Purchases/Sales Accounts in place of Goods Account

Goods/Stock a/c

In the initial stages of learning accountancy we use the element (account head) Goods or Stock. In analysing the transactions of purchase and sale, we conclude that one of the elements effected by those transaction is Goods/Stock.

Goods

  • A raw material or product that is bought and sold commercially
  • Articles of commerce
  • commodity

Stock

  • The merchandise that a shop has on hand
  • Inventory

The products that an organisation deals with in its business are what are identified as Goods.

Examples

  • For an organisation making and selling shoes, shoes are goods.
  • For an organisation which is in the business of buying and selling fertilizer, fertilizer is goods.
  • For an organisation in the business of making and selling aircrafts, aircrafts form goods.
  • For a road side vendor selling vegetables, vegetables form goods.

Goods/Stock vs. 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.

Examples

  • 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).

  • 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 and purpose for which it is being used.

Transaction of Sale » Profit included

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 ourselves 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 5,000", we cannot always assume that goods costing 5,000 are going out.

Assuming that the profit included in the value of sale is 1,000, we can say that goods costing 4,000 are being sold for 5,000.

Problem with using Goods/Stock a/c

Consider the following transactions of a trader...
  • Bought goods for cash 8,000
  • Bought goods from M/s Roddic & CO. on credit 12,000
  • Sold goods costing 9,000 for cash 15,000
  • sold goods costing 10,000 on credit to Mr. Tejamul 18,000
For the purpose of this explanation, consider that all the goods that are sold are delivered.

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 _____
Particulars Amount
(Dr)
Credit
(Cr)
Goods/Stock a/c
To Cash a/c
Dr
8,000

8,000
[Being the value of goods purchased for cash ]
Goods/Stock a/c
To Roddic & Co a/c
Dr
12,000

12,000
[Being the value of goods purchased on credit from M/s Roddic & CO., ]
Cash a/c
To Goods/Stock a/c
Dr
15,000

15,000
[Being the value of goods sold for cash ]
Mr. Tejamul a/c
To Goods/Stock a/c
Dr
18,000

18,000
[Being the value of goods sold on credit to Mr. Tejamul]

Posting » Goods/Stock a/c

Consider the postings made to the Goods/Stock a/c only.
Goods/Stock a/c
Dr Cr
Particulars Amount Particulars Amount
To Cash a/c
To M/s Roddic & Co. a/c
8,000
12,000
By Cash a/c
By Tejamul a/c
15,000
18,000
sub-total 20,000 sub-total 33,000
To Balance c/d 13,000    
Total 33,000 Total 33,000
    By Balance b/d 13,000

Credit balance in Goods/Stock a/c!!

The Goods/Stock a/c shows a credit balance. What does this mean? Is it appropriate to see a credit balance in the Goods/Stock a/c? If not. Why?

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.

  • 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. Goods of the value indicated by the balance are with the organisation.
  • 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 credits (going out) is greater than the total of debits (coming in).

    This is an indication that goods of the value greater than that with the organisation have been sold. Since, delivering goods that the organisation does not possess is not possible, this is inappropriate.

Considering Cost of goods sold

Had the sale transactions been recorded at the cost value of goods sold, then the goods/stock account would have been as under.

Recording Sales at Cost of Goods Sold

Consider the same transactions of the trader as above ...
  • Bought goods for cash 8,000
  • Bought goods from M/s Roddic & CO. on credit 12,000
  • Sold goods costing 9,000 for cash 15,000
  • sold goods costing 10,000 on credit to Mr. Tejamul 18,000

Profit = Sale Price - Cost Price

Profit made on
  • Cash Sale = 6,000 (15,000 − 9,000)
  • Credit Sale = 8,000 (18,000 − 10,000)

Recording sales at cost using Goods/Stock a/c

The Journal entries for recording the sale transactions, considering the cost of goods sold.
Journal in the books of M/s __ for the period from ____ to _____
Particulars Amount
(Dr)
Credit
(Cr)
Goods/Stock a/c
To Cash a/c
To Profit a/c
Dr
15,000

9,000
6,000
[Being the cost value of goods sold for cash and the profit made thereon]
Goods/Stock a/c
To Mr. Tejamul a/c
To Profit a/c
Dr
18,000

10,000
8,000
[Being the cost value of goods sold on credit to Mr. Tejamul and the profit made thereon]

Posting » Goods/Stock a/c

Consider the postings made to the Goods/Stock a/c only.
Goods/Stock a/c
Dr Cr
Particulars Amount Particulars Amount
To Cash a/c
To M/s Roddic & Co. a/c
8,000
12,000
By Cash a/c
By Tejamul a/c
9,000
10,000
sub-total 20,000 sub-total 19,000
By Balance c/d 1,000
Total 20,000 Total 20,000
To Balance b/d 1,000
Goods/Stock a/c now shows a debit balance of 1,000 which is the value of goods or unsold stock with the organisation.

The information provided by the Goods/Stock a/c is rational.

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.

Some of the reasons for not being able to identify the profit included in every sale transaction

  1. Organisations fix selling prices based on cost particulars of the previous period or an estimate of the cost in a future period.

    Example

    Sale price has been fixed on April 1st by taking the cost particulars of the previous period.
    • Cost per unit = 40
    • Profit per unit = 20 (50% on cost or 1/3 on sale)
    • Sale per unit = 60

    Either way there is no guarantee that the actual costs incurred during the course of business would match the costs that have been used in fixing selling prices. Thus, even if the same parameters (profit as a % of sale) are used for arriving at the cost based on the sale value, it may not reflect the appropriate cost of the goods being sold.

  2. The theoretical possibility of the existence of cost accounting records whereby the cost particulars of every item of sale being made can be ascertained distinctly and immediately without any effort at the point of sale is impractical.
  3. 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 and make use of them to get the cost of the item being sold at the point of sale.
  4. The cost benefit analysis of the cost of the effort to be made for recognising the element of profit included in a transaction of sale against the value of benefit derived from such an exercise would make it imprudent to try doing it.

The information relating to cost of goods sold in each transaction would be needed only for the purpose of recording the transaction with cost as the transaction amount and it serves no other purpose in general.

Thus, in practical accounting, a method that eliminates the need for ascertaining the cost of goods sold in each transaction is used for recording the transactions of sale.

Separate accounts for recording Purchases and Sales

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.

Purchases a/c

In place of Goods/Stock a/c while recording purchases, Purchases a/c is used in place of Goods/Stock a/c. The transaction value is the cost of purchase.

Sales a/c

In place of Goods/Stock a/c while recording sales, Sales a/c is used in place of Goods/Stock a/c. The transaction value is the sale value.

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
  • Bought Goods for cash 10,000 from M/s Shamir Jain & Co.,
  • Bought Goods on credit from M/s Ramdas & Bros. for 10,000.
  • Sold goods for cash 12,000 to Mr. Naryan Tiwari
  • Sold goods on credit to Mr. Natekar for 8,000
  • Paid M/s Ramdas and Brothers by cheque 5,000
  • Received from Mr. Natekar 2,000

Illustration - Solution [Journal & Ledger]

Journal in the books of M/s __ for the period from ____ to _____
Particulars Amount
(Dr)
Credit
(Cr)
Purchases a/c
To Cash a/c
Dr 10,000
10,000
[Being the value of goods purchased for cash ]
Purchases a/c
To M/s Ramdas & Bros. a/c
Dr 10,000
10,000
[Being the value of goods purchased on credit from M/s Roddic & CO., ]
Cash a/c
To Sales a/c
Dr 12,000
12,000
[Being the value of goods sold for cash ]
Mr. Natekar a/c
To Sales a/c
Dr 8,000
8,000
[Being the value of goods sold on credit to Mr. Natekar ]
M/s Ramdas & Bros. a/c
To Bank a/c
Dr 5,000
5,000
[Being the amount paid to M/s Ramdas & Bros. vide cheque no. ___ dated ____ towards dues ]
Cash a/c
To Mr. Natekar a/c
Dr 2,000
2,000
[Being the amount received from Mr. Natekar vide cash receipt no. ___ dated ___ towards dues ]

Ledger Posting

Purchases a/c
Dr Cr
Particulars Amount Particulars Amount
To Cash a/c
To M/s Ramdas & Bros. a/c
 
8,000
12,000
Sales a/c
Dr Cr
Particulars Amount Particulars Amount
By Cash a/c
By Natekar a/c
 
12,000
8,000
M/s Ramdas & Bors. a/c
Dr Cr
Particulars Amount Particulars Amount
To Bank a/c 5,000 By Purchases a/c
10,000
 
Mr. Natekar a/c
Dr Cr
Particulars Amount Particulars Amount
To Sales a/c 8,000 By Cash a/c
2,000
 

Purchases a/c and Sales a/c are 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 transaction as an expenditure towards purchase of goods. Goods are treated as assets even though they possess the characteristics of an asset. This is so irrespective of the magnitude and value of the product/item bought

Since purchases represents expenditure for the organisation and all accounts which are related to expenses and losses are nominal accounts, we can say Purchases a/c is a nominal account.