Financial Accounting: Information for Decisions, 9e PDF
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University of Wisconsin-Madison
2019
John J. Wild
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This is a 9th edition textbook on financial accounting. The text is written by John J. Wild and the publisher is McGraw-Hill Education, published in 2019. It covers financial accounting information and decision making. It emphasizes real-world data and updated topics like revenue recognition and sustainability.
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Financial Accounting Page i INFORMATION FOR DECISIONS 9th edition John J. Wild University of Wisconsin at Madison ...
Financial Accounting Page i INFORMATION FOR DECISIONS 9th edition John J. Wild University of Wisconsin at Madison Page ii To my students and family, especially Kimberly, Jonathan, Stephanie, and Trevor. FINANCIAL ACCOUNTING: INFORMATION FOR DECISIONS, NINTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2019 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2017, 2015, and 2013. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 LWI 21 20 19 18 ISBN 978-1-259-91704-2 MHID 1-259-91704-5 Executive Portfolio Manager: Steve Schuetz Product Developer: Michael McCormick Marketing Manager: Zachary Rudin Content Project Managers: Lori Koetters, Brian Nacik Buyer: Sandy Ludovissy Design: Debra Kubiak Content Licensing Specialist: Melissa Homer Cover Image: © Rawpixel.com/Shutterstock.com RF Compositor: Aptara®, Inc. All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Names: Wild, John J., author. Title: Financial accounting : information for decisions / John J. Wild, University of Wisconsin at Madison. Description: Ninth Edition. | Dubuque, IA : McGraw-Hill Education, | Revised edition of the author’s Financial accounting, Identifiers: LCCN 2017034971 | ISBN 9781259917042 (alk. paper) | ISBN 1259917045 (alk. paper) Subjects: LCSH: Accounting. Classification: LCC HF5635.W695 2019 | DDC 657—dc23 LC record available at https://lccn.loc.gov/2017034971 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw- Hill Education does not guarantee the accuracy of the information presented at these sites. mheducation.com/highered About the Author Page iii Courtesy of John J. Wild JOHN J. WILD is a distinguished professor of accounting at the University of Wisconsin at Madison. He previously held appointments at Michigan State University and the University of Manchester in England. He received his BBA, MS, and PhD from the University of Wisconsin. John teaches accounting courses at both the undergraduate and graduate levels. He has received numerous teaching honors, including the Mabel W. Chipman Excellence-in-Teaching Award and the departmental Excellence-in- Teaching Award, and he is a two-time recipient of the Teaching Excellence Award from business graduates at the University of Wisconsin. He also received the Beta Alpha Psi and Roland F. Salmonson Excellence-in-Teaching Award from Michigan State University. John has received several research honors, is a past KPMG Peat Marwick National Fellow, and is a recipient of fellowships from the American Accounting Association and the Ernst and Young Foundation. John is an active member of the American Accounting Association and its sections. He has served on several committees of these organizations, including the Outstanding Accounting Educator Award, Wildman Award, National Program Advisory, Publications, and Research Committees. John is author of Fundamental Accounting Principles, Financial Accounting, Managerial Accounting, and College Accounting, all published by McGraw-Hill Education. John’s research articles on accounting and analysis appear in The Accounting Review; Journal of Accounting Research; Journal of Accounting and Economics; Contemporary Accounting Research; Journal of Accounting, Auditing and Finance; Journal of Accounting and Public Policy; and other journals. He is past associate editor of Contemporary Accounting Research and has served on several editorial boards including The Accounting Review. In his leisure time, John enjoys hiking, sports, boating, travel, people, and spending time with family and friends. Difference Makers in Teaching... Page iv Chapter Preview Learning analytics show that students learn better when material is broken into “blocks” of content. Each chapter opens with a visual preview. Learning objective numbers highlight the location of related content. Each “block” of content concludes with a Need-to-Know (NTK) to aid and reinforce student learning. Visual aids and concise, bullet-point discussions further help students learn. New Revenue Recognition Wild uses the popular gross method for merchandising transactions (net method is covered in an appendix). The gross method is widely used in practice and best for student success. Adjusting entries for new revenue recognition rules are included in an appendix. Assignments are clearly marked and separated. Wild is GAAP compliant. Up-to-Date and Current This book reflects changes in accounting for revenue recognition, investments, leases, and extraordinary items. It is important students learn GAAP accounting. Less is More Wild has markedly fewer pages than competing books covering the same material. The text is to the point and uses visuals to aid student learning. Bullet-point discussion aids learning. The 9th edition has 64 fewer pages than the 8th edition—a near 10% reduction! Visual Learning Learning analytics tell us today’s students do not read large blocks of text. Wild has adapted to student needs by having informative visual aids throughout. Many visuals and exhibits are new to this edition. Videos Page v A growing number of students now learn accounting online. To aid instructors and students, Wild has the largest set of learning resources. Wild offers nearly 500 videos to ensure student success. Wild also has instructor resources to add a personal touch to these learning aids. Concept Overview Videos cover each chapter’s learning objectives with narrated, animated presentations that frequently assess comprehension. Wild has over 140 concept overview presentations, the most of any competing text. Need-to-Know Demonstrations Need-to-Know demonstrations are located at key junctures in each chapter. These demonstrations pose questions about the material just presented—content that students “need to know” to learn accounting. Accompanying solutions walk students through key procedures and analysis necessary to be successful with homework and test materials. Need-to-Know demonstrations are supplemented with narrated, animated, step-by-step walk-through videos led by an instructor and available via Connect. Comprehensive Need-to-Know Comprehensive Need-to-Knows are problems that draw on material from the entire chapter. They include a complete solution, allowing students to review the entire problem- solving process and achieve success. Page vi Using Accounting for Decisions Whether we prepare, analyze, or apply accounting information, one skill remains essential: decision making. To help develop good decision-making habits and to illustrate the relevance of accounting, we use a learning framework to enhance decision making in four ways. (See the four nearby examples for the different types of decision boxes, including those that relate to fraud.) Decision Insight provides context for business decisions. Decision Ethics and Decision Maker are role-playing scenarios that show the relevance of accounting. Decision Analysis provides key tools to help assess company performance. Financial Statement Analysis New to this edition, Financial Statement Analysis assignments have students evaluate the most current financial statements from Apple, Google, and Samsung. Students compute key metrics and compare performance between companies and industry. These assignments are auto-gradable in Connect and are included after Problem Set B in the text. Serial Problems use a continuous running case study to illustrate chapter concepts in a familiar context. The Serial Problem can be followed continuously from the first chapter or picked up at any later point in the book; enough information is provided to ensure students can get right to work. Keep It Real Page vii Research shows that students learn best when using current data from real companies. Wild uses the most current data from real companies for assignments, examples, and analysis in the text. See Chapter 13 for use of real data. Sustainability and Accounting Companies increasingly issue sustainability information, and accountants are being asked to prepare, analyze, and audit these reports. Wild includes brief sections that cover the importance of sustainability within the context of accounting, including standards from the Sustainability Accounting Standards Board (SASB). New to this edition, sustainability assignments cover chapter material with a social responsibility twist. Each chapter has at least two sustainability assignments. Page viii Page ix Page x Page xi Content Revisions Enhance Page xii Learning This edition’s revisions are driven by feedback from instructors and students. They include New or revised layout for many chapters that organizes materials into common sections, with each section followed by a Need-to-Know (NTK) demonstration. Many new, revised, and updated assignments throughout, including real-world and sustainability assignments. Many Need-to-Know (NTK) demonstrations added to chapters at key junctures to reinforce learning. Adjusting entries for new revenue recognition rules set in an appendix. Gross method is primary method for merchandising transactions, mimicking practice. Updated Sustainability section for each chapter, with examples linked to the new chapter-opening company. New annual reports and new real-world (FSA) assignments: Apple, Google, and Samsung. Revised art program, visual infographics, and text layout. Updated ratio/tool analysis using data from well-known firms. Revised General Ledger and Excel assignments for most chapters. New and revised entrepreneurial examples and elements. New technology content integrated and referenced throughout. Revised Global View section moved to the very end of each chapter following assignments. New Analysis assignments using real-world data from Apple, Google, and Samsung—titled Financial Analysis, Comparative Analysis, and Global Analysis. Chapter 1 Updated opener—Apple and entrepreneurial assignment. Updated salary info for accountants. Reorganized “Ethics” section to include enforcing ethics. Streamlined the “Fundamentals of Accounting” section. Shortened the “International Standards” section. Revised the business entity discussion along with adding LLC. Updated the section on revenue recognition. Updated section on accounting constraints. New layout for introducing the expanded accounting equation. New layout for introducing financial statements. Updated Apple numbers for NTK 1-5. Global View moved to follow assignments—for all chapters. Updated Social Index graph for sustainable investing in Decision Insight box. New company, Nike, and data for Decision Analysis section. Add two new Exercise assignments. Added new analysis assignments: Financial Analysis, Comparative Analysis, and Global Analysis. Chapter 2 NEW opener—Fitbit and entrepreneurial assignment. Revised chapter preview chart. Updated Apple’s analysis to launch chapter. New layout for the four types of accounts that determine equity. Enhanced Exhibit 2.4 to categorize individual accounts using accounting equation. Improved presentation of the “Double-Entry System” section. Added computation explanations to Exhibit 2.8. New presentation for “Summarizing Transactions in a Ledger” section. Enhanced section on financial statement preparation. Updated Apple data for NTK 2-4. New Sustainability discussion on the FitForGood organization. Updated debt ratio analysis using Costco. Added two new Quick Studies. Added one new Exercise. Updated Piaggio’s (IFRS) balance sheet in Global View. Chapter 3 NEW opener—Urban One and entrepreneurial assignment. Revised presentation of “Accrual Basis vs. Cash Basis” section. Updated “Recognizing Revenues and Expenses” section. New streamlined “Framework for Adjustments” section. Continue to emphasize 3-step adjusting process. Simplified the “Explanation” section for each adjustment. New graphic to introduce accrued services revenue. New and enhanced Exhibit 3.12 on summary of adjustments. New art distinguishing between temporary and permanent accounts. Shortened discussion of closing entries. Exhibit 3.17 color-coded all adjustments. Enhanced Exhibit 3.19 on steps of the accounting cycle with images. Streamlined section on a classified balance sheet. Sustainability section focuses on community involvement. Updated profit margin and current ratio analysis using Visa and Costco. Improved layouts for Exhibits 3A.1 to 3A.5. Appendix 3B and 3C moved to online only. Added one Quick Study and one Exercise linked to sustainability. Reorganized Global View section. Updated Piaggio’s classified balance sheet for Global View. Chapter 4 NEW opener—Build-A-Bear and entrepreneurial assignment. Revised introduction for servicers vs. merchandisers using Liberty Tax and Nordstrom. Streamlined introduction to inventory systems. New NTK 4-1 covers the basics of merchandising. Reorganization of “Purchases” section to aid learning. Enhanced entries on payment of purchases within discount period vs. after discount period. Reorganized explanation for FOB terms. Improved discussion of entries for sales with discounts vs. sales without discounts. Revised presentation of Exhibit 4.10. New Appendix 4B explains adjusting entries for future sales discounts, returns, and allowances. Color-coded Exhibit 4.12 to highlight different merchandising transactions. Sustainability section focuses on accounting to track donations to World Wildlife Fund. Updated acid-test ratio and gross margin analysis using Nike. Appendix 4C covers the net method. New Appendixes 4D and 4E moved to online only. Added one Quick Study and one Exercise related to sustainability. Updated Volkswagen income report in Global View. Chapter 5 NEW opener—Shake Shack and entrepreneurial assignment. Simplified the introduction to inventory costing. Shortened the explanation for specific identification. Revised image for each inventory method to show inventory at the shop and cost flows out for delivery. Added colored arrow lines to Exhibits 5.5 and 5.6 to show cost flows from purchases to sales. “Lower of Cost or Market” section greatly simplified. Enhanced layout to explain effects of inventory errors across years. New Sustainability section highlights key inventory ingredients for success. Updated inventory turnover and days’ sales in inventory analysis using Toys “R” Us. Appendix 5A: New images show inventory level and cost flow of goods for each inventory method. Added one Quick Study and two Exercises related to sustainability. Chapter 6 NEW opener—Care.com and entrepreneurial assignment. New framework from COSO to guide internal control, including the COSO cube. Streamlined discussion of principles of internal control. New discussion of internal control failure at Amazon that cost customers $150 million. New discussion box on fraud discovery with updated data from ACFE. New evidence from ACFE on how cash is stolen from companies. Streamlined the petty cash discussion. Simplified the bank statement for learning. New summary image on adjustments for bank balance and for book balance. Simplified discussion of debit and credit memoranda. Revised pie chart from ACFE on the top contributors to fraud. New Sustainability section explains how Care.com empowers women to realize their dreams. Updated days’ sales uncollected analysis using Starbucks and Jack in the Box. Added one Quick Study and two new Exercises. Chapter 7 NEW opener—Facebook and entrepreneurial assignment. Revised chapter preview chart. Page xiii New learning objectives, P2 and P3—combined as P2 in prior edition. Updated data in Exhibit 7.1. New section for sales using store credit cards. Simplified section for sales using bank (third-party) credit cards to focus on entries for cash received at point of sale. Revised NTK 7-1 for new credit card entries. Streamlined section on direct write-off method. New Exhibit 7.6 showing allowances set aside for future bad debts along with journal entries. Continued our 3-step adjustment applied to allowance for doubtful accounts. Continued Exhibit 7.10 showing the accounting adjustment in each case. New calendar graphic added as learning aid with Exhibit 7.12. New Sustainability section on Facebook’s commitment to clean energy. Updated accounts receivable analysis using Visa and Mastercard. Added one Quick Study and one Exercise related to sustainability. Added new Exercise covering receivables with a store credit card. Chapter 8 Updated opener—Kate Spade and entrepreneurial assignment. Updated data in Exhibit 8.1. Revised images for Exhibit 8.2. Added entry with Exhibit 8.3 Simplified Exhibit 8.4 for lump-sum purchases. Added Excel demos for straight-line (Exhibit 8.6) and double- declining balance (Exhibit 8.11). Simplified “Partial-Year Depreciation” section. Added margin table to Exhibit 8.14 as learning aid. New table to explain additional expenditures, including examples and entries. New simple introduction to finance leases and operating leases, including basic entries in the margin. Added paragraph on R&D expenditures. Updated asset turnover analysis using Starbucks and Jack in the Box. Simplified Appendix 8A by excluding exchanges without commercial substance. Added one Quick Study and one Exercise related to sustainability. Chapter 9 NEW opener—Pandora Media and entrepreneurial assignment. Streamlined first sections on defining and classifying liabilities. Updated data in Exhibit 9.2. Removed footnote on how to reverse calculate sales taxes. Streamlined “Short-Term Notes Payable” section. Simplified explanation of FICA taxes. Updated payroll tax rates and explanations. New section on internal controls for payroll. Simplified bonus explanation and computations. Updated new NTK 9-3 and NTK 9-4. New Sustainability section on Pandora’s energy efficiency. New W-4 form added to Appendix 9A. Added one Quick Study and one Exercise related to sustainability. Chapter 10 NEW opener—e.l.f. Cosmetics and entrepreneurial assignment. Streamlined section on bond financing. Shortened “Bond Issuing” section. Updated the IBM stock quote data. New NTK 10-1 covering bonds issued at par. Simplified Exhibit 10.6 on discount bonds by showing only one interest calculation. New T-accounts with Exhibit 10.6 to show bonds payable and the discount on bonds payable through maturity. Simplified numbers in Exhibit 10.7. Simplified Exhibit 10.10 on premium bonds. Simplified numbers in Exhibit 10.11. Bond pricing moved to Appendix 10A. Simplified Exhibit 10.12 for teaching note amortization schedule. New Sustainability section explains charitable donations from e.l.f. Updated debt-to-equity analysis using Nike and Under Armour. New Excel computations for bond pricing in Appendix 10A. Simplified numbers in Exhibits 10B.1 and 10B.2. Revised Appendix 10C to reflect new standard on finance leases and operating leases. Added one Quick Study and one Exercise related to sustainability. Chapter 11 NEW opener—Yelp and entrepreneurial assignment. Streamlined discussion of corporate form of organization. Updated the Target stock quote. Simplified “Cash Dividends” section. Simplified “Stock Dividends” section. Continued 5-step process for stock dividends. Streamlined section on dividend preference of preferred stock. Shortened section on reasons for issuing preferred stock. Updated the Apple statement of equity in Exhibit 11.10. New Sustainability section explains accounting for the Yelp Foundation. Updated PE and dividend yield using Amazon, Altria, Visa, and Mastercard. Simplified book value per share explanation and computations. Added two new Quick Study assignments related to sustainability. Chapter 12 NEW opener—Vera Bradley and entrepreneurial assignment. New box on Tesla’s cash outflows and growing market value. Slightly revised infographics on examples of cash flows from operating, investing, and financing. Kept 5-step process for preparing statement of cash flows. Streamlined sections on analyzing the cash account and noncash accounts. New graphic on use of indirect and direct methods in practice. New presentation to aid learning of indirect adjustments to income. Simplified T-accounts to reconstruct cash flows. Updated box comparing operating cash flows to income for companies. Simplified reconstruction entries to help compute cash flows. Kept “Summary T-Account” for learning statement of cash flows. New Sustainability section on accounting for Vera Bradley Foundation for Breast Cancer. Updated cash flow on total assets analysis using Nike and Under Armour. Added one Quick Study and one Exercise related to sustainability. Chapter 13 NEW opener—Morgan Stanley and entrepreneurial assignment. Streamlined “Basics of Analysis” section. Updated data for all analyses of Apple using horizontal, vertical, and ratio analysis. Updated comparative analysis using Google and Samsung. Streamlined section on ratio analysis. Revised Sustainability section on Morgan Stanley’s initiatives. Streamlined the analysis reporting section. Shortened Appendix 13A. Added one Quick Study and one Exercise related to sustainability. Appendix A New financial statements for Apple, Google, and Samsung. Appendix B New organization with detailed subheadings. Added Excel computations for PV and FV of single amounts. Added Excel computations for PV and FV of annuity. Appendix C Revised chapter preview chart. New learning objective P4 to account for new category of stock investments. Revised Exhibit C.2 to reflect new standard on accounting for stock investments with insignificant influence. Reorganized text to first explain debt securities then stock securities. Revised trading and available-for-sale securities to explain that this applies only to debt securities given the new standard. Continued 3-step process for fair-value adjustment of portfolios. New section on stock investments with significant influence. New Exhibit C.6 to describe accounting for equity securities by ownership level. Updated Google example for comprehensive income. Updated component-returns analysis using Gap. Investments in international operations set online as Appendix D. Contributors... Page xiv John J. Wild and McGraw-Hill Education recognize the following instructors for their valuable feedback and involvement in the development of Financial Accounting, 9e. We are thankful for their suggestions, counsel, and encouragement. Khaled Abdou, Penn State University–Berks Dee Amaradasa, North Central Texas College Anne Marie Anderson, Raritan Valley Community College Elaine Anes, Heald College–Fresno Jerome Apple, University of Akron Jack Aschkenazi, American Intercontinental University Sidney Askew, Borough of Manhattan Community College Lawrence Awopetu, University of Arkansas–Pine Bluff Jon Backman, Spartanburg Community College Charles Baird, University of Wisconsin–Stout Michael Barendse, Grossmont College Richard Barnhart, Grand Rapids Community College Beverly R. Beatty, Anne Arundel Community College Anna Beavers, Laney College Judy Benish, Fox Valley Technical College Patricia Bentley, Keiser University Teri Bernstein, Santa Monica College Jaswinder Bhangal, Chabot College Sandra Bitenc, University of Texas at Arlington Susan Blizzard, San Antonio College Marvin Blye, Wor-Wic Community College Patrick Borja, Citrus College Anna Boulware, St. Charles Community College Gary Bower, Community College of Rhode Island–Flanagan Leslee Brock, Southwest Mississippi Community College Gregory Brookins, Santa Monica College Regina Brown, Eastfield College Tracy L. Bundy, University of Louisiana at Lafayette Roy Carson, Anne Arundel Community College Deborah Carter, Coahoma Community College Roberto Castaneda, DeVry University Online Martha Cavalaris, Miami Dade College Amy Chataginer, Mississippi Gulf Coast Community College Gerald Childs, Waukesha County Technical College Colleen Chung, Miami Dade College–Kendall Shifei Chung, Rowan University Robert Churchman, Harding University Marilyn Ciolino, Delgado Community College Thomas Clement, University of North Dakota Oyinka Coakley, Broward College Susan Cockrell, Birmingham-Southern College Jay Cohen, Oakton Community College Lisa Cole, Johnson County Community College Robbie R. Coleman, Northeast Mississippi Community College Christie Comunale, Long Island University–C.W. Post Campus Jackie Conrecode, Florida Gulf Coast University Debora Constable, Georgia Perimeter College Shawna Coram, Florida State College at Jacksonville Susan Cordes, Johnson County Community College Anne Cordozo, Broward College Cheryl Corke, Genesee Community College James Cosby, John Tyler Community College Ken Couvillion, Delta College Loretta Darche, Southwest Florida College Judy Daulton, Piedmont Technical College Annette Davis, Glendale Community College Dorothy Davis, University of Louisiana–Monroe Walter DeAguero, Saddleback College Mike Deschamps, MiraCosta College Pamela Donahue, Northern Essex Community College Steve Doster, Shawnee State University Larry Dragosavac, Edison Community College Samuel Duah, Bowie State University Robert Dunlevy, Montgomery County Community College Jerrilyn Eisenhauer, Tulsa Community College–Southeast Ronald Elders, Virginia College Terry Elliott, Morehead State University Patricia Feller, Nashville State Community College Albert Fisher, College of Southern Nevada Annette Fisher, Glendale Community College Ron Fitzgerald, Santa Monica College David Flannery, Bryant and Stratton College Hollie Floberg, Tennessee Wesleyan College Linda Flowers, Houston Community College Jeannie Folk, College of DuPage Rebecca Foote, Middle Tennessee State University Paul Franklin, Kaplan University Tim Garvey, Westwood College Barbara Gershman, Northern Virginia Community College– Woodbridge Barbara Gershowitz, Nashville State Technical Community College Mike Glasscock, Amarillo College Diane Glowacki, Tarrant County College Ernesto Gonzalez, Florida National College Lori Grady, Bucks County Community College Gloria Grayless, Sam Houston State University Ann Gregory, South Plains College Rameshwar Gupta, Jackson State University Amy Haas, Kingsborough Community College Pat Halliday, Santa Monica College Keith Hallmark, Calhoun Community College Rebecca Hancock, El Paso Community College–Valley Verde Mechelle Harris, Bossier Parish Community College Tracey Hawkins, University of Cincinnati–Clermont College Thomas Hayes, University of Arkansas–Ft. Smith Laurie Hays, Western Michigan University Roger Hehman, University of Cincinnati–Clermont College Sueann Hely, West Kentucky Community & Technical College Cheri Hernandez, Des Moines Area Community College Margaret Hicks, Howard University Melanie Hicks, Liberty University James Higgins, Holy Family University Patricia Holmes, Des Moines Area Community College Barbara Hopkins, Northern Virginia Community College–Manassas Wade Hopkins, Heald College Aileen Huang, Santa Monica College Les Hubbard, Solano College Deborah Hudson, Gaston College James Hurst, National College Page xv Constance Hylton, George Mason University Christine Irujo, Westfield State University Tamela Jarvais, Prince George’s Community College Fred Jex, Macomb Community College Gina M. Jones, Aims Community College Jeff Jones, College of Southern Nevada Rita Jones, Columbus State University Odessa Jordan, Calhoun Community College Dmitriy Kalyagin, Chabot College Thomas Kam, Hawaii Pacific University Naomi Karolinski, Monroe Community College Shirly A. Kleiner, Johnson County Community College Kenneth A. Koerber, Bucks County Community College Jill Kolody, Anne Arundel Community College Tamara Kowalczyk, Appalachian State University Anita Kroll, University of Wisconsin–Madison David Krug, Johnson County Community College Christopher Kwak, DeAnza College Tara Laken, Joliet Junior College Margaret Costello Lambert, Oakland Community College Jeanette Landin, Empire College Beth Lasky, Delgado Community College Miriam Lefkowitz, CUNY–Brooklyn College Neal Leviton, Santa Monica College Adria N. Lindquist, Christopher Newport University Danny Litt, University of California, Los Angeles James L. Lock, Northern Virginia Community College Steve Ludwig, Northwest Missouri State University Debra Luna, El Paso Community College Amado Mabul, Heald College Lori Major, Luzerne County Community College Jennifer Malfitano, Delaware County Community College Maria Mari, Miami Dade College–Kendall Thomas S. Marsh, Northern Virginia Community College– Annandale Karen Martinson, University of Wisconsin–Stout Brenda Mattison, Tri-County Technical College Stacie Mayes, Rose State College Mark McCarthy, East Carolina University Clarice McCoy, Brookhaven College Tammy Metzke, Milwaukee Area Technical College Jeanine Metzler, Northampton Community College Theresa Michalow, Moraine Valley Community College Julie Miller, Chippewa Valley Technical College Tim Miller, El Camino College John Minchin, California Southern University Edna C. Mitchell, Polk State College Jill Mitchell, Northern Virginia Community College April Mohr, Jefferson Community and Technical College, SW Lynn Moore, Aiken Technical College Angela Mott, Northeast Mississippi Community College Andrea Murowski, Brookdale Community College Timothy Murphy, Diablo Valley College Kenneth F. O’Brien, Farmingdale State College Kathleen O’Donnell, Onondaga Community College Ahmed Omar, Burlington County College Robert A. Pacheco, Massasoit Community College Margaret Parilo, Cosumnes River College Paige Paulsen, Salt Lake Community College Yvonne Phang, Borough of Manhattan Community College Chuck Pier, Angelo State University Gary Pieroni, Diablo Valley College Susan H. Pope, University of Akron Debbie Porter, Tidewater Community College, Virginia Beach Kristen Quinn, Northern Essex Community College James Racic, Lakeland Community College David Ravetch, University of California, Los Angeles Ruthie Reynolds, Howard University Cecile Roberti, Community College of Rhode Island Morgan Rockett, Moberly Area Community College Patrick Rogan, Cosumnes River College Paul Rogers, Community College of Beaver County Brian Routh, Washington State University–Vancouver Helen Roybark, Radford University Alphonse Ruggiero, Suffolk County Community College Joan Ryan, Clackamas Community College Martin Sabo, Community College of Denver Arjan Sadhwani, South University Gary K. Sanborn, Northwestern Michigan College Kin Kin Sandhu, Heald College Marcia Sandvold, Des Moines Area Community College Gary Schader, Kean University Barbara Schnathorst, The Write Solution, Inc. Darlene Schnuck, Waukesha County Technical College Elizabeth Serapin, Columbia Southern University Geeta Shankhar, University of Dayton Regina Shea, Community College of Baltimore County–Essex James Shelton, Liberty University Jay Siegel, Union County College Gerald Singh, New York City College of Technology Lois Slutsky, Broward College–South Gerald Smith, University of Northern Iowa Ryan Smith, Columbia College Chicago Kathleen Sobieralski, University of Maryland University College Charles Spector, State University of New York at Oswego Diane Stark, Phoenix College Thomas Starks, Heald College Carolyn L. Strauch, Crowder College Latazia Stuart, Fortis University Online Gene Sullivan, Liberty University David Sulzen, Ferrum College Dominique Svarc, William Rainey Harper College Linda Sweeney, Sam Houston State University Carl Swoboda, Southwest Tennessee Community College, Macon Diane Tanner, University of North Florida Margaret Tanner, University of Arkansas–Ft. Smith Ulysses Taylor, Fayetteville State University Anthony Teng, Saddleback College Paula Thomas, Middle Tennessee State University Teresa Thompson, Chaffey Community College Leslie Thysell, John Tyler Community College Melanie Torborg, Globe University Shafi Ullah, Broward College Bob Urell, Irvine Valley College Adam Vitalis, Georgia Tech Patricia Walczak, Lansing Community College Terri Walsh, Seminole State College–Oviedo Shunda Ware, Atlanta Technical College Janis Weber, University of Louisiana–Monroe Dave Welch, Franklin University Page xvi Joe Welker, College of Western Idaho Jean Wells–Jessup, Howard University Christopher Widmer, Tidewater Community College Jonathan M. Wild, Oklahoma State University Andrew Williams, Edmonds Community College Wanda Wong, Chabot College John Woodward, Polk State College Patricia Worsham, Norco College, Riverside Community College Gail E. Wright, Stevenson University Kean Wu, Rochester Institute of Technology Lynnette Yerbury, Salt Lake Community College Judy Zander, Grossmont College Mary Zenner, College of Lake County Jane Zlojutro, Northwestern Michigan College Many talented educators and professionals have worked hard to create the materials for this product, and for their efforts, I’m grateful. I extend a special thank you to our contributing and technology supplement authors, who have worked so diligently to support this product. Contributing Author: Kathleen O’Donnell, Onondaga Community College Accuracy Checkers: Dave Krug, Johnson County Community College; Mark McCarthy, East Carolina University; and Beth Kobylarz LearnSmart Author: April Mohr, Jefferson Community and Technical College, SW Concept Overview Videos: April Mohr, Jefferson Community and Technical College, SW PowerPoint Presentations and Instructor Resource Manual: April Mohr, Jefferson Community and Technical College, SW Digital Contributor, Connect Content, General Ledger Problems, Test Bank, and Exercise PowerPoints: Kathleen O’Donnell, Onondaga Community College Special recognition extends to the entire team at McGraw-Hill Education: Tim Vertovec, Steve Schuetz, Natalie King, Zach Rudin, Julie Wolfe, Michele Janicek, Michael McCormick, Lori Koetters, Xin Lin, Kevin Moran, Debra Kubiak, Brian Nacik, and Daryl Horrocks. I could not have published this new edition without your efforts. John J. Wild Brief Contents Page xvii 1 Introducing Financial Statements 2 2 Financial Statements and the Accounting System 50 3 Adjusting Accounts for Financial Statements 98 4 Reporting and Analyzing Merchandising Operations 160 5 Reporting and Analyzing Inventories 214 6 Reporting and Analyzing Cash, Fraud, and Internal Control 262 7 Reporting and Analyzing Receivables 302 8 Reporting and Analyzing Long-Term Assets 336 9 Reporting and Analyzing Current Liabilities 378 10 Reporting and Analyzing Long-Term Liabilities 422 11 Reporting and Analyzing Equity 462 12 Reporting and Analyzing Cash Flows 502 13 Analyzing and Interpreting Financial Statements 548 A Financial Statement Information A-1 B Applying Present and Future Values B C Investments C D International Operations (online) Contents Page xviii Preface iv 1 Introducing Financial Statements 2 Importance of Accounting 4 Users of Accounting Information 4 Opportunities in Accounting 5 Fundamentals of Accounting 7 Ethics—A Key Concept 7 Generally Accepted Accounting Principles 8 International Standards 8 Conceptual Framework 9 Business Transactions and Accounting 11 Accounting Equation 11 Transaction Analysis 13 Summary of Transactions 16 Communicating with Users 17 Income Statement 17 Statement of Retained Earnings 19 Balance Sheet 19 Statement of Cash Flows 19 Decision Analysis—Return on Assets 21 Appendix 1A Return and Risk 25 Appendix 1B Business Activities 25 Global View 49 2 Financial Statements and the Accounting System 50 Using Financial Statements 52 Using Ratios to Analyze Financial Statements 52 Liquidity (and Efficiency) 53 Solvency 53 Profitability 53 Market Prospects 53 Summarizing Ratios 53 Basis of Financial Statements 54 Source Documents 54 The “Account” Underlying Financial Statements 54 Ledger and Chart of Accounts 57 Double-Entry Accounting 58 Debits and Credits 58 Double-Entry System 59 Analyzing and Processing Transactions 60 Journalizing and Posting Transactions 60 Processing Transactions—An Example 63 Summarizing Transactions in a Ledger 67 Trial Balance 69 Preparing a Trial Balance 69 Financial Statements Prepared from Trial Balance 70 Decision Analysis—Debt Ratio 74 Global View 96 3 Adjusting Accounts for Financial Statements 98 Timing and Reporting 100 The Accounting Period 100 Accrual Basis versus Cash Basis 100 Recognizing Revenues and Expenses 101 Framework for Adjustments 102 Deferral of Expense 102 Prepaid Insurance 102 Supplies 103 Other Prepaid Expenses 104 Depreciation 104 Deferral of Revenue 106 Unearned Consulting Revenue 107 Accrued Expense 108 Accrued Salaries Expense 108 Accrued Interest Expense 109 Future Cash Payment of Accrued Expenses 110 Accrued Revenue 110 Accrued Services Revenue 111 Accrued Interest Revenue 112 Future Cash Receipt of Accrued Revenues 112 Links to Financial Statements 113 Trial Balance and Financial Statements 113 Adjusted Trial Balance 113 Preparing Financial Statements 114 Closing Process 116 Temporary and Permanent Accounts 117 Recording Closing Entries 117 Post-Closing Trial Balance 120 Accounting Cycle 121 Classified Balance Sheet 122 Classification Structure 122 Classification Categories 122 Decision Analysis—Profit Margin and Current Ratio 124 Appendix 3A Alternative Accounting for Prepayments 129 Page xix Appendix 3B Work Sheet as a Tool (online) Appendix 3C Reversing Entries (online) Global View 158 4 Reporting and Analyzing Merchandising Operations 160 Merchandising Activities 162 Reporting Income for a Merchandiser 162 Reporting Inventory for a Merchandiser 162 Operating Cycle for a Merchandiser 163 Inventory Systems 163 Accounting for Merchandise Purchases 164 Purchases without Cash Discounts 164 Purchases with Cash Discounts 165 Purchases with Returns and Allowances 166 Purchases and Transportation Costs 167 Accounting for Merchandise Sales 169 Sales without Cash Discounts 170 Sales with Cash Discounts 170 Sales with Returns and Allowances 171 Adjusting and Closing for Merchandisers 173 Adjusting Entries for Merchandisers 173 Preparing Financial Statements 174 Closing Entries for Merchandisers 174 Summary of Merchandising Entries 174 More on Financial Statement Formats 176 Multiple-Step Income Statement 176 Single-Step Income Statement 177 Classified Balance Sheet 178 Decision Analysis—Acid-Test and Gross Margin Ratios 180 Appendix 4A Periodic System 184 Appendix 4B Adjusting Entries under New Revenue Recognition Rules 188 Appendix 4C Net Method 190 Appendix 4D Work Sheet—Perpetual System (online) Appendix 4E Work Sheet—Periodic System (online) Global View 212 5 Reporting and Analyzing Inventories 214 Inventory Basics 216 Determining Inventory Items 216 Determining Inventory Costs 216 Internal Controls and Taking a Physical Count 216 Inventory Costing under a Periodic System 217 Inventory Cost Flow Assumptions 217 Inventory Costing Illustration 218 Specific Identification 219 First-In, First-Out 219 Last-In, First-Out 220 Weighted Average 221 Financial Statement Effects of Costing Methods 221 Valuing Inventory at LCM and the Effects of Inventory Errors 223 Lower of Cost or Market 223 Financial Statement Effects of Inventory Errors 225 Decision Analysis—Inventory Turnover and Days’ Sales in Inventory 227 Appendix 5A Inventory Costing under a Perpetual System 234 Appendix 5B Inventory Estimation Methods 240 Global View 260 6 Reporting and Analyzing Cash, Fraud, and Internal Control 262 Fraud and Internal Control 264 Purpose of Internal Control 264 Principles of Internal Control 264 Technology, Fraud, and Internal Control 266 Limitations of Internal Control 267 Control of Cash 268 Cash, Cash Equivalents, and Liquidity 268 Cash Management 268 Control of Cash Receipts 269 Control of Cash Disbursements 270 Banking Activities as Controls 275 Basic Bank Services 275 Bank Statement 276 Bank Reconciliation 277 Decision Analysis—Days’ Sales Uncollected 282 Appendix 6A Documentation and Verification 284 Global View 301 7 Reporting and Analyzing Receivables 302 Valuing Accounts Receivable 304 Direct Write-Off Method 306 Allowance Method 308 Estimating Bad Debts 310 Percent of Sales Method 310 Percent of Receivables Method 311 Aging of Receivables Method 311 Notes Receivable 314 Computing Maturity and Interest 315 Recording Notes Receivable 315 Valuing and Settling Notes 316 Disposal of Receivables 317 Decision Analysis—Accounts Receivable Turnover 318 Global View 334 Page xx 8 Reporting and Analyzing Long-Term Assets 336 SECTION 1—PLANT ASSETS 338 Cost Determination 338 Machinery and Equipment 339 Buildings 339 Land Improvements 339 Land 339 Lump-Sum Purchase 339 Depreciation 340 Factors in Computing Depreciation 340 Depreciation Methods 341 Partial-Year Depreciation 344 Change in Estimates 345 Reporting Depreciation 345 Additional Expenditures 346 Ordinary Repairs 347 Betterments and Extraordinary Repairs 347 Disposals of Plant Assets 348 Discarding Plant Assets 348 Selling Plant Assets 349 SECTION 2—NATURAL RESOURCES 351 Cost Determination and Depletion 351 Plant Assets Tied into Extracting 352 SECTION 3—INTANGIBLE ASSETS 352 Cost Determination and Amortization 352 Types of Intangibles 353 Decision Analysis—Total Asset Turnover 356 Appendix 8A Exchanging Plant Assets 360 Global View 376 9 Reporting and Analyzing Current Liabilities 378 Known Liabilities 380 Characteristics of Liabilities 380 Accounts Payable 381 Sales Taxes Payable 381 Unearned Revenues 382 Short-Term Notes Payable 382 Payroll Liabilities 385 Employee Payroll and Deductions 385 Employer Payroll Taxes 386 Internal Control of Payroll 387 Multi-Period Known Liabilities 388 Estimated Liabilities 389 Health and Pension Benefits 389 Vacation Benefits 389 Bonus Plans 390 Warranty Liabilities 390 Multi-Period Estimated Liabilities 391 Contingent Liabilities 392 Accounting for Contingent Liabilities 392 Applying Rules of Contingent Liabilities 392 Uncertainties That Are Not Contingencies 393 Decision Analysis—Times Interest Earned Ratio 394 Appendix 9A Payroll Reports, Records, and Procedures 396 Appendix 9B Corporate Income Taxes 402 Global View 421 10 Reporting and Analyzing Long-Term Liabilities 422 Basics of Bonds 424 Bond Financing 424 Bond Issuing 425 Bond Trading 425 Par Bonds 425 Discount Bonds 426 Bond Discount or Premium 426 Issuing Bonds at a Discount 427 Premium Bonds 429 Issuing Bonds at a Premium 429 Bond Retirement 432 Long-Term Notes Payable 433 Installment Notes 433 Mortgage Notes and Bonds 435 Decision Analysis—Debt Features and the Debt-to- Equity Ratio 436 Appendix 10A Bond Pricing 440 Appendix 10B Effective Interest Amortization 441 Appendix 10C Leases and Pensions 443 Global View 461 11 Reporting and Analyzing Equity 462 Corporate Form of Organization 464 Corporate Advantages 464 Corporate Disadvantages 464 Corporate Organization and Management 464 Corporate Stockholders 465 Corporate Stock 466 Common Stock 467 Issuing Par Value Stock 467 Issuing No-Par Value Stock 468 Page xxi Issuing Stated Value Stock 468 Issuing Stock for Noncash Assets 468 Dividends 469 Cash Dividends 469 Stock Dividends 470 Stock Splits 472 Preferred Stock 473 Issuance of Preferred Stock 473 Dividend Preference of Preferred Stock 474 Reasons for Issuing Preferred Stock 474 Treasury Stock 476 Purchasing Treasury Stock 476 Reissuing Treasury Stock 476 Reporting of Equity 478 Statement of Retained Earnings 478 Statement of Stockholders’ Equity 479 Decision Analysis—Earnings per Share, Price-Earnings Ratio, Dividend Yield, and Book Value per Share 479 Global View 500 12 Reporting and Analyzing Cash Flows 502 Basics of Cash Flow Reporting 504 Purpose of the Statement of Cash Flows 504 Importance of Cash Flows 504 Measurement of Cash Flows 504 Classification of Cash Flows 504 Noncash Investing and Financing 506 Format of the Statement of Cash Flows 506 Preparing the Statement of Cash Flows 507 Cash Flows from Operating 508 Indirect and Direct Methods of Reporting 508 Applying the Indirect Method 509 Summary Adjustments for Indirect Method 511 Cash Flows from Investing 513 Three-Step Analysis 513 Analyzing Noncurrent Assets 513 Cash Flows from Financing 514 Three-Step Analysis 514 Analyzing Noncurrent Liabilities 514 Analyzing Equity 515 Proving Cash Balances 516 Summary Using T-Accounts 517 Decision Analysis—Cash Flow Analysis 518 Appendix 12A Spreadsheet Preparation of the Statement of Cash Flows 521 Appendix 12B Direct Method of Reporting Operating Cash Flows 523 Global View 547 13 Analyzing and Interpreting Financial Statements 548 Basics of Analysis 550 Purpose of Analysis 550 Building Blocks of Analysis 550 Information for Analysis 550 Standards for Comparisons 551 Tools of Analysis 551 Horizontal Analysis 551 Comparative Statements 551 Trend Analysis 554 Vertical Analysis 555 Common-Size Statements 555 Common-Size Graphics 557 Ratio Analysis 559 Liquidity and Efficiency 559 Solvency 562 Profitability 563 Market Prospects 564 Summary of Ratios 564 Decision Analysis—Analysis Reporting 566 Appendix 13A Sustainable Income 569 Global View 587 Appendix AFinancial Statement Information A-1 Apple A-2 Google A-10 Samsung A-14 Appendix BApplying Present and Future Values B Appendix CInvestments C Appendix DInternational Operations (online) Index IND-1 Chart of Accounts CA Brief Review Financial Reports and Tables BR Selected Transactions and Relations BR-1 Fundamentals and Analyses BR-2 Design elements: Lightbulb: ©Chuhail/Getty Images RF; Blue globe: ©nidwlw/Getty Images RF and ©Dizzle52/Getty Images RF; Chess piece: ©Andrei Simonenko/Getty Images RF and ©Dizzle52/Getty Images RF; Mouse: ©Siede Preis/Getty Images RF; Global View globe: ©McGraw-Hill Education and ©Dizzle52/Getty Images RF; Sustainability: ©Dizzle52/Getty Images RF Page 2 chapter 1 Introducing Financial Statements Chapter Preview ACCOUNTING USES C1 Purpose of accounting C2 Accounting information users Opportunities in accounting NTK 1-1 ETHICS AND ACCOUNTING C3 Ethics—Key concept C4 Generally accepted accounting principles Conceptual framework NTK 1-2 TRANSACTION ANALYSIS A1 Accounting equation and its components Expanded accounting equation P1 Transaction analysis—Illustrated NTK 1-3, 1-4 FINANCIAL STATEMENTS P2 Income statement Statement of retained earnings Balance sheet Statement of cash flows A2 Financial analysis NTK 1-5 Chapter Preview is organized by key ‘blocks’ of content and includes learning objectives followed by Need-To-Know (NTK) guided video examples Learning Objectives are classified as conceptual, analytical, or procedural Learning Objectives CONCEPTUAL C1 Explain the purpose and importance of accounting. C2 Identify users and uses of, and opportunities in, accounting. C3 Explain why ethics are crucial to accounting. C4 Explain generally accepted accounting principles and define and apply several accounting principles. C5 Appendix 1B—Identify and describe the three major activities of organizations. ANALYTICAL A1 Define and interpret the accounting equation and each of its components. A2 Compute and interpret return on assets. A3 Appendix 1A—Explain the relation between return and risk. PROCEDURAL P1 Analyze business transactions using the accounting equation. P2 Identify and prepare basic financial statements and explain how they interrelate. Page 3 ©Albert L. Ortega/Getty Images Big Apple “The first Apple was … my whole life” —Steve Wozniak A Decision Feature launches each chapter showing the relevance of accounting for a real entrepreneur. An Entrepreneurial Decision assignment returns to this feature with a mini-case CUPERTINO, CA—“When I designed the Apple stuff,” says Steve Wozniak, “I never thought in my life I would have enough money to fly to Hawaii or make a down payment on a house.” But some dreams do come true. Woz, along with Steve Jobs and Ron Wayne, founded Apple (Apple.com) when Woz was 25 and Jobs was 21. Today, Apple boasts a value of over $700 billion and revenues of over $200 billion—recent revenues and income follow. The young entrepreneurs faced challenges, including how to read and interpret accounting data. They also needed to finance the company, which they did by selling Woz’s HP calculator and Jobs’s Volkswagen van. The $1,300 raised helped them purchase the equipment Woz used to build the first Apple computer. In setting up their company, the owners chose between a partnership and a corporation. They decided on a partnership that included Ron as a third partner with 10% ownership. A few days later, Ron had a change of heart when he considered the unlimited liability of a partnership. He pulled out, giving up his 10% ownership, worth roughly $70 billion today. Within nine months, Woz and Jobs converted Apple to a corporation. As Apple grew, Woz and Jobs had to learn more accounting, along with details of preparing and interpreting financial statements. Important questions involving transaction analysis and financial reporting arose, and the owners took care to do things right. “Everything we did,” asserts Woz, “we were setting the tone for the world.” Apple’s stock price reflects that tone. Woz and Jobs focused their accounting system to provide information for Apple’s business decisions. Today, Woz believes that Apple is key to the language of technology, just as accounting is the language of business. In retrospect, Woz says, “Every dream I have ever had in life has come true ten times over.” Sources: Apple website, January 2018; Woz.org, January 2018; Apple 2016 Sustainability Report, April 2016; Greenbiz, October 2014; iWoz: From Computer Geek to Cult Icon, W.W. Norton & Co., 2006; Founders at Work, Apress, 2007 Page 4 IMPORTANCE OF ACCOUNTING C1 Explain the purpose and importance of accounting. Why is accounting so popular on campus? Why are there so many openings for accounting jobs? Why is accounting so important to companies? Why do politicians and business leaders focus on accounting regulations? The answer is that we live in an information age in which accounting information impacts us all. Accounting is an information and measurement system that identifies, records, and communicates information about an organization’s business activities. Exhibit 1.1 shows these accounting functions. Exhibit 1.1 Accounting Functions Our most common contact with accounting is through credit approvals, checking accounts, tax forms, and payroll. These experiences focus on recordkeeping, or bookkeeping, which is the recording of transactions and events. This is just one part of accounting. Accounting also includes the analysis and interpretation of information. Technology plays a major role in accounting. Technology reduces the time, effort, and cost of recordkeeping while improving accuracy. As technology makes more information available, the demand for accounting knowledge increases. Consulting, planning, and other financial services are closely linked to accounting. Point: Technology is only as useful as the accounting data available, and users’ decisions are only as good as their understanding of accounting. Users of Accounting Information C2 Identify users and uses of, and opportunities in, accounting. Accounting is called the language of business because it communicates data that help people make better decisions. Exhibit 1.2 divides these people into two groups, external users and internal users, and provides examples of each. Exhibit 1.2 Users of Accounting Information Infographics reinforce key concepts through visual learning Page 5 External Information Users External users of accounting information do not directly run the organization and have limited access to its accounting information. Financial accounting serves external users by providing them with general-purpose financial statements. The term general-purpose refers to the broad range of purposes for these statements. Following is a partial list of external users and decisions they make with accounting information. Lenders (creditors) loan money or other resources to an organization. Banks, savings and loans, and mortgage companies are lenders. Lenders use information to assess if an organization will repay its loans with interest. Shareholders (investors) are the owners of a corporation. They use accounting reports to decide whether to buy, hold, or sell stock. Boards of directors oversee organizations. Directors use accounting information to evaluate the performance of executive management. External (independent) auditors examine financial statements to verify that they are prepared according to generally accepted accounting principles. Nonexecutive employees and labor unions use accounting information to assess job prospects and bargain for better wages. Regulators have legal authority over certain activities of organizations. For example, the Internal Revenue Service (IRS) requires accounting reports in computing taxes. Voters, legislators, and government officials use accounting information to evaluate government performance. Contributors to nonprofit organizations use accounting information to evaluate the use and impact of their donations. Suppliers use accounting information to judge the financial health of a customer before making sales on credit. Customers use financial reports to assess the staying power of potential suppliers. Internal Information Users Internal users of accounting information directly manage organization operations. Managerial accounting serves the decision-making needs of internal users. Internal reports are designed for the unique needs of managerial or executive employees, such as the chief executive officer (CEO). Following is a partial list of internal users and decisions they make with accounting information. Research and development managers need information about projected costs and revenues of innovations. Purchasing managers need to know what, when, and how much to purchase. Human resource managers need information about employees’ payroll, benefits, and performance. Production managers use information to monitor costs and ensure quality. Distribution managers need reports for timely and accurate delivery of products and services. Marketing managers use reports about sales and costs to target consumers, set prices, and monitor consumer needs. Service managers require information on costs and benefits of looking after products and services. Opportunities in Accounting Accounting has four areas of opportunities: financial, managerial, taxation, and accounting-related. Exhibit 1.3 lists selected opportunities in each area. Page 6 Exhibit 1.3 Accounting Opportunities Exhibit 1.4 shows that the majority of opportunities are in private accounting, which are employees working for businesses. Public accounting involves accounting services such as auditing and taxation. Opportunities also exist in government and not-for- profit agencies, including business regulation and law enforcement. Exhibit 1.4 Accounting Jobs by Area Accounting specialists are highly regarded, and their professional standing is often denoted by a certificate. Certified public accountants (CPAs) must meet education and experience requirements, pass an exam, and be ethical. Many accounting specialists hold certificates in addition to or instead of the CPA. Two of the most common are the certificate in management accounting (CMA) and the certified internal auditor (CIA). Employers also look for specialists with designations such as certified bookkeeper (CB), certified payroll professional (CPP), certified fraud examiner (CFE), and certified forensic accountant (CrFA). Point: The largest accounting firms are EY, KPMG, PwC, and Deloitte. Point: Census Bureau reports that higher education yields higher pay: Master’s degree $73,738 Bachelor’s degree 56,665 Associate’s degree 39,771 High school degree 30,627 No high school degree 20,241 Accounting specialists are in demand. Exhibit 1.5 reports average annual salaries for several accounting positions. Salaries vary based on location, company size, and other factors. Exhibit 1.5 Accounting Salaries for Selected Positions NEED-TO-KNOWs highlight key procedures and concepts in learning Page 7 accounting NEED-TO-KNOW 1-1 Accounting Users C1 C2 Identify the following users of accounting information as either an (a) external or (b) internal user. 1. ________ Regulator 2. ________ CEO 3. ________ Shareholder 4. ________ Controller 5. ________ Executive employee 6. ________ External auditor 7. ________ Production manager 8. ________ Nonexecutive employee Solution 1. a 2. b 3. a 4. b 5. b 6. a 7. b 8. a Do More: QS 1-1, QS 1-2, E 1-1, E 1-2, E 1-3 FUNDAMENTALS OF ACCOUNTING Accounting is guided by principles, standards, concepts, and assumptions. This section describes several of these key fundamentals of accounting. Ethics—A Key Concept C3 Explain why ethics are crucial to accounting. For information to be useful, it must be trusted. This demands ethics in accounting. Ethics are beliefs that separate right from wrong. They are accepted standards of good and bad behavior. Identifying the ethical path is a course of action that avoids casting doubt on one’s decisions. To help, ethics rules are often set. Exhibit 1.6 gives a three-step process for making ethical decisions. Exhibit 1.6 Ethical Decision Making Accountants face ethical choices as they prepare financial reports. These choices can affect the salaries and bonuses paid to workers. They can even affect the success of products and services. Misleading information can lead to a wrongful closing of a division that harms workers and the business. There is an old saying: Good ethics are good business. Point: A Code of Conduct is available at AICPA.org. Fraud Triangle: Ethics under Attack The fraud triangle shows that three factors push a person to commit fraud. Opportunity. A person must be able to commit fraud with a low risk of getting caught. Pressure, or incentive. A person must feel pressure or have incentive to commit fraud. Rationalization, or attitude. A person justifies fraud or does not see its criminal nature. The key to stopping fraud is to focus on prevention. It is less expensive and more effective to prevent fraud from happening than it is to detect it. By the time a fraud is discovered, the money is often gone. Point: ACFE reports 86% of fraud victims recover none or only part of their losses. Internal controls are used to reduce fraud. Internal controls are procedures to protect assets, ensure reliable accounting, promote efficiency, and uphold company policies. Examples are good records, physical controls (locks), and independent reviews. Page 8 Ethical Risk boxes highlight ethical issues from practice Ethical risk Cooking the Books Our economic and social welfare depends on reliable accounting. Some individuals forgot that and are now paying their dues. They include Hisao Tanaka of Toshiba, guilty of inflating income by $1.2 billion over five years; Tsuyoshi Kikukawa of Olympus, guilty of hiding $1.7 billion in losses; Bernard Ebbers of WorldCom, convicted of an $11 billion accounting scandal; Andrew Fastow of Enron, guilty of hiding debt and inflating income; and Ramalinga Raju of Satyam Computers, accused of overstating assets by $1.5 billion. ©Craig Ruttle/AP Images Real company names are in bold magenta Enforcing Ethics In response to major accounting scandals, like those at Enron and WorldCom, Congress passed the Sarbanes-Oxley Act, also called SOX, to help stop financial abuses. SOX requires documentation and verification of internal controls and emphasizes effective internal controls. Management must issue a report stating that internal controls are effective. Auditors must verify the effectiveness of internal controls. Ignoring SOX can lead to penalties and criminal prosecution of executives. CEOs and CFOs who knowingly sign off on bogus accounting reports risk millions of dollars in fines and years in prison. Point: An audit examines whether financial statements are prepared using GAAP. Point: Bloomberg Businessweek reports that external audit costs run about $35,000 for start- ups, up from $15,000 pre-SOX. Some of the more publicized accounting scandals in recent years follow. Point: SOX requires a business that sells stock to disclose a code of ethics for its executives. Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd- Frank, has two notable provisions: Clawback Mandates recovery (clawback) of excess incentive compensation. Whistleblower SEC pays whistleblowers 10% to 30% of sanctions exceeding $1 million. Generally Accepted Accounting Principles C4 Explain generally accepted accounting principles and define and apply several accounting principles. Financial accounting is governed by concepts and rules known as generally accepted accounting principles (GAAP). GAAP aims to make information relevant, reliable, and comparable. Relevant information affects decisions of users. Reliable information is trusted by users. Comparable information helps contrast organizations. The Securities and Exchange Commission (SEC), a U.S. government agency, has the legal authority to set GAAP. The SEC oversees proper use of GAAP by companies that raise money from the public through issuance of stock and debt. The SEC has largely given the task of setting U.S. GAAP to the Financial Accounting Standards Board (FASB), which is a group that sets accounting principles. Point: CPAs who audit financial statements must disclose where those statements do not comply with GAAP. If CPAs do not report noncompliance, they can lose their licenses and be subject to criminal and civil actions and fines. Page 9 International Standards Our global economy demands comparability in accounting reports. The International Accounting Standards Board (IASB), a group consisting of individuals from many countries, issues International Financial Reporting Standards (IFRS) that identify preferred accounting practices. These standards are similar to, but sometimes different from, U.S. GAAP. The FASB and IASB are working to reduce differences in U.S. GAAP and IFRS. Global View section covers international accounting relevant to each chapter—it is located after each chapter’s assignments Conceptual Framework The FASB conceptual framework consists broadly of the following: Objectives—to provide information useful to investors, creditors, and others. Qualitative Characteristics—to require relevant, reliable, and comparable information. Elements—to define items that financial statements can contain. Recognition and Measurement—to set criteria for an item to be recognized as an element; and how to measure it. Point: For updates on the FASB and IASB conceptual framework, check FASB.org or ifrs.org. Principles and Assumptions of Accounting There are two types of accounting principles (and assumptions). General principles are the assumptions, concepts, and guidelines for preparing financial statements; these are shown in purple font in Exhibit 1.7, along with key assumptions in red font. Specific principles are detailed rules used in reporting business transactions and events; they are described as we encounter them. Exhibit 1.7 Building Blocks for GAAP Accounting Principles General principles consist of at least four basic principles, four assumptions, and one constraint. Measurement principle (cost principle) Accounting information is based on actual cost (with possible later adjustments to market). Cost is measured on a cash or equal-to-cash basis. This means if cash is given for a service, its cost is measured by the cash paid. If something besides cash is exchanged (such as a car traded for a truck), cost is measured as the cash value of what is given up or received. Information based on cost is considered objective. Objectivity means that information is supported by independent, unbiased evidence. Later chapters introduce fair value. Point: A company pays $500 for equipment. The cost principle requires it be recorded at $500. It makes no difference if the owner thinks this equipment is worth $700. Revenue recognition principle Revenue is recognized (1) when goods or services are provided to customers and (2) at the amount expected to be received from the customer. Revenue (sales) is the amount received from selling products and services. The amount received is usually in cash, but it is also common to receive a customer’s promise to pay at a future date, called credit sales. (To recognize means to record it.) Example: A lawn service bills a customer $800 on June 1 for two months of mowing (June and July). The customer pays the bill on July 1. When is revenue recorded? Answer: It is recorded over time as it is earned; record $400 revenue for June and $400 for July. Expense recognition principle (matching principle) A company records the expenses it incurred to generate the revenue reported. An example is rent costs of office or store space. Example: Credit cards are used to pay $200 in gas for a lawn service during June and July. The cards are paid in August. When is expense recorded? Answer: If revenue is earned over time, record $100 expense in June and $100 in July. Full disclosure principle A company reports the details behind financial statements that would impact users’ decisions. Those disclosures are often in footnotes to the statements. Decision Insight Page 10 Measurement and Recognition Revenues for the Carolina Panthers, Denver Broncos, Green Bay Packers, and other professional football teams include ticket sales, television and cable broadcasts, radio rights, concessions, and advertising. Revenues from ticket sales are earned when the NFL team plays each game. Advance ticket sales are not revenues; instead, they are a liability until the NFL team plays the game for which the ticket was sold. At that point, the liability is removed and revenues are reported. ©Ingram Publishing / SuperStock Accounting Assumptions There are four accounting assumptions. Going-concern assumption Accounting information presumes that the business will continue operating instead of being closed or sold. This means, for example, that property is reported at cost instead of liquidation value. Monetary unit assumption Transactions and events are expressed in monetary, or money, units. Examples of monetary units are the dollar in the United States and the peso in Mexico. Time period assumption The life of a company can be divided into time periods, such as months and years, and useful reports can be prepared for those periods. Business entity assumption A business is accounted for separately from other business entities and its owner. Exhibit 1.8 describes four common business entities. Point: Abuse of the entity assumption was a main cause of Enron’s collapse. Exhibit 1.8 Types and Attributes of Businesses *When a corporation issues only one class of stock, it is called common stock (or capital stock). Point: Proprietorships, partnerships, and LLCs are managed by their owners. In a corporation, the owners ( shareholders) elect a board of directors who hire managers to run the business. Point: Double taxation means that (1) the corporation income is taxed and (2) any dividends to owners are taxed as part of the owners’ personal income. Decision Ethics boxes are role-playing exercises that stress ethics in accounting Decision Ethics Entrepreneur You and a friend develop a new design for in-line skates that improves speed. You plan to form a business to manufacture and sell the skates. You and your friend want to minimize taxes, but your big concern is potential lawsuits from customers who might be injured on these skates. What form of organization do you set up? Answer: You should probably form an LLC. An LLC helps protect personal property from lawsuits directed at the business. Also, an LLC is not subject to an additional business income tax. You also must examine the ethical and social aspects of starting a business where injuries are expected. Accounting Constraints The cost-benefit constraint, or cost Page 11 constraint, says that information disclosed must have benefits greater than the costs of providing it. Materiality, or the ability of information to influence decisions, is also sometimes mentioned as a constraint. Conservatism and industry practices are sometimes listed as well. NEED-TO-KNOW 1-2 Accounting Guidance C3 C4 Part 1: Identify each of the following terms/phrases as either an accounting (a) principle, (b) assumption, or (c) constraint. 1. ________ Cost-benefit 2. ________ Measurement 3. ________ Business entity 4. ________ Going-concern 5. ________ Full disclosure 6. ________ Time period 7. ________ Expense recognition 8. ________ Revenue recognition Solution 1. c 2. a 3. b 4. b 5. a 6. b 7. a 8. a Part 2: Complete the following table with either a yes or a no regarding the attributes of a partnership and a corporation. Solution a. no b. no c. no d. no e. yes f. yes g. yes h. yes Do More: QS 1-3, QS 1-4, QS 1-5, QS 1-6, E 1-4, E 1-5, E 1-6, E 1-7 BUSINESS TRANSACTIONS AND ACCOUNTING A1 Define and interpret the accounting equation and each of its components. To understand accounting information, we need to know how an accounting system captures relevant data about transactions and then classifies, records, and reports data. Accounting Equation Accounting reflects two basic aspects of a company: what it owns and what it owes. Assets are resources a company owns or controls. Examples are cash, supplies, equipment, and land. The claims on a company’s assets—what it owes—are separated into owner and nonowner claims. Liabilities are what a company owes its nonowners (creditors) in future payments, products, or services. Equity (also called stockholders’ equity or capital) refers to the claims of its owner(s). Together, liabilities and equity are the source of funds to acquire assets. The relation of assets, liabilities, and equity is shown in the following accounting equation. Assets = Liabilities + Equity The accounting equation applies to all transactions and events, to all companies and organizations, and to all points in time. Liabilities are usually shown before equity in this equation because creditors’ claims are paid before the claims of owners. (This equation can be rearranged; for example, Assets − Liabilities = Equity.) Using Apple as an example, its assets equal $321,686, its liabilities equal $193,437, and its equity equals $128,249 ($ in millions). Let’s look at the accounting equation in more detail. Page 12 Margin notes further enhance textual material Point: “On credit” and “on account” mean cash is paid at a future date. Assets Assets are resources a company owns or controls. These resources are expected to yield future benefits. Examples are web servers for an online services company, musical instruments for a rock band, and land for a vegetable grower. A receivable is an asset that promises a future inflow of resources. A company that provides a service or product on credit has an account receivable from that customer. Liabilities Liabilities are creditors’ claims on assets. These claims are company obligations to provide assets, products, or services to others. A payable is a liability that promises a future outflow of resources. Examples are wages payable to workers, accounts payable to suppliers, notes payable to banks, and taxes payable. Key terms are in bold and defined again in the glossary Equity Equity is the owner’s claim on assets, and is equal to assets minus liabilities. Equity is also called net assets or residual equity. Equity increases from owner investments, called stock issuances, and from revenues. It decreases from dividends and from expenses. Equity consists of four elements. This breakdown of equity yields the following expanded accounting equation. Net income occurs when revenues exceed expenses. Net income increases equity. A net loss occurs when expenses exceed revenues, which decreases equity. Decision Insight Big Data The SEC keeps an online database called EDGAR (sec.gov/edgar) that has accounting information for thousands of companies, such as Apple, that issue stock to the public. The annual report filing for most publicly traded U.S. companies is known as Form 10-K, and the quarterly filing is Form 10-Q. Information services such as Finance.Google.com and Finance.Yahoo.com offer online data and analysis. ©Thomas Trutschel/Photothek via Getty Images NEED-TO-KNOW 1-3 Accounting Equation A1 Part 1: Use the accounting equation to compute the missing financial statement amounts. Solution a. $120 b. $400 Part 2: Use the expanded accounting equation to compute the missing financial statement amounts. Solution a. $65 b. $10 Do More: QS 1-7, QS 1-8, E 1-8, E 1-9 Transaction Analysis Page 13 P1 Analyze business transactions using the accounting equation. Business activities are described in terms of transactions and events. External transactions are exchanges of value between two entities, which yield changes in the accounting equation. An example is the sale of the AppleCare Protection Plan by Apple. Internal transactions are exchanges within an entity, which may or may not affect the accounting equation. An example is Twitter’s use of its supplies, which are reported as expenses when used. Events are happenings that affect the accounting equation and are reliably measured. They include business events such as changes in the market value of certain assets and liabilities and natural events such as fires that destroy assets and create losses. This section uses the accounting equation to analyze 11 transactions and events of FastForward, a start-up consulting (service) business, in its first month of operations. Remember that after each transaction and event, assets always equal liabilities plus equity. Transaction 1: Investment by Owner On December 1, Chas Taylor forms a consulting business, named FastForward and set up as a corporation. FastForward evaluates the performance of footwear and accessories. Taylor owns and manages the business. The business will publish online reviews and consult with clubs, athletes, and others who purchase Nike and Adidas products. Taylor invests $30,000 cash in the new company and deposits the cash in a bank account opened under the name of FastForward. After this transaction, cash (an asset) and stockholders’ equity each equals $30,000. Equity is increased by the owner’s investment (stock issuance), which is included in the column titled Common Stock. The effect of this transaction on FastForward is reflected in the accounting equation as follows (we label the equity entries). Point: There are 3 basic types of company operations: (1) Services—providing services for profit, (2) Merchandisers—buying products and reselling them for profit, and (3) Manufacturers—creating products and selling them for profit. Transaction 2: Purchase Supplies for Cash FastForward uses $2,500 of its cash to buy supplies of Nike and Adidas footwear for performance testing over the next few months. This transaction is an exchange of cash, an asset, for another kind of asset, supplies. It simply changes the form of assets from cash to supplies. The decrease in cash is exactly equal to the increase in supplies. The supplies of footwear are assets because of the expected future benefits from the test results of their performance. Page 14 Transaction 3: Purchase Equipment for Cash FastForward spends $26,000 to acquire equipment for testing footwear. Like transaction 2, transaction 3 is an exchange of one asset, cash, for another asset, equipment. The equipment is an asset because of its expected future benefits from testing footwear. This purchase changes the makeup of assets but does not change the asset total. The accounting equation remains in balance. Transaction 4: Purchase Supplies on Credit Taylor decides more supplies of footwear and accessories are needed. These additional supplies cost $7,100, but FastForward has only $1,500 in cash. Taylor arranges to purchase them on credit from CalTech Supply Company. Thus, FastForward acquires supplies in exchange for a promise to pay for them later. This purchase increases assets by $7,100 in supplies, and liabilities (called accounts payable to CalTech Supply) increase by the same amount. Example: If FastForward pays $500 cash in transaction 4, how does this partial payment affect the liability to CalTech? Answer: The liability to CalTech is reduced to $6,600 and the cash balance is reduced to $1,000. Transaction 5: Provide Services for Cash FastForward plans to earn revenues by selling online ad space and by consulting with clients about footwear and accessories. It earns net income only if its revenues are greater than its expenses. In its first job, FastForward provides consulting services and immediately collects $4,200 cash. The accounting equation reflects this increase in cash of $4,200 and in equity of $4,200. This increase in equity is shown in the far right column under Revenues because the cash received is earned by providing consulting services. Point: Revenue recognition principle requires that revenue is recognized when work is performed. Transactions 6 and 7: Payment of Expenses in Cash FastForward pays $1,000 to rent its facilities. Paying this amount allows FastForward to occupy the space for the month of December. The rental payment is shown in the following accounting equation as transaction 6. FastForward also pays the biweekly $700 salary of the company’s only employee. This is shown in the accounting equation as transaction 7. Both transactions 6 and 7 are December expenses for FastForward. The costs of both rent and salary are expenses, not assets, because their benefits are used in December (they have no future benefits after December). The accounting equation shows that both transactions reduce cash and equity. The far right column shows these decreases as Expenses. Page 15 Point: Expense recognition principle requires that expenses are recognized when the revenue they help generate is recorded. Expenses are outflows of net assets, which decrease equity. Transaction 8: Provide Services and Facilities for Credit FastForward provides consulting services of $1,600 and rents its test facilities for $300 to Adidas. Adidas is billed for the $1,900 total. This transaction creates a new asset, called accounts receivable, from Adidas. Equity is increased from the two revenue components shown in the Revenues column of the accounting equation. Point: Transaction 8, like 5, records revenue when work is performed, not necessarily when cash is received. Transaction 9: Receipt of Cash from Accounts Receivable The client in transaction 8 (Adidas) pays $1,900 to FastForward 10 days after it is billed for consulting services. This transaction 9 does not change the total amount of assets and does not affect liabilities or equity. It converts the receivable (an asset) to cash (another asset). It does not create new revenue. Revenue was recognized when FastForward performed the services in transaction 8, not when the cash is collected. Point: Transaction 9 involved no added client work, so no added revenue is recorded. Point: Receipt of cash is not always a revenue. Transaction 10: Payment of Accounts Payable FastForward pays CalTech Supply $900 cash as partial payment for its earlier $7,100 purchase of supplies (transaction 4), leaving $6,200 unpaid. This transaction decreases FastForward’s cash by $900 and decreases its liability to CalTech Supply by $900. Equity does not change. This event does not create an expense even though cash flows out of FastForward (instead the expense is recorded when FastForward uses these supplies). Page 16 Transaction 11: Payment of Cash Dividend FastForward declares and pays a $200 cash dividend to its owner (the only shareholder). Dividends (decreases in equity) are not reported as expenses because they do not help earn revenue. Because dividends are not expenses, they are not used in computing net income. Summary of Transactions We summarize in Exhibit 1.9 the effects of these 11 transactions of FastForward using the accounting equation. Assets equal liabilities plus equity after each transaction. Exhibit 1.9 Summary of Transactions Using the Accounting Equation Page 17 NEED-TO-KNOW 1-4 Transaction Analysis P1 Assume Tata Company began operations on January 1 and completed the following transactions during its first month of operations. Arrange the following asset, liability, and equity titles in a table like Exhibit 1.9: Cash; Accounts Receivable; Equipment; Accounts Payable; Common Stock; Dividends; Revenues; and Expenses. Jamsetji Tata invested $4,000 cash in Tata Company in exchange for Jan. 1 its common stock. 5 The company purchased $2,000 of equipment on credit. 14 The company provided $540 of services for a client on credit. 21 The company paid $250 cash for an employee’s salary. Solution Do More: QS 1-10, QS 1-11, E 1-10, E 1-11, E 1-13 COMMUNICATING WITH USERS P2 Identify and prepare basic financial statements and explain how they interrelate. Financial statements are prepared in the order below using the 11 transactions of FastForward. (These statements are unadjusted—we explain this in Chapters 2 and 3.) The four financial statements and their purposes follow. Income Statement FastForward’s income statement for December is shown at the top of Exhibit 1.10. Information about revenues and expenses is taken from the Equity columns of Exhibit 1.9. Revenues are reported first on the income statement. They include consulting revenues of $5,800 from transactions 5 and 8 and rental revenue of $300 from transaction 8. Expenses are reported after revenues. (We list larger amounts first, but we can sort expenses in different ways.) Rent and salary expenses are from transactions 6 and 7. Expenses are the costs to generate the revenues Page 19 reported. Net income (or loss) is reported at the bottom of the statement and is the amount earned in December. Stockholders’ investments and dividends are not part of income. Exhibit 1.10 Financial Statements and Their Links Point: A statement’s heading identifies the company, the statement title, and the date or time period. Point: Arrow lines show how the statements are linked. ① Net income is used to compute equity.② Retained earnings is used to prepare the balance sheet.③ Cash from the balance sheet is used to reconcile the statement of cash flows. Point: The income statement, the statement of retained earnings, and the statement of cash flows are prepared for a period of time. The balance sheet is prepared as of a point in time. Point: A single ruled line means an addition or subtraction. Final totals are double underlined. Negative amounts may or may not be in parentheses. Point: Net income is sometimes called earnings or profit. Statement of Retained Earnings The statement of retained earnings reports how retained earnings changes over the reporting period. This statement shows beginning retained earnings, events that increase it (net income), and events that decrease it (dividends and net loss). Ending retained earnings is computed in this statement and is carried over and reported on the balance sheet. FastForward’s statement of retained earnings is the second report in Exhibit 1.10. The beginning balance is measured as of the start of business on December 1. It is zero because FastForward did not exist before then. An existing business reports a beginning balance equal to the prior period’s ending balance (such as from November 30). FastForward’s statement shows the $4,400 of net income for the period, which links the income statement to the statement of retained earnings (see line ①). The statement also reports the $200 cash dividends and FastForward’s end-of-period retained earnings balance. Balance Sheet FastForward’s balance sheet is the third report in Exhibit 1.10. This statement shows FastForward’s financial position at the close of business on December 31. The left side of the balance sheet lists FastForward’s assets: cash, supplies, and equipment. The upper right side of the balance sheet shows that FastForward owes $6,200 to creditors. Any other liabilities (such as a bank loan) would be listed here. The equity balance is $34,200. Line ② shows the link between the ending balance of the statement of retained earnings and the retained earnings balance on the balance sheet. (This presentation of the balance sheet is called the account form: assets on the left and liabilities and equity on the right. Another presentation is the report form: assets on top, followed by liabilities and then equity at the bottom. Both are acceptable.) As always, the accounting equation balances: Assets of $40,400 = Liabilities of $6,200 + Equity of $34,200. Statement of Cash Flows FastForward’s statement of cash flows is the final report in Exhibit 1.10. The first section reports cash flows from operating activities. It shows the $6,100 cash received from clients and the $5,100 cash paid for supplies, rent, and employee salaries. Outflows are in parentheses to denote subtraction. Net cash provided by operating activities for December is $1,000. The second section reports investing activities, which involve buying and selling assets such as land and equipment that are held for long-term use (typically more than one year). The only investing activity is the $26,000 purchase of equipment. The third section shows cash flows from financing activities, which include long-term borrowing and repaying of cash from lenders and the cash investments from, and dividends to, stockholders. FastForward reports $30,000 from the owner’s initial investment and a $200 cash dividend. The net cash effect of all financing transactions is a $29,800 cash inflow. The final part of the statement shows an increased cash balance of $4,800. The ending balance is also $4,800 as it started with no cash—see line ③. Point: Payment for supplies is an operating activity because supplies are expected to be used up in short-term operations (typically less than one year). Point: Investing activities refer to long-term asset investments by the company, not to owner investments. NEED-TO-KNOW 1-5 Financial Statements P2 Prepare the (a) income statement, (b) statement of retained earnings, and (c) balance sheet for Apple using the following condensed data from its fiscal year ended September 24, 2016 ($ in millions). Solution ($ in millions) Page 20 Do More: QS 1-12, QS 1-13, QS 1-14, E 1-15, E 1-16, E 1-17 SUSTAINABILITY AND ACCOUNTING Sustainability refers to environmental, social, and governance (ESG) aspects of a company. A company’s social aspects include donations to hospitals, colleges, community programs, and charities. Environmental aspects include programs to reduce pollution, increase use of sustainable materials, and support “green” activities. Governance aspects include social responsibility programs, community relations, product safety, and improving worker conditions. Source: Sustainability Accounting Standards Board (SASB) The Sustainability Accounting Standards Board (SASB) is a nonprofit entity engaged in creating and disseminating sustainability accounting standards for use by companies. Sustainability accounting standards are intended to complement financial accounting standards. The SASB has its own Conceptual Framework to guide the development of sustainability standards. Page 21 ©Xinhua/Alamy Stock Photo Apple, as introduced in this chapter’s opening feature, focuses on sustainability. Apple hired a Vice President of Environmental Initiatives, Lisa Jackson (in photo, and the first African-American EPA Administrator), to oversee its sustainability initiative. Lisa sets high goals for Apple, including powering all of its facilities with 100% renewable energy and making its products 100% recyclable. “We are swinging for the fences,” exclaims Lisa. In Apple’s sustainability report, Lisa points out that the company powers data centers with 100% renewable energy and relies on renewable energy to power 80% of its corporate facilities and 50% of its retail stores. Lisa stresses that “[sustainability] is really important at Apple.” Apple is committed to reducing carbon emissions. “We would like to eliminate certain toxins,” explains Lisa. Apple’s sustainability report asserts that it has markedly improved its carbon efficiency and reduced the amount of carbon dioxide produced per dollar of revenue. Lisa insists, “Leave the world better than how we found it … this is what really inspires people at Apple.” Decision Insight boxes highlight relevant items from practice Decision Insight Sustainability Returns Virtue is not always its own reward. Compare the S&P 500 with the iShares MSCI KLD 400 Social (DSI), which covers 400 companies that have especially good records for sustainability. We see that returns for companies with sustainable behavior are roughly on par with, or better than, those of the S&P 500 for the recent three-year period—see graph. Decision Analysis (a section at the end of each chapter) covers ratios for decision making using real company data. Instructors can skip this section and cover all ratios in Chapter 13 Decision Analysis Return on Assets A2 Compute and interpret return on assets. We organize financial statement analysis into four areas: (1) liquidity and efficiency, (2) solvency, (3) profitability, and (4) market prospects—Chapter 13 has a ratio listing with definitions and groupings by area. When analyzing ratios, we use a company’s prior-year ratios and competitor ratios to identify good, bad, or average performance. This chapter presents a profitability measure: return on assets. Return on assets is useful in evaluating management, analyzing and forecasting profits, and planning activities. Return on assets (ROA), also called return on investment (ROI), is defined in Exhibit 1.11. Exhibit 1.11 Return on Assets Net income is from the annual income statement, and average total assets is computed by adding the beginning and ending amounts for that same period and dividing by 2. Nike reports total net income of $3,760 million for 2016. At the beginning of 2016 its total assets are $21,597 million, and at the end of 2016 they total $21,396 million. Nike’s return on assets for 2016 is: Is a 17.5% return on assets good or bad for Nike? To help answer this Page 22 question, we compare (benchmark) Nike’s return with its prior performance and the return of its competitor, Under Armour. Nike’s return for each of the prior four years is in the middle column of Exhibit 1.12, which ranges from 14.9% to 17.5%. Exhibit 1.12 Nike and Under Armour Returns Nike shows a stable pattern of good returns that reflects effective use of assets. Nike has outperformed Under Armour in each of the last four years. Its management performed well based on Nike’s return on assets. Each Decision Analysis section ends with a role-playing scenario to show the usefulness of ratios Decision Maker Business Owner You own a winter ski resort that earns a 21% return on its assets. An opportunity to purchase a winter ski equipment manufacturer is offered to you. This manufacturer earns a 14% return on its assets. The industry return for competitors of this manufacturer is 9%. Do you purchase this manufacturer? The 14% return on assets for the manufacturer exceeds the 9% industry return. This is positive for a potential purchase. Also, this purchase is an opportunity to spread your risk over two businesses. Still, you should hesitate to purchase a business whose 14% return is lower than your current 21% return. You might better direct efforts to increase investment in your resort if it can earn more than the 14% alternative. Comprehensive Need-to-Know is a review of key chapter content. The Planning the Solution section offers strategies in solving it NEED-TO-KNOW 1-6 COMPREHENSIVE Transaction Analysis, Statement Preparation, and Return on Assets After several months of planning, Jasmine Worthy started a haircutting business called Expressions. The following events occurred during its first month of business. a. On August 1, Worthy invested $3,000 cash and $15,000 of equipment in Expressions in exchange for its common stock. b. On August 2, Expressions paid $600 cash for furniture for the shop. c. On August 3, Expressions paid $500 cash to rent space in a strip mall for August. d. On August 4, it purchased $1,200 of equipment on credit for the shop (recorded as accounts payable). e. On August 5, Expressions opened for business. Cash received from haircutting services in the first week and a half of business (ended August 15) was $825. f. On August 15, Expressions provided $100 of haircutting services on account. g. On August 17, Expressions received a $100 check for services previously rendered on account. h. On August 17, Expressions paid $125 cash to an assistant for hours worked for the grand opening. i. Cash received from services provided during the second half of August was $930. j. On August 31, Expressions paid $400 cash toward the accounts payable entered into on August 4. k. On August 31, Expressions paid $900 cash in dividends to Worthy (sole shareholder). Required Page 23 1. Arrange the following asset, liability, and equity titles in a table similar to the one in Exhibit 1.9: Cash; Accounts Receivable; Furniture; Store Equipment; Accounts Payable; Common Stock; Dividends; Revenues; and Expenses. Show the effects of each transaction using the accounting equation. 2. Prepare an income statement for August. 3. Prepare a statement of retained earnings for August. 4. Prepare a balance sheet as of August 31. 5. Prepare a statement of cash flows for August. 6. Determine the return on assets ratio for August. PLANNING THE SOLUTION Set up a table like Exhibit 1.9 with the appropriate columns for accounts. Analyze each transaction and show its effects as increases or decreases in the appropriate columns. Be sure the accounting equation remains in balance after each transaction. Prepare the income statement, and identify revenues and expenses. List those items on the statement, compute the difference, and label the result as net income or net loss. Use information in the Equity columns to prepare the statement of retained earnings. Use information in the last row of the transactions table to prepare the balance sheet. Prepare the statement of cash flows; include all events listed in the Cash column
