Goods may be unsold at the end of an accounting period and therefore, still be in stock. The purchase cost of these goods should therefore NOT be included in the cost of sales of the period.
For example, suppose Widgets & Co (who have no stock at the start of the year) purchase 40,000 widgets for £20,000 and sold 30,000 of them for £2. Total sales for the year are therefore 30,000 x £2 = £60,000. At the end of the year, there are 10,000 unsold widgets in stock, valued at £0.50 each.
Widgets & Co have purchased 40,000 widgets, but only sold 30,000. Purchase costs of £20,000 and sales of £60,000 do not relate to the same quanitity of widgets (goods).
The gross profit for the year should be calculated by “matching” sales to the cost of those widgets that have been sold. Therefore, the gross profit is:
Sales (30,000 x £2) £60,000
Purchases (40,000 x £0.50) £20,000
Less closing stock (10,000 x £0.50) £5,000
Cost of Sales (30,000 widgets) £15,000
Gross Profit (£60,000 – £15,000) £45,000
Therefore only the purchase cost of the widgets that have been sold are actually taken into account in calculating the cost of sales and therefore, the gross profit for the period.
The cost of the unsold widgets are shown in the balance sheet.