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.
A deposit recorded by the business but not yet appearing on the bank statement is called this.
Correct Response: Deposit in transit
Why: A deposit in transit has already been recorded in the company's books but has not yet been processed by the bank. It is added to the bank side of the reconciliation.
Exam Tip: Recorded by company, waiting on bank.
Beginning Inventory + Purchases - Ending Inventory produces this amount.
Correct Response: Cost of Goods Sold
Why: Goods available for sale equals beginning inventory plus purchases. Subtracting ending inventory leaves the cost of inventory that was sold, which is Cost of Goods Sold.
Exam Tip: COGS = Beginning Inventory + Purchases - Ending Inventory.
Revenue minus expenses produces this result when revenue is greater.
Correct Response: Net Income
Why: When total revenue exceeds total expenses, the difference is net income. If expenses exceed revenue, the result is a net loss.
Exam Tip: Profit = revenue greater than expenses.
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.
Checks recorded by the company but not yet cleared by the bank are called these.
Correct Response: Outstanding checks
Why: Outstanding checks have reduced the company's book Cash balance but have not yet been deducted by the bank. They are subtracted from the bank statement balance during reconciliation.
Exam Tip: Recorded by company, not yet cleared by bank.
Beginning inventory is $12,000, purchases are $38,000, and ending inventory is $15,000. This is COGS.
Correct Response: $35,000
Why: COGS = $12,000 + $38,000 - $15,000 = $35,000.
Exam Tip: Add goods available, then subtract what remains.
Revenue is $70,000 and expenses are $52,000. This is net income
Correct Response: $18,000
Why: Net income = $70,000 - $52,000 = $18,000.
Exam Tip: Subtract expenses from revenue.
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 $6,000 six-month insurance policy begins January 1. This is one month of Insurance Expense.
Correct Response: $1,000
Why: One month of coverage costs $6,000 / 6 = $1,000. At January 31, $1,000 is transferred from Prepaid Insurance to Insurance Expense.
Exam Tip: Prepaids become expenses as benefits are used.
The bank reports a $75 service charge not yet on the books. The company debits Bank Fee Expense and credits this account.
Correct Response: Cash
Why: A bank service charge reduces the company's available cash. The company records Bank Fee Expense with a debit and reduces Cash with a credit.
Exam Tip: Bank fees reduce book Cash.
Equipment costs $42,000, has a $6,000 salvage value, and a six-year life. This is annual straight-line depreciation.
Correct Response: $6,000
Why: Straight-line depreciation = (Cost - Salvage Value) / Useful Life. ($42,000 - $6,000) / 6 = $6,000 per year.
Exam Tip: Subtract salvage value before dividing.
After closing entries, only these types of accounts appear on the post-closing trial balance.
Correct Response: Permanent accounts
Why: Temporary accounts such as revenues, expenses, and dividends are closed at period-end. Permanent asset, liability, and equity accounts carry their balances into the next period.
Exam Tip: Post-closing = permanent accounts only.
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 company received $9,000 for six months of services beginning October 1. By December 31, this amount has been earned.
Correct Response: $4,500
Why: The monthly amount is $9,000 / 6 = $1,500. October, November, and December represent three earned months: $1,500 x 3 = $4,500.
Exam Tip: Recognize only the portion actually earned.
The bank balance is $18,000, deposits in transit are $2,500, and outstanding checks are $1,800. This is the adjusted bank balance.
Correct Response: $18,700
Why: Adjusted bank balance = $18,000 + $2,500 - $1,800 = $18,700. Deposits in transit are added and outstanding checks are subtracted.
Exam Tip: Bank side: add deposits in transit, subtract outstanding checks.
Equipment cost is $50,000 and accumulated depreciation is $18,000. This is its book value.
Correct Response: $32,000
Why: Book value = Asset Cost - Accumulated Depreciation. $50,000 - $18,000 = $32,000. Book value is an accounting amount and is not necessarily market value.
Exam Tip: Book value is cost less accumulated depreciation.
Cash is $18,000, A/R is $12,000, Equipment is $40,000, and Accumulated Depreciation is $10,000. These are total net assets.
Correct Response: $60,000
Why: Net equipment is $40,000 - $10,000 = $30,000. Total net assets = $18,000 + $12,000 + $30,000 = $60,000.
Exam Tip: Subtract contra-assets before totaling net assets.
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
A company forgets to record $5,000 of accrued wages. Expenses and liabilities are understated, while this is overstated.
Correct Response: Net Income
Why: If Wages Expense is omitted, total expenses are too low. If Wages Payable is omitted, liabilities are too low. Lower reported expenses cause net income to be too high by $5,000.
Exam Tip: Missing expenses overstate profit.
Why: If Wages Expense is omitted, total expenses are too low. If Wages Payable is omitted, liabilities are too low. Lower reported expenses cause net income to be too high by $5,000.
Exam Tip: Missing expenses overstate profit.
Bank balance is $31,200, deposits in transit $4,100, outstanding checks $3,600, and the bank mistakenly deducted $700. This is the corrected bank balance.
Correct Response: $32,400
Why: Adjusted balance = $31,200 + $4,100 - $3,600 + $700 = $32,400. The $700 bank error is added back because it incorrectly reduced this company's account.
Exam Tip: Correct bank errors on the bank side.
Merchandise sells for $7,500 and originally cost $4,200. This is gross profit on the sale.
Correct Response: $3,300
Why: Gross profit = Sales Revenue - Cost of Goods Sold. $7,500 - $4,200 = $3,300.
Exam Tip: Gross profit measures sales above merchandise cost.
Book Cash is $20,300. A $90 fee and $250 NSF check reduce it, while a $600 electronic customer payment increases it. This is adjusted book Cash.
Correct Response: $20,560
Why: Adjusted book Cash = $20,300 - $90 - $250 + $600 = $20,560. Bank fees and NSF checks reduce the book balance; unrecorded electronic receipts increase it.
Exam Tip: On the book side, record items the bank knows about but the company has not yet recorded.