Test #3 Flashcards
Service companies
sell services rather than physical goods
merchandising companies
sell foods that have been purchased from a supplier
manufacturing compnaies
sell goods that it has made itself
internal controls
• Protect against theft of assets
• Enhance the reliability of accounting information
• Promote efficient and effective operations
• Ensure compliance with applicable laws and
regulations
Limitations of Internal Control
- Cost vs. benefit
* Human error or fraud
5 Common Principles of
Internal Control
- establish responsibility
- segregate duties
- restrict assets
- document procedures
- independently verify
Estblishing responsible
Assign each task to only one
employee
segregate duties
Do not make one employee
responsible for all parts of a
process
restrict assets
Do not provide access to
assets or information unless it
is needed to fulfill assigned
responsibilities
documnet procedies
Prepare documents to show
activities that have occurred
independently verify
Check others’ work
Why put internal control measures in place for cash?
Volume of cash transactions is huge
• Cash is vulnerable to theft b/c it is valuable & portable
• Cash comes in many forms – money or any instrument
banks will accept for deposit and increase co.’s account
(i.e. cash equivalents – short-term, highly liquid
investments maturing within 3 months)
Primary goal of internal control for cash receipts
is to
ensure that the business receives the appropriate
amount of cash and safely deposits it in the bank
cheques received by mail are processed in the
same way as cash receipts except that instead of using a
cash register, a clerk opens the mail and lists the
amounts received on a cash receipt list
EFT
cash received electronically via electronic fund
transfers (EFTs) are is deposited directly into the
company’s bank account and only needs a journal entry
to record it
Bank Procedures and Reconciliation
Common for the balance on the bank statement and
the balance in the cash account in the books to be
different
Remember – the bank statement the bank sends you is
prepared from the bank’s point of view (so while the
business considers cash in the bank as an asset (debit),
the bank will see it as a liability (credit)
• Bank Reconciliation
– is an internal report prepared to
verify the accuracy of both the bank statement and the
cash accounts
Bank Reconciliation
Compare the activity listed on the bank statement with
the activity listed in the company’s cash account and
account for any differences
• Common order of analysis
1) Identify any deposits in transit
2) Identify any outstanding cheques
3) Record other transactions on the bank statement
including interest received, EFTs, NSF cheques and
service charges
4) Determine the impact of errors
Journal Entries
After the bank reconciliation is completed, the
reconciling items found for the company’s books need
to be recorded so the books are updated
PerpetualInventory System
Updates inventory records every time inventory is bought,
sold, or returned (perpetually updated)
• Provides better control because the inventory is
constantly updated which allows managers to better
manage levels, costs, and estimate shrinkage
• This means sales transactions require 2 journal entries:
REVENUE: Selling price is recorded as an increase in
Cash or A/R and an increase in Sales Revenue
EXPENSE: Cost is removed from Inventory and reported
as an expense called Cost of Goods Sold (COGS)
Sales Returns & Allowances
Sales Discounts
Both of these accounts REDUCE revenue
They are contra-revenue accounts
(which means they sit next to the revenue accounts on
the Income Statement but have the opposite effect)
• Gross Profit
is also called Gross Margin
• Gross Profit Percentage indicates the % of profit earned on
each dollar of sales, after deducting the cost of goods sold
• Higher ratio = greater profit available to cover operating
and other expenses
3
Gross Profit Analysis
Net Sales – Cost of Goods Sold = Gross Profit
Gross Profit Percentage
indicates the % of profit earned on
each dollar of sales, after deducting the cost of goods sold
• Higher ratio =
greater profit available to cover operating
and other expenses
Gross Profit Percentage can be used to:
see if a company if earning enough on each sale to cover
it’s operating expenses
analyze changes in a company’s operations over time
compare one company to another
Horizontal (trend) analyses
– used to recognize financial
changes that unfold over time
Comparing
performance
over time.
- Vertical (common-size) analyses
used to understand
important relationships within financial statements
Examines
relationships on
the same
financial stmt.
- Financial ratios
calculations done to assess profitability,
liquidity, and solvency
Examines
relationships
among various
items
vertical (common size (analysis)
Expresses each financial statement amount as a
% of another amount on the same financial
statement
• On a balance sheet: Total Assets = 100%
• On an income statement: Net Sales = 100%
Profitability Ratios
• Examine a company’s ability to generate income
Liquidity Ratios
• Determine a company’s ability to pay current
obligations
Solvency Ratios
• Examine a company’s ability to survive and repay
long-term debt
Net Profit Margin
- profitability ratio
- the percentage of revenue that ultimately makes it into net income, after deducting expesnes
Gross Profit Percentage
- profitability ratio
- how much profit was made, on average, on each dollar of sales after deducting the cost of goods sold
Asset Turnover
- profitability ratio
- indicates the amount of sales revenue generated for each dollar invested in assets during the period
Fixed Asset Turnover
- profitability ratio
- indicated how much revenue the company generates in sales for each dollar invested in fixed assets( buildings, property)
Return on Equity (ROE)
- profitability ratio
- reports the net amount earned during the period as a percentage of each dollar contributed by shareholders and retained in the business
Earnings per share (ESP)
- profitability ratio
- indicates the amount of earnings generated for each common share outstanding
Price/Earnings (P/E) Ratio
indicates how many times over shareholders would be willing to pay for a share in the company.
Receivables turnover
-liquidity turnover
how quick can you turn receivables into another asset (cash)
inventory turnover
-liquidity turnover
indicates how frequently inventory is bought and sold during the year
current ratio
liquidity ratio
- the companies abilities to pay off current liabilities with current assets
Quick Ratio
liquidity ratio
- compares sum of cash, short-term investments, and accounts receivable to current liabilities
Debt-to-Assets
solvency ratio
indicates the proportion of total assets that creditors finance. If it’s below 50 then you are mostly financed by equity.
Times Interest Earned
indicates how many times the company’s interest expense was covered by its operating results.
