Key Concepts
A trading business buys and sells inventory at different times. Cost of sales is the cost of the specific inventory units sold — and the business must decide which units are assumed to have been sold first.
Under the First-In, First-Out (FIFO) method, the inventory that was purchased first is assumed to be sold first. This means:
- Cost of sales is calculated starting from the oldest (earliest purchased) inventory.
- Ending inventory is made up of the most recently purchased goods.
Journal entries for sales and returns:
| Transaction | Debit | Credit |
|---|---|---|
| Sell inventory (cost side) | Cost of sales (+expense) | Inventory (−asset) |
| Sell inventory (revenue side) | Trade receivables — [Customer] (+asset) | Sales revenue (+income) |
| Customer returns inventory (cost side) | Inventory (+asset) | Cost of sales (−expense) |
| Customer returns inventory (revenue side) | Sales returns (−income) | Trade receivables — [Customer] (−asset) |
"Think of it as a conveyor belt." New goods join at the back of the belt. The goods at the front — the ones that arrived earliest — come off and are sold first, so the oldest goods always leave before the newer ones.
During October 20X9, Tropical Trading bought the following from Amber Traders on credit:
| Date | Quantity purchased | Total cost |
|---|---|---|
| 2 Oct | 5,500 cars | $9,100 |
| 4 Oct | 1,500 cars | $2,325 |
| 6 Oct | 5,200 cars | $8,300 |
| 18 Oct | 4,800 cars | $7,200 |
| 21 Oct | 3,200 cars | $4,800 |
During the same month, Tropical Trading sold toy cars to Boon Seng on credit:
| Date | Transaction |
|---|---|
| 8 Oct | Sold 8,000 toy cars for $17,600 |
| 24 Oct | Sold 10,000 toy cars for $22,000 |
Apply FIFO — always start from the beginning inventory, then use purchases in order:
| Batch | Quantity | Cost |
|---|---|---|
| Beginning inventory (1 Oct) | 1,000 cars | $1,500 |
| Purchase (2 Oct) | 5,500 cars | $9,100 |
| Purchase (4 Oct) | 1,500 cars | $2,325 |
| Total sold (8 Oct) | 8,000 cars | $12,925 |
Cost of sales on 8 October 20X9 = $1,500 + $9,100 + $2,325 = $12,925
(Always start counting from the beginning inventory!)
After the 8 Oct sale, the earliest remaining inventory is the 6 Oct purchase. The 24 Oct sale of 10,000 cars is filled from the 6 Oct purchase (5,200 cars) and then the 18 Oct purchase (4,800 cars): 5,200 + 4,800 = 10,000.
| Batch | Quantity | Cost |
|---|---|---|
| Purchase (6 Oct) | 5,200 cars | $8,300 |
| Purchase (18 Oct) | 4,800 cars | $7,200 |
| Total sold (24 Oct) | 10,000 cars | $15,500 |
Cost of sales on 24 October 20X9 = $8,300 + $7,200 = $15,500
After the 24 Oct sale, the remaining inventory is the 21 Oct purchase: 3,200 cars @ $4,800.
Ending inventory = $4,800
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| 20X9 | |||
| 8 Oct | Cost of sales | 12,925 | |
| Inventory | 12,925 | ||
| Trade receivables — Boon Seng | 17,600 | ||
| Sales revenue | 17,600 |
| Date | Particulars | Dr ($) | Cr ($) | Balance ($) |
|---|---|---|---|---|
| 20X9 | ||||
| 1 Oct | Balance b/d | 1,500 Dr | ||
| 2 Oct | Trade payables — Amber Traders | 9,100 | 10,600 Dr | |
| 4 Oct | Trade payables — Amber Traders | 2,325 | 12,925 Dr | |
| 6 Oct | Trade payables — Amber Traders | 8,300 | 21,225 Dr | |
| 8 Oct | Cost of sales | 12,925 | 8,300 Dr | |
| 18 Oct | Trade payables — Amber Traders | 7,200 | 15,500 Dr | |
| 21 Oct | Trade payables — Amber Traders | 4,800 | 20,300 Dr | |
| 24 Oct | Cost of sales | 15,500 | 4,800 Dr | |
| 1 Nov | Balance b/d | 4,800 Dr |
Statement of Financial Performance for the month ended 31 October 20X9 (extract)
| $ | |
|---|---|
| Sales revenue | 39,600 |
| Less: Cost of sales | (28,425) |
| Gross profit | 11,175 |
Statement of Financial Position as at 31 October 20X9 (extract)
| $ | |
|---|---|
| Current assets | |
| Inventory | 4,800 |
Not starting from beginning inventory in FIFO. Always begin with the opening balance before starting with the purchases. Skipping the beginning inventory understates cost of sales.
Confusing which batch is left after a sale. After selling from the earliest batches, carefully track what remains before the next sale. Work through a running balance.
Using only one journal entry for a credit sale. A credit sale requires two entries: one for cost (Dr Cost of sales / Cr Inventory) and one for revenue (Dr Trade receivables / Cr Sales revenue).