accounting for "sold" inventory

[David Cousens]

David Cousens wrote:

 

>>Hi Jay

>> 

>> 

>> 

>>Maf is right.

>> 

>> 

>> 

>>You normally create an expense account Cost of Goods Sold (CoGS) and 

>>you have an Asset  account Inventory.  When you make a sale of an item 

>>for $50 whose cost is $10, your Accounts Receivable AR is debited by $50,
your Sales

>>Income account is credited by $40 and the CoGS   Expense account is
credited

>>by the "cost"  of the item $10, i.e.  a split in GnuCash terms.

>> 

>I'm going to add something to this. While "cost of goods sold" may be
thought of as an expense this is one of those cases where perhaps accounts
>are best thought of in terms of debits and credits. Thus ..........

> 

>Inventory (parent, an account of type asset)

>     Goods inventory (child, normal balance debit)

>     Cost of goods sold (child, normal balance credit)

> 

>As described above, when you sell a widget, AR is debited 50; Sales income
credited $40, and Cost of goods sold credited $10.

>When you have sold all the widgets (the original goods inventory) the cost
of goods sold will be the same amount on the opposite side of the >ledger
and the total remaining for Inventory $0 (since it's two children cancel
each other out).

> 

>Michael

 

Hi  Michael,

 

What you are suggesting will work from a practical point of view and is
obviously simpler if you have a very rapid turnover of inventory, i.e. the
purchase and sale of inventory items  normally occurs within a single
accounting period. With reduced inventory holdings this may be the case in
many businesses these days (although see discussion below for qualifications
on the "period"). It really depends on the scale and type of the business (
e.g. private vs publicly listed) and the external reporting requirements.

 

If however you are required to prepare accounts in accordance with the GAAP
or any of the local or international standards  (Australia for me but also,
NZ,  UK, most of Europe, most of Asia and the US ) (e.g. for a public
company) the purchase of inventory is generally treated as a capital
expenditure as the inventory frequently has a lifetime greater than the
current accounting period while the CoGS is treated as an expense incurred
within the current accounting period against the income earned within that
period.  This provides a mechanism for carrying forward expenditure incurred
in an accounting period to be apportioned against sales in future accounting
periods where there may be no expenditure incurred in that period. It is
part of the GAAP practice of recognising expenditure in the same period as
the income generated by that expenditure is earned.

 

It  obviously becomes more important in manufacturing industries where there
are additional contributions to the CoGS other than the purchase price of
goods ( material costs, labour costs, overhead costs( utilities, admin
costs), storage costs, freight and shipping costs to name a few), but even
where you are reselling purchased goods , you still need to account for some
overheads.  In most cases, these costs are normally capitalised into the
value of the inventory when they are incurred and then apportioned via a
CoGS expense when the inventory item is sold. 

 

Many larger  businesses may also close their income and expenses to equity
on a monthly or quarterly basis so this becomes the de facto period in which
expenditure should be matched against the income generated by that
expenditure rather than the annual or bi- annual  external reporting period.


 

 

David