Financial Accounting Tools for Business Decision Making (PDF)

FINANCIAL ACCOUNTING EIGHTH EDITION Tools for Business Decision Making The following is a sample chart of accounts. It does not represent a comprehensive chart of all the accounts used in this textbook but rather those accounts that are commonly used. This sample ch...

FINANCIAL ACCOUNTING EIGHTH EDITION Tools for Business Decision Making The following is a sample chart of accounts. It does not represent a comprehensive chart of all the accounts used in this textbook but rather those accounts that are commonly used. This sample chart of accounts is for a company that generates both service revenue as well as sales revenue. It uses the perpetual approach to inventory. If a periodic system was used, the following temporary accounts would be needed to record inventory purchases: Purchases, Freight-In, Purchase Returns and Allowances, and Purchase Discounts. CHART OF ACCOUNTS Stockholders’ Assets Liabilities Equity Revenues Expenses Cash Notes Payable Common Stock Service Revenue Administrative Expenses Accounts Accounts Payable Paid-in Capital in Sales Revenue Receivable Excess of Par Amortization Unearned Service Value—Common Sales Discounts Expense Allowance for Revenue Stock Doubtful Sales Returns and Bad Debt Expense Accounts Salaries and Preferred Stock Allowances Wages Payable Cost of Goods Sold Interest Paid-in Capital in Interest Revenue Receivable Interest Payable Excess of Par Depreciation Value—Preferred Gain on Disposal Expense Inventory Dividends Payable Stock of Plant Assets Freight-Out Supplies Income Taxes Treasury Stock Payable Income Tax Prepaid Insurance Retained Earnings Expense Bonds Payable Prepaid Rent Dividends Insurance Expense Discount on Bonds Land Payable Income Summary Interest Expense Equipment Premium on Bonds Loss on Disposal of Payable Plant Assets Accumulated Depreciation— Mortgage Payable Maintenance and Equipment Repairs Expense Buildings Rent Expense Accumulated Salaries and Wages Depreciation— Expense Buildings Selling Expenses Copyrights Supplies Expense Goodwill Utilities Expense Patents  ACCOUNT CLASSIFICATION AND PRESENTATION Normal Account Title Classification Financial Statement Balance A Accounts Payable Current Liability Balance Sheet Credit Accounts Receivable Current Asset Balance Sheet Debit Accumulated Depreciation—Buildings Plant Asset—Contra Balance Sheet Credit Accumulated Depreciation—Equipment Plant Asset—Contra Balance Sheet Credit Administrative Expenses Operating Expense Income Statement Debit Allowance for Doubtful Accounts Current Asset—Contra Balance Sheet Credit Amortization Expense Operating Expense Income Statement Debit B Bad Debt Expense Operating Expense Income Statement Debit Bonds Payable Long-Term Liability Balance Sheet Credit Buildings Plant Asset Balance Sheet Debit C Cash Current Asset Balance Sheet Debit Common Stock Stockholders’ Equity Balance Sheet Credit Copyrights Intangible Asset Balance Sheet Debit Cost of Goods Sold Cost of Goods Sold Income Statement Debit D Debt Investments Current Asset/ Balance Sheet Debit Long-Term Investment Depreciation Expense Operating Expense Income Statement Debit Discount on Bonds Payable Long-Term Liability—Contra Balance Sheet Debit Dividend Revenue Other Income Income Statement Credit Dividends Temporary account closed Retained Earnings Debit to Retained Earnings Statement Dividends Payable Current Liability Balance Sheet Credit E Equipment Plant Asset Balance Sheet Debit F Freight-Out Operating Expense Income Statement Debit G Gain on Disposal of Plant Assets Other Income Income Statement Credit Goodwill Intangible Asset Balance Sheet Debit I Income Summary Temporary account closed Not Applicable (1) to Retained Earnings Income Tax Expense Income Tax Expense Income Statement Debit Income Taxes Payable Current Liability Balance Sheet Credit Insurance Expense Operating Expense Income Statement Debit Interest Expense Other Expense Income Statement Debit Interest Payable Current Liability Balance Sheet Credit Interest Receivable Current Asset Balance Sheet Debit Interest Revenue Other Income Income Statement Credit Inventory Current Asset Balance Sheet (2) Debit  Normal Account Title Classification Financial Statement Balance L Land Plant Asset Balance Sheet Debit Loss on Disposal of Plant Assets Other Expense Income Statement Debit M Maintenance and Repairs Expense Operating Expense Income Statement Debit Mortgage Payable Long-Term Liability Balance Sheet Credit N Notes Payable Current Liability/ Balance Sheet Credit Long-Term Liability P Patents Intangible Asset Balance Sheet Debit Paid-in Capital in Excess of Par Stockholders’ Equity Balance Sheet Credit Value—Common Stock Paid-in Capital in Excess of Par Stockholders’ Equity Balance Sheet Credit Value—Preferred Stock Preferred Stock Stockholders’ Equity Balance Sheet Credit Premium on Bonds Payable Long-Term Liability—Contra Balance Sheet Credit Prepaid Insurance Current Asset Balance Sheet Debit Prepaid Rent Current Asset Balance Sheet Debit R Rent Expense Operating Expense Income Statement Debit Retained Earnings Stockholders’ Equity Balance Sheet and Retained Credit Earnings Statement S Salaries and Wages Expense Operating Expense Income Statement Debit Salaries and Wages Payable Current Liability Balance Sheet Credit Sales Discounts Revenue—Contra Income Statement Debit Sales Returns and Allowances Revenue—Contra Income Statement Debit Sales Revenue Revenue Income Statement Credit Selling Expenses Operating Expense Income Statement Debit Service Revenue Revenue Income Statement Credit Current Asset/Long-Term Stock Investments Balance Sheet Debit Investment Supplies Current Asset Balance Sheet Debit Supplies Expense Operating Expense Income Statement Debit T Treasury Stock Stockholders’ Equity Balance Sheet Debit U Unearned Service Revenue Current Liability Balance Sheet Credit Utilities Expense Operating Expense Income Statement Debit (1) The normal balance for Income Summary will be credit when there is a net income, debit when there is a net loss. The Income Summary account does not appear on any financial statement. (2) If a periodic system is used, Inventory also appears on the income statement in the calculation of cost of goods sold. FINANCIAL ACCOUNTING EIGHTH EDITION Tools for Business Decision Making Paul D. Kimmel PhD, CPA University of Wisconsin—Milwaukee Milwaukee, Wisconsin Jerry J. Weygandt PhD, CPA University of Wisconsin—Madison Madison, Wisconsin Donald E. Kieso PhD, CPA Northern Illinois University DeKalb, Illinois  DEDICATED TO the Wiley sales representatives who sell our books and service our adopters in a professional and ethical manner, and to Merlynn, Enid, and Donna Vice President and Director George Hoffman Executive Editor Michael McDonald Development Editor Ed Brislin Editorial Supervisor Terry Ann Tatro Editorial Associate Margaret Thompson Senior Content Manager Dorothy Sinclair Senior Production Editor Suzie Pfister Executive Marketing Manager Karolina Zarychta Hons Product Design Manager Allison Morris Product Designer Matt Origoni Media Specialist Elena Santa Maria Design Director Harry Nolan Cover Design Maureen Eide Interior Design Maureen Eide Senior Photo Editor Mary Ann Price Market Solutions Assistant Elizabeth Kearns Cover Credit Susanna Price/Getty Images, Inc. This book was set in New Aster LT Std by Aptara®, Inc. and printed and bound by Courier/Versailles. The cover was printed by Courier/Versailles. 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ISBN-13 978-1-118-55255-1 Binder-Ready Version ISBN 978-1-118-95390-7 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 Brief Contents 1 Introduction to Financial Statements 2 2 A Further Look at Financial Statements 44 3 The Accounting Information System 90 4 Accrual Accounting Concepts 150 5 Merchandising Operations and the Multiple-Step Income Statement 214 6 Reporting and Analyzing Inventory 266 7 Fraud, Internal Control, and Cash 316 8 Reporting and Analyzing Receivables 374 9 Reporting and Analyzing Long-Lived Assets 422 10 Reporting and Analyzing Liabilities 478 11 Reporting and Analyzing Stockholders’ Equity 536 12 Statement of Cash Flows 590 13 Financial Analysis: The Big Picture 646 APPENDICES A Specimen Financial Statements: Apple Inc. A-1 B Specimen Financial Statements: Columbia Sportswear Company B-1 C Specimen Financial Statements: VF Corporation 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 Reporting and Analyzing Investments H-1 COMPANY INDEX I-1 SUBJECT INDEX I-5 iii  From the Authors Dear Student, Why This Course? Remember your biology course in high school? Did you have one of those “invisible man” models (or maybe something more high-tech than that) that gave you the opportunity to look “inside” the human body? This accounting course offers something similar. To understand a business, you have to understand the financial insides of a business organization. A financial accounting course will help you understand the essential financial components of businesses. Whether you are looking at a large multinational company like Apple or Starbucks or a single- owner software consulting business or coffee shop, knowing the fundamentals of financial accounting will help you understand what is happening. As an employee, a manager, an investor,a business owner, or a director of your own personal finances—any of which roles you will have at some point in your life—you will make better “Whether you are looking at a large decisions for having taken this course. multinational company like Apple or Starbucks or a single-owner software Why This Book? Hundreds of thousands of students consulting business or coffee shop, have used this textbook. Your instructor has chosen it knowing the fundamentals of financial for you because of its trusted reputation. The authors accounting will help you understand have worked hard to keep the book fresh, timely, and what is happening.” accurate. How to Succeed? We’ve asked many students and many instructors whether there is a secret for success in this course. The nearly unanimous answer turns out to be not much of a secret: “Do the homework.” This is one course where doing is learn- ing. The more time you spend on the homework assignments—using the various tools that this textbook provides—the more likely you are to learn the essential concepts, techniques, and methods of accounting. Besides the textbook itself, WileyPLUS and the book’s companion website also offer various support resources. Good luck in this course. We hope you enjoy the experience and that you put to good use throughout a lifetime of success the knowledge you obtain in this course. We are sure you will not be disappointed. Paul D. Kimmel Jerry J. Weygandt Donald E. Kieso iv Author Commitment Jerry Weygandt Paul Kimmel Don Kieso JERRY J. WEYGANDT, PhD, CPA, is Arthur PAUL D. KIMMEL, PhD, CPA, received his DONALD E. KIESO, PhD, CPA, received his Andersen Alumni Emeritus Professor of bachelor’s degree from the University of bachelor’s degree from Aurora University Accounting at the University of Wisconsin— Minnesota and his doctorate in account- and his doctorate in accounting from the Madison. He holds a Ph.D. in accounting ing from the University of Wisconsin. He University of Illinois. He has served as chair- from the University of Illinois. Articles by is an Associate Professor at the University man of the Department of Accountancy and Professor Weygandt have appeared in the of Wisconsin—Milwaukee, and has pub- is currently the KPMG Emeritus Professor of Accounting Review, Journal of Accounting lic accounting experience with Deloitte Accountancy at Northern Illinois University. Research, Accounting Horizons, Journal & Touche (Minneapolis). He was the He has public accounting experience with of Accountancy, and other academic and recipient of the UWM School of Business Price Waterhouse & Co. (San Francisco professional journals. These articles have Advisory Council Teaching Award, the and Chicago) and Arthur Andersen & Co. examined such financial reporting issues Reggie Taite Excellence in Teaching (Chicago) and research experience with the as accounting for price-level adjustments, Award and a three-time winner of the Research Division of the American Institute pensions, convertible securities, stock option Outstanding Teaching Assistant Award at of Certified Public Accountants (New York). contracts, and interim reports. Professor the University of Wisconsin. He is also a He has done postdoctoral work as a Visiting Weygandt is author of other accounting and recipient of the Elijah Watts Sells Award Scholar at the University of California at financial reporting books and is a member for Honorary Distinction for his results on Berkeley and is a recipient of NIU’s Teaching of the American Accounting Association, the CPA exam. He is a member of the Excellence Award and four Golden Apple the American Institute of Certified Public American Accounting Association and Teaching Awards. Professor Kieso is the Accountants, and the Wisconsin Society of the Institute of Management Accountants author of other accounting and business Certified Public Accountants. He has served and has published articles in Accounting books and is a member of the American on numerous committees of the American Review, Accounting Horizons, Advances Accounting Association, the American Accounting Association and as a member in Management Accounting, Managerial Institute of Certified Public Accountants, and of the editorial board of the Accounting Finance, Issues in Accounting Education, the Illinois CPA Society. He has served as Review; he also has served as President Journal of Accounting Education, as well a member of the Board of Directors of the and Secretary-Treasurer of the American as other journals. His research interests Illinois CPA Society, then AACSB’s Accounting Accounting Association. In addition, he has include accounting for financial instruments Accreditation Committees, the State of Illinois Comptroller’s Commission, as Secretary- been actively involved with the American and innovation in accounting education. He Treasurer of the Federation of Schools of Institute of Certified Public Accountants has published papers and given numerous Accountancy, and as Secretary-Treasurer and has been a member of the Accounting talks on incorporating critical thinking into of the American Accounting Association. Standards Executive Committee (AcSEC) accounting education, and helped prepare a Professor Kieso is currently serving on the of that organization. He has served on catalog of critical thinking resources for the Board of Trustees and Executive Committee the FASB task force that examined the Federated Schools of Accountancy. of Aurora University, as a member of the reporting issues related to accounting for Board of Directors of Kishwaukee Community income taxes and served as a trustee of the Hospital, and as Treasurer and Director of Financial Accounting Foundation. Professor Valley West Community Hospital. From 1989 Weygandt has received the Chancellor’s to 1993 he served as a charter member of Award for Excellence in Teaching and the national Accounting Education Change the Beta Gamma Sigma Dean’s Teaching Commission. He is the recipient of the Award. He is on the board of directors of Outstanding Accounting Educator Award from M & I Bank of Southern Wisconsin. He is the Illinois CPA Society, the FSA’s Joseph A. the recipient of the Wisconsin Institute of Silvoso Award of Merit, the NIU Foundation’s CPA’s Outstanding Educator’s Award and Humanitarian Award for Service to Higher the Lifetime Achievement Award. In 2001 Education, a Distinguished Service Award he received the American Accounting from the Illinois CPA Society, and in 2003 an Association’s Outstanding Educator Award. honorary doctorate from Aurora University. Quickly identify areas of strength and weakness before the first exam, and use the information to build a learning path to success. A little time with ORION goes a long way. Based on usage data, students who engage in ORION adaptive practice—just a few minutes per week—get better outcomes. In fact, students who used ORION five or more times over the course of a semester reported the following results:  Developing effective problem solving skills requires practice, relevant feedback, and insightful examples. New PRACTICE QUESTIONS WITH SOLUTIONS include: BRIEF EXERCISES EXERCISES DO IT! Exercises c06ReportingAndAnalyzingInventory.indd Page 295 01/06/15 8:11 PM f-0161 /202/WB01539/9781 PROBLEMS All new practice questions provide assessment, helping students see what they understand and where they can improve. Algorithmic versions of the questions allow students to revisit practice questions until they understand a c06ReportingAndAnalyzingInventory.indd Page 291 01/06/15 8:11 PM f-0161 /202/WB01539/9781118552551/ch06/text_s topic completely. Solutions S l ti tto practice ti multiple-choice lti l questions, exercises, and problems are now available at the end of each chapter. p p REVIEW AND PRACTICE INSTRUCTIONS c06ReportingAndAnalyzingInventory.indd Page 294 01/06/15 8:11 PM f-0161 Prepare /202/WB01539/9781118552551/ch06/text_s a schedule to determine the correct inventory amount. Provide explanations for ▼ LEARNING OBJECTIVES REVIEW each item above, saying why you did or did not make an adjustment for each item. 1 Discuss how to classify and determine inventory. Inventory turnover is calculated as cost of goods sold SOLUTION Merchandisers need only one inventory classification, divided by average inventory. It can be converted to merchandise inventory, to describe the different items average days in inventory by dividing 365 days by the 1. Ending inventory—as reported $650,000 that make up total inventory. Manufacturers, on the inventory turnover. A higher inventory turnover or lower other hand, usually classify inventory into three catego- average days in inventory suggests that management is 1. Subtract from inventory: The goods belong to ries: finished goods, work in process, and raw materi- trying to keep inventory levels low relative to its sales Bosnia Corporation. Sergei is merely holding them for Bosnia. (200,000) als. To determine inventory quantities, manufactur- level. 2. Add to inventory: The goods belong to Sergei when ers (1) take a physical inventory of goods on hand and The LIFO reserve represents the difference between they were shipped. 40,000 (2) determine the ownership of goods in transit or on ending inventory using LIFO and ending inventory if FIFO consignment. were employed instead. For some companies this differ- 3. Subtract from inventory: Office supplies should be ence can be significant, and ignoring it can lead to inappro- carried in a separate account. They are not considered inventory 2 Apply inventory cost flow methods and discuss their priate conclusions when using the current ratio or inven- financial effects. The primary basis of accounting for held for resale. (15,000) tory turnover. inventories is cost. Cost includes all expenditures neces- 4. Add to inventory: The goods belong to Sergei until sary to acquire goods and place them in a condition ready *4 Apply inventory cost flow methods to perpetual inven- they are shipped (Jan. 1). 30,000 for sale. Cost of goods available for sale includes (a) cost tory records. Under FIFO, the cost of the earliest goods of beginning inventory and (b) cost of goods purchased. on hand prior to each sale is charged to cost of goods sold. SOLUTIONS The inventory cost flow methods are specific identification Under LIFO, the cost of the most recent purchase prior to and three assumed cost flow methods—FIFO, LIFO, and sale is charged to cost of goods sold.1. (d) A Under thephysical average-inventory is usually taken when a limited number of goods are being sold or received, and at the end average-cost. of the after cost method, a new average cost is computed company’s each fiscal year. Choice (a) is incorrect because a physical inventory count is usually taken when the com- The cost of goods available for sale may be allocated purchase. pany has the least, not greatest, amount of inventory. Choices (b) and (c) are correct, but (d) is the better answer. to cost of goods sold and ending inventory by specific *5 Indicate the effects of inventory errors Goods 2. (a)on the fi held nan- on consignment should not be included because another company has title (ownership) to the identification or by a method based on an assumed cost cial statements. In the income statement of theThe goods. current other choices are incorrect because (b) goods shipped on consignment to another company and flow. When prices are rising, the first-in, first-out (FIFO) year: (1) An error in beginning inventory will have (c) goods a in transit from another company shipped FOB shipping point should be included in a company’s ending method results in lower cost of goods sold and higher reverse effect on net income (e.g., overstatement of (d) is incorrect because (a) is not included in the physical inventory. inventory. Choice net income than the average-cost and the last-in, first-out inventory results in understatement of net income, and (LIFO) methods. The reverse is true when prices are fall- 3. (b) The inventory vice versa). (2) An error in ending inventory will have held on consignment by Rogers should be included in Railway’s inventory balance at cost ing. In the balance sheet, FIFO results in an ending inven- ($35,000). Theofpurchased goods of $13,000 should not be included in inventory until January 3 because the goods a similar effect on net income (e.g., overstatement tory that is closest to current value, whereas the inven- inventory results in overstatement of are net shipped income).FOBIf destination. Therefore, the correct amount of inventory is $215,000 ($180,000 + $35,000), not tory under LIFO is the farthest from current value. LIFO (a)in$230,000, (c) $228,000, or (d) $193,000. ending inventory errors are not corrected the follow- lt i th l ti t (b fl t 4. (c) Under FIFO, ending inventory will consist of 5,000 units from the Nov. 8 purchase and 4,000 units from the June 19 purchase. Therefore, ending inventory is (5,000 × $13) + (4,000 × $12) = $113,000, not (a) $99,000, (b) $108,000, or (d) $117,000. 5. (d) Under LIFO, ending inventory will consist of 8,000 units from the inventory at Jan. 1 and 1,000 units from the June 19 purchase. Therefore, ending inventory is (8,000 × $11) + (1,000 × $12) = $100,000, not (a) $113,000, (b) $108,000, or (c) $99,000. 6 (d) Under the average-cost method total cost of goods available for sale needs to be calculated in order to deter-  What’s New? Focus on the Accounting Cycle To help students master accounting cycle concepts, we added (1) new, recurring illustrations that show students the big picture of the accounting cycle, (2) new comprehensive accounting cycle exercises and problems, and (3) new accounting cycle questions in the Test Bank and. Student Practice and Solutions New practice opportunities with solutions are integrated throughout the textbook and WileyPLUS course. Each textbook chapter now provides students with a Review and Practice section that includes learning objective sum- maries, multiple-choice questions with feedback for each answer choice, practice exercises with solutions, and a prac- tice problem with a solution. Also, all learning objective modules in the textbook are followed by a DO IT! exercise with an accompanying solution. In WileyPLUS, two brief exercises, two DO IT! exercises, two exercises, and a new problem are available for practice with each chapter. All of the new practice questions are algorithmic, providing students with multiple opportunities for advanced practice. WileyPLUS assessment now includes new narrative student feedback. Over 3,500 questions, including new medium-level, computational, and accounting-cycle-based questions, are avail- able for practice and review. is an adaptive study and practice tool that helps students build proficiency in course topics. Updated Content and Design We scrutinized all content to find new ways to engage students and help them learn accounting concepts. A new learning objective structure helps students practice their understanding of concepts with DO IT! exercises before they move on to different topics in other learning objectives. Coupled with a new interior design, revised infographics, and the newly designed interactive chapter tutorials, the new outcomes-oriented approach motivates students and helps them make the best use of their time. WileyPLUS Videos Over 150 videos are available in WileyPLUS. More than 80 of the videos are new to the Eighth Edition. The videos walk students through relevant homework problems and solutions, review important concepts, provide overviews of Excel skills, and explore topics in a real-world context. Real World Context: Feature Stories and Comprehensive Problems New feature stories frame chapter topics in a real-world company example. Also, the feature stories now closely cor- relate with the Using Decision Tools problem at the end of each chapter. In WileyPLUS, real-world Insight boxes now have questions that can be assigned as homework. More information about the Eighth Edition is available on the book’s website at www.wiley.com/college/kimmel. viii Table of Contents Introduction to Financial The Accounting Information 1 Statements 2 3 System 90 Knowing the Numbers 3 Accidents Happen 91 LO 1: Study the forms of business organization and LO 1: Analyze the effect of business transactions the uses of accounting information. 4 on the basic accounting equation. 92 Forms of Business Organization 4 Accounting Transactions 92 Users and Uses of Financial Information 5 Analyzing Transactions 93 Ethics in Financial Reporting 7 Summary of Transactions 99 LO 2: Explain the three principal types of business LO 2: Explain how accounts, debits, and activity. 8 credits are used to record business Financing Activities 9 transactions. 100 Investing Activities 9 Debits and Credits 101 Operating Activities 9 Debit and Credit Procedures 101 LO 3: Describe the four financial statements and Stockholders’ Equity Relationships 104 how they are prepared. 11 Summary of Debit/Credit Rules 105 Income Statement 11 LO 3: Indicate how a journal is used in the Retained Earnings Statement 12 recording process. 106 Balance Sheet 13 The Recording Process 106 Statement of Cash Flows 14 The Journal 106 Interrelationships of Statements 15 LO 4: Explain how a ledger and posting help Other Elements of an Annual Report 18 in the recording process. 109 A Look at IFRS 42 The Ledger 109 Chart of Accounts 109 Posting 110 A Further Look at Financial The Recording Process Illustrated 111 2 Statements 46 Summary Illustration of Journalizing and Posting 117 Just Fooling Around? 45 LO 5: Prepare a trial balance. 119 LO 1: Identity the sections of a classified Limitations of a Trial Balance 119 balance sheet. 46 A Look at IFRS 148 Current Assets 46 Long-Term Investments 48 Property, Plant, and Equipment 48 Intangible Assets 48 4 Accrual Accounting Concepts 46 Current Liabilities 50 Keeping Track of Groupons 151 Long-Term Liabilities 50 LO 1: Explain the accrual basis of accounting and Stockholders’ Equity 50 the reasons for adjusting entries. 152 LO 2: Use ratios to evaluate a company’s The Revenue Recognition Principle 152 profitability, liquidity, and solvency. 51 The Expense Recognition Principle 152 Ratio Analysis 51 Accrual versus Cash Basis of Accounting 153 Using the Income Statement 52 The Need for Adjusting Entries 154 Using a Classified Balance Sheet 53 Types of Adjusting Entries 155 Using the Statement of Cash Flows 57 LO 2: Prepare adjusting entries for deferrals. 156 LO 3: Discuss financial reporting concepts. 58 Prepaid Expenses 156 The Standard-Setting Environment 58 Unearned Revenues 160 Qualities of Useful Information 59 LO 3: Prepare adjusting entries for accruals. 163 Assumptions in Financial Reporting 60 Accrued Revenues 163 Principles in Financial Reporting 61 Accrued Expenses 164 Cost Constraint 62 Summary of Basic Relationships 167 A Look at IFRS 87 ix LO 4: Prepare an adjusted trial balance and Reporting and Analyzing closing entries. 170 6 Inventory 266 Preparing the Adjusted Trial Balance 170 Preparing Financial Statements 171 “Where Is That Spare Bulldozer Blade?” 267 Quality of Earnings 172 LO 1: Discuss how to classify and Closing the Books 175 determine inventory. 268 Summary of the Accounting Cycle 177 Classifying Inventory 268 LO *5: APPENDIX 4A: Describe the purpose and Determining Inventory Quantities 269 the basic form of a worksheet. 182 LO 2: Apply inventory cost flow methods and A Look at IFRS 212 discuss their financial effects. 271 Specific Identification 272 Cost Flow Assumptions 273 Merchandising Operations Financial Statement and Tax Effects of Cost Flow 5 and the Multiple-Step 150 Methods 277 Income Statement Using Inventory Cost Flow Methods Consistently 280 Buy Now, Vote Later 215 LO 3: Explain the statement presentation and LO 1: Describe merchandising operations and analysis of inventory. 281 inventory systems. 216 Presentation 281 Operating Cycles 216 Lower-of-Cost-or-Market 281 Flow of Costs 217 Analysis 283 LO 2: Record purchases under a perpetual Analysts’ Adjustments for LIFO Reserve 284 inventory system. 219 LO *4: APPENDIX 6A: Apply inventory cost flow Freight Costs 221 methods to perpetual inventory records. 287 Purchase Returns and Allowances 221 First-In, First-Out (FIFO) 287 Purchase Discounts 222 Last-In, First-Out (LIFO) 288 Summary of Purchasing Transactions 223 Average-Cost 289 LO 3: Record sales under a perpetual LO *5: APPENDIX 6B: Indicate the effects of inventory system. 224 inventory errors on the financial Sales Returns and Allowances 225 statements. 289 Sales Discounts 226 Income Statement Effects 289 LO 4: Prepare a multiple-step income Balance Sheet Effects 290 statement and a comprehensive income A Look at IFRS 314 statement. 227 Single-Step Income Statement 227 Multiple-Step Income Statement 228 Fraud, Internal Control, Comprehensive Income Statement 231 7 and Cash 316 LO 5: Determine cost of goods sold under a periodic inventory system. 233 Minding the Money in Madison 317 LO 6: Compute and analyze gross profit LO 1: Define fraud and the principles of rate and profit margin. 234 internal control. 318 Gross Profit Rate 234 Fraud 318 Profit Margin 235 The Sarbanes-Oxley Act 318 LO *7: APPENDIX 5A: Record purchases and Internal Control 319 sales of inventory under a periodic Principles of Internal Control Activities 320 inventory system. 239 Limitations of Internal Control 326 Recording Merchandise Transactions 239 LO 2: Apply internal control principles Recording Purchases of Merchandise 239 to cash. 327 Freight Costs 240 Cash Receipts Controls 328 Recording Sales of Merchandise 240 Cash Disbursements Controls 330 Comparison of Entries—Perpetual vs. LO 3: Apply the control features of a bank Periodic 241 account. 333 A Look at IFRS 264 Electronic Funds Transfer (EFT) System 333 Bank Statements 333 Reconciling the Bank Account 334 x LO 4: Explain the reporting of cash and the basic Revising Periodic Depreciation 435 principles of cash management. 340 Impairments 436 Reporting Cash 340 LO 3: Explain how to account for the disposal of Managing and Monitoring Cash 341 plant assets. 437 Cash Budgeting 344 Sale of Plant Assets 437 LO *5: APPENDIX 7A: Explain the operation of a Retirement of Plant Assets 438 petty cash fund. 347 LO 4: Identity the basic issues related to reporting Establishing the Petty Cash Fund 347 intangible assets. 439 Making Payments from Petty Cash 347 Accounting for Intangible Assets 440 Replenishing the Petty Cash Fund 348 Types of Intangible Assets 440 A Look at IFRS 371 LO 5: Discuss how long-lived assets are reported and analyzed. 443 Presentation 443 Reporting and Analyzing Analysis 444 8 Receivables 374 LO *6: APPENDIX 9A: Compute periodic depreciation using the declining-balance What’s Cooking? 375 method and the units-of-activity method. 449 LO 1: Explain how companies recognize Declining-Balance Method 449 accounts receivable. 376 Units-of-Activity Method 450 Types of Receivables 376 A Look at IFRS 475 Recognizing Accounts Receivable 376 LO 2: Describe how companies value accounts Reporting and Analyzing receivable and record their disposition. 378 Valuing Accounts Receivable 378 10 Liabilities 478 Disposing of Accounts Receivable 385 LO 3: Explain how companies recognize, value, and And Then There Were Two 479 dispose of notes receivable. 387 LO 1: Explain how to account for current Determining the Maturity Date 388 liabilities. 480 Computing Interest 388 What Is a Current Liability? 480 Recognizing Notes Receivable 388 Notes Payable 480 Valuing Notes Receivable 389 Sales Taxes Payable 481 Disposing of Notes Receivable 389 Unearned Revenues 481 LO 4: Describe the statement presentation of Current Maturities of Long-Term Debt 482 receivables and the principles of receivables Payroll and Payroll Taxes Payable 483 management. 391 LO 2: Describe the major characteristics of Financial Statement Presentation of bonds. 485 Receivables 391 Types of Bonds 486 Managing Receivables 392 Issuing Procedures 486 Evaluating Liquidity of Receivables 394 Determining the Market Price of Bonds 486 Accelerating Cash Receipts 396 LO 3: Explain how to account for bond A Look at IFRS 419 transactions. 489 Issuing Bonds at Face Value 489 Discount or Premium on Bonds 489 Reporting and Analyzing Issuing Bonds at a Discount 490 9 Long-Lived Assets 422 Issuing Bonds at a Premium 492 Redeeming Bonds at Maturity 493 A Tale of Two Airlines 423 Redeeming Bonds before Maturity 493 LO 1: Explain the accounting for plant LO 4: Discuss how liabilities are asset expenditures. 424 reported and analyzed. 495 Determining the Cost of Plant Assets 424 Presentation 495 Expenditures During Useful Life 427 Analysis 496 To Buy or Lease? 428 LO *5: APPENDIX 10A: Apply the straight-line LO 2: Apply depreciation methods to method of amortizing bond discount and plant assets. 429 bond premium. 502 Factors in Computing Depreciation 430 Amortizing Bond Discount 502 Depreciation Methods 430 Amortizing Bond Premium 503 xi LO *6: APPENDIX 10B: Apply the effective-interest Significant Noncash Activities 593 method of amortizing bond discount and bond Format of the Statement of premium. 504 Cash Flows 594 Amortizing Bond Discount 505 LO 2: Prepare a statement of cash flows using Amortizing Bond Premium 506 the indirect method. 595 LO *7: APPENDIX 10C: Describe the accounting Indirect and Direct Methods 596 for long-term notes payable. 507 Indirect Method—Computer Services A Look at IFRS 534 Company 596 Step 1: Operating Activities 598 Summary of Conversion to Net Cash Reporting and Analyzing Provided by Operating Activities– 11 Stockholders’ Equity 536 Indirect Method 601 Step 2: Investing and Financing Oh Well, I Guess I’ll Get Rich 537 Activities 603 LO 1: Discuss the major characteristics of a Step 3: Net Change in Cash 604 corporation. 538 LO 3: Use the statement of cash flows to Characteristics of a Corporation 538 evaluate a company. 607 Forming a Corporation 541 The Corporate Life Cycle 607 Stockholder Rights 541 Free Cash Flow 609 Stock Issue Considerations 542 LO *4: APPENDIX 12A: Prepare a statement Corporate Capital 544 of cash flows using the direct method. 611 LO 2: Explain how to account for the issuance of Step 1: Operating Activities 613 common and preferred stock, and the purchase Step 2: Investing and Financing Activities 617 of treasury stock. 545 Step 3: Net Change in Cash 618 Accounting for Common Stock 545 LO *5: APPENDIX 12B: Use the T-account Accounting for Preferred Stock 546 approach to prepare a statement of Treasury Stock 547 cash flows. 618 LO 3: Explain how to account for cash dividends A Look at IFRS 643 and describe the effect of stock dividends and stock splits. 549 Cash Dividends 549 Financial Analysis: The Dividend Preferences 552 13 Big Picture 646 Stock Dividends 553 Stock Splits 555 It Pays to Be Patient 647 LO 4: Discuss how stockholders’ equity is LO 1: Apply the concept of sustainable income reported and analyzed. 557 and quality of earnings. 648 Retained Earnings 557 Sustainable Income 648 Retained Earnings Restrictions 558 Quality of Earnings 652 Balance Sheet Presentation of Stockholders’ LO 2: Apply horizontal analysis and vertical Equity 558 analysis. 654 Analysis of Stockholders’ Equity 560 Horizontal Analysis 655 Debt versus Equity Decision 562 Vertical Analysis 657 LO *5: APPENDIX 11A: Prepare entries LO 3: Analyze a company’s performance using for stock dividends. 565 ratio analysis. 660 A Look at IFRS 587 Price-Earnings Ratio 660 Liquidity Ratios 660 Solvency Ratios 661 Profitability Ratios 661 12 Statement of Cash Flows 590 LO *4: APPENDIX 13A: Evaluate a company comprehensively using ratio analysis. 666 Got Cash? 591 Liquidity Ratios 668 LO 1: Discuss the usefulness and format of the Solvency Ratios 670 statement of cash flows. 592 Profitability Ratios 672 Usefulness of the Statement of Cash Flows 592 A Look at IFRS 699 Classification of Cash Flows 592 xii  Present Value of a Single Amount G-7 Specimen Financial A Statements: Apple Inc. A-1 Present Value of an Annuity G-9 Time Periods and Discounting G-11 Present Value of a Long-Term Note or Bond G-11 Specimen Financial LO 3: Use a financial calculator to solve time B Statements: Columbia B-1 value of money problems. G-13 Sportswear Company Present Value of a Single Sum G-14 Present Value of an Annuity G-15 Useful Applications of the Financial Specimen Financial Calculator G-15 C Statements: C-1 VF Corporation Reporting and Analyzing Specimen Financial H Investments H-1 D Statements: D-1 Amazon.com, Inc. LO 1: Explain how to account for debt investments. H-1 Why Corporations Invest H-1 Specimen Financial Accounting for Debt Investments H-3 E Statements: E-1 LO 2: Explain how to account for stock Wal-Mart Stores, Inc. investments. H-4 Holdings of Less than 20% H-4 Specimen Financial Holdings Between 20% and 50% H-5 F Statements: Louis Vuitton F-1 Holdings of More than 50% H-6 LO 3: Discuss how debt and stock investments G Time Value of Money G-1 are reported in the financial statements. H-7 Categories of Securities H-7 LO 1: Compute interest and future values. G-1 Balance Sheet Presentation H-10 Nature of Interest G-1 Presentation of Realized and Unrealized Gain Future Value of a Single Amount G-3 or Loss H-11 Future Value of an Annuity G-4 Statement of Cash Flows Presentation H-12 LO 2: Compute present values. G-7 Company Index I-1 Present Value Variables G-7 Subject Index I-5 xiii Acknowledgments Financial Accounting has benefitted 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. Eighth Edition Nancy Fan Charles Leflar California State Polytechnic University, University of Arkansas Dennis Avola Pomona Jennifer LeSure Northeastern University Magdy Farag Ivy Tech Community College Thomas Bednarcik California State Polytechnic University, Claudia Lubaski Robert Morris University Illinois Pomona Lorain County Community College Martin Blaine Linda Flaming Yuanyuan Ma Columbus State Community College Monmouth University University of Minnesota Bradley Blaylock Joseph Fournier Don McFall Oklahoma State University University of Rhode Island Hiram College Gary Bower Amy Geile Allison McLeod Community College of Rhode Island University of Arizona University of North Texas Robert Braun Alan Glaser Maha Mitrelis Southeastern Louisiana University Franklin & Marshall College Providence College Lou Bravo J. D. 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You can send your thoughts and ideas about the text- Thompson, product design manager Allie Morris, product book to us via email at: [email protected]. designer Matt Origoni, designer Maureen Eide, photo editor Mary Ann Price, and Jackie Henry at Aptara. All of these Paul D. Kimmel Jerry J. Weygandt Donald E. Kieso professionals provided innumerable services that helped the Milwaukee, Wisconsin Madison, Wisconsin DeKalb, Illinois textbook take shape. xvii 1Introduction to Financial Statements The Chapter Preview describes the purpose of the chapter and highlights C HAPT ER PREVIEW major topics. How do you start a business? How do you determine whether your business is making or losing money? How should you finance expansion—should you borrow, should you issue stock, should you use your own funds? How do you convince banks to lend you money or investors to buy your stock? Success in business requires making countless decisions, and decisions require financial information. The purpose of this chapter is to show you what role accounting plays in providing financial information. The Chapter Outline presents the chapter’s topics and subtopics, as well as practice opportunities. CHAPTER OUTLINE LEARNING OBJECTIVES PRACTICE Forms of business DO IT! Identify the forms of business organization ▼ 1 organization and the uses of Users and uses of financial Business Organization accounting information. information 1 Forms Ethics in financial reporting DO IT! Financing activities Explain the three principal types of ▼ 2 business activity. Investing activities 2 Business Activities Operating activities Income statement Retained earnings statement DO IT! Describe the four financial statements Balance sheet 3a Financial Statements ▼ 3 and how they are prepared. Statement of cash flows Interrelationships of statements 3 3b Components of Annual Other annual report elements Reports Go tto Go o th thee RE REVIEW REVI VIEW VIEW A AND ND P PRACTICE RACT RA CTIC CT ICE IC CE section sec ecti tion tion at at the the end end of the the chapter cha hapt p er ffor pt or a ttargeted arge argete geted ted su summ summary mmar mmaryy an ar and d ex exer exercises erci cise ise sess wi w with ith h ssolutions. ollut uti tions ions.. Visi Visitt si Visit for ad for fo addi additional dditi tion ionall ttutorials utor ut oriia or ials ialls a and nd dppractice ract cti tic ice op ice oppo opportunities. port rtun tun unit i ies it ies.  © My Good Images/Shutterstock F EAT URE STORY The Feature Story helps you picture how the chapter topic relates to the real world of accounting and business. Many students who take this course do not plan to be Today, Columbia has more than 4,000 employees and accountants. If you are in that group, you might be annual sales in excess of $1 billion. Its brands include thinking, “If I’m not going to be an accountant, why Columbia, Mountain Hardwear, Sorel, and Montrail. do I need to know accounting?” Gert still heads up the Board of Well, consider this quote from Directors, and Tim is the company’s Harold Geneen, the former President and CEO. chairman of IT&T: “To be good at Columbia doesn’t just focus on your business, you have to know Knowing the financial success. The company is very the numbers—cold.” In business, Numbers committed to corporate, social, and accounting and financial environmental responsibility. For statements are the means for example, several of its factories have communicating the numbers. If participated in a project to increase you don’t know how to read financial statements, you health awareness of female factory workers in developing can’t really know your business. countries. Columbia was also a founding member of the Knowing the numbers is sometimes even a matter of Sustainable Apparel Coalition, which is a group that corporate survival. Consider the story of Columbia strives to reduce the environmental and social impact of Sportswear Company, headquartered in Portland, the apparel industry. In addition, it monitors all of the Oregon. Gert Boyle’s family fled Nazi Germany when independent factories that produce its products to she was 13 years old and then purchased a small hat ensure that they comply with the company’s Standards of company in Oregon, Columbia Hat Company. In 1971, Manufacturing Practices. These standards address issues Gert’s husband, who was then running the company, including forced labor, child labor, harassment, wages died suddenly of a heart attack. The company was in and benefits, health and safety, and the environment. the midst of an aggressive expansion, which had taken Employers such as Columbia Sportswear generally its sales above $1 million for the first time but which assume that managers in all areas of the company had also left the company financially stressed. Gert are “financially literate.” To help prepare you for took over the small, struggling company with help from that, in this textbook you will learn how to read and her son Tim, who was then a senior at the University of prepare financial statements, and how to use basic Oregon. Somehow, they kept the company afloat. tools to evaluate financial results. 4 1 Introduction to Financial Statements Identify the forms of business organization and the uses of LEARNING 1 ▼ OBJECTIVE accounting information. Suppose you graduate with a business degree and decide you want to start your own business. But what kind of business? You enjoy working with people, espe-