CHAP 7 LECTURE NOTES –

Cost of sales and inventories

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

Capital and revenue items

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IAS 2 - Inventories
Inventories include:
assets held for sale in the ordinary course of business (finished goods/goods purchase
d and held for resale),
assets in the production process for sale in the ordinary course of business (work in
process-WIP/work in progress),
and materials and supplies that are consumed in production (raw materials). [IAS 2.6]

NCA/FIXED ASSETS – FOR USE SUDDENLY WANNA

For sales SELL  IFRS 5 (NOT IN SCOPE OF IAS 2)
The objective of IAS 2

Prescribe the accounting treatment for inventories. Provides guidance for

determining the cost of inventories and for subsequently recognising an e
xpense, including any write-down to net realisable value.
OVERVIEW OF INVENTORY ACCOUNTING

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Cost of sales
 Formula for the cost of goods sold

Opening inventory A
Added cost of purchases C
Added cost of delivery inwards (see bellow) D
Less closing inventory (B)
Cost of sales/COGS X
Cost of sales is deducted from revenue to arrive at gross profit
MI COGS
A

PURCHASES C X X
DELIVERY INWARDS D

B
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DELIVERY COST
 Delivery inwards: added to cost of purchases
 Delivery outwards: is a distribution cost, included in
statement of profit or loss.

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Inventory written off or written down
At the end of the period, trader might be unable to sell all inventories due to:
 Lost or stolen
 Damaged or become worthless
 Obsolete or out of date/fashion
--- written off (thrown goods away)
--- written down to NRV (net realiable value)
Cost : $1,000
NRV: $200  written down

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Ex: Inventory written off or written down

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Inventory destroyed or stolen and subject to an insurance claim

Accounting treatment
Cost of goods stolen or destroyed Put out of purchases and include in Other Expenses (title a/c:
Costs of goods stolen or destroyed/Loss on inventory/
Inventory loss…)

Insurance claim Other income

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Inventory destroyed or stolen and subject to an insurance claim

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Explanation
1/Delivery costs are distribution costs (operating ex);
2/ Ending Inventory = 18,200 but 18,000 of them stolen:
Dr Loss on Inv 18,000 (other ex)
Cr Ending Inv 18,000

Inv COGS
15.000

98.000 X X
150 Loss on Inv

18.000 18.000
200

15,000 + 98,000 + 150 – X – 18,000 = 200

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Accounting for Opening & closing inventories

At the beginning of the year: Understand: this is the approach of

Dr COS (opening b/l)
Cr Inventory periodic system in US/VAS system
Entries during the year
During the year, purchases are recorded by the following entry.
Dr Purchases (SPL)
Cr Cash or payables
The inventory account is not touched at all.
At the end of the year:
a/ Dr COS (SPL) Inventories
MI COGS
Cr Purchases (SPL) A
b/ Dr Inventory (SFP) (closing b/l)
PURCHASES C X X
Cr COS DELIVERY INWARDS D
c/ Dr P&L account (Income summary)
Cr COS
B

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Adjusting the trial balance
 Adjusting entry for updating Inventories and COS at the period-end:
DR Ending Inventories
Dr COS
Cr Purchases Inventories
MI COGS
Cr Delivery inwards A

Cr Opening Inventories PURCHASES C X X

DELIVERY INWARDS D
 Prepare FSs
B

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Example

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Solution
This method slow you down

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Solution
Sam’s Music shop
SPL & SCE £
Revenues 38,745
COS (13,324)
Gross profit 25,421
Expenses (12,785)
Net profit 12,636

SCE:
Opening capital: 10,000
Add: additional investments: 0
+ Profit for the year 12,636
Less: Drawings (9,158)
Ending capital: 13,478
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Solution

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Example

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Counting inventories
Counting inventories/physical counts:
 Methods: Weight, measure, count
 Once the quantity of inventories through counting is determined then
a policy is required for valuing the inventory.

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Valuing inventories
Valuation (at the end of period for ENDING INVENTORY) – LOWER OF COSTS
OR NRV
Inventories must be valued at the lower of:
 Cost
 Net realisable value (NRV)
 WHY? BECAUSE WE HAVE TO COMPLY WITH PRUDENCE PRINCIPLES

NRV = Estimated selling price – estimated cost of completion – the estimated

costs necessary to make the sale (estimated profit for inventory).

Net realisable value 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 [IAS02.06].
NRV < COST. REASONS? SELF-READING

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Example – lower of costs or NRV

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Determining the cost of inventory
INPUT COST OF INV INITIALLY
RECOGNISED BY ACCOUNTANTS

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/inventory/goods
 Delivery inwards (FOB shipping point)
 Import taxes and duties
 Conversion costs (converting raw materials into final product, including labor and
production overhead) [IAS 02]

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Example Manufacturing companies,
focus, specially difficult if
linking to chap 12.

Prepare the statement of profit or loss of this business for the reporting period?

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 PRODUCTION/MANUFACTURING COMPANIES
Raw materials WIP FINISHED GOODS COS
A - H
B D D D D

C
Production wages
X X
E E E E E

Production overheads
F F
F F F I

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Solution

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Valuing inventories
Cost
Cost comprises:
Can use per IAS 2 Inventories:
 Specific identification (not in this course)
 FIFO (First In Last Out)
 Average cost (both periodic weighted average and continuous weighted aver
age)
 LIFO (Last In First Out) is not permitted

Remember: applying the approach of periodic sy

stem in computing output cost of inventory
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EXAMPLE

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DRAFTING PAPERS
DATE (FIFO) INPUTS OUTPUTS ENDING BALANCE

OPENING B/L

DATE (WAC) INPUTS OUTPUTS ENDING BALANCE

OPENING B/L

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SOLUTION (FIFO)

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SOLUTION (AVCO)

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Note to students

The table in the previous 2 slides are inapproriate for Periodic inventory
system, but like I said before, in the scope of this course, the textbook
simply combine the 2 inventory system into one: Perpetual inventory
system + Periodic inventory system.

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Total sales
COS (total output cost) – FIFO/WAC
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SOLUTION FIFO

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SOLUTION (AVCO)

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SOLUTION

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Using Margin and Mark-up% 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

Example: A business has inventories with a total selling price of $1,000. What is the cost of t
he closing inventory assuming the business operates:
a/ on a margin of 25%
b/on a mark-up of 25%.

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Solution

Understand:
a/Cost + 25% Sales = Sales (margin on sales)
b/ Cost +25% Cost = Sales (mark up on costs)

a/ COS = $750
b/ COS = $800

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Writing off inventories, and inventory drawings
 Provided inventory actually held is valued at the lower of cost and NRV, no inventory
write off entries are needed (It means Inv are already written off/adjusted, no need
for furthur adjustment entries at the end of the period).
 In case, owner takes out for personal use:
Dr Drawings
THEY ASSUME THE DRAWINGS ARE AT THE OPENNING
Cr COS , NOT AT THE END OF YEAR. THAT THE REASON WHY
CR COS, NOT DR DRAWINGS/CR ENDING INV

Inventories
MI COGS
A

PURCHASES C X X
DELIVERY INWARDS D

B
Homework

Self-test textbook chap 7

Testbank chap 7

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MULTIPLE CHOICES