Determining The Cost of Goods Sold

In order that we can calculate Profit we need to calculate our Sales less the Cost of those Sales, called the

Cost of Goods Sold.

There are two ways to calculate the Cost of Goods Sold
1 By keeping track of the cost of every item sold.
This involves a great deal of clerical work as we record both the cost and sales price of stock we sell.

This method is called the
Perpetual Inventory Method

(possibly because we are perpetually writing up the books!)

2 The second method involves counting the stock at the beginning and end of the accounting period and using a formula to calculate the Cost of Goods Sold.

As we must periodically count the stock we call this the
Periodic or Physical Inventory Method

The formula is
Cost of Goods Sold = Opening Stock + Purchases - Closing Stock

Graphically we can represent it as

Of the Stock that was available, (Opening Stock and Purchases), some remains, (Closing Stock), the rest must be the Cost of Goods Sold.

The advantage of the Periodic method is we don't need to record the cost of every individual sale.

Instead we use the formula to calculate the Cost Of Goods Sold at the end of the Accounting period.

Note that the Closing Stock at the end of one accounting period becomes the Opening Stock for the next Accounting period.

Under this method we don't post additions of stock to the Stock or Inventory account.

Instead we only post new stock to a Purchases expense account.

For example,
Bought $500 of stock for cash

Debit Purchases account $500 Credit Bank Account $500

Having established the Cost of Goods Sold we can now calculate the Gross and Net Profit for the period.

Practice Exercises

You should attempt exercise 3.1

Exercise

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