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Professor please help me with this queries. Thank you.
When an inventory is lost and it is not insured so the expense charged in COS (SOPL) is moved to period expense?Question 1
Can you please tell me which expenses exactly Administration or Distribution expenses?Question 2
Secondly, please tell me why it is removed from cost of sales as in real it is a production expense? What is reason of charging in Period Expenses (one of above).I do not know why you write that it is moved to a period expense. If inventory is lost it is an expense and reduces the profit however we choose to show it.
Let me explain with a simple example. Suppose we have no opening inventory, the purchases are 500, the closing inventory (for the moment, nothing had been lost) is 100, and the sales are 600. In that case the cost of sales is 400 and the gross profit (and also the net profit if we ignore any other expenses) is 600 – 400 = 200. (So they are selling everything at a mark-up of 50% of cost).
Suppose now, for the same example, inventory of 60 has been lost (so the actual closing inventory is now 40). If we prepared the accounts in the normal way we would show the cost of sale as being 500 – 40 = 460, and the gross profit (and the net profit ignoring other expenses) as being 600 – 460 = 140. Although that is the correct net profit, it looks as though goods are being sold at a mark-up on cost of 140/460 = 30.4%. This is misleading because we are still selling everything we sell at a mark-up of 50% – the profit is lower because of the lost inventory.
So…..to make it more realistic, we add the lost inventory to the inventory that is left and so when calculating the gross profit we use inventory as 40 + 60 = 100. This gives the gross profit as 200 as before and a mark-up on cost of 50% (which is what we are actually selling at).
Then when calculating the net profit we take the gross profit of 200 and subtract the lost inventory of 60, which gives a net profit of 140.
The net profit is 140 in both cases and it is simply a change in presentation. There is no rule as to which way to present it (again the net profit is the same in both cases, and that it what matters most.)
If we do take the second approach, then again there is no rule but the 60 would normally be shown under administration expenses (although it is only obviously for limited companies that we need to categorise the expenses anyway).
For the purpose of incomplete records questions I suggest that you watch my free lectures on mark-ups and margins!
Amazing Explanation! I wish I could have teachers like you in my hometown. Thanks a lot Professor.
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