Accounting Principles Thirteenth Edition PDF

Accounting Principles Thirteenth Edition JERRY J. WEYGANDT PhD, CPA University of Wisconsin—Madison Madison, Wisconsin PAUL D. KIMMEL PhD, CPA University of Wisconsin—Milwaukee...

Accounting Principles Thirteenth Edition JERRY J. WEYGANDT PhD, CPA University of Wisconsin—Madison Madison, Wisconsin PAUL D. KIMMEL PhD, CPA University of Wisconsin—Milwaukee Milwaukee, Wisconsin DONALD E. KIES O PhD, CPA Northern Illinois University DeKalb, Illinois  DEDICATED TO Our wives, Enid, Merlynn, and Donna, for their love, support, and encouragement. DIRECTOR Michael McDonald ACQUISITIONS EDITOR Lauren Harrell Krassow LEAD PRODUCT DESIGNER Ed Brislin PRODUCT DESIGNER Matt Origoni MARKETING MANAGER Carolyn Wells EDITORIAL SUPERVISOR Terry Ann Tatro EDITORIAL ASSOCIATE Margaret Thompson MARKETING ASSISTANT Ashley Migliaro EDITORIAL ASSISTANT Alyce Pellegrino SENIOR CONTENT MANAGER Dorothy Sinclair SENIOR PRODUCTION EDITOR Elena Saccaro SENIOR DESIGNER Wendy Lai SENIOR PHOTO EDITOR Mary Ann Price COVER IMAGE Kurt Heim/Stocksy This book was set in Stix Regular by Aptara®, Inc. and printed and bound by Quad Graphics/Versailles. 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Printed in America. 10 9 8 7 6 5 4 3 2 1  Brief Contents 1 Accounting in Action 1-1 2 The Recording Process 2-1 3 Adjusting the Accounts 3-1 4 Completing the Accounting Cycle 4-1 5 Accounting for Merchandising Operations 5-1 5A Accounting for Merchandising Operations (periodic approach)* 6 Inventories 6-1 6A Inventories (perpetual approach)* 7 Accounting Information Systems 7-1 8 Fraud, Internal Control, and Cash 8-1 9 Accounting for Receivables 9-1 10 Plant Assets, Natural Resources, and Intangible Assets 10-1 11 Current Liabilities and Payroll Accounting 11-1 12 Accounting for Partnerships 12-1 13 Corporations: Organization and Capital Stock Transactions 13-1 14 Corporations: Dividends, Retained Earnings, and Income Reporting 14-1 15 Long-Term Liabilities 15-1 16 Investments 16-1 17 Statement of Cash Flows 17-1 18 Financial Analysis: The Big Picture 18-1 19 Managerial Accounting 19-1 20 Job Order Costing 20-1 20A Job Order Costing (non-debit and credit approach)* 21 Process Costing 21-1 21A Process Costing (non-debit and credit approach)* iii iv Brief Contents 22 Cost-Volume-Profit 22-1 23 Incremental Analysis 23-1 24 Budgetary Planning 24-1 25 Budgetary Control and Responsibility Accounting 25-1 26 Standard Costs and Balanced Scorecard 26-1 27 Planning for Capital Investments 27-1 A P P EN D IC E S A Specimen Financial Statements: Apple Inc. A-1 B Specimen Financial Statements: PepsiCo, Inc. B-1 C Specimen Financial Statements: The Coca-Cola Company C-1 D Specimen Financial Statements: Amazon.com, Inc. D-1 E Specimen Financial Statements: Wal-Mart Stores, Inc. E-1 F Specimen Financial Statements: Louis Vuitton F-1 G Time Value of Money G-1 H Just-in-Time Processing and Activity-Based Costing H-1 C A S ES FOR M A NAG E RIA L DE CIS IO N M A K ING* CO MPA N Y INDE X / S U BJE CT INDE X I-1 * Available in WileyPLUS and Wiley Custom.  From the Authors Dear Student, WHY THIS TEXT? Your instructor has chosen this text for you because of the authors’ trusted reputation. The authors have W H Y T H I S C O U R S E? Remember your biology worked hard to write a text that is engaging, timely, and accurate. course in high school? Did you have one of those “invis- ible man” models (or maybe something more high-tech HOW TO SUCCEED? We’ve asked many students and many than that) that gave you the opportunity to look “inside” instructors whether there is a secret for success in this course. the human body? This accounting course offers something The nearly unanimous answer turns out to be not much of a similar. To understand a secret: “Do the homework.” This is one business, you have to under- course where doing is learning. The “Whether you are looking at a large multina- stand the financial insides of more time you spend on the homework tional company like Apple or Starbucks or a business organization. An assignments—using the various tools a single-owner software consulting business that this text provides—the more likely accounting course will help or coffee shop, knowing the fundamentals of you are to learn the essential concepts, you understand the essen- accounting will help you understand what is techniques, and methods of accounting. tial financial components of happening.” Besides the text itself, WileyPLUS also businesses. Whether you are looking at a large multina- offers various support resources. tional company like Apple or Starbucks or a single-owner Good luck in this course. We hope you enjoy the experience software consulting business or coffee shop, knowing the and that you put to good use throughout a lifetime of success fundamentals of accounting will help you understand what the knowledge you obtain in this course. We are sure you will is happening. As an employee, a manager, an investor, a not be disappointed. business owner, or a director of your own personal finances— any of which roles you will have at some point in your Jerry J. Weygandt life—you will make better decisions for having taken this Paul D. Kimmel course. Donald E. Kieso v Author Commitment Jerry Weygandt Paul Kimmel Don Kieso J ER RY J. W EYGA N D T , P h D, PAU L D. K I M M E L , PhD, CPA, DONALD E. KIESO, PhD, CPA, C PA , is Arthur Andersen Alumni Emeritus received his bachelor’s degree from the Uni- received his bachelor’s degree from Aurora Uni- Professor of Accounting at the University of versity of Minnesota and his doctorate in ac- versity and his doctorate in accounting from the Wisconsin—Madison. He holds a Ph.D. in counting from the University of Wisconsin. University of Illinois. He has served as chairman accounting from the University of Illinois. He teaches at the University of Wisconsin— of the Department of Accountancy and is currently Articles by Professor Weygandt have appeared Milwaukee, and has public accounting expe- the KPMG Emeritus Professor of Accountancy in The Accounting Review, Journal of Account- rience with Deloitte & Touche (Minneapolis). at Northern Illinois University. He has public ing Research, Accounting Horizons, Journal of He was the recipient of the UWM School of accounting experience with Price Waterhouse Accountancy, and other academic and profes- Business Advisory Council Teaching Award, & Co. (San Francisco and Chicago) and Arthur sional journals. These articles have examined the Reggie Taite Excellence in Teaching Award Andersen & Co. (Chicago) and research experi- such financial reporting issues as accounting for and a three-time winner of the Outstanding ence with the Research Division of the American price-level adjustments, pensions, convertible Teaching Assistant Award at the University of Institute of Certified Public Accountants (New securities, stock option contracts, and interim Wisconsin. He is also a recipient of the Elijah York). He has done post doctorate work as a reports. Professor Weygandt is author of other Watts Sells Award for Honorary Distinction for Visiting Scholar at the University of California accounting and financial reporting books and his results on the CPA exam. He is a member of at Berkeley and is a recipient of NIU’s Teach- is a member of the American Accounting the American Accounting Association and the ing Excellence Award and four Golden Apple Association, the American Institute of Cer- Institute of Management Accountants and has Teaching Awards. Professor Kieso is the author tified Public Accountants, and the Wiscon- published articles in The Accounting Review, of other accounting and business books and is a sin Society of Certified Public Accountants. Accounting Horizons, Advances in Manage- member of the American Accounting Associa- He has served on numerous committees of ment Accounting, Managerial Finance, Issues tion, the American Institute of Certified Public the American Accounting Association and in Accounting Education, Journal of Account- Accountants, and the Illinois CPA Society. as a member of the editorial board of The ing Education, as well as other journals. His He has served as a member of the Board of Accounting Review; he also has served as Pres- research interests include accounting for finan- Directors of the Illinois CPA Society, then ident and Secretary-Treasurer of the American cial instruments and innovation in accounting AACSB’s Accounting Accreditation Commit- Accounting Association. In addition, he has education. He has published papers and given tees, the State of Illinois Comptroller’s Commis- been actively involved with the American numerous talks on incorporating critical think- sion, as Secretary-Treasurer of the Federation Institute of Certified Public Accountants and ing into accounting education, and helped pre- of Schools of Accountancy, and as Secretary- has been a member of the Accounting Standards pare a catalog of critical thinking resources for Treasurer of the American Accounting Associa- Executive Committee (AcSEC) of that organ- the Federated Schools of Accountancy. tion. Professor Kieso is currently serving on the ization. He has served on the FASB task force Board of Trustees and Executive Committee of that examined the reporting issues related to Aurora University, as a member of the Board of accounting for income taxes and served as a trus- Directors of Kishwaukee Community Hospital, tee of the Financial Accounting Foundation. Pro- and as Treasurer and Director of Valley West fessor Weygandt has received the Chancellor’s Community Hospital. From 1989 to 1993 he Award for Excellence in Teaching and the Beta served as a charter member of the national Ac- Gamma Sigma Dean’s Teaching Award. He is on counting Education Change Commission. He the board of directors of M & I Bank of Southern is the recipient of the Outstanding Accounting Wisconsin. He is the recipient of the Wisconsin Educator Award from the Illinois CPA Society, Institute of CPA’s Outstanding Educator’s Award the FSA’s Joseph A. Silvoso Award of Merit, and the Lifetime Achievement Award. In 2001 the NIU Foundation’s Humanitarian Award for he received the American Accounting Associa- Service to Higher Education, a Distinguished tion’s Outstanding Educator Award. Service Award from the Illinois CPA Society, and in 2003 an honorary doctorate from Aurora vi University.  Hallmark Features Accounting Principles, Thirteenth Edition, provides a simple and practical introduction to the fundamentals of accounting. It explains the concepts you need to know. This edition continues this approach by offering even more explanations, illustrations, and homework problems to help students get a firm understanding of the accounting cycle. DO IT! Exercises DO IT! Exercises in the body of the text prompt students to stop and review key concepts. They outline the Action Plan necessary to complete the exercise as well as show a detailed solution. c04CompletingTheAccountingCycle.indd Page 4-34 18/08/17 3:54 PM f-0162 /208/WB02197/9781119411017/ch04/text_s DO IT! 3 Correcting Entries ACTION PLAN Compare the incorrect Sanchez Company discovered the following errors made in January 2020. entry with correct entry. 1. A payment of Salaries and Wages Expense of $600 was debited to Supplies and credited to Cash, After comparison, make both for $600. an entry to correct the 2. A collection of $3,000 from a client on account was debited to Cash $200 and credited to Service accounts. Revenue $200. 3. The purchase of supplies on account for $860 was debited to Supplies $680 and credited to Ac- counts Payable $680. Correct the errors without reversing the incorrect entry. Solution c15LongTermLiabilities.indd 1. Salaries and WagesPage 15-26 10/9/17 11:15 PM user Expense 600 /208/WB02197/9781119411017/ch15/text_s Supplies 600 2. Service Revenue 200 Cash 2,800 Accounts Receivable 3,000 Review and Practice Each chapter concludes with a Review and Practice section which includes a review of learn- ing objectives, key terms glossary, practice multiple-choice questions with annotated solu- tions, practice brief exercises with solutions, practice exercises with solutions, and a practice problem with a solution. Practice Brief Exercises Prepare the current assets section of a 3. (LO 4) Financial Statement The balance sheet debit column of the worksheet for Miguel balance sheet. Company includes the following accounts: Accounts Receivable $25,000, Prepaid Insurance $7,000, Cash $8,000, Supplies $11,000, and Stock Investments (short-term) $14,000. Prepare the current assets section of the balance sheet, listing the accounts in proper sequence. Solution 3. Miguel Company Partial Balance Sheet Current assets Cash $ 8,000 Stock investments 14,000 Accounts receivable 25,000 Supplies 11,000 Prepaid insurance 7,000 Total current assets $65,000 vii  c02TheRecordingProcess.indd Page 2-3 27/09/17 9:42 PM f-0162 /208/WB02197/9781119411017/ch02/text_s viii Hallmark Features Infographic Learning c04CompletingTheAccountingCycle.indd Page 4-26 18/08/17 3:54 PM f-0162 /208/WB02197/9781119411017/ch04/text_s Over half of the text is visual, providing students alternative ways of learning about accounting. In addition, a new interior design promotes accessibility. ILLUSTRATION 2.1 Title of Account Basic form of account Left or debit side Right or credit side c04CompletingTheAccountingCycle.indd Page 4-19 18/08/17 3:54 PM f-0162 /208/WB02197/9781119411017/ch04/text_s Real-World Decision-Making Real-world examples that illustrate interesting situations in companies and how accounting information is used are integrated throughout the text, such as in the opening Feature Story as well as the Insight boxes. People, Planet, and Profit Insight Regaining Goodwill with the five corporations that ranked highest within each, are as follows. After falling to unforeseen lows Social Responsibility: (1) Whole Foods Market, (2) Johnson & amidst scandals, recalls, and eco- Johnson, (3) Google, (4) The Walt Disney Company, (5) Procter nomic crises, the American pub- & Gamble Co. lic’s positive perception of the reputation of corporate America Emotional Appeal: (1) Johnson & Johnson, (2) Amazon.com, is on the rise. Overall corporate (3) UPS, (4) General Mills, (5) Kraft Foods reputation is experiencing reha- Financial Performance: (1) Google, (2) Berkshire Hathaway, bilitation as the American public (3) Apple, (4) Intel, (5) The Walt Disney Company gives high marks overall to cor- Products and Services: (1) Intel Corporation, (2) 3M Company, porate America, specific indus- (3) Johnson & Johnson, (4) Google, (5) Procter & Gamble Co. tries, and the largest number of individual companies in a dozen Source: www.harrisinteractive.com. © Gehringi/iStockphoto years. This is according to the findings of a Harris Interactive RQ Study, which measures the reputations of the 60 most visible Name two industries today which are probably rated low on companies in the United States. the reputational characteristics of “being trusted” and “having The survey focuses on six reputational dimensions that influence high ethical standards.” (Go to WileyPLUS for this answer and reputation and consumer behavior. Four of these dimensions, along additional questions.) Additional Guidance Throughout the text, marginal notes, such as Helpful Hints, Alternative Terminology, and Ethics Notes, are provided as additional guidance. In addition, more than 100 new solution walkthrough videos are now available in WileyPLUS. Correcting Entries—An Avoidable Step ETHICS NOTE Unfortunately, errors may occur in the recording process. Companies should correct errors, as When companies find errors soon as they discover them, by journalizing and posting correcting entries. If the account- in previously released ing records are free of errors, no correcting entries are needed. income statements, they You should recognize several differences between correcting entries and adjusting en- restate those numbers. Per- tries. First, adjusting entries are an integral part of the accounting cycle. Correcting entries, haps because of the in- on the other hand, are unnecessary if the records are error-free. Second, companies journalize creased scrutiny caused by and post adjustments only at the end of an accounting period. In contrast, companies make Sarbanes-Oxley, in a recent correcting entries whenever they discover an error (see Ethics Note). Finally, adjusting year companies filed a re- entries always affect at least one balance sheet account and one income statement account. In cord 1,195 restatements  Contents Summary Illustration of Journalizing and Posting 2-19 1 Accounting in Action 1-1 The Trial Balance 2-21 Limitations of a Trial Balance 2-22 Knowing the Numbers: Columbia Sportswear 1-1 Locating Errors 2-22 Accounting Activities and Users 1-3 Dollar Signs and Underlining 2-22 Three Activities 1-3 A Look at IFRS 2-46 Who Uses Accounting Data 1-4 The Building Blocks of Accounting 1-6 Ethics in Financial Reporting 1-6 Generally Accepted Accounting Principles 1-8 3 Adjusting the Accounts 3-1 Measurement Principles 1-8 Assumptions 1-9 Keeping Track of Groupons: Groupon 3-1 The Accounting Equation 1-11 Accrual-Basis Accounting and Adjusting Entries 3-2 Assets 1-11 Fiscal and Calendar Years 3-3 Liabilities 1-11 Accrual- versus Cash-Basis Accounting 3-3 Owner’s Equity 1-12 Recognizing Revenues and Expenses 3-3 Analyzing Business Transactions 1-13 The Need for Adjusting Entries 3-5 Accounting Transactions 1-14 Types of Adjusting Entries 3-5 Transaction Analysis 1-14 Adjusting Entries for Deferrals 3-6 Summary of Transactions 1-19 Prepaid Expenses 3-6 The Four Financial Statements 1-20 Unearned Revenues 3-10 Income Statement 1-20 Adjusting Entries for Accruals 3-13 Owner’s Equity Statement 1-22 Accrued Revenues 3-13 Balance Sheet 1-22 Accrued Expenses 3-14 Statement of Cash Flows 1-23 Summary of Basic Relationships 3-17 Appendix 1A: Career Opportunities in Accounting 1-24 Adjusted Trial Balance and Financial Statements 3-20 Public Accounting 1-24 Preparing the Adjusted Trial Balance 3-21 Private Accounting 1-25 Preparing Financial Statements 3-21 Governmental Accounting 1-25 Appendix 3A: Alternative Treatment of Deferrals 3-24 Forensic Accounting 1-25 Prepaid Expenses 3-25 “Show Me the Money” 1-25 Unearned Revenues 3-26 A Look at IFRS 1-47 Summary of Additional Adjustment Relationships 3-27 Appendix 3B: Financial Reporting Concepts 3-28 Qualities of Useful Information 3-28 Assumptions in Financial Reporting 3-28 2 The Recording Process 2-1 Principles in Financial Reporting 3-29 Accidents Happen: MF Global Holdings 2-1 Cost Constraint 3-30 Accounts, Debits, and Credits 2-2 A Look at IFRS 3-58 The Account 2-2 Debits and Credits 2-3 Summary of Debit/Credit Rules 2-6 4 Completing the Accounting The Journal 2-7 Cycle 4-1 The Recording Process 2-7 The Journal 2-8 Everyone Likes to Win: Rhino Foods 4-1 The Ledger and Posting 2-10 The Worksheet 4-2 The Ledger 2-10 Steps in Preparing a Worksheet 4-3 Posting 2-12 Preparing Financial Statements from a Worksheet 4-10 Chart of Accounts 2-13 Preparing Adjusting Entries from a Worksheet 4-11 The Recording Process Illustrated 2-13 Closing the Books 4-11 ix x Contents Preparing Closing Entries 4-12 Recording Purchases of Merchandise 5-26 Posting Closing Entries 4-14 Recording Sales of Merchandise 5-27 Preparing a Post-Closing Trial Balance 4-16 Journalizing and Posting Closing Entries 5-28 The Accounting Cycle and Correcting Entries 4-19 Using a Worksheet 5-29 Summary of the Accounting Cycle 4-19 A Look at IFRS 5-54 Reversing Entries—An Optional Step 4-19 Correcting Entries—An Avoidable Step 4-19 Classified Balance Sheet 4-23 6 Inventories 6-1 Current Assets 4-24 Long-Term Investments 4-25 “Where Is That Spare Bulldozer Blade?”: Property, Plant, and Equipment 4-25 Caterpillar 6-1 Intangible Assets 4-25 Classifying and Determining Inventory 6-2 Current Liabilities 4-26 Classifying Inventory 6-3 Long-Term Liabilities 4-27 Determining Inventory Quantities 6-4 Owner’s Equity 4-28 Inventory Methods and Financial Effects 6-7 Appendix 4A: Reversing Entries 4-29 Specific Identification 6-7 Reversing Entries Example 4-29 Cost Flow Assumptions 6-8 A Look at IFRS 4-59 Financial Statement and Tax Effects of Cost Flow Methods 6-12 Using Inventory Cost Flow Methods Consistently 6-14 5 Accounting for Merchandising Effects of Inventory Errors 6-15 Income Statement Effects 6-15 Operations 5-1 Balance Sheet Effects 6-16 Inventory Statement Presentation and Analysis 6-17 Buy Now, Vote Later: REI 5-1 Presentation 6-17 Merchandising Operations and Inventory Systems 5-3 Lower-of-Cost-or-Net Realizable Value 6-17 Operating Cycles 5-3 Analysis 6-18 Flow of Costs 5-4 Appendix 6A: Inventory Methods and the Perpetual Recording Purchases under a Perpetual System 5-6 System 6-20 Freight Costs 5-8 First-In, First-Out (FIFO) 6-20 Purchase Returns and Allowances 5-9 Last-In, First-Out (LIFO) 6-21 Purchase Discounts 5-9 Average-Cost 6-22 Summary of Purchasing Transactions 5-10 Appendix 6B: Estimating Inventories 6-22 Recording Sales Under a Perpetual System 5-11 Gross Profit Method 6-23 Sales Returns and Allowances 5-12 Retail Inventory Method 6-24 Sales Discounts 5-13 A Look at IFRS 6-48 The Accounting Cycle for a Merchandising Company 5-15 Adjusting Entries 5-15 Closing Entries 5-15 7 Accounting Information Summary of Merchandising Entries 5-16 Systems 7-1 Multiple-Step and Comprehensive Income Statements 5-17 QuickBooks® Helps This Retailer Sell Guitars: Intuit 7-1 Multiple-Step Income Statement 5-18 Overview of Accounting Information Systems 7-2 Single-Step Income Statement 5-20 Computerized Accounting Systems 7-3 Comprehensive Income Statement 5-21 Manual Accounting Systems 7-5 Classified Balance Sheet 5-21 Subsidiary Ledgers 7-5 Appendix 5A: Worksheet for a Merchandising Subsidiary Ledger Example 7-6 Company 5-23 Advantages of Subsidiary Ledgers 7-7 Using a Worksheet 5-23 Special Journals 7-8 Appendix 5B: Periodic Inventory System 5-24 Sales Journal 7-9 Determining Cost of Goods Sold Under a Periodic Cash Receipts Journal 7-11 System 5-25 Purchases Journal 7-15 Recording Merchandise Transactions 5-25 Cash Payments Journal 7-17  Contents xi Effects of Special Journals on the General Journal 7-20 10 Plant Assets, Natural Resources, Cyber Security: A Final Comment 7-21 and Intangible Assets 10-1 A Look at IFRS 7-44 How Much for a Ride to the Beach?: Rent-A-Wreck 10-1 Plant Asset Expenditures 10-2 Determining the Cost of Plant Assets 10-3 8 Fraud, Internal Control, Expenditures During Useful Life 10-5 and Cash 8-1 Depreciation Methods 10-7 Factors in Computing Depreciation 10-7 Minding the Money in Madison: Barriques 8-1 Depreciation Methods 10-8 Fraud and Internal Control 8-3 Depreciation and Income Taxes 10-13 Fraud 8-3 Revising Periodic Depreciation 10-13 The Sarbanes-Oxley Act 8-3 Impairments 10-13 Internal Control 8-4 Plant Asset Disposals 10-14 Principles of Internal Control Activities 8-4 Retirement of Plant Assets 10-15 Limitations of Internal Control 8-10 Sale of Plant Assets 10-15 Cash Controls 8-11 Natural Resources and Intangible Assets 10-17 Cash Receipts Controls 8-12 Natural Resources 10-17 Cash Disbursements Controls 8-14 Depletion 10-17 Petty Cash Fund 8-16 Intangible Assets 10-18 Control Features of a Bank Account 8-19 Accounting for Intangible Assets 10-18 Making Bank Deposits 8-19 Research and Development Costs 10-21 Writing Checks 8-20 Statement Presentation and Analysis 10-21 Electronic Funds Transfer (EFT) System 8-21 Presentation 10-21 Bank Statements 8-21 Analysis 10-22 Reconciling the Bank Account 8-22 Appendix 10A: Exchange of Plant Assets 10-23 Reporting Cash 8-27 Loss Treatment 10-24 Cash Equivalents 8-27 Gain Treatment 10-24 Restricted Cash 8-27 A Look at IFRS 10-46 A Look at IFRS 8-48 11 Current Liabilities and Payroll 9 Accounting for Receivables 9-1 Accounting 11-1 A Dose of Careful Management Keeps Receivables Healthy: Financing His Dreams: Wilbert Murdock 11-1 Whitehall-Robins 9-1 Accounting for Current Liabilities 11-2 Recognition of Accounts Receivable 9-2 What Is a Current Liability? 11-2 Types of Receivables 9-3 Notes Payable 11-3 Recognizing Accounts Receivable 9-3 Sales Taxes Payable 11-4 Valuation and Disposition of Accounts Receivable 9-5 Unearned Revenues 11-4 Valuing Accounts Receivable 9-5 Current Maturities of Long-Term Debt 11-5 Disposing of Accounts Receivable 9-11 Reporting and Analyzing Current Liabilities 11-6 Notes Receivable 9-13 Reporting Uncertainty 11-6 Determining the Maturity Date 9-14 Reporting of Current Liabilities 11-7 Computing Interest 9-15 Analysis of Current Liabilities 11-8 Recognizing Notes Receivable 9-15 Accounting for Payroll 11-9 Valuing Notes Receivable 9-16 Determining the Payroll 11-10 Disposing of Notes Receivable 9-16 Recording the Payroll 11-13 Presentation and Analysis 9-18 Employer Payroll Taxes 11-16 Presentation 9-19 Filing and Remitting Payroll Taxes 11-18 Analysis 9-20 Internal Control for Payroll 11-19 A Look at IFRS 9-41 Appendix 11A: Additional Fringe Benefits 11-20 xii Contents Paid Absences 11-21 Dividend Preferences 14-4 Postretirement Benefits 11-21 Stock Dividends 14-7 A Look at IFRS 11-41 Stock Splits 14-9 Reporting and Analyzing Stockholders’ Equity 14-11 Retained Earnings 14-11 12 Accounting for Partnerships 12-1 Statement Presentation and Analysis 14-13 Corporate Income Statements 14-16 From Trials to the Top Ten: Razor & Tie 12-1 Income Statement Presentation 14-16 Forming a Partnership 12-2 Income Statement Analysis 14-16 Characteristics of Partnerships 12-3 Appendix 14A: Stockholders’ Equity Organizations with Partnership Characteristics 12-3 Statement 14-18 Advantages and Disadvantages of Partnerships 12-5 Appendix 14B: Book Value per Share 14-18 The Partnership Agreement 12-6 Book Value per Share 14-18 Accounting for a Partnership Formation 12-6 Book Value versus Market Price 14-20 Accounting for Net Income or Net Loss 12-8 A Look at IFRS 14-38 Dividing Net Income or Net Loss 12-8 Partnership Financial Statements 12-11 Liquidation of a Partnership 12-12 15 Long-Term Liabilities 15-1 No Capital Deficiency 12-13 Capital Deficiency 12-15 And Then There Were Two: Chrysler 15-1 Appendix 12A: Admissions and Withdrawals Major Characteristics of Bonds 15-2 of Partners 12-18 Types of Bonds 15-3 Admission of a Partner 12-18 Issuing Procedures 15-3 Withdrawal of a Partner 12-21 Bond Trading 15-4 Determining the Market Price of a Bond 15-5 Accounting for Bond Transactions 15-6 13 Corporations: Organization and Issuing Bonds at Face Value 15-7 Capital Stock Transactions Discount or Premium on Bonds 15-7 13-1 Issuing Bonds at a Discount 15-8 Oh Well, I Guess I’ll Get Rich: Facebook 13-1 Issuing Bonds at a Premium 15-9 Corporate Form of Organization 13-2 Redeeming Bonds at Maturity 15-11 Characteristics of a Corporation 13-3 Redeeming Bonds before Maturity 15-11 Forming a Corporation 13-5 Accounting for Long-Term Notes Payable 15-12 Stockholder Rights 13-6 Reporting and Analyzing Long-Term Liabilities 15-14 Stock Issue Considerations 13-6 Presentation 15-14 Corporate Capital 13-9 Use of Ratios 15-14 Accounting for Stock Transactions 13-10 Debt and Equity Financing 15-15 Accounting for Common Stock 13-10 Lease Liabilities 15-16 Accounting for Preferred Stock 13-12 Appendix 15A: Straight-Line Amortization 15-17 Accounting for Treasury Stock 13-14 Amortizing Bond Discount 15-17 Statement Presentation of Stockholders’ Amortizing Bond Premium 15-19 Equity 13-17 Appendix 15B: Effective-Interest Amortization 15-20 A Look at IFRS 13-36 Amortizing Bond Discount 15-20 Amortizing Bond Premium 15-22 A Look at IFRS 15-41 14 Corporations: Dividends, Retained Earnings, and Income 16 Investments 16-1 Reporting 14-1 “Is There Anything Else We Can Buy?”: Owning a Piece of the Action: Van Meter Inc. 14-1 Time Warner 16-1 Accounting for Dividends and Stock Splits 14-2 Accounting for Debt Investments 16-2 Cash Dividends 14-3 Why Corporations Invest 16-2  Contents xiii Accounting for Debt Investments 16-4 Quality of Earnings 18-7 Accounting for Stock Investments 16-6 Horizontal Analysis and Vertical Analysis 18-9 Holdings of Less than 20% 16-6 Horizontal Analysis 18-10 Holdings Between 20% and 50% 16-7 Vertical Analysis 18-12 Holdings of More than 50% 16-8 Ratio Analysis 18-14 Reporting Investments in Financial Statements 16-10 Liquidity Ratios 18-15 Debt Securities 16-11 Solvency Ratios 18-16 Equity Securities 16-14 Profitability Ratios 18-16 Balance Sheet Presentation 16-15 Comprehensive Example of Ratio Analysis 18-17 Presentation of Realized and Unrealized A Look at IFRS 18-51 Gain or Loss 16-16 A Look at IFRS 16-35 19 Managerial Accounting 19-1 Just Add Water... and Paddle: Current Designs 19-1 17 Statement of Cash Flows 17-1 Managerial Accounting Basics 19-3 Comparing Managerial and Financial Accounting 19-3 Got Cash?: Microsoft 17-1 Management Functions 19-3 Usefulness and Format of the Statement of Organizational Structure 19-5 Cash Flows 17-3 Managerial Cost Concepts 19-7 Usefulness of the Statement of Cash Flows 17-3 Manufacturing Costs 19-7 Classification of Cash Flows 17-3 Product Versus Period Costs 19-8 Significant Noncash Activities 17-4 Illustration of Cost Concepts 19-9 Format of the Statement of Cash Flows 17-5 Manufacturing Costs in Financial Statements 19-10 Preparing the Statement of Cash Flows— Income Statement 19-11 Indirect Method 17-6 Indirect and Direct Methods 17-7 Cost of Goods Manufactured 19-11 Indirect Method—Computer Services Cost of Goods Manufactured Schedule 19-12 Company 17-7 Balance Sheet 19-13 Step 1: Operating Activities 17-9 Managerial Accounting Today 19-14 Summary of Conversion to Net Cash Provided Service Industries 19-14 by Operating Activities—Indirect Focus on the Value Chain 19-15 Method 17-12 Balanced Scorecard 19-17 Step 2: Investing and Financing Activities 17-13 Business Ethics 19-17 Step 3: Net Change in Cash 17-14 Corporate Social Responsibility 19-18 Analyzing the Statement of Cash Flows 17-17 Free Cash Flow 17-17 20 Job Order Costing 20-1 Appendix 17A: Statement of Cash Flows—Direct Method 17-19 Profiting from the Silver Screen: Disney 20-1 Step 1: Operating Activities 17-19 Cost Accounting Systems 20-3 Step 2: Investing and Financing Activities 17-24 Process Cost System 20-3 Step 3: Net Change in Cash 17-26 Job Order Cost System 20-3 Appendix 17B: Worksheet for the Indirect Method 17-26 Job Order Cost Flow 20-4 Preparing the Worksheet 17-27 Accumulating Manufacturing Costs 20-5 Appendix 17C: Statement of Cash Flows—T-Account Assigning Manufacturing Costs 20-7 Approach 17-31 Raw Materials Costs 20-8 A Look at IFRS 17-58 Factory Labor Costs 20-10 Predetermined Overhead Rates 20-12 Entries for Jobs Completed and Sold 20-15 18 Financial Analysis: The Big Assigning Costs to Finished Goods 20-15 Picture 18-1 Assigning Costs to Cost of Goods Sold 20-16 Summary of Job Order Cost Flows 20-17 It Pays to Be Patient: Warren Buffett 18-2 Job Order Costing for Service Companies 20-18 Sustainable Income and Quality of Earnings 18-3 Advantages and Disadvantages of Job Sustainable Income 18-3 Order Costing 20-19 xiv Contents Applied Manufacturing Overhead 20-20 Target Net Income 22-18 Under- or Overapplied Manufacturing Margin of Safety 22-20 Overhead 20-21 Appendix 22A: Regression Analysis 22-21 21 Process Costing 21-1 23 Incremental Analysis 23-1 The Little Guy Who Could: Jones Soda 21-1 Keeping It Clean: Method Products 23-1 Overview of Process Cost Systems 21-3 Decision-Making and Incremental Uses of Process Cost Systems 21-3 Analysis 23-3 Process Costing for Service Companies 21-4 Incremental Analysis Approach 23-3 Similarities and Differences Between Job Order Cost How Incremental Analysis Works 23-4 and Process Cost Systems 21-4 Qualitative Factors 23-5 Process Cost Flow and Assigning Costs 21-6 Relationship of Incremental Analysis Process Cost Flow 21-6 and Activity-Based Costing 23-5 Assigning Manufacturing Costs—Journal Entries 21-6 Types of Incremental Analysis 23-6 Equivalent Units 21-9 Special Orders 23-6 Weighted-Average Method 21-9 Make or Buy 23-8 Refinements on the Weighted-Average Method 21-10 Opportunity Cost 23-9 The Production Cost Report 21-12 Sell or Process Further 23-10 Compute the Physical Unit Flow (Step 1) 21-13 Single-Product Case 23-11 Compute the Equivalent Units of Multiple-Product Case 23-11 Production (Step 2) 21-13 Repair, Retain, or Replace Equipment 23-14 Compute Unit Production Costs (Step 3) 21-14 Eliminate Unprofitable Segment or Prepare a Cost Reconciliation Schedule Product 23-15 (Step 4) 21-15 Preparing the Production Cost Report 21-15 Costing Systems—Final Comments 21-16 24 Budgetary Planning 24-1 Appendix 21A: FIFO Method for Equivalent What’s in Your Cupcake?: BabyCakes NYC 24-1 Units 21-17 Effective Budgeting and the Master Equivalent Units Under FIFO 21-17 Budget 24-3 Comprehensive Example 21-18 Budgeting and Accounting 24-3 FIFO and Weighted-Average 21-22 The Benefits of Budgeting 24-3 Essentials of Effective Budgeting 24-3 22 Cost-Volume-Profit 22-1 The Master Budget 24-6 Sales, Production, and Direct Materials Don’t Worry—Just Get Big: Amazon.com 22-1 Budgets 24-8 Cost Behavior Analysis 22-2 Sales Budget 24-8 Variable Costs 22-3 Production Budget 24-9 Fixed Costs 22-3 Direct Materials Budget 9-10 Relevant Range 22-5 Direct Labor, Manufacturing Overhead, and S&A Mixed Costs 22-6 Expense Budgets 24-13 Mixed Costs Analysis 22-7 Direct Labor Budget 24-13 High-Low Method 22-7 Manufacturing Overhead Budget 24-14 Importance of Identifying Variable and Selling and Administrative Expense Budget 24-15 Fixed Costs 22-9 Budgeted Income Statement 24-15 Cost-Volume-Profit Analysis 22-10 Cash Budget and Budgeted Balance Sheet 24-17 Basic Components 22-10 Cash Budget 24-17 CVP Income Statement 22-11 Budgeted Balance Sheet 24-20 Break-Even Analysis 22-14 Budgeting in Nonmanufacturing Mathematical Equation 22-15 Companies 24-22 Contribution Margin Technique 22-15 Merchandisers 24-22 Graphic Presentation 22-16 Service Companies 24-23 Target Net Income and Margin of Safety 22-18 Not-for-Profit Organizations 24-24  Contents xv Journal Entries 26-20 25 Budgetary Control and Ledger Accounts 26-22 Responsibility Accounting 25-1 Appendix 26B: Overhead Controllable and Volume Variances 26-23 Pumpkin Madeleines and a Movie: Tribeca Grand Overhead Controllable Variance 26-23 Hotel 25-1 Overhead Volume Variance 26-24 Budgetary Control and Static Budget Reports 25-3 Budgetary Control 25-3 Static Budget Reports 25-4 27 Planning for Capital Flexible Budget Reports 25-6 Investments 27-1 Why Flexible Budgets? 25-7 Developing the Flexible Budget 25-9 Floating Hotels: Holland America Line 27-2 Flexible Budget—A Case Study 25-9 Capital Budgeting and Cash Payback 27-3 Flexible Budget Reports 25-11 Cash Flow Information 27-3 Responsibility Accounting and Responsibility Illustrative Data 27-4 Centers 25-13 Cash Payback 27-4 Controllable versus Noncontrollable Revenues Net Present Value Method 27-6 and Costs 25-15 Equal Annual Cash Flows 27-7 Principles of Performance Evaluation 25-15 Unequal Annual Cash Flows 27-8 Responsibility Reporting System 25-17 Choosing a Discount Rate 27-9 Types of Responsibility Centers 25-18 Simplifying Assumptions 27-9 Investment Centers 25-22 Comprehensive Example 27-10 Return on Investment (ROI) 25-23 Capital Budgeting Challenges and Responsibility Report 25-23 Refinements 27-11 Judgmental Factors in ROI 25-24 Intangible Benefits 27-11 Improving ROI 25-24 Profitability Index for Mutually Exclusive Appendix 25A: ROI vs. Residual Income 25-26 Projects 27-13 Residual Income Compared to ROI 25-27 Risk Analysis 27-14 Residual Income Weakness 25-27 Post-Audit of Investment Projects 27-15 Internal Rate of Return 27-16 Comparing Discounted Cash Flow Methods 27-17 26 Standard Costs and Balanced Annual Rate of Return 27-18 Scorecard 26-1 80,000 Different Caffeinated Combinations: Starbucks 26-2 Appendix A Specimen Financial Overview of Standard Costs 26-3 Distinguishing Between Standards Statements: and Budgets 26-4 Apple Inc. A-1 Setting Standard Costs 26-4 Direct Materials Variances 26-7 Analyzing and Reporting Variances 26-7 Calculating Direct Materials Variances 26-9 Appendix B Specimen Financial Direct Labor and Manufacturing Overhead Statements: Variances 26-11 Direct Labor Variances 26-11 PepsiCo, Inc. B-1 Manufacturing Overhead Variances 26-14 Variance Reports and Balanced Scorecards 26-16 Reporting Variances 26-16 Income Statement Presentation of Variances 26-16 Appendix C Specimen Financial Balanced Scorecard 26-17 Statements: The Coca- Appendix 26A: Standard Cost Accounting Cola Company C-1 System 26-20 xvi Contents Using Financial Calculators G-15 Appendix D Specimen Financial Present Value of a Single Sum G-16 Statements: Present Value of an Annuity G-17 Amazon.com, Inc. D-1 Future Value of a Single Sum G-17 Future Value of an Annuity G-17 Internal Rate of Return G-18 Useful Applications of the Financial Calculator G-18 Appendix E Specimen Financial Statements: Wal-Mart Appendix H Just-in-Time Processing Stores, Inc. E-1 and Activity-Based Costing H-1 Appendix F Specimen Financial Just-in-Time Processing and Activity-Based Costing H-1 Statements: Louis Just-in-Time Processing H-1 Vuitton F-1 Activity-Based Costing H-3 Applying Activity-Based Costing H-4 Identify and Classify Activities and Assign Overhead to Cost Pools (Step 1) H-5 Appendix G Time Value of Money G-1 Identify Cost Drivers (Step 2) H-5 Compute Activity-Based Overhead Rates (Step 3) H-6 Interest and Future Values G-1 Allocate Overhead Costs to Products (Step 4) H-6 Nature of Interest G-1 Comparing Unit Costs H-7 Future Value of a Single Amount G-3 Benefits of ABC H-8 Future Value of an Annuity G-5 Limitations of ABC H-8 Present Values G-7 Present Value Variables G-7 Cases for Managerial Decision-Making Present Value of a Single Amount G-7 (The full text of these cases is available in WileyPLUS.) Present Value of an Annuity G-9 Time Periods and Discounting G-11 Company Index I-1 Present Value of a Long-Term Note or Bond G-11 Subject Index I-4 Capital Budgeting Situations G-14  Acknowledgments Accounting Principles has benefited greatly from the input of focus group participants, manuscript reviewers, those who have sent comments by letter or e-mail, ancillary authors, and proofers. We greatly appreciate the constructive suggestions and innovative ideas of reviewers and the creativity and accuracy of the ancillary authors and checkers. Karen Andrews Cole Engel Yvonne Phang Lewis-Clark State College Fort Hays State University Borough of Manhattan Community College Sandra Bailey Larry Falcetto Brandis Phillips Oregon Institute of Technology Emporia State University North Carolina A&T State University Shele Bannon Gary Ford Mary Phillips Queensborough Community College Tompkins Cortland Community College North Carolina Central University Robert Barta Alan Foster Laura Prosser Suffolk County Community College J.S. Reynolds Community College Black Hills State University Ellen Bartley Dale Fowler La Vonda Ramey St. Joseph’s College Ohio Christian University Schoolcraft College LuAnn Bean George Gardner J. Ramos-Alexander Florida Institute of Technology Bemidji State University New Jersey City University Quent Below Willard Garman Michelle Randall Roane State Community College University of California, Los Angeles Schoolcraft College Lila Bergman Heidi Hansel Ruthie Reynolds Hunter College Kirkwood Community College Tennessee State University Jack Borke Coby Harmon Kathie Rogers University of Wisconsin—Platteville University of California—Santa Barbara Suffolk Community College Glen Brauchle Derek Jackson Kent Schneider Dowling College St. Mary’s University of Minnesota East Tennessee State University Douglas Brown Jospeh Jurkowski Nadia Schwartz Forsyth Technical Community College D’youville College Augustana College Ronald Campbell Randy Kidd Mehdi Sheikholeslami North Carolina A&T State University Metropolitan Community College Bemidji State University Elizabeth Capener Cindy Killian Alice Sineath Dominican University of California Wilkes Community College University of Maryland University College Beth Carraway Shirly Kleiner Bradley Smith Horry-Georgetown Technical College Johnson County Community College Des Moines Area Community College Jackie Caseu David Krug Emil Soriano Cape Fear Community College Johnson County Community College Contra Costa College Kim Charland Christy Land Teresa Speck Kansas State University Catawba Valley Community College St. Mary’s University of Minnesota Sandee Cohen Anita Leslie Lynn Stallworth Columbia College Chicago York Technical College Appalachian State University Suzanne Cory Lori Major John Stancil St. Mary’s University Luzerne County Community College Florida Southern College Paul Cox Charles Malone Linda Summey Medgar Evers College North Carolina A&T State University Central Carolina Community College Joseph Cunningham Ken Mark Joan Van Hise Harford Community College Kansas City Kansas Community College Fairfield University Kate Demarest Barbara Michal Dick Wasson Carroll Community College University of Rio Grande Southwestern College Richard Dugger Jill Misuraca Pat Wright Kilgore College University of Tampa Long Island University Bill Elliott Allison Moore Lori Grady Zaher Oral Roberts University Los Angeles Southwest College Bucks County Community College James Emig Barbara Muller Judith Zander Villanova University Arizona State University Grossmont College xvii xviii Acknowledgments We thank Benjamin Huegel and Teresa Speck of St. Mary’s editorial associate Margaret Thompson, product designer Matt Origoni, University for their extensive efforts in the preparation of the assistant project manager Cyndy Taylor, designer Wendy Lai, photo homework materials related to Current Designs. We also appreciate editor Mary Ann Price, indexer Steve Ingle, senior production editor the considerable support provided to us by the following people at Elena Saccaro, and Denise Showers at Aptara. All of these professionals Current Designs: Mike Cichanowski, Jim Brown, Diane Buswell, provided innumerable services that helped the text take shape. and Jake Greseth. We also benefited from the assistance and sugges- We will appreciate suggestions and comments from users— tions provided to us by Joan Van Hise in the preparation of materials instructors and students alike. You can send your thoughts and ideas related to sustainability. about the text to us via email at: [email protected]. We appreciate the exemplary support and commitment given to us by editor Lauren Harrell Krassow, marketing manager Carolyn Wells, Jerry J. Weygandt Paul D. Kimmel Donald E. Kieso lead product designer Ed Brislin, editorial supervisor Terry Ann Tatro, Madison, Wisconsin Milwaukee, Wisconsin DeKalb, Illinois  CHAPTER 1 © My Good Images/Shutterstock Accounting in Action The Chapter Preview describes the purpose of the chapter and highlights major topics. Chapter Preview The following Feature Story about Columbia Sportswear Company highlights the importance of having good financial information and knowing how to use it to make effective business decisions. Whatever your pursuits or occupation, the need for financial information is inescap- able. You cannot earn a living, spend money, buy on credit, make an investment, or pay taxes without receiving, using, or dispensing financial information. Good decision-making depends on good information. The Feature Story helps you picture how the chapter topic relates to the real world of accounting and business. have to know the numbers—cold.” In business, accounting Feature Story and financial statements are the means for communicating the numbers. If you don’t know how to read financial statements, Knowing the Numbers you can’t really know your business. Many students who take this course do not plan to be accoun- Knowing the numbers is sometimes even a matter of cor- tants. If you are in that group, you might be thinking, “If I’m porate survival. Consider the story of Columbia Sportswear not going to be an accountant, why do I need to know account- Company, headquartered in Portland, Oregon. Gert Boyle’s ing?” Well, consider this quote from Harold Geneen, the for- family fled Nazi Germany when she was 13 years old and mer chairman of IT&T: “To be good at your business, you then purchased a small hat company in Oregon, Columbia Hat 1-1 1-2 CHA PT E R 1 Accounting in Action Company. In 1971, Gert’s husband, who was then running the have participated in a project to increase health awareness of company, died suddenly of a heart attack. The company was female factory workers in developing countries. Columbia was in the midst of an aggressive expansion, which had taken its also a founding member of the Sustainable Apparel Coalition, sales above $1 million for the first time but which had also which is a group that strives to reduce the environmental and left the company financially stressed. Gert took over the small, social impact of the apparel industry. In addition, it monitors struggling company with help from her son Tim, who was then all of the independent factories that produce its products to en- a senior at the University of Oregon. Somehow, they kept the sure that they comply with the company’s Standards of Manu- company afloat. Today, Columbia has more than 4,000 em- facturing Practices. These standards address issues including ployees and annual sales in excess of $1 billion. Its brands forced labor, child labor, harassment, wages and benefits, include Columbia, Mountain Hardwear, Sorel, and Montrail. health and safety, and the environment. Gert still heads up the Board of Directors, and Tim is the Employers such as Columbia Sportswear generally as- company’s President and CEO. sume that managers in all areas of the company are “finan- Columbia doesn’t just focus on financial success. The cially literate.” To help prepare you for that, in this textbook company is very committed to corporate, social, and envi- you will learn how to read and prepare financial statements, ronmental responsibility. For example, several of its factories and how to use basic tools to evaluate financial results. The Chapter Outline presents the chapter’s topics and subtopics, as well as practice opportunities. Chapter Outline L EARNING OBJECTIVES LO 1 Identify the activities and Three activities DO IT! 1 Basic Concepts users associated with accounting. Who uses accounting data LO 2 Explain the building blocks of Ethics DO IT! 2 Building Blocks of accounting: ethics, principles, and GAAP Accounting assumptions. Measurement principles Assumptions LO 3 State the accounting equation, Assets DO IT! 3 Owner’s Equity Effects and define its components. Liabilities Owner’s equity LO 4 Analyze the effects of business Accounting transactions DO IT! 4 Tabular Analysis transactions on the accounting Transaction analysis equation. Summary of transactions LO 5 Describe the four financial Income statement DO IT! 5 Financial Statement statements and how they are Owner’s equity statement Items prepared. Balance sheet Statement of cash flows Go to the Review and Practice section at the end of the chapter for a review of key concepts and practice applications with solutions. Visit WileyPLUS with ORION for additional tutorials and practice opportunities.  Accounting Activities and Users 1-3 Accounting Activities and Users LEARNING OBJECTIVE 1 Identify the activities and users associated with accounting. What consistently ranks as one of the top career opportunities in business? What frequently rates among the most popular majors on campus? What was the undergraduate degree chosen by Nike founder Phil Knight, Home Depot co-founder Arthur Blank, former acting director of the Federal Bureau of Investigation (FBI) Thomas Pickard, and numerous members of Congress? Accounting.1 Why did these people choose accounting? They wanted to understand what was happening financially to their organizations. Accounting is the financial information system that provides these insights. In short, to understand your organization, you have to know the numbers. Accounting consists of three basic activities—it identifies, records, and communicates Essential terms are printed in the economic events of an organization to interested users. Let’s take a closer look at these blue when they first appear, and three activities. are defined in the end-of-chapter Glossary Review. Three Activities As a starting point to the accounting process, a company identifies the economic events relevant to its business. Examples of economic events are the sale of snack chips by PepsiCo, the provision of cell phone services by AT&T, and the payment of wages by Facebook. Once a company like PepsiCo identifies economic events, it records those events in order to provide a history of its financial activities. Recording consists of keeping a systematic, chronological diary of events, measured in dollars and cents. In recording, PepsiCo also classifies and summarizes economic events. Finally, PepsiCo communicates the collected information to interested users by means of accounting reports. The most common of these reports are called financial statements. To make the reported financial information meaningful, PepsiCo reports the recorded data in a standardized way. It accumulates information resulting from similar transactions. For exam- ple, PepsiCo accumulates all sales transactions over a certain period of time and reports the data as one amount in the company’s financial statements. Such data are said to be reported in the aggregate. By presenting the recorded data in the aggregate, the accounting process simplifies a multitude of transactions and makes a series of activities understandable and meaningful. A vital element in communicating economic events is the accountant’s ability to ana- lyze and interpret the reported information. Analysis involves use of ratios, percentages, graphs, and charts to highlight significant financial trends and relationships. Interpretation involves explaining the uses, meaning, and limitations of reported data. Appendices A–E show the financial statements of Apple Inc., PepsiCo Inc., The Coca-Cola Com- pany, Amazon.com, Inc., and Wal-Mart Stores, Inc., respectively. (In addition, in the A Look at IFRS section at the end of each chapter, the French company Louis Vuitton Moët Hennessy is analyzed.) We refer to these statements at various places throughout the textbook. At this point, these financial statements probably strike you as complex and con- fusing. By the end of this course, you’ll be surprised at your ability to understand, analyze, and interpret them. 1 The appendix to this chapter describes job opportunities for accounting majors and explains why accounting is such a popular major. 1-4 CHA PT E R 1 Accounting in Action Illustration 1.1 summarizes the activities of the accounting process. ILLUSTRATION 1.1 The activities of the accounting process Communication Identification Recording CHIP CITY DEL Prepare accounting reports L............. Select economic events (transactions) Record, classify, and summarize Analyze and interpret for users You should understand that the accounting process includes the bookkeeping function. Bookkeeping usually involves only the recording of economic events. It is therefore just one part of the accounting process. In total, accounting involves the entire process of identifying, recording, and communicating economic events.2 Who Uses Accounting Data The financial information that users need depends upon the kinds of decisions they make. There are two broad groups of users of financial information: internal users and external users. Internal Users Internal users of accounting information are the managers who plan, organize, and run a business. These include marketing managers, production supervisors, finance directors, and company officers. In running a business, internal users must answer many important questions, as shown in Illustration 1.2. ILLUSTRATION 1.2 Questions that internal users ask Questions Asked by Internal Users ON ON STRIKE ONSTRIKE E STRIK STOCK COLA Snack chips Beverages Finance Marketing Human Resources Management Is cash sufficient to pay What price should Apple charge Can General Motors afford Which PepsiCo product line is dividends to for an iPad to maximize the to give its employees pay the most profitable? Should any Microsoft stockholders? company's net income? raises this year? product lines be eliminated? 2 The origins of accounting are generally attributed to the work of Luca Pacioli, an Italian Renaissance mathemati- cian. Pacioli was a close friend and tutor to Leonardo da Vinci and a contemporary of Christopher Columbus. In his 1494 text Summa de Arithmetica, Geometria, Proportione et Proportionalite, Pacioli described a system to ensure that financial information was recorded efficiently and accurately.  Accounting Activities and Users 1-5 To answer these and other questions, internal users need detailed information on a timely basis. Managerial accounting provides internal reports to help users make decisions about their companies. Examples are financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. Accounting Across the Organization Clif Bar & Company Owning a Piece of the Bar ership plan (ESOP) in 2010. This plan gives its employees 20% ownership of the company. The ESOP also resulted in Clif Bar The original Clif Bar® energy enacting an open-book management program, including the bar was created in 1990 after six commitment to educate all employee-owners about its finances. months of experimentation by Armed with basic accounting knowledge, employees are more Gary Erickson and his mother in aware of the financial impact of their actions, which leads to her kitchen. Today, the company better decisions. has almost 300 employees and is considered one of the leading Landor’s Breakaway Brands®. One of Clif Bar & Company’s What are the benefits to the company and to the employees of proudest moments was the cre- making the financial statements available to all employees? (Go © Dan Moore/iStockphoto ation of an employee stock own- to WileyPLUS for this answer and additional questions.) Accounting Across the Organization boxes demonstrate applications of accounting information in various business functions. External Users External users are individuals and organizations outside a company who want financial in- formation about the company. The two most common types of external users are investors and creditors. Investors (owners) use accounting information to decide whether to buy, hold, or sell ownership shares of a company. Creditors (such as suppliers and bankers) use accounting information to evaluate the risks of granting credit or lending money. Illustration 1.3 shows some questions that investors and creditors may ask. ILLUSTRATION 1.3 Questions that external users ask Questions Asked by External Users Yeah! What do we do if they catch us? BILL COLLECTOR Investors Investors Creditors Is General Electric earning How does Disney compare in size Will United Airlines be able satisfactory income? and profitability with Time Warner? to pay its debts as they come due? Financial accounting answers these questions. It provides economic and financial in- formation for investors, creditors, and other external users. The information needs of external users vary considerably. Taxing authorities, such as the Internal Revenue Service, want to know whether the company complies with tax laws. Regulatory agencies, such as the Secu- rities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules. Customers are interested in whether a company like Tesla Motors will continue to honor product warranties and support its product lines. Labor unions, such as the Major League Baseball Players Association, want to know whether the owners have the ability to pay increased wages and benefits. 1-6 CHA PT E R 1 Accounting in Action The DO IT! exercises ask you to put newly acquired knowledge to work. They outline the Action Plan necessary to complete the exercise, and they show a Solution. DO IT! 1 Basic Concepts ACTION PLAN Review the basic concepts Indicate whether each of the five statements presented below is true or false. If false, indicate how discussed. to correct the statement. Develop an understanding 1. The three steps in the accounting process are identification, recording, and communication. of the key terms used. 2. Bookkeeping encompasses all steps in the accounting process. 3. Accountants prepare, but do not interpret, financial reports. 4. The two most common types of external users are investors and company officers. 5. Managerial accounting activities focus on reports for internal users. Solution 1. True 2. False. Bookkeeping involves only the recording step. 3. False. Accountants analyze and interpret information in reports as part of the communication step. 4. False. The two most com- mon types of external users are investors and creditors. 5. True. Related exercise material: DO IT! 1.1, E1.1, and E1.2. The Building Blocks of Accounting LEAR NING OBJECTIVE 2 Explain the building blocks of accounting: ethics, principles, and assumptions. A doctor follows certain protocols in treating a patient’s illness. An architect follows certain structural guidelines in designing a building. Similarly, an accountant follows certain stan- dards in reporting financial information. These standards are based on specific principles and assumptions. For these standards to work, however, a fundamental business concept must be present—ethical behavior. Ethics in Financial Reporting People won’t gamble in a casino if they think it is “rigged.” Similarly, people won’t play the stock market if they think prices are rigged. At one time, the financial press was full of articles about financial scandals at Enron, WorldCom, HealthSouth, and AIG. As more scandals came to light, a mistrust of financial reporting in general seemed to be developing. One article in the Wall Street Journal noted that “repeated disclosures about questionable accounting ETHICS NOTE practices have bruised investors’ faith in the reliability of earnings reports, which in turn has Circus-founder P.T. Barnum sent stock prices tumbling.” Imagine trying to carry on a business or invest money if you could is alleged to have said, “Trust not depend on the financial statements to be honestly prepared. Information would have no everyone, but cut the deck.” credibility. There is no doubt that a sound, well-functioning economy depends on accurate and What Sarbanes-Oxley does dependable financial reporting. is to provide measures that United States regulators and lawmakers were very concerned that the economy would (like cutting the deck of play- suffer if investors lost confidence in corporate accounting because of unethical financial re- ing cards) help ensure that porting. In response, Congress passed the Sarbanes-Oxley Act (SOX) to reduce unethical fraud will not occur. corporate behavior and decrease the likelihood of future corporate scandals (see Ethics Note). As a result of SOX, top management must now certify the accuracy of financial information. Ethics Notes help sensitize you In addition, penalties for fraudulent financial activity are much more severe. Also, SOX in- to some of the ethical issues in creased the independence requirements of the outside auditors who review the accuracy of accounting. corporate financial statements and increased the oversight role of boards of directors.  The Building Blocks of Accounting 1-7 The standards of conduct by which actions are judged as right or wrong, honest or dishon- est, fair or not fair, are ethics. Effective financial reporting depends on sound ethical behavior. To sensitize you to ethical situations in business and to give you practice at solving ethical dilemmas, we address ethics in a number of ways in this textbook: 1. A number of the Feature Stories and other parts of the textbook discuss the central impor- tance of ethical behavior to financial reporting. 2. Ethics Insight boxes and marginal Ethics Notes highlight ethics situations and issues in actual business settings. 3. Many of the People, Planet, and Profit Insight boxes focus on ethical issues that compa- nies face in measuring and reporting social and environmental issues. 4. At the end of the chapter, an Ethics Case simulates a business situation and asks you to put yourself in the position of a decision-maker in that case. When analyzing these various ethics cases and your own ethical experiences, you should apply the three steps outlined in Illustration 1.4. ILLUSTRATION 1.4 Steps in analyzing ethics cases and situations 1. Recognize an ethical 2. Identify and analyze 3. Identify the alternatives, situation and the ethical the principal elements and weigh the impact of issues involved. in the situation. each alternative on various Use your personal ethics to Identify the stakeholders— stakeholders. identify ethical situations and persons or groups who may Select the most ethical #1 #2 issues. Some businesses and professional organizations be harmed or benefited. Ask the question: What are the alternative, considering all the consequences. Sometimes there ALT ALT provide written codes of responsibilities and obligations will be one right answer. Other ethics for guidance in some of the parties involved? situations involve more than business situations. one right solution; these situations require an evaluation of each and a selection of the best alternative. Insight boxes provide examples of business situations from various perspectives—ethics, investor, international, and corporate social responsibility. Guideline answers to the critical thinking questions as well as additional questions are available in WileyPLUS. Ethics Insight Dewey & LeBoeuf LLP I Felt the Pressure—Would “I intentionally gave the auditors incorrect information in the course of the audit.” You? What happened here is that a small group of lower-level em- “I felt the pressure.” That’s what some ployees over a period of years carried out the instructions of their of the employees of the now-defunct bosses. Their bosses, however, seemed to have no concern as evi- law firm of Dewey & LeBoeuf denced by various e-mails with one another in which they referred LLP indicated when they helped to to their financial manipulations as accounting tricks, cooking t