she has Dr Purchases (SPL)
inventory costing only £200 left; goods costing Cr Cash or payables

£18,000 have been stolen. The inventory account is not touched at all.
At the end of the year:
Prepare Farita's statement of profit or loss assuming
a/ Dr COS (SPL)
(a) Farita has relevant insurance and her insurer has
Cr Purchases (SPL)
agreed to pay her claim for 75% of the cost; and (b)
b/ Dr Inventory (SFP)
Farita does not have any insurance.
Cr COS
c/ Dr P&L account (Income summary)
13 Cr COS 14

Interactive question 3 Worked example

A business has opening capital of £2,000, represented entirely
In its nominal ledger Wickham plc had a by inventory. During the first year's trading, when the owner
took no drawings, the following transactions occurred.
balance on its inventory account at 1 July 20X2 £
of £23,490. At the end of the reporting period, Purchases of goods for resale, on credit 4,300
30 June 20X3, it had inventory of £40,285. Payments for trade payables 3,600
Sales, all on credit 8,000
Requirement
Receipts from trade receivables 3,200
Prepare the journal entries to record the Non-current assets purchased for cash 1,500
situation as at the end of the reporting period Other expenses, all paid in cash 900
in the nominal ledger of Wickham plc, in All 'other expenses' relate to the current year.
preparation for drawing up the statement of Closing inventory is valued at £1,800.
Requirement
profit or loss and statement of financial
Prepare the ledger accounts, including a cost of sales ledger
position. account and a profit and loss ledger account, for the 12-month
15
reporting period and a statement of financial position as at the
end of the reporting period.
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Adjusting the trial balance Worked example

Approach is as follows:
 Calculate the value of closing
inventories.
 Prepare the year-end journals for
opening inventories, purchases and
closing inventories and enter the
journals as adjustment to the initial
TB.
 Prepare FSs

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Counting inventories Valuing inventories

Counting inventories Valuation

 Once the quantity of inventories Inventories must be valued at the
through counting is determined then lower of:
a policy is required for valuing the  Cost
inventory.  Net realisable value (NRV)

NRV = Estimated selling price – Estimated cost of completion and

the estimated costs necessary to make the sale

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NRV < COST. REASONS? Interactive question 4

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Determining the cost of inventory Worked example

Total cost of an item of inventory includes

all costs incurred in bringing the item to
its present location and condition. This
consists of:
 The purchase cost of raw materials
 Delivery inwards
 Import taxes and duties
 Conversion costs (converting raw
materials into final product, including
Prepare the statement of profit or loss of this business
labor and production overhead) for the reporting period?
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Valuing inventories Worked example

Cost
Cost comprises:
Can use per IAS 2 Inventories:
 Specific identification (not in this course)
 FIFO (First In First Out)
 Average cost (both periodic weighted
average and continuous weighted
average)
 LIFO (Last In First Out) is not
permitted Remember: applying the
approach of periodic system in
computing output cost of inventory 25 26

Using and Mark-up/Margin percentages

Worked example to establish cost

 Mark-up is calculated on cost: profit

expressed as percentage of cost
 Margin is calculated on sales: profit
expressed as percentage of price

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Interactive question 6 Writing off inventories, and inventory drawings

A business has inventories with a total selling price of  Provided inventory actually held is
$1,000. valued at the lower of cost and NRV,
Requirement no inventory writeoff entries are
What is the cost of the closing inventory assuming needed (It means Inv are already
the business operates: written off/adjusted, no need for
a/ on a margin of 25% furthur adjustment entries at the end
b/on a mark-up of 25%. of the period).
 In case, owner takes out for personal
use:
Dr Drawings
Cr COS
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This is the end of

chapter 7
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