Quiz 3 Mistakes to Avoid
These are some of the most tempting mistakes in the Quiz 3 material. Click each one to see why it is wrong and what to do instead.
Using selling price to calculate Cost of Goods Sold Tap to reveal
Sales Revenue is based on what the customer pays.
Cost of Goods Sold is based on what the merchandise cost the retailer.
A $100 sale does not mean COGS is $100.
Treating inventory as an expense when it is purchased Tap to reveal
Merchandise purchased for resale is initially an asset.
Its cost stays in Inventory until the merchandise is sold. Only then does the cost become Cost of Goods Sold.
Recording freight-in as an immediate expense Tap to reveal
When the buyer is responsible for freight needed to bring purchased merchandise to its location, that cost becomes part of Inventory under the perpetual system.
The freight cost follows the inventory cost and becomes expense when the related merchandise is sold.
Recording only one entry for a merchandise sale Tap to reveal
Under a perpetual inventory system, a merchandise sale has two effects.
One entry records the selling price and Sales Revenue. The second records Cost of Goods Sold and reduces Inventory.
Forgetting to subtract sales returns and discounts when finding net sales Tap to reveal
Net Sales is not simply Sales Revenue.
Net Sales = Sales Revenue - Sales Returns and Allowances - Sales Discounts
Subtracting operating expenses before calculating gross profit Tap to reveal
Gross profit focuses only on the relationship between sales and the cost of the merchandise sold.
Net Sales - COGS = Gross Profit
Operating expenses are subtracted afterward to calculate Operating Income.
Jumping into dollars before figuring out the inventory units Tap to reveal
For inventory costing problems, solve the units first.
Determine:
units available → units sold → units remaining
Then attach costs to those units.
Assuming FIFO means the oldest physical items must actually be sold first Tap to reveal
FIFO is a cost-flow assumption.
It assigns the oldest costs to COGS first. It does not necessarily describe the physical movement of the inventory.
Reversing FIFO and LIFO Tap to reveal
FIFO: oldest costs → COGS; newest costs → Ending Inventory
LIFO: newest costs → COGS; oldest costs → Ending Inventory
Write the layers out before calculating.
Forgetting that COGS plus Ending Inventory must equal the total cost available Tap to reveal
The inventory costing methods divide the same cost pool between COGS and Ending Inventory.
Always check:
COGS + Ending Inventory = Cost of Goods Available for Sale
If it does not reconcile, something went wrong.
Treating weighted-average cost as an average of the different unit prices Tap to reveal
Weighted-average cost is based on the entire cost pool and all units available.
Total Cost of Goods Available ÷ Total Units Available
Do not simply average the listed unit prices unless the quantities happen to be equal.
Deciding who owns goods in transit without checking the FOB terms Tap to reveal
Start with ownership.
FOB shipping point: ownership generally transfers when the goods are shipped.
FOB destination: the seller generally owns the goods until they reach the destination.
Guessing the effect of an ending inventory error instead of following the equation Tap to reveal
Use the relationship:
Beginning Inventory + Purchases - Ending Inventory = COGS
Then follow the chain:
Ending Inventory → COGS → Net Income → Retained Earnings
Thinking understated Ending Inventory also understates COGS Tap to reveal
Ending Inventory is subtracted in the COGS calculation.
If Ending Inventory is understated, too little is subtracted.
Therefore COGS is overstated, Net Income is understated, and Retained Earnings is understated.
Assuming a higher inventory turnover is always better Tap to reveal
Higher turnover generally means inventory is moving more quickly, but context matters.
Inventory levels that are too low can lead to stockouts and lost sales.
Using ending inventory instead of average inventory in the turnover calculation Tap to reveal
Inventory turnover uses Average Inventory.
Inventory Turnover = COGS ÷ Average Inventory
Average Inventory is generally:
(Beginning Inventory + Ending Inventory) ÷ 2