Inventory Systems (Grade 11 NSC Matric Accounting): Revision Notes
Recording Trading Stock
Introduction to trading stock
Trading stock, also called inventory, refers to goods that a business purchases with the intention of reselling them to customers. For accounting purposes, businesses must keep accurate records of their trading stock to track what they own and to calculate their profit correctly. The way a business records its trading stock depends on which inventory system it uses.
There are two main systems for recording trading stock: the perpetual stock system and the periodic stock system. Each system has different methods and requirements for tracking inventory throughout the financial year.
Understanding the difference between these two systems is fundamental to recording stock transactions correctly. The system used affects when transactions are recorded, which accounts are used, and how easily problems can be detected.
Understanding inventory systems
The choice of inventory system affects how a business maintains its records, when it records transactions, and how easily it can detect problems with stock. Both systems ultimately require a physical stock take at the end of the financial year, but they differ significantly in their day-to-day operations.
The perpetual stock system
Under the perpetual stock system, businesses maintain continuous, up-to-date records of all stock movements. This means that every time goods are purchased, sold, returned, or donated, the business immediately records the transaction in the Trading stock account.
How it works:
- The business keeps a Trading stock account in the General Ledger that is updated throughout the year
- Every purchase of stock is debited to the Trading stock account
- Every sale, donation, or other decrease in stock is credited to the Trading stock account
- At any point during the year, the balance of the Trading stock account should match the actual physical stock in the business
- The cost of sales is recorded as each transaction takes place, not at the end of the year
Key advantages:
- Stock levels are always known without needing to count
- Stock deficits (shortages due to theft, damage, or errors) can be detected when the physical stock take is done
- Better control over inventory throughout the year
- More accurate, real-time information for decision-making
Even though records are kept continually, businesses using the perpetual system must still conduct a physical stock take at the end of the financial year. This physical count serves as a check against the records and helps identify any discrepancies.
The periodic stock system
Under the periodic stock system, businesses do not maintain a Trading stock account during the year. Instead, they only determine the value of their stock at the end of the financial year through a physical stock take.
How it works:
- No Trading stock account is used during the financial year
- Purchases are recorded in a separate Purchases account (not Trading stock)
- The business only knows its exact stock value when it conducts a physical stock take at year-end
- Cost of sales must be calculated at the end of the financial year using the formula: Opening stock + Purchases - Closing stock = Cost of sales
- Stock on hand throughout the year is unknown without conducting a special count
Important considerations:
- Stock deficits may not be discovered since there are no records to compare against
- Less control over inventory during the year
- Simpler record-keeping but less information available
- Still requires a physical stock take at year-end to determine closing stock value
Comparing the two systems
Understanding the differences between these systems helps you choose the appropriate accounting treatment for different business scenarios. Here is a comprehensive comparison:
| Feature | Perpetual stock system | Periodic stock system |
|---|---|---|
| Updating frequency | Stock is updated continually throughout the year | Stock is only updated at year-end |
| Year-end requirement | The value of stock must be determined by a physical stock take at the end of the year | The value of stock must be determined by a physical stock take at the end of the year |
| Trading stock account | The balance of the Trading stock account should be equal to the value of the actual stock in the business | No Trading stock account is used during the year |
| Deficit detection | Trading stock deficits could be detected by comparing physical count to records | Trading stock deficits may not be discovered since no records exist to compare |
| Cost of sales | Cost of sales is recorded as the transaction takes place | Cost of sales must be calculated at the end of the financial year |
Recording transactions under the perpetual stock system
Let's examine how transactions are recorded using the perpetual system through a practical example.
Worked Example: Mbedzi Stores (perpetual system)
Mbedzi Stores uses the perpetual stock system. During May 20.1 (their financial year-end), they had the following transactions:
Given information:
- Trading stock on hand on 1 May 20.1: R17 000
- Merchandise purchased and paid for by cheque: R9 500
- Trading stock purchased on credit: R9 655
- Donation of goods to local charity: R600
- Cost price of goods sold on credit: R6 600
- Cost price of goods sold for cash: R3 560
- Cost price of goods returned by debtors: R1 125
- Goods returned to suppliers: R750
- The owner took merchandise for personal use: R2 000
- Transport of merchandise paid by cheque: R340
- Physical stock take on 31 May 20.1 showed actual stock: R24 000
Important note about an error: Trading stock bought on credit for R250 during April was incorrectly recorded in the packing materials column of the Creditors Journal. This error must be corrected.
How to record these transactions:
Step 1: Start with the opening balance The Trading stock account begins with a debit balance of R17 000 (stock on hand at the start)
Step 2: Record increases to stock (debit entries)
- Merchandise purchased for cash: R9 500
- Trading stock purchased on credit: R9 655
- Goods returned by debtors: R1 125 (these items come back into stock)
- Correction entry for April error: R250 (this stock was purchased but not recorded correctly)
Step 3: Record decreases to stock (credit entries)
- Donation to charity: R600 (stock given away)
- Cost of goods sold on credit: R6 600 (stock sold)
- Cost of goods sold for cash: R3 560 (stock sold)
- Goods returned to suppliers: R750 (stock sent back)
- Owner's drawings: R2 000 (owner took stock for personal use)
Step 4: Note about transport costs Transport of R340 is a separate expense and is NOT recorded in the Trading stock account. It goes to a Carriage on purchases or Transport expense account.
Step 5: Calculate the expected balance After recording all transactions, calculate what the balance should be according to your records.
Step 6: Compare with physical stock take The physical count shows R24 000. If your calculated balance differs from R24 000, there is a stock shortage (deficit) that needs to be investigated and recorded.
Exam tip: In perpetual system questions, always check that your closing balance matches the physical stock take value provided. If it doesn't match, you may have missed a transaction or made a calculation error.
Recording transactions under the periodic stock system
Under the periodic system, the approach is quite different because no Trading stock account is maintained during the year.
Worked Example: Sefatsa Traders (periodic system)
Sefatsa Traders uses the periodic stock system. They had the following transactions during May 20.2:
Transactions:
- Purchased merchandise from Kwezi Limited and paid by cheque: R7 000
- Purchased merchandise on credit from Zion Wholesalers: R23 000
- Sold merchandise on credit to Lesego Seane for R9 000 (Sefatsa uses a 25% profit mark-up on cost price)
- Returned merchandise to Zion Wholesalers, cost price: R400
- Sold goods for cash, cost price R2 580, at cost plus 25%
- Lesego Seane returned goods previously sold to him for R1 250
Additional information:
- Stock on hand at start (1 May 20.2): R2 400
- Stock on hand at end (31 May 20.2): R23 220
Recording approach for periodic system:
Step 1: No Trading stock account during the year Purchases are recorded in a Purchases account, not a Trading stock account
Step 2: At year-end only
- Record the closing stock value (R23 220) as a debit in the Trading stock account
- Record the opening stock value (R2 400) as a credit in the Trading stock account
- The difference shows the change in stock levels
Step 3: Calculate cost of sales at year-end
Use the cost of sales formula:
Cost of Sales = Opening Stock + Purchases - Closing Stock
Understanding mark-up percentages:
When a business marks up goods by 25% on cost price:
- If cost price = R100
- Mark-up = R100 × 25% = R25
- Selling price = R100 + R25 = R125
To calculate cost price when you know selling price:
- Selling price = Cost + 25% of Cost = 125% of Cost
- If selling price = R9 000, then Cost = R9 000 ÷ 1.25 = R7 200
Calculating stock losses and purchases
Sometimes you need to work backwards to calculate missing figures. This is particularly common with periodic system questions.
Worked Example: Calculating purchases (Mthombeni Stores)
Given information for the year ended 31 May 20.2:
- Trading stock (1 June 20.1): R120 000
- Trading stock (31 May 20.2): R180 000
- Cash sales for the year: R500 000
- Debtors control (1 June 20.1): R160 000
- Debtors control (31 May 20.2): R145 000
- Receipts from debtors during year: R615 000
- Stock returned by debtors during year: R20 000
- Gross profit percentage on cost: 25%
Task: Calculate the cost price of merchandise purchased during the year.
Solution approach:
Step 1: Find total sales
- Cash sales: R500 000
- Credit sales: Calculate from Debtors control account
- Opening balance: R160 000
- Add: Credit sales (unknown)
- Less: Receipts (R615 000)
- Less: Returns (R20 000)
- Equals: Closing balance R145 000
- Credit sales = R145 000 + R615 000 + R20 000 - R160 000 = R620 000
- Total sales = R500 000 + R620 000 = R1 120 000
Step 2: Calculate cost of sales
- Gross profit is 25% on cost
- If cost = 100%, then selling price = 125%
- Cost of sales = R1 120 000 ÷ 1.25 = R896 000
Step 3: Use cost of sales formula to find purchases
- Cost of Sales = Opening Stock + Purchases - Closing Stock
- R896 000 = R120 000 + Purchases - R180 000
- Purchases = R896 000 - R120 000 + R180 000 = R956 000
Exam tip: Always work systematically through T-accounts when you need to find missing figures. The Debtors control account is particularly useful for finding credit sales.
Determining stock losses
When disaster strikes and stock is destroyed, you can calculate the value of lost stock using the periodic system formulas.
Worked Example: Stock destroyed (Mathe Traders)
Scenario: Mathe Traders' store was destroyed in a rain storm during May 20.3, but stock valued at R94 000 was saved. The business adds 100% profit on cost price (this means they double the cost price to get selling price).
Given information:
- Sales: R980 000
- Purchases: R760 000
- Trading stock (beginning of year): R120 000
- Customs duties: R20 000
- Stock saved: R94 000
Solution:
Step 1: Calculate cost of sales
- Selling price = Cost + 100% of Cost = 200% of Cost
- Cost of sales = R980 000 ÷ 2 = R490 000
Step 2: Calculate what closing stock should have been
- Cost available for sale = Opening stock + Purchases + Customs duties
- Cost available for sale = R120 000 + R760 000 + R20 000 = R900 000
- Expected closing stock = Cost available - Cost of sales
- Expected closing stock = R900 000 - R490 000 = R410 000
Step 3: Calculate stock destroyed
- Expected closing stock: R410 000
- Less: Stock saved: R94 000
- Stock destroyed: R316 000
Note on customs duties: Import duties paid on goods purchased are added to the cost of those goods, so they increase the total cost of stock available for sale.
Key accounting entries
Key Points to Remember:
For perpetual stock system:
- Purchase stock for cash: Dr Trading stock, Cr Bank
- Purchase stock on credit: Dr Trading stock, Cr Creditors control
- Sell stock (record cost): Dr Cost of sales, Cr Trading stock
- Return stock to supplier: Dr Creditors control, Cr Trading stock
- Stock returned by customer: Dr Trading stock, Cr Cost of sales
- Donations/drawings of stock: Dr Donations/Drawings, Cr Trading stock
For periodic stock system:
- Purchase stock: Dr Purchases, Cr Bank/Creditors (NOT recorded in Trading stock)
- Sales: Dr Debtors/Bank, Cr Sales (stock account not affected)
- At year-end only: Dr Trading stock (closing), Cr Trading account
- At year-end only: Dr Trading account, Cr Trading stock (opening)
Exam tips for recording trading stock
Critical Exam Success Points:
- Always check which system is being used - perpetual or periodic - as this determines your entire approach
- Under perpetual system, every stock movement must be recorded in the Trading stock account immediately
- Under periodic system, purchases go to a Purchases account, and Trading stock is only touched at year-end
- Physical stock takes are required for both systems at the end of the financial year
- Stock deficits can only be detected under the perpetual system by comparing records to physical count
- Cost of sales in perpetual system is recorded as goods are sold; in periodic system it's calculated at year-end
- Watch for tricky transactions: donations, drawings, returns (both to suppliers and from customers)
- Transport costs are usually expenses, not part of stock cost (unless stated otherwise)
- Mark-up percentages: Make sure you understand whether it's mark-up on cost or margin on selling price
- When calculating backwards, use T-accounts to track your working systematically
Remember!
Key Points to Remember:
-
Trading stock can be recorded using two systems: perpetual (continuous updates) or periodic (year-end only).
-
Perpetual system advantages: Stock is updated continually, deficits can be detected, and you always know your stock levels. A Trading stock account is maintained throughout the year.
-
Periodic system characteristics: No Trading stock account during the year, cost of sales calculated at year-end, and stock deficits may go undetected. Simpler but provides less control.
-
Both systems require a physical stock take at the end of the financial year to verify the actual stock value.
-
Cost of sales formula (periodic system): Opening Stock + Purchases - Closing Stock = Cost of Sales. This formula is essential for year-end calculations and finding missing figures.