Key Concepts
According to the matching theory, the cost incurred to buy inventory must be matched against the sales revenue earned from selling the inventory in the same accounting period to determine the gross profit for that period.
Cost of sales refers to the cost incurred in buying the inventory that was sold. Whenever there is a sale, the cost of the inventory sold is recognised as cost of sales immediately.
At the end of the financial period, the cost of sales account is closed and the balance transferred to the Income summary account.
| Account | Debit | Credit |
|---|---|---|
| Cost of sales | Income summary | Cost of sales |
The Cost of sales figure is read directly from the ledger account balance.
Closing entries: to reduce expense accounts to zero, they are credited:
- Dr Income summary → Cr Cost of sales
Closing entry — 31 December 20X5:
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| 20X5 | |||
| 31 Dec | Income summary | 145,000 | |
| Cost of sales | 145,000 |
Confusing cost of sales with sales revenue — cost of sales is a debit balance (expense); sales revenue is a credit balance (income).