Contra-Accounts for Control and Analysis in Merchandise Accounting

1. Chapter 5 Merchandise Accounting and Internal Control Financial Accounting 4e by Porter and Norton

2. Contra-accounts used for control and analysis purposes Income Statement of a Merchandiser Cash sales $ 350,000 Credit sales 124,000 Total 474,000 Less: Sales returns & allowances ( 12,400) Sales discounts ( 34,600) Net sales $ 427,000

3. Sales Sales Discounts Sales Returns Sales Allowances Sales Contra-Accounts normal credit balance normal debit balance normal debit balance normal debit balance

4. Trade Discounts Offered to special class of customers Quantity Discounts Offered to customers willing to buy in large quantities Trade & Quantity Discounts Not recorded in accounting records – actual selling price is net amount, not list price

5. 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 days 2/10, n/30 Deduct 2% of invoice amount if paid within 10 days; otherwise full invoice amount is due in 30 days

6. Recording Sales Discounts Cash 980 Sales 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.

7. Cost of goods sold The Cost of Goods Sold Model New purchases Beginning inventory Inventory not sold - appears on balance sheet Ending inventory Inventory sold - appears on income statement

8. “Pool” of goods available to sell during the period 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

9. Perpetual Inventory Systems Inventory records are updated after each purchase or sale • Point of sale terminals have improved ability of mass merchandisers to maintain perpetual systems

10. 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

11. Cost of Goods Purchased • Includes invoice price: Plus: Transportation-in Less: Purchase returns and allowances Purchase discounts

12. Recording Purchase Discounts Accounts Payable 500 Cash 495 Purchase Discounts 5 ($ 500 x 1% = $5 discount) To record payment within discount period to supplier who offers 1% purchase discount.

13. Buyer Seller FOB Destination Point • No sale or purchase until inventory reaches its destination • Seller responsible for inventory while in transit Title Passes at Destination

14. Buyer Seller FOB Shipping Point • Both sale and purchase recorded upon shipment • Buyer responsible for inventory while in transit Title Passes when Shipped

15. Internal Auditors External Auditors Audit Committee of Board of Directors Responsibility for Internal Control Management

16. Internal Control Control Environment Internal Control Procedures Accounting System

17. The Control Environment • Management’s competence and operating style • Personnel policies and practices • Influence of board of directors

18. 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

19. Internal Control Procedures Independent Review and Appraisal Independent Verification Design & Use of Business Documents Safeguarding Assets and Records Proper Authorizations Segregation of Duties 19

20. LOAN APPROVED Proper Authorizations • Authority and responsibility go hand in hand

21. Segregation of duties • Separate physical custody from the accounting for assets

22. Independent Verification • One individual or department acts as a check on the work of another

23. Safeguarding Assets and Records • Protect assets and accounting records from loss, theft, unauthorized use, etc.

24. Audit Report Independent Review and Appraisal • Provide for periodic review and appraisal of the accounting system and the people operating it.

25. Design and Use of Business Documents • Capture all relevant information about a transaction and assist in proper recording and classification. • Are properly controlled

26. Limitations on Internal Control • No system is entirely foolproof • Employees in collusion can override the best controls • Cost vs. benefit tradeoff

27. Appendix Internal Control for a Merchandising Company

28. Date Paycheck for John Doe Dept. of Treasurer Date Jane Doe Paycheck for Dept. of Treasurer Controls Over Cash • All cash receipts deposited intact daily • All cash disbursements made by check

29. Controls Over Cash Received Over the Counter • Cash registers • Prenumbered customer receipts • Investigation of recurring discrepancies

30. Controls Over Cash Received in the Mail • Two employees open mail • Prelist prepared • Monthly customer statements

31. Document Flow for Merchandise Receiving Report Purchase Requisition Purchase Order Invoice Approval Purchase Invoice Check prepared

32. End of Chapter 5