Merchandise Accounting

1
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
Sales Revenue
Cash or A/R
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 124,000
• Total 474,000
• 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
(Sales Returns and Allowances)
(Cash) or (A/R)
Decreases Sales Revenue, this is a Contra-Revenue
account.
Sales Revenue xxx Less Sales RA xx
Sales Dis. xx Net Sales xx
6
Trade Quantity Discounts

• Not always recorded separately in companys
  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? Wouldnt a
better symbol would be g (gross) or t
(total). But this is a term thats been used for
many years and it has become accepted in practice
over time!
9
Recording Sales Discounts Example
-----------Balance Sheet------------- --Income
Statement-- Assets Liabilities
OE Revenues - Expenses
Accounts Sales Receivable 5,000 Revenue
5,000
Assume a credit sale of 5,000 with payment terms
of 1/10, net 30. Effect on the B/S Equation?
Using the Gross Sales Method, Sales Discount is
not recorded unless the discount is taken. (The
Net Method uses Interest Revenue if not.) 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 RA xx
Sales Dis. xx Net Sales (on I/S) xx
It might mean Net Sales are OVERSTATED.
10
Recording Sales Discounts Example
-----------Balance Sheet------------- --Income
Statement-- Assets Liabilities
OE Revenues - Expenses
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
50 5,000 x
1
Cash Recd Gross Sales - Sales Discount
4,950 5,000 - 50
A A/R
R Sales
CR Sales Discounts
A Cash
5,000
5,000
5,000
4,950
50
Customers Balance after payment.
0
11
Recording Sales Discounts Example
-----------Balance Sheet------------- --Income
Statement-- Assets Liabilities
OE Revenues - Expenses
Accounts Sales Receivable (5,000)
Discounts Cash 4,950
(50)
If customer pays within the discount period, they
receive a 1 discount. What is the effect on the
B/S Equation?
Notice the net increase in assets and equity
(revenues) is 4,950
A A/R
R Sales
CR Sales Discounts
A Cash
5,000
50
5,000
5,000
4,950
0
4,950
4,950
12
Inventory Recording SystemsTwo 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., 7-11s) dont? 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.

15
The Cost of Goods Sold ModelPeriodic Inventory

• Beginning Inventory (B/S) 10,000
• Cost of Goods Purchased 40,000
• Cost of Goods Available for Sale 50,000
• - Ending Inventory (B/S) (20,000)
• Cost of Goods Sold (I/S) 30,000

16
The Cost of Goods Purchased ModelPeriodic
Inventory
Purchases
Gross invoice price
Plus Transportation-in
Shipping cost to buyer, if any
Less Purchase Returns
Allowances Purchase Discounts
Opposite of Sales RA
Opposite of Sales Discounts
Cost of Goods Purchased
Internal calculation not an account nor reported
in F/Ss
17
Cost of Goods Purchased Periodic InventoryWhat
type of ACCOUNTS would these be in the B/S
Equation?
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.
Transportation-in
Less Purchase returns allowances
Purchase discounts
Cost of Goods Purchased
18
Cost of Goods Purchased Periodic InventoryWhat
type of ACCOUNTS would these be in the B/S
Equation?
Purchases
Transportation-in?
Expense account it is part of COGS
Less Purchase Returns Allowances
Purchase Discounts
Cost of Goods Purchased
19
Cost of Goods Purchased Periodic InventoryWhat
type of ACCOUNTS would these be in the B/S
Equation?
Purchases
Transportation-in
Contra-Expense account to Purchases
Less Purchase Returns Allowances ?
Purchase Discounts
Cost of Goods Purchased
20
Cost of Goods Purchased Periodic InventoryWhat
type of ACCOUNTS would these be in the B/S
Equation?
Purchases
Transportation-in
Less Purchase Returns Allowances
Purchase Discounts ?
Contra-Expense account to Purchases
Cost of Goods Purchased
21
RECORDING PURCHASE DISCOUNTS PERIODIC INVENTORY
SYSTEM
-----------Balance Sheet------------- --Income
Statement-- Assets Liabilities
OE Revenues - Expenses
Accts. Purchases
Payable (1,000)
1,000
Assume a credit purchase of 1,000 with payment
terms of 2/10, net 30. Record effect on B/S
equation
L Accounts Payable
E Purchases
1,000
1,000
22
RECORDING PURCHASE DISCOUNTS PERIODIC INVENTORY
SYSTEM
Formula Purchase Discount Purchase Price x
Discount 20
1,000 x .02
Cash Paid Gross Purchase - Purchase Discount
980 1,000 -
20
If company pays within discount period, they can
deduct a 2 discount. Determine the effect on
the B/S equation.
E Purchases
L Accts Payable
A Cash
CE Pur. Discount
1,000
1,000
1,000
20
980
0
A/P is fully paid!
23
RECORDING PURCHASE DISCOUNTS PERIODIC INVENTORY
SYSTEM
-----------Balance Sheet------------- --Income
Statement-- Assets Liabilities
OE Revenues - Expenses
Cash Accts. Purchase (980)
Payable Discounts
(1,000) 20
Company pays within the discount period they can
deduct a 2 discount. What is the effect on the
B/S Equation?
E Purchases
L Accts Payable
A Cash
CE Pur. Discount
1,000
1,000
1,000
20
980
0
24
FOB Destination Point(Freight On Board)
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

25
FOB Shipping Point
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

26
Internal Control Systems(require 3 components)
CONCEPT Techniques used to safeguard protect
assets of company
27
Responsibilities for Internal Control
Internal Auditors
External Auditors CPAs
Audit Committee of Board of Directors
Management Sets and enforces policies Internal
Auditors Test for compliance CPAs Verifies and
reports to Audit Comm.
28
The Control EnvironmentAn Attitude

• Reflect managements understanding of controls,
  competence and operating style
• Necessitate certain control policies and
  practices
• Require influence and support of Board of
  Directors

29
The Accounting SystemA 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

30
Internal Control ProceduresKey Safeguards used
in Practice
31
Proper Authorizations

• Concept Authorizations are required before
  assets are transferred, used or exchanged

32
Segregation of duties

• Concept Separate the physical custody of assets
  from the accounting for assets

33
Independent Verification

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

34
Protecting Assets and Records

• Concept Protect assets and accounting records
  from loss, theft, unauthorized use, etc.

35
Independent Review and Appraisal

• Concept Conduct periodic review of internal
  controls and appraisal of the accounting system
  as well as the people operating it.

36
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

37
Limitations on Internal Control

• No system can be entirely foolproof breakdowns
  can occur
• Employee collusion can override the best controls
• Cost vs. benefit tradeoffs exist

38
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

39
Appendix 5A

• Internal Control for a Merchandising Company

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Controls Over Cash

• All cash receipts deposited intact daily
• All cash disbursements made by check

41
Controls Over Cash Received Over the Counter

• Cash registers
• Prenumbered customer receipts

42
Controls Over Cash Received in the Mail

• Two employees open mail
• Prelist prepared
• Customer statements
• Investigation of recurring discrepancies

43
Document Flow for Merchandise
Harcourt Brace Company items and derived items