3. Accounting for Opening and Closing Inventories

Question 1

What problems exist for the basic formula of cost of sales? (3)

Answer 1

1) How do you manage to get a precise count of inventories held at any one time?
2) Once counted, how do you value the inventories?
3) Assuming the inventories are given a value, how des the double entry bookkeeping for inventories work?

Question 2

Explain ledger accounting for inventories.

Answer 2

As inventory is a statement of financial position balance, closing inventory at the end of one period becomes opening inventory at the start of the next period.
1. Opening inventory needs to be transferred from the inventory account to the cost of sales account (as it will be sold in the period).
2. Purchases of inventories are transferred to a cost of sales ledger account.
3. The inventory account is only used at the end of a reporting period, when the business counts and values closing inventory, during the inventory count.
4. At the inventory count date, an inventory listing is extracted from the computerised accounting system and a physical count takes place to verify the accuracy and completeness of the listing.
5. Once an inventory count has been carried out and the business has a value for its closing inventory, a journal entry is made debiting current assets - inventory and crediting cost of sales.

The closing inventory reduces cost of sales (as it represents amount have not been sold in the period). The debit balance on the closing inventory account represents a current asset in the statement of financial position.

6. The balance on the cost of sales ledger account should then be transferred to the profit and loss ledger account as a component of the profit calculation at the end of the period.

Question 3

What is the total amount of inventory that a business can sell in a period?

Answer 3

The opening inventories and the purchases represent the total amount of inventory that a business can sell in a period.