Chapter 6 - Objectives Merchandising Operations &

Internal Control• Identify Management issues in a

Merchandising businesses

• Understand terms of sale

• Do JEs for a Perpetual Inventory system; prepare an Income Statement

• Do JEs for a Periodic Inventory system; prepare an Income Statement

Chapter 6 - Objectives Merchandising Operations &

Internal Control• Define Internal Control

• Describe limitations of IC• Apply IC to Merchandising

transactions

Management Issues

• Cash Flow Management

• Profitability Management – are you on budget?

• Choice of Inventory System –– Perpetual?

– Periodic?

Perpetual Inventory System

• Continuous “perpetual” accounting records are kept to track the Sales transaction AND the Cost of the Goods Sold.

Better tracking of item availability, on hand, on order

• 2 journal entries for a sale

Periodic Inventory System

• No tracking

• Inventory just counted “periodically” to see what is on hand.

• 1 journal entry for sale

Sales Revenues -Under a Periodic System

• ONLY 1 entry is made for each sale

–one to record sale

What is the Sales Returns and Allowances Account?

• Contra Revenue Account to sales

• Used to show how much came in on returns and allowances

Excessive returns and allowances suggest:inferior merchandiseinefficiencies in filing orderserrors in billing customersmistakes in delivery or shipment of goods

What Is the Sales Discount Account?

• Contra Revenue Account to sales• Used to disclose amount of cash discounts

taken by customers

Key difference between periodic and perpetual

inventory…

is the point at which the costs of goods sold is

computed.

No attempt is made on date of sale to record the cost of merchandise sold...

Periodic Inventory

Companies that use periodic inventory take a physical count

to...

determine ending inventorycompute cost of goods sold

Companies that use perpetual inventory must take a physical inventory to check accuracy of “book inventory” to actual inventory.

Taking a Physical Inventory

• Determining inventory quantities by counting, weighting or measuring each type of inventory.

• Determining ownership of goods, including goods in transit,consigned goods.

• Quantity of each kind of inventory is listed on inventory summary sheets where unit costs are applied.

Questions Concerning Ownership

• Do all the goods included in the count belong to the company?

• Does the company own any goods not included in the count?

Goods in Transit

These are goods on board a truck, train, ship, or plane at the end of the period.

36

Goods in Transit

Who includes these in inventory?Buyer?Seller?

The Company

with Legal Title

Shipping Terms

• FOB (free on board) shipping point- ownership of goods passes to buyer when public carrier accepts the goods

• FOB (free on board) destination- ownership of goods remains with the seller until the goods reach the buyer

Ownership passes to

owner here

Ownership passes to

buyer here

PublicCarrierCo

PublicCarrierCo

Seller

Seller

Buyer

Buyer

FOB Shipping Point

FOB Destination Point

Illustration 6-4

Consigned Goods

Goods in your store that you don’t pay for until they sell…

the company does not take ownership.

Example: Perpetual vs. Periodic

Income Statement Presentation

The income statement for a merchandising company is the same whether a periodic or perpetual inventory system is used, except for the

cost of goods sold section.

Sales revenuesSales $ 480,000Less: Sales returns and allowance $12,000

Sales discounts 8,000 20,000Net sales 460,000Cost of goods sold 316,000Gross profit $ 144,000Operating expenses Selling expenses:

Store salaries expense $45,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000

Total selling expenses $76,000 Administrative expenses Salaries expense $19,000

Utilities expense 17,000 Insurance Expense 2,000

Total administrative expenses 38,000 Total operating expenses 114,000 Income from operations $ 30,000

Select Buy, INC.Income Statement (Perpetual)

For the Year Ended December 31, 2001

Illustration 5-3

Sales revenuesSale $ 480,000Less: Sales returns and allowance $12,000

Sales discounts 8,000 20,000Net sales 460,000Cost of goods sold

Inventory, January 36,000Purchases $ 325,000

Less: Purchase returns and allowances $10,400

Purchase discounts 6,800 17,200Net Purchases 307,800

Add: Freight-in 12,200 Cost of goods purchased 320,000 Cost of goods available for sale 356,000 Inventory, December 31 40,000 Cost of goods sold 316,000Gross profit 144,000Operating expenses 114,000Net Income $

30,000

Income Statement (Periodic) Illustration 6-6

Prepare an Income Statement – Periodic Invent.

INTERNAL CONTROL

“Scrap” is inventory that is broken, either in the warehouse or on the production floor. Rather than discard it, the company has a policy of filling a box up with scrap (metal fitting, clamps, sheet metal). When the box is full, one employee hauls it to the Scrap Dealer, who weighs it, and issues the company a check for the items. Depending upon the weight of the box (determined at the scrap dealer’s), the check amounts vary.

• Is there an Internal Control Issue?

A small landscaping company buys rocks and lumber. One of the project managers is responsible for ordering the lumber, which he does by calling up the lumber dealer and ordering a shipment over the phone. No purchase order is used. The lumber dealer delivers lumber directly to the job site and invoices the company once a month, on one bill.

• Is there an Internal Control Issue?

A retail store has been experiencing higher than expected Cost of Goods Sold. You use the periodic inventory system.

• Is there an Internal Control Issue?

Should a retail store always give the customer a receipt? Do you check your receipt?

• Is there an Internal Control Issue?

INTERNAL CONTROL- components

• Control Environment

• Risk Assessment

• Information/communication

• Control activities

• Monitoring

Internal Control • Doesn’t save you from:

Collusion or Embezzlement

Reasonable Assurance: Assets are safeguarded Financial Statements are Reliable

Free from Errors and Irregularities

Follow the 7 Control Activities

Control Activities (7) of IC1. Authorization2. Recording Transactions3. Documents & Records4. Physical, Mechanical, Electronic Controls 5. Periodic Checks – (Independent Internal Verification) 6. Separation (Segregation) of duties7. Sound Personnel Procedures

Balancing act for a Merchandising business. . ..

• Key goals– Prevent losses of cash or inventory– To provide accurate records

• Broader goals– Keep the RIGHT balance of inventory– Keep $$$ on hand to pay, on time, with

discounts– Extend credit only to creditworthy customers

Internal Control for Merchandising

• Control of Cash Sales Receipts

• Control of Cash Purchases and Disbursements– Use a PO!

• (purchase requisitionpurhcase orderinvoicereceiving reportcheck authorizationcheck

THINGS YOU NEED TO KNOW

• The Best ICs are PREVENTIVE

• Put an experienced person in charge of the plan

• Get Management BUY-IN

• Accounting Systems CAN help

CONCLUSIONS. . . .

• All companies need Internal Controls. . .

• Fraud may happen, but don’t tempt them