Financial accounting 1461435852

Financial Accounting Financial Accounting [Authors removed at request of original publisher] University of Minnesota Libraries Publishing edition, 2015 This edition adapted from a work originally produced in 2010 by a publisher who has requested that it not receive attribution Minneapolis, MN Financial Accounting by [Authors removed at request of original publisher] is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted iv • FINANCIAL ACCOUNTING Publisher Information Financial Accounting is adapted from a work produced and distributed under a Creative Commons license (CC BY-NC-SA) in 2012 by a publisher who has requested that they and the original author not receive attribution This adapted edition is produced by the University of Minnesota Libraries Publishing through the eLearning Support Initiative This adaptation has reformatted the original text, and replaced some images and figures to make the resulting whole more shareable This adaptation has not significantly altered or updated the original 2012 text This work is made available under the terms of a Creative Commons Attribution-NonCommercial-ShareAlike license iv About the Authors Unnamed Author, University of Richmond Unnamed Author is an associate professor of accounting at the Robins School of Business at the University of Richmond In 2006, he was named by BusinessWeek as one of twenty-six favorite undergraduate business professors in the United States In 2007, he was named Virginia Professor of the Year by the Carnegie Foundation for the Advancement of Teaching and the Council for the Advancement and Support of Education In 2009, he was selected as one of the one hundred most influential members of the accounting profession by Accounting Today Unnamed Author has two market-leading textbooks published with McGraw-Hill—Advanced Accounting (10th edition, 2010) and Essentials of Advanced Accounting (4th edition, 2010), both coauthored with Tom Schaefer of the University of Notre Dame and Tim Doupnik of the University of South Carolina At the Robins School of Business, Unnamed Author teaches Fundamentals of Financial Accounting, Intermediate Financial Accounting I, Intermediate Financial Accounting II, and Advanced Financial Accounting He earned his BA degree in accounting from Duke University and his MA degree in business and economics, with a minor in education, from Appalachian State University He has written numerous articles and made many presentations around the country on teaching excellence Unnamed Author also has three decades of experience operating his own CPA review programs In 2008, he created CPA Review for Free (http://www.CPAreviewforFREE.com), which provides thousands of free questions to help accountants around the world prepare for the CPA Exam Unnamed Author and his wife, Sarah, have four children and four grandchildren Unnamed Author, University of North Carolina at Chapel Hill Unnamed Author has received multiple teaching awards at the University of North Carolina’s Kenan-Flagler Business School (ten), at Duke University’s Fuqua School of Business (five), and at North Carolina State University (five) He has been included among the outstanding Fuqua faculty in four editions of the BusinessWeek Guide to the Best Business Schools Unnamed Author also received the James M Johnston Teaching Excellence Award at the University of North Carolina in 2005 His classes were featured on businessweek.com and sportsillustrated.cnn.com in 2006 Unnamed Author has served as a training consultant on three continents for Glaxo Wellcome, IBM, Nortel Networks, Paragon Trade Brands, Siemens, Starwood, and Wells Fargo He has developed and delivered various executive education seminars as well as CPA, CMA, and CIA review courses For six years, he lectured simultaneously in the State, Carolina, and Duke CPA preparatory classes For seven years, Unnamed Author taught Financial Accounting and Managerial Accounting on cable television in the Research Triangle area His scholarly work has been published in TAXES and Journal of Accounting Education Unnamed Author was born in Harrisburg, Pennsylvania, in 1954 He captained three sports at Susquehanna Township High School Unnamed Author holds academic degrees from Lehigh University and Duke University He attended Lehigh on a basketball scholarship and graduated magna cum laude Unnamed Auhtor worked as an auditor for Deloitte Haskins and Sells in Philadelphia He has attained eleven professional designations in accounting, financial planning, insurance, and management: CPA (certified public accountant), CMA (certified management accountant), CCA (certified cost analyst), CIA (certified internal auditor), ChFC (chartered financial consultant), CLU (chartered life underwriter), CFP (certified financial planner), AIAF (associate in insurance accounting and finance), CFE (certified fraud examiner), CFM (certified in financial management), and CBM (certified business manager) Unnamed Author and his wife, Mary Anne, are the parents of two sons and one daughter: Charles (1979), Timothy (1983), and Corey (1987) They reside in Raleigh, North Carolina v vi • FINANCIAL ACCOUNTING Acknowledgments A textbook of this size owes a genuine debt of gratitude to a long list of wonderful people We want to acknowledge the time, energy, ideas, and patience invested by each of the following individuals Book Development and Support A warm thank you to Jeff Shelstad, Bradley Felix, Sharon Koch, Shannon Gattens, Jenn Yee, Stacy Claxton, Chrissy Chimi, John Britton, and Barbara Corbin Textbook Reviewers • • • • • • • • • • • • • • • • • • • • • • • • • Pervaiz Alam, Kent State University Jane Austin, Oklahoma City University Richard Baldwin, Johnson & Wales University, Friedman Center, Graduate School Sheila Bedford, American University Bruce Branson, North Carolina State University Rada Brooks, University of California, Berkeley, Haas School of Business Charles Bunn, Wake Technical Community College Stan Clark, University of Southern Mississippi Sue Cunningham, Rowan Cabarrus Community College Betty David, Francis Marion University Carolyn Dreher, Southern Methodist University, Cox School of Business Wilbert Harri, Pima Community College Lori Holder-Webb, Simmons College School of Management Ethan Kinory, Baruch College, City University of New York Pamela Legner, College of DuPage Randall Lewis, Spring Arbor University Chao-Shin Liu, University of Notre Dame Mary Middleton, University of Richmond Jane Mooney, Simmons College David Sulzen, Ferrum College Diane Tanner, University of North Florida Steven Thoede, Texas State University Robin Thomas, North Carolina State University Wendy Wilson, Southern Methodist University Gregory Yost, University of West Florida The authors also appreciate the efforts of Lydia Rosencrants, LaGrange College Accountancy and Business Programs, who has assisted the project by developing the end-of-chapter and supplementary material We want to give a special word of thanks to Katie Fischer for reading the early chapters of this textbook and giving a wonderful perspective from a student’s point of view vi Preface How to Use This Book: From the Authors to the Students If we have done our job properly during the creation of this textbook, it will be like no other educational material that you have ever experienced We literally set out to rethink the nature, structure, and purpose of college textbooks Every feature that you find here was designed to enhance student learning We want this material to be presented in a manner that is both innovative and effective The two of us have taught in college for over sixty years Year in and year out, financial accounting has always seemed to us to be both interesting and relevant to everyday life We believe it is knowledge well worth acquiring From the day we started this project, we hoped to share our enthusiasm with you, to develop a book that you will find to be both readable and worth reading Historically, textbooks have been presented as dry monologues, a one-way conversation that often seems to talk to the teacher more than to the student “Boring” and “confusing” should never be synonymous with any aspect of education Instead, we seek to promote an active dialogue Authors, teachers, and students should work together to create an environment where education flourishes We want you, the student, to understand the nature of our endeavor After all, the only reason that this book exists is to aid you in learning financial accounting If you not read the chapters because you find them boring or if you not understand the material that is included, no one benefits We will have wasted our time We view this textbook as a guide In constructing these seventeen chapters, we have worked to guide you on a voyage through the world of business and financial reporting We want to help you attain a usable knowledge of the principles of financial accounting as well as an appreciation for its importance and logic By learning its theory, presentation, and procedures, individuals become capable of using financial accounting to make prudent business decisions That is an important goal regardless of the direction of your career We have relied on our experience as teachers to highlight the aspects of this material that make it interesting, logical, and relevant Talk, though, is cheap Saying that this book is different and interesting does not make it so Be a wise consumer When someone tries to sell you something, force them to back up their claims So How Does This Book Work? What Makes It Special? Every chapter is introduced with a short video in which one of the authors provides an overview of the material and a discussion of its importance Thus, students are never forced to begin reading blindly, struggling to put new subjects into an understandable context Even before the first written word, each chapter is explained through the opening video Simply put, this introduction makes the subject matter more understandable and your reading more interesting and efficient We attempt to remove the mystery from every aspect of financial accounting because we want you to be an effective learner This textbook is written entirely in a question-and-answer format The Socratic method has been used successfully for thousands of years to help students develop critical thinking skills We that here on every page of every chapter A question is posed and the answer is explained Then, the next logical question is put forth to lead you through the material in a carefully constructed sequential pattern Topics are presented and analyzed as through a conversation This format breaks each chapter down into easy-to-understand components A chapter is not thirty pages of seemingly unending material Instead, it is twenty to forty questions and answers that put the information into manageable segments with each new question logically following the previous one vii viii • FINANCIAL ACCOUNTING All college textbooks present challenging material However, that is no excuse for allowing readers to become lost Educational materials should be designed to enhance learning and not befuddle students At key points throughout each chapter, we have placed embedded multiple-choice questions along with our own carefully constructed answers These questions allow you to pause at regular intervals to verify that you understand the material that has been covered Immediate feedback is always a key ingredient in successful learning These questions and answers are strategically placed throughout every chapter to permit ongoing review and reinforcement of knowledge For a course such as financial accounting, each subject should relate in some manner to the real world of business Therefore, every chapter includes a discussion with a successful investment analyst about the material that has been presented This expert provides an honest and open assessment of financial accounting straight from the daily world of high finance and serious business decisions Every question, every answer, every topic need to connect directly to the world we all face Students should always be curious about the relevance of every aspect of a textbook’s coverage We believe that it is helpful to consider this material from the perspective of a person already working in the business environment of the twenty-first century In many chapters, we also talk about the current evolution occurring in financial accounting as the United States moves from following U.S rules (U.S GAAP) to international standards (IFRS) The world is getting smaller as companies and their operations become more global At the same time, technology makes the amount of available information from around the world almost beyond comprehension Consequently, throughout this textbook, we interview one of the partners of a large international accounting firm about the impact of possibly changing financial accounting in this country so that all reporting abides by international accounting rules rather than solely U.S standards Each chapter ends with a final video However, instead of merely reviewing the material one last time in a repetitive fashion, we challenge you to select the five most important elements of each chapter Some coverage is simply more important than others That is a reasonable expectation Part of a successful education is gaining the insight to make such evaluations Then, we provide you with our own top five The lists not need to match; in fact, it is unlikely that they will be the same That is not the purpose This exercise should encourage you to weigh the significance of the material What really makes a difference based on your understanding of financial accounting? In what areas should you focus your attention? Is This Book Unique? We truly believe so We believe that it has an educationally creative structure that will promote your learning and make the educational process more effective and more interesting: • • • • • Opening videos for the chapters Socratic method Embedded multiple-choice questions Discussions with both an investment analyst and an international accounting expert Closing videos establishing top-five lists for each chapter Every page of this book, every word in fact, has been created to encourage and enhance your understanding We want PREFACE • ix you to benefit from our coverage, but just as importantly, we want you to enjoy the process When presented correctly, learning can be fun and, we believe, should be Please feel free to contact us if you have any suggestions for improvement We would love to hear from you Finally, this book is dedicated to our wives and our families It is also dedicated to the thousands of wonderful teachers across the world who walk into countless college classrooms each day and make learning happen for their students You make the world better Chapter 1: Why Is Financial Accounting Important? Video Clip (click to see video) Unnamed Author introduces the course objectives and Chapter “Why Is Financial Accounting Important?” 523 • FINANCIAL ACCOUNTING the year, Happy Toy incurred cost of goods sold of $25,000 Happy Toy ended 20X9 with $2,700 in inventory and $3,800 in accounts payable How much cash did Happy Toy pay for purchases during 20X9? 5.1 $26,000 5.2 $22,600 5.3 $24,000 5.4 $27,400 Where would the purchase of available for sale securities appear on the statement of cash flows? 6.1 Operating section 6.2 Investing section 6.3 Financing section 6.4 Supplemental schedule Crystal Bell Company generated $48,900 in net income during the year Included in this number are a deprecation expense of $13,000 and a gain on the sale of equipment of $4,000 In addition, accounts receivable increased by $16,000, inventory decreased by $5,090, accounts payable decreased $4,330 and interest payable increased $1,200 Based on the above information, what would Crystal Bell’s cash flow from operations using the indirect method? 7.1 $54,120 7.2 $71,940 7.3 $48,900 7.4 $43,860 Transportation Inc incurred rent expense of $98,000 during the year Prepaid rent increased by $34,000 during the year How much cash did Transportation pay for rent during the year? 8.1 $98,000 8.2 $64,000 8.3 $132,000 8.4 $34,000 Problems Use the following abbreviations to indicate in which section of the statement of cash flows you would find each item below 17.6 END-OF-CHAPTER EXERCISES • 524 O = Operating Section I = Investing Section F = Financing Section 1.1 Issuance of bonds payable 1.2 Cash paid for interest 1.3 Cash collected from customers 1.4 Paid dividends 1.5 Sold equipment 1.6 Issued preferred stock 1.7 Cash paid for inventory purchases 1.8 Purchased an equity investment in another company 1.9 Cash received from dividend income Roy Company enjoyed sales during 20X1 of $120,000 Roy began the year with $56,000 in accounts receivable and ended the year with $79,000 in accounts receivable Determine the amount of cash Roy collected from customers during 20X1 Whitmore Corporation had cost of goods sold of $4,793,000 during the year Whitmore had the following account balances at the beginning and end of the year Figure 17.37 Change in Inventory and Account Payable Balances What amount of cash did Whitmore pay for inventory purchases this year? Jamison Company’s income statement for 20X6 is below Figure 17.38 Jamison Company Income Statement as of 12/31/X6 525 • FINANCIAL ACCOUNTING Figure 17.39 Selected Balance Sheet Accounts from the Beginning and End of 20X6 Determine Jamison’s cash flow from operations using both the direct and indirect methods Killian Corporation had several transactions during the year that impacted long-term assets and liabilities and owners’ equity Determine if each of the following items would be shown in investing activities, financing activities or neither Figure 17.40 Determination of Cash Flow Balances 17.6 END-OF-CHAPTER EXERCISES • 526 Ruthers Corporation began business on January 1, 20X5 The financial statements for Ruthers’ first year are given below Because it is the first year of the company, there are no beginning balances for the balance sheet accounts This should simplify your preparation of the cash flow statement Figure 17.41 Ruthers Corporation Income Statement as of 12/31/X5 527 • FINANCIAL ACCOUNTING Figure 17.42 Ruthers Corporation Balance Sheet 12/31/X5 Additional Information: 6.1 Ruthers purchased land for $14,000 cash 6.2 Common stock was issued for $4,500 6.3 A note payable was signed for $10,000 cash 17.6 END-OF-CHAPTER EXERCISES • 528 Prepare Ruthers’ statement of cash flows for 20X5 using the indirect method of calculating cash flows from operations Looney Company is in the process of preparing financial statements for the year ended 12/31/X9 The income statement as of 12/31/X9 and comparative balance sheets are presented below Note that the Balance Sheet is presented with the most current year first, as is done in practice Figure 17.43 Looney Company Income Statement as of 12/31/X9 Figure 17.44 Looney Company Balance Sheet December 31, 20X9 and 20X8 529 • FINANCIAL ACCOUNTING The following additional information has been assembled by Looney’s accounting department: 7.1 Equipment was purchased for $90 7.2 Long-term debt of $70 was issued for cash 7.3 Looney issued eleven shares of common stock for cash during 20X9 Prepare Looney’s statement of cash flows as of 12/31/X9 using the direct method 17.6 END-OF-CHAPTER EXERCISES • 530 The following information relates to Henrich’s Hat Store Inc for the year ended December 31, 20X8 Figure 17.45 Henrich’s Hat Store Inc Balance Sheet 531 • FINANCIAL ACCOUNTING Figure 17.46 Henrich’s Hat Store Inc Income Statement for the Year Ended December 31, 20X8 Other information: 8.1 The company purchased a building and fixtures with cash during the year, but none were sold 8.2 Dividends of $170,000 were declared and paid 8.3 Proceeds from the sale of common stock totaled $520,000 8.4 Land was purchased for $300,000 cash Prepare the statement of cash flows for Henrich’s Hat Store Inc for the year ended December 31, 20X8 using the indirect method of calculating cash flows from operations Comprehensive Problem This problem has carried through several chapters, building in difficulty Hopefully, it has allowed students to continuously practice skills and knowledge learned in previous chapters In Chapter 16 “In a Set of Financial Statements, What Information Is Conveyed about Shareholders’ Equity?”, you prepared Webworks statements for April They are included here as a starting point for May This will be your final month of preparing financial statements for Webworks This month, the statement of cash flows will be added To simply the problem, fewer transactions than usual are included Here are Webworks financial statements as of April 30 Figure 17.47 Webworks Financial Statements 17.6 END-OF-CHAPTER EXERCISES • 532 Figure 17.48 Figure 17.49 533 • FINANCIAL ACCOUNTING The following events occur during May: a Webworks starts and completes twelve more Web sites and bills clients for $9,000 b Webworks purchases supplies worth $140 on account c At the beginning of May, Webworks had twenty-two keyboards costing $121 each and twenty-eight flash drives costing $25 each Webworks uses periodic FIFO to cost its inventory 17.6 END-OF-CHAPTER EXERCISES • 534 each d On account, Webworks purchases eighty-three keyboards for $122 each and ninety flash drives for $26 e Webworks sells 98 keyboards for $14,700 and 100 of the flash drives for $3,000 cash f Webworks collects $9,000 in accounts receivable g Webworks pays its $500 rent h Webworks pays off $14,000 of its accounts payable i Webworks sells all of its shares of QRS stock for $14 per share j Webworks pays Juan $750 for his work during the first three weeks of May k Webworks pays off its salaries payable from April l Webworks pays Leon and Nancy a salary of $4,000 each m Webworks’ note payable permits early payment with no penalty Leon and Nancy decide to use some of their excess cash and pay off the note and interest payable The note was paid at the beginning of May, so no interest accrued during May n Webworks pays taxes of $740 in cash Required: A Prepare journal entries for the above events B Post the journal entries to T-accounts C Prepare an unadjusted trial balance for Webworks for May D Prepare adjusting entries for the following and post them to your T-accounts o Webworks owes Juan $200 for his work during the last week of May p Webworks receives an electric bill for $450 Webworks will pay the bill in June q Webworks determines that it has $70 worth of supplies remaining at the end of May r Webworks is continuing to accrue bad debts at 10 percent of accounts receivable s Webworks continues to depreciate its equipment over five years and its furniture over five years, using the straight-line method t The license agreement should be amortized over its one-year life u Record cost of goods sold E Prepare an adjusted trial balance F Prepare financial statements, including the statement of cash flows, for May Prepare the operating section using the indirect method Appendix: Present Value Tables Figure 17.1 Present Value of $1 Figure 17.2 Present Value of Annuity Due (annuity in advance—beginning of period payments) 535 APPENDIX: PRESENT VALUE TABLES • 536 Figure 17.3 Present Value of Ordinary Annuity (annuity in arrears—end of period payments) 537 • FINANCIAL ACCOUNTING