Accountancy · Ch 8 — Financial Statements - I
Cost of Goods Sold and Closing Stock–Trading Account Revisited
Cost of Goods Sold and Closing Stock–Trading Account Revisited
Cost of Goods Sold and Closing Stock – Trading Account Revisited
The trading account shows the gross profit or gross loss from the basic operations of a business. In the simplest case, when there is no opening stock and no closing stock, the cost of goods sold is simply the total of purchases and all direct expenses.
Cost of Goods Sold = Purchases + Direct Expenses
In the example given, purchases are ₹75,000 and wages (a direct expense) are ₹8,000. So the cost of goods sold is ₹83,000. This calculation assumes that every item purchased has been sold during the year — there is nothing left unsold.
The Effect of Closing Stock
In reality, a business almost always has some unsold goods at the end of the accounting period. These unsold goods are called closing stock. Suppose out of the ₹75,000 worth of goods purchased, Ankit could sell only goods costing ₹60,000. That means goods costing ₹15,000 remain unsold at the year-end. This unsold stock must be deducted from the total of purchases and direct expenses to arrive at the true cost of goods sold.
Cost of Goods Sold = Purchases + Direct Expenses – Closing Stock
= ₹75,000 + ₹8,000 – ₹15,000 = ₹68,000
Because closing stock is not an expense (it is an asset that will be sold next year), deducting it from the cost side increases the gross profit. In the original trading account (without closing stock), the gross profit was ₹42,000. After accounting for closing stock of ₹15,000, the gross profit becomes ₹57,000.
The Journal Entry for Closing Stock
Closing stock does not normally appear in the trial balance. It is brought into the books at the end of the year through a journal entry:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| March 31 | Closing Stock A/c Dr. | 15,000 | ||
| To Trading A/c | 15,000 |
This entry does two things:
- It creates a new asset account called Closing Stock (₹15,000), which will appear on the balance sheet.
- It credits the Trading Account, which effectively reduces the cost of goods sold and increases the gross profit.
The closing stock of the current year becomes the opening stock of the next year. That opening stock will be sold during the following year, so it must be added back to purchases when computing the next year's cost of goods sold.
The Complete Formula with Opening Stock
When a business has both opening stock and closing stock, the cost of goods sold is:
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses – Closing Stock
This is the standard formula used in most real trading accounts.
The textbook's Illustrations 5 and 6 (cost of goods sold, and a complete trading and profit & loss account) now live in this chapter's Illustrations & practice tab, alongside their full solutions.
The gross profit from the trading account is brought down to the credit side of the profit & loss account as "Gross profit b/d". All indirect expenses (salaries, rent, advertisement, commission, discount allowed, bad debts, sales expenses, repairs) are debited to the profit & loss account. The balancing figure is the net profit, which is transferred to the capital account.