Blog

ACCT5930 Topic 5 – Internal Control & Cash Inventory Balance Sheet Income Statement Statement of cash flows Introduction and overview of the three key financial statements (week1) Assets, Liabilities and Equity (week 1) Revenues and Expenses (week 2) Accrual accounting and transaction analysis (week 2) The accounting cycle (week 3) including adjusting entries (week 4) Expanded record keeping (week 4) Internal control (week 5) Inventory / COGS (week 5) Non-current assets (week 6) Liabilities & Equity (week 7) Financial statement analysis (week 8) Cash flows (week 9 & 10) Three key statements Fo un da tio nt op ics Ex pa nd ed to pi cs ACCT5930- Financial Accounting course overview Learning Objectives Internal control: Define and explain the concept of internal control. Identify features of an effective internal control system Appreciate the limitations of a system of internal control. Apply principles of internal control to cash including the preparation of a bank reconciliation statement. Learning Objectives (cont.): Inventory: Prepare journal entries for perpetual and periodic inventory systems. Appreciate the need for cost flow assumptions. Apply specific identification as a means of determining inventory cost. Apply the following cost flow assumptions as a means of calculating inventory cost First-in First-out (FIFO) Last-in First-out (LIFO) WeightedAverage / Moving Average Apply the ‘lower of cost and net realisable value’ rule. Outline of Topic 5 1. Internal Control and Cash Internal Control Bank Reconciliation 2. Inventory Inventory recording system Inventory cost flow assumptions Internal Control Background What is internal control The overall procedures adopted by a business to safeguard the assets, promote the reliability of accounting data, and encourage compliance with management policies. Internal control is not simply the attempt to stop theft! Financial accounting contributes to internal control. Features of an effective internal control system Management acts in a manner which demonstrates internal control is important. Clear lines of responsibility. Separation of record keeping from handling of assets (separation of duties). Employees to take regular annual leave or regular rotation of duties. Maintenance of effective records Internal auditing and stocktakes. Physical protection of assets (and insurance). Adequate pay and motivation for employees. Limitations of Internal Controls Management override Collusion Computer fraud Cost vs benefits Size limitations Employee negligence / carelessness Why is Cash Control Important Cash: Is transferred easily from one person to another. Cannot be specifically identified as belonging to one particular person. Therefore: Cash is an asset that is most commonly the subject of misappropriation or fraud. Cash Control Procedures Separation of recording and handling cash. Separation of receiving and paying cash. All cash receipts banked intact daily. All payments (except petty cash) made by cheque or electronic funds transfer (EFT). Authorised supporting documentation for payments. Cheques / EFT documentation countersigned. Pay on invoice and cancel documentation Physical safeguards over cash Reconcile bank accounts regularly. Bank Statement and Reconciliation Additional internal control can be achieved by comparing the Bank Statement with the deposit and withdrawal records. This is achieved with a bank reconciliation statement. Bank reconciliation involves comparing the balance in the cash at bank ledger with the bank balance according to the company’s bankers (as shown on the bank statement) and explaining any differences between the two figures. Bank Reconciliation Statement Why might the balance as per the bank statement be different from the balance in the cash at bank ledger 1. New items that appear on the bank statement. The company was previously unaware of these items. eg. bank charges 2. Items included in the cash journals (ie. cash receipts and cash payments) but not included in the bank statement. eg. unpresented cheques 3.Errors in either the accounting system or the bank statement. Reasons for Differences Timing Differences Deposits recorded but not yet received by the bank (‘Deposits In Transit’). Payments recorded but not yet paid from the bank account (‘Unpresented cheques’). These require reconciliation, not an adjustment in the accounting system. Reasons for Differences Information Asymmetry Deposits not recorded in the accounting records but recorded by the bank (e.g. interest credited by the bank, direct credits). Payments not recorded in the accounting records but recorded by the bank (e.g. bank charges, interest charged, direct debits, dishonoured cheques). These require adjustments in the accounting system (ie. a journal entry). Bank reconciliations Adjusted cash balance as per the bank equals Adjusted cash balance as per cash account in the company’s ledger. Illustration You have been supplied with the following information produced by comparing the records of Oneup Ltd with the most recent bank statement: a. Debit balance as per Cash at Bank account in ledger as at 30 June: $13,100.00 b. Credit balance as per bank statement as at 30 June: $17,315.90 c. Deposits not reflected on bank statement: $2,300.00 d. Unpresented cheques 30 June: $6,285.90 e. Service charge on bank statement not recorded in books: $150.00 f. Cheque for postage expense $400.00, incorrectly recorded as $780.00 Required 1. Prepare a bank reconciliation statement as at 30 June. 2. Prepare entries in general journal form to update the records of Oneup Ltd. Illustration Oneup Ltd Bank Reconciliation Statement as at 30 June Balance as per bank statement Add: Outstanding deposit Deduct: Unpresented cheques Adjusted bank balance 17,315.90 CR 2,300.00 19,615.90 6,285.90 13,330.00 CR Balance as per ledger Add: Correction Deduct: Bank charges Adjusted Balance as per ledger 13,100.00 DR 380.00 13,480.00 150.00 13,330.00 DR Illustration General Journal June 30 Dr Bank Charges Cr Cash at Bank 150.00 150.00 June 30 Dr Cash at Bank Cr Postage Expense 380.00 380.00 Revision Question (from TCM) On 30/6/20, the bank account for Holmes Traders showed a debit balance of $13 418 and the bank statement showed a credit balance of $20 208. A comparison of the two sets of records disclosed: 1. That there was a bank charge of $10 2.That a direct credit from Emma and Tim Limited had been received for $1000 but was not included in the company’s records 3.That the date of a deposit of $2450 was shown by Holmes Traders as 30 June 2020, whereas the bank did not record the deposit until 1 July 2020 4. There were unpresented cheques totalling $8250. Required: Prepare a bank reconciliation statement at 30 June 2020. $ 20 208 Dr Balance as per Bank statement Add: Deduct Adjusted Balance as per Bank Balance as per Bank A/C in ledger Add: Deduct: Adjusted cash bal as per Bank A/C in ledger 14 408 Dr Holmes Traders Bank reconciliation statement as at 30 June 2020 Outline of Topic 5 1. Internal Control and Cash Internal Control Bank Reconciliation 2. Inventory Inventory recording system Inventory cost flow assumptions Background – Defining Inventory Inventories are assets (a) Held for sale in the ordinary course of business (b) In the process of production for such sale; or (c) In the form of materials or supplies to be consumed in the production process or in producing the rendering of services. Inventory types Raw Materials Work in Progress Finished Goods Inventory Merchandise Inventory Background – Cost of Inventory “The cost of inventories shall comprise all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition”. Perpetual and Periodic Systems Accounting for inventory involves the Inventory asset on the Balance Sheet and the Cost of Goods Sold expense on the Income Statement. Two accounting methods of maintaining inventory records: Perpetual: Maintains continuous records on the flow of units of inventory for all transactions to calculate closing balance of Inventory Periodic: Uses data on beginning inventory, additions to inventory, and an end-of-period count to deduce COGS Closing Entries – Periodic System Under the periodic system, closing entries not only close the temporary accounts of ‘Sales’ (a revenue account) and ‘Purchases’ (an expense account), they also adjust the Balance Sheet account of ‘Inventory’. Dr Sales xxx Cr P&L Summary xxx Dr P&L Summary xxx Cr Purchases xxx Dr P&L Summary Opening inv. amount Cr Inventory Opening inv. amount Dr Inventory Closing inv. amount Cr P&L Summary Closing inv. amount Choice of Inventory Control System The choice between perpetual and periodic inventory systems could depend on: Unit value of inventory Volume of inventory handled Relative cost of maintaining respective systems Cost Flow Assumptions Often, inventory is purchased at various times during the year, where the price of these items may vary. When inventory is stored for later use/sale, items with different costs are mixed together. This creates complications in accounting for the closing inventory balance and COGS Refer to following illustration Cost Flow Assumptions XYZ Company had 1,500 shirts on hand at 1 January 2019. Each shirt cost $8 to purchase. During the year XYZ made the following purchases: 22 January 10,000 shirts at $13 each 19 April 19,000 shirts at $10 each 28 June 8,000 shirts at $12 each 12 September 15,000 shirts at $15 each 8 November 6,000 shirts at $13 each A stocktake at the end of the year revealed that there were 3,500 shirts on hand as at 31 December

2019. Cost of goods sold 56 000 @ $ Ending inventory 3 500 @ $ Cost Flow Assumptions How can we overcome this problem Track each individual item through the inventory flow (specific identification) Accurate approach based on physical flow of goods Traditionally has been time consuming and expensive. Technology making specific identification easier (eg. bar code technology). In cases where the costs of this approach outweigh the benefits, cost flow assumptions are a useful alternative. Cost Flow Assumptions Some possibilities include: First-in First-out method (FIFO) Last-in First-out method (LIFO) WeightedAverage method (or moving average) When prices are changing (e.g. with inflation) each method will provide different ending inventory and COGS amounts. REMEMBER: These are assumptions about inventory flow within an organisation. The actual physical flow of inventory may be different. First-in First-out (FIFO) This method assumes that the first units purchased are the first units sold. Ending inventory is assumed to consist of the most recently acquired units. Points to note: Results in a higher profit level in times of rising prices (relative to LIFO and weighted average). Suitable assumption for perishable items or those subject to obsolescence. Closing inventory balance is closer to current cost (relative to LIFO and weighted average). Last-in First-out (LIFO) This method assumes that the last units purchased (i.e. the most recent purchases) are the first units sold. Ending inventory is assumed to consist of the earliest acquired units. Points to note: Results in a higher reported COGS and lower inventory balance than other methods in times of rising prices (beneficial for tax purposes in some countries). Does not usually match the physical flow. Results in an outdated inventory balance (inventory recoded at old prices). Not permitted under Australian accounting standards. Weighted Average Using this method, a weighted average cost is calculated and then applied to the number of units sold and the number of units in ending inventory. When using a perpetual inventory control system, it is referred to as the moving average method. Points to note: Simple to apply and less subject to profit manipulation. Appropriate for products that are homogeneous (i.e., the same) and tend to be mixed together. Weighted average Periodic: Weighted average = Total cost of goods available for sale for a period Total number units available for sale for a period Perpetual: Moving weighted average – recalculate the average price after every purchase FIFO vs. LIFO vs. Weighted Average Assumptions about inventory flow within an organisation The actual physical flow of inventory may be different When prices are changing, each method will provide different ending inventory and cost of goods sold amounts Regardless of method: Opening inventory + cost of Inventory purchased = COGS + Ending Inventory i.e., if a business spent money on inventory, at the end of the period it has either been sold (COGS), or is still with the company (in ending inventory) (assuming no theft/damage etc!) Illustration Each method will be illustrated using the periodic and perpetual inventory systems. The calculations are the same irrespective of whether a periodic or perpetual system is employed, except that under the perpetual system the calculation must be performed each time a transaction occurs. Illustration – ABC Ltd ABC Ltd bought and sold inventory during January. Over the following slides you will be asked to calculate: Using the periodic system method: A. COGS and ending inventory under: 1. FIFO, 2. LIFO, 3.WeightedAverage, 4. Specific ID B. Show Closing entries for FIFO Using the perpetual system method: A. COGS and ending inventory under: 1. FIFO, 2. LIFO, 3. Moving Average Lecture Example- Periodic System ABC Ltd made several inventory purchases during January (see the table below). A stocktake at the end of January revealed that 350 units were still on hand. Required: A.Calculate ABC Ltd’s ending inventory and COGS at 31/1/19 under the periodic inventory system using: 1. FIFO 2. LIFO 3. WeightedAverage 4. Specific Identification B. Prepare closing entries relating to inventory for FIFO Details Date Units Unit Cost Total Cost Opening stock 1/1/19 200 $2 $400 Purchased 15/1/19 300 $3 $900 Purchased 28/1/19 500 $4 $2,000 Total 1,000 $3,300 Lecture Example – Periodic System How many units were sold during the month Units Beginning Inventory + Purchases – Ending Inventory = Inventory Sold A1. Lecture Example – FIFO Periodic Sold 650 units – 200 @ $2 = 400 – 300 @ $3 = 900 – 150 COGS @ $4 = 600 $1 900 Ending inventory (350 @ $4) $1 400 Units Unit cost o/b 200 $2 300 $3 500 $4 A2. Lecture Example – LIFO Periodic Sold 650 units – @ – @ $4 = $3 = COGS Ending inventory (150@$3 + 200@$2) Units Unit cost o/b 200 $2 300 $3 500 $4 A3. Lecture Example – Weighted Avg Periodic Units Unit Cost Total Cost Total Cost = $ 200 $2 $400 Total Units = 1,000 300 $3 $900 WA cost/unit = $ 500 $4 $2,000 1,000 $3,300 Sold 650 units COGS ( x $3.30) $2,145 Ending Inv ( x $3.30) $1,155 47 A4. Lecture Example – Specific Identification Assume that the 350 units in ending inventory can be separately identified as 100 from the opening stock, and 250 from the purchase on 28th Jan Ending Inventory 350 units = $1200: – 100 @ $2 (100 from o/b) – 250 @ $4 (250 from 28th Jan) Sold 650 units – 100 @ $2 = 200 – 300 @ $3 = 900 – 250 @ $4 = 1 000 COGS $2 100 Units Unit cost o/b 200 $2 300 $3 500 $4 Compare the Results Periodic FIFO LIFO Wght Avg Specific ID COGS 1,900 2, 450 2,145 2,100 Ending Inv 1,400 850 1,155 1,200 B. Closing Entries (for FIFO only) Part of the closing process (illustration relates to FIFO). Dr P&L Summary 2,900 Cr Purchases 2,900 Dr P&L Summary 400 Cr Inventory 400 1,400Dr Inventory Cr P&L Summary 1,400 Lecture Example- Perpetual System ABC Ltd made several inventory purchases and sales during January (see the table below). A stocktake at the end of January revealed that 350 units were still on hand. Required: A. Calculate ABC Ltd’s ending inventory and COGS at 31/1/19 under the perpetual inventory system using: 1. FIFO 2. LIFO 3. WeightedAverage Details Date Units Unit cost Total cost Units sold Opening stock 1/1/19 200 $2 $400 Purchased 15/1/19 300 $3 $900 Sold 17/1/19 250 Purchased 28/1/19 500 $4 $2 000 Sold 30/1/19 400 Total 1 000 $3 300 650 PURCHASES COGS ENDING STOCK/INV. Date Units Unit $ Total $ Units Unit $ Total $ Units Unit $ Total $ A1. Lecture Example – FIFO Perpetual PURCHASES COGS ENDING STOCK/INV. Date Units Unit $ Total $ Units Unit $ Total $ Units Unit $ Total $ A2. Lecture Example – LIFO Perpetual PURCHASES COGS ENDING STOCK/INV. Date Units Unit $ Total $ Units Unit $ Total $ Units Unit $ Total $ A3. Lecture Example – Moving Average Perpetual Compare the Results Periodic Perpetual FIFO LIFO Weight Avg FIFO LIFO Moving Avg COGS 1,900 2, 450 2,145 1,900 2,350 2,063 Ending Inv 1,400 850 1,155 1,400 950 1,238 Choice of Method Depends on: Effect on the financial statements Information needs of management and financial statement users Accounting standard requirements AASB Requirements: Where items are not ordinarily interchangeable, costs should be assigned using specific identification. Otherwise, FIFO or weighted average must be used. LIFO is not permitted. Inventory Valuation Standards states that inventory should be measured at the lower of cost and net realisable value (also referred to as lower of cost and market value ‘LCM’ Rule). Definition of net realisable value: “…the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.” Any loss from the application of this rule is recorded as an expense in the accounting period in which the write down occurs. LCM Rule – An Example Question: Assume that the cost of inventory is calculated to be $140,000. However, the net realisable value is only $125,000. Required: Prepare journal entries to apply the lower of cost and net realisable value rule. Dr Inventory Loss Cr Inventory 15,000 15,000 Financial Statement Presentation Merchandising business: All inventory is in a saleable condition (eg. supermarket). Therefore one balance sheet item called “inventory” is sufficient. Manufacturing Business: Not all inventory is in a saleable condition. There may be a selection of raw materials, work in progress and finished goods inventory. Therefore, an inventory classification for each item is needed. PURCHASES COGS ENDING STOCK/INV. Date Units Unit $ Total $ Units Unit $ Total $ Units Unit $ Total $ 1/1 200 2 400 15/1 300 3 900 200 300 2 3 400 900 17/1 200 50 2 3 400 150 250 3 750 28/1 500 4 2000 250 500 3 4 750 2000 30/1 250 150 3 4 750 600 350 4 1400 TOTAL 1900 1400 Answers to Lecture example A1. Lecture Example – FIFO Perpetual A2. Lecture Example – LIFO Perpetual PURCHASES COGS ENDING STOCK/INV. Date Units Unit cost Total cost Units Unit cost Total cost Units Unit cost Total cost 1/1 200 2 400 15/1 300 3 900 200 300 2 3 400 900 17/1 250 3 750 200 50 2 3 400 150 28/1 500 4 2 000 200 50 500 2 3 4 400 150 2000 30/1 400 4 1600 200 50 100 2 3 4 400 150 400 TOTAL 2 350 950 A3. Lecture Example – Moving Avg Perpetual PURCHASES COGS ENDING INV. Date Units Unit cost Total cost Units Unit cost Total cost Units Unit cost Total cost 1/1 200 2 400 15/1 300 3 900 *500 2.60 1300 ($400+$900)/(200+300) = $2.60/unit 17/1 250 2.60 650 250 2.60 650 28/1 500 4 2 000 *750 3.53 2 650 ($650+$2000)/(250+500) = $3.53/unit 30/1 400 3.53 1413.33 350 3.53 1 236.67 TOTAL 2 063.33 1 236.67