Yes, you can use coupons on sales/GC deals (duh, what would be the point otherwise?). Yes, you can use previously earned/purchased GC's to pay for a transaction in which you will earn more GC's. You just can't use the GC you got from the Kashi deal to pay for the Kashi deal.
Your cashier was misinformed. Fortunately, it sounds like the CS desk at your store was on top of things
Better luck next time.