McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 Internal Control, Cash, and Merchandise Sales PowerPoint Authors: Brandy Mackintosh Lindsay Heiser

6-2 Learning Objective 6-1 Distinguish among service, merchandising, and manufacturing operations.

6-3 Operating Cycles

6-4 Operating Cycles Sell Products Collect Cash Incur Operating Expenses Buy Raw Materials Make Products Manufacturing Company

6-5 Learning Objective 6-2 Explain common principles and limitations of internal control.

6-6 Internal Control Internal control is important to all types and sizes of organizations, especially after the business failures and accounting scandals involving Enron and other companies in the early 2000s. The Sarbanes-Oxley (SOX) Act requires all public companies to assess the effectiveness of internal controls over financial reporting. Effective internal controls play an essential role in creating an ethical business environment, improving financial performance, and preventing fraud. All companies include as part of their operating activities a variety of procedures and policies that are referred to as internal controls.

6-7 Common Control Principles

6-8 Control Limitations Internal controls can never completely prevent and detect errors and fraud. Benefits vs. Cost Human Error or Fraud

6-9 Learning Objective 6-3 Apply internal control principles to cash receipts and payments.

6-10 Controlling and Reporting Cash Internal control of cash is important to any organization. Volume of cash is enormous. Cash is valuable and “owned” by person possessing it.

6-11 Cash Received in Person Segregate Duties Cashier Custody Recording

6-12 Cash Received in Person

6-13 Cash Received from a Remote Source Cash Received by Mail Cash Received Electronically

6-14 Cash Payments Writing a Check Electronic Funds Transfer A voucher system is a process for approving and documenting all purchases and payments on account. Most companies pay cash to their employees through EFTs, which are known by employees as direct deposits.

6-15 Learning Objective 6-4 Perform the key control of reconciling cash to bank statements.

6-16 Bank Procedures and Reconciliation Banks provide services that help businesses to control cash in several ways: Restricting Access Documenting Procedures Independently Verifying A bank reconciliation is an internal report prepared to verify the accuracy of both the bank statement and the cash accounts of a business or individual.

6-17 Bank Statement

6-18 Reconciling Differences

6-19 Bank Reconciliation To determine the appropriate cash balance, these balances need to be reconciled.

6-20 Bank Reconciliation Bank Reconciliation Goals 1.Identify the deposits in transit. 2.Identify the outstanding checks. 3.Record other transactions on the bank statement. 4.Determine the impact of errors.

6-21 Bank Reconciliation

6-22 Reporting Cash and Cash Equivalents Cash includes money or any instrument that banks will accept for deposit and immediate credit to a company’s account, such as a check, money order, or bank draft. Cash equivalents are short-term, highly liquid investments purchased within three months of maturity.

6-23 Learning Objective 6-5 Explain the use of a perpetual inventory system as a control.

6-24 Controlling and Reporting Merchandise Sales Inventory Quantities Inventory Costs Financial Statements Unsold Inventory Balance Sheet Sold Inventory Income Statement

6-25 Perpetual Inventory System In a perpetual inventory system, the inventory records are updated “perpetually,” that is, every time inventory is bought, sold, or returned. Perpetual systems often are combined with bar codes and optical scanners.

6-26 Periodic Inventory System In a periodic inventory system, the inventory records are updated “periodically,” that is, at the end of the accounting period. To determine how much merchandise has been sold, periodic systems require that inventory be physically counted at the end of the period.

6-27 Inventory Control Perpetual Inventory System Continuous Tracking Can Estimate Shrinkage Periodic Inventory System No Up-to-Date Records Can’t Estimate Shrinkage

6-28 Learning Objective 6-6 Analyze sales transactions under a perpetual inventory system.

6-29 Sales Transactions Merchandisers earn revenues by transferring ownership of merchandise to a customer, either for cash or on credit. For a merchandiser who is shipping goods to a customer, the transfer of ownership occurs at one of two possible times: 1. FOB shipping point —the sale is recorded when the goods leave the seller’s shipping department. 2. FOB destination —the sale is recorded when the goods reach their destination (the customer).

6-30 Sales Transactions Every merchandise sale has two components, each of which requires an entry in a perpetual inventory system. Selling Price Cost

6-31 Sales Transactions Assume Wal-Mart sells two Schwinn mountain bikes for $400 cash. The bikes had previously been recorded in Wal-Mart’s Inventory at a total cost of $ Analyze Liabilities Assets = Stockholders’ Equity + Cash +$400 Inventory -$350 Sales Revenue (+R) +$400 Cost of Goods Sold (+E) -$350 2 Record dr Cash (+A) cr Sales Revenue (+R, +SE) dr Cost of Goods Sold (+E, -SE) cr Inventory (-A)

6-32 Sales Returns and Allowances When goods sold to a customer arrive in damaged condition or are otherwise unsatisfactory, the customer can (1) return them for a full refund or (2) keep them and ask for a reduction in the selling price, called an allowance.

6-33 Sales Returns and Allowances Suppose that after Wal-Mart sold the two Schwinn mountain bikes, the customer returned one to Wal-Mart. Assuming that the bike is still like new, Wal-Mart would refund the $200 selling price to the customer and take the bike back into inventory. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash -$200 Inventory +$175 Sales Returns and Allowances (+xR) -$200 Cost of Goods Sold (-E) +$175 2 Record dr Sales Returns & Allowances (+xR, -SE) cr Cash (-A) dr Inventory (+A) cr Cost of Goods Sold (-E, +SE)

6-34 Sales on Account and Sales Discounts A sales discount is a sales price reduction given to customers for prompt payment of their account balance.

6-35 Sales on Account and Sales Discounts Suppose Wal-Mart’s warehouse store (Sam’s Club) sells printer paper on account to a local business for $1,000 with payment terms of 2/10, n/30. The paper cost Sam’s Club $ Record dr Accounts Receivable (+A) cr Sales Revenue (+R, +SE) dr Cost of Goods Sold (+E, -SE) cr Inventory (-A) 1, , Analyze Liabilities Assets = Stockholders’ Equity + Accounts Receivable+$1,000 Inventory -$700 Sales Revenue (+R) +$1,000 Cost of Goods Sold (+E) -$700

Record dr Cash (+A) dr Sales Discounts (+xR, -SE) cr Accounts Receivable (-A) 1, Sales on Account and Sales Discounts To take advantage of this 2% discount, the customer must pay Wal-Mart within 10 days. If the customer does so, it will deduct the $20 discount (2% $1,000) from the total owed ($1,000), and then pay $980 to Wal-Mart. (2% × $1,000) 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash +$980 Accounts Receivable -$1,000 Sales Discounts (+xR) -$20

6-37 Summary of Sales-Related Transactions The sales returns and allowances and sales discounts introduced in this section were recorded using contra-revenue accounts.

6-38 Learning Objective 6-7 Analyze a merchandiser’s multistep income statement.

6-39 Gross Profit Percentage Gross Profit % = Gross Profit Net Sales × 100

6-40 Comparing Operating Results Across Companies and Industries

McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 Solved Exercises M6-10, M6-19, E6-5, E6-7, E6-10, E6-17

6-42 M6-10 Calculating Shrinkage in a Perpetual Inventory System Corey’s Campus Store has $4,000 of inventory on hand at the beginning of the month. During the month, the company buys $41,000 of merchandise and sells merchandise that had cost $30,000. At the end of the month, $13,000 of inventory is on hand. How much shrinkage occurred during the month? Beginning inventory Purchases Cost of Goods Sold Ending balance Inventory count Shrinkage $ 4, , ,000 15, ,000 $ 2,000

6-43 M6-19 Calculating the Impact of Changes in Gross Profit Percentage on Operating Income Luxottica Group, the Italian company that sells Ray Ban and Killer Loop sunglasses, reported a gross profit percentage of 66.4 percent in 2008 and 65.4 percent in In each of these two years, the company’s net sales was fairly steady at approximately 5 million euro. Assuming that Luxottica’s operating expenses were 2.6 million euro in each year, how much more (or less) income from operations did Luxottica report in 2009 than in 2008? Sales Gross profit percentage Gross Profit Operating Expenses Income from Operations Luxottica earned € 50,000 less in 2009 than €5,000,000 x ,270,000 2,600,000 € 670, €5,000,000 x ,320,000 2,600,000 € 720,000

6-44 End of Chapter 6