How stock movements affect cost of goods sold

The short answer

Stock is an asset while it sits in the warehouse. When goods are sold, IAS 2 requires the carrying amount of those goods to be recognised as an expense in the same period as the related revenue. That expense is the cost of goods sold. Gross profit is sales minus cost of goods sold, so an error in stock quantities or in unit costs goes straight into profit.

Which cost to assign

IAS 2 assigns cost by specific identification for items that are not ordinarily interchangeable, and by the first-in first-out (FIFO) or weighted average cost formula for items that are. LIFO is not among the permitted formulas. A weighted average can be calculated periodically or as each shipment is received; the second variant is often called a moving average.

A worked example

In the first article of this series the company bought 400 units at 10 each and sold 150 of them for 2,400. Cost of goods sold was 1,500 and 2,500 of stock remained. Suppose it then buys 250 more units at 14 and sells 100 units.

After the second purchase the stock holds 250 units at 10 and 250 units at 14, worth 6,000 in total, so the average cost is 12 per unit. The table above uses that average for the second sale. With FIFO the second sale would instead take the oldest units first:

Under FIFO the second sale costs 1,000 instead of 1,200, so profit is 200 higher while purchase prices are rising, and the stock left is worth 200 more. The total of stock value plus cost of the sale is the same, 6,000; the formulas only divide it differently between the balance sheet and the income statement. A company applies one formula consistently to similar items. IAS 2 also measures inventory at the lower of cost and net realisable value.

In TexaCore

This section describes the product. The stock record keeps a quantity and an average cost for each item in each warehouse. Every incoming movement recalculates the average as a weighted average of the stock on hand and the incoming quantity at its cost; an outgoing movement leaves the average unchanged. That is a moving average, so the first table above is the method the application follows.

When you post a sales invoice with stock lines, the entry includes a cost-of-sales debit and an inventory credit at that cost. Posting is refused if the cost-of-sales and inventory accounts are not set in the accounting settings, or if the items have no cost, so that revenue is not booked with a zero cost by accident. See warehouse management, accounting and reports.

Scope of this article

This article explains general accounting principles using IFRS terms and an invented company. Tax and statutory rules differ by country and are not covered; check them with a qualified accountant. The cost method of your own company should follow its accounting policy and local requirements.