Chapter 6 Merchandising Operations and Internal Control Belverd

Chapter 6 Merchandising Operations and Internal Control Belverd E. Needles, Jr. Marian Powers -----Multimedia Slides by: Dr. Howard A. Kanter, CPA De. Paul University Milton M. Pressley University of New Orleans Copyright Houghton Mifflin Company. All rights reserved. 6 -1

LEARNING OBJECTIVES 1. Identify the management issues related to merchandising businesses. 2. Explain the advantages and disadvantages of the periodic inventory system and calculate cost of goods sold. 3. Explain the advantages and disadvantages of the perpetual inventory system and state the importance of taking a physical inventory. 4. Contrast and record transactions related to sales and purchases under the periodic and the perpetual inventory systems. Copyright Houghton Mifflin Company. All rights reserved. 6 -2

LEARNING OBJECTIVES (continued) 5. Define internal control and identify the three elements of the internal control structure, including seven examples of control procedures. 6. Describe the inherent limitations of internal control. 7. Apply control procedures to common merchandising transactions. 8. Apply sales and purchases discounts to merchandising transactions. Copyright Houghton Mifflin Company. All rights reserved. 6 -3

Management Issues in Merchandising Businesses OBJECTIVE 1 Identify the management issues related to merchandising

u Merchandising businesses differ from service businesses in that they have goods on hand for sale to customers and engage in a series of transactions called the operating cycle. Copyright Houghton Mifflin Company. All rights reserved. 6 -5

The Operating Cycle of Merchandising Concerns Purchases Payment of cash CASH Purchase on credit ACCOUNTS PAYABLE MERCHANDISE INVENTORY Sales for cash Sales on credit Collection of cash ACCOUNTS RECEIVABLE Copyright Houghton Mifflin Company. All rights reserved. 6 -6

Cash Flow Management u Since purchases of merchandise are usually made on credit, the merchandiser must plan for cash flows from within the company or from borrowing to finance the inventory until it is sold and resulting revenue is collected. u Operators of a merchandising business must carefully manage cash flows or liquidity. u If a company can’t pay its bills when due, it may be forced out of business. Copyright Houghton Mifflin Company. All rights reserved. 6 -7

Profitability Management u. A company must sell its merchandise at a price that exceeds its cost by a sufficient margin to pay operating expenses and have enough left to provide sufficient net income or profitability. u Profitability management includes: Setting appropriate prices for merchandise. 4 Purchasing merchandise at favorable prices and terms. 4 Maintaining acceptable levels of operating expenses. 4 u An effective tool for controlling expenses is the operating budget. Copyright Houghton Mifflin Company. All rights reserved. 6 -8

Features of the Periodic Inventory System u Physically count inventory, usually at end of accounting period. u No detailed records of the actual inventory are maintained during the accounting period. u Less costly than perpetual inventory method, but provides less information. Copyright Houghton Mifflin Company. All rights reserved. 6 -9

Features of the Perpetual Inventory System u Continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold. u More effective for providing information about quantities and ensuring optimal customer service. Copyright Houghton Mifflin Company. All rights reserved. 6 -10

Control of Merchandising Operations u Principal transactions of merchandising businesses are vulnerable to theft and embezzlement. Cash and inventory are easy to steal. 4 These asset accounts are usually involved in a large number of transactions. 4 u Management’s responsibility is to establish an environment, accounting systems, and control procedures that will protect the company’s assets. u These systems and procedures are called the internal control structure. Copyright Houghton Mifflin Company. All rights reserved. 6 -11

Inventory Systems OBJECTIVE 2 Explain the advantages and disadvantages of the periodic inventory system

The Components of Cost of Goods Sold Cost of goods sold in 19 x 2: Beginning inventory 12/31/x 1: $52, 800 $131, 360 Net cost of purchases for 19 x 2: $126, 860 Merchandise sold to customers Goods available for sale: $179, 660 Ending inventory 12/31/x 2: $48, 300 Copyright Houghton Mifflin Company. All rights reserved. Merchandise carried over to next year 6 -13

Periodic Inventory System u Count inventory periodically, usually at end of accounting period. u Do not maintain detailed records. u Figure for inventory on hand is accurate only on the balance sheet date. 4 As soon as any sales or purchases are made, the figure becomes a historical amount until the end of the next accounting period. u May be used in business to reduce clerical cost. Copyright Houghton Mifflin Company. All rights reserved. 6 -14

Periodic Inventory System (Continued) u An important component of Cost of Goods Sold is net cost of purchases. u Net cost of purchases is computed as: Total Purchases xxxx Less: Deductions (xxxx) Net Purchases xxxx Plus: Freight Charges xxxx Net Cost of Purchases xxxx Copyright Houghton Mifflin Company. All rights reserved. 6 -15

Perpetual Inventory System OBJECTIVE 3 Explain the advantages and disadvantages of the perpetual inventory system and state the importance of a physical inventory. Copyright Houghton Mifflin Company. All rights reserved. 6 -16

Perpetual Inventory System u Records are kept of the quantity and, usually, the cost of individual items as they are bought or sold. u This system provides useful information for management purposes. u The cost of each item is recorded in the Merchandise Inventory account when purchased. u As merchandise is sold, its cost is transferred from Merchandise Inventory account to the Cost of Goods Sold account. Copyright Houghton Mifflin Company. All rights reserved. 6 -17

Perpetual Inventory System (Continued) u The balance of the Merchandise Inventory account equals the cost of goods on hand. u The balance of the Cost of Goods Sold account equals the cost of the merchandise sold to customers. u The Purchases account is not used. u Due to the widespread use of computers, the distinction between which inventory system is most appropriate is blurred. Copyright Houghton Mifflin Company. All rights reserved. 6 -18

Taking a Physical Inventory u. A physical inventory means actually counting all merchandise on hand. u It is easy to omit or double count items. u It is done under both periodic and perpetual inventory systems. u Merchandise inventory includes all goods intended for sale, regardless of where they are physically located. Copyright Houghton Mifflin Company. All rights reserved. 6 -19

Taking a Physical Inventory (Continued) u The count does not include merchandise sold but not delivered or goods that cannot be sold. u The actual count is usually taken after close of business on the last day of the fiscal year. u Counting procedures must be carefully planned and may include the use of bar coding. Copyright Houghton Mifflin Company. All rights reserved. 6 -20

Inventory Losses u Most companies experience losses from spoilage, shoplifting, and theft by employees. u The periodic inventory system does not provide a means for identifying these losses. u Theft losses become a part of cost of goods sold for the period. u Perpetual inventory system makes it easier to identify such losses. Copyright Houghton Mifflin Company. All rights reserved. 6 -21

Merchandising Transactions OBJECTIVE 4 Contrast and record transactions related to sales and purchases under the periodic and the perpetual inventory systems. Copyright Houghton Mifflin Company. All rights reserved. 6 -22

Sales Terms u Trade 4 A discount. reduction of the list price. u Sales discount. 4 Discount given for early payment. 4 Taken if payment is made within the terms of sale. For example, “ 2/10, n/30. ” 4 Practice of giving sales discounts has been declining. Copyright Houghton Mifflin Company. All rights reserved. 6 -23

Sales Terms u FOB (Continued) shipping point. 4 Title passes at origin. 4 Buyer pays the freight. u FOB destination. 4 Title passes at destination. 4 Seller pays the freight. Copyright Houghton Mifflin Company. All rights reserved. 6 -24

Purchases of Merchandise on Credit Periodic inventory system. Oct. 3 Purchases Accounts Payable 4, 890 Perpetual inventory system. Oct. 3 Merchandise Inventory 4, 890 Accounts Payable Copyright Houghton Mifflin Company. All rights reserved. 4, 890 6 -25

Transportation Costs on Purchases Periodic inventory system. Oct. 4 Freight In Accounts Payable 160 Perpetual inventory system. Oct. 4 Freight In Accounts Payable Copyright Houghton Mifflin Company. All rights reserved. 160 6 -26

Purchases Returns and Allowances Periodic inventory system. Oct. 6 Accounts Payable Purchase Returns and Allowances 480 Perpetual inventory system. Oct. 6 Accounts Payable Merchandise Inventory Copyright Houghton Mifflin Company. All rights reserved. 480 6 -27

Payments on Account Periodic inventory system. Oct. 10 Accounts Payable Cash 4, 410 Perpetual inventory system. Oct. 10 Accounts Payable Cash Copyright Houghton Mifflin Company. All rights reserved. 4, 410 6 -28

Sales of Merchandise on Credit Periodic inventory system. Oct. 7 Accounts Receivable Sales 1, 200 Perpetual inventory system. Oct. 7 Accounts Receivable 1, 200 Sales Cost of Goods Sold 720 Merchandise Inventory Copyright Houghton Mifflin Company. All rights reserved. 1, 200 720 6 -29

Payment of Delivery Costs Periodic inventory system. Oct. 8 Freight Out Expense Cash 78 78 Perpetual inventory system. Oct. 8 Freight Out Expense Cash Copyright Houghton Mifflin Company. All rights reserved. 78 78 6 -30

Returns of Merchandise Sold on Credit Periodic inventory system. Oct. 9 Sales Returns and Allowances Accounts Receivable 300 Perpetual inventory system. Oct. 9 Sales Returns and Allowances Accounts Receivable Merchandise Inventory Cost of Goods Sold Copyright Houghton Mifflin Company. All rights reserved. 300 180 6 -31

Receipts on Account Periodic inventory system. Nov. 5 Cash Accounts Receivable 900 Perpetual inventory system. Nov. 5 Cash Accounts Receivable Copyright Houghton Mifflin Company. All rights reserved. 900 6 -32

Internal Control Structure: Basic Elements and Procedures OBJECTIVE 5 Define internal control and identify the three elements of the internal control structure, including seven examples of control procedures. Copyright Houghton Mifflin Company. All rights reserved. 6 -33

Internal Control Defined u Internal control is all the policies and procedures management uses to: 4 Protect the firm’s assets and ensure the accuracy and reliability of the accounting records. 4 Promote operating efficiency and encourage adherence to management’s policies. Copyright Houghton Mifflin Company. All rights reserved. 6 -34

Elements of Internal Control Internal control includes: 1. The control environment. 2. The accounting system. 3. The control procedures. u Copyright Houghton Mifflin Company. All rights reserved. 6 -35

The Control Environment u Created by the overall attitude, awareness, and actions of management. u Influenced by: 4 Management’s philosophy and operating style. 4 Organizational structure. 4 Methods of assigning authority and responsibility. 4 Personnel policies and practices. Copyright Houghton Mifflin Company. All rights reserved. 6 -36

The Accounting System u Methods and records to identify, assemble, analyze, classify, record, and report a company’s transactions, and to make sure that the goals of internal control are being met. Copyright Houghton Mifflin Company. All rights reserved. 6 -37

Control Procedures 1. 2. 3. 4. 5. 6. 7. Authorization. Recording transactions. Documents and records. Limited access. Periodic independent verification. Separation of duties. Sound personnel procedures. Copyright Houghton Mifflin Company. All rights reserved. 6 -38

Limitations of Internal Control OBJECTIVE 6 Describe the inherent limitations of internal control. Copyright

Limitations of Internal Control u Human error. u Misunderstandings. u Mistakes in judgment. u Carelessness. u Distraction. u Fatigue. u Collusion. u Dishonesty. u Changes in conditions. Copyright Houghton Mifflin Company. All rights reserved. 6 -40

Internal Control over Merchandising Transactions OBJECTIVE 7 Apply control procedures to common merchandising transactions.

Internal Control and Management Goals u Goals for the success of a merchandising business. 4 Prevent losses of cash or inventory owing to theft or fraud. 4 Provide accurate records of merchandising transactions. Copyright Houghton Mifflin Company. All rights reserved. 6 -42

Goals for Management u Keep enough inventory on hand to sell to customers without overstocking. u Keep enough cash on hand to pay for purchases in time to receive discounts. u Keep credit losses as low as possible by making credit sales only to customers who are likely to pay on time. Copyright Houghton Mifflin Company. All rights reserved. 6 -43

Controls for Meeting Management’s Goals u Cash budget. u Separation of duties. Copyright Houghton

Control of Cash Sales Receipts u Cash is received either by mail or over the counter. In either case: It should be recorded immediately in cash receipts journal. 4 It establishes a written record of cash receipts. 4 u Control of cash received through the mail. Encourage customers to pay by check. 4 Handle by two or more employees. 4 Make a list of receipts in triplicate. 4 u Control of cash received over the counter. Cash registers. 4 Prenumbered sales tickets. 4 Copyright Houghton Mifflin Company. All rights reserved. 6 -45

Internal Control for Purchasing and Paying for Goods and Services Check Deposit Ticket SUPPLIER 3 BANKING SYSTEM 7 Goods Invoice THE COMPANY Purchase Order PURCHASING DEPARTMENT REQUESTING DEPARTMENT Purchase Requisition 2 1 RECEIVING DEPARTMENT Goods 4 Purchase Order Copy Receiving Report ACCOUNTING DEPARTMENT TREASURER 5 Check Authorization (with documentation) 6 Monthly Bank Statement Copyright Houghton Mifflin Company. All rights reserved. 6 -46

PURCHASE REQUISITION No. 7077 Martin Maintenance Company Credit Office From: To: Date: Purchasing Department September 6, 19 xx Suggested Vendor: Company Please purchase the following items: Quantity 20 boxes Number Henderson Supply Description X 144 FAX paper rolls Reason for Request To be filled in by Purchasing Department Six months’ supply for office Date ordered 9/8/xx P. O. No. J 102 Approved Copyright Houghton Mifflin Company. All rights reserved. 6 -47

PURCHASE ORDER No. J 102 Martin Maintenance Company 8428 Rocky Island Avenue Chicago, Illinois 60643 To: Henderson Supply Company 2525 25 th Street Mesa, Illinois 61611 Ship to: Martin Maintenance Company Above Address Date: September 8, 19 xx FOB: Destination Ship by: September 12, 19 xx Terms: 2/10, n/30 Please ship the following: Quantity 20 boxes 3 Number Description X 144 FAX paper rolls Purchase order number must appear on all shipments and invoices. Copyright Houghton Mifflin Company. All rights reserved. Price Per 12. 00 box Amount $240. 00 Ordered by 6 -48

INVOICE No. 0468 September 12, 19 xx Henderson Supply Company 2525 25 th Street Mesa, Illinois 61611 Date Sold to: Ship to: J 102 Your Order No. Same Martin Maintenance Company 8428 Rocky Island Avenue Chicago, Illinois 60643 Sales Representative: Joe Jacobs Quantity Ordered Shipped 20 20 FOB Destination Description Price Per Amount X 144 FAX paper rolls 12. 00 box $240. 00 Terms: 2/10, n/30 Via: Self Date Shipped: 9/12/xx Copyright Houghton Mifflin Company. All rights reserved. 6 -49

CHECK AUTHORIZATION NO. CHECK 7077 J 102 JR 065 0468 Requisition Purchase Order Receiving Report INVOICE Price Calculations Terms Approved for Payment Copyright Houghton Mifflin Company. All rights reserved. 6 -50

Check and Remittance Advice Martin Maintenance Company 8428 Rocky Island Avenue Chicago, Illinois 60643 2570 61 -153/313 NO. 9/21 PAY TO THE ORDER OF Henderson Supply Company $ 235. 20 Two hundred thirty-five and 20/100 ------THE LAKE PARK NATIONAL BANK xx 19 Dollars Martin Maintenance Company Chicago, Illinois by Remittance Advice Date P. O. No. 9/21/xx J 102 DESCRIPTION 20 X 144 FAX paper rolls Supplied Inv. No. 0468 Less 2% discount Net AMOUNT $240. 00 4. 80 $235. 20 Martin Maintenance Company Copyright Houghton Mifflin Company. All rights reserved. 6 -51

Accounting for Discounts SUPPLEMENTAL OBJECTIVE 8 Apply sales and purchases discounts to merchandising transactions.

Sales Discounts Original sale on credit. Sept. 20 Accounts Receivable Sales 300 Customer takes advantage of discount. Sept. 29 Cash Sales Discounts Accounts Receivable 294 6 300 Customer does not take advantage of discount. Nov. 19 Cash Accounts Receivable Copyright Houghton Mifflin Company. All rights reserved. 300 6 -53

Purchases Discounts Take discount when paying. Nov. 22 Accounts Payable Purchases Discounts Cash 1, 300 26 1, 274 Do not take discount when paying. Dec. 12 Accounts Payable Cash Copyright Houghton Mifflin Company. All rights reserved. 1, 300 6 -54

OK, LET’S REVIEW. . . 1. Identify the management issues related to merchandising businesses. 2. Explain the advantages and disadvantages of the periodic inventory system and calculate cost of goods sold. 3. Explain the advantages and disadvantages of the perpetual inventory system and state the importance of taking a physical inventory. Copyright Houghton Mifflin Company. All rights reserved. 6 -55

CONTINUING OUR REVIEW. . . 4. Contrast and record transactions related to sales and purchases under the periodic and the perpetual inventory systems. 5. Define internal control and identify the three elements of the internal control structure, including seven examples of control procedures. Copyright Houghton Mifflin Company. All rights reserved. 6 -56

AND FINALLY. . . 6. Describe the inherent limitations of internal control. 7. Apply control procedures to common merchandising transactions. 8. Apply sales and purchases discounts to merchandising transactions. Copyright Houghton Mifflin Company. All rights reserved. 6 -57