Product as Goods/Stock vs. Product as an Asset

The physical magnitude and the value of the product is immaterial in deciding whether it should be considered as goods/stock or not. A product that seems to be an asset in the general context might be stock for a business organisation. Eg: 01. For an organisation in the business of making and selling aircrafts, aircrafts form goods. But for any other organisation an Aircraft would be an Asset (even for organisations in the business of transportation or travel). 02. For an organisation buying and selling Motor Cars (a motor car dealer), motor cars would form goods or stock. But for any other organisation Motor Car would be an Asset. The same product that is treated as an asset in one organisation may form goods in another. Therefore in deciding whether a particular item is goods or an asset, we should look into the context in which it is being used.

Transaction of Sale » Profit included

"accountancy,basic,financial,accounting,process" One of the basic objectives of business is to earn profits. Profit is inherent in business. In the earlier stages of learning, we ignored the presence of profit element in the transactions of sale of goods. That was done to enable easier understanding and to guard the student from getting confused with too many aspects at the same time. We should understand that there is every possibility for the sales value to include a certain amount of profit. The value at which the sale is being made includes an element of profit in it except in cases where the goods are sold for loss or at cost value. When the interpretation of a transaction reads "Sold goods for cash Rs. 5,000", we cannot always assume that goods costing Rs. 5,000 are going out. If we know that the profit included in the value of sale is say Rs. 1,000, then we can say that goods costing Rs. 4,000 are being sold for Rs. 5,000.

Problem with using Goods/Stock a/c

Consider the following transactions of a trader... June15th: Bought goods for cash Rs. 8,000 June16th: Bought goods from M/s Roddic & CO. on credit Rs. 12,000 June18th: Sold goods for cash Rs. 12,000 June20th: Sold goods on credit to Mr. Tejamul Rs. 12,000 • Recording using Goods/Stock a/c The Journal entries for recording the above transactions of purchase and sale Journal in the books of M/s __ for the period from ____ to _____ Date V/R No. Particulars L/F Debit Amount (in Rs) Credit Amount (in Rs) June 15th – Goods/Stock a/c       To Cash a/c [Being the value of goods purchased for cash ] Dr – – 8,000 8,000 June 16th – Goods/Stock a/c       To Roddic & Co a/c [Being the value of goods purchased on credit from M/s Roddic & CO., ] Dr – – 12,000 12,000 June 18th – Cash a/c       To Goods/Stock a/c [Being the value of goods sold for cash ] Dr – – 12,000 12,000 June 20th – Mr. Tejamul a/c       To Goods/Stock a/c [Being the value of goods sold on credit to Mr. Tejamul ] Dr – – 12,000 12,000 • Posting » Goods/Stock a/c Consider the postings made to the Goods/Stock a/c only. Dr Goods/Stock a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs) 15/06/05 16/06/05 To Cash a/c To M/s Roddic       & Co. a/c – – 8,000 12,000 18/06/05 20/06/05 By Cash a/c By Tejamul a/c – – 12,000 12,000   sub-total   20,000   sub-total   24,000 20/06/05 To Balance c/d – 4,000           Total   24,000   Total   24,000         21/06/05 By Balance b/d – 4,000 • Balance in Goods/Stock a/c » Credit Balance!! The Goods/Stock a/c shows a credit balance. What does this mean? Why is it inappropriate to see a credit balance in the Goods/Stock a/c? Goods are assets and Goods/Stock a/c is a real account. It will be debited whenever the asset comes in and will be credited whenever the asset goes out. The Goods/Stock account may show a credit/debit/nil balance. » Debit Balance There will be a debit balance in the account as long as the total of debits (coming in) is greater than total of credits (going out). This is an indication that all the goods received have not been sold yet. The debit balance in the account indicates that we have an asset of that much value. » Nil Balance There will be no balance in the account if the total of debits (coming in) is equal to the total of credits (going out). This is an indication that all the goods received have been sold. » Credit Balance There will be a credit balance in the account as long as the total of debits (coming in) is less than total of credits (going out). This is an indication that goods have been sold without receiving them. What should the credit balance in the account indicate ?? There is a negative asset. This is improbable. The account is giving erroneous information. This happens on account of sales recorded with an element of profit in it.

Recording Sales at Cost of Goods Sold

Consider the same transactions of the trader as above ... June15th: Bought goods for cash Rs. 8,000 June16th: Bought goods from M/s Roddic & CO. on credit Rs. 12,000 June18th: Sold goods for cash Rs. 12,000 June20th: Sold goods on credit to Mr. Tejamul Rs. 12,000 • Cost of goods purchased = Rs. 8,000 + Rs. 12,000 = Rs. 20,000 • Value of Total Sales made = Rs. 12,000 + Rs. 12,000 = Rs. 24,000 Assume that the trader sells goods at a profit of 50% on cost (which shall be 1/3 on sales). • Profit included in the Sales value = Sales Value × Profit as a proportion of Sales = Rs. 12,000 × 1/3 = Rs. 4,000 in each sale transaction • Cost of Goods Sold = Sales Value − Profit included = Rs. 12,000 − Rs. 4,000 = Rs. 8,000 in each sale transaction • Cost of Goods remaining unsold = Cost of Goods Purchased − Cost of Goods Sold = Rs. 20,000 − (Rs. 8,000 + Rs. 8,000) = Rs. 4,000 in total The journal entries and the ledger postings for recording the transactions relating to purchase and sale would be the same. Only the amounts relating to the transactions of sale would be different. The transactions can be re-interpreted as June15th: Bought goods for cash Rs. 8,000 June16th: Bought goods from M/s Roddic & CO. on credit Rs. 12,000 June18th: Sold goods costing Rs. 8,000 at a profit of Rs. 4,000 (for cash Rs. 12,000) June20th: Sold goods costing Rs. 8,000 on credit at a profit of Rs. 4,000 to Mr. Tejamul (for Rs. 12,000) • Recording using Goods/Stock a/c The Journal entries for recording the above transactions of purchase and sale (considering the sale at cost of goods sold). Journal in the books of M/s __ for the period from ____ to _____ Date V/R No. Particulars L/F Debit Amount (in Rs) Credit Amount (in Rs) June 18th – Cash a/c       To Goods/Stock a/c       To Profit a/c [Being the value/cost of goods sold for cash and the profit made thereon] Dr – – 12,000 8,000 4000 June 20th – Mr. Tejamul a/c       To Goods/Stock a/c       To Profit a/c [Being the value/cost of goods sold for cash and the profit made thereon] Dr – – 12,000 8,000 4000 • Posting » Goods/Stock a/c Consider the postings made to the Goods/Stock a/c only. Dr Goods/Stock a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs) 15/06/05 16/06/05 To Cash a/c To M/s Roddic       & Co. a/c – – 8,000 12,000 18/06/05 20/06/05 By Cash a/c By Tejamul a/c – – 8,000 8,000   sub-total   20,000   sub-total   16,000         20/06/05 By Balance c/d – 4,000   Total   20,000   Total   20,000 21/06/05 To Balance b/d – 4,000         Goods/Stock a/c now shows a debit balance of Rs. 4,000 which is the value of goods or unsold stock with the organisation. The information provided by the Goods/Stock a/c is rational and there would not be any erroneous information thrown out by the account.

Difficulty in ascertaining Cost of Goods Sold

Will it be possible to find out the cost of goods sold relating to every sale? Surely not, in most cases. There are a lot of reasons for not being able to identify the profit included in every sale transaction Initially the selling price would be set based on the cost which makes it possible to know the percentage of profit included in the sale price. Sticking to that selling price would not be possible unless the organisation sells at fixed prices. Where the selling prices are being varied depending on the negotiations made with the customers, volume of sale, market conditions etc., it would not be possible to use the same percentages for assessing the cost of goods sold. All these being natural occurrences in business, it would become tough to assess the profit included in a sale and thereby the cost of goods sold. Theoretically, it would be possible to find the cost from the original price and then find the profit by comparing the actual price with the cost. This needs additional efforts to be put in. Where the organisation sells a lot of products, like in the case of many retail shops, the profit margins may not be the same on all the products. Even if the sales are made at fixed prices, there would be so many different percentages in use that it becomes difficult to remember and recognise the percentages. The effort to be made for recognising the element of profit included in a transaction of sale would look improbable as the benefit derived out of doing so is negligible. The information relating to cost of goods sold in each transaction would be needed only for the purpose of recording the transaction as above and it serves no other purpose in general. There are other methods which enable us to identify the profit being made and the cost of goods sold in total.

Separate accounts for recording Purchases and Sales

• Purchases a/c : Sales a/c On account of the improbableness of using Goods/Stock a/c for recording the transactions of Purchase and Sale of goods by finding out the cost of good sold, two separate account heads are created to record the transactions of purchase and sale, naming them "Purchases a/c" and "Sales a/c" respectively. Purchase Transaction » The element effected would be Purchases a/c (in place of Goods a/c) Sale Transaction » The element effected would be Sales a/c (in place of Goods a/c) Purchases are recorded at cost and Sales are recorded at the value for which the goods have been sold in the transaction. • Where is Goods a/c used? The Goods/Stock a/c is not used in practical accounting environments. We do not find its presence in the list of Chart of Accounts (list of Account Heads affected by transactions relating to business).

Illustration » Problem

Journalise the following transactions and prepare all possible ledger accounts from them.7 18th June: Bought Goods for cash Rs. 10,000 from M/s Shamir Jain & Co., 18th June: Bought Goods on credit from M/s Ramdas & Bros. for Rs. 10,000. 19th June: Sold goods for cash Rs. 12,000 to Mr. Naryan Tiwari 21st June: Sold goods on credit to Mr. Natekar for Rs. 8,000 24th June: Paid M/s Ramdas and Brothers by cheque Rs. 5,000 24th June: Received from Mr. Natekar Rs. 2,000

Illustration » Solution [Journal & Ledger]

Journal in the books of M/s __ for the period from ____ to _____ Date V/R No. Particulars L/F Debit Amount (in Rs) Credit Amount (in Rs) June 18th – Purchases a/c       To Cash a/c [Being the value of goods purchased for cash ] Dr – – 10,000 10,000 June 18th – Purchases a/c       To M/s Ramdas & Bros. a/c [Being the value of goods purchased on credit from M/s Roddic & CO., ] Dr – – 10,000 10,000 June 18th – Cash a/c       To Sales a/c [Being the value of goods sold for cash ] Dr – – 12,000 12,000 June 19th – Mr. Tejamul a/c       To Sales a/c [Being the value of goods sold on credit to Mr. Tejamul ] Dr – – 12,000 12,000 • Ledger Posting Dr Purchases a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)                 25/06/05 25/06/05 To Cash a/c To M/s Ramdas       & Bros. a/c – – 8,000 12,000         Dr Sales a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)                         18/06/05 19/06/05 By Cash a/c By Mr. Tejamul a/c – – 12,000 12,000                 Dr M/s Ramdas & Bors. a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)                         18/06/05 By Purchases a/c – 12,000                 Dr Mr. Tejamul a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)                 19/06/05 To Sales a/c – 12,000

Purchases a/c, Sales a/c » Nominal Accounts

• Sales a/c Sales represents income (also called revenue) for the organisation. Since all those accounts which are related to incomes and gains are nominal accounts, we can say Sales a/c is also a nominal account. There is a certain element of profit included in the value of sales. Even this fact supports the treatment of Sales a/c as a nominal account. • Purchases a/c While purchasing the products/items that we use for the purpose of business, we treat the purchase as purchase of goods and not as purchase of an asset. This is so irrespective of the magnitude and value of the product/item bought We treat purchase of goods as expenditure incurred for the purpose of the business and not towards purchasing an asset. Thereby the value of goods purchased would indicate the expenditure incurred in buying the goods for the purpose of the business. Therefore purchases represent expenditure for the organisation. Since all those accounts which are related to expenses and losses are nominal accounts, we can say Purchases a/c is a nominal account.

Purchases a/c balance represents an asset !!

To understand how and why this is so, let us consider an example. Mr. Zerard started a business on 30th December with a Capital of Rs. 10 lakhs in Cash. On the same day he bought Furniture worth Rs. 6 lakhs and Stock worth Rs. 3 lakhs for the shop whereby the organisation is left with a cash balance of Rs. 1,00,000. Furniture a/c (representing an asset) is a Real account. Thus the organisation would say, it has an asset (in the form of Furniture) worth Rs. 6,00,000 . Cash a/c (representing an asset) is a Real account. Thus the organisation would say, it has an asset (in the form of cash) worth Rs. 1,00,000. Purchases a/c (representing an expenditure) is a Nominal account. Thus the organisation would say, it has incurred an expenditure of Rs. 3,00,000. The organisation spent another Rs. 50,000 on other expenses the next day. The cash balance left with it would be Rs. 50,000. At this point, the organisation would say, that It has assets worth Rs. 6,50,000 (Furniture - Rs. 6,00,000 + Cash - Rs. 50,000) and It has incurred an expenditure of Rs. 3,50,000 (Rs. 3,00,000 on Stock + Rs. 50,000 on others). For some reason, Mr. Zerard decided to dispose off the business on January 1st. He had a friend who was willing to take up the business and pay for whatever assets he had in the business forgetting the expenses he incurred till then. Since Mr. Zerard was compelled to sell, he agreed to the proposal. What would Mr. Zerard's claim be? Would it be Rs. 6,50,000 (Furniture - Rs. 6,00,000 + Cash - Rs. 50,000) or Rs. 9,50,000 (Furniture - Rs. 6,00,000 + Stock - Rs. 3,00,000 + Cash - Rs. 50,000) or Rs. 9,50,000 for sure. If that is acceptable, then we are accepting the fact that the stock purchased is an asset. Thus we say that purchases/goods has dual nature. At the time of purchase goods we treat it as expenditure incurred. But when we are required to state the value of our assets we include that within our list of assets. For all practical purposes, just consider the Purchases a/c to be a nominal account. We create and use a separate account to represent the value of goods purchases as and when that value is to be treated as an asset.

Author Credit : The Edifier

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