chapter 6 Internal control, cash and merchandise

Lesson 6-3 Apply internal control principles to cash receipts and payments

Cash receipts: 1. cashiers are held individually responsible for cash they receive 2. different individuals be assigned to receive, maintain custody of, and record cash 3. cash be stored in a locked safe until it has been deposited in a bank 4. cash register receipts cash cout sheets daily cash summary reports and bank deposit slips be prepared to doc. the cash received and deposited 5. cash register receipts be matched to cash counts and deposit slips, to independently verify that all the cash was received and deposited

sales discount journal entry

Dr Cash (+A) Dr Sales discount (+xR, -SE) Cr Account receivable (-A)

what is the difference between FOB shipping point and FOB destination?

FOB shipping point is when the sale is recorded when the goods LEAVE the seller's shipping department FOB destination is different because the sale is recorded when the goods REACH their destination (the customer)

Lesson 6-5 Explain the use of perpetual inventory system as a control

Perpetual inventory systems protect against undetected theft because they provide an up-to-date record of inventory that should be on hand at any given time, which can be compared to a count of the physical quantity that actually is on hand Perpetual inventory systems serve to promote efficient and effective operations because they are updated every time inventory is purchased, sold, or returned

Lesson 6-2 Explain common principles and limitations of internal control

The concept of internal control is broad. there are 5 basic principles: 1. establish responsibility for each task 2. segregate duties so that one employee cannot initiate, record, approve and handle a single transaction 3. restrict access to those employees who have been assigned responsibility 4. document procedures performed 5. independently verify work done by others inside and outside the business Internal controls may be limited by cost, human error, and fraud

how do FOB shipping and FOB destination relate to revenue principle?

They related to revenue principle because the revenues are not recorded until they are earned, which is determined by the type of FOB.

why are contra-revenue accounts used rather than directly deducting from Sales revenue ?

Using a contra-revenue account instead of directly reducing the sales account allows the company to track the value of goods returned

what are the purposes of a bank reconciliation?

a bank reconciliation is a key internal control because it provides independent verification of all cash transactions that the bank has processed for the company

what are the important aspects of a bank statement?

a bank statement provides an overall summary of the activity in the account. the summary is followed by a list of specific transactions posted to the account, and/or a running balance items like: clearing checks, deposits made, other transactions

manufacturing company

a company that sells goods that it has made itself

merchandising company

a company that sells goods which have been obtained from a supplier

service company

a company that sells services rather than physical goods

which type of system provides better internal control over inventory?

a perpetual inventory system provides the best inventory control because its continuous tracking of transactions allows companies to instantly determine the quantity of products, and to evaluate the amount of time in inventory.

voucher system

a process for approving and documenting all purchases and payments on account

imprest system

a process that controls the amount paid to others by limiting the total amount of money available for making payments to others

what is a sales discount? 2/10, n/30?

a sales discount is a cash discount offered to customers to encourage prompt payment. specific terms like 2/10 indicates that if the customer pays by the 10th day of the sale date a 2% discount will be deducted from the selling price -n/30 implies that if a payment is not made within the 10-day period, the full amount will be due 30 days after the date of sale -sales discounts are calculated after taking into account any sales returns and allowances. -sales discounts are different from "discounts" you would get in a clearance section. reductions in selling price of merchandise that occur before sale is not considered a transaction and is not recorded in the accounting system *a sales discount must occur after the initial sale has been made**

perpetual inventory system

a system in which a detailed inventory record is maintained by recording each purchase and sale of inventory during the accounting period

periodic inventory system

a system in which ending inventory and cost of goods sold are determined only at the end of the accounting period based on a physical inventory count

what balances are reconciled?

a. interest received b. electronic funds transfer c. NSF checks d. service charges e. company errors

segregation of duties

an internal control that involves separating employees' duties so that the work of one person can be used to check the work of another person

why is it a good idea to assign each task to only one employee?

assigning responsibilities to only one employee creates a security system; this is so that one employee can't make a mistake or commit a dishonest act without someone else discovering it.

why is a physical count of inventory necessary in a periodic inventory system?

because in a periodic system the inventory on hand and the inventory sold is unavailable, the employees must physically count the inventory at the end of the period, and then adjust the balances for inventory and COGS

what type of items should be reported as cash and cash equivalents?

cash deposited with banks and cash on hand / petty cash cash equivalents are short-term, highly liquid investments purchased within 3 months of maturity - CDS

sales/cash discount

cash discount offered to customers to encourage prompt payment of an account receivable

Lesson 6-3 Apply internal control principles to cash receipts and payments (continued)

cash payments: 1. only certain individuals or departments initiate purchase requests 2. different individuals be assigned to order, receive and pay for purchases 3. access to checks and valuable property be restricted 4. purchase requisitions, purchase orders, receiving reports and pre-numbered checks be used to doc. the work done 5. each step in the payment process occurs only after the preceding step has been independently verified using the documents listed in (4)

NSFchecks

checks written for an amount greater than the funds available to cover them

frequent mistakes: discounts

discounts (or "markdowns") in the selling price of merchandise occur prior to making a sale, so they are not recorded. Sales discounts, given to customers after making a sale, are recorded in a contra-revenue account, to offset the sales revenue recorded on the initial sales transaction

in what way does documentation act as a control?

documentation creates a record of whether goods were shipped, customers were billed, cash received, etc. without these docs, a company wouldn't know what transaction were entered into the accounting system

describe the journal entries that are made in perpetual inventory system when inventory is sold on credit

dr Accounts Receivable (+A) cr Sales revenue (+R, +SE) (journal entry for credit sale)

sale of merchandise (perpetual) journal entry

dr cash (+A) cr Sales revenue (+R, +SE) dr COGS (+E, -SE) cr Inventory (-A)

cash shortage journal entry

dr cash (+A) dr cash shortage (+E, -SE) cr Sales Revenue (+R, +SE)

sales discount journal entry

dr cash (+A) 160 dr sales discount (+xR, -SE) 40 cr Account receivable ( - A) 200

what are the two components of a merchandise sale?

every merchandise sale has two components, each of which requires an entry in a perpetual inventory system 1. selling price - recorded as an INCREASE in Sales Revenue and INCREASE in either cash (cash sale) Account receivable (credit sale) 2. Cost - that was incurred to buy the merchandise is removed from Inventory and reported as an expense calls COGS

alternative terms

gross profit = gross margin or margin

frequent mistakes: gross profit

gross profit percentage is calculated as a percentage of net sales, not as a percentage of total revenue or costs of gods sold

gross profit percentage

indicates how much above cost a company sells its products; calculated as gross profit divided by net sales

what is internal control from the CEO of CFO perspective?

internal control is a broad concept that includes setting strategic objectives, identifying risks the company faces, hiring good employees, instilling ethical principles, motivating them to achieve the company's objectives, and providing the resources and information they need to fulfill those objectives

what is the distinction between merchandising and manufacturing companies?

merchandising companies buy the products from the suppliers. manufacturing companies make the products that it sells

cash

money or any instrument that banks will accept for deposit and immediate credit to the company's account, such as a check, money order, or bank draft

gross profit (gross margin, margin)

net sales less cost of goods sold

Lesson 6-7 analyze a merchandiser's multi-step income statement

one key item in merchandiser's multi-step income statement = GROSS PROFIT net sales - COGS / Net sales x 100 *the percentage of profit earned on each dollar of sales, after considering the cost of products sold *a higher ratio means that greater profit is available to cover operating and other expenses

bank reconciliation

process of using both the bank statement and the cash accounts of a business to determine the appropriate amount of cash in a bank account, after taking into consideration delays or errors in processing cash transactions

internal control

processes by which a company provides reasonable assurance regarding the reliability of the company's financial reporting, the effectiveness and efficiency of its operations, and its compliance with applicable laws and regulations

sales returns and allowances

reduction of sales revenues for return of or allowances for unsatisfactory goods

multistep income statement

reports alternative measurs of income by calculating subtotals for core and peripheral business activities

what is the distinction between retail and wholesale merchandising companies?

retailers sell directly to individual consumers; wholesalers sell their inventory to retail businesses for resale

helpful reminder: sales returns

sales returns have two components 1. an adjustment to the selling price (record a contra-revenue and a decrease in cash or accounts receivable) 2. return of goods previously recorded as sold (record an increase in inventory and a decrease in cost of goods sold). Sales allowances involve only the first component, because no goods are returned to the seller

what is the difference between sales revenue and net sales?

sales revenue is an account that keeps track of revenue created by sales Net sales

what is the distinction between service and merchandising companies?

service companies provide services for cash, whereas merchandising companies buy and sell products to customers for cash

cash equivalents

short-term, highly liquid investments purchased within three months of maturity

what are some of the methods for restricting access?

some methods to restrict access are physically locking up valuable assets AND electronically securing access to assets and information.

FOB shipping point

term of sale indicating that goods are owned by the customer the moment they leave the seller's premises

FOB destination

term of sale indicating that goods are owned by the seller until delivered to the customer

Lesson 6-4 Perform the key control of reconciling cash to bank statements

the bank reconciliation requires determining two categories of items 1.those that have been recorded in the company's books but not in the banks statement of account 2. those that have been reported in the banks statement of account but not in the company's books (the second category of items provides the data needed to adjust the cash account to the balance that will be reported on the balance sheet)

shrinkage

the cost of inventory lost to theft, fraud, and error

what is gross profit and how is gross profit percentage computed?

the difference between selling price and the cost. -gross profit is not directly recorded in an account by itself but is a subtotal produced by subtracting COGS - Sales Revenue (income statement accounts) The gross profit percentage is computed by subtracting net sales from COGS / net sales x 100

what is the main distinction between perpetual and periodic inventory systems?

the main difference between perpetual and periodic inventory is a perpetual system updates the inventory records immediately after purchase, sale and return of merchandise, the periodic system updates the inventory records only at the end of the accounting period.

what is the operating cycle for service and merchandising companies?

the operating cycles is a series of activities that a company undertakes to generate revenues/cash - service companies = simple operating cycle: collect cash --> use that money to pay for operating expenses -merchandising companies= complex operating cycle: buy inventory--> sell inventory--> collect cash--> pay operating expenses/ buy more inventory

what is the primary internal control goal for cash payments?

the primary goal of internal controls for cash payments is to ensure that the business pays ONLY for properly authorized transactions

what is the primary internal control goal for cash receipts?

the primary internal control goal for cash receipts is to ensure that the business receives the appropriate amount of cash and safely deposits it in the bank

why would a bank's reconciliation differ from a company's?

the records can differ for two basic reasons: 1. the company has recorded some items that the bank doesn't know about at the time it prepares the statement of account 2. the bank has recorded some items that the company doesn't know about until the bank statement is examined

helpful reminder: bank reconciliation

when preparing a bank reconciliation, your goals are to determine which transactions the bank has not yet processed and which transactions your company has not yet processed. You will record transactions correctly processed by the bank but not yet processed by your company

Lesson 6-1 Distinguish among service, merchandising and manufacturing operations

*Service companies sell services rather than physical goods; so their income statements show costs of SERVICE rather than cost of GOODS sold (WorldGym) *merchandise companies sell goods that have been obtained from a supplier; -retail merchandise companies sell directly to consumers (walmart, costco) -wholesale merchandise companies sell to retail companies *manufacturing companies sell goods that they have made themselves

Lesson 6-6 Analyze sales transactions under a perpetual inventory system

-in a perpetual inventory system, two entries are made very time inventory is sold 1. record the sale (and then debit Cash or accounts receivable) 2. record COGS (and then credit to inventory) -Sales discounts and sales returns and allowances are reported as contra-revenues, REDUCING net sales

why is gross profit an important part of the income statement? what does it tell you?

-the percentage of profit earned on each dollar of sales, after considering the cost of products sold higher ratio = company sells products for a greater markup over its costs used to 1) analyze changes in the company's operations over time 2) compare one company to another 3) determine whether a company is earning enough on each sale to cover operating expenses

what are two limitations of internal control?

1. an organization will implement internal controls only to the extent that their benefits exceed their costs. 2.internal controls can fail as a result of human error or fraud. people make mistakes in performing control procedures; criminally minded employees will override internal controls or work together (collude) to get around them

the five principles of internal control

1. restrict access - don't provide access to assets/ info unless needed 2. document procedures - prepare docs that show activities occurred 3.independent verify - check other's work 4. establish responsibility - assign each task to only one employee 5. segregate duties - don't make 1 employee responsible for all parts of a process

proper order of income statement

1. sales revenues 2. sales discount 3. net sales 4. COGS = Gross profit

what items do you need to adjust your cash records? the banks?

3. interest deposited 4. electronic funds transfer 5. service charges 6. NSF checks 7. your own errors 1. bank errors 2. time lags

what is the distinction between sales returns and sales allowances?

A sales return is when the customer returns the item for a full refund. A sales allowance is when the customer keeps the item, but asks for a reduction in the selling price