Chapter 6 Internal Control andFinancial Reporting for Cash and Merchandise Sales
Learning Objectives1. Distinguish among service, merchandising, and manufacturing operations.2. Explain common principles and limitations of internal control.3. Apply internal control principles to cash receipts and payments.4. Perform the key control of reconciling cash to bank statements.5. Explain the use of a perpetual inventory system as a control.6. Analyze sales transactions under a perpetual inventory system.7. Analyze a merchandiser’s multistep income statement.
Operating Cycles Sell Services Service Collect Company Cash Incur Operating Expenses
Operating Cycles Sell Products Make Manufacturing Collect Products Cash Company Incur Buy Raw Operating Materials Expenses
Internal Control All companies include as part of their operating activities a variety of procedures and policies that are referred to as internal controls. Internal controls are the methods a company uses to: 1. Protect against the theft of assets. 2. Enhance the reliability of accounting information. 3. Promote efficient and effective operations. 4. Ensure compliance with applicable laws and regulations.
Common Control Principles Principle Explanation Examples Assign each task to only one Each Wal-Mart cashier uses aEstablish responsibility person. different cash drawer Do not make one employee Wal-Mart cashiers, who ring upSegregate duties responsible for all parts of a sales, do not approve price process. changes. Do not provide access to Wal-Mart secures valuable assets or information unless it assets such as cash andRestrict access is needed to fulfill assigned access to its computer responsibilities. systems (passwords, firewalls). Prepare documents to show Wal-Mart pays suppliers usingDocument procedures activities that have occurred. prenumbered checks. Check others work. Wal-Mart compares cash balances in its accountingIndependently verify records to the cash balances reported by its bank, and accounts for any differences.
Control Limitations Internal controls can never completely prevent and detect errors and fraud. Human Error orBenefits vs. Cost Fraud
Controlling and Reporting Cash Internal control of cash is important to any organization. Cash is valuable Volume of cash and “owned” by is enormous. person possessing it.
Cash Received in Person Segregate Duties Cashier Recording Custody
Cash Received in Person
Cash Received in Person
Cash Received from a RemoteSource Cash Received by Mail Cash Received Electronically
Cash Payments Cash Payments Electronic Writing a Funds Check Transfer A voucher system is a process for approving Most companies pay cash to their employees and documenting all purchases and through EFTs, which are known by payments on account. employees as direct deposits.
Bank Procedures and ReconciliationBanks provide services that help businesses to control cash in several ways: Restricting Documenting Independently Access Procedures Verifying A bank reconciliation is an internal report prepared to verify the accuracy of both the bank statement and the cash accounts of a business or individual.
Bank Statement 1 2 3 4 5
Reconciling Differences Your Bank May Not Know About . . . 1. Errors made by the bank. 2. Time lags: a. Deposits that you made recently. b. Checks that you wrote recently. You May Not Know About . . . 3. Interest the bank has put into your account. 4. Electronic funds transfer (EFT) 5. Service charges taken out of your account. 6. Customer checks you deposited but that bounced. 7. Errors made by you.
Bank Reconciliation To determine the appropriate cash balance, these balances need to be reconciled.
Bank Reconciliation Bank Reconciliation Goals1.Identify the deposits in transit.2.Identify the outstanding checks.3.Record other transactions on the bank statement.4.Determine the impact of errors.
Reporting Cash and CashEquivalents Cash includes money or any instrument that banks will accept for deposit and immediate credit to a company’s account, such as a check, money order, or bank draft. Cash equivalents are short-term, highly liquid investments purchased within three months of maturity.
Controlling and Reporting MerchandiseSalesInventory Inventory FinancialQuantities Costs Statements Unsold Balance Inventory Sheet Sold Income Inventory Statement
Perpetual Inventory System In a perpetual inventorysystem, the inventory recordsare updated “perpetually,” that is, every time inventory is bought, sold, or returned. Perpetual systems often are combined with bar codes and optical scanners.
Periodic Inventory System In a periodic inventory system,the inventory records are updated “periodically,” thatis, at the end of the accounting period. To determine how much merchandise has been sold, periodicsystems require that inventory be physically counted at the end of the period.
Inventory Control Perpetual Periodic Inventory Inventory System System No Up-to- Continuous Date Tracking Records Can Can’t Estimate Estimate Shrinkage Shrinkage
Sales Transactions Merchandisers earn revenues by transferring ownership of merchandise to a customer, either for cash or on credit.For a merchandiser who is shipping goods to a customer, thetransfer of ownership occurs at one of two possible times:1. FOB shipping point —the sale is recorded when the goods leave the seller’s shipping department.2. FOB destination —the sale is recorded when the goods reach their destination (the customer).
Sales TransactionsEvery merchandise sale has two components,each of which requires an entry in a perpetual inventory system. Selling Price Cost
Sales TransactionsAssume Wal-Mart sells two Schwinn mountain bikes for $400 cash. The bikes had previously been recorded in Wal-Mart’s Inventory at a total cost of $350. 1 Analyze Assets = Liabilities + Stockholders Equity (a) Cash +400 Sales Revenue (+R) +400 (b) Inventory -350 Cost of Goods Sold (+E) -350 2 Record
Sales Returns and Allowances When goods sold to a customer arrive in damaged condition or are otherwise unsatisfactory, the customer can (1) return them for a full refund or (2) keep them and ask for a reduction in the selling price, called an allowance.
Sales Returns and AllowancesSuppose that after Wal-Mart sold the two Schwinn mountain bikes, thecustomer returned one to Wal-Mart. Assuming that the bike is still likenew, Wal-Mart would refund the $200 selling price to the customer and take the bike back into inventory. 1 Analyze Assets = Liabilities + Stockholders Equity (a) Cash -200 Sales Returns and Allowances (+xR) -200 (b) Inventory +175 Cost of Goods Sold (-E) +175 2 Record
Sales on Account and SalesDiscounts A sales discount is a sales price reduction given to customers for prompt payment of their account balance.
Sales on Account and Sales DiscountsSuppose Wal-Mart’s warehouse store (Sam’s Club) sells printer paper on account to a local business for $1,000 with payment terms of 2/10, n/30. The paper cost Sam’s Club $700. 1 Analyze Assets = Liabilities + Stockholders Equity (a) Accounts Receivable +1,000 Sales Revenue (+R) +1,000 (b) Inventory -700 Cost of Goods Sold (+E) -700 2 Record
Sales on Account and Sales DiscountsTo take advantage of this 2% discount, the customer must pay Wal-Mart within 10 days. If the customer does so, it will deduct the $20 discount(2% $1,000) from the total owed ($1,000), and then pay $980 to Wal- Mart. 1 Analyze Assets = Liabilities + Stockholders Equity Cash +980 Sales Discounts (+xR) -20 Accounts Receivable -1,000 2 Record (2% × $1,000)
Summary of Sales-RelatedTransactions The sales returns and allowances and sales discounts introduced in this section were recorded using contra-revenue accounts.
Comparing Operating ResultsAcross Companies and Industries Gross Profit Percentage by Industry 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Wal-Mart’s Gross Profit Percentage 0.0% 2009 2008 2007
In class problem #1: Bank reconciliationThe June bank statement indicates a balance of $10,638, while the cash ledger account on that date shows a balance of $11,391. Additional information is: Deposits in transit $1,800. Bank service charge $6 Interest received from the bank $20. Outstanding checks $960. NSF (not sufficient fund) check of a customer $18 EFT (electronic funds transfer) received from a customer $100. Check No. 104 in payment of an accounts payable cleared the bank for $65 but was erroneously recorded in our books as $56.Prepare a bank reconciliation, and give any reconciling journal entries that should be made as a result of the bank reconciliation.
In class problem #2The following transactions were selected from the records of Evergreen Company: July 12: Sold merchandise to Sally, who paid $1,000 cash. The goods cost Evergreen $600. July 15: Sold merchandise to Claudio’s Chair Company at a selling price of $5,000 on account with terms 3/10, n/30. The goods cost Evergreen $3,500. July 16: Claudio’s Chair Company returned $500 merchandise (original cost of the merchandise was $350) for full credit. July 21: Collected payment from Claudio’s Chair CompanyRequirement:1) Prepare journal entries for the above transactions.2) Compute net sales and cost of goods sold in July.
In class problem #3Prepare JEs for both Dayton Company and Matrix Company: Oct. 5: Dayton purchased goods with an invoice price of $100 from Matrix with terms of 2/10, n/30. The goods had cost Matrix $70. Oct 7, Dayton returned 10% of the purchase of Oct 5 to Matrix for full credit. Oct. 10: Matrix received payment from Dayton (within discount period)