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
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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