Accounting for Managers: Interpreting accounting information for decision-making

156 ACCOUNTING FOR MANAGERS

administration, finance etc.) costs of the business, i.e. those not directly concerned
with buying, making or providing goods or services, but supporting that activity.
To calculate the cost of sales, we need to take into account the change in
inventory, to ensure that we match the income from the sale of goods with the
cost of the goods sold. As we saw in Chapter 6,inventory (or stock)is the value of
goods purchased or manufactured that have not yet been sold. Therefore:

cost of sales=opening stock+purchases−closing stock

for a retailer, or:

cost of sales=opening stock+cost of production−closing stock

for a manufacturer. For a service provider, there can be no inventory of services
provided but not sold, as the production and consumption of services take place
simultaneously, so:

cost of sales=cost of providing the services that are sold

Financial statements produced for external purposes, as we saw in Chapter 6,
show merely the value of sales, cost of sales, gross profit, expenses and net profit.
For management accounting purposes, however, a greater level of detail is shown.
A simple example is:

Sales 1,000,000

Less:costofsales

Opening stock 250,000

Plus purchases (or cost of production) 300,000

Stock available for sale 550,000

Less closing stock 200,000

Cost of sales 350,000

Gross profit 650,000

Less period costs 400,000

Operating profit 250,000

Direct and indirect costs

Accounting systems typically record costs in terms of line items. As we saw
in Chapter 3, line items reflect the structure of an accounting system around
accounts for each type of expense, such as materials, salaries, rent, advertising
etc. Production costs (the cost of producing goods or services) may be classed as
direct or indirect.Direct costsare readily traceable to particular product/services.
Indirect costsare necessary to produce a product/service, but are not able to