Closing inventory reduces the cost of goods sold, and goods taken by the owner must be removed from purchases. Get both right and the cost of goods sold reflects only what was sold to customers.
This lesson is part of year-end adjustments. The owner’s withdrawals are introduced in separating personal and business transactions.
What is the formula?
Cost of goods sold = opening inventory + purchases − closing inventory. Purchases here means the figure after removing any goods that did not go to customers.
Goods taken by the owner are drawings. They leave the inventory, but they are not sales, so they do not belong in the cost of goods sold.
Worked example: with and without goods taken
A business has opening inventory of RM12 000, purchases of RM68 000 and closing inventory of RM15 500.
Ignoring the owner’s goods. Cost of goods sold = 12 000 + 68 000 − 15 500 = RM64 500.
The owner took goods bought for RM600. Debit Drawings RM600 and credit Purchases RM600. Purchases become 68 000 − 600 = RM67 400.
Cost of goods sold = 12 000 + 67 400 − 15 500 = RM63 900.
The two answers differ by exactly RM600. The first one charges the owner’s personal goods against the business’s sales.
How is closing inventory valued?
Value each item at the lower of its cost and net realisable value. Suppose an item was bought for RM1 000, but it is damaged. It can be sold for RM1 300 after a repair of RM500.
Net realisable value = 1 300 − 500 = RM800. The item is counted at RM800, not RM1 000, so the closing inventory falls by RM200.
The mistake that loses marks
The common slip is to leave the owner’s goods inside purchases and then also record drawings. This charges the cost twice, once to cost of goods sold and once to equity.
The repair is to think of where the goods went. Goods that left for the owner are drawings, so they come out of purchases and go into drawings.
Check yourself
Opening inventory is RM9 400, purchases are RM51 000 and closing inventory is RM11 200. The owner took goods bought for RM400. Find the cost of goods sold.
Answer
Adjusted purchases = 51 000 − 400 = 50 600.
Cost of goods sold = 9 400 + 50 600 − 11 200 = RM48 800.
The RM400 goes to drawings, not to the cost of goods sold.
What to study next
See where these figures appear in the final accounts through financial statements of a sole trader. Then use the adjustments practice set.
For a teacher to go through inventory and drawings on your own questions, see online one-to-one Accounting tuition.