• Cost of goods sold

• Accounting for opening and

closing inventories
Inventory • Counting inventories
• Valuing inventories
• IAS 2

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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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 Cost of goods sold 2

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

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 Cost of goods sold 3

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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 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 Statement of profit or loss $ 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 Statement of profit or loss $ opening inventory

CREDIT Inventory $ opening inventory

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 Accounting for opening and closing inventories 4

• The exact reverse entry is made for the closing inventory

(which will be next year’s opening inventory):

DEBIT Inventory $ closing inventory

CREDIT Statement of profit or loss $ closing inventory

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 Counting inventories 1

Counting inventories
• In order to make the entry for the closing inventory, we
need to know what is held at the year-end. We find this out
not from the accounting records, but by going into the
warehouse and actually counting the boxes on the
shelves.

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 Counting inventories 2

• Some businesses keep detailed records of inventory

coming in and going out, so as not to have to count
everything on the last day of the year. These records are
not part of the double entry system.

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 Valuing inventories 1

Valuation
Inventories must be valued at the lower of:
• Cost
• Net realisable value (NRV)

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 Valuing inventories 2

Cost
Can use per IAS 2:
• FIFO (First In Last Out)
• Average cost
• LIFO (Last In First Out) is not permitted

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 Valuing inventories 3

NRV
Expected selling price X
Less: costs to get items ready for sale (X)
selling costs (X)
X

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 Valuing inventories 4

• Inventory forms a major part of the assets of some

companies.
• So the value placed on the inventory can make a big
difference to the profit or loss reported.

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 IAS 2

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

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 IAS 2 (cont’d)

IAS 2
• Inventory can include raw materials, work in progress,
finished goods, goods purchased for resale
• FIFO and average cost are allowed
• LIFO is not allowed

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 IAS 2 (cont’d)

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

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 IAS 2 (cont’d)

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

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 Inventories and short-term WIP (IAS 2) 4

• Costs of purchase
– Purchase price
– Import duties and other taxes
– Transport, handling and any other costs directly attributable
to the acquisition of finished goods, materials and services
– Less trade discounts, rebates and other similar items
•Costs of conversion
– Direct materials and labour
– Variable production overheads
– Fixed production overheads (these must be allocated to
items of inventory based on the entity's normal level of
activity)

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 Inventories and short-term WIP (IAS 2) 5

• Other costs incurred in bringing inventories to their

present location and condition.
For example: the non-production overheads of
designing a product for a specific customer
But not:
– Abnormal wastage (materials, labour or overheads)
– Storage costs
– Administrative overheads
– Selling costs

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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

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 Lecture example 1 (cont’d)

A All four items

B 1 only
C 2 and 3 only
D 2, 3, and 4 only

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 Answer to lecture example 1

C
Transport costs to deliver goods to customers are an
example of carriage outwards and should not be included.
Administrative overheads do not relate to production and
cannot therefore be included.
The depreciation of the factory machine is a production
overhead and should be included.

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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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 Answer to lecture example 2

Net realisable value is:

$
Estimated selling price 35
Less: costs of completion (12)
Less: selling costs (1)
22

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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

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 Lecture example 3 (cont’d)

Sales during January were as follows:

Date Units purchased 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

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 Answer to lecture example 3

(a) Closing inventories (FIFO)

Purchases
Opening 10 Jan 20 Jan 25 Jan
inventories
200 300 350 250
Sales
14 Jan (200) (80)
21 Jan (220) (180)
26 Jan (80)
Nil Nil 90 250
@ $11.50 @ $13.00
= $1,035 = $3,250

$4,285
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 Answer to lecture example 3 (cont’d)

Cost of sales (FIFO)

$
Opening inventories (200 × $10) 2,000
Purchases 10,530
12,530
Less: closing inventories (4,285)
8,245

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 Answer to lecture example 3 (cont’d)
(b) Closing inventories and cost of sales (AVCO)
Average Total Cost of
Units Cost Unit Cost Cost Sales
$ $ $ $
1.1.X2 b/f 200 10.00 2,000
10.1.X2 Purchase 300 10.85 3,255
500 (W1) 10.51 5,255
14.1.X2 Sales (280) 10.51 (2,943) 2,943
220 2,312
20.1.X2 Purchase 350 11.50 4,025
570 (W2) 11.12 6,337
21.1.X2 Sales (400) 11.12 (4,448) 4,448
170 1,889
25.1.X2 Purchase 250 13.00 3,250
420 (W3) 12.24 5,139
28.1.X2 Sale (80) 12.24 (979) 979
340 4,160 8,370

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 Answer to lecture example 3 (cont’d)

(W1) $5,255/500 = $10.51

(W2) $6,337/570 = $11.12
(W3) $5,139/420 = $12.24

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 Inventories and short-term WIP (IAS 2) 6

• An approximation to the cost of inventories may also be

calculated using one of two techniques:
– Standard costs: here a cost card is produced to value
the normal production values in an item of inventory
(raw materials used, labour hours incurred).
Standard costs should be reviewed regularly to
ensure that they approximate to current costs.
– Retail method: here the cost of inventories is
calculated by taking the selling price of the
inventories less the average profit margin realised on
the sale of the inventories.

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