7 cost of sales and inventories

Question 1

calc for closing inventory

Answer 1

closing inventory = quantity x value

Question 2

what are the three costing methods

Answer 2

FIFO, LIFO, AVCO

Question 3

explain the differences in AVCO AND FIFA profit in relation to prices rising

Answer 3

prices rising:
FIFO profit>AVCO profit
FIFO Closing inventory>AVCO closing inventories

prices falling:
FIFO profit<AVCO profit
FIFO closing inventory<AVCO closing inventory

Question 4

explain the difference between how markup and margin care calculated

Answer 4

mark-up is calculated on cost

margin is calculated on sales

Question 5

what figures should be 100% on margin and markup

Answer 5

if using a margin on sales, the sales figure should be 100%

if using a mark-up on cost, the cost of sales figure should be 100%

Question 6

explain the dr and cr if an owner takes items from inventory

Answer 6

we never adjust opening or closing inventory (never double entry).

we reduce the purchases figure in cost of sales with the cost of items withdrawn.

Dr Drawings (£ cost of items)
Cr Purchases (£cost of items (don’t be tempted to credit inventories)

Question 7

Platoon plc is preparing its financial statements for the year ended 30 April 20X1, having extracted
an initial trial balance.
It had no opening inventory, its purchases in the period were £686,880 and closing inventories were
valued as £18,647 on 30 April 20X1.
Requirement
Which two of the following journal entries are required to record cost of sales and closing
inventories at 30 April 20X1?
A Dr Cost of sales: £686,880; Cr Inventories: £686,880
B Dr Purchases: £686,880; Cr Cost of sales: £686,880
C Dr Cost of sales: £686,880; Cr Purchases: £686,880
D Dr Inventories: £18,647; Cr Cost of sales: £18,647
E Dr Cost of sales: £18,647; Cr Inventories: £18,647
F Dr Inventories: £18,647; Cr Purchases: £18,647

Answer 7

Correct answer(s):
C Dr Cost of sales: £686,880; Cr Purchases: £686,880
D Dr Inventories: £18,647; Cr Cost of sales: £18,647
Applying the cost of sales equation, cost of sales = opening inventories + purchases – closing
inventories, purchases made in the year are transferred to cost of sales at the year-end by debiting
cost of sales and crediting purchases (C). Closing inventories are recorded as a current asset by
debiting inventories and crediting cost of sales (D).

Question 8

In a period of rising prices, applying the first in first out (FIFO) method to determine the cost of
inventories will give a lower gross profit figure than the average cost (AVCO) method.
True A
False B
Closing inventory is a debit in the statement of profit or loss.
True C
False
give reasoning

Answer 8

Correct answer(s):
False B
If prices are rising, the charge to cost of sales will be higher if AVCO is used. Gross profit will
therefore be lower under this method.
Correct answer(s):
False D
Closing inventory is a debit in the statement of financial position and a credit in the statement of
profit or loss.

Question 9

Morgan plc’s direct production cost of each unit of inventory is £46. Production overheads are £15
per unit. Currently the goods can only be sold if they are modified at a cost of £17 per unit. The
selling price of each modified unit is £80 and selling costs are estimated at 10% of selling price.
Requirement
At what amount should each unmodified unit of inventory be included in the statement of financial
position?
A £48
B £55
C £64
D £61

Answer 9

Question 10

11 Which two of the following may be included when arriving at the cost of finished goods inventory for
inclusion in the financial statements of a manufacturing company?
A Delivery inwards
B Delivery outwards
C Depreciation of delivery vehicles
D Finished goods storage costs
E Production line wages

Answer 10

11 Correct answer(s):
A Delivery inwards
E Production line wages
(B) and (C) are distribution costs and (D) is not incurred in arriving at the cost of finished goods.

Question 11

12 Which of the following statements about inventory for the purposes of the statement of financial
position is correct?
A Average cost (AVCO) and last in first out (LIFO) are both acceptable methods, under IAS 2,
Inventories, of arriving at the cost of inventories.
B The cost of inventories of finished goods may include labour and materials cost only, without
including overheads.
C Inventories should be included at the lowest of cost, net realisable value and replacement cost.
D It may be acceptable for the cost of inventories to be based on selling price less estimated profit
margin.

give a reason as to why it is/isnt correct

Answer 11

12 Correct answer(s):
D It may be acceptable for the cost of inventories to be based on selling price less estimated profit
margin.
Selling price less an estimated profit margin is an acceptable method of arriving at the cost of
inventory. It is a frequently used method in the retail industry. Regarding (A), LIFO is not an
acceptable inventory valuation method. Overheads should be included in cost (B), and under IAS 2,
inventories should be included in the SOFP at the lower of cost and NRV, replacement cost (C) is not
relevant.