Trading account and cost of sales: worked examples

Method and where the marks are

The trading account finds one figure: gross profit, which is revenue less the cost of the goods actually sold. If cost of sales is wrong, gross profit is wrong, and so is every ratio built on it. The core formula is: opening inventory plus purchases plus carriage inwards minus purchases returns minus closing inventory equals cost of sales.

Revenue minus sales returns gives net sales. Net sales minus cost of sales gives gross profit.

Set it out in this order with each line labelled. That earns the method marks even before the final answer.

Start with the sales figure. Sales returns (returns inwards) are deducted from sales to give net sales. They never go near purchases.

Write "Sales", then "less Returns inwards" directly beneath. Do the same on purchases.

Purchases returns (returns outwards) are deducted from purchases. Keep the two kinds of returns firmly on their own sides.

Carriage turns on direction. Carriage inwards is the cost of bringing goods into the business, so it is part of the cost of buying and is added within cost of sales. Carriage outwards is the cost of delivering goods to customers, so it is a selling expense and belongs in the expenses part of the income statement.

Ask "in or out?" for every carriage line before you place it. Goods taken by the owner for personal use are drawings. Deduct them from purchases, because those goods were never available to sell.

Inventory valuation is where care pays off. Opening inventory is added, because those goods were available to sell this year.

Closing inventory is subtracted, because those goods are still on the shelf and their cost is carried forward. This is the matching concept. You charge against sales only the cost of what was sold. Value inventory at the lower of cost and net realisable value.

If goods cost RM5,000 but are now damaged and could only be sold for RM3,800, value them at RM3,800. Using cost when net realisable value is lower overstates both closing inventory and profit. Examiners test this directly.

When cost of sales is settled, the subtraction to reach gross profit is simple. Show net sales, then cost of sales as an indented block built from its component lines, then gross profit as a ruled figure. The block shows you understand which items belong to cost of sales and which do not.

Marks are mostly lost on these points. Carriage outwards, discounts and office or selling expenses do not belong in the trading account. Forgetting to adjust purchases for goods taken by the owner, or for a capital item such as a delivery van wrongly posted to purchases, is another.

If the question gives a mark-up or margin, remember that mark-up is profit on cost and margin is profit on sales. Mixing them gives a plausible but wrong answer. A quick check is that cost of sales plus gross profit must equal net sales.

If cost of sales questions keep giving you the wrong gross profit, we can help. One of our teachers can work through your past-paper answers with you and find where the figure goes astray. Book a trial class