Chapter 12: Inventory and Cost of Sales

Methods of valuing inventory

Cost of inventory is recorded as an asset using the perpetual inventory system or in the temporary purchases account using the periodic system and transferred to SOPL as it is sold

Mark-up on cost = GP ÷ CP
Expected gross profit % = GP ÷ SP


Calculating Cost of sales from Mark up on cost:


  • Sales amount * 100/100+MarkUp%

Calculating Cost of sales from GP%


  • Sales amount * (100-GP%)/100

see pg371

Costs of inventory

VAT
If VAT is non recoverable, it becomes an extra cost to the entity

Transport costs
Transport inwards is the cost of transporting the inventory from the supplier to the purchaser's premises

  • cost is included in the cost of inventory asset in SOFP

Transport outwards is the cost of delivery of sold goods to a customer

  • cost is recorded as a selling expense in SOPL
  • cost of delivering goods after sale is not recorded under inventory!
    see pg374

Goods in transit

  • if control has not been passed to buyer: goods remain asset of seller & do not affect statements of buyer

- if has been passed to buyer:


goods that have been delivered:

  • included in physical count of inventory

goods that have not been delivered
• not included in physical count of inventory
•need to be recorded as a goods in transit asset with a corresponding liability

Inventory shortages

Periodic system

  • compare actual GP% with expected GP%
  • difference between these values is the inventory shortage (loss to theft etc) and needs to investigated
  • cost of inventory shortage is included in cost of sales

Perpetual system

  • cost of closing inventory according to the physical count is compared to inventory count in general ledger
  • inventory account is adjusted to show inventory shortage (debit inventory shortage expense account (which is closed off to cost of sales) and credit inventory account)

FIFO (First In, First Out)

  • assumes that the first units acquired are the first units sold
  • cost of sales is represented by the cost of the earliest purchases
  • closing inventory is represented by the cost of the latest purchases

Weighted Average cost

  • based on the cost flow assumption of the weighted average of the cost of similar items purchased at the beginning of the period and the cost of similar items purchased during the period

Weighted average cost per item = (Cost of inventory on hand at beginning of the period + cost of inventory purchased during the period) ÷ total number of units available for sale


In times of rising prices:

  • cost of sales is reported at an amount above the FIFO amount and closing inventory is reported at an amount below the FIFO amount

Adjustment to be made to inventory if selling price is less than cost

Cost of inventory is written down to net realisable value


NRV = estimated selling price - costs of completion - costs to make sale


If NRV is less than costs of inventory
Cost of inventory must be written down to represent the expected reduction and an expense recognised


If NRV is higher than costs of inventory
No adjustment is required

Cost of sales

Formula:
Opening inventory + purchases - closing inventory = Cost of Sales


"Cost of goods available for sale" is opening inventory + purchases

Cost price + Mark up (%of cost) = Selling price


Selling price - GP%(selling price) = Cost price
Selling price * 100/100+Markup% = Cost price
(think of calculating cost price in tax...)


Selling price * GP% = gross profit/mark up on cost


(Selling price - cost price)/cost price = Markup%


Periodic Inventory system:

  • records purchases of inventory during a period in a temporary account (closed off at end of period) called 'purchases'
  • account is only correct at end of period when it is updated with physical count of inventory
    Cost of sales = opening inventory + purchases - closing inventory
  • THE COST OF GOODS SOLD AFTER A SALE IS NOT RECORDED. ONLY USE FORMULA TO CALC THIS VALUE/LEDGER AT END OF PERIOD

Perpetual inventory system:

  • records inventory purchased during a period in the inventory asset account
  • account is always correct, keeps track of inventory at any time
    Closing inventory = opening inventory + purchases - cost of sales

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NB when printing these notes! find in documents under "Accounting"

if beginning inventory is understated, your cost of goods sold will be understated by the error amount. Then, since cost of goods sold is understated, your net income and gross profit are overstated. & vice versa