Financial & Managerial Accounting 2002e

Financial & Managerial Accounting 2002e
Belverd E. Needles, Jr. Marian Powers Susan Crosson Multimedia Slides by: Harry Hooper Sante Fe Community College Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Chapter 6 Merchandising Operations and Internal Control
Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Copyright©2002 by Houghton Mifflin Company. All rights reserved.
LEARNING OBJECTIVES Identify the management issues related to merchandising businesses. Define and distinguish the terms of sale for merchandising transactions. Prepare an income statement and record merchandising transactions under the perpetual inventory system. Prepare an income statement and record merchandising transactions under the periodic inventory system. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

LEARNING OBJECTIVES (continued)
Define internal control, identify the five components of internal control, and explain seven examples of control activities. Describe the inherent limitations of internal control. Apply internal control activities to common merchandising transactions. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Supplemental Objective
8. Apply sales and purchases discounts to merchandising transactions. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Management Issues in Merchandising Businesses
OBJECTIVE 1 Identify the management issues related to merchandising businesses. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Merchandising businesses differ from service businesses in that they have goods on hand for sale to customers and engage in a series of transactions, listed below, called the operating cycle. Purchase of inventory for cash or credit Payment for purchases made on credit Sales of inventory for cash or credit Collection of cash from credit sales Copyright©2002 by Houghton Mifflin Company. All rights reserved.

The Operating Cycle of Merchandising Concerns

Cash Flow Management Purchases of merchandise are usually made on credit. Suppliers of merchandise usually require payment before inventory is sold. The merchandiser must plan for cash flows from prior sales, additional stockholders’ investment, or from borrowing to finance the inventory until it is sold and resulting revenue is collected. Operators of a merchandising business must carefully manage cash flows or liquidity. If a company can’t pay its bills when due, it may be forced out of business. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Profitability Management
A company must sell its merchandise at a price that exceeds its cost by a sufficient margin to pay operating expenses and have enough left to provide sufficient net income or profitability. Profitability management includes: Setting appropriate prices for merchandise. Purchasing merchandise at favorable prices and terms. Maintaining acceptable levels of operating expenses. An effective tool for controlling expenses is the operating budget. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Features of the Perpetual Inventory System
Continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold. More effective for providing current, real time information about actual quantities and dollar amounts of inventory available for sale and sold. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Features of the Periodic Inventory System
Physically count inventory, usually at end of accounting period. No detailed records of the actual inventory available or sold are maintained during the accounting period. Less costly than perpetual inventory method, but provides less information. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Control of Merchandising Operations
Principal transactions of merchandising businesses are vulnerable to theft and embezzlement. Cash and inventory are easy to steal. These asset accounts are usually involved in a large number of transactions. Management’s responsibility is to establish an environment, accounting systems, and control procedures that will protect the company’s assets. These systems and procedures are called internal control. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Discussion Q. What four issues must be faced by managers of merchandising businesses? A. The four issues that must be faced by managers of merchandising businesses are (1) cash flow management, (2) profitability management, (3) choosing between the periodic and the perpetual inventory systems, and (4) establishing an internal control structure that protects the business’s assets. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Sales Terms Trade discount. A reduction of the list price. Not shown in accounting records. Sales discount. Discount given for early payment. Taken if payment is made within the terms of sale. For example, “2/10, n/30.” Practice of giving sales discounts has been declining. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Sales Terms (Continued)
FOB shipping point. Title passes at origin. Buyer pays the freight. FOB destination. Title passes at destination. Seller pays the freight. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Perpetual Inventory System
OBJECTIVE 3 Prepare an income statement and record merchandising transactions under the perpetual inventory system. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Applying the Perpetual Inventory System
Inventory and cost of Goods Sold are continually updated during the accounting period, as purchases, sales, and other inventory transactions take place. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Transactions Related to Purchases of Merchandise
Purchases of Merchandise on Credit The cost of merchandise purchased is placed in the Merchandise Inventory account at the time of purchase. Transportation Costs on Purchases Accumulated in a Freight In / Transportation In account. In some cases, the seller pays the freight charges and bills them to the buyer as a separate item on the invoice. Purchases Returns and Allowances Returned merchandise is removed from the Merchandise Inventory account. Payments on Account Payments by cash (or checks) to suppliers. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Transactions Related to Sales of Merchandise
At the time of sale, the cost of merchandise is transferred from the Merchandise Inventory account to the Cost of Goods Sold account. In the case of a return, the cost of the merchandise is transferred from Cost of Goods Sold back to Merchandise Inventory. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Transactions Related to Sales of Merchandise (continued)
Sales of Merchandise on Credit Two entries are necessary Record the sale as a debit to Accounts Receivable Update the Cost of Goods sold by transferring from Merchandise Inventory Cash sales of Merchandise Debit Cash for the amount of the sale Payment of Delivery Costs Accumulated in the Freight Out Expense account Shown as a selling expense on the income statement Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Returns of Merchandise Sold Accumulated in the Sales Return and Allowances account, a contra-revenue account, with a normal debit balance, deducted from Sales in the income statement The cost of merchandise must also be transferred from the COGS account back into the Merchandise Inventory account Receipts on Account Receipts of cash (or checks) from credit customers recorded as credits to Accounts Receivable Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Discussion Q. How are merchandising transactions recorded under the perpetual inventory system? A. Merchandising transactions are recorded during the accounting periods, as purchases, sales, and other inventory transactions take place. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Merchandising Transactions
OBJECTIVE 4 Prepare an income statement and record merchandising transactions under the periodic inventory system. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Applying the Periodic Inventory System
Cost of Goods Sold must be computed, because it is not updated for purchases, sales and other transactions during the accounting period. To calculate cost of goods sold: Net purchases = (total purchases – deductions) Net cost of purchases = (net purchases + freight charges on the purchases Goods available for sale = (net cost of purchases + beginning purchases) Costs of Goods Sold = (Goods available for sale – ending inventory) Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Physical inventory is taken and recorded in the Merchandise Inventory account at the end of the period. A Purchases account is used to accumulate the purchases of merchandise during the accounting period. A Purchases Returns and Allowances account is used to accumulate returns of and allowances on purchases. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

The Components of Cost of Goods Sold

Purchases of Merchandise on Credit Purchases, a temporary account, used to accumulate the total cost of merchandise purchased for resale during the accounting period. It does not indicate whether merchandise has been sold or is still on hand. Transportation Costs on Purchases Usually accumulated in a Freight In account. In some cases, the seller pays the freight charges and bills them to the buyer as a separate item on the invoice. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Transactions Related to Purchases of Merchandise (continued)
Purchases Returns and Allowances Recorded in the Purchases Returns and Allowances account. A contra-purchases account with a normal credit balance, deducted form Purchases on the income statement. Payments on Account Payments made to suppliers. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Transactions Related to Sales of Merchandise
Sales of Merchandise on Credit Debit the Accounts Receivable account for the amount of the sale. Cash Sales of Merchandise Debit Cash for the amount of the sale. Payment of Delivery Costs Accumulated in the Freight Out / Delivery Expense account. Shown as a selling expense on the income statement. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Returns of Merchandise Sold Accumulated in the Sales Return and Allowances account. A contra-revenue account, with a normal debit balance deducted from Sales on the income statement. Receipts on Account Payments of cash (or checks) received from credit customers. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Credit Card Sales The seller pays the credit card company (typically 2 to 6 percent of the total sale) for the service. The cost is treated as a selling expense. Cash Credit Card Discount Expense 40 Sales ,000 Made sales on Visa cards Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Inventory Losses Losses from spoilage, shoplifting, employee and contractor theft. Not identifiable by the periodic inventory system. Identified by the perpetual inventory system as the discrepancy between physical inventory (taken at intervals) and the inventory account balance. Inventory Shortage 130 Inventory 130 Made adjustment for inventory shrinkage Inventory shortage is usually an increase in Cost of Goods Sold. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Discussion Q. How are merchandising transactions recorded under the periodic system? A. Merchandising transactions are recorded at the end of the accounting period, therefore, Costs of Goods Sold and Inventory must be computed at that time. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Internal Control Structure: Basic Elements and Procedures
OBJECTIVE 5 Define internal control, identify the five components of internal control and explain seven examples of control activities. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Internal Control Defined
Internal control is all the policies and procedures management uses to: Protect the firm’s assets and ensure the accuracy and reliability of the accounting records. Promote operating efficiency and encourage adherence to management’s policies. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Components of Internal Control
Internal control includes: The control environment. Risk assessment. Information and communication. Control activities. Monitoring. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

The Control Environment
Created by the overall attitude, awareness, and actions of management. Influenced by: Management’s philosophy and operating style. Organizational structure. Methods of assigning authority and responsibility. Personnel policies and practices. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Risk Assessment The identification of areas where risks of loss of assets or inaccuracies in the accounting records are high so that adequate controls can be implemented. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Information and Communication
Relates to the accounting systems established by management to identify, assemble, analyze, classify, record, and report a company’s transactions and to the clear communication of individual responsibilities in achieving these functions. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Monitoring Involves management’s regular assessment of the quality of internal control including periodic review of actual compliance with all policies and procedures. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Control Activities 1. Authorization 2. Recording transactions 3. Documents and records 4. Physical controls 5. Periodic checks 6. Separation of duties 7. Sound personnel procedures Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Discussion Q. A good system of internal controls accomplishes what broad objectives? A. It safeguards the company assets, produces reliable accounting records, promotes operating efficiency, and encourages adherence to management’s policies. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Limitations of Internal Control
Human error. Misunderstandings. Mistakes in judgment. Carelessness. Distraction. Fatigue. Collusion. Dishonesty. Changes in conditions. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Discussion Q. Why is the separation of duties necessary to ensure sound internal control? What does this principle assume about the relationships of employees in a company and the possibility of two or more of them stealing from the company? Copyright©2002 by Houghton Mifflin Company. All rights reserved.

A. The separation of duties is important to sound internal control because a person who combines the responsibilities of keeping records, operating a department, and managing assets would be able to misappropriate assets without detection. The separation of duties assumes that two or more employees will not work together to overcome the controls. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Internal Control over Merchandising Transactions
OBJECTIVE 7 Apply internal control activities to common merchandising transactions. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Internal Control and Management Goals
Key Goals for the success of a merchandising business. Prevent losses of cash or inventory owing to theft or fraud. Provide accurate records of merchandising transactions, and account balances. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Goals for Management Broader Goals: Keep enough inventory on hand to sell to customers without overstocking. Keep enough cash on hand to pay for purchases in time to receive discounts. Keep credit losses as low as possible by making credit sales only to customers who are likely to pay on time. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Control of Cash Sales Receipts
Cash is received either by mail or over the counter. In either case: It should be recorded immediately in cash receipts journal. It establishes a written record of cash receipts. Control of cash received through the mail. Encourage customers to pay by check. Handle by two or more employees. Make a list of receipts in triplicate. Control of cash received over the counter. Cash registers. Pre-numbered sales tickets. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Control of Purchases and Cash Disbursements
Pay cash only based on specific authorization backed by proof of validity and amount of claim. Separate purchasing and payment duties. Document and verify by at least 2 people. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Internal Control for Purchasing and Paying for Goods and Services

Check and Remittance Advice

Discussion Q. Name the documents needed for an internal control plan for purchases and cash disbursements. A. Purchase requisition, purchase order, invoice, receiving report, check authorization, check with a remittance advice. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Sales Discounts Original sale on credit (2/10,n/60) Sept. 20 Accounts Receivable 300 Sales Customer takes advantage of discount. Sept. 29 Cash Sales Discounts Accounts Receivable 300 Customer does not take advantage of discount. Nov. 19 Cash Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Purchases Discounts Original Purchase Credit (2/10,n/30) Nov. 12 Purchases 1,300 Accounts Payable 1,300 Take discount when paying. Nov. 22 Accounts Payable 1,300 Purchases Discounts Cash ,274 Do not take discount when paying. Dec. 12 Accounts Payable 1,300 Cash 1,300 Purchase discounts do not apply to freight, taxes, etc. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

Discussion Q. What is the normal balance of the Sales Discounts account? Is it an asset, a liability, an expense, or a contra-revenue account? A. The normal balance of the Sales Discounts account is a debit balance. Sales Discounts is a contra-revenue account. It is deducted from gross sales on the income statement. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

OKAY, LET’S REVIEW... Identify the management issues related to merchandising businesses. Define and distinguish the terms of sale for merchandising transactions Prepare an income statement and record merchandising transactions under the perpetual inventory system. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

CONTINUING OUR REVIEW... Prepare an income statement and record merchandising transactions under the periodic inventory system. Define internal control, identify the five components of internal control, and explain seven examples of control activities. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

AND FINALLY... Describe the inherent limitations of internal control. Apply internal control activities to common merchandising transactions. Apply sales and purchases discounts to merchandising transactions. Copyright©2002 by Houghton Mifflin Company. All rights reserved.

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