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Chapter 6

Merchandising Operations

and

Internal Control

Adapted from Financial Accounting 4e by Porter and Norton

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Income Statement of a Merchandiser

Cash sales $ 350,000Credit sales 124,000

Total 474,000Less: Sales returns &

allowances ( 12,400) Sales discounts ( 34,600)

Net sales $ 427,000

Contra-accounts used for control and analysis purposes

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Sales Contra-Accounts

Sales

normalcredit

balance

Sales Discounts

Sales AllowancesSales Returns

normaldebit

balance

normaldebit

balance

normaldebit

balance

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Trade & Quantity Discounts

Trade DiscountsOffered to special class of customers

Quantity DiscountsOffered to

customers willing to buy in large

quantities

Not recorded in accounting records – actual selling price is net amount, not list price

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Credit Terms and Sales Discounts

n/30 Payment due 30 days from invoice date

1/10, n/30 Deduct 1% of invoice amount if paid within 10 days; otherwise full invoice amount is due in 30

days2/10, n/30 Deduct 2% of invoice amount if

paid within 10 days; otherwise full invoice amount is due in 30 days

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Recording Sales Discounts

Cash 980Sales Discounts 20

Accounts Receivable 1,000

($1,000 x 2% = $20 discount)

To record collection on account of customer who has taken 2% sales discount.

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Newpurchases

Beginninginventory

The Cost of Goods Sold Model

Cost of goods

sold

Inventory not sold - appears on

balancesheet Inventory sold -

appears onincome statement

Ending inventory

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An increase in ending inventory means more was bought than sold

The Cost of Goods Sold Model

Beginning inventory $ 15,000

Plus: Cost of goods purchased 63,000

= Cost of goods available for sale 78,000

Less: Ending inventory ( 18,000)

= Cost of goods sold $ 60,000

“Pool” of goodsavailable to sell

during the period

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Perpetual Inventory Systems

Point of sale terminals have improved ability of mass merchandisers to maintain perpetual systems

Inventory records are updated after each purchase or sale

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Periodic Inventory Systems

Reduces record-keeping but also decreases ability to track theft, breakage, etc. and prepare interim financial statements

Inventory records are updated periodically

based on physical inventory counts

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Cost of Goods Purchased

Includes invoice price:

Less:

Purchase returns and allowances

Purchase discounts

Plus:

Transportation-in

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Recording Purchase Discounts

Accounts Payable 500Cash 495

Purchase Discounts 5

($ 500 x 1% = $5 discount)

To record payment within discount period to supplier who offers 1% purchase discount.

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FOB Destination Point

No sale or purchase until inventory reaches its destination

Seller responsible for inventory while in transit

Seller Buyer

TitlePasses at

Destination

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FOB Shipping Point

Both sale and purchase recorded upon shipment Buyer responsible for inventory while in transit

Seller Buyer

TitlePasses when

Shipped

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Responsibility for Internal Control

Management

External Auditors Audit

Committee of Board of

Directors

InternalAuditors

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Internal Control

Control Environment

AccountingSystem

InternalControl

Procedures

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The Control Environment

Management’s competence and operating style

Personnel policies and practices

Influence of board of directors

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The Accounting System

Can be manual or automated systems or a combination of both

Use of journals is an integral part of any system

Methods and records used to report transactions and maintain financial

information

Internal Control Procedures

Segregationof Duties

SafeguardingAssets and

Records

ProperAuthorizations

IndependentVerification

Design & Use of BusinessDocuments

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IndependentReview andAppraisal

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Proper Authorizations

Authority and responsibility go hand in hand

LOANAPPROVED

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Segregation of duties

Separate physical custody from the accounting for assets

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Independent Verification

One individual or department acts as a check on the work of another

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Safeguarding Assets and Records

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

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Independent Review and Appraisal

Provide for periodic review and appraisal of the accounting system and the people operating it.

AuditReport

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Design and Use of Business Documents

Capture all relevant information about a transaction and assist in proper recording and classification.

Are properly controlled

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Limitations on Internal Control

No system is entirely foolproof– Employees in collusion can override the best

controls– Cost vs. benefit tradeoff

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Appendix

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 Paycheck for

Dept. of Treasurer

John Doe

Payche

ck for

Date

Dept.

of Tre

asurer

Jane D

oeDate

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Controls Over Cash Received Over the Counter

Cash registers

Prenumbered customer receipts

Investigation of recurring discrepancies

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Controls Over Cash Received in the Mail

Two employees open mail

Prelist prepared Monthly customer

statements

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Document Flow for Merchandise

Checkprepared

PurchaseRequisition

Receiving Report

Purchase Order

Invoice Approval

Purchase Invoice