Content Standard 6.2

Relationship Between the Trial Balance, Closing Inventory and Financial Statements

Hubungan antara Imbangan Duga, Inventori Akhir dan Penyata Kewangan

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Explanation

Inventory means the goods or stock that a business buys or produces with the intention of reselling them at a profit. For retailers and wholesalers, inventory refers to finished goods bought from suppliers and held until sold to customers. Within an accounting period there are two important types of inventory: opening inventory (stock at the beginning of the period) and closing inventory (unsold stock remaining at the end of the period). This standard focuses on how closing inventory is valued, recorded and then linked to the Trial Balance and the Financial Statements so that cost of sales and gross profit can be determined accurately.

There are two inventory recording systems. The periodic inventory system does not keep daily inventory records; instead the quantity and value of closing inventory are determined only through a physical stock count at the end of the accounting period. This system is simple and suits small businesses that carry many low-value items. The perpetual inventory system, on the other hand, updates the inventory record every time a purchase or sale occurs, usually using an inventory card or a computerised system, so that the inventory balance is known at any time. The perpetual system improves internal control and helps detect stock losses, but it costs more and needs more record-keeping.

Closing inventory is valued using the prudence principle (conservatism), that is, at the lower of cost and net realisable value (NRV). Cost is the purchase price plus the costs of bringing the inventory to its present condition and location, while net realisable value is the estimated selling price less the estimated costs of completing and selling the goods. This 'lower of the two' rule prevents a business from overstating its assets and profit. The inventory card is a document that records the inward movement (purchases) and outward movement (sales) of a particular item, complete with quantity, unit cost and balance, so that the value of closing inventory can be computed using methods such as first-in first-out (FIFO) or weighted average.

The link between inventory and the Trial Balance is often tested. Opening inventory appears on the debit side of the Trial Balance because it is brought forward from the previous period, but closing inventory does NOT appear in the Trial Balance. The reason is that closing inventory is known only after the physical stock count at the end of the period, that is after the Trial Balance has been prepared. Closing inventory is therefore treated as additional information (an adjustment) placed below the Trial Balance and recorded with the double entry: Debit Inventory (closing) and Credit the Income Statement (cost of sales section).

In the Financial Statements, closing inventory appears in TWO places. First, in the Income Statement it is deducted from the cost of goods available for sale to arrive at cost of sales, and this deduction increases gross profit. Second, in the Statement of Financial Position it is recorded as a current asset. The closing inventory of one period becomes the opening inventory of the next period. Accurate Financial Statements depend on understanding this flow: opening inventory (from the Trial Balance) enters cost of sales, while closing inventory (the adjustment) is deducted from cost of sales and carried to current assets.

Worked examples

Example 1: Double entry for closing inventory

Perniagaan Runcit Mekar Jaya closes its accounts on 31 December 2025. After a physical stock count, closing inventory is valued at RM8,500 (cost). This value does not appear in the Trial Balance because it is only known after the Trial Balance has been prepared.

The double entry to record closing inventory is: Debit Inventory RM8,500; Credit Income Statement (cost of sales) RM8,500.

Effect: the Inventory account (asset) increases by RM8,500 and is carried to the Statement of Financial Position as a current asset, while cost of sales falls by RM8,500, thereby increasing gross profit.

Example 2: Lower of cost and NRV rule

Bengkel Kraf Seri Wangi holds 100 units of an item at period end. Unit cost is RM50, so total cost is RM5,000. Because the goods are now obsolete, the estimated selling price is only RM45 per unit and selling costs are RM3 per unit, so net realisable value is RM42 per unit or RM4,200 in total.

Applying the prudence principle, closing inventory is valued at RM4,200 (NRV is lower than the RM5,000 cost).

Entry: Debit Inventory RM4,200; Credit Income Statement RM4,200. It is this RM4,200 that appears as a current asset, not RM5,000.

Example 3: Flow of inventory through cost of sales

Kedai Buku Ilmu Sakti has opening inventory RM6,000 (from the Trial Balance), purchases RM40,000 and closing inventory RM9,000 (adjustment). Cost of goods available for sale = RM6,000 + RM40,000 = RM46,000.

Cost of sales = RM46,000 - RM9,000 (closing inventory) = RM37,000.

Note: opening inventory enters cost of sales (from the Trial Balance), while closing inventory is deducted from cost of sales and at the same time carried to the Statement of Financial Position as a current asset of RM9,000.

Practice

Explain why opening inventory appears in the Trial Balance but closing inventory does not.

Answer: Opening inventory is the stock balance brought forward from the previous accounting period. It already exists in the records at the start of the period, so it appears on the debit side of the Trial Balance as an asset. Closing inventory, however, can only be determined after a physical stock count is carried out at the end of the period, that is after the Trial Balance has been prepared. Because its value is not yet known when the Trial Balance is drawn up, closing inventory is treated as additional information (an adjustment) and recorded with the double entry: Debit Inventory; Credit Income Statement.

Perniagaan Damai Sentosa has opening inventory RM12,000, purchases RM55,000, purchase returns RM2,000 and closing inventory RM10,000. Calculate cost of sales and show the double entry for closing inventory.

Answer: Net purchases = RM55,000 - RM2,000 = RM53,000. Cost of goods available for sale = opening inventory + net purchases = RM12,000 + RM53,000 = RM65,000. Cost of sales = RM65,000 - closing inventory RM10,000 = RM55,000. Double entry for closing inventory: Debit Inventory RM10,000; Credit Income Statement RM10,000. The closing inventory of RM10,000 is also carried to the Statement of Financial Position as a current asset.

Syarikat Tekun Maju holds 200 units of an item at a cost of RM30 per unit. The expected selling price is RM28 per unit and selling costs are RM1 per unit. Determine the value of closing inventory and state the principle used.

Answer: Total cost = 200 x RM30 = RM6,000. Net realisable value (NRV) per unit = RM28 - RM1 = RM27, so total NRV = 200 x RM27 = RM5,400. Under the prudence principle (conservatism), inventory is valued at the lower of cost and NRV. Since RM5,400 is lower than RM6,000, closing inventory is valued at RM5,400. It is this value that is recorded and carried to the Statement of Financial Position.

Compare the periodic inventory system with the perpetual inventory system in terms of how the value of closing inventory is determined.

Answer: In the periodic inventory system, inventory records are not updated with each transaction; the value and quantity of closing inventory are determined only through a physical stock count at the end of the accounting period. It is simple and inexpensive but does not provide an inventory balance at all times. In the perpetual inventory system, inventory records are updated every time a purchase or sale occurs, using an inventory card or a computerised system, so the inventory balance and value are known at any time. This system makes control and detection of stock losses easier but costs more and needs more record-keeping.

Exam tips

Key terms

Closing inventory: The value of unsold trading goods at the end of the accounting period; shown as a current asset and deducted in cost of sales.
Periodic inventory system: A system that determines the value of closing inventory only through a physical stock count at period end, without continuous records.
Perpetual inventory system: A system that updates the inventory record on every purchase or sale so that the inventory balance is always known.
Net realisable value (NRV): Estimated selling price less estimated costs to complete and sell the goods; compared with cost, and the lower of the two is used.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 4

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