VCE Accounting (Year 11) · Unit 2 — Recording and Reporting · 18m read

Recording for a Trading Business — Inventory and Cost of Goods Sold

Ever wondered why a shop's profit isn't just the money from sales minus what it paid for stuff? That's because you need to track *when* inventory moves in and out of your business. In this topic, you'll learn how to record inventory transactions and calculate your cost of goods sold (the actual cost of items you've sold) so you can work out your real gross profit — not just a rough guess.

Learning objective: Account for inventory transactions and calculate cost of goods sold and gross profit.

By the end of this lesson you can:

I can record purchases and sales of inventory using the perpetual system.
I can calculate cost of goods sold and gross profit.
I can prepare the trading section of the Income Statement.

Inventory is the shop's stock cupboard. Track what comes in and goes out so you know cost of goods sold and true profit.

Perpetual inventory system

### What is a trading business?

A trading business buys goods (inventory/stock) and sells them for profit. Revenue alone doesn't tell you profitability — you need to know what the goods cost.

### Key accounts

Inventory (Asset): Records the cost of goods currently held for sale. Updated with every purchase and sale.

Cost of Goods Sold (COGS) (Expense): The cost of inventory that has been sold.

Sales Revenue (Revenue): The selling price received for goods sold.

### Perpetual inventory system

Under the perpetual system, inventory is updated continuously after every purchase and sale:

When goods are PURCHASED:
$$\text{Dr Inventory} \quad | \quad \text{Cr Cash/Accounts Payable}$$

When goods are SOLD:
$$\text{Dr Cash/Accounts Receivable} \quad | \quad \text{Cr Sales Revenue} \quad \text{(selling price)}$$

AND simultaneously:

$$\text{Dr Cost of Goods Sold} \quad | \quad \text{Cr Inventory} \quad \text{(cost price)}$$

This two-entry process records both the revenue AND the reduction in inventory.

### Calculating gross profit

$$\text{Gross Profit} = \text{Sales Revenue} - \text{Cost of Goods Sold}$$

$$\text{Net Profit} = \text{Gross Profit} - \text{Operating Expenses}$$

### Trading section of Income Statement

Sales Revenue $XX,000
Less: Cost of Goods Sold ($XX,000)
---------
Gross Profit $XX,000
Less: Operating Expenses ($XX,000)
---------
Net Profit $XX,000

### Inventory records — the Stock Card (FIFO method)

VCAA uses FIFO (First In, First Out): the oldest inventory is sold first.

Stock card tracks: Date, Description, Purchases (units, cost, total), Sales (units, cost, total), Balance (units, cost, total).

Trading Business Formulas

Gross profit: \text{GP} = \text{Sales Revenue} - \text{COGS}
Net profit: \text{NP} = \text{GP} - \text{Operating Expenses}
Gross profit %: \text{GP\%} = \dfrac{\text{GP}}{\text{Sales Revenue}} \times 100 (Profitability ratio)
Markup %: \text{Markup\%} = \dfrac{\text{GP}}{\text{COGS}} \times 100 (Profit as % of cost)

Quick reference

| Concept | Formula/meaning |
|---|---|
| COGS | Cost of inventory sold |
| Gross profit | Sales − COGS |
| Perpetual system | Continuous records (stock cards) |
| FIFO | First in, first out |
| Stock loss/gain | Physical vs records |

Key ideas at a glance

Record at cost: Purchase price.
Use stock cards: Perpetual.
FIFO costing: Oldest first.
Stocktake: Check records.

Worked example (Medium)

A shop buys 20 units at $30 each and sells 15 units at $50 each. Record the transactions and calculate gross profit.

Record purchase of 20 units @ $30. \text{Dr Inventory} \ 600 \quad | \quad \text{Cr Accounts Payable} \ 600
Record sale of 15 units @ $50 (revenue). \text{Dr Accounts Receivable} \ 750 \quad | \quad \text{Cr Sales Revenue} \ 750
Record COGS (15 units @ $30). \text{Dr Cost of Goods Sold} \ 450 \quad | \quad \text{Cr Inventory} \ 450
Gross profit. GP = 750 - 450 = \$300
Remaining inventory. 5 units × $30 = $150 remaining in Inventory account.

Answer: Gross profit = $300. Remaining inventory = $150 (5 units). Gross profit % = $300/$750 × 100 = 40%.

Worked example (Hard)

A retailer uses the perpetual inventory system. During March: purchased 100 units at $20 each on credit; sold 60 units at $35 each on credit; 5 sold units were returned by customers (in good condition). Record ALL journal entries and calculate closing inventory and gross profit.

Purchase entry. \text{Dr Inventory } 2{,}000 \quad | \quad \text{Cr Accounts Payable } 2{,}000
Sale entry (revenue). \text{Dr Accounts Receivable } 2{,}100 \quad | \quad \text{Cr Sales Revenue } 2{,}100
Sale entry (COGS). \text{Dr Cost of Goods Sold } 1{,}200 \quad | \quad \text{Cr Inventory } 1{,}200
Sales return (revenue reversal). Customer returns 5 units: \text{Dr Sales Returns } 175 \quad | \quad \text{Cr Accounts Receivable } 175
Sales return (inventory restoration). \text{Dr Inventory } 100 \quad | \quad \text{Cr Cost of Goods Sold } 100
Calculate closing inventory. Opening: 0. Purchased: 100 units. Sold: 60. Returned: 5 (back in stock). Closing: 45 units × $20 = $900. \text{Closing Inventory} = 2{,}000 - 1{,}200 + 100 = \$900
Calculate gross profit. GP = (2{,}100 - 175) - (1{,}200 - 100) = 1{,}925 - 1{,}100 = $825

Answer: Closing inventory: $900 (45 units). Gross profit: $825. Key: sales returns require TWO reversing entries (revenue AND COGS). Under perpetual inventory, inventory and COGS are updated with every transaction.

Common mistakes

Recording only ONE entry for a sale in a perpetual inventory system Under perpetual inventory, every sale requires TWO entries: (1) the revenue entry (Dr AR/Cash, Cr Sales Revenue at selling price) and (2) the COGS entry (Dr COGS, Cr Inventory at cost price). Missing the second entry overstates inventory and understates COGS. Fix: For EVERY sale in perpetual inventory: Entry 1 — Dr AR/Cash [selling price], Cr Sales Revenue [selling price]. Entry 2 — Dr COGS [cost price], Cr Inventory [cost price]. Two entries, different amounts. Practice this until it is automatic.
Using selling price instead of cost price for COGS entries COGS records the COST of inventory sold, not the revenue earned. Students sometimes use the selling price ($35/unit) for the COGS entry instead of the cost price ($20/unit). Fix: COGS is ALWAYS at COST price. Sales Revenue is at SELLING price. The difference between selling price and cost price is the gross profit margin. Keep these two amounts separate in your head.

Perpetual vs Periodic — Two Inventory Systems

VCE Accounting focuses on the perpetual inventory system, but understanding how it compares to the periodic system helps you appreciate why perpetual is preferred in modern business.

Perpetual inventory system:
- Inventory account is updated with every purchase and every sale.
- COGS is calculated at the time of each sale.
- The Inventory account always shows the current balance.
- Requires technology (barcode scanners, POS systems) to track individual items.
- Used by most modern retailers (Woolworths, Coles, JB Hi-Fi).

Periodic inventory system:
- Inventory is only counted at the end of the period (physical stocktake).
- COGS is calculated at period-end: Opening Inventory + Purchases − Closing Inventory = COGS.
- The Inventory account is only updated periodically — not after each transaction.
- Simpler but less accurate — no real-time information about stock levels.

Why perpetual is better for most businesses:
1. Real-time stock information: Managers know exactly what's in stock at any moment — essential for reordering and avoiding stockouts.
2. Better cost control: COGS is known immediately, allowing real-time profit tracking.
3. Shrinkage detection: Comparing perpetual records to physical counts reveals theft, damage, or recording errors.
4. Decision-making: Managers can identify fast-moving and slow-moving products instantly.

VCE exam tip: All VCE Accounting questions assume perpetual inventory unless stated otherwise. When recording sales, ALWAYS include both the revenue entry AND the COGS entry. This is the most commonly tested perpetual inventory skill.

Practice questions

Under the perpetual inventory system, when a sale is made:
1. Only the revenue is recorded
2. Both the revenue and the COGS are recorded simultaneously
3. Only COGS is updated at year end
4. Inventory is not adjusted until the count
(1 marks)
Using the following data, prepare the trading section of the Income Statement: Sales $45,000; Opening inventory $5,000; Purchases $28,000; Closing inventory $6,000.
(3 marks)

Summary

Perpetual inventory: updated continuously. Two entries per sale: revenue + COGS.
COGS = Opening Inventory + Purchases − Closing Inventory.
Gross Profit = Sales Revenue − COGS.
Net Profit = Gross Profit − Operating Expenses.
FIFO: sell oldest stock first (relevant for stock card calculations).