Question

Each time inventory is sold, two transactions occur: revenues (sales) are recorded, and inventory is used up to become an expense. This means two journal entries are recorded:

DR Cash (or accounts receivable if on account)
     CR Sales
(to record sales revenues earned)

DR Cost of Goods Sold
     CR Inventory
(To record inventory becoming the expense of the sale)

Consider the impact of recording these two transactions.   What key profit factor do you learn from this journal entry?   What does recording this transaction tell you about the gross profit on each sale? Does this gross profit indicate overall profitability?  

Answer 1

whenever inventory is sold, two journal entries are recorded:

DR Cash (or accounts receivable if on account)
     CR Sales
(to record sales revenues earned)

DR Cost of Goods Sold
     CR Inventory
(To record inventory becoming the expense of the sale)

Considering these two journal entries , see the below explanations:

1. Key profit factor:

Key profit factor learned from these transactions, is the gross profit on sales of product .

these recorded entries show,

if the cost of goods sold is less than the Sales value of product , there will be gross profit.

  if the cost of goods sold is more than the Sales value of product , there will be gross loss.

2.

Gross profit on sale:

These transactions show that every time inventory is sold ,

Total sale amount received on product is credited as revenue.

and cost of manufacturing the product sold is debited as expense.

Gross profit is calculated as :

Gross profit = Sales - cost of goods sold

thus the difference between the sale price and cost of each product will be the gross profit generated on each product.

3.

Overall profitability:

to answer the third question in this case,

No, Gross profit does not indicate the overall profitability.

this is just the gross profit which is derived by deducting the manufacturing and direct costs from the product sold.

There are other cost involved in the business , which are not directly attributed to the product.

these are indirect costs,

Such as selling overheads, Admisitrative overheads etc.

after deducting these costs from the gross profits, The overall profit ( also called as net profit ) is derived .

Finish.

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