Cost of sales and accounting for inventory Flashcards
Adjustments needed as a result of the key accounting concepts (what is each ones purpose)
- Accruals & Prepayments
- Inventory (stock) and the cost of sales
- Bad & doubtful debts
- Depreciation
- Accruals & Prepayments
- To match expenses to the period they relate
- Inventory (stock) and the cost of sales
- To match sales with actual cost of those sales
- Bad and doubtful debts
- To be prudent in recognising debts that may not be recoverable
- Depreciation
- To match cost of a non current asset over its useful economic life
What is the double entry of an accrual and a prepayment?
Accrual = Dr Expense
Cr Accrual
Prepayment = Dr Prepayments
Cr Expense
Key accounting concept - Accruals
- The __________ recognised in the __________ ____________ are those related to the ______ recorded.
i.e. sales should be matched against the cost of those sales
- The expenses recognised in the income statement are those related to the sales recorded.
i.e. sales should be matched against the cost of those sales
Cost of sales adjustment - Example
Jonny started to trade selling rugby balls. He bought 100 at £10 each and in the year sold 80 for £15 each
£
Sales (80 @ £15) 1,200
Less purchases (100 @ £10) (1,000)
Difference 200
Is this difference Jonny’s profit and why?
No because profit is not a measure of cashflow.
A profitable business may need an overdraft. A loss making business may have cash
Cost of sales adjustment - Example - Jonny continued
Sales should be matched with _____ __ _____
Sale proceeds from selling 80 balls should be matched with the ______ of _______ 80 balls
The 20 balls he has not sold should be removed from the ___________ ___________ and recognised as an ______ in the _________ ______
Sales should be matched with cost of sales
Sale proceeds from selling 80 balls should be matched with the cost of buying 80 balls
The 20 balls he has not sold should be removed from the income statement and recognised as an asset in the balance sheet
Cost of sales adjustment
Jonny started to trade selling rugby balls. He bought 100 at £10 each and in the year sold 80 for £15 each
What should this look like?
Sales (80 @ £15) 1,200
Less cost of sales
purchases (100 @ £10) 1,000
Less closing inventory (20 @ £10) (200)
(800)
Gross Profit 400
Cost of sales adjustment - Jonny year 2
Next year Jonny bought another 550 balls
At the year end he had 125 remaining.
How many has he sold in the year?
Opening inventory 20 balls
Bought in year (purchases) 550 balls
570 balls
Less Closing inventory (125 balls)
Balls sold in the year 445 balls
Cost of sales formula
Cost of sales = (opening inventory + purchases) - closing inventory
Cost of sales
- Do not confuse no of units with their value. The income statement contains _____ not units
- Cost of sale adjustment ensures we match the sales ________ _________ with the ______ of the goods which have been _____. Otherwise profit figures would be _________ or _________ depending on whether we had sold more inventory (stock) than we had purchased during the year or vice –versa.
- Closing inventory (stock) from one period is always the _________ inventory (stock) for the next period.
- The opening inventory figure (if there is any) will always appear as a ______ balance in the trial balance.
- Opening inventory is an ______ but goes on the _________ __________
- Closing inventory goes on the __ and __
- Do not confuse no of units with their value. The income statement contains values not units
- Cost of sale adjustment ensures we match the sales revenue gained with the costs of the goods which have been sold. Otherwise profit figures would be boosted or reduced depending on whether we had sold more inventory (stock) than we had purchased during the year or vice –versa.
- Closing inventory (stock) from one period is always the opening inventory (stock) for the next period.
- The opening inventory figure (if there is any) will always appear as a Debit balance in the trial balance.
- Opening inventory is an asset but goes on the income statement
- Closing inventory goes on the IS and BS
Inventory: Valuation
- At the end of the accounting period there will be a stock take. (2 reasons why?)
- Inventory is valued at the lower of cost and Net Realisable Value (NRV) (what is NRV?)
- At the end of the accounting period there will be a stock take.
- To count the actual quantity of each item
- To note slow-moving items, damaged goods, obsolete items
- Inventory is valued at the lower of cost and Net Realisable Value (NRV)
- NRV is the new value of an item and what you can sell it for
Inventory is valued at the lower of cost and Net Realisable Value
What is cost?
- General accounting rule – use _______ cost rather than ________ cost but…
- Inventories may comprise _____________ products such as oil, gas, rugby balls etc.
- They may be purchased throughout the year at a ________ of _______.
- General accounting rule – use historic cost rather than current cost but…
- Inventories may comprise homogenous products such as oil, gas, rugby balls etc.
- They may be purchased throughout the year at a variety of prices.
Possible costing solutions (3 and their definition)
FIFO: First in, First out
- Goods which arrive first are used first (particularly for perishable goods)
LIFO: Last in, First out (Disallowed under International Accounting Standards)
- Goods which arrive last are used first
WAC: Weighted average cost
- Goods are valued at the average price of the inventories held
Which method should be used?
In financial accounting we can only use?
And what concept should we keep to?
What method can we use in management accounting?
Only FIFO or WAC may be used in financial accounting. The same method should be used every year = Consistency concept
Any method may be used in management accounting
What is Net Realisable Value?
Estimated future selling price less all additional costs to be incurred before sale
Mark-ups and margins
What are they calculated on?
What are they used for?
- Margin is calculated on sales (sales is the 100% figure)
- Mark-up is calculated on cost (cost is the 100% figure)
Profit margin = profit/sales
Sales = cost + gross profit
Margins and mark-ups can@ be used to establish costs and profits
