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Accounting Principles by Jerry Weygandt and Paul Kimmel

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This accounting course offers something similar: To understand a business, you have to understand the financial insides of a business organization. An accounting course will help you under stand the essential financial components of businesses. Whether you are looking at a large multinational company like Microsoft or Starbucks or a singleowner software consulting business or coffee shop, knowing the fundamentals of accounting will help you understand what is happening. As an employee, a manager, an investor, a business owner, or a director of your own personal finances—any of which roles you will have at some point in your life—you will be much the wiser for having taken this course. Hundreds of thousands of students have used this textbook. Your instructor has chosen it for you because of its trusted reputation. The authors have worked hard to keep the book fresh, timely, and accurate. This textbook contains features to help you learn best, whatever your learning style. To understand what your learning style is, spend about ten minutes to take the learning style quiz at the book’s companion website. Then, look at page vii for how you can apply an understanding of your learning style to this course. When you know more about your own learning style, browse through the Student Owner’s Manual on pages viii–xi. It shows you the main features you will find in this textbook and explains their purpose

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Jerry J Weygandt PhD, CPA

University of Wisconsin—Madison Madison, Wisconsin

Paul D Kimmel PhD, CPA

University of Wisconsin—Milwaukee Milwaukee, Wisconsin

Donald E Kieso PhD, CPA

Northern Illinois University DeKalb, Illinois

10

ACCOUNTING

P R I N C I P L E S

John Wiley & Sons, Inc.

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Dedicated to the Wiley sales representatives who sell our books and service our adopters in a professional and ethical manner and to Enid, Merlynn, and Donna

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This book was set in Times Ten by Aptara®, Inc and printed and bound by RR Donnelley The cover was printed by RR Donnelley.Copyright © 2007, 2009, 2012 John Wiley & Sons, Inc All rights reserved No part of this publication may be reproduced, stored

in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning orotherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior writ-ten permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright ClearanceCenter, Inc 222 Rosewood Drive, Danvers, MA 01923, website www.copyright.com Requests to the Publisher for permissionshould be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774,(201)748-6011, fax (201)748-6008, website http://www.wiley.com/go/permissions

Founded in 1807, John Wiley & Sons, Inc has been a valued source of knowledge and understanding for more than 200 years,helping people around the world meet their needs and fulfill their aspirations Our company is built on a foundation of principlesthat include responsibility to the communities we serve and where we live and work In 2008, we launched a Corporate CitizenshipInitiative, a global effort to address the environmental, social, economic, and ethical challenges we face in our business Among theissues we are addressing are carbon impact, paper specifications and procurement, ethical conduct within our business and amongour vendors, and community and charitable support For more information, please visit our website: www.wiley.com/go/citizenship.Evaluation copies are provided to qualified academics and professionals for review purposes only, for use in their courses duringthe next academic year These copies are licensed and may not be sold or transferred to a third party Upon completion of thereview period, please return the evaluation copy to Wiley Return instructions and a free of charge return shipping label areavailable at www.wiley.com/go/returnlabel Outside of the United States, please contact your local representative

ISBN-13 978-0-470-53479-3 (main textbook)ISBN-13 978-1-118-00929-1 (BRV edition)Printed in the United States of America

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From the Authors

Dear Student,

Why This Course? Remember your biology course in high school? Did you have

one of those “invisible man” models (or maybe something more high-tech than that) that gave you the opportunity to look “inside” the human body? This accounting course offers something similar: To understand a business, you have to understand the financial insides of a business organization An accounting course will help you under- stand the essential financial components of businesses Whether you are looking at a large multinational company like Microsoft or Starbucks or a single-owner software consulting business or coffee shop, knowing the fundamentals of accounting will help you understand what is happening As an employee, a manager, an investor, a business owner, or a director of your own personal finances—any of which roles you will have at some point in your life—you will be much the wiser for having taken this course.

Why This Book? Hundreds of thousands of students have used this textbook Your

instructor has chosen it for you because of its trusted reputation The authors have worked hard to keep the book fresh, timely, and accurate.

This textbook contains features to help you learn best, whatever your learning style To understand what your learning style is, spend about ten minutes to take the learning style quiz at the book’s companion website Then, look at page vii for how you can apply an understanding of your learning style to this course When you know more about your own learning style, browse through the Student Owner’s Manual on pages viii–xi It shows you the main features you will find in this textbook and explains their purpose.

How To Succeed? We’ve asked many students and many instructors whether there

is a secret for success in this course The nearly unanimous answer turns out to be not much of a secret: “Do the homework.” This is one course where doing is learning, and the more time you spend on the homework assignments—using the various tools that this textbook provides—the more likely you are to learn the essential concepts, techniques, and methods of accounting Besides the textbook itself, the book’s companion website offers various support resources.

Good luck in this course We hope you enjoy the experience and that you put to good use throughout a lifetime of success the knowledge you obtain in this course We are sure you will not be disappointed.

Jerry J Weygandt Paul D Kimmel Donald E Kieso

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Jerry Weygandt

Jerry J Weygandt, PhD, CPA, is ArthurAndersen Alumni Emeritus Professor ofAccounting at the University of Wisconsin—

Madison He holds a Ph.D in accountingfrom the University of Illinois Articles byProfessor Weygandt have appeared in theAccounting Review Journal of AccountingResearch, Accounting Horizons, Journal ofAccountancy, and other academic and professional journals These articles haveexamined such financial reporting issues

as accounting for price-level adjustments, pensions, convertible securities, stock optioncontracts, and interim reports ProfessorWeygandt is author of other accounting andfinancial reporting books and is a member

of the American Accounting Association, the American Institute of Certified PublicAccountants, and the Wisconsin Society ofCertified Public Accountants He has served

on numerous committees of the AmericanAccounting Association and as a member

of the editorial board of the AccountingReview; he also has served as President and Secretary-Treasurer of the AmericanAccounting Association In addition, he hasbeen actively involved with the AmericanInstitute of Certified Public Accountants and has been a member of the AccountingStandards Executive Committee (AcSEC) ofthat organization He has served on the FASBtask force that examined the reporting issuesrelated to accounting for income taxes and served as a trustee of the FinancialAccounting Foundation Professor Weygandthas received the Chancellor’s Award forExcellence in Teaching and the Beta GammaSigma Dean’s Teaching Award He is on theboard of directors of M & I Bank of SouthernWisconsin He is the recipient of theWisconsin Institute of CPA’s OutstandingEducator’s Award and the LifetimeAchievement Award In 2001 he received the American Accounting Association’sOutstanding Educator Award

Paul D Kimmel, PhD, CPA, received his bachelor’s degree from the University ofMinnesota and his doctorate in accountingfrom the University of Wisconsin He is anAssociate Professor at the University ofWisconsin—Milwaukee, and haspublic accounting experience with Deloitte

& Touche (Minneapolis) He was the recipient

of the UWM School of Business AdvisoryCouncil Teaching Award, the Reggie Taite Excellence in Teaching Award and athree-time winner of the OutstandingTeaching Assistant Award at the University

of Wisconsin He is also a recipient of theElijah Watts Sells Award for HonoraryDistinction for his results on the CPA exam

He is a member of the American AccountingAssociation and the Institute of ManagementAccountants and has published articles inAccounting Review, Accounting Horizons,Advances in Management Accounting,Managerial Finance, Issues in AccountingEducation, Journal of Accounting Education,

as well as other journals His research interests include accounting for financialinstruments and innovation in accountingeducation He has published papers andgiven numerous talks on incorporating critical thinking into accounting education,and helped prepare a catalog of criticalthinking resources for the Federated Schools

of Accountancy

Donald E Kieso, PhD, CPA, received hisbachelor’s degree from Aurora University and his doctorate in accounting from theUniversity of Illinois He has served as chairman of the Department of Accountancyand is currently the KPMG Emeritus Professor

of Accountancy at Northern Illinois University

He has public accounting experience withPrice Waterhouse & Co (San Francisco andChicago) and Arthur Andersen & Co.(Chicago) and research experience with theResearch Division of the American Institute ofCertified Public Accountants (New York) Hehas done post doctorate work as a VisitingScholar at the University of California atBerkeley and is a recipient of NIU’s TeachingExcellence Award and four Golden AppleTeaching Awards Professor Kieso is theauthor of other accounting and businessbooks and is a member of the AmericanAccounting Association, the AmericanInstitute of Certified Public Accountants, andthe Illinois CPA Society He has served as amember of the Board of Directors of theIllinois CPA Society, then AACSB’s AccountingAccreditation Committees, the State ofIllinois Comptroller’s Commission, asSecretary-Treasurer of the Federation

of Schools of Accountancy, and as Secretary-Treasurer of the AmericanAccounting Association Professor Kieso iscurrently serving on the Board of Trusteesand Executive Committee of AuroraUniversity, as a member of the Board ofDirectors of Kishwaukee CommunityHospital, and as Treasurer and Director ofValley West Community Hospital From 1989

to 1993 he served as a charter member ofthe national Accounting Education ChangeCommission He is the recipient of theOutstanding Accounting Educator Awardfrom the Illinois CPA Society, the FSA’s Joseph

A Silvoso Award of Merit, the NIUFoundation’s Humanitarian Award for Service

to Higher Education, a Distinguished ServiceAward from the Illinois CPA Society, and

in 2003 an honorary doctorate from Aurora University

About the Authors

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What TYPE of learner are you?

• Underline

• Use different colors

• Use symbols, flow charts, graphs, different

arrangements on the page,white spaces

Convert your lecture notes into

“page pictures.”

To do this:

• Use the “Intake” strategies

• Reconstruct images in different ways

• Redraw pages from memory

• Replace words with symbols and initials

• Look at your pages

The Navigator/Feature Story/Preview

Infographics/IllustrationsAccounting Equation AnalysesHighlighted words

Demonstration Problem/

Action PlanQuestions/Exercises/ProblemsFinancial Reporting ProblemComparative Analysis Problem

On the WebTutorials, video, iPod apps

• Recall your “page pictures.”

• Draw diagrams where appropriate

• Practice turning your visuals back into words

• Attend lectures and tutorials

• Discuss topics with students and instructors

• Explain new ideas to other people

• Use a tape recorder

• Leave spaces in your lecturenotes for later recall

• Describe overheads, pictures,and visuals to somebody who was not in class

You may take poor notesbecause you prefer to listen

Therefore:

• Expand your notes by talking with others and with information from your textbook

• Tape-record summarized notes and listen

• Read summarized notes out loud

• Explain your notes to another “aural” person

PreviewInsight BoxesReview It/Do it!/Action PlanSummary of Study ObjectivesGlossary

Demonstration Problem/Action Plan

Self-Test QuestionsQuestions/Exercises/ProblemsFinancial Reporting ProblemComparative Analysis Problem

On the WebDecision Making Across the Organization

Tutorials, video

Communication Activity Ethics Case

• Talk with the instructor

• Spend time in quiet places recalling the ideas

• Practice writing answers

to old exam questions

• Say your answers out loud

• Use lists and headings

• Use dictionaries, glossaries, and definitions

• Read handouts, textbooks, and supplementary library readings

• Use lecture notes

• Write out words again and again

• Reread notes silently

• Rewrite ideas and principlesinto other words

• Turn charts, diagrams, and other illustrations into statements

The Navigator/Feature Story/Study

Objectives/PreviewReview It/Do it!/Action PlanSummary of Study ObjectivesGlossary/Self-Test QuestionsQuestions/Exercises/ProblemsWriting Problems

Financial Reporting ProblemComparative Analysis Problem

“All About You” Activity

On the WebDecision Making Across the OrganizationCommunication ActivityFlashcards

• Write exam answers

• Practice with multiple-choicequestions

• Write paragraphs, beginningsand endings

• Write your lists in outline form

• Arrange your words into hierarchies and points

• Use all your senses

• Go to labs, take field trips

• Listen to real-life examples

• Pay attention to applications

• Use hands-on approaches

• Use trial-and-error methods

You may take poor notesbecause topics do not seemconcrete or relevant

Therefore:

• Put examples in your summaries

• Use case studies and applications to help with principles and abstract concepts

• Talk about your notes with another “kinesthetic” person

• Use pictures and photographs that illustrate an idea

The Navigator/FeatureStory/PreviewInfographics/IllustrationsReview It/Do it!/Action PlanSummary of Study ObjectivesDemonstration Problem/

Action PlanSelf-Test QuestionsQuestions/Exercises/ProblemsFinancial Reporting ProblemComparative Analysis Problem

On the WebDecision Making Across the OrganizationCommunication Activity

“All About You” Activity

• Write practice answers

• Role-play the exam situation

Intake:

To take in the information To make a study package

Text features that mayhelp you the most

Output:

To do well on exams

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Accrued Revenues

Debit Adjusting Entry (+)

Credit Adjusting Entry (+)

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Student Owner’s Manual Using Your Textbook Effectively

Helpful Hints in the margins further clarify concepts being discussed They are like having an instructor with you as you read.

Insight examples give you more glimpses into how actual companies make decisions using accounting information These high- interest boxes focus on various themes—

ethics, international, and investor concerns.

A critical thinking question asks you to apply your accounting learning to the story in the example Guideline Answers appear at the end of the chapter.

Ethics Notes and International Notes point out ethical and international points related to the nearby text discussion.

Accounting Across the Organization examples show the use of accounting by people in non-accounting functions—such

as finance, marketing, or management.

Guideline Answers appear at the end of

the chapter.

● Scan Study Objectives ●

● Read Feature Story ●

● Read text and answerDo it!p 102 ●

p 110 ● p 116 ● p 121 ●

● Work ComprehensiveDo it!p 122 ●

● Review Summary of Study Objectives ●

● Answer Self-Test Questions ●

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International Note

Rules for accounting for specifi c events sometimes differ across countries For example, European companies rely less on historical cost and more on fair value than U.S companies Despite the differences, the double-entry accounting system is the basis of accounting systems worldwide.

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INVESTOR S O IINSIGHT S G

How to Read Stock Quotes

Organized exchanges trade the stock of publicly held companies at dollar prices per share cial press reports the high and low prices of the stock during the year, the total volume of stock change for the day Nike is listed on the New York Stock Exchange Here is a recent listing for Nike:

Stock High Low Volume High Low Close Net Change

Nike 78.55 48.76 5,375,651 72.44 69.78 70.61 21.69 These numbers indicate the following: The high and low market prices for the last 52 weeks have closing prices for that date were $72.44, $69.78, and $70.61, respectively The net change for the day was a decrease of $1.69 per share.

For stocks traded on organized exchanges, how are the dollar prices per share established?

What factors might influence the price of shares in the marketplace? (See page 629.)

?

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ACCOU CCOUNTING GAC OSS CROSS THEORGANIZATION G O

Wall Street No Friend of Facebook

In the 1990s, it was the dream of every young technology entrepreneur to start a stock exchange It seemed like there was a never-ending supply of 20-something year-old technology entrepreneurs that made millions doing IPOs of companies that never made

a profit and eventually failed In sharp contrast to this is Mark Zuckerberg, the 25-year-old founder and CEO of Facebook If Facebook did an IPO, he would make billions of dollars But, he

is in no hurry to go public Because his company doesn’t need to invest in factories, distribution Zuckerberg has more control over the direction of the company Right now, he and the other term investment horizons rather than long-term goals In addition, publicly traded companies face many more financial reporting disclosure requirements.

Source: Jessica E Vascellaro, “Facebook CEO in No Rush to ‘Friend’ Wall Street,” Wall Street Journal Online

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Brief Do it! exercises ask you to put to work your newly acquired knowledge.

They outline an Action Plan necessary

to complete the exercise, and they show a Solution.

Accounting equation analyses appear next to key journal entries They will help you understand the impact of an accounting transaction on the components of the accounting equation, on the stockholders’ equity accounts, and on the company’s cash flows.

Comprehensive Do it! problem with Action Plan gives you an opportunity to see a detailed solution to a

representative problem before you do your homework Coincides with the Do it!

problems within the chapter

Do it! Review problems appear in the homework material and provide another

way for you to determine whether you have mastered the content in the

An analysis of the accounts shows the following.

1 Insurance expires at the rate of $100 per month.

2 Supplies on hand total $800.

Do it!

Adjusting Entries for Deferrals

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Bernie Ebbers was the founder and CEO of the phone company WorldCom The company engaged in a series of increasingly large, debt-financed acquisitions of other companies These acquisitions made the company grow quickly, which made had different accounting systems, WorldCom’s financial records were a mess When WorldCom’s performance started to flatten out, Bernie coerced WorldCom’s accountants to engage in a number of fraudulent activities to make net income look better than it really was and thus prop up the stock price One of these frauds involved treating $7 billion of line costs as capital expenditures The line costs, which were rental fees paid to other phone companies to use their phone lines, had recognition to future periods and thus boosted current-period profi ts.

Total take: $7 billion

THE MISSING CONTROLS

Documentation procedures The company’s accounting system was a disorganized

collection of non-integrated systems, which resulted from a series of corporate acquisitions Top management took advantage of this disorganization to conceal its fraudulent activities.

Independent internal verifi cation A fraud of this size should have been detected

shown in the accounting records.

1 Cash-basis accounting.

2 Fiscal year.

3 Revenue recognition principle.

4 Expense recognition principle.

(a) Monthly and quarterly time periods.

(b) Accountants divide the economic life of a business

into artificial time periods.

(c) Efforts (expenses) should be matched with

ac-complishments (revenues).

Identify timing concepts.

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What happens when no-par stock does not have a stated value? In that case, the corporation credits the entire proceeds to Common Stock Thus, if Hydro-Slide shares at $8 per share for cash as follows.

Anatomy of a Fraud boxes illustrate how

a lack of specific internal controls resulted in real-world frauds.

Financial statements appear regularly

Those from actual companies are identified

by a company logo or a photo.

Illustration 14-11

Disclosure of restriction Tektronix Inc.

Notes to the Financial Statements Certain of the Company’s debt agreements require compliance with debt covenants.

The Company had unrestricted retained earnings of $223.8 million after meeting those requirements.

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An additional parallel set of C Problems appears at the book’s companion website.

Problems: Set C

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student

Companion site to access Problem Set C.

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(Note: This is a continuation of the Cookie Chronicle from Chapters 1 and 2 Use the

infor-mation from the previous chapters and follow the instructions below using the general ledger accounts you have already prepared.)

Continuing Cookie Chronicle

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Those exercises and problems that focus on accounting situations faced by service companies

are identified by the icon shown here.

Comprehensive Problems combine material from the current chapter with previous chapters so that you understand how “it all fits together.”

The Continuing Cookie Chronicle exercise follows the continuing saga of accounting

for a small business begun by an

entrepreneurial student.

The Waterways Continuing Problem uses the business activities of a fictional company, to help you apply managerial accounting topics to a realistic entrepreneurial situation.

h bl

Waterways Continuing Problem

(Note: The Waterways Problem begins in Chapter 19 and continues in the remaining chapters.

You can also find this problem at the book’s Student Companion site.)

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Exercises: Set B

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student

Companion site to access Exercise Set B.

P3-5A On September 1, 2012, the account balances of Moore Equipment Repair were as follows.

Journalize transactions and follow through accounting cycle to preparation of fi nancial statements.

(SO 5, 6, 7)

101 Cash $ 4,880 154 Accumulated Depreciation—Equipment $ 1,500

112 Accounts Receivable 3,520 201 Accounts Payable 3,400

126 Supplies 2,000 209 Unearned Service Revenue 1,400

153 Equipment 15,000 212 Salaries and Wages Payable 500

301 Owner’s Capital 18,600

$25,400 $25,400

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Exercises: Set B are available online at www.wiley.com/college/weygandt.

In the textbook, two similar sets of Problems—A and B—are keyed

to the same study objectives.

Selected problems, identified by this icon, can be solved using the General Ledger Software (GLS) package.

An icon identifies Exercises and Problems that can be solved using Excel templates at the student website.

E3-10 The income statement of Brandon Co for the month of July shows net income of $1,400 based on Service Revenue $5,500, Salaries and Wages Expense $2,300, Supplies Expense $1,200, and Utilities Expense $600 In reviewing the statement, you discover the following.

1 Insurance expired during July of $400 was omitted.

2 Supplies expense includes $250 of supplies that are still on hand at July 31.

Prepare correct income statement.

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The Broadening Your Perspective section helps to pull together concepts from the chapter and apply them to real-world business situations.

The Financial Reporting Problem focuses on reading and understanding the financial statements of PepsiCo , which are available in Appendix A.

BROADENING YOUR PERSPECTIVE

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Financial Reporting and Analysis

Financial Reporting Problem: PepsiCo, Inc.

BYP3-1 The financial statements of PepsiCo, Inc are presented in Appendix A at the end of this textbook.

Instructions (a) Using the consolidated financial statements and related information, identify items that may result in

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Comparative Analysis Problem: PepsiCo, Inc

vs The Coca-Cola Company

BYP3-2PepsiCo ’s financial statements are presented in Appendix A Financial statements for The Coca-Cola Company are presented in Appendix B.

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A Comparative Analysis Problem compares and contrasts the financial reporting of

PepsiCo and The Coca-Cola Company

E20-12 Alma Ortiz and Associates, a CPA firm, uses job order costing to capture the costs of its audit jobs There were no audit jobs in process at the beginning of November Listed below are data concerning the three audit jobs conducted during November.

Perez Rivera Sota

Direct materials $600 $400 $200 Auditor labor costs $5,400 $6,600 $3,375 Auditor hours 72 88 45

Determine cost of jobs and ending balance in work in process and overhead accounts.

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Comprehensive Problem: Chapters 3 to 7

CP7 Packard Company has the following opening account balances in its general and subsidiary ledgers on January 1 and uses the periodic inventory system All accounts have normal debit and credit balances.

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Ethics Cases ask you to reflect

on typical ethical dilemmas, analyze the stakeholders and the issues involved, and

decide on an appropriate

course of action.

Decision Making Across the Organization cases help you build decision-making skills by analyzing

accounting information in a less structured situation These cases require you to work in teams.

A Look at IFRS provides an overview

of the International Financial Reporting Standards (IFRS) that relate to

the chapter topics, highlights the differences between GAAP and IFRS, discusses IFRS/GAAP convergence efforts, and tests your understanding through IFRS Self-Test Questions and IFRS Concepts and Application.

Decision Making Across the Organization

BYP20-1 Burgio Parts Company uses a job order cost system For a number of months, there has been

an ongoing rift between the sales department and the production department concerning a special-order cost plus a markup of 40% of cost.

Ethics Case

BYP3-6Bluestem Company is a pesticide manufacturer Its sales declined greatly this year due to the passage of legislation outlawing the sale of several of Bluestem’s chemical pesticides In the coming year, Bluestem will have environmentally safe and competitive chemicals to replace these discontinued prod- ucts Sales in the next year are expected to greatly exceed any prior year’s The decline in sales and profi ts year’s profits He believes that such a dip could cause a significant drop in the market price of Bluestem’s stock and make the company a takeover target.

T id hi ibili h id ll i C hi B ll ll di hi i d’

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FASB Codification Activity offers you the

opportunity to use this online system, which contains all the authoritative literature

related to a particular topic

FASB Codifi cation Activity

BYP3-8 If your school has a subscription to the FASB Codifi cation, go to http://aaahq.org/asclogin.cfm

to log in and prepare responses to the following.

Instructions

Access the glossary (“Master Glossary”) to answer the following.

(a) What is the definition of revenue?

(b) What is the definition of compensation?

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Real World Focus problems require you to

apply techniques and concepts learned in

the chapter to specific situations faced by

actual companies.

Real-World Focus

BYP19-3Anchor Glass Container Corporation , the third largest manufacturer of glass containers in the United States, supplies beverage and food producers and consumer products manufacturers nationwide

Parent company Consumers Packaging Inc (Toronto Stock Exchange: CGC) is a leading international

designer and manufacturer of glass containers.

The following management discussion appeared in a recent annual report of Anchor Glass.

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Communication Activity problems help you to apply and practice business communication skills.

Communication Activity

BYP3-5 In reviewing the accounts of Keri Ann Co at the end of the year, you discover that adjusting entries have not been made.

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All About You activities are designed to get you thinking and talking about how accounting impacts your personal life.

“All About You” Activity

BYP3-7 Companies must report or disclose in their financial statements information about all liabilities, including potential liabilities related to environmental clean-up There are many situations in which you will be asked to provide personal financial information about your assets, liabilities, revenue, and expenses.

Sometimes you will face difficult decisions regarding what to disclose and how to disclose it.

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Managerial Analysis assignments build analytical and decision-making skills in situations required by managers.

Managerial Analysis

BYP19-2 B.J King is a fairly large manufacturing company located in the southern United States The company manufactures tennis rackets, tennis balls, tennis clothing, and tennis shoes, all bearing the com- pany’s distinctive logo, a large green question mark on a white-flocked tennis ball The company’s sales have been increasing over the past 10 years.

The tennis racket division has recently implemented several advanced manufacturing techniques

Robot arms hold the tennis rackets in place while glue dries, and machine vision systems check for defects

managers work in the tennis racket division.

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It is often difficult for companies to determine in what time period they should report particular revenues and expenses Both the IASB and FASB are working on a joint project to develop a common conceptual framework, as well as a revenue recognition project, that will enable com- panies to better use the same principles to record transactions consistently over time.

IFRS A Look at IFRS

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On the Web

BYP3-3 No financial decision maker should ever rely solely on the financial information reported in the annual report to make decisions It is important to keep abreast of financial news This activity demon- strates how to search for financial news on the Web.

Address: http://biz.yahoo.com/i, or go to www.wiley.com/college/weygandt

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Prior Editions

Thanks to the following reviewers and focus group

participants of prior editions of Accounting Principles:

John Ahmad, Northern Virginia Community College—Annandale;

Sylvia Allen, Los Angeles Valley College; Matt Anderson, Michigan

State University; Alan Applebaum, Broward Community College;

Juanita Ardovany, Los Angeles Valley College; Yvonne Baker,

Cincinnati State Tech Community College; Peter Battelle, University

of Vermont; Colin Battle, Broward Community College; Jim

Benedum; Beverly Beatty, Anne Arundel Community College;

Milwaukee Area Technical College; Jaswinder Bhangal, Chabot

College; Bernard Bieg, Bucks County College; Michael Blackett,

National American University; Barry Bomboy, J Sargeant Reynolds

Community College; Kent D Bowen, Butler County Community

College; David Boyd, Arkansas State University; Greg Brookins,

Santa Monica College; Kurt H Buerger, Angelo State University;

Leroy Bugger, Edison Community College; Leon Button, Scottsdale

Community College

Ann Cardozo, Broward Community College; Steve Carlson,

University of North Dakota; Fatma Cebenoyan, Hunter College;

Kimberly Charland, Kansas State University; Trudy Chiaravelli,

Lansing Community College; Shifei Chung, Rowan University; Siu

Chung, Los Angeles Valley College; Lisa Cole, Johnson County

Community College; Kenneth Couvillion, San Joaquin Delta

College; Alan B Czyzewski, Indiana State University; Thomas

Davies, University of South Dakota; Peggy DeJong, Kirkwood

Community College; John Delaney, Augustana College; Tony

Dellarte, Luzerne Community College; Kevin Dooley, Kapi’olani

Community College; Pam Donahue, Northern Essex Community

College; Edmond Douville, Indiana University Northwest; Pamela

Druger, Augustana College; Russell Dunn, Broward Community

College; John Eagan, Erie Community College; Richard Ellison,

Middlesex Community College; Dora Estes, Volunteer State

Community College; Mary Falkey, Prince Georges Community

College

Raymond Gardner, Ocean County College; Lori Grady, Bucks

County Community College; Richard Ghio, San Joaquin Delta

College; Joyce Griffin, Kansas City Community College; Amy Haas,

Kingsborough Community College, CUNY; Lester Hall, Danville

Community College; Becky Hancock, El Paso Community College;

Jeannie Harrington, Middle Tennessee State University; Bonnie

Harrison, College of Southern Maryland; William Harvey, Henry

Ford Community College; Michelle Heard, Metropolitan

Community College; Ruth Henderson, Union Community College;

Ed Hess, Butler County Community College; Kathy Hill, Leeward

Community College; Patty Holmes, Des Moines Area Community

College; Zach Holmes, Oakland Community College; Paul Holt,

Texas A&M—Kingsville; Audrey Hunter, Broward Community

College; Verne Ingram, Red Rocks Community College; Joanne

Johnson, Caldwell Community College; Naomi Karolinski, Monroe

Community College; Anil Khatri, Bowie State University; Shirley

Kleiner, Johnson County Community College; Jo Koehn, Central

Missouri State University; Ken Koerber, Bucks County Community

College; Adriana Kulakowski, Mynderse Academy

Sandra Lang, McKendree College; Cathy Xanthaky Larsen,Middlesex Community College; David Laurel, South TexasCommunity College; Robert Laycock, Montgomery College;Natasha Librizzi, Madison Area Technical College; William P Lovell,Cayuga Community College; Melanie Mackey, Ocean CountyCollege; Jerry Martens, Community College of Aurora; MaureenMcBeth, College of DuPage; Francis McCloskey, CommunityCollege of Philadelphia; Chris McNamara, Finger Lakes CommunityCollege; Lori Major, Luzerne County Community College; EdwinMah, University of Maryland, University College; Thomas Marsh,Northern Virginia Community College—Annandale; Jim Martin,University of Montevallo; Suneel Maheshwari, Marshall University;Shea Mears, Des Moines Area Community College; Pam Meyer,University of Louisiana—Lafayette; Cathy Montesarchio, BrowardCommunity College

Robin Nelson, Community College of Southern Nevada; Joseph M.Nicassio, Westmoreland County Community College; MichaelO’Neill, Seattle Central Community College; Mike Palma, GwinnettTech; George Palz, Erie Community College; Michael Papke,Kellogg Community College; Ruth Parks, Kellogg CommunityCollege; Al Partington, Los Angeles Pierce College; Jennifer Patty,Des Moines Area Community College; Yvonne Phang, Borough ofManhattan Community College; Jan Pitera, Broome CommunityCollege; Mike Prockton, Finger Lakes Community College; Laura M.Prosser, Black Hills State University; Bill Rencher, Seminole

Community College; Jenny Resnick, Santa Monica College; ReneeRigoni, Monroe Community College; Kathie Rogers, SUNY Suffolk;

Al Ruggiero, SUNY Suffolk; Jill Russell, Camden County College.Roger Sands, Milwaukee Area Technical College; Marcia Sandvold,Des Moines Area Community College; Richard Sarkisian, CamdenCommunity College; Kent Schneider, East Tennessee StateUniversity; Karen Searle, Paul J Shinal, Cayuga CommunityCollege; Beth Secrest, Walsh University; Kevin Sinclair, LehighUniversity; Alice Sineath, Forsyth Tech Community College; LeonSingleton, Santa Monica College; Michael S Skaff, College of theSequoias; Jeff Slater, North Shore Community College; Lois Slutsky,Broward Community College; Dan Small, J Sargeant ReynoldsCommunity College; Lee Smart, Southwest Tennessee CommunityCollege; James Smith, Ivy Tech State College; Carol Springer,Georgia State University; Jeff Spoelman, Grand Rapids CommunityCollege; Norman Sunderman, Angelo State University

Donald Terpstra, Jefferson Community College; Lynda Thompson,Massasoit Community College; Shafi Ullah, Broward CommunityCollege; Sue Van Boven, Paradise Valley Community College;Christian Widmer, Tidewater Community College; Wanda Wong,Chabot College; Pat Walczak, Lansing Community College; KentonWalker, University of Wyoming; Patricia Wall, Middle TennesseeState University; Carol N Welsh, Rowan University; IdaleneWilliams, Metropolitan Community College; Gloria Worthy,Southwest Tennessee Community College

Thanks also to “perpetual reviewers” Robert Benjamin, TaylorUniversity; Charles Malone, Tammy Wend, and Carol Wysocki, all

of Columbia Basin College; and William Gregg of MontgomeryCollege We appreciate their continuing interest in the textbookand their regular contributions of ideas to improve it

Accounting Principles has benefited greatly from the input of focus group participants, manuscript reviewers,

those who have sent comments by letter or e-mail, ancillary authors, and proofers We greatly appreciate

the constructive suggestions and innovative ideas of reviewers and the creativity and accuracy of the

ancillary authors and checkers.

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Tenth Edition

Thanks to the following reviewers, focus group participants,

and others who provided suggestions for the Tenth Edition:

Sylvia Allen Los Angeles Valley College

Juanita Ardavany Los Angeles Valley College

Shele Bannon Queensborough Community College

Amy Bentley Tallahassee Community College

Timothy Bergsma Davenport University

Teri Bernstein Santa Monica College

Stanley Carroll New York City College of Technology

Siu Chung Los Angeles Valley College

Carol Collinsworth University of Texas—Brownsville

Kelly Cranford Hinds Community College—Raymond

Liz Diers Black Hills State University

Samuel A Duah Bowie State University

Carle Essig Montgomery County Community College

Annette Fisher Glendale Community College

Kelly Ford Queensborough Community College

Lori Grady Bucks County Community College

Mary Halford Prince Georges Community College

Thomas Kam Hawaii Pacific University

Naomi Karolinski Monroe Community College

Lynn Krausse Bakersfield College

David Krug Johnson County Community College

Cathy X Larson Middlesex Community College

David Laurel South Texas College

Christina Manzo Queensborough Community College

Beverly Mason Front Range Community College

Robert Maxwell College of the Canyons

Jill Mitchell Northern Virginia Community College—

AnnandaleRonald O’Brien Fayetteville Technical Community College

Michael Motes University of Maryland University College

Gregory L Prescott University of South Alabama

Jan Pitera Broome Community College

Debra A Sills Porter Tidewater Community College

William Prosser Cuyuga County Community College

Ada Rodriguez Lehman College, The City University of

New YorkEric Rothenburg Kingsborough Community College, The City

University of New York

Al Ruggiero Suffolk County Community College

Marcia Sandvold Des Moines Area Community College

Mary Jane Sauceda University of Texas—Brownsville

Paul J Shinal Cayauga Community College

Bradley Smith Des Moines Area Community College

Scott Stroher Glendale Community College

Geoffrey Tickell Indiana University of Pennsylvania

Pat Walczak Lansing Community College

Jack Wiehler San Joaquin Delta College

Ancillary Authors, Contributors, and Proofers

We sincerely thank the following individuals for their hard work

in preparing the content that accompanies this textbook:

LuAnn Bean Florida Institute of TechnologyJohn C Borke University of Wisconsin—PlattevilleRichard Campbell Rio Grande CollegeSiu Chung Los Angeles Valley CollegeMel Coe DeVry Institute of Technology, AtlantaChris Cole Cole Creative GroupJoan Cook Milwaukee Area Technical CollegeLarry Falcetto Emporia State UniversityMark Gleason Metropolitan State UniversityLori Grady Bucks County Community CollegeCoby Harmon University of California, Santa BarbaraDouglas W Kieso Aurora UniversityYvonne Phang Borough of Manhattan Community CollegeRex A Schildhouse San Diego Community College—MiramarEileen Shifflett James Madison UniversityDiane Tanner University of North FloridaSheila Viel University of Wisconsin—MilwaukeeDick Wasson Southwestern CollegeBernard Weinrich Lindenwood UniversityMelanie Yon

We also greatly appreciate the expert assistance provided

by the following individuals in checking the accuracy

of the content that accompanies this textbook:

LuAnn Bean Florida Institute of TechnologyJack Borke University of Wisconsin—Platteville

Terry Elliott Morehead State UniversityJames Emig Villanova UniversityLarry Falcetto Emporia State UniversityAnthony Falgiani Western Illinois UniversityLori Grady Bucks County Community CollegeKirk Lynch Sandhills Community CollegeKevin McNelis New Mexico State UniversityJill Misuraca Central Connecticut State UniversityBarbara Muller Arizona State UniversityJohn Plouffe California State University—Los Angeles

Ed Schell University of HawaiiRex Schildhouse San Diego Community College—MiramarAlice Sineath Forsyth Tech Community CollegeTeresa Speck St Mary’s UniversityLynn Stallworth Appalachian State UniversitySheila Viel University of Wisconsin—MilwaukeeDick Wasson Southwestern CollegeAndrea Weickgenannt Xavier UniversityBernie Weinrich Lindenwood University

Our thanks to the publishing “pros” who contribute to our efforts to

publish high-quality products that benefit both teachers and students:

Terry Ann Tatro, development editor; Ed Brislin, project editor; Yana

Mermel, project editor; Allie K Morris, executive media editor; Greg

Chaput, media editor; Jacqueline Kepping, editorial assistant; Valerie

A Vargas, senior production editor; Maddy Lesure, textbook designer;

Dorothy Sinclair, managing editor; Erin Bascom, production editor,

Pam Kennedy, director of production and manufacturing; Ann Berlin,

vice president of higher education production and manufacturing;

Mary Ann Price, photo editor; Sandra Rigby, illustration editor;

Suzanne Ingrao of Ingrao Associates, project manager; Jo-Anne

Naples, permissions editor; Denise Showers of Aptara Inc., project

manager at Aptara Inc.; Danielle Urban, project manager at Elm Street

Publishing Services; and Cyndy Taylor They provided innumerable

services that helped this project take shape

We also appreciate the exemplary support and professional

commit-ment given us by Chris DeJohn, associate publisher, and the enthusiasm

and ideas that Ramona Sherman, senior marketing manager, brings tothe project

Finally, our thanks to Amy Scholz, Susan Elbe, George Hoffman, TimStookesberry, Joe Heider, Bonnie Lieberman, and Will Pesce for theirsupport and leadership in Wiley’s College Division

We thank PepsiCo, Inc for permitting us the use of its 2009 annualreports for our specimen financial statements and accompanyingnotes You can send your thoughts and ideas about the textbook to

us via email at: AccountingAuthors@yahoo.com

Jerry J WeygandtMadison, WisconsinPaul D KimmelMilwaukee, WisconsinDonald E KiesoDeKalb, IllinoisFMTOC_SE.qxd 12/11/10 5:45 AM Page xiii

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Brief Contents

1 Accounting in Action 2

2 The Recording Process 50

3 Adjusting the Accounts 98

4 Completing the Accounting Cycle 152

5 Accounting for Merchandising Operations 208

6 Inventories 260

7 Accounting Information Systems 314

8 Fraud, Internal Control, and Cash 360

9 Accounting for Receivables 414

10 Plant Assets, Natural Resources, and Intangible Assets 456

11 Current Liabilities and Payroll Accounting 508

12 Accounting for Partnerships 552

13 Corporations: Organization and Capital Stock Transactions 592

14 Corporations: Dividends, Retained Earnings, and Income Reporting 632

15 Long-Term Liabilities 668

16 Investments 722

17 Statement of Cash Flows 760

18 Financial Statement Analysis 824

25 Standard Costs and Balanced Scorecard 1146

26 Incremental Analysis and Capital Budgeting 1192 APPENDICES

A Specimen Financial Statements: PepsiCo, Inc A1

B Specimen Financial Statements: The Coca-Cola Company, Inc B1

C Specimen Financial Statements: Zetar plc C1

D Time Value of Money D1

E Using Financial Calculators E1

F Standards of Ethical Conduct for Management Accountants F1

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Assumptions 10 The Basic Accounting Equation 12 Assets 12

Liabilities 13 Owner’s Equity 13 Using the Accounting Equation 14 Transaction Analysis 15

Summary of Transactions 20 Financial Statements 21 Income Statement 23 Owner’s Equity Statement 23 Balance Sheet 24

Statement of Cash Flows 24 APPENDIX 1A Accounting Career Opportunities 29 Public Accounting 29

Private Accounting 29 Opportunities in Government 30 Forensic Accounting 30

“Show Me the Money” 30

A Look at IFRS 46

chapter 2

Feature Story: Accidents Happen 50 The Account 52

Debits and Credits 52 Summary of Debit/Credit Rules 56 Steps in the Recording Process 57 The Journal 58

The Ledger 60 The Recording Process Illustrated 63 Summary Illustration of Journalizing and Posting 70

The Trial Balance 70 Limitations of a Trial Balance 72 Locating Errors 72

Use of Dollar Signs 73

A Look at IFRS 94

chapter 3

Feature Story: What Was Your Profit? 98 Timing Issues 100

Fiscal and Calendar Years 100 Accrual- vs Cash-Basis Accounting 101 Recognizing Revenues and Expenses 101 The Basics of Adjusting Entries 103

Types of Adjusting Entries 103 Adjusting Entries for Deferrals 104 Adjusting Entries for Accruals 111 Summary of Basic Relationships 117 The Adjusted Trial Balance and Financial Statements 119

Preparing the Adjusted Trial Balance 119 Preparing Financial Statements 120 APPENDIX 3A Alternative Treatment of Prepaid Expenses and Unearned Revenues 124

Prepaid Expenses 125 Unearned Revenues 126 Summary of Additional Adjustment Relationships 127

A Look at IFRS 148

chapter 4

Feature Story: Everyone Likes to Win 152 Using a Worksheet 154

Steps in Preparing a Worksheet 154 Preparing Financial Statements from

a Worksheet 158 Preparing Adjusting Entries from a Worksheet 158

Closing the Books 160 Preparing Closing Entries 161 Posting Closing Entries 163 Preparing a Post-Closing Trial Balance 165 Summary of the Accounting Cycle 167 Reversing Entries—An Optional Step 168 Correcting Entries—An Avoidable Step 168 The Classified Balance Sheet 170

Current Assets 172 Long-Term Investments 172 Property, Plant, and Equipment 173 Intangible Assets 173

Current Liabilities 174 Long-Term Liabilities 175 Owner’s Equity 176

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APPENDIX 4A Reversing Entries 181

Reversing Entries Example 181

Freight Costs 215 Purchase Returns and Allowances 216 Purchase Discounts 216

Summary of Purchasing Transactions 217 Recording Sales of Merchandise 218

Sales Returns and Allowances 219 Sales Discounts 220

Completing the Accounting Cycle 222

Adjusting Entries 222 Closing Entries 222 Summary of Merchandising Entries 223 Forms of Financial Statements 224

Multiple-Step Income Statement 224 Single-Step Income Statement 227 Classified Balance Sheet 227 APPENDIX 5A Periodic Inventory System 232

Determining Cost of Goods Sold Under a Periodic System 232

Recording Merchandise Transactions 233 Recording Purchases of Merchandise 233 Recording Sales of Merchandise 234 APPENDIX 5B Worksheet for a Merchandising

Determining Inventory Quantities 263

Taking a Physical Inventory 263 Determining Ownership of Goods 264 Inventory Costing 266

Specific Identification 267 Cost Flow Assumptions 267 Financial Statement and Tax Effects of Cost Flow Methods 272

Using Inventory Cost Flow Methods Consistently 274

Lower-of-Cost-or-Market 275

Inventory Errors 276 Income Statement Effects 276 Balance Sheet Effects 277 Statement Presentation and Analysis 278 Presentation 265

Analysis 279 APPENDIX 6A Inventory Cost Flow Methods in Perpetual Inventory Systems 283

First-In, First-Out (FIFO) 283 Last-In, First-Out (LIFO) 284 Average-Cost 284

APPENDIX 6B Estimating Inventories 286 Gross Profit Method 287

Retail Inventory Method 288

A Look at IFRS 310

chapter 7

Feature Story: QuickBooks® Helps This Retailer Sell Guitars 314 Basic Concepts of Accounting Information Systems 316

Computerized Accounting Systems 316 Manual Accounting Systems 319 Subsidiary Ledgers 319

Subsidiary Ledger Example 320 Advantages of Subsidiary Ledgers 321 Special Journals 322

Sales Journal 323 Cash Receipts Journal 325 Purchases Journal 329 Cash Payments Journal 331 Effects of Special Journals on the General Journal 334

Writing Checks 380 Bank Statements 381

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Reconciling the Bank Account 383 Electronic Funds Transfer (EFT) System 387 Reporting Cash 388

Cash Equivalents 388 Restricted Cash 389

A Look at IFRS 410

chapter 9

Feature Story: A Dose of Careful Management Keeps Receivables Healthy 414

Types of Receivables 416 Accounts Receivable 417 Recognizing Accounts Receivable 417 Valuing Accounts Receivable 418 Disposing of Accounts Receivable 425 Notes Receivable 427

Determining the Maturity Date 428 Computing Interest 429

Recognizing Notes Receivable 430 Valuing Notes Receivable 430 Disposing of Notes Receivable 431 Statement Presentation and Analysis 433 Presentation 433

Analysis 433

A Look at IFRS 453

chapter 10

Plant Assets, Natural Resources,

Feature Story: How Much for a Ride to the Beach? 456 SECTION 1 Plant Assets 458 Determining the Cost of Plant Assets 459 Land 459

Land Improvements 459 Buildings 460

Equipment 460 Depreciation 462 Factors in Computing Depreciation 463 Depreciation Methods 464

Depreciation and Income Taxes 468 Revising Periodic Depreciation 468 Expenditures During Useful Life 470 Plant Assets Disposals 471

Retirement of Plant Assets 471 Sale of Plant Assets 472 SECTION 2 Natural Resources 474 SECTION 3 Intangible Assets 475 Accounting for Intangible Assets 475 Patents 476

Copyrights 476 Trademarks and Trade Names 476 Franchises and Licenses 477 Goodwill 477

Research and Development Costs 478 Statement Presentation and Analysis 479 Presentation 479

Analysis 480 APPENDIX 10A Exchange of Plant Assets 484 Loss Treatment 484

Sales Taxes Payable 511 Unearned Revenues 512 Current Maturities of Long-Term Debt 513 Statement Presentation and Analysis 514 Contingent Liabilities 515

Recording a Contingent Liability 516 Disclosure of Contingent Liabilities 517 Payroll Accounting 518

Determining the Payroll 519 Recording the Payroll 522 Employer Payroll Taxes 525 Filing and Remitting Payroll Taxes 528 Internal Control for Payroll 528 APPENDIX 11A Additional Fringe Benefits 532 Paid Absences 532

Post-Retirement Benefits 533

A Look at IFRS 549

chapter 12

Feature Story: From Trials to Top Ten 552 Partnership Form of Organization 554 Characteristics of Partnerships 554 Organizations with Partnership Characteristics 555

Advantages and Disadvantages of Partnerships 556

The Partnership Agreement 558 Basic Partnership Accounting 559 Forming a Partnership 559 Dividing Net Income or Net Loss 560 Partnership Financial Statements 563 Liquidation of a Partnership 564

No Capital Deficiency 565 Capital Deficiency 568 APPENDIX 12A Admission and Withdrawal of Partners 572

Admission of a Partner 572 Withdrawal of a Partner 576 xviii

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chapter 13

Corporations: Organization and

Feature Story: What’s Cooking? 592 The Corporate Form of Organization 594 Characteristics of a Corporation 595 Forming a Corporation 597

Ownership Rights of Stockholders 598 Stock Issue Considerations 598 Corporate Capital 601

Accounting for Issues of Common Stock 603 Issuing Par Value Common Stock for Cash 603 Issuing No-Par Common Stock for Cash 604 Issuing Common Stock for Services or Noncash Assets 605

Accounting for Treasury Stock 606 Purchase of Treasury Stock 607 Disposal of Treasury Stock 608 Preferred Stock 610

Dividend Preferences 610 Liquidation Preference 611 Statement Presentation 611

A Look at IFRS 629

chapter 14

Corporations: Dividends, Retained Earnings, and Income

Feature Story: Owning a Piece of the Action 632 Dividends 634

Cash Dividends 634 Stock Dividends 638 Stock Splits 640 Retained Earnings 642 Retained Earnings Restrictions 643 Prior Period Adjustments 644 Retained Earnings Statement 645 Statement Presentation and Analysis 646 Stockholders’ Equity Presentation 646 Stockholders’ Equity Analysis 647 Income Statement Presentation 647 Income Statement Analysis 648

Issuing Bonds at Face Value 674

Discount or Premium on Bonds 675 Issuing Bonds at a Discount 676 Issuing Bonds at a Premium 677 Accounting for Bond Retirements 678 Redeeming Bonds at Maturity 679 Redeeming Bonds before Maturity 679 Converting Bonds into Common Stock 679 Accounting for Other Long-Term Liabilities 680 Long-Term Notes Payable 680

Lease Liabilities 683 Statement Presentation and Analysis 684 Presentation 684

Analysis 685 APPENDIX 15A Present Value Concepts Related to Bond Pricing 690

Present Value of Face Value 690 Present Value of Interest Payments (Annuities) 692

Time Periods and Discounting 693 Computing the Present Value of a Bond 693 APPENDIX 15B Effective-Interest Method of Bond Amortization 695

Amortizing Bond Discount 695 Amortizing Bond Premium 697 APPENDIX 15C Straight-Line Amortization 699 Amortizing Bond Discount 699

Amortizing Bond Premium 700

Balance Sheet Presentation 736 Presentation of Realized and Unrealized Gain or Loss 737

Classified Balance Sheet 738

A Look at IFRS 757

chapter 17

Feature Story: Got Cash? 760 The Statement of Cash Flows: Usefulness and Format 762

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Usefulness of the Statement of Cash Flows 762

Classification of Cash Flows 763 Significant Noncash Activities 764 Format of the Statement of Cash Flows 765 Preparing the Statement of Cash Flows 766 Indirect and Direct Methods 767

Preparing the Statement of Cash Flows—Indirect Method 768

Step 1: Operating Activities 769 Summary of Conversion to Net Cash Provided

by Operating Activities—Indirect Method 773 Step 2: Investing and Financing Activities 774 Step 3: Net Change in Cash 775

Using Cash Flows to Evaluate a Company 778 Free Cash Flow 778

APPENDIX 17A Using a Work Sheet to Prepare the Statement of Cash Flows—Indirect Method 783

Preparing the Worksheet 784 APPENDIX 17B Statement of Cash Flows—Direct Method 789

Step 1: Operating Activities 790 Step 2: Investing and Financing Activities 794 Step 3: Net Change in Cash 795

A Look at IFRS 820

chapter 18

Feature Story: It Pays to Be Patient 824 Basics of Financial Statement Analysis 826 Need for Comparative Analysis 826 Tools of Analysis 827

Horizontal Analysis 827 Balance Sheet 828 Income Statement 829 Retained Earnings Statement 830 Vertical Analysis 831

Balance Sheet 831 Income Statement 831 Ratio Analysis 833 Liquidity Ratios 835 Profitability Ratios 838 Solvency Ratios 842 Summary of Ratios 843 Earning Power and Irregular Items 846 Discontinued Operations 846

Extraordinary Items 847 Changes in Accounting Principle 848 Comprehensive Income 849

Quality of Earnings 850 Alternative Accounting Methods 850 Pro Forma Income 850

Management Functions 880 Organizational Structure 881 Business Ethics 882

Managerial Cost Concepts 884 Manufacturing Costs 884 Product versus Period Costs 886 Manufacturing Costs in Financial Statements 887

Income Statement 887 Cost of Goods Manufactured 888 Balance Sheet 890

Cost Concepts—A Review 891 Managerial Accounting Today 894 The Value Chain 894

Technological Change 895 Just-in-Time Inventory Methods 895 Quality 896

Activity-Based Costing 896 Theory of Constraints 896 Balanced Scorecard 897

chapter 20

Feature Story: “ And We’d Like It in Red” 922 Cost Accounting Systems 924

Job Order Cost System 924 Process Cost System 925 Job Order Cost Flow 926 Accumulating Manufacturing Costs 927 Assigning Manufacturing Costs to Work in Process 929

Assigning Costs to Finished Goods 936 Assigning Costs to Cost of Goods Sold 937 Job Order Costing for Service Companies 937 Summary of Job Order Cost Flows 938 Advantages and Disadvantages of Job Order Costing 940

Reporting Job Cost Data 941 Under- or Overapplied Manufacturing Overhead 941

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Similarities and Differences between Job Order Cost and Process Cost Systems 967

Process Cost Flow 969 Assignment of Manufacturing Costs—Journal Entries 970

Equivalent Units 972 Weighted-Average Method 973 Refinements on the Weighted-Average Method 974

Production Cost Report 975 Comprehensive Example of Process Costing 976

Compute the Physical Unit Flow (Step 1) 977 Compute Equivalent Units of Production (Step 2) 978

Compute Unit Production Costs (Step 3) 978 Prepare a Cost Reconciliation Schedule (Step 4) 979

Preparing the Production Cost Report 980 Costing Systems—Final Comments 981 Contemporary Developments 982 Just-in-Time Processing 982 Activity-Based Costing 984 APPENDIX 21A Example of Traditional Costing versus Activity-Based Costing 989

Production and Cost Data 989 Unit Costs Under Traditional Costing 989 Unit Costs Under ABC 989

Comparing Unit Costs 990 Benefits and Limitations of Activity-Based Costing 991

chapter 22

Feature Story: Understanding Medical Costs Might Lead to Better Health Care 1010 Cost Behavior Analysis 1012

Variable Costs 1012 Fixed Costs 1013 Relevant Range 1014 Mixed Costs 1015 Importance of Identifying Variable and Fixed Costs 1019

Cost-Volume-Profit Analysis 1020 Basic Components 1020 CVP Income Statement 1020 Break-even Analysis 1023 Target Net Income 1026 Margin of Safety 1027 CVP and Changes in the Business Environment 1028

CVP Income Statement Revisited 1030 APPENDIX 22A Variable Costing 1034 Effects of Variable Costing on Income 1035 Rationale for Variable Costing 1036

chapter 23

Feature Story: The Next amazon.com?

Not Quite 1052 Budgeting Basics 1054 Budgeting and Accounting 1054 The Benefits of Budgeting 1055 Essentials of Effective Budgeting 1055 Length of the Budget Period 1055 The Budgeting Process 1055 Budgeting and Human Behavior 1056 Budgeting and Long-Range Planning 1058 The Master Budget 1058

Preparing the Operating Budgets 1059 Sales Budget 1059

Production Budget 1060 Direct Materials Budget 1061 Direct Labor Budget 1063 Manufacturing Overhead Budget 1064 Selling and Administrative Expense Budget 1065

Budgeted Income Statement 1065 Preparing the Financial Budgets 1067 Cash Budget 1067

Budgeted Balance Sheet 1070 Budgeting in Non-Manufacturing Companies 1072

Merchandisers 1072 Service Enterprises 1073 Not-for-Profit Organizations 1073

Examples 1099 Uses and Limitations 1100 Flexible Budgets 1101 Why Flexible Budgets? 1101 Developing the Flexible Budget 1103 Flexible Budget—A Case Study 1104 Flexible Budget Reports 1106 Management by Exception 1108 The Concept of Responsibility Accounting 1109 Controllable versus Non-controllable Revenues and Costs 1111

Responsibility Reporting System 1111 Types of Responsibility Centers 1112 Responsibility Accounting for Cost Centers 1114 Responsibility Accounting for Profit Centers 1115 Responsibility Accounting for Investment

Centers 1117 Principles of Performance Evaluation 1120

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The Need for Standards 1148

Distinguishing between Standards and Budgets 1148

Why Standard Costs? 1149

Setting Standard Costs—A Difficult Task 1150

Ideal versus Normal Standards 1150

Statement Presentation of Variances 1161

Balanced Scorecard 1162

System 1168

Journal Entries 1168 Ledger Accounts 1170

Feature Story: Soup Is Good Food 1192

SECTION 1 Incremental Analysis 1194 Management’s Decision-Making Process 1194

The Incremental Analysis Approach 1195 How Incremental Analysis Works 1195

Types of Incremental Analysis 1196

Accept an Order at a Special Price 1196 Make or Buy 1198

Sell or Process Further 1200 Retain or Replace Equipment 1201 Eliminate an Unprofitable Segment 1202 Allocate Limited Resources 1204

SECTION 2 Capital Budgeting 1205 Evaluation Process 1206

Annual Rate of Return 1207 Cash Payback 1208

Discounted Cash Flow 1210

Net Present Value Method 1210 Internal Rate of Return Method 1212 Comparing Discounted Cash Flow Methods 1214

Present Value Variables D3 Present Value of a Single Amount D3 Present Value of an Annuity D5 Time Periods and Discounting D7 Computing the Present Value of a Long-Term Note or Bond D7

appendix E

Present Value of a Single Sum E1

Plus and Minus E2 Compounding Periods E2 Rounding E2

Present Value of an Annuity E2 Useful Applications of the Financial Calculator E3

Auto Loan E3 Mortgage Loan Amount E3

photo credits PC-1 company index I-1 subject index I-3

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Accounting in Action

Study Objectives

After studying this chapter, you should be able to:

[ 1 ] Explain what accounting is.

[ 2 ] Identify the users and uses of accounting.

[ 3 ] Understand why ethics is a fundamental

business concept.

[ 4 ] Explain generally accepted accounting

principles.

[ 5 ] Explain the monetary unit assumption and the

economic entity assumption.

[ 6 ] State the accounting equation, and defi ne its

components.

[ 7 ] Analyze the effects of business transactions on

the accounting equation.

[ 8 ] Understand the four fi nancial statements and

how they are prepared.

Feature Story

KNOWING THE NUMBERS

Many students who take this course do not plan to be accountants If you are in that group, you might be thinking, “If I’m not going to be an accountant, why do I need

to know accounting?” In response, consider the quote from Harold Geneen, the former chairman of IT&T : “To be good at your business, you have to know the numbers—

cold.” Success in any business comes back to the numbers You will rely on them to make decisions, and managers will use them to evaluate your performance That is true whether your job involves marketing, produc- tion, management, or information systems.

In business, accounting and fi nancial statements are the means for communi- cating the numbers If you don’t know how

to read fi nancial statements, you can’t really know your business.

Many companies spend signifi cant resources teaching their employees basic accounting so

Read text and answer Do it! p 11 ●

p 14 ● p 21 ● p 25 ●

● Work Comprehensive Do it! p 26

● Review Summary of Study Objectives ●

● Go to WileyPLUS for practice and tutorials ●

Read A Look at IFRS p 46

● ✔

[ The Navigator ]

2

Study Objectives give you a framework for

learning the specifi c concepts covered in the

chapter.

The Navigator is a learning system designed to prompt you to

use the learning aids in the chapter and set priorities as you study.

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Inside CHAPTER 1

Accounting Across the Organization: The Scoop on Accounting (p 6)

Ethics Insight: The Numbers Behind Not-for-Profi t Organizations (p 8)

International Insight: The Korean Discount (p 10)

Accounting Across the Organization: Spinning the Career Wheel (p 12)

that they can read fi nancial statements and understand how their actions affect the company’s fi nancial results

One such company is Springfi eld ReManufacturing Corporation (SRC) When Jack Stack and 11 other managers purchased SRC for 10 cents

a share, it was a failing division of

International Harvester Jack’s 119 employees, however, were counting

on him for their livelihood He decided that for the company to survive, every employee needed to think like a businessperson and to act like an owner To accomplish this, all employees at SRC took basic accounting courses and participated in weekly reviews of the company’s fi nancial statements

SRC survived, and eventually thrived To this day, every employee (now numbering more than 1,000) undergoes this same training.

Many other companies have adopted this approach, which is called “open-book management.”

Even in companies that do not practice open-book management, employers generally assume that managers in all areas of the company are “fi nancially literate.”

Taking this course will go a long way to making you fi nancially literate In this book, you will learn how to read and prepare fi nancial statements, and how to use basic tools to evaluate

fi nancial results Appendices A and B provide real fi nancial statements of two well-known companies, PepsiCo, Inc and The Coca-Cola Company Throughout this textbook, we attempt to increase your familiarity with fi nancial reporting by providing numerous references, questions, and exercises that encourage you to explore these fi nancial statements.

● ✔

[ The Navigator ]

3

The Feature Story helps you picture how the chapter topic relates to the real world of

accounting and business You will fi nd references to the story throughout the chapter.

“Inside Chapter x” lists boxes

in the chapter that should be of special interest to you.

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Federal Bureau of Investigation (FBI) Thomas Pickard, and numerous members

of Congress? Accounting.1 Why did these people choose accounting? They wanted

to understand what was happening fi nancially to their organizations Accounting

is the fi nancial information system that provides these insights In short, to stand your organization, you have to know the numbers.

under-Accounting consists of three basic activities—it identifi es, records, and municates the economic events of an organization to interested users Let’s take a

com-closer look at these three activities.

Three Activities

As a starting point to the accounting process, a company identifi es the economic events relevant to its business Examples of economic events are the sale of snack

chips by PepsiCo , providing of telephone services by AT&T , and payment of wages

by Ford Motor Company

Once a company like PepsiCo identifi es economic events, it records those

events in order to provide a history of its fi nancial activities Recording consists of

The opening story about Springfi eld ReManufacturing Corporation highlights the importance of

having good fi nancial information to make effective business decisions Whatever one’s pursuits or

occupation, the need for fi nancial information is inescapable You cannot earn a living, spend money,

buy on credit, make an investment, or pay taxes without receiving, using, or dispensing fi nancial

information Good decision making depends on good information.

The purpose of this chapter is to show you that accounting is the system used to provide useful fi nancial

information The content and organization of Chapter 1 are as follows.

• Ethics in fi nancial reporting

• Generally accepted accounting principles

• Measurement principles

• Income statement

• Owner’s equity statement

• Balance sheet

• Statement of cash

fl ows

Accounting in ActionWhat Is Accounting?

The Preview describes and

outlines the major topics and

subtopics you will see in the

chapter.

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What Is Accounting? 5

keeping a systematic, chronological diary of events, measured in dollars and cents

In recording, PepsiCo also classifi es and summarizes economic events.

Finally, PepsiCo communicates the collected information to interested users by means of accounting reports The most common of these reports are called fi nan- cial statements To make the reported fi nancial information meaningful, PepsiCo

reports the recorded data in a standardized way It accumulates information ing from similar transactions For example, PepsiCo accumulates all sales transac- tions over a certain period of time and reports the data as one amount in the

result-company’s fi nancial statements Such data are said to be reported in the aggregate

By presenting the recorded data in the aggregate, the accounting process simplifi es

a multitude of transactions and makes a series of activities understandable and meaningful.

A vital element in communicating economic events is the accountant’s ability to

analyze and interpret the reported information Analysis involves use of ratios,

per-centages, graphs, and charts to highlight signifi cant fi nancial trends and relationships

Interpretation involves explaining the uses, meaning, and limitations of reported data Appendix A of this textbook shows the fi nancial statements of PepsiCo, Inc ; Appendix B illustrates the fi nancial statements of The Coca-Cola Company We re- fer to these statements at various places throughout the text At this point, they probably strike you as complex and confusing By the end of this course, you’ll be surprised at your ability to understand, analyze, and interpret them.

Illustration 1-1 summarizes the activities of the accounting process.

2The origins of accounting are generally attributed to the work of Luca Pacioli, an Italian Renaissance mathematician Pacioli was a close friend and tutor to Leonardo da Vinci and a contemporary of

Christopher Columbus In his 1494 text Summa de Arithmetica, Geometria, Proportione et Proportionalite,

Pacioli described a system to ensure that fi nancial information was recorded effi ciently and accurately

You should understand that the accounting process includes the bookkeeping

function Bookkeeping usually involves only the recording of economic events It is therefore just one part of the accounting process In total, accounting involves the entire process of identifying, recording, and communicating economic events.2

Communication

Prepare accounting reports

Analyze and interpret for users

Annual NOKIAReport Annual

NOKIAReport

Illustration 1-1

The activities of the accounting process

Essential terms are printed

in blue when they fi rst appear, and are defi ned in the end-of- chapter glossary.

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6 1 Accounting in Action

Who Uses Accounting Data

The information that a user of fi nancial information needs depends upon the kinds

of decisions the user makes There are two broad groups of users of fi nancial mation: internal users and external users.

infor-INTERNAL USERS Internal users of accounting information are managers who plan, organize, and run

the business These include marketing managers, production supervisors, fi nance directors, and company offi cers In running a business, internal users must answer many important questions, as shown in Illustration 1-2.

Questions Asked by Internal Users

Is cash sufficient to pay

dividends to

Microsoftstockholders?

Stockholder

Finance

Can we afford to give

General Motors employeespay raises this year?

STRIKE

Unfair Practices U

Human Resources

Beverages

Beve eve ev e ev ev v v er r rage age ag age ag ag a g ge g g

Snack chips ack c ack ck ck chi ck c ck ck c ck c k k k c k k k c k k ch k c k k c chi c ch h

the most profitable? Should anyproduct lines be eliminated?

Management

will maximize the company'snet income?

MENU

Brielist Sgt P.B.

All I

Whe

Marketing

To answer these and other questions, internal users need detailed information

on a timely basis Managerial accounting provides internal reports to help users make decisions about their companies Examples are fi nancial comparisons of op- erating alternatives, projections of income from new sales campaigns, and forecasts

of cash needs for the next year.

EXTERNAL USERS External users are individuals and organizations outside a company who want fi nancial

information about the company The two most common types of external users are

A CCOUNTING A CROSS THE O RGANIZATION

The Scoop on Accounting

Accounting can serve as a useful recruiting tool even for the human resources department Rhino Foods, located in Burlington, Vermont, is a manufacturer of specialty ice cream Its corporate website includes the following:

“Wouldn’t it be great to work where you were part of a team? Where your input and hard work made a difference? Where you weren’t kept in the dark about what management was thinking? Well—it’s not a dream! It’s the way we do business Rhino Foods believes in family, honesty and open communication—

we really care about and appreciate our employees—and it shows Operating sults are posted and monthly group meetings inform all employees about what’s happening in the Company Employees also share in the Company’s profi ts, in addition to having an excellent comprehensive benefi ts package.”

various business functions.

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investors and creditors Investors (owners) use accounting information to make sions to buy, hold, or sell ownership shares of a company Creditors (such as suppliers

deci-and bankers) use accounting information to evaluate the risks of granting credit or lending money Illustration 1-3 shows some questions that investors and creditors may ask.

3“U.S Share Prices Slump,” Wall Street Journal (February 21, 2002)

Questions Asked by External Users

Is General Electric earningsatisfactory income?

Yeah!

Investors

Investors

to pay its debts as they come due?

What do we do

if they catch us?

BILL COLLECTOR

Creditors

Illustration 1-3

Questions that external users ask

The Building Blocks of Accounting 7

Financial accounting answers these questions It provides economic and fi nancial information for investors, creditors, and other external users The information needs

of external users vary considerably Taxing authorities, such as the Internal Revenue Service, want to know whether the company complies with tax laws Regulatory agencies, such as the Securities and Exchange Commission or the Federal Trade

Commission, want to know whether the company is operating within prescribed

rules Customers are interested in whether a company like General Motors will

con-tinue to honor product warranties and support its product lines Labor unions such as

the Major League Baseball Players Association want to know whether the owners have the ability to pay increased wages and benefi ts.

The Building Blocks of Accounting

A doctor follows certain standards in treating a patient’s illness An architect follows certain standards in designing a building An accountant follows certain standards in reporting fi nancial information For these standards to work, a funda- mental business concept must be at work—ethical behavior.

Ethics in Financial Reporting

People won’t gamble in a casino if they think it is “rigged.” Similarly, people won’t play the stock market if they think stock prices are rigged In recent years the fi nan- cial press has been full of articles about fi nancial scandals at Enron , WorldCom ,

HealthSouth , AIG , and others As the scandals came to light, mistrust of fi nancial

reporting in general grew One article in the Wall Street Journal noted that

“repeated disclosures about questionable accounting practices have bruised tors’ faith in the reliability of earnings reports, which in turn has sent stock prices tumbling.”3 Imagine trying to carry on a business or invest money if you could not depend on the fi nancial statements to be honestly prepared Information would have no credibility There is no doubt that a sound, well-functioning economy depends on accurate and dependable fi nancial reporting.

inves-United States regulators and lawmakers were very concerned that the omy would suffer if investors lost confi dence in corporate accounting because of

Understand why ethics is

a fundamental business concept.

Trang 32

8 1 Accounting in Action

unethical fi nancial reporting In response, Congress passed the Sarbanes-Oxley Act of

2002 (SOX, or Sarbox) Its intent is to reduce unethical corporate behavior and

decrease the likelihood of future corporate scandals As a result of SOX, top management must now certify the accuracy of fi nancial information In addition, penalties for fraudulent fi nancial activity are much more severe

Also, SOX increased the independence of the outside auditors who review the accuracy of corporate fi nancial statements and increased the oversight role of boards of directors.

The standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair, are ethics Effective fi nancial reporting depends on sound ethical behavior To sensitize you to ethical situations in business and to give you practice at solving ethical dilemmas,

we address ethics in a number of ways in this book:

1 A number of the Feature Stories and other parts of the text discuss the central

importance of ethical behavior to fi nancial reporting.

2 Ethics Insight boxes and marginal Ethics Notes highlight ethics situations and

issues in actual business settings.

3 Many of the All About You topics (available on the book’s companion website)

focus on ethical issues you may face in your college and early-career years.

4 At the end of the chapter, an Ethics Case simulates a business situation and

asks you to put yourself in the position of a decision maker in that case.

When analyzing these various ethics cases, as well as experiences in your own life, it is useful to apply the three steps outlined in Illustration 1-4.

Identify the stakeholders—

persons or groups who may

be harmed or benefited Askthe question: What are theresponsibilities and obligations

of the parties involved?

3 Identify the alternatives, and weigh the impact of each alternative on various stakeholders.

Select the most ethicalalternative, considering all theconsequences Sometimes therewill be one right answer Othersituations involve more thanone right solution; thesesituations require an evaluation

of each and a selection of thebest alternative

1 Recognize an ethical situation and the ethical issues involved.

Use your personal ethics toidentify ethical situations andissues Some businesses andprofessional organizationsprovide written codes ofethics for guidance in somebusiness situations

Illustration 1-4

Steps in analyzing ethics

cases and situations

Ethics Note

Circus-founder P.T Barnum is

alleged to have said, “Trust

everyone, but cut the deck.” What

Sarbanes-Oxley does is to provide

measures that (like cutting the

deck of playing cards) help ensure

that fraud will not occur

The Numbers Behind Not-for-Profi t Organizations

Accounting plays an important role for a wide range of business organizations wide Just as the integrity of the numbers matters for business, it matters at least as much for not-for-profi t organizations Proper control and reporting help ensure that money is used the way donors intended Donors are less inclined to give to an organization if they think the organization is subject to waste or theft The accounting challenges of some large interna-tional not-for-profi ts rival those of the world’s largest businesses For example, after the Haitian earthquake, the Haitian-born musician Wyclef Jean was criticized for the poor accounting controls in a relief fund that he founded Since then, he has hired a new accountant and improved the transparency regarding funds raised and spent

world-What benefi ts does a sound accounting system provide to a not-for-profi t organization?

(See page 46.)

?

E THICS

Ethics Notes help sensitize you

to some of the ethical issues in

accounting.

Insights provide examples of business situations from various perspectives—ethics, investor, and international.

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Generally Accepted Accounting Principles

The accounting profession has developed standards that are generally accepted and universally practiced This common set of standards is called generally accepted accounting principles (GAAP) These standards indicate how to report economic events.

The primary accounting standard-setting body in the United States is the

Financial Accounting Standards Board (FASB) The Securities and Exchange Commission (SEC) is the agency of the U.S government that oversees

U.S fi nancial markets and accounting standard-setting bodies The SEC relies on the FASB to develop accounting standards, which public compa- nies must follow Many countries outside of the United States have adopted the accounting standards issued by the International Accounting Standards Board (IASB) These standards are called International Financial Reporting Standards (IFRS).

As markets become more global, it is often desirable to compare the result of companies from different countries that report using different accounting standards In order to increase comparability, in recent years the two standard-setting bodies have made efforts to reduce the differ- ences between U.S GAAP and IFRS This process is referred to as con- vergence As a result of these convergence efforts, it is likely that someday there will be a single set of high-quality accounting standards that are used by compa- nies around the world Because convergence is such an important issue, we high-

light any major differences between GAAP and IFRS in International Notes (as shown in the margin here) and provide a more in-depth discussion in the A Look

at IRFS section at the end of each chapter.

Measurement Principles

GAAP generally uses one of two measurement principles, the cost principle or the fair value principle Selection of which principle to follow generally relates to trade- offs between relevance and faithful representation Relevance means that fi nancial

information is capable of making a difference in a decision Faithful representation

means that the numbers and descriptions match what really existed or happened—

it if factual.

COST PRINCIPLE

The cost principle (or historical cost principle) dictates that companies record sets at their cost This is true not only at the time the asset is purchased, but also over the time the asset is held For example if Best Buy purchases land for $300,000, the company initially reports it in its accounting records at $300,000 But what does Best Buy do if, by the end of the next year, the fair value of the land has in- creased to $400,000? Under the cost principle, it continues to report the land at

as-$300,000.

FAIR VALUE PRINCIPLE

The fair value principle states that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability) Fair value information may be more useful than historical cost for certain types of assets and liabilities For example, certain investment securities are reported at fair value because market value information is usually readily available for these types of assets In determin- ing which measurement principle to use, companies weigh the factual nature of cost

fi gures versus the relevance of fair value In general, most companies choose to use cost Only in situations where assets are actively traded, such as investment securities,

do companies apply the fair value principle extensively.

The Building Blocks of Accounting 9

International Note

Over 100 countries use tional Financial Reporting Stan-dards (called IFRS) For example, all companies in the European Union follow international standards The differences between U.S and international standards are not generally signifi cant

Interna-International Notes highlight

differences between U.S and international accounting standards.

Helpful Hints further clarify

concepts being discussed.

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10 1 Accounting in Action

Assumptions

Assumptions provide a foundation for the accounting process Two main

assump-tions are the monetary unit assumption and the economic entity assumption.

MONETARY UNIT ASSUMPTION

The monetary unit assumption requires that companies include in the accounting records only transaction data that can be expressed in money terms This assump- tion enables accounting to quantify (measure) economic events The monetary unit assumption is vital to applying the cost principle.

This assumption prevents the inclusion of some relevant information in the accounting records For example, the health of a company’s owner, the quality of service, and the morale of employees are not included The reason: Companies can- not quantify this information in money terms Though this information is impor- tant, companies record only events that can be measured in money.

ECONOMIC ENTITY ASSUMPTION

An economic entity can be any organization or unit in society It may be a company

(such as Crocs, Inc ), a governmental unit (the state of Ohio), a municipality (Seattle), a school district (St Louis District 48), or a church (Southern Baptist)

The economic entity assumption requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities

To illustrate, Sally Rider, owner of Sally’s Boutique, must keep her personal living costs separate from the expenses of the Boutique Similarly, McDonald’s ,

Coca-Cola , and Cadbury-Schweppes are segregated into separate economic entities for accounting purposes.

Proprietorship. A business owned by one person is generally a proprietorship The owner is often the manager/operator of the business Small service-type businesses (plumbing companies, beauty salons, and auto repair shops), farms, and small retail stores (antique shops, clothing stores, and used-book stores)

are often proprietorships Usually only a relatively small amount of money (capital) is necessary to start in business as a proprietorship The owner (proprietor) receives any profi ts, suffers any losses, and is personally liable for all debts of the business There is no legal distinction between the business

Explain the monetary

unit assumption and

the economic entity

assumption.

Ethics Note

The importance of the economic

entity assumption is illustrated by

scandals involving Adelphia In this

case, senior company employees

entered into transactions that

blurred the line between the

employees’ fi nancial interests and

those of the company For example,

Aldephia guaranteed over $2 billion

of loans to the founding family

What is meant by the phrase “make the country’s businesses more transparent”?

Why would increasing transparency spur economic growth? (See page 46.)

?

The Korean Discount

If you think that accounting standards don’t matter, consider recent events in South Korea For many years, international investors complained that the fi nancial reports

of South Korean companies were inadequate and inaccurate Accounting practices there often resulted in huge differences between stated revenues and actual revenues Because investors did not have faith in the accuracy of the numbers, they were unwilling to pay as much for the shares of these companies relative to shares of comparable companies in different coun-tries This difference in stock price was often referred to as the “Korean discount.”

In response, Korean regulators decided that, beginning in 2011, companies will have to comply with international accounting standards This change was motivated by a desire to

“make the country’s businesses more transparent” in order to build investor confi dence and spur economic growth Many other Asian countries, including China, India, Japan, and Hong Kong, have also decided either to adopt international standards or to create standards that are based on the international standards

Source: Evan Ramstad, “End to ‘Korea Discount’?” Wall Street Journal (March 16, 2007).

II NTERNATIONAL O II NSIGHT S G

Trang 35

as an economic unit and the owner, but the accounting records of the business ties are kept separate from the personal records and activities of the owner.

partnership. In most respects a partnership is like a proprietorship except that more than one owner is involved Typically a partnership agreement (written or oral) sets forth such terms as initial investment, duties of each partner, division of net income (or net loss), and settlement to be made upon death or withdrawal of a partner Each partner generally has unlimited personal liability for the debts of the partnership

Like a proprietorship, for accounting purposes the partnership transactions must

be kept separate from the personal activities of the partners Partnerships are often

used to organize retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certifi ed public accountants).

corpora-tion law and having ownership divided into transferable shares of stock is a ration The holders of the shares (stockholders) enjoy limited liability; that is, they are not personally liable for the debts of the corporate entity Stockholders may transfer all or part of their ownership shares to other investors at any time (i.e., sell

corpo-their shares) The ease with which ownership can change adds to the attractiveness

of investing in a corporation Because ownership can be transferred without

dis-solving the corporation, the corporation enjoys an unlimited life.

Although the combined number of proprietorships and partnerships in the United States is more than fi ve times the number of corporations, the revenue produced by corporations is eight times greater Most of the largest enterprises in the United States—for example, ExxonMobil , Ford , Wal-Mart , Citigroup , and

Apple —are corporations.

The Building Blocks of Accounting 11

The Do it! exercises ask you to

put newly acquired knowledge

to work They outline the Action Plan necessary to complete the exercise, and they show a Solution.

Indicate whether each of the fi ve statements presented below is true or false.

1 The three steps in the accounting process are identifi cation, recording, and

com-munication.

2 The two most common types of external users are investors and company

offi cers.

3 Congress passed the Sarbanes-Oxley Act of 2002 to reduce unethical behavior

and decrease the likelihood of future corporate scandals.

4 The primary accounting standard-setting body in the United States is the Financial Accounting Standards Board (FASB).

5 The cost principle dictates that companies record assets at their cost In later

periods, however, the fair value of the asset must be used if fair value is higher than its cost.

Related exercise material: E1-1, E1-2, E1-3, E1-4, and Do it! 1-1

action plan

✔ Review the basic concepts learned to date

✔ Develop an understanding

of the key terms used

1 True 2 False The two most common types of external users are investors and creditors 3 True 4 True 5 False The cost principle dictates that com- panies record assets at their cost Under the cost principle, the company must also use cost in later periods as well.

● ✔

[ The Navigator ]

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12 1 Accounting in Action

State the accounting

equation, and defi ne its

components.

The Basic Accounting Equation

The two basic elements of a business are what it owns and what it owes Assets are

the resources a business owns For example, Google has total assets of mately $40.5 billion Liabilities and owner’s equity are the rights or claims against these resources Thus, Google has $40.5 billion of claims against its $40.5 billion of assets Claims of those to whom the company owes money (creditors) are called

approxi-liabilities Claims of owners are called owner’s equity Google has liabilities of $4.5

billion and owners’ equity of $36 billion.

We can express the relationship of assets, liabilities, and owner’s equity as an equation, as shown in Illustration 1-5.

Illustration 1-5

This relationship is the basic accounting equation Assets must equal the sum of liabilities and owner’s equity Liabilities appear before owner’s equity in the basic accounting equation because they are paid fi rst if a business is liquidated.

The accounting equation applies to all economic entities regardless of size, nature

of business, or form of business organization It applies to a small proprietorship such

as a corner grocery store as well as to a giant corporation such as PepsiCo The equation

provides the underlying framework for recording and summarizing economic events.

Let’s look in more detail at the categories in the basic accounting equation.

Assets

As noted above, assets are resources a business owns The business uses its assets in carrying out such activities as production and sales The common characteristic

A CCOUNTING A CROSS THE O RGANIZATION

Spinning the Career Wheel

One question that students frequently ask is, “How will the study of accounting help me?” It should help you a great deal, because a working knowledge of

accounting is desirable for virtually every fi eld of endeavor Some examples of how

accounting is used in other careers include:

General management: Imagine running Ford Motors, Massachusetts General Hospital, Northern Virginia Community College, a Subway franchise, a Trek bike shop All general manag-ers need to understand accounting data in order to make wise business decisions

Marketing: A marketing specialist at a company like Procter & Gamble develops strategies

to help the sales force be successful But making a sale is meaningless unless it is a profi table sale Marketing people must be sensitive to costs and benefi ts, which accounting helps them quantify and understand

Finance: Do you want to be a banker for Bank of America, an investment analyst for Goldman Sachs, a stock broker for Merrill Lynch? These fi elds rely heavily on accounting In all of them you will regularly examine and analyze fi nancial statements In fact, it is diffi cult to get a good

fi nance job without two or three courses in accounting

Real estate: Are you interested in being a real estate broker for Prudential Real Estate? Because a third party—the bank—is almost always involved in fi nancing a real estate transac-tion, brokers must understand the numbers involved: Can the buyer afford to make the pay-ments to the bank? Does the cash fl ow from an industrial property justify the purchase price?

What are the tax benefi ts of the purchase?

How might accounting help you? (See page 46.)

?

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possessed by all assets is the capacity to provide future services or benefi ts In a

business, that service potential or future economic benefi t eventually results in cash infl ows (receipts) For example, Campus Pizza owns a delivery truck that provides economic benefi ts from delivering pizzas Other assets of Campus Pizza are tables, chairs, jukebox, cash register, oven, tableware, and, of course, cash.

Liabilities

Liabilities are claims against assets—that is, existing debts and obligations nesses of all sizes usually borrow money and purchase merchandise on credit These economic activities result in payables of various sorts:

• Campus Pizza, for instance, purchases cheese, sausage, fl our, and beverages on

credit from suppliers These obligations are called accounts payable.

• Campus Pizza also has a note payable to First National Bank for the money

borrowed to purchase the delivery truck.

• Campus Pizza may also have salaries and wages payable to employees and sales and real estate taxes payable to the local government.

All of these persons or entities to whom Campus Pizza owes money are its creditors.

Creditors may legally force the liquidation of a business that does not pay its

debts In that case, the law requires that creditor claims be paid before ownership

claims.

Owner’s Equity

The ownership claim on total assets is owner’s equity It is equal to total assets nus total liabilities Here is why: The assets of a business are claimed by either cred- itors or owners To fi nd out what belongs to owners, we subtract the creditors’ claims (the liabilities) from assets The remainder is the owner’s claim on the assets—the

mi-owner’s equity Since the claims of creditors must be paid before ownership claims, owner’s equity is often referred to as residual equity.

INCREASES IN OWNER’S EQUITY

In a proprietorship, owner’s investments and revenues increase owner’s equity.

the business These investments increase owner’s equity They are recorded in a

category called owner’s capital.

busi-ness activities entered into for the purpose of earning income Generally, revenues

result from selling merchandise, performing services, renting property, and lending money Common sources of revenue are sales, fees, services, commissions, interest, dividends, royalties, and rent.

Revenues usually result in an increase in an asset They may arise from ent sources and are called various names depending on the nature of the business

differ-Campus Pizza, for instance, has two categories of sales revenues—pizza sales and beverage sales.

DECREASES IN OWNER’S EQUITY

In a proprietorship, owner’s drawings and expenses decrease owner’s equity.

a separate classifi cation called drawings to determine the total withdrawals for each

accounting period Drawings decrease owner’s equity They are recorded in a

category called owner’s drawings.

Helpful Hint

In some places, we use the term ”owner’s equity” and

in others we use ”owners’

equity.” Owner’s (singular,

possessive) refers to one owner (the case with a sole

proprietorship) Owners’

(plural, possessive) refers to multiple owners (the case with partnerships or corporations)

The Basic Accounting Equation 13

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14 1 Accounting in Action

Expenses Expenses are the cost of assets consumed or services used in the process

of earning revenue They are decreases in owner’s equity that result from operating the business For example, Campus Pizza recognizes the following expenses: cost of

ingredients (meat, fl our, cheese, tomato paste, mushrooms, etc.); cost of beverages;

salaries and wages expense; utilities expense (electric, gas, and water expense);

delivery expense (gasoline, repairs, licenses, etc.); supplies expense (napkins, gents, aprons, etc.); rent expense; interest expense; and property tax expense.

deter-In summary, owner’s equity is increased by an owner’s investments and by enues from business operations Owner’s equity is decreased by an owner’s with- drawals of assets and by expenses Illustration 1-6 expands the basic accounting equation by showing the accounts that comprise owner’s equity This format is referred to as the expanded accounting equation

Basic Equation: Assets 5 Liabilities 1 Owner’s Equity Expanded Assets 5 Liabilities 1 Owner’s Capital 2 Owner’s Drawings Equation: 1 Revenues 2 Expenses

Illustration 1-6

Expanded accounting equation

Using the Accounting Equation

Transactions (business transactions) are a business’s economic events recorded by countants Transactions may be external or internal External transactions involve

ac-economic events between the company and some outside enterprise For example, Campus Pizza’s purchase of cooking equipment from a supplier, payment of monthly

rent to the landlord, and sale of pizzas to customers are external transactions Internal transactions are economic events that occur entirely within one company The use of

cooking and cleaning supplies are internal transactions for Campus Pizza.

Analyze the effects of

business transactions on

the accounting equation.

Classify the following items as investment by owner (I), owner’s drawings (D), revenues (R), or expenses (E) Then indicate whether each item increases or decreases owner’s equity.

(2) Service Revenue (4) Salaries and Wages Expense

Related exercise material: BE1-1, BE1-2, BE1-3, BE1-4, BE1-5, E1-5, E1-6, E1-7, and Do it! 1-2

✔ Review the rules for

changes in owner’s equity:

Investments and revenues

increase owner’s equity

Expenses and drawings

decrease owner’s equity

✔ Recognize that drawings

are withdrawals of cash or

other assets from the business

for personal use

● ✔

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Companies carry on many activities that do not represent business tions Examples are hiring employees, answering the telephone, talking with cus- tomers, and placing merchandise orders Some of these activities may lead to business transactions: Employees will earn wages, and suppliers will deliver ordered merchandise The company must analyze each event to fi nd out if it af- fects the components of the accounting equation If it does, the company will record the transaction Illustration 1-7 demonstrates the transaction-identifi cation process.

transac-Helpful Hint

You will want to study these transactions until you are sure you under-stand them They are not diffi cult, but understand-ing them is important to your success in this course

The ability to analyze transactions in terms of the basic accounting equation is essential in accounting

Each transaction must have a dual effect on the accounting equation For

example, if an asset is increased, there must be a corresponding: (1) decrease in another asset, or (2) increase in a specifi c liability, or (3) increase in owner’s

equity.

Two or more items could be affected For example, as one asset is increased

$10,000, another asset could decrease $6,000 and a liability could increase $4,000

Any change in a liability or ownership claim is subject to similar analysis.

Transaction Analysis

The following examples are business transactions for a computer programming business during its fi rst month of operations.

programming service which he names Softbyte On September 1, 2012, he invests

$15,000 cash in the business This transaction results in an equal increase in assets and owner’s equity.

Yes No

RecordDon't

potential customerPurchase computer

ZZ

Is the financial position (assets, liabilities, or owner’s equity) of the company changed?

Bank

Home Accounting Ballence

Illustration 1-7

Transaction-identifi cation process

Using the Accounting Equation 15

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16 1 Accounting in Action

Observe that the equality of the accounting equation has been maintained Note that the investments by the owner do not represent revenues, and they are excluded

in determining net income Therefore it is necessary to make clear that the increase

is an investment (increasing Owner’s Capital) rather than revenue.

equipment for $7,000 cash This transaction results in an equal increase and crease in total assets, though the composition of assets changes Cash decreases

de-$7,000, and the asset Equipment increases $7,000 The specifi c effect of this action and the cumulative effect of the fi rst two transactions are:

trans-Cash decreases $7,000, and the asset Equipment increases $7,000

Basic Analysis

Equation Analysis

Assets 5 Liabilities 1 Owner’s Equity

from Acme Supply Company computer paper and other supplies expected to last several months Acme agrees to allow Softbyte to pay this bill in October This transaction is a purchase on account (a credit purchase) Assets increase because of the expected future benefi ts of using the paper and supplies, and liabilities increase

by the amount due Acme Company.

The asset Supplies increases $1,600, and the liability Accounts Payable increases by $1,600

Basic Analysis

Equation Analysis

Equation Analysis

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