Accurately accounting for stocks (also known as inventory) is essential for determining the cost of goods sold (COGS) and ensuring the correct valuation of assets on the balance sheet. This process involves recording purchases, sales, and adjustments to inventory using accepted valuation methods such as FIFO (First-In, First-Out), LIFO (Last-In, First-Out), or the Weighted Average Cost method. Below is a comprehensive example that illustrates how to account for stock transactions and their impact on financial statements.
1. Scenario for Stock Accounting
Consider the following transactions for a retail business during January:
- Jan 1: Opening stock of 100 units at $10 each = $1,000.
- Jan 5: Purchased 200 units at $12 each = $2,400.
- Jan 10: Sold 150 units at $20 each.
- Jan 20: Purchased 100 units at $15 each = $1,500.
- Jan 25: Sold 100 units at $22 each.
2. Accounting Using the FIFO Method
Under the FIFO (First-In, First-Out) method, the oldest inventory items are sold first. This method assumes that the stock acquired first is sold before newer inventory.
A. Calculating Cost of Goods Sold (COGS)
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- Jan 10 Sale of 150 Units:
- 100 units from Jan 1 stock at $10 each = $1,000.
- 50 units from Jan 5 purchase at $12 each = $600.
- Jan 10 Sale of 150 Units:
Total COGS for Jan 10 Sale = $1,600
-
- Jan 25 Sale of 100 Units:
- Remaining 150 units from Jan 5 purchase:
- 150 units at $12 each = $1,800 (from which 100 units are sold).
- 100 units sold at $12 each = $1,200.
- Remaining 150 units from Jan 5 purchase:
- Jan 25 Sale of 100 Units:
Total COGS for Jan 25 Sale = $1,200
B. Total Cost of Goods Sold for January
Total COGS = $1,600 (Jan 10) + $1,200 (Jan 25) = $2,800
C. Calculating Closing Stock
After the sales, the remaining inventory consists of:
- 50 units from Jan 5 purchase at $12 each = $600.
- 100 units from Jan 20 purchase at $15 each = $1,500.
Closing Stock = $600 + $1,500 = $2,100
3. Journal Entries for Stock Transactions
A. Recording Purchases
Jan 5 Purchase:
Debit: Inventory $2,400
Credit: Accounts Payable (or Cash) $2,400
Jan 20 Purchase:
Debit: Inventory $1,500
Credit: Accounts Payable (or Cash) $1,500
B. Recording Sales
Jan 10 Sale (150 units at $20 each):
Debit: Accounts Receivable (or Cash) $3,000
Credit: Sales Revenue $3,000
Jan 25 Sale (100 units at $22 each):
Debit: Accounts Receivable (or Cash) $2,200
Credit: Sales Revenue $2,200
C. Recording Cost of Goods Sold (COGS)
Jan 10 Sale COGS:
Debit: COGS $1,600
Credit: Inventory $1,600
Jan 25 Sale COGS:
Debit: COGS $1,200
Credit: Inventory $1,200
4. Financial Statements Impact
A. Income Statement (for January)
| Particulars | Amount |
|---|---|
| Sales Revenue | $5,200 |
| Less: Cost of Goods Sold (COGS) | ($2,800) |
| Gross Profit | $2,400 |
B. Balance Sheet (as of January 31)
| Assets | Amount |
|---|---|
| Current Assets | |
| Cash/Accounts Receivable | $5,200 |
| Inventory (Closing Stock) | $2,100 |
| Total Current Assets | $7,300 |
5. Example Using Weighted Average Cost Method
In the Weighted Average Cost method, the average cost per unit is calculated and applied to both COGS and ending inventory.
A. Calculating Weighted Average Cost per Unit
Total Units Purchased: 100 (Jan 1) + 200 (Jan 5) + 100 (Jan 20) = 400 units
Total Cost: $1,000 (Jan 1) + $2,400 (Jan 5) + $1,500 (Jan 20) = $4,900
Weighted Average Cost per Unit: $4,900 ÷ 400 units = $12.25 per unit
B. Applying Weighted Average Cost
- Jan 10 Sale of 150 units: 150 × $12.25 = $1,837.50 (COGS)
- Jan 25 Sale of 100 units: 100 × $12.25 = $1,225 (COGS)
Total COGS = $1,837.50 + $1,225 = $3,062.50
C. Calculating Closing Stock (Weighted Average)
Remaining units: 400 – 250 = 150 units
Closing Stock = 150 × $12.25 = $1,837.50he Importance of Accurate Stock Accounting
Proper accounting for stocks is essential for determining the cost of goods sold, valuing inventory correctly on the balance sheet, and calculating gross profit on the income statement. The choice of inventory valuation method—whether FIFO, LIFO, or Weighted Average Cost—significantly impacts financial statements and tax obligations. By accurately recording stock transactions and understanding their financial implications, businesses can ensure transparency, regulatory compliance, and sound financial decision-making.