Accounting for Inventory

We will learn how to calculate the cost of purchase and determine the cost of sales using the FIFO (First-In, First-Out) method. The lesson also covers how to prepare journal entries for inventory transactions, including the purchase of inventory, return of inventory to suppliers, and sales of inventory. In addition, students will learn how these transactions are recorded in the Inventory account.

Related Lessons:
  1. S3 Valuation of Inventory
  2. S3 Answering Inventory Scenario Based Question

Calculate Cost of Purchase of Inventory

To calculate the cost of purchasing inventory:

Step 1: Determine purchase price
Original purchase price – trade discount

Step 2: Determine net purchase
Purchase price (from step 1) – purchase returns

Step 3: Determine cost of purchase
Net purchase (from step 2) + all other costs (as listed below) incurred for the purchase

Possible cost that may be incurred for the purchasing inventory and preparing it for resale includes:

  1. Freight charges
  2. Import duties
  3. Import taxes
  4. Delivery charges
  5. Transport insurance
  6. Packing materials
  7. Wages paid to employee preparing the goods for resale 

Calculating Cost of Sales (FIFO Method)

Cost of sales is the portion of inventory that was sold.

FIFO refers to first in first out. It is a method of determining cost of sales where goods bought earliest is deemed to be sold first.

To calculate cost of sales using the FIFO method, we first find the total number of units sold. We then use the cost of the same number of units that were bought first.

Recording Inventory

Journal entries to record the purchase of inventory:

1. For cash purchases
Dr Inventory
     Cr Cash in hand

2. For purchases made through the bank
Dr Inventory
      Cr Cash at bank

3. For credit purchases
Dr Inventory
      Cr Trade payable

To record purchases returned to credit supplier,
Dr Trade payable
      Cr Inventory

Journal entries to record the cost of sales of inventory:

1. For sales of goods
Dr Cost of sales
     Cr Inventory

2. For sales return
Dr Inventory
      Cr Cost of sales

3. To close the cost of sales account
Dr Income summary
      Cr Cost of sales

Recording in the Financial Statements

In the Statement of financial performance, cost of goods is deducted from the net sales revenue to derive at the gross profit or loss.
Here’s an extract of how cost of sales is presented in the statement:

Sales revenue
Less Sales return
Net Sales revenue
Less Cost of sales
Gross profit or loss

Balance inventory not sold are assets to the business and are recorded in the Statement of financial position as a Current Asset.

Watch: Full Concept Breakdown

Share With Friends:

Related Lessons:

  1. S3 Valuation of Inventory
  2. S3 Answering Inventory Scenario Based Question

error:
Scroll to Top