1. Merchandise Accounting
Chapter 5
Merchandise Accounting
&
Internal Control

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

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

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

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

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

7. Credit Terms and Sales Discounts (used B2B in certain industries to encourage prompt payment)
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

8. Credit Terms and Sales Discounts (used B2B in certain industries to encourage prompt payment)
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? Wouldn’t a better symbol be “g” (“gross”) or “t” (total). But this is a term that’s been used for many years and it has become accepted in practice over time!

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?
Balance Sheet Income Statement--
Assets = Liabilities + OE Revenues - Expenses
Accounts Sales
Receivable $5, Revenue $5,000
Using the Gross Sales Method, Sales Discount is not recorded unless
the discount is taken.
What could this mean about the
Net Sales reported on the I/S for
a company using the Gross Method?
Sales Revenue xxx
Less: Sales R&A xx
Sales Dis. xx
Net Sales (on I/S) xx
It might mean Net Sales are OVERSTATED.

10. 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?
FORMULA: Sales Discount = Gross Sales x Discount %
$ = $5, x %
Cash Received = Gross Sales - Sales Discount
$4, = $5, $50
How would this event be recorded?
A: Cash
A: A/R
R: Sales
CR: Sales Discounts
$4,950
$5,000
$5,000
$5,000
$50 $0
Customer’s Balance after payment.

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?
Balance Sheet Income Statement--
Assets = Liabilities + OE Revenues - Expenses
Accounts Sales
Receivable ($5,000) Discounts
Cash $4, ($50)
Notice the net increase in assets and equity (revenues) is $4,950 from Sale and Collection
$4,950
A: Cash
A: A/R
R: Sales
CR: Sales Discounts
$5,000
$4,950
$5,000
$5,000
$50 $0

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

13. Perpetual Inventory Systems
Concept: Inventory records are perpetually updated – i.e., with each purchase or sale.
Traditionally used for low-volume, high-priced inventory items (e.g., autos or jewelers)
Recently, Point of Sale (POS) terminals have improved ability of mass merchandisers (like grocery stores) to utilize perpetual inventory systems
Why do some stores (e.g., Jewel) use scanners, while others (e.g., 7-11’s) don’t? Impact on customers?

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

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

16. The Cost of Goods Purchased Model Periodic Inventory
Less:
Purchase Returns
& Allowances
Purchase Discounts
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/S’s

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

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

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

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

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

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

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

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

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

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

27. The Control Environment: An Attitude
Reflect management’s understanding of controls, competence and operating style
Necessitate certain control policies and practices
Require influence and support of Board of Directors

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

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

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

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

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

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

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

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

36. Limitations on Internal Control
No system can be entirely foolproof; breakdowns can occur
Employee collusion can override the best controls
Cost vs. benefit tradeoff’s exist

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

38. Internal Control for a Merchandising Company
Appendix 5A
Internal Control for a Merchandising Company

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

40. Controls Over Cash Received Over the Counter
Cash registers
Prenumbered customer receipts

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

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