7 - Cost of sales and inventories

Question 1

What are inventories?

Answer 1

Inventories are current assets that are held for sale in the ordinary course of business.

Can include:
Goods purchased and held for resale
Finished goods
Work in progress
Raw materials

Question 2

What is the gross profit formula?

Answer 2

Gross profit = Revenue - cost of sales

Question 3

What is the cost of sales formula?

Answer 3

Opening inventory + purchases + carriage inwards - closing inventories

Question 4

What is carriage inward?

Answer 4

Delivery costs to receive goods

Question 5

What is carriage outward?

Answer 5

Delivery costs to distribute goods to customers - treated as an expense (usually distribution costs)

Question 6

What are the cost of sales for businesses that provide services?

Answer 6

Direct labour costs
Sales commission - where a business pays its employees commission for securing work
Materials used

Question 7

What would be the accounting entry for closing / opening inventory?

Answer 7

Closing:
Dr Inventories (current asset) account
Cr cost of sales expense

Opening:
Dr cost of sales expense
Cr Inventories (current asset) account

Question 8

Difference between SOFP and PNL for cost of sales

Answer 8

For SOFP:
Cost of sales = opening + purchases - closing

For PNL:
Only closing inventories come under the inventory section

Question 9

How to count inventories?

Answer 9

For most businesses you do something called a stock take.
Closing inventories = Quantity x value

For companies with large inventory levels, you carry out a continuous inventory record

Question 10

How are inventories valued?

Answer 10

They are valued at the lower of cost and net realisable value

Cost:
It is the historic cost of purchasing the goods or the costs to date of manufacturing them. It includes purchase price, delivery, import taxes and duties and any conversion costs to bring it to its present location and condition

NRV:
It is the expected selling price, less any further direct costs before sale (cost to complete, modification costs, selling and distro expenses

Question 11

Determining costs of inventories

Answer 11

Raw materials:
Cost = purchasing price including import duties, transport, handling and non recoverable VAT.

Part completed items (work in progress):
Cost = cost of purchase + conversion costs and other costs to bring it to its finished state

Finished goods: Present location and condition

Question 12

What are a few of the costing methods?

Answer 12

FIFO: First in first out. Older items are sold first so closing inventories are the newer items

LIFO: Last in first out. This is disallowed under IASs

AVCO: Average cost. As each delivery is received a new “average” cost is calculated for the total inventories held. The average is used to value items sold and any remaining inventories

Question 13

Prices rising and falling effect on FIFO and AVCO

Answer 13

Prices rising:
FIFO profit > AVCO profit
FIFO closing inv > AVCO closing inv

Prices falling:
FIFO profit < AVCO profit
FIFO closing inv < AVCO closing inv

Question 14

What is the difference between mark-up and margin?

Answer 14

Mark-up is calculated on cost
Margin is calculated on sales

If using mark up on cost, the cost of sales figure should be 100%
If using margin on sales, the sales figure should be 100%

If something has a margin of 40% that means gross profit is 40%

A mark up of 40% means sales is 140% and cost of sales is 100%

Question 15

Inventory drawings

Answer 15

If owner takes inventory out instead of money:

Dr Drawings
Cr Purchases