Adjusting Closing Stock for Trial Balance in Financial Statements

When preparing for a trial balance, the adjustment for closing stock or inventory is a crucial step to ensure the financial statements accurately reflect the current financial position of a business. This guide will walk you through the process of determining and adjusting closing stock, its impact on the profit and loss account, the necessary journal entries, and its reflection in the balance sheet.

Adjustment for Closing Stock

Determining Closing Stock Value: The first step is to ascertain the value of the closing stock at the end of the accounting period. This can be achieved through physical inventory counts or inventory valuation methods such as FIFO (First-In, First-Out), LIFO (Last-In, First-Out), or the weighted average method.

Adjust the Profit and Loss Account

The value of the closing stock is deducted from the Cost of Goods Sold (COGS) in the income statement. This adjustment increases the profit for the period because it reflects the inventory that has not been sold yet. Essentially, it acts as an offset to the COGS, indicating the value of goods available for sale and not yet sold.

Example

Suppose the closing stock is valued at $10,000.

In the Income Statement: Reduce COGS by $10,000. In the Trial Balance: List the closing stock as a debit under current assets for $10,000.

Summary: The adjustment for closing stock decreases COGS, increases profit, and adds to current assets. This ensures the trial balance accurately reflects the business's financial position at the end of the accounting period.

Unsold Closing Stock as Next Year's Opening Stock

According to Finance Strategists, the unsold closing stock of the current year serves as the opening stock for the next year. Since this unsold stock will be sold in the following year, its cost is not considered an expense of the current year but rather an expense in the subsequent year when it is sold. This makes it necessary to record it on the credit side of the trading account.

Journal Entries

If showing closing stock in the trial balance: Stock A/C Dr To Purchases A/C

The justification for this entry is that a percentage of purchases that is not sold is shown as closing stock. Therefore, the stock account is debited, and the purchase account is credited.

If the valuation of closing stock is done after preparing the trial balance: Stock A/C Dr
To Trading A/C

The rationale here is to determine profit by subtracting sales from the cost of goods sold (COGS). The formula for COGS is: Opening stock Purchases - Closing stock. Hence, the trading account is credited with the closing stock value to accurately reflect the COGS.

Finally, the closing stock is shown at the asset side of the balance sheet under the heading of current assets, ensuring a comprehensive and accurate financial statement.