Chapter 6 – Reporting and Analyzing Inventory
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Topic
Classifying inventory- For a merchandising firm, we refer to
items for resale as “inventory” or “merchandise inventory.”
For a manufacturing firm, inventory is classified as raw
materials, work in process, and finished goods.
Valuing inventory- 1) determine inventory quantities, 2) price
the inventory
Determining ownership- goods in transit, consigned goods
Inventory costing methods- 1) Specific identification, 2)
First-in, first-out (FIFO), Last-in, first-out (LIFO), and
Average Cost (aka, weighted average)
Use text problem (E6-5) to illustrate calculations
Goods Available – Ending Inventory = Cost of Goods Sold
$12,000
- $5,400
= $6,600
Effects of inventory methods on income statement (cost of
goods sold and income tax expense), balance sheet
(inventory, taxes payable, retained earnings)
Use of Inventory methods in US (FIFO=44%)
Effects on taxes this year and next year
Effects on cash due to taxes paid
Consistency required once a method is chosen
Mention the Lower-of-Cost-or-Market method- Very
conservative
Inventory Turnover Ratio – Cost of Goods Sold / Average
Inventory
Days in Inventory – 365 / Inventory Turnover Ratio
These are similar to the Receivables Turnover Ratios
Mention the use of the LIFO Reserve – the difference
between the ending inventory using LIFO and FIFO.
Required footnote disclosure for companies using LIFO.
A Look at IFRS (Accounting for Inventory)
Chapter 7 – Fraud, Internal Control, and Cash
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Minding the Money in Moose Jaw- Stephanie probably has good
control over food, supplies, and equipment. Read this section
carefully after reading the rest of the chapter and note the internal
control weaknesses over cash.
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Fraud-A dishonest act by an employee that results in a personal
benefit to the employee at a cost to the employer- bookkeeper
diverts cash from his employer to his personal bank account;
shipping clerk ships merchandise to himself; computer operator
embezzles cash; church treasurer “borrows” church funds. Chapter
tends to stress the theft of assets (employee fraud), but fraudulent
reporting (management fraud) is also significant.
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Fraud Triangle- Incentive (financial pressure), Opportunity,
Rationalization (attitude). Our Internal Control system attempts to
minimize opportunity (cost/benefit considerations)
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Sarbanes-Oxley Act of 2002 (SOX). Auditors must now audit both
the financial statements and the system of internal controls.
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Internal Control- Methods and measures adopted to safeguard
assets, enhance reliability of accounting records, increase
efficiency of operations, and ensure compliance with laws and
regulations.
337- Principles of Internal Control- Establish responsibility; segregation
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of duties; documentation procedures; physical controls;
independent internal verification (audits); human resource control.
INTERNAL CONTROL FEATURES (see link on accounting
assignment sheet)
SEPARATION OF DUTIES-AUTHORIZATION, ACCOUNTING, &
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CUSTODY
2
COMPETENT, HONEST EMPLOYEES
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BOND EMPLOYEES
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EXTENDED VACATION, ROTATION OF JOBS
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PROCEDURES MANUALS
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ASSIGN AUTHORITY AND RESPONSIBILITY
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PHYSICAL CONTROL OF ASSETS
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PHYSICAL CONTROL OF ACCOUNTING RECORDS
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GOOD ACCOUNTING SYSTEM AND FINANCIAL STATEMENTS
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AUDIT-INTERNAL AND EXTERNAL
UNANNOUNCED PHYSICAL COUNTS
REASONABLENESS TESTS (ratio analysis)
PERFORMANCE EVALUATIONS
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Anatomy of a Fraud
Lawrence Fairbanks- purchased items for self- missing control was
segregation of duties
Angela Bauer- issued company checks to herself—missing control
was segregation of duties
Multiple employees submitted vouchers for reimbursement for
same trip- missing control was documentation procedures
Alex Parviz received commissions for sales he didn’t makemissing control was physical control over mailroom and insurance
applications
Bobbi Jean filed expense reimbursement reports for purchase of
her own clothes- missing control- segregation of duties and
independent verification
Ellen and Josephine never took vacations. Embezzled funds by
keeping cash paid by hotel guests- missing control was human
resource control as Ellen had been fired by previous employer for
same scheme
Limitations on Internal Control- reasonable assurance, not absolute
assurance
Internal Controls over Cash
INTERNAL CONTROL OVER CASH (see same link on accounting
assignment sheet)
ALL OF ABOVE FEATURES APPLY
CHECKING ACCOUNT
BANK RECONCILIATION
PETTY CASH FUND
Must consider control over cash receipts and controls over cash
disbursements
Journal entry for cash sale where there is a shortage or overage
(Cash Short or Over)
Use of the Voucher System- Verify purchase order, purchase
invoice, and receiving report- attach all three to voucher.
Responsible individual then authorizes payment.
Petty Cash Fund (Journal entries illustrated in Appendix- page 367-
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Proper use of a checking account is a good control over cash
Illustration of Laird Company Bank Statement from the National
Bank & Trust
Bank Reconciliation procedure
Laird Company’s Bank Reconciliation and required journal entries
Cash account, bank reconciliation, and Cash balance on Balance
Sheet should all agree- Laird Company, $12,204.85
Madoff’s Ponzi Scheme
Principles of good Cash Management1. Increase speed of cash collections (offer cash discount)
2. Keep inventory levels low (Just-in-Time Inventory system)
3. Delay payment of liabilities (take advantage of cash discounts
but pay on last day to receive discount, e.g., 2/10, n/30)
4. Plan the timing of major expenses (Capital Budget)
5. Invest idle cash (Prepare cash budget to determine funds
available to invest or funds needed to borrow.
Cash Budget for Hayes Company
Journal entries for Petty Cash (establish the fund, replenish it, and
enlarge fund)
A Look at IFRS (Internal Control)
Chapter 8 – Reporting and Analyzing Receivables
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Topic
Types of Receivables- Name those that we have used
previously
Note entry for accrued interest earned.
Valuing Accounts Receivable- we won’t collect all that is
owed to us
Direct write-off method. Simple and useful if there are few
bad debts (aka, uncollectible accounts). However, it doesn’t
provide a good matching of revenues and expenses. You
are not responsible for this
Allowance method- provides a good matching of revenues
and expenses by estimating bad debts at the end of a
period.
How do we estimate bad debts? Look at past experience.
Apply a percentage of net sales or percentage of
receivables that occurred in the past. Better yet, age the
accounts receivable.
Adjusting entry to record estimated bad debts
Entry to actually write off a bad debt in the following period
Entries to collect an account that had been previously
written off
Aging Schedule, Journal entry, and T account presentationSTUDY THIS!
Notes Receivable. Illustration of a promissory note
Computing interest- we’ve been doing this since Basic
Training
Recognizing notes receivable- loan money and receive a
note; make a sale and receive a note; receive a note as an
extension of a past due account receivable.
Journal entries for the collection of a note and another
entry to accrue interest on a note at the end of the period.
Managing Receivables:
1. Determine to whom to extend credit
2. Establish a payment period (COD, n/20, 2/10, n/30)
3. Monitor collections
4. Evaluate the liquidity of receivables (aging schedule)
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5. Accelerate cash receipts when possible
Ratios for evaluating receivables
1) Receivables turnover ratio (net sales/average
receivables)
(Some use net credit sales/average receivables)
2) Average collection period (aka, days in receivables)
365 / Receivables Turnover Ratio
We’ll compute similar ratios to evaluate inventory in the
next chapter
Review the “Comprehensive Do It!”
A Look at IFRS (Receivables)
Chapter 10 – Reporting and Analyzing Liabilities (Current Liabilities pages 504-512)
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Topic
Long-term liabilities were covered earlier- Long-term notes
payable and bonds payable. Our discussion today focuses
on current liabilities.
A current liability is one that is paid out of current assets
(usually cash) or creation of other current liability (AP
converted into NP), and paid within one year or the
company’s operating cycle (the longer). Most operating
cycles are for far less than one year.
Entries for Notes Payable and Interest Payable
Entry for Sales Tax Payable
Entry for Unearned Revenue
Current maturity of long-term debt
Payroll Taxes Payable- entry to record the payroll and entry
to record the employer’s payroll tax expense