- This topic has 6 replies, 2 voices, and was last updated 7 years ago by
.
- Posts
If closing inventory is overstated by $5000, $5000 is subtracted from the profit to correct it.
I thought it would be added back. Because closing inventory is subtracted from revenue, and if closing inventory was overstated by $5000 that means $5000 too much was subtracted before this correction.
What am I missing?
Closing inventory is not subtracted from the revenue, it is subtracted from the cost of sales (cost of sales = opening inventory + purchases – closing inventory).
So if we reduce inventory (because it is currently overstated) then it means the cost of sales is higher, and therefore profit is lower.
This is something else I stress in the lectures (are you watching the free lectures?) – that higher closing inventory means higher profit, and lower closing inventory means lower profit. It is something that is very commonly asked in several different types of questions.
Yes! I see my confusion. Thank you.
I only discovered the site when I started revising. I will try and watch the lectures on my areas of weakness. I have been using the revision materials and they have really cleared up a lot of similar points of confusion that I was having.
John one last thing about this topic, I hope you don’t mind!
I just saw this on an ACCA practice exam answer:
An increase in the amount of inventory held will have no impact on the gross profit of the company as only purchases that have been sold are charged as cost of sales.
^this has slightly confused me, in terms of the formula for cost of sales: cost of sales = opening inventory + purchases – closing inventory. Wont higher closing inventory mean lower cost of sales and so higher gross profit?
I appreciate your help on this.
It is a bit of a trick question.
In order to increase the inventory they would have to make more purchases. If both purchases and closing inventory increase, then there will be no change to the cost of sales (and therefore no change to the profit).
Changing the value of the inventory (because it had been valued wrongly) is different to changing the amount of the inventory. If the value is changed (for example, because it has been overstated) then the profit will change.
- The topic ‘profit and closing inventory’ is closed to new replies.