Acca f3 Financial Accounting (int) Study Text

Part D  Recording transactions and events

  8:  Inventory

127

$

$

Sales (20,000 units)

100,000

Purchases (30,000 units)

60,000

Less closing inventory (10,000 units @ $2)

20,000

Cost of sales (20,000 units) 

40,000

Gross profit

60,000

1.3 Example continued 

We shall continue the example of the Umbrella Shop into its next accounting year, 1 October 20X5 to 30 

September 20X6. During the course of this year, Perry P Louis purchased 40,000 umbrellas at a total cost 

of $95,000. During the year he sold 45,000 umbrellas for $230,000. At 30 September 20X6 he had 5,000 

umbrellas left in inventory, which had cost $12,000. 

What was his gross profit for the year? 

Solution

In this accounting year, he purchased 40,000 umbrellas to add to the 10,000 he already had in inventory at 

the start of the year. He sold 45,000, leaving 5,000 umbrellas in inventory at the year end. Once again, 

gross profit should be calculated by matching the value of 45,000 units of sales with the cost of those 

45,000 units. 

The cost of sales is the value of the 10,000 umbrellas in inventory at the beginning of the year, plus the 

cost of the 40,000 umbrellas purchased, less the value of the 5,000 umbrellas in inventory at the year end. 

$

$

Sales (45,000 units)

230,000

Opening inventory (10,000 units) *

20,000

Add purchases (40,000 units)

  95,000

115,000

Less closing inventory (5,000 units)

  12,000

Cost of sales (45,000 units)

103,000

Gross profit

127,000

* Taken from the closing inventory value of the previous accounting year, see paragraph 1.3. 

1.4 The cost of goods sold 

The cost of goods sold is found by applying the following formula. 

$

Opening inventory value 

X

Add cost of purchases (or, in the case of a manufacturing company, the 

  cost of production)

 X 

X

Less closing inventory value

(X)

Equals cost of goods sold

 X 

In other words, to match 'sales' and the 'cost of goods sold', it is necessary to adjust the cost of goods 

manufactured or purchased to allow for increases or reduction in inventory levels during the period. 

The 'formula' above is based on a logical idea. You should learn it, because it is fundamental among the 

principles of accounting. 

Test your knowledge of the formula with the following example. 

Formula to 

learn

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8: Inventory   Part D  Recording transactions and events 

1.5 Example: Cost of goods sold and variations in inventory levels 

On 1 January 20X6, the Grand Union Food Stores had goods in inventory valued at $6,000. During 20X6 

its proprietor purchased supplies costing $50,000. Sales for the year to 31 December 20X6 amounted to 

$80,000. The cost of goods in inventory at 31 December 20X6 was $12,500. 

Calculate the gross profit for the year. 

Solution

GRAND UNION FOOD STORES 

TRADING ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20X6 

$

$

Sales

80,000

Opening inventories

6,000

Add purchases

50,000

56,000

Less closing inventories

12,500

Cost of goods sold

43,500

Gross profit

36,500

1.6 The cost of carriage inwards and outwards 

Carriage inwards is included in the cost of purchases. 

Carriage outwards is a selling expense. 

'Carriage' refers to the 

cost of transporting purchased goods from the supplier to the premises of the 

business which has bought them. Someone has to pay for these delivery costs: sometimes the supplier 

pays, and sometimes the purchaser pays. When the purchaser pays, the cost to the purchaser is carriage 

inwards (

into the business). When the supplier pays, the cost to the supplier is known as carriage 

outwards (

out of the business). 

The

cost of carriage inwards is usually added to the cost of purchases.

The

cost of carriage outwards is a selling and distribution expense in the income statement.

1.7 Example: Carriage inwards and carriage outwards 

Gwyn Tring, trading as Clickety Clocks, imports and resells clocks. He pays for the costs of delivering the 

clocks from his supplier in Switzerland to his shop in Wales. 

He resells the clocks to other traders throughout the country, paying the costs of carriage for the 

consignments from his business premises to his customers. 

On 1 July 20X5, he had clocks in inventory valued at $17,000. During the year to 30 June 20X6 he 

purchased more clocks at a cost of $75,000. Carriage inwards amounted to $2,000. Sales for the year 

were $162,100. Other expenses of the business amounted to $56,000 excluding carriage outwards which 

cost $2,500. Gwyn Tring took drawings of $20,000 from the business during the course of the year. The 

value of the goods in inventory at the year end was $15,400. 

Required

Prepare the income statement of Clickety Clocks for the year ended 30 June 20X6. 

FAST FORWARD

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Part D  Recording transactions and events

  8:  Inventory

129

Solution

CLICKETY CLOCKS 

INCOME STATEMENT FOR THE YEAR ENDED 30 JUNE 20X6 

$

$

Sales

162,100

Opening inventory

17,000

Purchases

75,000

Carriage inwards

   2,000

94,000

Less closing inventory

15,400

Cost of goods sold

78,600

Gross profit

83,500

Carriage outwards

2,500

Other expenses

56,000

58,500

Net profit (transferred to statement of financial position)

25,000

1.8 Goods written off or written down 

A trader might be unable to sell all the goods that he purchases, because a number of things might 

happen to the goods before they can be sold. For example: 

(a) 

Goods might be lost or stolen. 

(b) 

Goods might be damaged, become worthless and so be thrown away. 

(c) 

Goods might become obsolete or out of fashion. These might be thrown away, or sold off at a very 

low price in a clearance sale. 

When goods are 

lost, stolen or thrown away as worthless, the business will make a loss on those goods 

because their 

'sales value' will be nil.

Similarly, when goods lose value because they have become 

obsolete or out of fashion, the business will 

make a loss if their clearance sales value is less than their cost. For example, if goods which originally 

cost $500 are now obsolete and could only be sold for $150, the business would suffer a loss of $350. 

If, at the end of an accounting period, a business still has goods in inventory which are either worthless or 

worth less than their original cost, the value of the inventories should be 

written down to:

(a) 

Nothing, if they are worthless 

(b) 

Their net realisable value, if this is less than their original cost 

This means that the loss will be reported as soon as the loss is foreseen, even if the goods have not yet 

been thrown away or sold off at a cheap price. This is an application of the prudence concept, which we 

looked at in

 Chapter 3

. 

The costs of inventory written off or written down should not usually cause any problems in calculating 

the gross profit of a business, because the cost of goods sold will include the cost of inventories written 

off or written down, as the following example shows. 

1.9 Example: Inventories written off and written down 

Lucas Wagg, trading as Fairlock Fashions, ends his financial year on 31 March. At 1 April 20X5 he had 

goods in inventory valued at $8,800. During the year to 31 March 20X6, he purchased goods costing 

$48,000. Fashion goods which cost $2,100 were still held in inventory at 31 March 20X6, and Lucas Wagg 

believes that these could only now be sold at a sale price of $400. The goods still held in inventory at 31 

March 20X6 (including the fashion goods) had an original purchase cost of $7,600. Sales for the year 

were $81,400. 

Required

Calculate the gross profit of Fairlock Fashions for the year ended 31 March 20X6. 

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