Chapter 7: Cost of Sales

and Inventory

DOAN THUY DUONG

SAA
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 Chapter 7: Cost of
Sales and Inventory
Learning Objectives
1 Inventory and Cost of Sales

2 Accounting for opening and closing inventory

3 Counting Inventory

4 Valuing Inventory

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 1. Inventory
 For retail business: Inventory is goods
purchased and held for resale
 For manufacturing business:

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 2. Cost of Sales

 Goods might be unsold at the end of a reporting period

and so still be held in inventory.
 Under the accrual concept, the cost of these goods should
not be included in cost of sales, instead it should be
carried
forward and matched against revenue in subsequent
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periods.
 Question 1

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 Note 1: Delivery inward and Delivery
outwards
 ‘Delivery' refers to the cost of transporting
purchased goods from the supplier to the premises
of the business which has bought them.
 The cost of delivery inwards is added to the cost
of purchases, and is therefore included in the
calculation of cost of sales and gross profit.
 The cost of delivery outwards is a distribution
cost deducted from gross profit in the statement
of profit or loss.

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 Note 2: Inventory written off or written down

 If, at the end of a reporting 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:
 Nothing, if they are worthless, or
 Their net realisable value, if this is
less than their original cost.
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 Note 3: Inventory destroyed or stolen and
subject to an insurance claim
 Where a material amount of inventory has been stolen
or destroyed:
 Purchases will include the cost of goods that could not be
sold, so the accrual principle is broken, yet they are not in
closing inventory either, so it will look as if the business's gross
margin on sales has
fallen catastrophically.
 There may be an amount of income as a result of an
insurance claim, which cannot be included in cost of sales
under the 'no offsetting‘ principle.
=> These problems are overcome by taking the cost of goods stolen or
destroyed out of purchases, and including it under expenses. The
insurance claim is treated as other income in calculating net profit; if it has
not yet been received in the form of cash it is disclosed as 'other
receivables' on the statement of financial position.
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 Note 4: Inventory drawings
 If an onwer takes items of inventory from
business as drawings, we reduce the cost of
sales with the cost of items withdrawn
Dr Drawings
Cr Cost of sales

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 3. Accounting for Opening and Closing
inventory
 In each reporting period, opening inventory is added
to cost of sale or is an expense in the statement of
profit or loss:
Dr Cost of Sales
Cr Inventory (opening inventory)
 Closing inventory is deducted from cost of sales in
the reporting period, so it can be carried forward and
matched against the revenue it earns in the next
period:
Dr Inventory (closing inventory)
Cr Cost of Sales
Þ The inventory account is only used at the end of a
reporting period when business counts and values
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closing inventory
 3. Accounting for Opening and Closing
inventory
 Purchase of inventories is added to cost of sale
Dr Cost of Sales
Cr Purchases
 The cost of sales account is finally transfered to P&L
account to calculate the profit at the end of period
Dr Profit and loss account
Cr Cost of Sale

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 Question 2

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 4. Counting Inventory

 To determine the quantity of inventories held in

the end of the reporting period
 In very small businesses => physically counting
inventory in one count at a designated time
 In large businesses with varied inventory =>
computerised to maintain continuous inventory
records. Some line of inventories are counted
daily => continuous count
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 5. Valuing inventory

Compare between the historical cost of inventory

(the cost at which the inventory was originally
bought) and the Net reaslisable value (NPV)
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 Cost of inventory

Cost of inventory (historical cost) = cost of purchase + cost of

conversion

 Cost of purchase: material costs, import tax, duties, freight,

delivery inwards, less trade discount received (if any)

 Cost of conversion : production wages and production

overheads

 Production wages : such as direct labor cost

 Production overheads (fixed and variable): factory heating and

light, salary of supervisor, depreciation of equipment

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 The Net realisable value (NRV)
 The NRV = the expected selling price – any cost still to be
incurred in getting the inventory ready for sale
 The NRV may less than (historical) cost of inventory because:
• Inventories are damaged or become obsolete;
• Cost to completion have increased in order to make the sale
• In increase in cost or fall in selling price;
• A physical deterioration in the condition of inventory
• Obsolescence of products
• A decision as part of the company’s marketing strategy to
manufacture and sell products at a loss
• Errors in production or purchasing.

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 Question 3

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 Question 4

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 Method to value inventory

LIFO is not allowed under IFRS

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 Question 5

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 Question 6

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