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1 Chapter 5 Merchandise Accounting & Internal Control.

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Presentation on theme: "1 Chapter 5 Merchandise Accounting & Internal Control."— Presentation transcript:

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2 1 Chapter 5 Merchandise Accounting & Internal Control

3 2 Key Concepts & Objectives u Sales Adjustments Net Sales –Discounts: Trade, Quantity & Prompt Pymt. –Returns & Allowances u Inventory Recording Systems –Perpetual vs. Periodic Inventory Systems u Cost of Goods Sold model u Cost of Goods Purchased model u Internal Control Systems Safeguard Assets

4 3 Sales of Merchandise – Review effect on the Accounting Equation -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE + Revenues - Expenses GAAP: Revenue is recognized when earned. Example: In this case (merchandise sale) when the exchange takes place. + Cash or + A/R +Sales Revenue

5 4 Internal Income Statement for a Merchandising company Cash sales$ 350,000 Credit sales 124,000 Total 474,000 Less: Sales returns & allowances* ( 12,400) Sales discounts* ( 34,600) Net Sales(on I/S)$ 427,000 *Contra-accounts used for control and analysis purposes. What information do they provide? Why is that useful? To whom? A Contra-Account must be used along with another account. Above are examples of Contra-Revenue accounts.

6 5 Sales Returns and Allowances - effect on the Accounting Equation Decreases Sales Revenue, this is a Contra-Revenue account. Sales Revenue xxx Less: Sales R&A xx Sales Dis. xx Net Sales xx -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE + Revenues - Expenses (Cash) or (A/R) (Sales Returns and Allowances)

7 6 Trade & Quantity Discounts Not always recorded separately in companys accounting records; Should they? Why? Trade Discounts Offered to special class of customers Quantity Discounts Offered to customers willing to buy in larger quantities

8 7 n/30 n/30 Payment due 30 days from invoice date 1/10, n/30 1/10, n/30 Deduct 1% of invoice amount if paid within 10 days; otherwise gross amount is due in 30 days 2/10, n/30 2/10, n/30 Deduct 2% of invoice amount if paid within 10 days; otherwise total invoice amount is due in 30 days Credit Terms and Sales Discounts (used B2B in certain industries to encourage prompt payment)

9 8 n/30 Payment due 30 days from invoice date 1/10, n/30 Deduct 1% of invoice amount if paid within 10 days; otherwise gross amount is due in 30 days 2/10, n/30 Deduct 2% of invoice amount if paid within 10 days; otherwise total invoice amount is due in 30 days Does n (for net) make sense? Wouldnt a better symbol be g (gross) or t (total). But this is a term thats been used for many years and it has become accepted in practice over time!

10 9 Recording Sales Discounts: Example Assume a credit sale of $5,000 with payment terms of 1/10, net 30. Effect on the B/S Equation? not recorded Using the Gross Sales Method, Sales Discount is not recorded unless the discount is taken. Sales Revenue xxx Less: Sales R&A xx Sales Dis. xx Net Sales (on I/S) xx It might mean Net Sales are OVERSTATED. -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE + Revenues - Expenses Accounts Sales Receivable $5,000Revenue $5,000 What could this mean about the Net SalesI/S Net Sales reported on the I/S for Gross Method a company using the Gross Method?

11 Recording Sales Discounts: Example within If customer pays within the discount period, they receive a 1% discount. What is the effect on the B/S Equation? A: A/RR: Sales $5,000 CR: Sales Discounts $5,000 $50 A: Cash $4,950 FORMULA: Sales Discount = Gross Sales x Discount % $50 = $5,000 x 1 % Cash Received = Gross Sales - Sales Discount $4,950 = $5,000 - $50 $0 Customers Balance after payment. recorded How would this event be recorded?

12 11 Recording Sales Discounts: Example If customer pays within the discount period, they receive a 1% discount. What is the effect on the B/S Equation? A: A/RR: Sales $5,000 CR: Sales Discounts $5,000 $50 A: Cash $4,950 -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE + Revenues - Expenses $0 Accounts Sales Receivable ($5,000) Discounts Cash $4,950 ($50) $4,950 SaleCollection Notice the net increase in assets and equity (revenues) is $4,950 from Sale and Collection $4,950

13 12 Inventory Recording Systems: Two Alternate Approaches u Concept: Different approaches are used to update accounting records for key inventory transactions u Transactions: –Purchases of goods from vendors (increase inventory) –Sales of goods to customers (decrease inventory) u Approaches: When to update? 1. Perpetual inventory system Constant updates 2. Periodic inventory system End-of-period updates

14 13 Perpetual Inventory Systems u Traditionally used for low-volume, high-priced inventory items (e.g., autos or jewelers) u Recently, Point of Sale (POS) terminals have improved ability of mass merchandisers (like grocery stores) to utilize perpetual inventory systems u Why do some stores (e.g., Jewel) use scanners, while others (e.g., 7-11s) dont? Impact on customers? perpetually updated Concept: Inventory records are perpetually updated – i.e., with each purchase or sale.

15 14 Periodic Inventory Systems u Reduces record-keeping (and costs), but u Decreases ability to: –track theft, breakage, etc., –provide high service levels to customers, and –prepare interim financial statements. financial reporting u Predominant method used for financial reporting! (Cost vs. Benefit) periodically updated Concept: Inventory records are periodically updated – only after physical inventory counts.

16 15 Beginning Inventory (B/S)$ 10,000 Cost of Goods Purchased + Cost of Goods Purchased 40,000 Cost of Goods Available for Sale 50,000 - Ending Inventory (B/S) (20,000) Cost of Goods Sold (I/S) $ 30,000 Periodic Inventory The Cost of Goods Sold Model Periodic Inventory Determined by physical count & shown on B/Ss Pool of goods available to be sold during the period Cost of Goods Purchased Lets see how Cost of Goods Purchased is calculated

17 16 The Cost of Goods Purchased Model Periodic Inventory Less: Purchase Returns & Allowances & Allowances Purchase Discounts Transportation-in Plus: Transportation-in Cost of Goods Purchased Purchases Gross invoice price Shipping cost to buyer, if any Opposite of Sales R&A Opposite of Sales Discounts Internal calculation; not an account nor reported in F/Ss

18 17 What type of ACCOUNTS would these be in the B/S Equation? Cost of Goods Purchased: Periodic Inventory What type of ACCOUNTS would these be in the B/S Equation? Less: Purchase Returns & Allowances & Allowances Purchase Discounts Transportation-in Plus: Transportation-in Cost of Goods Purchased Purchases? Expense Account Why Expense Account………. ………..but Why? 1.Periodic InvSOLD 1.Periodic Inv. assumes all inventory is SOLD! PURCHASES EXPENSE I/S 2.So PURCHASES are really the same as COGS i.e., an EXPENSE in I/S. COGS G/L calculated amountI/S 3. (COGS is not an account in the G/L but it is a calculated amount for I/S.) end of periodCOGS & INV F/S purposes 4.So at end of period COGS & INV must be updated to proper balances for F/S purposes.

19 18 What type of ACCOUNTS would these be in the B/S Equation? Cost of Goods Purchased: Periodic Inventory What type of ACCOUNTS would these be in the B/S Equation? Less: Purchase Returns & Allowances & Allowances Purchase Discounts Transportation-in? Plus: Transportation-in? Cost of Goods Purchased Purchases Expense Expense account; it is part of COGS

20 19 What type of ACCOUNTS would these be in the B/S Equation? Cost of Goods Purchased: Periodic Inventory What type of ACCOUNTS would these be in the B/S Equation? Less: Purchase Returns & Allowances & Allowances Purchase Discounts Purchase Discounts Plus: Transportation-in Cost of Goods Purchased Purchases Contra-Expense account to Purchases

21 20 credit purchase$1,000 effect Assume a credit purchase of $1,000 with payment terms of 2/10, net 30. Record effect on B/S equation E: Purchases L: Accounts Payable $1,000 -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE + Revenues - Expenses RECORDING PURCHASE DISCOUNTS: PERIODIC INVENTORY SYSTEM Accts. Purchases Payable ($1,000) $1,000

22 21 paysdiscount period If company pays within discount period, they can deduct 2% discount a 2% discount. Determine the effect on the B/S equation. E: PurchasesL: Accts Payable 1,000 A: Cash Formula: Purchase Discount = Purchase Price x Discount % $20 $20 = $1,000 x.02 Cash Paid = Gross Purchase - Purchase Discount $980 $980 = $1,000 - $20 CE: Pur. Discount $1,000$20 $980 $0 RECORDING PURCHASE DISCOUNTS: PERIODIC INVENTORY SYSTEM A/P is fully paid!

23 22 E: PurchasesL: Accts Payable $1,000 A: CashCE: Pur. Discount $1,000$20$980 $0 Cash Accts. Purchase ($980) Payable Discounts ($1,000) $20 RECORDING PURCHASE DISCOUNTS: PERIODIC INVENTORY SYSTEM paysdiscount period If company pays within discount period, they can deduct 2% discount a 2% discount. Determine the effect on the B/S equation. -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE + Revenues - Expenses

24 23 FOB Destination Point (Freight On Board) not recorded destination point u Sale or purchase is not recorded until inventory reaches its destination point. u Seller u Seller responsible for inventory while in transit. u Importance: Year-end cut-off or Damage claim Seller Buyer Title Passes at Destination

25 24 FOB Shipping Point u Sale and purchase shipment u Sale and purchase are both recorded upon shipment – when truck leaves the dock u Buyertransit u Buyer responsible for inventory while in transit u Importance: F/S Cut-offs and Damage claims Seller Buyer Title Passes when Shipped

26 25 Internal Control Systems (require 3 components) Control Environment Accounting System Internal Control Procedures CONCEPT: Techniques used to safeguard & protect assets of company

27 26 Responsibilities for Internal Control External Auditors CPAs Internal Auditors Audit Committee of Board of Directors Management has the primary responsibility Management: Sets and enforces policies Internal Auditors: Test for compliance CPAs: Verifies and reports to Audit Comm.

28 27 The Control Environment: An Attitude u Reflect managements understanding of controls, competence and operating style u Necessitate certain control policies and practices u Require influence and support of Board of Directors

29 28 The Accounting System: A Necessity u Systems can be manual, automated or a combination of both u Use of documentation (audit trail) is integral part of any system and internal controls DEFN: Methods, records and systems used to record transactions and report financial information

30 29 Internal Control Procedures: Key Safeguards used in Practice Safeguarding Assets and Records Proper Authorizations Independent Verification Design & Use of Business Documents Independent Review and Appraisal Establishing Audit Trail Segregation of Duties

31 30 Proper Authorizations u Concept: Authorizations are required before assets are transferred, used or exchanged LOAN APPROVED

32 31 Segregation of duties u Concept: Separate the physical custody of assets from the accounting for assets

33 32 Independent Verification u Concept: Another individual or department (e.g., Internal Auditors) serve to verify or double-check the work of another

34 33 Protecting Assets and Records u Concept: Protect assets and accounting records from loss, theft, unauthorized use, etc.

35 34 Independent Review and Appraisal u Concept: Conduct periodic review of internal controls and appraisal of the accounting system as well as the people operating it. CPAs Audit Report

36 35 Design and Use of Business Documents u Concept: Capture all relevant information about a transaction in order to properly record and classify financial effects. u Requires: Audit trail capabilities

37 36 Limitations on Internal Control u No system can be entirely foolproof; breakdowns can occur – Employee collusion can override the best controls – Cost vs. benefit tradeoffs exist

38 37 Summary: Key Concepts & Objectives u Adjustments to Sales Net Sales –Discounts: Trade, Quantity & Prompt Pymt. –Returns & Allowances u Inventory Recording Systems –Perpetual vs. Periodic Inventory Systems u Cost of Goods Sold model u Cost of Goods Purchased model u Internal Control Systems Safeguard Assets

39 38 Appendix 5A Internal Control for a Merchandising Company

40 39 Controls Over Cash u All cash receipts deposited intact daily u All cash disbursements made by check Paycheck for Dept. of Treasurer John Doe Paycheck for Date Dept. of Treasurer Jane Doe Date

41 40 Controls Over Cash Received Over the Counter u Cash registers u Prenumbered customer receipts

42 41 Controls Over Cash Received in the Mail u Two employees open mail u Prelist prepared u Customer statements u Investigation of recurring discrepancies

43 42 Document Flow for Merchandise Check prepared Purchase Requisition Receiving Report Purchase Order Invoice Approval Purchase Invoice


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