Chapter 6
Internal Control, Bank Reconciliation’s, & Merchandising Firms
Please Note: We will include some Chapter 7 material within this chapter!
· The operating cycle of a merchandising firm is longer than that of a service firm.
· Internal Controls help a business safeguard its assets, enhance accuracy and reliability of its accounting records, and create an ethical business environment.
o Establish Responsibility
o Segregate Duties
o Restrict Access
o Document Procedures
o Independently Verify
o Other Controls: Bonding of employees, mandatory vacations, collusion, etc.
· Problems that can arise: cost vs. benefit, human element, size of business
· What are: Remittance advise, Electronic funds transfer (EFT), & Imprest system
· 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.
o See Exhibit 6.6, page 265 for examples of reconciling differences
o Per Bank: deposits in transit, outstanding checks, bank errors
o Per Books: interest, EFT’s, service charges, NSF checks, company errors
· Only Per Book items need journalized!!
· Cash (immediate) vs. Cash Equivalents (highly liquid – 3 months or less till maturity)
· Perpetual Inventory – detailed inventory system in which the cost of inventory is maintained and the records continuously show the inventory that should be on hand.
· Periodic Inventory – inventory system in which detailed records are not maintained and the cost of goods sold is determined only at the end of the accounting period.
· FOB shipping point (sale is recorded when the goods leave the seller’s shipping department) vs. FOB destination (sale is recorded when the goods reach their destination/customer)
Perpetual Merchandising Transactions:
Seller’s Books
· When a sale is made, two entries are recorded (Sale and COGS) pg. 271 & 273
· When the seller pays shipping, it will be considered an operating expense called Freight-Out
· When a return occurs, reverse the initial sales entry with one exception pg. 272
o Sales Returns and Allowances is a contra-revenue!
· When a customer pays their balance, record payments including discounts pg. 273
o Sales Discounts is a contra-revenue!
o Credit term examples: 2/10, n/30 or 2/10 EOM
Buyer’s Books
· When goods are bought, record the purchase pg. 320
· When the buyer pays shipping, it’s considered an addition to Inventory pg. 321
· When a return occurs, reverse the initial sales entry pg. 321
· When the buyer pays off their balance, record payments including discounts pg. 322
o Note that Inventory is credited on the buyer’s books when a discount occurs.
Periodic Merchandising Transactions:
Seller’s Books
· Since inventory and COGS is computed at the end of the period, only the sales entry and the return entries are effected
o When a sale occurs, show only the sales entry (i.e., no second entry)
o When a return occurs, reverse the sales entry (i.e., no second entry)
Buyer’s Books
· Entries are the same as the perpetual method, however the Inventory account will be named something other than Inventory in each transaction.
o The following accounts will be used in substitute for Inventory:
§ Purchases
§ Freight-In
§ Purchase Returns and Allowances
§ Purchase Discounts
· Exhibit 7.6 on page 322 shows how to compute cost of goods available for sale
o To get cost of goods sold, simply subtract ending inventory from that number!
Multi-step Income Statement Format
Sales Revenue
- Less: Sales R & A
Sales Discounts
= Net Sales
- Cost of Goods Sold
= Gross Profit
- Operating Expenses (rent, utilities, depreciation, freight-out, selling, general, administrative, etc.)
= Income from Operations
+/- Non-Operating Revenues and Expenses (interest, gain/loss from investing activities, other)
= Income before Income Taxes
- Income Tax Expense
= Net Income
Additional (Profitability) Ratio: Gross Profit Percentage = Gross Profit / Net Sales