Acca f3 Financial Accounting (int) Study Text

130

8: Inventory   Part D  Recording transactions and events 

Solution

Initial calculation of closing inventory values: 

INVENTORY COUNT 

At cost

Realisable value

Amount written down

$

$

$

Fashion goods

2,100

400

1,700

Other goods (balancing figure)

5,500

5,500

7,600

5,900

1,700

FAIRLOCK FASHIONS 

TRADING ACCOUNT FOR THE YEAR ENDED 31 MARCH 20X6 

$

$

Sales 

 

 81,400

Value of opening inventory

8,800

Purchases

48,000

56,800

Less closing inventory

  5,900

Cost of goods sold 

 

 50,900

Gross profit 

 

 30,500

By using the figure of $5,900 for closing inventories, the cost of goods sold automatically includes the 

inventory written down of $1,700. 

Question 

Gross profit 

Gross profit for 20X7 can be calculated from: 

A 

purchases for 20X7, plus inventory at 31 December 20X7, less inventory at 1 January 20X7 

B 

purchases for 20X7, less inventory at 31 December 20X7, plus inventory at 1 January 20X7 

C 

cost of goods sold during 20X7, plus sales during 20X7 

D 

net profit for 20X7, plus expenses for 20X7 

Answer

The correct answer is D. Gross profit less expenses = net profit. Therefore net profit plus expenses = 

gross profit. 

2 Accounting for opening and closing inventories

Opening inventories brought forward in the inventory account are transferred to the trading account, and 

so at the end of the accounting year the balance on the inventory account ceases to be the opening 

inventory value b/f and becomes instead the closing inventory value c/f.

2.1 Recap 

In Section 1, we saw that in order to calculate 

gross profit it is necessary to work out the cost of goods 

sold, and in order to calculate the cost of goods sold it is necessary to have values for the 

opening

inventory (ie inventory in hand at the beginning of the accounting period) and closing inventory

(ie inventory in hand at the end of the accounting period). 

You should remember, in fact, that the trading part of an income statement includes: 

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Part D  Recording transactions and events

  8:  Inventory

131

$

Opening inventory

X

Plus purchases

X

Less closing inventory

(X)

Equals cost of goods sold

X

However, just writing down this formula hides three basic problems. 

(a) 

How do you manage to get a 

precise count of inventory in hand at any one time? 

(b) 

Even once it has been counted, how do you 

value the inventory? 

(c) 

Assuming the inventory is given a value, how does the 

double entry bookkeeping for inventory 

work?

The purpose of this chapter is to answer all three of these questions. In order to make the presentation a 

little easier to follow, it is convenient to take the last one first. 

2.2 Ledger accounting for inventories 

The value of 

closing inventories is accounted for in the nominal ledger by debiting an inventory account 

and crediting the trading account at the end of an accounting period. Inventory will therefore have a debit 

balance at the end of a period, and this balance will be shown in the statement of financial position as a 

current asset. 

It has already been shown that purchases are introduced to the trading section of the income statement by 

means of the double entry: 

DEBIT

Trading account 

$X

CREDIT

Purchases account 

 $X 

But what about opening and closing inventories? How are their values accounted for in the double entry 

bookkeeping system? The answer is that a inventory account must be kept. This inventory account is only 

ever used at the end of an accounting period, when the business counts up and values the inventory in 

hand, in a inventory count. 

(a) 

When a inventory count is made, the business will have a value for its closing inventory, and the 

double entry is: 

DEBIT

Inventory account (closing inventory value) 

$X

CREDIT

Trading account 

 $X 

However, rather than show the closing inventory as a 'plus' value in the trading account (by 

adding it to sales) it is usual to show it as a 'minus' figure in arriving at cost of sales. This is 

illustrated in Paragraph 2.1 above. The debit balance on inventory account represents an 

asset, which will be shown as part of current assets in the statement of financial position. 

(b) 

Closing inventory at the end of one period becomes opening inventory at the start of the next 

period. The inventory account remains unchanged until the end of the next period, when the value 

of opening inventory is taken to the trading account: 

DEBIT

Trading account 

$X

CREDIT

Inventory account (value of opening inventory) 

 $X 

Partly as an example of how this ledger accounting for inventories works, and partly as revision on ledger 

accounting in general, try the following exercise. It is an example from an earlier part of this text which has 

had a closing inventory figure included. 

Question

Inventories

A business is established with capital of $2,000 and this amount is paid into a business bank account by 

the proprietor. During the first year's trading, the following transactions occurred. 

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