Which formula correctly computes Ending Inventory using the gross profit method?

• A. Ending Inventory = Beginning Inventory + Purchases − Cost of Goods Sold; COGS = Net Sales × Gross Margin.
• B. Ending Inventory = Beginning Inventory + Purchases − Estimated COGS; Estimated COGS = Net Sales × (1 − Gross Margin).
• C. Ending Inventory = Beginning Inventory − Purchases + Estimated COGS; Estimated COGS = Net Sales × (1 + Gross Margin).
• D. Ending Inventory = Beginning Inventory + Net Sales − Estimated COGS; Estimated COGS = Gross Margin × Net Sales.

Answer: (B)

The key idea is to estimate COGS from net sales using the gross margin, then apply the usual inventory flow equation. The gross margin tells us what portion of net sales remains after covering the cost of goods sold, so COGS is Net Sales multiplied by (1 − Gross Margin). Once you have that estimated COGS, you combine beginning inventory and purchases (which add to inventory) and subtract the estimated COGS (which represents the cost of goods sold during the period) to arrive at ending inventory.

So the correct approach is:

Estimated COGS = Net Sales × (1 − Gross Margin)

Ending Inventory = Beginning Inventory + Purchases − Estimated COGS

This is the best answer because it uses the proper relationship between net sales, gross margin, and COGS, and it applies the standard inventory formula. Using COGS as Net Sales × Gross Margin would give gross profit, not COGS; subtracting Purchases from Beginning Inventory misstates how inventory changes; and using (1 + Gross Margin) or adding Net Sales instead of Purchases would distort the calculations.