McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 6
Internal Control and Financial
Reporting for Cash and Merchandise
Sales
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Fred Phillips, Ph.D., CA
Learning Objective 1
Distinguish among service,
merchandising, and
manufacturing
operations.
6-3
Operating Cycles
Sell
Services
Service
Company
Collect
Cash
Incur
Operating
Expenses
6-4
Operating Cycles
Sell
Products
Buy
Products
Merchandising
Company
Incur
Operating
Expenses
6-5
Collect
Cash
Operating Cycles
Sell
Products
Make
Products
Buy Raw
Materials
6-6
Manufacturing
Company
Incur
Operating
Expenses
Collect
Cash
Learning Objective 2
Explain common principles
and limitations of internal
control.
6-7
Internal Control
All companies include as part of their operating
activities a variety of procedures and policies that
are referred to as internal controls.
Internal controls are the methods a company
uses to:
1. Protect against the theft of assets.
2. Enhance the reliability of accounting
information.
3. Promote efficient and effective operations.
4. Ensure compliance with applicable laws
and regulations.
6-8
Common Control Principles
Principle
Establish responsibility
Segregate duties
Restrict access
Document procedures
Independently verify
6-9
Explanation
Assign each task to only one
person.
Do not make one employee
responsible for all parts of a
process.
Do not provide access to
assets or information unless it
is needed to fulfill assigned
responsibilities.
Prepare documents to show
activities that have occurred.
Check others' work.
Examples
Each Wal-Mart cashier uses a
different cash drawer
Wal-Mart cashiers, who ring up
sales, do not approve price
changes.
Wal-Mart secures valuable
assets such as cash and
access to its computer
systems (passwords, firewalls).
Wal-Mart pays suppliers using
prenumbered checks.
Wal-Mart compares cash
balances in its accounting
records to the cash balances
reported by its bank, and
accounts for any differences.
Control Limitations
Internal controls can never
completely prevent and detect
errors and fraud.
Benefits vs. Cost
6-10
Human Error or
Fraud
Learning Objective 3
Apply internal control
principles to cash receipts and
payments.
6-11
Controlling and Reporting Cash
Internal control of cash is important
to any organization.
Volume of cash
is enormous.
6-12
Cash is valuable
and “owned” by
person
possessing it.
Cash Received in Person
Segregate Duties
Cashier
Recording
Custody
6-13
Cash Received in Person
6-14
Cash Received in Person
6-15
Cash Received from a Remote
Source
Cash Received
by Mail
Cash Received
Electronically
6-16
Cash Payments
Cash Payments
Writing a
Check
Electronic
Funds
Transfer
A voucher
system
is acash
process
foremployees
approving
Most
companies
pay
to their
and
documenting
all purchases
through
EFTs, which
are knownand
by
payments
account.
employees
as on
direct
deposits.
6-17
Learning Objective 4
Perform the key control of
reconciling cash to bank
statements.
6-18
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.
6-19
Bank Statement
1
2
6-20
3
4
5
Reconciling Differences
Your Bank May Not Know About . . .
1. Errors made by the bank.
2. Time lags:
a. Deposits that you made recently.
b. Checks that you wrote recently.
3.
4.
5.
6.
7.
6-21
You May Not Know About . . .
Interest the bank has put into your account.
Electronic funds transfer (EFT)
Service charges taken out of your account.
Customer checks you deposited but that bounced.
Errors made by you.
Bank Reconciliation
To determine the appropriate cash
balance, these balances need to be
reconciled.
6-22
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.
6-23
Bank Reconciliation
6-24
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.
6-25
Learning Objective 5
Explain the use of a perpetual
inventory system as a control.
6-26
Controlling and Reporting
Merchandise Sales
Inventory
Quantities
6-27
Inventory
Costs
Financial
Statements
Unsold
Inventory
Balance
Sheet
Sold
Inventory
Income
Statement
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.
6-28
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.
6-29
Inventory Control
6-30
Perpetual
Inventory
System
Periodic
Inventory
System
Continuous
Tracking
No Up-to-Date
Records
Can
Estimate
Shrinkage
Can’t
Estimate
Shrinkage
Learning Objective 6
Analyze sales transactions
under a perpetual inventory
system.
6-31
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).
6-32
Sales Transactions
Every merchandise sale has two components,
each of which requires an entry in a perpetual
inventory system.
Selling
Price
Cost
6-33
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 $350.
1 Analyze
Assets
(a) Cash +400
(b) Inventory -350
2
6-34
Record
=
Liabilities
+
Stockholders' Equity
Sales Revenue (+R) +400
Cost of Goods Sold (+E) -350
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.
6-35
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
Assets
(a) Cash -200
(b) Inventory +175
2
6-36
Record
=
Liabilities
+
Stockholders' Equity
Sales Returns and Allowances (+xR) -200
Cost of Goods Sold (-E) +175
Sales on Account and Sales
Discounts
A sales discount is a sales price reduction
given to customers for prompt payment of
their account balance.
6-37
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 $700.
1 Analyze
Assets
(a) Accounts Receivable +1,000
(b) Inventory -700
2
6-38
Record
=
Liabilities
+
Stockholders' Equity
Sales Revenue (+R) +1,000
Cost of Goods Sold (+E) -700
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.
1 Analyze
Assets
Cash +980
Accounts Receivable -1,000
2
=
Liabilities
+
Stockholders' Equity
Sales Discounts (+xR) -20
Record
(2% × $1,000)
6-39
Summary of Sales-Related
Transactions
The sales returns and allowances and sales
discounts introduced in this section were
recorded using contra-revenue accounts.
6-40
Learning Objective 7
Analyze a merchandiser’s
multistep income statement.
6-41
Gross Profit Percentage
Gross
Gross Profit
=
× 100
Profit %
Net Sales
6-42
Comparing Operating Results
Across Companies and Industries
Gross Profit Percentage
40.0%
35.0%
30.0% by Indus
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
6-43
Chapter 6
Solved Exercises
M6-11, M6-19, E6-5, E6-7, E6-10,
E6-17
M6-11 Calculating Shrinkage in a Perpetual Inventory System
Corey’s Campus Store has $50,000 of inventory on hand at the
beginning of the month. During the month, the company buys $8,000
of merchandise and sells merchandise that had cost $30,000. At the
end of the month, $25,000 of inventory is on hand. How much
shrinkage occurred during the month?
Beginning inventory
Purchases
Cost of Goods Sold
Ending balance
Inventory count
Shrinkage
6-45
$50,000
+8,000
-30,000
28,000
-25,000
$3,000
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 68.3 percent in 2007
and 66.5 percent in 2008. 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
2008 than in 2007?
2007
Sales
€ 5,000,000
Gross profit percentage
x 0.683
Gross Profit
3,415,000
Operating Expenses
2,600,000
Income from Operations € 815,000
2008
€ 5,000,000
x 0.665
3,325,000
2,600,000
€ 725,000
Luxottica earned € 90,000 less in 2008 than in 2007.
6-46
E6-5 Preparing a Bank Reconciliation and Journal Entries, and
Reporting Cash
Hills Company’s June 30, 2010, bank statement and the June ledger
account for cash are summarized here:
Required:
1. Prepare a bank reconciliation. A comparison of the checks written
with the checks that have cleared the bank shows outstanding
checks of $700. Some of the checks that cleared in June were
written prior to June. No deposits in transit were noted in May, but a
deposit is in transit at the end of June.
6-47
E6-5 Preparing a Bank Reconciliation and Journal Entries, and
Reporting Cash
HILLS COMPANY
Bank Reconciliation
June 30, 2010
Bank Statement
Company's Books
Ending balance per bank
statement………………….
Ending balance per Cash
account………………………
$6,070
Additions:
Deposit in transit…………….
Additions:
1,000*
7,070
Deductions:
Outstanding
checks…………
Up-to-date cash balance….
*$19,000 – $18,000 = $1,000.
6-48
$6,400
None
6,400
Deductions:
700
$6,370
Bank service charge……
Up-to-date cash balance……
30
$6,370
E6-5 Preparing a Bank Reconciliation and Journal Entries, and
Reporting Cash
2. Give any journal entries that should be made as a result of the
bank reconciliation.
dr Office Expenses (+E,-SE)................................................................
cr Cash (-A) ....................................................................
To record bank service charges.
30
30
3. What is the balance in the Cash account after the reconciliation
entries?
$6,370 ($6,400 - $30)
4. In addition to the balance in its bank account, Hills Company
also has $300 cash on hand. This amount is recorded in a
separate T-account called Cash on Hand. What is the total
amount of cash that should be reported on the balance sheet at
June 30?
Balance sheet (June 30, 2008):
Current assets:
Cash ($6,370 + $300) ........................................................
6-49
$6,670
E6-7 Identifying Shrinkage and Other Missing Inventory
Information
Calculate the missing information for each of the following
independent cases:
Beg.
Cost of
Case Inventory Purchases Goods Sold
6-50
Ending
Inventory
(perpetual)
Ending Inventory
(As Counted)
Shrinkage
A
$100
$700
$300
$500
?
$420
$80
?
B
200
800
850
?
150
150
?0
C
150
500
200
450
440
?
10
D
260
?
600
650
210
200
?10
E6-10 Recording Journal Entries for Net Sales with Credit Sales
and Sales Discounts
Using the information in E6-9, prepare journal entries to record the
transactions, assuming Solitare uses a perpetual inventory system.
Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The
goods cost Solitare $70.
6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The
goods cost Solitare $60.
14 Collected cash due from Wizard Inc.
Feb. 2 Collected cash due from SpyderCorp.
28 Sold goods for $50 to Bridges with terms 2/10, n/45. The
goods cost Solitare $30.
Jan. 6
6-51
dr Accounts Receivable (+A) ...............................................100
cr Sales Revenue (+R,+SE) ...........................................
100
dr Cost of Goods Sold (+E,-SE) .......................................... 70
cr Inventory (-A) .............................................................
70
E6-10 Recording Journal Entries for Net Sales with Credit Sales
and Sales Discounts
Using the information in E6-9, prepare journal entries to record the
transactions, assuming Solitare uses a perpetual inventory system.
Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The
goods cost Solitare $70.
6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The
goods cost Solitare $60.
14 Collected cash due from Wizard Inc.
Feb. 2 Collected cash due from SpyderCorp.
28 Sold goods for $50 to Bridges with terms 2/10, n/45. The
goods cost Solitare $30.
Jan. 6
6-52
dr Accounts Receivable (+A) ............................................... 80
cr Sales Revenue (+R,+SE) ...........................................
80
dr Cost of Goods Sold (+E,-SE) .......................................... 60
cr Inventory (-A) .............................................................
60
E6-10 Recording Journal Entries for Net Sales with Credit Sales
and Sales Discounts
Using the information in E6-9, prepare journal entries to record the
transactions, assuming Solitare uses a perpetual inventory system.
Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The
goods cost Solitare $70.
6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The
goods cost Solitare $60.
14 Collected cash due from Wizard Inc.
Feb. 2 Collected cash due from SpyderCorp.
28 Sold goods for $50 to Bridges with terms 2/10, n/45. The
goods cost Solitare $30.
Jan. 14
6-53
dr Cash (+A) ($1,000 x 98%) ............................................... 98
dr Sales Discounts (+xR,-SE) ($1,000 x 2%) ...................... 2
cr Accounts Receivable (-A)...........................................
100
E6-10 Recording Journal Entries for Net Sales with Credit Sales
and Sales Discounts
Using the information in E6-9, prepare journal entries to record the
transactions, assuming Solitare uses a perpetual inventory system.
Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The
goods cost Solitare $70.
6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The
goods cost Solitare $60.
14 Collected cash due from Wizard Inc.
Feb. 2 Collected cash due from SpyderCorp.
28 Sold goods for $50 to Bridges with terms 2/10, n/45. The
goods cost Solitare $30.
Feb. 2
6-54
dr Cash (+A) ........................................................................ 80
cr Accounts Receivable (-A)...........................................
80
E6-10 Recording Journal Entries for Net Sales with Credit Sales
and Sales Discounts
Using the information in E6-9, prepare journal entries to record the
transactions, assuming Solitare uses a perpetual inventory system.
Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The
goods cost Solitare $70.
6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The
goods cost Solitare $60.
14 Collected cash due from Wizard Inc.
Feb. 2 Collected cash due from SpyderCorp.
28 Sold goods for $50 to Bridges with terms 2/10, n/45. The
goods cost Solitare $30.
Feb. 28
6-55
dr Accounts Receivable (+A) ............................................... 50
cr Sales Revenue (+R,+SE) ...........................................
50
dr Cost of Goods Sold (+E,-SE) .......................................... 30
cr Inventory (-A) .............................................................
30
E6-17 Inferring Missing Amounts Based on Income Statement
Relationships
Supply the missing dollar amounts for the income statement of
Williamson Company for each of the following independent cases:
Sales Revenue .........................................
Sales Returns and Allowances .................
Net Sales
............................................
Cost of Goods Sold...................................
Gross Profit ............................................
6-56
Case A
Case B
Case C
$ 8,000
150
7,850
5,750
$ 2,100
$ 6,000
500
5,500
4,050
$ 1,450
$ 6,195
275
5,920
5,400
$ 520
End of Chapter 6