How accounting treats goods a business gives away free

A business sometimes lets goods leave with no money coming back. A shop hands out free samples. A bakery sends unsold stock to a flood-relief collection.

A stationer gives exercise books to a nearby school. The goods were bought with the business’s money, so their cost is already in purchases.

The goods will never be sold. The question is where their cost should go, and why the answer this time is not drawings.

Why the cost begins its life inside purchases

When the business bought this stock, it meant to sell it. The cost went into purchases and feeds into cost of sales. Nothing marked these items as different.

The complication comes later, when some leave as a gift, a sample or a donation. Their cost is recorded as part of the goods available to sell, when it was always going somewhere else.

The first move is familiar; the destination is not

If you have met goods taken by the owner for personal use, the first step will look familiar. The goods were neither sold nor left in closing inventory, so their cost cannot stay in purchases.

If it does, cost of sales absorbs it as though the goods were sold, and gross profit is understated for a reason unrelated to trading. So the cost is taken out of purchases.

The second step differs. Goods the owner keeps become drawings. Goods the business gives away for its own purposes become an expense, and which expense depends on why they were given.

Free samples are an advertising cost

Handing out samples spends value to attract customers, the same aim as a poster or paid advertisement, but paid in stock instead of cash. The cost is an advertising or promotion expense. It sits in the income statement below gross profit, among running costs.

The matching concept supports this: a cost incurred to generate sales belongs against that period’s revenue. Giving away RM500 of product to win business is RM500 spent on marketing.

Donated stock is a donation

When goods go to a charity, community event or school with no expectation of custom, the cost is recorded as a donation. It is also an income statement expense, under its own heading.

Advertising aims to sell more. A donation is a gift with no commercial purpose. In both cases the goods left for a purpose of the business, so the cost is a business cost, not a withdrawal by the owner.

Why drawings would be the wrong home

Drawings means the owner taking value out for their own benefit. That is not what happened.

The owner gained nothing personally. The business chose to promote itself or support a cause.

Under the business entity concept, the business is separate from its owner, and here the business gave up the value. Recording the gift as drawings would wrongly reduce the owner’s capital and leave profit for the year untouched, hiding a real business expense.

The goods leave at cost, never at selling price

The cost that leaves purchases is what the goods cost, not what a customer might have paid. No sale took place, so no profit has been earned, and the realisation concept recognises profit only when it is made.

Valuing the samples at selling price would credit the business with profit on goods it gave away.

What happens to the two profit figures

Because the cost is taken out of purchases, cost of sales counts only goods that reached paying customers. Gross profit is protected in both cases. Below that line, the paths diverge.

Goods taken by the owner become drawings and never touch profit for the year. Goods given away as advertising or donations are expenses, so they reduce profit for the year. That is correct, because the business gave up real value.

Why the distinction is worth getting right

Two lots of goods can leave a business in much the same way but land in different places. One goes in the capital section as drawings.

The other goes in the income statement as an expense. The difference is who the leaving was for.

If it served the owner, it is drawings. If it served the business, to sell more or to give, it is a cost of the year.

If your child can move goods out of purchases for drawings but hesitates over free stock, one of our teachers can show why samples become advertising. Book a trial class to try it.

Syllabus reference: Cambridge 0452 and 0985, syllabus for 2027 to 2029, sub-topic 6.2 Interpretation of accounting ratios (page 18).