Fundamental of accounting PDF

Fundamental of accounting i…..ch-3 UNIT 3. ACCOUNTING FOR MERCHANDISING BUSINESSES 3.0 AIMS & OBJECTIVES After reading this unit, you will be able to: - describe what a merchandising business is and compare it to a service giving business. - describe the difference between the two alter...

Fundamental of accounting i…..ch-3 UNIT 3. ACCOUNTING FOR MERCHANDISING BUSINESSES 3.0 AIMS & OBJECTIVES After reading this unit, you will be able to: - describe what a merchandising business is and compare it to a service giving business. - describe the difference between the two alternative systems of recording inventory (periodic and the perpetual inventory systems) - record journal entries for merchandising transactions such as the purchase and sale of merchandise - complete the worksheet of a merchandising business and record adjustment journal entries related to the Merchandise Inventory account - prepare financial statements for a merchandising business 3.1 INTRODUCTION In the previous chapters, you saw how to record transactions of a service business. The steps that we go through to prepare the financial statements of other types of businesses (such as a merchandising business) are basically the same. Transactions are first journalized, and then posted to the ledger; a worksheet is prepared and completed…. But, there are some transactions in merchandising companies that you don‟t find in a service giving business, like the purchase of goods for sale and the sale of those goods. The first section of this chapter, therefore, discusses the nature of a merchandising business and how to record merchandising transactions. The next section discusses about the preparation of financial statements for merchandising companies. SECTION-ONE: RECORDING MERCHANDISING TRANSACTIONS 3.2 NATURE OF A MERCHANDISING BUSINESS 3.2.1What is a Merchandising Business? A merchandising business buys goods in finished form for resale to customers. A merchandising business sells tangible goods to its customers. When we say goods it can be anything that has physical characteristics that you can see and touch (i.e., tangible). These can be goods ranging from television sets, cars, office table and chair (furniture), to chewing gums, toothbrushes and various stationery. These goods 64 Fundamental of accounting i…..ch-3 that a merchandising company sells to its customers are called merchandise inventory. (A customer is an individual or a firm to whom a business sells its products.) One final thing that you should know about a merchandising business is that a merchandising company does not produce the goods that it sells. Instead, it buys these goods from manufacturers, which produce the goods using raw materials. The following diagram can help you to better visualize the flow of goods from a manufacturer to the final consumer: sells Merchandising companies Manufacturers wholesalers sell Retailer final consumer goods goods A wholesaler is a trader, which buys goods from manufacturers and sells them to a retailer or another wholesaler. It is the retailer who sells the goods to the final consumer by buying them from wholesalers (or sometimes from a manufacturer). When you want to buy a soap to wash your clothes, where do you buy it? Who is the manufacturer of the soap? Are there any wholesalers of that soap in your area? Can the wholesaler be taken as the customer of the manufacturer? And finally, can we say the shop from which you buy the soap is a merchandising business? 3.2.2 Comparison of Financial Statements for Merchandising and Service Businesses Income Statement A model income statement for a merchandising business and another one for a service business are shown below. Compare them carefully. 65 Fundamental of accounting i…..ch-3 ABC service company XYZ merchandising Income statement Income statement For the year ended Dec.31, 200x For the year ended Dec.31, 200x Revenue: Revenue: Service fee………………….Birr 23,200 Net Sales…………………Birr 360,000 Cost of goods sold…………….(256,000) Gross Profit …………………….104,000 Expenses: Various Operating Various Operating Expenses (7120) Expenses……………………….(79,400)n Net Income 16080 Net Income ……………………..24,600 As you can see from the above Income Statements, merchandising companies have to pay to buy the goods that they sell. Therefore, they have to deduct this cost of goods sold in addition to other operating expenses from their sales revenue to determine their net income. The difference between sales revenue and cost of goods sold is referred to as gross profit. Why „gross‟? Because other expenses have yet to be deducted to arrive at the net profit or net income of the business. Balance Sheet The Balance Sheet of a service business and that of a merchandising business are similar in every aspect except one thing. The current assets section of the Balance Sheet of a mercha ndising business includes one asset that service companies do not have. That is merchandise inventory. Merchandise inventory refers to goods bought by a merchandising business for resale to customers. So, if a merchandising business has some unsold goods (merchandise) on hand at the end of the year this would be reported as one asset on the Balance Sheet. 3.3 THE PERIODIC AND THE PERPETUAL INVENTORY SYSTEMS The value of goods (merchandise) on hand at the end of the year for resale would be reported on the Balance Sheet as one asset as described above. This means that we need to open a separate ledger account in which to record merchandise inventory information. The two alternatives in dealing with this account are: 66 Fundamental of accounting i…..ch-3 1. To up date this account every time goods are bought and sold (continuously = perpetually) or 2. To up date this account only at the end of the period (periodically). 3. 3.1 The Periodic Inventory System Under this system, as the name periodic suggests, the inventory account is updated only periodically i.e., only at the end of a period. When goods are bought, a temporary purchases account is debited instead of the inventory account itself. Likewise, when goods are sold revenue is recorded, but the fact that there is a reduction in merchandise inventory is not recognized. This is because the Merchandise Inventory account is not credited every time goods are sold. Therefore, if one wants to know the cost of goods on hand, it is a must that a physical inventory be conducted first. The account doesn‟t reflect the value of goods on hand because it was not up dated when merchandise was bought and sold. Physical inventory means counting the quantity of goods on hand. Once the quantity of goods on hand has been determined, it is multiplied by the unit price of those goods to determine the cost of goods on hand. In conclusion, under the periodic system, since the merchandise inventory account is not continually updated, the cost of merchandise on hand is determined only at the end of the period after carrying out a physical inventory. Companies such as department stores or „super markets‟, which sell small items, use periodic systems. 3.3.2 Perpetual Inventory Systems A perpetual inventory system continuously records the amount of inventory on hand (perpetual =continuous). Under this system, the merchandise inventory account is debited or credited every time (goods) are bought or sold. When an item is sold, its cost is recorded in a separate cost of goods sold account in addition to recording sales. The cost of merchandise on hand can be looked up from the merchandise Inventory account any time, without conducting a physical inventory. 67 Fundamental of accounting i…..ch-3 Check Your Progress Exercise-1 If you have a supermarket business, would you use the perpetual or periodic system? What if your system is computerized? Explain. 3.4 RECORDING PURCHASES AND SALES TRANSACTIONS The following discussions in the remainder of this chapter all assume the use of a periodic inventory system. The perpetual system will be discussed in part two of this course. 3.4.1 Recording Sales When a merchandising company transfers goods to the buyer, in exchange for cash or a promise top at a later date, revenue is produced to the company. This revenue is recorded in a Sales account. However, the sales revenue, which is reported on the Income Statement is Net Sales. That is, Net Sales = Gross Sales – Sales Discounts- Sales Returns and Allowances Recording Gross Sales The gross sales amount is obtained from sales invoices. An invoice is a document, prepared by the seller of merchandise to notify to the buyer the details of the sale. These details can include number of items sold, unit price of items, total price, terms of sale and manner of shipment. When goods are delivered to the customer, the Sales account is credited because revenues are increased by credits. A company can sell goods either for cash or on account. Recording Cash Sales When merchandise is sold on cash, the Cash account is debited and the revenue account Sales is credited. Example – Ika Company based in Bahir Dar, buys and sells used commodities. On January 14. 2001. Ika sold goods for Birr 20,000. Record the transaction. Answer: January 14, Dr. Cash………………………………..20,000.00 68 Fundamental of accounting i…..ch-3 Cr. Sales……………………………………20,000.00 Recording Credit Sales The Accounts Receivable account is debited when goods are sold on account (for credit). Example - Ika sold goods worth Birr 35,000 on account on January 15, 2001. Record the transaction. Solution January 15. Accounts Receivable…………………..35,000.00 Sales…………………………………………35,000.00 Determining Gross Sales when there are trade discounts A trade discount is a percentage deduction from the specified list price or catalogue price of merchandise. Trade discounts allow us: - To avoid publishing a new catalogues every time prices change. - To grant quantity discounts - Quotation of different prices to different types of customers. Trade discounts are not recorded in the seller‟s accounting records; they are only used to calculate the gross selling price. Example: IKA sold 500 T.V. sets, each with a list price of Birr 80, on January 17, 2001 for cash. It gave the customer a 30% trade discount, as the customer was a very loyal one. Record the sale. Answer: List price of goods ( 80 X 500) Birr 40,000 Less: Trade discount (30 % of 40,000) (12,000) Invoice price 28,000 Journal entry: Cash……………………..28,000 Sale………………………28,000 69 Fundamental of accounting i…..ch-3 Check Your Progress Exercise –2 1. Record the journal entry if IKa Company above sold goods with a list price of Birr 52,000 to a customer on account. Ika offered the customer a trade discount of 20% for purchases above Birr 40,000 as it usually does. Recording Deductions from Gross Sales Go back to illustration 1- and have a look at the model Income Statement of a merchandising company. You will see that the sales reported on the income statement is net sales, i.e., after deduction of sales discounts and sales returns and allowances. Gross sales (from invoice)…………………..XXX Less: Sales discounts…………………………….(XX) Sales returns and allowances ………….…..(XX) Net sales……………………………….XX Sales Discounts Sales Discounts are deductions from invoice price to customers who pay early when goods are sold on credit. As a seller, you would usually want to be paid as soon as possible. This is because, as you can imagine, you can use the money for various purposes once you have been paid. If you want your customers to pay you early the customary practice is to offer them a (deduction) discount from the invoice price if they pay early. How much discount is given usually depends on the credit terms. These terms (agreements) are usually stated on the invoice. The most frequently used terms are stated below: - “n/30” or “Net 30” – means there is no discount even if the customer pays before the payment date. - 2/10, n/30 –means the due date of the payment is after 30 days of the sale. But if the customer pays with in 10 days she will get a 2% discount. - 2/EOM, n/60- means the normal due date is with in 60 days of the sale but the customer will get a 2% discount if she pays before the end of month of sale. 70 Fundamental of accounting i…..ch-3 Check Your Progress Exercise -3 1. What do the credit terms 1/15,n/60; 2/10, n/EOM; and n/60 mean? ………………………………………………………………………………………………… ………………………………………………………………………………………………… ………………………………………………………………………………………………… Sales discounts are purchase discounts from the side of the buyer. Sales discounts and purchase discounts are the same thing seen from different sides. They are generally called cash discounts together. A cash discount is, therefore, deduction from original invoice price for early payment when goods are sold on credit (on account). Example: On January 21, 2001 IKA Company sold merchandise for birr 20,000 on account. The credit terms are 2/10, n/30. The customer paid on January 31, (10 days after invoice date). A. How much would IKA Company collect from this sale? B. Record the necessary journal entries on January 21 and January 31. Solution: A- Since the customer paid with in the discount period, i.e., with in 10 days, she will get a 2% discount. Therefore, Invoice price……………………..20,000 Less: Sales Discount (2% X 20,000)………(400) Cash collected …………. 19,600 B- Journal Entries: January 21 A/R…………………..20,000 Sales……………………..20,000 January 31, Cash………………….19600 Sales Discounts ………...400 A/R………………..20,000 71 Fundamental of accounting i…..ch-3 You might initially have thought of debiting the Sales account for Birr 400 on January 31, since the actual cash collected from the sales of those goods is birr 400 less than what was recorded as Sales on January 21. But it is better to record the reduction in sales in a separate contra Sales account. A contra account reduces another account. In this case, the amount in the Sales Discount account will be deducted from (Gross) Sales on the income statement. That way, we can disclose how much sales discount was offered and taken during the year on the income statement, separately. Check Your Progress Exercise - 4 IKA Company sold goods worth Birr 120,000 on account to Gizu company terms 1/10, n/60 on January 18, 2001. Gizu Company paid on January 28, 2001. A- How much would IKA Company collect from this sale? B- Record the necessary journal entries on January 18 and on January 28. Sales Returns and Allowances Customers can return merchandise they have bought if they find it to be defective or of the wrong model, or unsatisfactory for a variety of reasons. A sales return is merchandise returned by a buyer. The buyer would be paid back her money if she has already paid. A sales allowance is a deduction from the original invoice price when the customer keeps the merchandise but is dissatisfied. If, for example, a customer buys an item worth birr 100 and finds it to be of the wrong color after receiving it, she may still want to retain the item even if she is dissatisfied with its color. In that case the seller may let her pay only, say, Birr 95 by giving her an allowance of Birr 5. Example: IKA Company sold merchandise worth Birr 15, 000 on February 3, 2001 on account terms 2/10, n/30. On February 5, the buyer returned a portion of the goods worth Birr 5,000 as they were found to be of the wrong model. The buyer then paid on February 13, 2001. 72 Fundamental of accounting i…..ch-3 Record the necessary journal entries on February 3,5 and 13. Solution: February 3 A/R…………………….15,000 Sales …………………….15,000 February 5 Sales Returns and Allowances ………5,000 A/R………………………………….5,000 February 13 Cash…………………………………..9800 Sales Discount ……………………….. 200 A/R…………………………10,000 Here, the buyer paid with in the discount period. Therefore, the amount that would be collected is: 15,000 – 5,000 = 10,000 Deduct: 2% Cash discount (200) Cash collected 9800 Check Your Progress Exercise -5 Assume the customer in the above example returned the goods on February 15 instead of February 5, after paying with in the discount period on February 13. Record the relevant Journal entries on February 3, 13 and 15. Go back to illustration (1) once again on page and you will see that we have so far been dealing with what net sales is composed of. You should by now be able to figure out how the net sales figure on the income statement is arrived at. In the following section, we will see how to record purchase transactions. Keep in mind that a merchandising company both buys and sells goods. 73 Fundamental of accounting i…..ch-3 3.4.2 Recording Purchases Under the periodic inventory system a merchandising company uses the Purchases account to record the cost of goods bought for resale to customers. Example: IKA Company bought goods worth Birr 43,000 from Saba Co., which is based in Addis Ababa, on account on January 4, 2001, terms 20/10, n/30. Record the transaction. Solution: January 4 – Purchases …………………..43,000 Accounts payable………………………..43,000 Check Your Progress Exercise - 6 Record the same transaction for IKA Company if the merchandise were bought for cash. ………………………………………………………………………………………………… …………………………………………………………………………………………………. Deductions from Purchases Purchase Discounts A merchandising company can buy goods under credit terms that permit it to get a discount if it pays with in a specified period of time. The deduction from the original purchase price is recorded in a separate contra Purchase account called Purchase Discounts. Example: IKA Company bought goods worth Birr 50,000 from Gibir Company on account on January 14, 2001, terms 1/10,n/60. Ika Company paid on January 24, 2001. Record the transactions on both dates. Solution: Jan. 14. Purchases………………..50,000 A/P………………………50,000 Jan. 24. A/P…………………… …50,000 Purchase Discounts …….......500 74 Fundamental of accounting i…..ch-3 Cash…………………….. 49,500 Check your Progress Exercise -7 1. What would Gibir Company record on January 14, and January 24? ………………………………………………………………………………………………… ………………………………………………………………………………………………… ………………………………………………………………………………………………… Purchase Returns and allowances A purchase return occurs when a buyer returns merchandise to a seller. A purchase allowance is a reduction on the price of goods bought for dissatisfaction on the side of the buyer. Both purchase returns and purchase allowances are recorded in a contra purchase account called Purchase Returns and Allowances. Example: In the previous example for IKA Company, a portion of the goods worth birr 5,000 bought on January 14 from Gibir Company were of the wrong size. Gibir Company acknowledged this and gave IKa Company a 5% price allowance on January 17. What should IKA Company record on January 17? Solution: January 17 A/P…………………………………250 Purchase Returnes and Allowance…………250 Check your Progress Exercise - 8 1. What would Gibir Co. record on January 17? ………………………………………………………………………………………………… ………………………………………………………………………………………………… ………………………………………………………………………………………………… 75 Fundamental of accounting i…..ch-3 When both purchase discounts and purchase returns and allowances are deducted from purchases what is obtained is called Net purchase. That is, Gross Purchase…………………………XX Less: Purchase discounts…………………….(XX) Purchase returns and allowances………(XX) Net Purchases…………………….XX Transportation costs Once merchandise has been bought it has to be moved from the seller‟s place to the buyer‟s place. A third party comes in to the scene here: the transportation company who moves the goods between the two places. That is: Seller Goods goods goods Buyer Freighter So, the question is, who is going to pay to the freighter (transportation) company. Who covers the transportation costs depends, as you might have guessed, on the agreement between the buyer and seller. The agreements are usually stated in the either of these two terms: - FOB Destination – means “free on board at destination “. That is, since the destination of the goods is the buyer‟s place, it is free at destination means transportation cost is paid when the goods are loaded. It simply means the seller pays transportation cost. FOB Destination means goods are shipped to their destination (to the buyer) with out transportation charge to the buyer. - FOB shipping Point –means “ free on board at shipping point”. That is, goods are loaded (on a truck or train) or shipped free of charge. It is, therefore, the buyer, which pays to the transportation company when the goods reach the buyer (their destination) Briefly, when the terms are FOB Shipping Point the buyer pays transportation costs. 76 Fundamental of accounting i…..ch-3 Transportation costs paid by a buyer of merchandise increase the cost of merchandise. They are recorded in a separate Transportation-In account that is used to record freight costs incurred in the acquisition of merchandise. Example IKA Company bought goods worth Birr 85,000 on account, terms 2/10,n/60 FOB shipping point on March 2, 2001.Transportoin cost of Birr 1,500 was paid on March 2. Ika Company paid on March 31, 2001. Record the necessary journal entries Solution: Here, since the terms are FOB Shipping Point, the buyer (Ika) pays transportation. March 2 -Purchase…………………..85,000 A/P………………………..85,000 -Transportation In……….....1500 Cash………………………1500 March 31 A/P…………………………85,000 Cash………………………..85,000 Check Your Progress Exercise -9 1. What would have been recorded by IKA, if it paid on March 12, 2001? What if the terms were FOB destination? ………………………………………………………………………………………………… ………………………………………………………………………………………………… ………………………………………………………………………………………………… Example: IKA Company sold goods worth Birr 135,000 terms 1/15, n/EOM on February 1, 2001. FOB Destination. It also paid transportation costs of Birr 800 on Feb. 1. The customer paid IKA on February 16, 2001. Record the relevant Journal entries. Answers: Feb 1 A/R…………………………..135,000 77 Fundamental of accounting i…..ch-3 Sales…………………………..135,000 Feb 16 Sales discount ………………….1,350 Cash………………………….133,650 A/R…………………………135,000 Delivery Expense…………………800 Cash……………………………800 The Delivery Expense account shows how much was incurred to deliver goods sold to customers. It is, therefore, shown on the income statement as a selling expense. Check Your Progress Exercise -10 1. What would the customer (buyer) recorded, in the above example, on February 1, and 13, 2001? ………………………………………………………………………………………………… ………………………………………………………………………………………………… ………………………………………………………………………………………………… Sometimes, the seller prepays the freight as a convenience to the buyer and later collects it on the due date of the invoice even though the terms are FOB shipping Point. Example Raey Co. sold goods worth Birr 40,000 on April 1, 2001 to IKA company terms 2/10, n/30 FOB Shipping Point. It also paid Birr 2,500 to Ergib Movers for transporting the goods and added the amount to the invoice. What would each of these companies record assuming IKA paid on April 31, 2001 Raey Co. (seller) IKa Co (Buyer) April 1- A/R…………….40,000 April 1-Purchases …………40,000 Sales………………40,000 A/P………………….40,000 A/R…………….2500 Transport-in ………2500 Cash…………….2500 A/P………………2500 April 31-Cash……………42,500 April 31- A/P…………………42,500 A/R………………42500 Cash…………………42,500 78 Fundamental of accounting i…..ch-3 Check Your Progress Exercise – 11 1. What would have been recorded on the above dates if IKa Co. Paid on April 11, 2001? ………………………………………………………………………………………………… ………………………………………………………………………………………………… ………………………………………………………………………………………………… If the buyer pays the transportation costs for the seller (when the terms are FOB Destination) the buyer simply deducts the freight paid from the amount to be paid to the seller. Example: X Company bought merchandise worth Birr 14,000 terms FOB destination from Y Co. on account. It paid Birr 350 transportation costs. What would be recorded on the books of the buyer and seller on the date of the sale? Buyer (X Co) Seller Y Co. -Purchase……….14,000 -. A/R……………….14,000 -A/P………………14,000 Sales………………….14,000 -A/P……………350 -Delivery exp……….350 Cash………..350 A/R………………350 Transfer of Title Shipping terms determine not only determine who pays for transportation. They also determine at what point ownership title of the goods sold transfers to the buyer. Put briefly, whose property is it when merchandise is in transit? 79 Fundamental of accounting i…..ch-3 1. When terms are FOB Destination we have seen that the seller covers transportation costs. By implication the seller takes the responsibility of safely moving and delivering the goods to the buyer. The buyer is not responsible for any damage that can happen to these goods in transit. Therefore, the goods become the buyer‟s property only when they are delivered to him /her. Conclusion: Ownership title of the goods transfers to the buyer at destination when the terms are FOB destination. 2. When the terms are FOB shipping point the buyer pays freight costs. The buyer takes the responsibility of safely moving these goods to his /her own place. The merchandise, therefore, becomes his/her property as soon as they are loaded on a truck or a train. Conclusion: Ownership title of goods transfers to the buyer at shipping point when terms are FOB shipping point. The following table summarizes it all. Sipping terms Transportation paid by Title Transfers When goods are Delivered to FOB Destination Seller Buyer FOB shipping point Buyer Freighter (transportation company) Summary of Section One Lets once again present the model Income Statement that we saw at the beginning of this chapter. This time around, however, it is a bit detailed. Please study the relationship between each item on the Income Statement carefully. Also try to remember how each item was recorded in journal entry form when the transactions affecting these accounts happened. XYZ Merchandising Co. 80 Fundamental of accounting i…..ch-3 Income statement For the year ended Dec. 31,2001 Gross Sales ………………………………………………… 400,000 Less: Sales Discounts (15,000) Sales Ret &All (25,000)……… ……………………. (40,000) Net sales………………………………………………………….360,000 Cost of goods sold: Beginning merchandise inventory (January 1, 2001)…10,000 Add: Purchases…………………..210,000 Less: Purchase Disc………..(5,000) Purchase Ret & All…(5,000) Net purchase…………………………..200,000 Add: Transportation –In……………………….66,000 Total cost of goods Available for sale………………...276,000 Less: Ending M.I (Dec. 31,2001)………………………(20.000) Cost of goods sold……………………………………………… (256,000) Gross profit……………………………………………………………… 104,000 Less: Various Selling and Administrative Expenses ………………………(79,400) Net Income………………………………………………… 24,600 Note: Under a periodic inventory system, the cost of goods sold during a period is determined only indirectly after comparing what was on hand at the beginning of the period, and the cost of goods purchased during the period with what is left on hand at the end of the period. That is, Beg inventory + Total cost of purchase –Ending inventory=Cost of Goods Sold. Under periodic inventory procedures no attempt is made to determine the cost of goods sold at the time of each sale. Instead, the cost of all the goods sold during the accounting period is determined at the end of the period. Summary of Important Relationships on the Income Statement 1. Net sales = Gross sales- (Sales Discounts + Sales Returns and allowances) 81 Fundamental of accounting i…..ch-3 2. Net purchases = Purchases – (Purchase Disc. + Purchase Ret. & allowance) 3. Total cost of Purchase = Net purchase + Transportation –In 4. Cost of goods sold = Beg inventory + Total cost of purchase –Ending inventory 5. Gross profit = Net sales – Cost of goods sold 6. Net Income = Gross Profit – operating (i.e., selling & administrative) expenses. SECTION TWO: REPORTING MERCHANDISING TRANSACTIONS In the previous section, we saw how purchase and sales transactions are recorded. In this section, we will see how those transactions are summarized and reported on the financial statements. 3.5 COMPLETING THE WORKSHEET FOR A MERCHANDISING COMPANY The use of a worksheet, as you remember, assists in preparing adjusting and closing entries. In addition it contains all of the information needed for the preparation of the financial statements. Except for the merchandise – related accounts, the work sheet for a merchandising Co. is the same as for a service company. The following illustration, therefore, assumes that all selling and administrative expenses have been adjusted. That accomplished, the only account, which remains to be adjusted, is the Merchandise Inventory account. Illustration The following is the trial balance of Hard Works, a merchandising business owned by Yibeltal. All accounts have been adjusted except the Merchandise Inventory account. Hard Works Trial Balance December 31, 2002 Account title Dr CR Cash 19,663 Account Receivable 1,880 Merchandise Inventory 7,000 82  Fundamental of accounting i…..ch-3 Accounts Payable 700 Yibeltal, Capital 25,000 Yibeltal,Drawings 2,000 Sales 14,600 Sales Discounts 44 Sales Returns and Allowances 20 Purchases 6,000 Purchase discounts 82 Purchase Returns and allowances 100 Transportation –In 75 Selling expenses 2,650 Administrative expenses 1,150 ________ 40,482 40,482  A physical inventory of merchandise carried out on December 31, 2002 showed Birr 10,000 of goods on hand. Required: A- Prepare a worksheet for Hard Works. B- Prepare financial statements from the worksheet C- Record the necessary adjustment journal entry in relation to merchandise inventory D- Record closing entries 83  Fundamental of accounting i…..ch-3 Hard Works Co. Worksheet for the year ended December 31,2002 Trial Balance Adjustment Adjusted Trial balance Income statement Balance sheet Account title Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash 19,663 19,663 19,663 Account 1 ,8 8 0 1 ,8 8 0 1 ,8 8 0 Receivable Merchandise 7 ,0 0 0 10,000 7 ,0 0 0 10,000 10,000 Inventory Accounts Payable 7 00 700 700 Yibeltal, Capital 25,000 25,000 2,5000 Yibeltal, Drawings 2 ,0 0 0 2 ,0 0 0 2 ,0 0 0 Income summery 7 ,0 0 0 10,000 7 ,0 0 0 10,000 7 ,0 0 0 10000 Sales 14,600 14,600 14600 Sales Discounts 44 44 44 Sales Returns and 20 20 20 Allowances Purchases 6 ,0 0 0 6 ,0 0 0 6 ,0 0 0 Purchase discounts 82 82 82 Purchase Returns 1 00 100 100 and allowances Transportation –In 75 75 75 Selling expenses 2 ,6 5 0 2 ,6 5 0 2 ,6 5 0 Administrative 1 ,1 5 0 1 ,1 5 0 1 ,1 5 0 expenses 40,482 40,482 17,000 17,000 50,482 50,482 16,939 24782 33,543 25,700 7 ,8 4 3 7 8 ,4 3 24,782 24782 33,543 33,543 Note: The merchandise inventory account before adjustment shows the inventory on hand at the beginning of the period. This is because, since purchases and sales of merchandise have not been debited or credited to the merchandise inventory account, this account would still show the beginning inventory amount at the end of the period. Therefore, an adjustment journal entry is needed to update this account. At the end of the period, a physical inventory would be conducted to determine the amount of inventory on hand. The adjustment journal entry removes beginning inventory amount from the merchandise inventory account and replaces it with the (ending) actual value of merchandise inventory on hand as determined by the physical inventory. 84 Fundamental of accounting i…..ch-3 The adjustment is:  Income summary (beginning inventory)…………..XXX Merchandise amount inventory……………………XXX  Merchandise Inventory…………………………….XXX Income Summary…………………………………..XXX An adjustment journal entry for Hard Works is presented latter in (c). 3.6 PREPARING FINANCIAL STATEMENTS FOR MERCHANDISING BUSINESSES We will discuss financial statements as we work on requirement (b) of our illustration. Once the worksheet has been completed, the financial statements are prepared. Next, any adjusting and closing entries are entered in the journal and posted to the ledger. Income Statement There are two widely used formats of the income statement. These are: The single – Step Income Statement This format is shown below for Hard Works Co. It shows cost of goods sold and operating expense but has only one subtotal for total expenses. Hard Works Co. Income statement For the year ended December 31, 2002 Net sales…………………………………………………..Br.14536 Expenses: Cost of goods sold………………………2893 Operating Expenses …………………….3800 (6693) Net Income……………………………………….7843 85 Fundamental of accounting i…..ch-3 The Multiple –Step Income Statement Hard Works Co. Income statement For the year ended December 31, 2002 Revenue: Gross Sales……………………………………………… Br. 14600 Less: Sales Discounts ………..44 Sales Returns &All……20……………… (64) Net Sales 14536 Less: Cost of goods sold: Beg. Inventory (Jan 1)…………………..7,000 Add: Purchase………………………6,000 Less: Purchase.……………….(82) Purchase Ret & all…….(100) Net Purchases……………..5818 Add: Transportation –In ……………75 Total cost of purchase……..5893 Total cost of Goods Available for sale……………..12,893 Less: ending Inventory (Dec.31)…………………………(10,000) Cost of Goods sold…………………………………………..(2893) Gross Profit……………………………………………11,643 Operating Expenses: Selling Expenses……………….2,650 Admin. Exp…………………….1,150 Total operating expenses……………….. (3800) Net Income……………………………… 7,843 86 Fundamental of accounting i…..ch-3 Hard Works Co. Statement of Owner’s Equity For the year Ended December 31, 2002 Yibeltal Capital Jan1,2002………………………Br..25,000 Add: Net Income for the year…………………………7843 Deduct: Owner‟s withdrawal during the year………....2,000 Yibeltal Capital December 31, 2002…………………30843 Hard Works Co. Balance sheet For the year Ended December 31, 2002 Assets: Liabilities & capital Liabilities: Cash…………………..19663 A/P……………………700 A/R…………………… 1880 Owner‟s Equity: Merch. Inventory…….10,000 Yibeltal Capital … 30843 Total Assets………….31,843 Total Liab. & O/E……31,843 C. Adjustment Journal entry -Income summary…………………..7,000 Merchandise Inventory………………7,000 -Merchandise Inventory…………….10,000 Income Summary…………………….10,000 D. Closing entries -Sales………………………………..14,600 Income summary……………………..14,600 -Income summary………………………66 Sales discount………………………………44 Sales Returns and Allowances…………… 20 87 Fundamental of accounting i…..ch-3 -Income summary………………………………6,075 Purchases…………………………………………….6,000 Transportation-In………………………………………..75 - Purchase Discounts………………………………..82 Purchase Ret. &All……………………………...100 Income Summary……………………………………….182 - Income summary……………………………….3,800 Selling Expenses…………………………………2650 Administrative expense…………………………..1150 - Income summary………………………………….7,843 Yibeltal Capital……………………………………7,843 - Yibeltal Captal……………………………………..2,000 Yibeltal Drawings……………………………………2,000 3.7 SUMMARY Even though the steps and procedures that we go through to prepare the financial statements of merchandising companies are the same with that of service businesses, there are transactions peculiar to merchandising companies. These include the purchase and sale of merchandise. You should be able to record these transactions by now. Go back and study the relationships between financial statement items summarized at the end of section one of this unit. 88 Fundamental of accounting i…..ch-3 3.8 ANSWERS TO CHECK YOUR PROGRESS EXERCISE Check Your Progress Exercise - 1 List price of goods……………………………….52,000 Less: Trade discount (20% X [52,000-40,000]) ……… (2400) Invoice Price……………………..49,600 Journal entry: - A/R……………………49,600 Sales…………………………49,600 Check Your Progress Exercise - 2 - 1/15, n/60 – 1% discount if customer pays with in 15 days, otherwise amount is due with in 60 days with out any discount. - 2/10, n/EOM – 2% discount if paid with in 10 days, otherwise the whole amount due at the end of the month of sale - n/60 – No discount – amount is due in 60 days Check Your Progress Exercise - 3 A – since the customer paid with in the discount period, i.e., with in 10 days, amount collected would be: 120,000 – 1% (120,000) = 118,800 B– Jan. 18 A/R………………………..120,000 Sales………………………….120,000 Jan. 28 Cash……………………….118800 Sales Discount……………….1200 A/R…………………………….120,000 89 Fundamental of accounting i…..ch-3 Check Your Progress Exercise - 4 Feb 3 - A/R …………………………….15,000 Sales …………………………….15,000 Feb 13- Cash……………………………..14,700 Sales Discount……………………...300 A/R……………………………….15,000 Feb 15- Sales Returns &Allowances……5,000 Cash……………………………….4900 Sales Discount………………………100 Check Your Progress Exercise - 5 January 4 Purchase ………………………….43,000 Cash……………………………….43,000 Check Your Progress Exercise - 6 Jan 14. A/R……………………………….50,000 Sales………………………………50,000 Jan 24. Cash………………………………49,500 Sales Discounts……………………… 500 A/R………………………………..50,000 Check Your Progress Exercise - 7 Jan 17. Sales Returns & Allowances………250 A/R…………………………………..250 Check Your Progress Exercise - 8 FOB shipping point March 12. A/P……………………………………85,300 Cash……………………………………..83,300 Purchase Discounts……………………. 1,700 90 Fundamental of accounting i…..ch-3 FOB Destination March 2 - Purchase……………………………….85,000 A/P……………………………………..85,000 March 31- A/P…………………………………….85,000 Cash……………………………………85,000 Check Your Progress Exercise - 9 Feb 1- Purchase………………………………..135,000 A/P……………………………………….135,000 Feb 13- A/P……………………………………..135,000 Cash………………………………………133,650 Purchase Discounts………………………… 1,350 Check Your Progress Exercise - 10 Seller Buyer April 1-A/R……………40,000 Purchase……………40,000 Sales…………………40,000 A/P……………………40,000 A/R………………2,500 Transportation-In……..2,500 Cash…………………..2,500 A/P……………2,500 April 11- Cash (39200 + 2500)…41,700 April 11-A/P…………42,500 Sales Discount…………...800 Cash…………….41,700 A/R (40,000 +2500)…….42,500 Purchase Discounts...800 3.9 MODEL EXAMINATION QUESTIONS 91 Fundamental of accounting i…..ch-3 1. You are provided with the following data from the records of three merchandising companies:(a), (b) and (c). Determine each of the missing numbers for each company. a b c Invoice cost of merchandise purchase Br.90, 000 Br.40, 000 Br.30, 500 Purchase discounts 4000 ? 650 Purchase returns and allowances 3,000 1,500 1,100 Transportatiln-In ? 3,500 4,000 Merchandise inventory (beginning of period) 7,000 ? 9,000 Total cost of merchandise purchases 89,400 39,500 ? Merchandise inventory (end of period) 4,400 7,500 ? Cost of goods sold ? 41,600 34,130 2. Prepare journal entries to record the following merchandising transactions of Shiach Company. The company uses the periodic inventory system. July 1 Purchased merchandise form Gizhy Company for $6,000 under credit terms of 1/15, n/30, FOB shipping point. 2 Sold merchandise to Terra Co. for $800 under credit terms of 2/10, n/60, FOB shipping point. 3 Paid $100 for freight (transportation) charges on the purchase of July 1. 8 Sold merchandise for $1,600 cash. 9 Purchased merchandise from Chilalo Co. for $2,300 under credit terms of 2/15, n/60, FOB destination. 12 Received a $200 credit memorandum acknowledging the return of merchandise purchased on July 9. 12 Received the balance due from Terra Co. for the credit sale dated July 2, net of the discount. 16 Paid the balance due to Gizhy Company within the discount period. 19 Sold merchandise to Urban Co. for $1,250 under credit terms of 2/15, n/60, FOB shipping point. 21 Issued a $150 credit memorandum to Urban Co. for an allowance on goods sold on July 19. 92 Fundamental of accounting i…..ch-3 22 Received a debit memorandum from Urban Co. for an error that overstated the total sales invoice by $50. 24 Paid Chilalo Co. the balance due after deducting the discount. 30 Received the balance due from Urban Co. for the credit sale dated July 19, net of the discount. 31 Sold merchandise to Terra Co. for $5,000 under credit terms of 2/10, n/60, FOB shipping point. 3. The following unadjusted trial balance was prepared at the end of the fiscal year for Tenkir Company: TENKIR COMPANY Unadjusted Trail Balance July 31, 2000 Cash……………………………………………….. $ 4,200 Merchandise Inventory…………………………… 11,500 Store supplies…………………………………….. 4,800 Prepaid Insurance………………………………… 2,300 Store equipment………………………………….. 41,900 Accumulated deprecation-Store Equipment… $ 15,000 Accounts payable…………………………………. 9,000 Gidey Tinker, capital…………………………….. 35,200 Gidey Tenkir, withdrawals ………………………. 3,200 Sales……………………………………………….. 104,000 Sales discounts…………………………………… 1,000 Sales returns and allowances…………………… 2,000 Cost of goods sold………………………………... 37,400 Depreciation expense – Store equipment…….. - Salaries expense………………………………… 31,000 Insurance expense………………………………. - Rent expense…………………………………….. 14,000 93 Fundamental of accounting i…..ch-3 Store supplies expense…………………………. - Advertising expense…………………………….. 9,900. Totals……………………………………………...$163,200 $163,200 Rent and salaries expense are equally divided between the selling and the general and administrative functions. Tenkir Company uses the periodic inventory system. Required: 1. Prepare adjusting journal entries for the following: a. Store supplies on hand at year-end amount to $1,650. b. Expired insurance, an administrative expense, for the year is $1,500. c. Depreciation expense, a selling expense, for the year is $1,400. d. A physical count of the ending merchandise inventory shows $11,100 of goods on hand. 2. Prepare a multiple-step income statement. 3. Prepare a single-step income statement. 4. Prepare all the necessary closing entries. 3.10 GLOSSARY OF TERMS A Merchandising Business- a business that buys and sells goods at a profit. Merchandise- anything that a merchandising company buys in order to resale it to its customers. Periodic Inventory System- a system of recording inventories that updates inventory records only once in an accounting period. Perpetual Inventory System- a system of recording inventories that continuously shows the balance of inventory on hand as the records about inventory are continuously updated. Physical Inventory- the act of counting (measuring, weighing, etc) merchandise in order to determine the quantity of goods on hand on a particular date. 94 Fundamental of accounting i…..ch-3 Trade Discount- deduction from the normal selling price (list price) to determine the invoice price of goods. Cash Discount- deduction from the invoice price of goods for early payment when goods are sold on credit. Cash discounts are called sales discounts for the seller whereas they are referred to as purchase discounts by the buyer. Purchase (or Sales) Returns- merchandise returned to the seller after it has already been sold or bought. Purchase (or Sales) Allowance- a deduction from the invoice price of goods when the goods bought or sold are agreed to be of defective or unsatisfactory for any reason. Contra Account- if an account is a contra account; its balance would be deducted from another account when it is presented in the financial statements. FOB Destination- an agreement that requires the seller of the goods to cover transportation costs. It is read as free on board at destination. FOB Shipping Point- an agreement that requires the buyer of merchandise to cover transportation costs. It is read as free on board at shipping point. 95 Fundamental of accounting i…..ch-3 unit 5. ACCOUNTING FOR INTERNAL CONTROL OVER CASH 5.0 AIMS & OBJECTIVES In this unit, internal control of cash, the accounting for cash transactions and other aspects will be discussed. After you have studied this unit, you should be able to: - define cash - identify the with composition of cash - explain the objectives of cash management - prepare a bank reconciliation - understand the internal control of cash 5.1 INTRODUCTION Since cash is the asset most likely to be used improperly by employees, exposed for embezzlement and many business transactions either directly or indirectly affect it, it is therefore necessary to have effective control of cash. 5.2 MEANING OF CASH Cash includes money on deposit in banks and other items that a bank will accept for immediate deposit. Money on deposit in banks includes checking and saving accounts. Other items such as ordinary checks received from customers, money orders, coins and currency and petty cash also are included as cash. Banks do not accept postage stamps, travel advances to employees, notes receivable or post-dated checks as cash. 1.3 CHARACTERISTICS OF CASH The following are some of the characteristics of cash: a) Cash is used as medium of exchange b) Cash is the most liquid asset c) Cash is mostly affected by business transactions d) Cash is used to measure the value of other assets e) Cash is mostly exposed to embezzlements 1.4 MANAGEMENT OF CASH 96 Fundamental of accounting i…..ch-3 Cash management refers to planning, controlling and accounting for cash transactions and cash balances. Efficient management of cash is essential to the survival and success of every business organization. Managing cash requires planning wisely so that there will not be excess cash held on hand at any point in time; or there is no shortage of cash at any point in time to meet the business‟s needs. 1.5 INTERNAL CONTROL OF CASH The need to safeguard cash is crucial in most businesses because cash is mostly exposed to embezzlement. Firms address this problem through the internal control system. An internal control system is a set of policies and procedures designed to protect assets, provide accurate accounting records and evaluate performances. A sound internal control system for cash increases the likely hood that the reported values for cash are accurate. Internal control for cash should include the following procedures: a) The individuals who receive cash should not also disburse (pay) cash b) The individuals who handle cash should not access accounting records c) Cash receipts are immediately recorded and deposited and are not used directly to make payments. d) Disbursements are made by serially numbered checks, only upon proper authorization by someone other than the person writing the check e) Bank accounts are reconciled monthly. The following are the most common elements of cash control and managements: bank account system, petty cash fund, voucher system, change fund, and cash short and over. 1.1.1 Control of Cash Through Bank Accounts Bank accounts are one of the most important means of controlling cash that provide several advantages such as: - Cash is physically protected by the bank, - A separate record of cash is maintained by the bank, - And customers may remit payments directly to the bank. 97 Fundamental of accounting i…..ch-3 If a company uses a bank account, monthly statements are received from the bank showing beginning and ending balances and transactions occurring during the month including checks paid, deposits received, and service charges. These monthly statements (reports) received from the bank are called bank statements. Bank statements generally are accompanied by checks paid and charged to the accounts during the month, debit and credited memos, which inform the company about changes in the cash accounts. For a bank, the depositor‟s cash b alance is a liability, the amount the bank owes to the firm. Therefore, a debit memo describes the amount and nature of decrease is the company‟s cash accounts. A credits memo indicates an increase in the cash balance of the depositor that it has with the bank. 1.1.1.1 Reconciliation of Bank and Book Cash Balances Monthly reconciling of the bank balance with the depositor‟s cash accounts balance is essential cash control procedure. To reconcile a bank statement means to verify that the bank balance and the accounting records of the depositor are consistent. The balance shown in a monthly bank statement seldom equals the balance appearing in the depositor‟s accounting records. Certain transactions recorded by the depositor may not have been recorded by the bank and vice versa. The most common examples that cause disparity between the two balances are: a) Outstanding checks: Checks issued and recorded by the company, but not yet presented to the bank for payment. b) Deposits in transit: Cash receipts recorded by the depositor, but not reached the bank to be included in the bank statement for the current month. c) Service charges: Banks often charge a fee for handling checking accounts. The amount of this charge is deducted by the bank form bank balance and debit memo is issued for the depositor. d) Charges for depositing NSF- checks: NSF stands for “Not Sufficient Funds.” When checks are deposited in an account, the bank generally gives the depositor immediate credit. On occasion, one of these checks may prove to be uncollectible because the maker of the check does not have sufficient funds in his or her account. In such a case, the bank will reduce the 98 Fundamental of accounting i…..ch-3 depositor‟s account by the amount of this uncollectible item and return the check to the depositor marked “NSF”. e) Notes collected by bank: If the bank collects a note receivable on behalf of the depositor, it credits the depositor‟s account and issues a credit memorandum for the depositor. When the depositor prepares bank reconciliation, the balances shown in the bank statement and in the accounting records both are adjusted for any unrecorded transactions. Additional adjustments may be required to correct any errors discovered in the bank statements or in the accounting records. 1.1.1.2 Steps in Preparing Bank Reconciliation A bank reconciliation is a schedule prepared by the depositor to bring the balance shown in the bank statement and the balance shown in the depositor‟s accounting into agreement. The steps to prepare a bank reconciliation are: a) The deposits listed on the bank statement are compared with the deposits shown in the accounting records. Any deposits not yet recorded by the bank are deposits in transit and should be added to the balance shown in the bank statements. b) The paid and received checks from the bank are compared with the check stubs. Any checks issued but not yet paid by the bank are outstanding checks and should be deducted from the balance reported in the bank statements. c) Any credit memorandums issued by the bank that have not been recorded by the depositor, are added to the balance per depositor‟s record. d) Any debit memorandums issued by the bank that have not been recorded by the depositor are deducted from the balance per depositor‟s record. e) Any errors in the bank statement or depositor‟s accounting records are adjusted. f) The equality of adjusted balance of statement and adjusted balance of the depositor‟s record is compared. g) Journal entries are prepared to record any items delayed by the depositor. 1.1.1.3 Illustration of Bank Reconciliation 99 Fundamental of accounting i…..ch-3 The January bank statement sent by Awash Bank to RAM Company shows Br. 5,000.17. Assume also that on January 31, 2000, the Cash account of RAM Co. shows a balance of Br.. 4,262.83The accountant of RAM Company has identified the following item s: 1. A deposit of Br. 410.90 made after banking hours on Jan. 31 does not appear on the bank statement. 2. Two checks issued in January have not yet been paid by the bank: Check No. 301 Br. 110.25 Check No. 342 607.50 3. A credit memorandum was included in the bank statement, which was for proceeds from collection of a non-interest bearing note receivable from MAN company Br. 524.74. 4. Three debit memorandums accompanied the bank statement: Fee charged by bank for handling collection of notes receivable Br.5; a check of Br. 50.25 received from a customer, RON company, and deposited by RAM company was charged back as NSF; and service charge by bank for the month of January amounts to Br. 12.00. 5. Check No. 305 was issued by RAM Company for payment of telephone expense in the amount of Br. 85 but was erroneously recorded in the cash payments journal as Br. 58. The January 31 bank reconciliation for RAM Company is shown below: RAM Company Bank Reconciliation January 31, 2000 Balance per bank statement, Jan. 31,2000 Br. 5,000.17 Add: Deposit of Jan. 31 not recorded by bank 410.90 100 Fundamental of accounting i…..ch-3 Subtotal Br. 5,411.07 Deduct: outstanding checks: No. 301 Br. 110.25 No. 342 607.50 117.75 Adjusted cash balance Br. 4,693.32 Balance per depositor‟s record, Jan. 31,2000 Br. 4,262.83 Add: Note Receivable collected by bank 524.74 Subtotal Br. 4,787.57 Deduct: collection fee Br. 5.00 NSF check of Ron Co. 50.25 Service charge 12.00 Error on check stub No. 305 27.00 94.25 Adjusted cash balance Br. 4,693.32 The following are journal entries related to the bank reconciliation. Jan. 31 cash 524.74 Notes Receivable 524.74 To record collection of Note Receivable Collected by bank 31 Miscellaneous Expense 17.00 Accounts Receivable-RON Co. 50.25 Utilities Exp. 27.00 Cash 94.25 To record bank service charges, NSF check and error in recording Check No. 305 1.1.2 Petty Cash Fund Petty cash fund, which is part of the total cash balance, is used to handle many types of small payments such as employee transportation costs, purchase of office supplies, purchase of postage stamps, and delivery charges. Many businesses find it convenient to make minor 101 Fundamental of accounting i…..ch-3 expenditures instead of writing checks. The petty cash amount various from Br. 50 or less to more than Br. 1,000, which will cover small expenditures for a period of two or three weeks. 1.1.2.1 Establishment of Petty Cash To establish a petty cash fund a check is issued to a bank. This check is cashed and the money is kept on hand in a petty cash box. One employee is designated as custodian of the fund. The issuance of the check for establishment is recoded by debiting petty cash account and crediting cash. 1.1.2.2 Replenishment of Petty Cash During the period, the custodian makes small payments form the petty cash fund and obtains a receipt or prepares a petty cash voucher. This petty cash voucher explains the nature and amount of every expenditure and is kept with the fund. When the fund runs low or at the end of the company‟s fiscal period, a check is issued to reimburse the fund for the expenditures made during the period. The issuance of this check is recorded by debiting the appropriate expense accounts and crediting cash or vouchers payable. 1.1.3 Voucher System One method to control cash disbursements is a voucher system. A voucher is a special form, which contains relevant data about a liability and its payment. In a voucher system, a voucher is prepared for each expenditure and approved by the designated officials. Each approved voucher represents liability and recorded in a voucher register, which is similar to purchases journal. Those registered vouchers are filed according to their payment date in an unpaid vouchers file. The vouchers and supporting documents then are sent to the treasure or other official is the finance department before issuing checks. When the checks are signed, the paid vouchers are recorded in a check register which is similar to cash payments journal. Those paid vouchers are filed in paid vouchers file according to their serial number for future reference. 1.1.4 Change Fund Some businesses that receive cash directly from customers should maintain a fund of currency and coins in order to make change (Amharic=>”zirzir”). This fund, which is part of the total cash balance, is called change fund. A change fund is established by issuing a check to the 102 Fundamental of accounting i…..ch-3 bank and transferring the cash to the custodian. The issuance of a check to establish a change fund is recorded by debiting cash on hand and crediting cash or voucher payable. Once a change fund is established, there will be no change in its balance unless there is a decision by management to increase or decrease the fund balance. 1.1.5Cash Short and Over In handling cash receipts from daily sales, a few errors in making changes will occur. These errors may cause a cash shortage or overage at the end of the day. The account cash short and over is debited if there is shortage and credited if there is overage. At the end of the period if the account had a debit balance, it appears in the Income statement as miscellaneous expense; if it has a credit balance, it is shown as miscellaneous revenue. For example, assume that the total cash sales recorded during the day amounts to Br. 12,420. However, the cash receipts in the cash register drawer (actual cash count) total Br. 12,415. The following entry would be made to adjust the accounting records for the shortage in the cash receipts: Cash Short and Over 5.00 Cash 5.00 To record a Br. 5.00 (Br. 12,420 – 12,415) Shortage in cash receipts for the day 1.6SUMMARY 1. Cash includes only those items immediately available to pay obligations. 103 Fundamental of accounting i…..ch-3 2. The objectives of cash management are accurate accounting for cash transactions, the prevention of losses through theft or fraud, and maintaining adequate cash balances. 3. The bank reconciliation adjusts the cash balance per book and the cash balance per bank statement for any unrecorded items such as outstanding checks and bank service charges. 4. Bank reconciliation produces the correct amount of cash to be included in the balance sheet at the end of the month. 5. A company may use a petty cash fund to make small payments that occur frequently, as payment by check would cause delay and excessive expense of maintaining records. 6. One of the best systems for establishing control of cash payments is the use of a voucher system. A voucher system uses vouchers, a voucher register, a file for unpaid vouchers, a check register and a file for paid vouchers. 104 Fundamental of accounting i…..ch-3 1.7 ANSWER TO CHECK YOUR PROGRESS EXERCISES Check Your Progress Exercise - 1 1. Cash includes all the items that are accepted for deposit by a bank, notably paper money and coins, money orders, and checks. 2. a) Post-dated checks b) Postage stamps Check Your Progress Exercise - 2 1. The basic purpose of a bank reconciliation is to achieve the control inherent in the maintenance of two independent records of cash transactions; one record maintained by the depositor and the other by the bank. When these two records are reconciled (brought into agreement), we gain assurance of a correct accounting for cash transactions. 2. a) Checks issued that have not been paid by the bank. b) Deposits not recorded by the bank. c) A customer‟s check which was deposited but returned because of a lack of funds in the account on which the check was drawn (in the customer‟s bank account). d) Note collected by bank e) Bank service charge Check Your Progress Exercise - 3 1. Yes. To record the unrecorded expenditures of Br. 40 at least by the end of the fiscal period 2. a) According to the earliest date b) In numerical order 3. In miscellaneous revenue section of Income statement 1.8 MODEL EXAMINATION QUESTIONS Part I. Short answer questions 1. In general terms, in which section does cash, appear on the balance sheet? 2. Explain some measures that strengthen internal control over cash receipts and payments. 3. What is the basic control feature in a voucher system? 105 Fundamental of accounting i…..ch-3 4. List two items often encountered in reconciling a bank account that may cause cash per the bank statement to be larger than the balance of cash shown in the depositor‟s accounting records. Part II. Work Out Questions 1. Shown below is the information needed to prepare a bank reconciliation for MITE company at December 31. a) At December 31, cash per the bank statement was $ 15,981; cash per the company‟s records was $ 17,445. b) Two-debit memorandum accompanied the bank statement: service charges for December of $ 24, and a $ 600 check drawn by RAMI marked „NSF‟. c) Cash receipts of $ 4,353 on December 31 were not deposited until January. d) The following checks had been issued in December but were not included among the paid checks returned by the bank: no. 620 for $ 978, no. 630 for $ 2,052, and no. 641 for $ 483. Required: i) Prepare a bank reconciliation at December 31 ii) Prepare the necessary journal entry or entries to update the accounting records based on the reconciliation. 2. RAM Company maintains its checking account with the Commercz Bank. The company is ready to prepare its December 31 bank reconciliation. The following data are available: a) The November 30 bank reconciliation showed the following: 1) Cash on hand (held by RAM company for day to day minor expenses), Br. 400 (included in RAM‟s cash account) 2) Deposit in transit, Br. 2,000, and 3) Checks outstanding: N0. 121 Br. 1,000 No. 130 2,000 No. 142 3,000 b) Bank Statement, December 31:  Balance, December 31 Br. 67,600  Deposits: 188,500 106 Fundamental of accounting i…..ch-3  Checks: No. 130, Br. 2,000; N0. 142, Br. 3,000; N0. 143 – 176, Br. 191,000 (196,000)  Note collected for RAM company (including Br. 720 interest) 16,720  NSF check, customer Binda (250)  Bank service charges (20)  Balance, December 31 Br. 76,550 Required: i) Determine deposit in transit and checks outstanding ii) Prepare the December 31 Bank reconciliation iii) Based on your bank reconciliation, give all journal entries that should be made at December 31. 1.9 GLOSSARY OF TERMS Bank reconciliation: a schedule that explains the difference between the balance of cash shown in the bank statement and the balance of cash shown in the depositor‟s records. Cash: money on deposit in banks and other items that a bank will accept for immediate deposit. Cash management: planning, controlling, and accounting for cash transactions and cash balances. Petty cash: small amount of cash, which is used to make small payments that occur frequently. Voucher: a written authorization used in approving a transaction for recording and payment. Voucher system: an accounting system designed to provide strong internal control over cash disbursements. 107 Fundamental of accounting i…..ch-3 108