Inventory & Cost of Goods Sold
Merchandise a business purchases and holds for resale to customers is called ________.
What is Inventory?
Explanation: Inventory consists of goods a business owns and intends to sell to customers. Until those goods are sold, Inventory is reported as a current asset on the Balance Sheet.
Exam Tip: Inventory is an asset, not an expense, while the merchandise is still held for sale.
Entries made at the end of an accounting period to update account balances before financial statements are prepared are called ________.
What are Adjusting Entries?
Explanation: Adjusting entries make sure revenues and expenses are recorded in the correct accounting period before the financial statements are prepared.
They are commonly needed for items such as prepaid expenses, supplies used, accrued expenses, accrued revenue, depreciation, and unearned revenue.
Exam Tip: Think: Adjust first → Prepare financial statements next.
Before merchandise is sold to a customer, Inventory is reported as a ________ on the Balance Sheet.
What is a Current Asset?
Explanation: Inventory is expected to be sold during the normal operating cycle of the business, so it is generally classified as a current asset.
When inventory is sold, its cost is removed from Inventory and becomes Cost of Goods Sold.
Exam Tip:
Before sale → Inventory (Asset)
After sale → Cost of Goods Sold (Expense)
Insurance paid in advance for coverage that will benefit future accounting periods is initially recorded as ________.
What is Prepaid Insurance?
Explanation: When insurance is paid before the coverage is used, the payment provides a future benefit. Therefore, it is initially recorded as an asset called Prepaid Insurance.
As the insurance coverage is used, part of the asset becomes Insurance Expense.
Initial Entry:
Debit Prepaid Insurance
Credit Cash
Adjusting Entry as coverage is used:
Debit Insurance Expense
Credit Prepaid Insurance
Exam Tip: Paid now, used later = Prepaid Asset.
When merchandise is sold, the cost of that merchandise is transferred from Inventory to ________.
What is Cost of Goods Sold?
Explanation: Cost of Goods Sold, commonly called COGS, represents the cost to the business of the merchandise that was actually sold to customers.
For example, suppose a business buys an item for $40 and later sells it for $75. The $75 is Sales Revenue, while the $40 cost becomes Cost of Goods Sold.
Exam Tip: Don't confuse what the customer pays with what the merchandise cost the business.
A business sells merchandise for $7,500 that originally cost the business $4,200. The Cost of Goods Sold is ________.
What is $4,200?
Explanation: COGS is based on what the merchandise cost the business, not the amount charged to the customer.
Sales Revenue = $7,500
Cost of Goods Sold = $4,200
The difference between Sales Revenue and COGS is called Gross Profit.
Exam Tip:
Sales Revenue − COGS = Gross Profit
A business has Sales Revenue of $7,500 and Cost of Goods Sold of $4,200. Gross Profit is ________.
What is $3,300?
Explanation: Gross Profit measures how much remains from sales after subtracting the cost of the merchandise sold.
Sales Revenue − Cost of Goods Sold = Gross Profit
$7,500 − $4,200 = $3,300
The $3,300 is not necessarily Net Income. The business may still have rent, wages, utilities, advertising, and other operating expenses to deduct.
Exam Tip: Keep these two calculations separate:
Sales − COGS = Gross Profit
Gross Profit − Operating Expenses = Net Income