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Chapter 7 • Cost of goods sold

• Accounting for opening and closing
inventories
Inventory
• Counting inventories
• Valuing inventories
• IAS 2 Inventories

BPP LEARNING MEDIA

Overview
Accounting adjustments

Inventory

Valuation Effects on profit

Cost Net realisable value

Methods of estimating cost

FIFO AVCO

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Inventories

 Inventories are assets:

• Held for sale in the ordinary course of business
• In the process of production for such sale; or
• In the form of materials or supplies to be consumed in the
production process or in the rendering of services
 Inventories can include raw materials, work in progress,
finished goods, goods purchased for resale

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Cost of goods sold 1

• Formula for the cost of goods sold

$
Opening inventory value X
Add: purchases (or production costs) X
X
Less: closing inventory value (X)
Cost of goods sold X

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COGS example 1

Perry P Louis, trading as the Umbrella Shop, ends his

financial year on 30 September each year. On 1 October
20X4 he had no goods in inventory. During the year to 30
September 20X5, he purchased 30,000 umbrellas costing
$60,000 from umbrella wholesalers and suppliers. He resold
the umbrellas for $5 each, and sales for the year amounted
to $100,000 (20,000 umbrellas). At 30 September there were
10,000 unsold umbrellas left in inventory, valued at $2 each.
What was Perry P Louis's gross profit for the year?

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Solution

Calculation of COGS $
Opening inventory value 0
Add: purchases (30,000units@$2)

Less: closing inventory (10,000units@$2)

Cost of goods sold

Calculation of gross profit

Sales (20,000 units)
Cost of goods sold (20,000 units)
Gross profit
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COGS example 1 (cont)

We shall continue the example of the Umbrella Shop

into its next accounting year, 1 October 20X5 to 30
September 20X6. During the course of this year, Perry
P Louis purchased 40,000 umbrellas at a total cost of
$95,000. During the year he sold 45,000 umbrellas for
$230,000. At 30 September 20X6he had 5,000
umbrellas left in inventory, which had cost $12,000.
What was his gross profit for the year?

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Solution

Calculation of COGS $
Opening inventory value (10,000unit@$2)
Add: purchases (40,000units)

Less: closing inventory (5,000units@)

Cost of goods sold

Calculation of gross profit

Sales (20,000 units)
Cost of goods sold (20,000 units)
Gross profit
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Accounting for opening and closing inventories 1

Entries during the year

• During the year, purchases are recorded by the following
entry.

DEBIT Purchases $ amount bought

CREDIT Cash or payables $ amount bought

• The inventory account is not touched at all.

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Accounting for opening and closing inventories 2

Entries at year-end
• The first thing to do is to transfer the purchases account
balance to the statement of profit or loss:

DEBIT Cost of sales (SPL) $ total purchases

CREDIT Purchases $ total purchases

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Accounting for opening and closing inventories 3

• The balance on the inventory account is still the opening

inventory balance. This must also be transferred to the
statement of profit or loss:

DEBIT Cost of sales (SPL) $ opening inventory

CREDIT Inventory $ opening inventory
• The exact reverse entry is made for the closing inventory
(which will be next year's opening inventory):

DEBIT Inventory $ closing inventory

CREDIT Cost of sales (SPL) $ closing inventory

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EXAMPLE

ABC company ends financial year on 31 December. During

20x7, the following transactions occurred in ABC company:
Purchases of goods for resale, on credit are $4,300
Sales, all on credit, are $5,000
Closing inventory is valued at $1,800
Opening inventory is valued at $1,000
Required: Journalise the transaction and calculate the gross
profit of ABC for the year ended 31 December 20X7.

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Solution

(1) Opening inventory

(2) Purchase

(3) Closing purchase account at year end

(4) Closing inventory

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Cost of inventory

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Cost of inventories

• The cost of inventories will consist of all the following costs

- Costs of Purchase: purchases price, import duties and
other taxes, freight, less trade discounts…
- Costs of conversion: direct cost, production overheads
- Other costs incurred in bringing the inventories to their
present location and condition

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Cost of goods sold

Carriage inwards
• Cost paid by purchaser of having goods transported to his
business
• Added to cost of purchases

Carriage outwards
• Cost to the seller, paid by the seller, of having goods
transported to customer
• Is a selling and distribution expense

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COGS example 2

• Clickety Clocks imports and resells clocks. On 1 July

20X5, he had clocks in inventory valued at $17,000.
During the year to 30 June 20X6 he purchased more
clocks at a cost of $75,000. Carriage inwards amounted to
$2,000. Sales for the year were $162,100. Other expenses
of the business amounted to $56,000 excluding carriage
outwards which cost $2,500. The value of the goods in
inventory at the year end was $15,400.
• Required: Prepare the statement of profit or loss of
Clickety Clocks for the year ended 30 June 20X6

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Solution

Calculation of COGS $
Opening inventory value
Add: purchases
Add: Carriage inwards

Less: closing inventory

Cost of goods sold

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Solution

CLICKETY CLOCKS
STATEMENT OF PROFIT OR LOSS FOR THE YEAR
ENDED 30 JUNE 20X6
$
Revenue
Cost of goods sold
Gross profit
Carriage outwards
Other expenses
Profit for the year

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• Formula for the cost of goods sold

$
Opening inventory value X
Add: purchases (or production costs) X
(Purchases + carriage in – Purchases returns)
X
Less: closing inventory value (X)
Cost of goods sold X

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Goods written off or written down 1

• (a) Goods might be lost or stolen.

• (b) Goods might be damaged, become worthless and so
be thrown away.
• (c) Goods might become obsolete or out of fashion. These
might be thrown away, or sold off at a very low price in a
clearance sale.

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Goods written off or written down 2

When goods are lost, stolen or thrown away as worthless,

the business will make a loss on those goods because their
'sales value' will be nil.
• If, at the end of an accounting period, a business still has
goods in inventory which are either worthless or worth less
than their original cost, the value of the inventories should
be written down to:
(a) Nothing, if they are worthless
(b) Their net realisable value, if this is less than their
original cost

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IAS 2 Inventories 3

IAS 2
• Inventories should be measured at the lower of cost and
net realisable value – the comparison between the two
should ideally be made separately for each item.
• Cost is the cost incurred in the normal course of business
in bringing the product to its present location and
condition, including production overheads and costs of
conversion.
• NRV is the estimated selling price in the ordinary course of
business less the estimated costs of completion and the
estimated costs necessary to make the sale

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Example

• Storm, an entity, had 500 units of product X at 30 June

20X7. The product had been purchased at a cost of $18
per unit and normally sells for $24 per unit. Recently,
product X started to deteriorate but can still be sold for
$20 per unit, provided that some rectification work is
undertaken at a cost of $3 per unit
• What was the value of closing inventory at 30 June 20X7?

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No netting off

• The IAS 2 rule “lower of cost and net realisable value”

shoudl be applied as far as possible on an item-by-item
basis

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Example

• Lucas Wagg, trading as Fairlock Fashions, ends his

financial year on 31 March. At 1 April 20X5 he had goods
in inventory valued at $8,800. During the year to 31 March
20X6, he purchased goods costing $48,000. Fashion
goods which cost $2,100 were still held in inventory at 31
March 20X6, and Lucas Wagg believes that these could
only now be sold at a sale price of $400. The goods still
held in inventory at 31 March 20X6 (including the fashion
goods) had an original purchase cost of $7,600.Sales for
the year were $81,400.
• Required: Calculate the gross profit of Fairlock Fashions
for the year ended 31 March 20X6.

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Solution
INVENTORY COUNT
At cost $ Realisable value $ Amount written down $

Fashion goods
Other goods

GROSS PROFIT CALCULATION $ $

Sales
Value of opening inventory
Purchases

Less closing inventory

Cost of goods sold
Gross profit
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Example of NRV

The following figures relate to inventory held at the year end.

A B C
Cost 20 9 12
Selling price 30 12 22
Selling cost - 2 8
Marketing costs 7 2 2
Units held 200 150 300
Calculate the value of inventory held

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Theoretical methods of estimating cost

Cost
Can use per IAS 2:
• FIFO (First In First Out)
• Average cost (both periodic weighted average and
continuous weighted average)
• LIFO (Last In First Out) is not permitted

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Methods of calculating the cost of inventory

• FIFO assumes that goods are sold or used in production in

the order in which they are bought into inventory.
The first item sold will be the earliest purchases
• LIFO assumes that sales or issues to production are made
from the most recent purchases
No longer allowed by IAS2
• AVCO assumes that the cost of an item of inventory is
calculated by taking the average of all inventory held.
The average cost can be calculated periodically or
continuously

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Example
• Invicta has closing inventory of 5 units at a cost of $3.50
per unit at 31 December 20X7. During the first week of
January 20X8, Invicta entered into the following
transactions:
• 2/1: Purchased 5 units at $4.00 per unit
• 4/1: Purchased 5 units at $5.00 per unit
• 6/1: Purchased 5 units at $5.50 per unit
• Invicta sold 7 units for $10.00 per unit on 5/1
• Required: Calculate the value of the closing inventory at
the end of the first week of trading using the following
inventory valuation methods: FIFO, periodic weighted
average cost, continuous weighted average cost
• Prepare the P/L statement for the first week of trading
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Example: FIFO

• It is assumed that the oldest items of inventory are sold

first
• Closing inventory value:

Closing inventory cost

• The closing inventory cost is the cost of the most recent
purchased of inventory

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Example: Periodic AVCO

• An average cost per unit is based upon the cost of

opening inventory + the cost of all purchased made
during the accounting period
• AVCO per unit =

• Closing inventory cost =

• Cost of sales =

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Example: Continuous AVCO

• AVCO per unit is updated each time a purchase of

inventory is made
• Any subsequent sales are accounted for at that AVCO per
unit until the next purchase is made and a new AVCO is
calculated
• #

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Lecture example 1

According to IAS 2 Inventories, which of the following

should not be included in determining the cost of the
inventories of an entity?
(1) Labour costs
(2) Transport costs to deliver goods to customers
(3) Administrative overheads
(4) Depreciation on factory machine
A All four items
B 1 only
C 2 and 3 only
D 2, 3, and 4 only
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Lecture example 2

Jessie is trying to value her inventory. She has the

following information available:
$
Selling price 35
Costs incurred to date 20
Cost of work to complete item 12
Selling costs per item 1

Required
What is the net realisable value of Jessie's inventory?

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Lecture example 3

On 1 January 20X7 a company held 200 units of finished

goods valued at $10 each. During January the following
transactions took place:
Date Units purchased Cost per unit
10 January 300 $10.85
20 January 350 $11.50
25 January 250 $13.00

Sales during January were as follows:

Date Units sold Cost per unit
14 January 280 $18.00
21 January 400 $18.00
28 January 80 $18.00

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Lecture example 3 (cont'd)

Required
Determine the valuation of closing inventories and cost of
sales using:
(a) FIFO
(b) Weighted average cost (continuous)
(c) Weighted average cost (periodic)

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