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Hallo,
I am wondering in the example below why do we credit Trading a/c and not Inventory a/c instead, when there’s a loss – inventory decreases, doesn’t it?
Example:
How should a loss of inventory (value $15,000) caused by flooding in the company’s warehouse be
accounted for? (Assume the inventory loss is not insured.)Solution
Dr I/S a/c $15,000
Cr Trading a/c $ 15000
– mentioning further in the solution that loss is not part of cost of sales, but the Trading a/c includes cost of sales as well, so is it our choice not to include it or it depends on the inventory method we decide to use?Thank you!
The entry in the inventory account is for the actual inventory at the end of the year.
However, if that inventory is lower that it should have been (because some was lost) then it will distort the gross profit because purchases less inventory will not be the cost of what was actually sold.
So….we credit the trading account so that it does show the gross profit on what was actually sold.
We need to debit the income statement because even though we are showing the true gross profit on what was sold, we do need to charge against the profit the loss on the inventory that disappeared.
Hallo,
I am rereading this example and wondering, what is the difference between the I/S a/c and the Trading a/c?
I thought the Trading a/c is part of the I/S a/c.
Thank you!
The trading account is the name given to the first part of the Statement of profit or loss (the Income Statement).
It is the part that gets to the gross profit.Hallo,
How can we debit and credit these two at the same time, when they both make the SOPOL?
If we dr the I/S a/c with a loss, it is so, because it is an expense for us.
But, why do we credit the trading a/c with it?
Thank you!
We credit the trading account simply to show the correct gross profihe goods that were actually sold.
We debit the income statement because it has lost us money.
The net effect on the final net profit is zero – we only do it so as to show the ‘real’ gross profit on what we actually sold.
Hallo,
But, even though the net effect on the final net profit is zero, don’t we really have less profit, if we have lost inventory, doesn’t it mean we have less profit?
I thought that after we get to the gross profit, we subtract this loss, to get to the net profit, but obviously not.
Thank you!
We do have less profit.
Consider this. We well goods for 100. We have purchases of 80. No opening inventory, and closing inventory of 20.
So the profit is 40.
Suppose exactly the same question, but 5 of the inventory has been stolen, so the inventory is 15.
What we could do is say cost of goods sold is 80 – 15 = 65. So the profit is 100 – 65 = 35.
But if we show this as the gross profit, then it looks as though we are selling things cheaper. But we are not, the profit is lower because of the theft not because we are selling things cheap.
So…..we when calculating the gross profit we show the closing inventory at 15 + 5 = 20, and therefore the gross profit is 40. But then we subtract the loss from the gross profit and arrive at a net profit of 35.
Same net profit, but better presentation.
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