Intermediate accounting 11th loren nikolai , john bazley and jefferson jones

Intermediate accounting 11th loren nikolai , john bazley and jefferson jones Intermediate accounting 11th loren nikolai , john bazley and jefferson jones Intermediate accounting 11th loren nikolai , john bazley and jefferson jones Intermediate accounting 11th loren nikolai , john bazley and jefferson jones Intermediate accounting 11th loren nikolai , john bazley and jefferson jones Intermediate accounting 11th loren nikolai , john bazley and jefferson jones

Intermediate Accounting 11th edition Loren A Nikolai Ernst & Young Professor, School of Accountancy University of Missouri—Columbia John D Bazley John J Gilbert Professor, School of Accountancy University of Denver Jefferson P Jones PricewaterhouseCoopers Associate Professor School of Accountancy, Auburn University Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Ki ngdom • United States Intermediate Accounting, Eleventh Edition Loren Nikolai, John Bazley, Jefferson Jones Vice President of Editorial, Business: Jack W Calhoun Publisher: Rob Dewey © 2010, 2007 South-Western, Cengage Learning ALL RIGHTS RESERVED No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including photocopying, recording, taping, Web distribution, information storage and retrieval systems, or in any other manner—except as may be permitted by the license terms herein Sr Acquisitions Editor: Matt 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the American Institute of Certified Public Accountants, Inc., is reprinted (or adapted) with permission Copyright 1967, 1971, 1972, 1973, and 1981 by the American Institute of Certified Public Accountants, Inc Reprinted (or adapted) with permission Portions of various FASB documents, copyright by the Financial Accounting Standards Board, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116, are reprinted with permission Materials from the Certified Management Accountant Examinations, Copyright © 1981, 1982, 1983, 1986, 1987 by the Institute of Certified Management Accountants are reprinted (or adapted) with permission Cover Image: © Getty Images/Photodisc Text Permissions Manager: Margaret Chamberlain-Gaston Photography Manager: Amanda Groszko Photo Researcher: PrePress Company Library of Congress Control Number: 2008941384 Student Edition ISBN 13: 978-0-324-65913-9 Student Edition ISBN 10: 0-324-65913-X Instructor’s Edition ISBN 13: 978-0-324-65914-6 Instructor’s Edition ISBN 10: 0-324-65914-8 South-Western Cengage Learning 5191 Natorp Boulevard Mason, OH 45040 USA Cengage Learning products are represented in Canada by Nelson Education, Ltd For your course and learning solutions, visit www.cengage.com Purchase any of our products at your local college store or at our preferred online store www.ichapters.com Printed in the United States of America 12 11 10 09 08 About the Authors LOREN A NIKOLAI Loren Nikolai is the Ernst & Young Professor in the School of Accountancy at the University of Missouri—Columbia (MU) He received his B.A and M.B.A from St Cloud State University and his Ph.D from the University of Minnesota Professor Nikolai has taught at the University of Wisconsin at Platteville and at the University of North Carolina at Chapel Hill Professor Nikolai has received numerous teaching awards He is the recipient of the MU Student-Athlete Advisory Council 2004 Most Inspiring Professor Award, the University of Missouri System 1999 Presidential Award for Outstanding Teaching, the MU Alumni Association 1996 Faculty Award, the MU College of Business 1994 Accounting Professor of the Year Award, the Missouri Society of CPAs 1993 Outstanding Accounting Educator of the Year Award, the MU 1992 Kemper Fellowship for Teaching Excellence, the St Cloud State University 1990 Distinguished Alumni Award, and the Federation of Schools of Accountancy 1989 Faculty Award of Merit He holds a CPA certificate in the state of Missouri and previously worked for the 3M Company Professor Nikolai is the lead author of Intermediate Accounting and has also been an author on four other accounting textbooks Professor Nikolai has published numerous articles in The Accounting Review, Journal of Accounting Research, The Accounting Educator’s Journal, Journal of Accounting Education, The CPA Journal, Management Accounting, Policy Analysis, Academy of Management Journal, Journal of Business Research, and other professional journals He was also lead author of a monograph published by the National Association of Accountants Professor Nikolai has served as an ad hoc reviewer for The Accounting Review and Issues in Accounting Education He has made numerous presentations around the country on curricular and pedagogical issues in accounting education and was advisor for Beta Alpha Psi for twenty years Professor Nikolai is a member of the American Accounting Association (AAA), the American Institute of Certified Public Accountants (AICPA), and the Missouri Society of CPAs (MSCPA) He has chaired and served on numerous committees of the AICPA, the MSCPA, the Federation of Schools of Accountancy (FSA), and the AAA He is past president of the FSA and currently is serving on the Board of Directors of the MSCPA Professor Nikolai is married and has two adult children, three grandsons, and four step-grandchildren His family has two cats, and he is an avid golfer and weight lifter JOHN D BAZLEY John Bazley is the John J Gilbert Professor in the School of Accountancy of the Daniels College of Business at the University of Denver, where he has received numerous teaching awards, including the University’s Distinguished Teaching Award Professor Bazley earned a B.A from the University of Bristol in England and an M.S and Ph.D from the University of Minnesota He has taught at the University of North Carolina at Chapel Hill and holds a CPA certificate in the state of Colorado He has taught national professional development classes for a major CPA firm and was consultant for another CPA firm Professor Bazley is the coauthor of Intermediate Accounting and has also been an author on three other accounting texts Professor Bazley has published articles in professional journals, including The Accounting Review, Management Accounting, Accounting Horizons, Practical Accountant, Academy of Management Journal, The Journal of Managerial Issues, and The International Journal of Accounting, and was a member of the Editorial Boards of Issues in Accounting Education and the Journal of Managerial Issues He has served on numerous committees of The Federation of Schools of Accountancy (including chair of the Student Lyceum Committee), the American Accounting Association, and the Colorado Society of CPAs (including the Continuing Professional Education Board) He is also a coauthor of a monograph on environmental accounting published by the National Association of Accountants Professor Bazley is a member of the American Institute of Certified Public Accountants, the Colorado Society of CPAs (CSCPA), and the American Accounting iii iv About the Authors Association He is a member of the Board of Trustees of the Educational Foundation of the CSCPA He has recently appeared as an expert witness for the Securities and Exchange Commission and as a consultant for a defendant in a securities fraud case Professor Bazley is married and has two children, who especially enjoy their three cats, one dog, and eleven reptiles He enjoys skiing, playing golf, car racing, and listening to jazz JEFFERSON P JONES Jeff Jones is the PricewaterhouseCoopers Associate Professor of Accounting in the School of Accountancy at Auburn University He received his B.S and Master of Accountancy from Auburn University and his Ph.D from Florida State University Professor Jones has received numerous teaching awards He is the recipient of the 2004 Auburn University College of Business McCartney Teaching Award, the 2008, 2007, 2006, 2005, 2003, and 2001 Beta Alpha Psi Outstanding Teaching Award, and the 2000 Auburn University School of Accountancy Teaching Award He has also been recognized in Who’s Who Among America’s Teachers (2002 and 2004) Professor Jones holds a CPA certificate in the state of Alabama and previously worked for Deloitte & Touche Professor Jones is a coauthor of Cornerstones of Financial Accounting and Intermediate Accounting Professor Jones has published articles in professional journals, including Advances in Accounting, Review of Quantitative Finance and Accounting, Issues in Accounting Education, International Journal of Forecasting, The CPA Journal, Managerial Finance, Journal of Accounting and Finance Research, and The Journal of Corporate Accounting and Finance Professor Jones has made numerous presentations around the country on research and pedagogical issues He is a member of the American Accounting Association, the American Institute of Certified Public Accountants, and the Alabama Society of CPAs (ASCPA) Professor Jones is married, has two children, and enjoys playing golf Preface YOUR STUDENTS’ GUIDE TO THE WORLD OF ACCOUNTING Known for its balanced coverage of both concepts and procedures, Intermediate Accounting gives students an unparalleled look at financial accounting information and its increasingly varied uses in the world today In addition to the thorough coverage of GAAP—tempered with a healthy respect and careful consideration of IFRS and the changing conceptual framework—expected of a book of its caliber, the timely eleventh edition illustrates the practices professional accountants execute daily, as well as the concepts behind those practices Through this approach, this textbook equips students with the tools needed to critically assess evolving accounting practices needed to meet the demands of a dynamic, professional world With three decades of experience, we continue to connect with the contemporary student with a revision that they will find more engaging and useful Increased and better examples help students as they “google” their textbooks, improving readability, while at the same time avoiding sacrifices as they are introduced to the language of the profession As before, compelling real-world financial statements and research cases help students see the implication of the material at hand and learn to apply it in a real business context Notably, Appendix A contains the 2007 financial statements and supplemental data of the Coca-Cola Company for use throughout the book, but the eleventh edition brings even more to the table Intermediate Accounting effectively imparts essential knowledge and skills through a student-friendly, easy to reference, and pedagogically sound presentation Coupling that with the comprehensive coverage, professional language, and real-world applications that have been the hallmarks of the text for many years, the eleventh edition provides the perfect link between the academic and professional world We believe this book simultaneously provides students with the vibrant pedagogy they need to understand the material and the technical complexity they need to succeed as professionals Intermediate Accounting, Eleventh Edition, consists of five parts containing 23 chapters, as follows: Part Financial Reporting: Concepts, Financial Statements, and Related Disclosures (Chapters 1–6, and the Time Value of Money Module) Part Financial Reporting: Asset Valuation and Income Measurement (Chapters 7–12) Part Financial Reporting: Valuation of Liabilities and Investments (Chapters 13–15) Part Financial Reporting: Stockholders’ Equity (Chapters 16–17) Part Financial Reporting: Special Topics (Chapters 18–23) CHANGING STUDENT READING BEHAVIOR Many instructors have commented on how students are no longer reading books in the traditional sense Indeed, current research indicates that students are more often than not “googling” their textbooks Accordingly, we have taken steps to increase the usability and relevance of our text—without sacrificing rigor and depth CONCEPTUAL–ANALYTICAL–REAL REPORT FRAMEWORK (C–A–R) Over the years, a major strength of Intermediate Accounting has been its comprehensive coverage of GAAP—now tempered with essential coverage of international reporting standards— but its unique and continuing hallmark is the authors’ conceptual and analytical discussions related to those procedures Through the C-A-R framework, the textbook draws out v vi Preface “C-A-R enhances the visualization of the important content and its interrelatedness Students find the C-A-R very helpful.” Abe Qastin Lakeland College “We need to develop problem solvers, not just technical accounting students The C-A-R framework helps them better connect the conceptual to the reporting in an easy-to-understand way.” Alee Phillips University of Kansas these important explanations and presents the underlying thought processes of financial analysis Coupled with the interactive revised Real Reports, the C-A-R progression bolsters students’ accounting savvy as they come to understand the logic and the practice of accounting In addition, the clear design format allows students to identify information quickly as they study Conceptual Supported by the conceptual framework introduced in Chapter 2, we relate the discussion of specific topics to the objectives of financial reporting, qualitative characteristics of accounting information, conceptual reporting guidelines, and to the concepts of liquidity, financial flexibility, risk, operating capability, and return on investment With the conceptual discussions, students begin to understand the environment that gave rise to a specific procedure Once that logic is placed, they can begin the practice of accounting with a firm understanding of the environment in which they operate Analysis To help bridge the gap between the conceptual and procedural, we indicate essential analytical coverage that illustrates the significance and application of certain key company characteristics and related ratio calculations to financial analysis This material illuminates the critical-thinking process, so that students can further understand how the logic of the conceptual framework translates to everyday accounting procedure and business practice By effectively grounding this translation in specific business activities, this coverage further prepares students to intelligently apply this material on their own Reporting In addition to a thorough understanding of business transactions and the environment of financial analysis, students need to be aware of issues that arise during financial reporting Using concrete examples, we describe how items are reported in financial statements, which instills in students a knowledge and understanding they need to efficiently and effectively report their findings according to GAAP A key aspect of the report coverage are the Real Reports The unique Real Report feature gives students the opportunity to test their reporting mettle with real company data Preface Real Reports When it’s time to put it all together, this feature encourages students to test their understanding by providing excerpts from real company reports and challenging students to answer several questions about the information they see As part of the Reporting material, students learn by doing, and stretch their understanding of each topic to its limit We have updated all of these Real Report features from the tenth to the eleventh edition With the answers provided in the end-of-chapter material, these self-contained features allow students a chance to test themselves as they read ENHANCED DESIGN FOR EXAMPLES In Intermediate Accounting, examples are clearly identified for easy reference For in-text examples, the example text heading are in red and when the example ends, there is a red diamond ♦ Major, numbered examples are in red but are in a box This useful design ensures that students will know where they are in the material at all times CLARIFYING COMPUTATIONAL STEPS Because complex computations can be hard for students to master, we reduce many computational procedures to a series of steps outlined in list format For instance, Example 8-4 vii “I appreciate the inclusion of actual annual report excerpts, because once they graduate my students will be responsible for preparing these reports for actual companies They need to be exposed to how accounting looks in the real world before they graduate, and the text helps prepare them for their future jobs.” Helen Brubeck San Jose State University “I like the “real life” annual report examples because they help to introduce the reading of annual reports to the students in a piecemeal basis, so that as they learn the basic accounting rules they are also becoming more familiar with how accounts are disclosed on real financial statements.” Derek Oler Indiana University “In my experience as a student and a teacher, it is these worked-out examples that students rely upon most when going through a text The expanded examples are one of the reasons I like this text so much!” Helen Brubeck San Jose State University viii Preface includes a series of steps for dollar-value LIFO calculations Similar lists of steps for the gross profit inventory method, retail inventory method, and dollar-value LIFO retail method appear in Chapter We include other computational steps where appropriate throughout the rest of the book STRAIGHTFORWARD DESIGN DISTINGUISHES IMPORTANT MATERIAL • • • • Key terms, definitions, and official statements are in boldface type Particularly important information is in italics All real company names are in red Exhibits of illustrations of journal entries, supporting schedules, and financial statements clarify concepts or procedures • All journal entries are in blue • Excerpts from real financial statements have a special background: REINFORCE COURSE MATERIAL “It is very clear the authors have employed a variety of pedagogical tools to facilitate the learning process Great job!” Florence Atiase University of Texas at Austin Improved summary features help students identify key concepts and link them to a more complete understanding of the accounting process ENHANCED! QUICK CHECK SUMMARY With all of the material presented to a student in an Intermediate Accounting text, these bulleted summaries help students identify key points, which allows them to test their knowledge and review for tests Preface CLEAR OBJECTIVES Objectives at the beginning of each chapter prepare students for what they will be studying We list each objective in the margin beside the topical coverage to reinforce students’ learning COMPREHENSIVE CHAPTER SUMMARIES Each chapter ends with a summary of the key points for each major topic Tied directly to the Objectives from the beginning of the chapter, these summaries provide students with a quick review of the important topical issues HELPFUL SUMMARY EXHIBITS Summary exhibits throughout the text help students pull together and understand what they have learned so far For instance, Exhibit 5-3 summarizes corporate earnings and cash flow topics, Exhibit 21-2 summarizes the criteria and classifications for leases, and Exhibit 23-1 summarizes the impacts on financial statements of the methods used for accounting changes and errors Classify the assets of a balance sheet ix Other Disclosure Issues 151 OTHER DISCLOSURE ISSUES A company cannot report all the relevant financial information about its activities directly in the body of the financial statements because some items not meet the recognition criteria we discussed earlier in the chapter As indicated throughout the balance sheet discussion, a company may make many disclosures in the notes accompanying its financial statements We discuss other significant disclosure issues here Understand the other disclosure issues for a balance sheet Summary of Accounting Policies To understand a company’s financial statements, an external user needs to know the company’s accounting policies, practices, and methods For this reason, GAAP requires the disclosure of certain information in a company’s annual report A company must include a description of all its significant accounting policies The disclosure should include principles relating to revenue recognition and asset allocation, particularly when these principles and methods involve (1) a selection from existing acceptable alternatives, (2) principles and methods peculiar to the industry in which the company operates, and (3) unusual or innovative applications of GAAP Examples cited include, among others, those policies related to the basis for consolidation, depreciation methods, amortization of intangibles, inventory pricing, recognition of profits on long-term contracts, and revenue recognition from franchise and leasing operations Although allowing for flexibility, the disclosure is particularly useful when made in a separate Summary of Significant Accounting Policies preceding the notes to the financial statements or as the initial note.18 We show this summary (in part) for the Black & Decker Corporation in Real Report 4-4 We include a complete summary in the Coca-Cola Company’s notes to its financial statements in Appendix A Real Report 4-4 Summary of Accounting Policies BLACK & DECKER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in part) Note 1: Summary of Accounting Policies (in part): Principles of Consolidation: The Consolidated Financial Statements include the accounts of the Corporation and its subsidiaries Intercompany transactions have been eliminated Inventories: Inventories are stated at the lower of cost or market The cost of United States inventories is based primarily on the last-in, first-out (LIFO) method; all other inventories are based on the first-in, first-out (FIFO) method Property and Depreciation: Property, plant, and equipment is stated at cost Depreciation is computed generally on the straight-line method Estimated useful lives range from 10 years to 50 years for buildings and years to 15 years for machinery and equipment Questions: Why is it important to disclose the accounting method used to compute the cost of inventory and to compute depreciation? If the company used accelerated deprecation for financial reporting purposes, how would the income statement and balance sheet be affected? 18 “Disclosure of Accounting Policies,” APB Opinion No 22 (New York: AICPA, 1972), par 8, 12, 13, and 15 (FASB Cod # 235-10-50) Analysis C R Reporting A C 152 Chapter • The Balance Sheet and the Statement of Changes in Stockholders’ Equity Fair Value and Risk of Financial Instruments Some companies, many of which are banks and brokerage firms, deal in financial instruments These financial instruments include items such as notes payable and receivable, contracts for loan commitments, collateralized mortgages, interest rate swaps, and put and call options on stocks In recent years, both the types and uses of financial instruments have increased to the point where the FASB has addressed the reporting and disclosure of their fair values and risk GAAP requires a company to disclose the fair value of all its financial instruments (both assets and liabilities), whether or not they are reported on its balance sheet A company is also required to disclose all significant concentrations of credit risk due to its financial instruments A company typically makes these disclosures in the notes to its financial statements GAAP also requires a company to report all derivative financial instruments as either assets or liabilities on its balance sheet, and to measure these items at their fair value A derivative financial instrument is, for example, an option to buy stock where the value of the option depends on the price of the stock A company is also required to disclose information such as the types of derivative instruments it holds, its objectives in holding the instruments, and its strategies for achieving these objectives The description must indicate the company’s risk management policy in regard to each type of instrument The intent of these disclosures is to improve the reporting of a company’s risk, liquidity, and financial flexibility In the past, companies were required to use different measurements (e.g., fair value and historical cost) for reporting related financial assets and liabilities This potentially led to volatility in their earnings because companies reported some financial assets subsequent to acquisition on their balance sheets at fair value (with a resulting loss or gain if the fair value changed from a previous accounting period) while they reported related liabilities at historical cost (with no related gain or loss) In response to this issue, GAAP now allows companies to elect to report certain financial instruments at fair value The objective is to improve financial reporting by providing companies with the opportunity to reduce this volatility by reporting related financial assets and financial liabilities at fair value Briefly, if a company elects to report certain financial assets and financial liabilities at fair value on its balance sheet, it must separate them from those similar financial assets and liabilities that are reported using another measurement attribute (e.g., historical cost) Also, the company must report any unrealized gains or losses resulting from changes in the fair value of these items in earnings on its income statement This GAAP does not apply to nonfinancial assets and liabilities, such as inventory and property, plant, and equipment We discuss required and elected fair value reporting and disclosures more fully in Chapters 7, 14, and 15.19 Loss and Gain Contingencies Certain situations may exist for a company on its balance sheet date that involve uncertainty as to possible losses or gains that the company may incur if some future event(s) occurs or fails to occur These are known as loss contingencies or gain contingencies and may need to be included directly in the company’s financial statements by recording a journal entry, or disclosed in a note accompanying the financial statements.20 A company accrues (reports a loss and a liability or a reduction of an asset) an estimated loss (or expense) from a loss contingency if (1) it is probable that a liability has been incurred 19 “Disclosures About Fair Value of Financial Instruments,” FASB Statement of Financial Accounting Standards No 107 (Norwalk, Conn.: FASB, 1991); “Accounting for Derivative Instruments and Hedging Activities,” FASB Statement of Financial Accounting Standards No 133 (Norwalk, Conn.: FASB, 1998); “The Fair Value Option for Financial Assets and Financial Liabilities,” FASB Statement of Financial Accounting Standards No 159 (Norwalk, Conn.: FASB, 2007); and “Disclosures about Derivative Instruments and Hedging Activities (an amendment of FASB Statement No 133),” FASB Statement No 161 (Norwalk, Conn.: FASB, 2008), (FASB Cod # 825-10-50) 20 “Accounting for Contingencies,” FASB Statement of Financial Accounting Standards No (Stamford, Conn.: FASB, 1975), par (FASB Cod # 450-10-05) Other Disclosure Issues (or an asset impaired) and (2) the amount of the loss can be reasonably estimated Examples of this type of loss contingency include product warranties and uncollectible accounts receivable If either of these conditions is not met—that is, if there is only a reasonable possibility that the loss may have been incurred or if the amount of the loss cannot be reasonably estimated—the company discloses the loss contingency in the notes to its financial statements The following diagram illustrates the alternative ways of accounting for loss contingencies: No No Loss Probable? or No No Disclosure Yes and Reasonably estimated? Reasonable possibility Report amount in financial statements Yes Disclose in notes to the financial statements The disclosure of any loss contingencies of a company is important to provide external users with additional information for helping predict its use of its financial resources in the future The additional quantitative information would include, for instance, the amount of any claim(s) against the company, the company’s best estimate of the maximum exposure to loss(es), and a tabulation of its recognized loss contingencies The additional qualitative information would include, for instance, a description of the contingency, factors that are likely to affect the ultimate outcome, an assessment of the most likely outcome, and the terms of relevant insurance.21 Examples of a loss contingency that are disclosed in the notes to the financial statements include guarantees of the debts of others and pending litigation against the company, where either the outcome of the litigation or the amount of possible loss is uncertain An illustration of this type of contingency for Pinnacle Entertainment Inc is shown in Real Report 4-5 Gain contingencies are not reported in a company’s financial statements and, if disclosed in a note, should be carefully explained to avoid misleading implications as to the likelihood of future revenues or gains.22 We discuss loss and gain contingencies in Chapter 13 Real Report 4-5 Contingency PINNACLE ENTERTAINMENT INC NOTES TO FINANCIAL STATEMENTS (in part) Note 11 Commitments and Contingencies Legal Jebaco Litigation: On August 9, 2006, Jebaco, Inc (“Jebaco”) filed suit in the U.S District Court for the Eastern District of Louisiana against Harrah’s Operating Co., Inc., Harrah’s Lake Charles, LLC, Harrah’s Star Partnership, Players LC, LLC, Players Riverboat Management, LLC, Players Riverboat II, LLC, and Pinnacle Entertainment, Inc The lawsuit arises out of an agreement between Jebaco and Harrah’s (as successor in interest to the various Players defendants) whereby Harrah’s is obligated to pay Jebaco an annual fee based on the number of patrons entering Harrah’s two Lake Charles, Louisiana riverboat (Continued) 21 Ibid., par 8–17 (FASB Cod # 450-20) and “Disclosure of Certain Loss Contingencies [an amendment of FASB Statements No and 141(R)]” FASB Proposed Statement of Financial Accounting Standards (Norwalk, Conn.: FASB, 2008) 22 Ibid., par 8–17 (FASB Cod # 450-20) Reporting A C 153 Chapter • The Balance Sheet and the Statement of Changes in Stockholders’ Equity casinos “Jebaco Agreement”) In November, 2006, we closed the transaction to acquire the Harrah’s Lake Charles subsidiaries, including the two riverboats The lawsuit filed by Jebaco asserts that Harrah’s, in ceasing gaming operations in Lake Charles and ceasing payments to Jebaco, breached its contractual obligations to Jebaco and asserts damages of approximately $34 million Jebaco also asserts our agreement with Harrah’s violates state and federal antitrust laws The lawsuit seeks antitrust damages jointly and severally against both us and Harrah’s based on a trebling of the $34 million in damages Jebaco alleges it has suffered The defendants have answered the complaint, denying all claims and asserting that the lawsuit is barred, among other reasons, because of the approval of our transaction with Harrah’s by the Louisiana Gaming Control Board and the lack of antitrust injury to Jebaco In January of 2007, all of the defendants moved to dismiss all of the claims of the complaint, which motions were denied While the outcome of this litigation is uncertain, management intends to defend it vigorously Question: What possible impact might settlement of this litigation have on Pinnacle Entertainment’s results of operations and future financial position given that its net income for 2006 was $77 million and its December 31, 2006 stockholders’ equity was $695 million? Subsequent Events A company usually does not issue its annual report for several weeks or months after the end of the accounting period because of the time needed for adjusting and closing the books and auditing the financial statements During this time, it is possible for significant business events and transactions to occur which, if not disclosed in the company’s annual report, would cause this report to be misleading Subsequent events are discussed more fully in an auditing book; we briefly summarize them here A subsequent event is one that occurs between a company’s balance sheet date and the date when it issues its annual report, as we show in the following time diagram: End of Accounting Period Annual Report Publication Date Ά 154 Subsequent Events If a subsequent event occurs that (1) provides additional evidence about conditions that existed on the balance sheet date and (2) significantly affects the estimate(s) used in preparing the company’s financial statements, the company must make an adjustment to the financial statements For instance, if a company obtains additional information indicating that a major customer’s account receivable is unlikely to be collected, it makes an adjustment to the allowance for doubtful accounts and the bad debt expense When a subsequent event occurs that provides evidence concerning conditions that did not exist on the company’s balance sheet date, but instead occurred after that date, the company does not adjust its financial statements Instead, the information is disclosed in a note, pro forma (“as if”) statement, or an explanatory paragraph in the audit report, depending upon the materiality of the financial impact Examples of these events include a fire or flood loss, a litigation settlement, and the sale of a bond or stock issue after the balance sheet date.23 23 AICPA Professional Standards, Volume (New York: AICPA, 2007), sec 560.03–560.09 Other Disclosure Issues 155 Related Party Transactions Transactions between related parties frequently occur in the normal course of business Related parties of a company include affiliated entities such as subsidiaries, trusts for the benefit of employees, its management, and its principal owners or immediate families Relationships between related parties may enable one of the parties to influence the other so that it is given preferential treatment To provide sufficient information for external users to understand a company’s financial statements, GAAP requires certain disclosures by the company For related party transactions these include (1) the nature of the relationship involved, (2) a description of the transactions, (3) the dollar amounts of the transactions, and (4) any amounts due to or from the related parties on the balance sheet date.24 Comparative Financial Statements Examples 4-1 and 4-2 show the ending balance sheet and the statement of changes in stockholders’ equity of the Caron Manufacturing Company for one year Many external users are interested in comparing the current financial statements with those of the previous year Also, many times trend information about a company will reveal useful insights about its past performance and future success For this reason, nearly all companies present comparative financial statements for the current and preceding accounting periods Additionally, in a supplemental schedule, most companies will present a summary of key accounting information for, say, the past five to ten years For instance, some companies report their debt ratio (total liabilities Ϭ total assets) to help external users (creditors and stockholders) assess the risk of their investment in the company We show the Coca-Cola Company’s comparative financial statements in Appendix A Analysis C R Auditor’s Report Many major financial decisions by investors, bankers, other creditors, and other users are based on the financial information presented in a company’s financial statements and related notes These financial statements are the responsibility of the company’s management To help ensure a fair presentation of corporate financial resources, obligations, and activities, companies’ financial statements and accompanying notes presented to external users are audited by an independent certified public accountant In an audit, the certified public accountant is responsible for making an examination of a company’s internal control, accounting system, records, and reports in accordance with generally accepted auditing standards Based on this examination, the auditor expresses an opinion as to the effectiveness of the company’s internal control over its financial reporting, and the fairness in accordance with generally accepted accounting principles of the company’s financial statements and accompanying notes Although this opinion is not itself part of the financial statements, it is an extremely important item of information, and one on which external users place much significance We discuss the auditor’s report in Chapter SEC Integrated Disclosures As we noted in Chapter 1, the Securities and Exchange Commission has the legal authority to prescribe accounting principles and reporting practices for all regulated (“publicly held”) companies Each year, within 60 days of its fiscal year-end, a regulated company must file a Form 10-K annual report with the SEC This report must be filed electronically according to the EDGAR requirements Each company’s chief executive and chief financial officer both must “certify” that the company’s annual report within the Form 10-K (or interm report within the company’s Form 10-Q) is both complete and accurate The SEC has also developed an “integrated” set of disclosure requirements 24 “Related Party Transactions,” FASB Statement of Financial Accounting Standards No 57 (Stamford, Conn.: FASB, 1982), par (FASB Cod # 850-10-50) Describe the SEC integrated disclosures 156 Chapter • The Balance Sheet and the Statement of Changes in Stockholders’ Equity that enable a company to satisfy certain Form 10-K disclosure requirements by referring to its stockholders’ annual report, provided the latter report includes certain items Since many regulated companies now include these items in their annual reports, we briefly summarize the items as follows For a more detailed discussion, see Regulation S-X of the SEC Comparative Financial Statements As we discussed in the previous section, most companies present comparative financial statements for at least two years The SEC requires comparative balance sheets for two years and comparative income statements and statements of cash flows for three years Selected Financial Data As we discussed in the previous section, most companies present a summary of important accounting information for several years The SEC requires specific disclosures for a five-year period These include net sales or operating revenues, income (loss) from continuing operations and related earnings per share, total assets, long-term obligations and redeemable stock, and cash dividends declared per share The SEC encourages the inclusion of other information that will help users understand and highlight trends Management’s Discussion and Analysis Analysis C R A company’s management must include a discussion and analysis (MD&A) of the company’s financial condition, changes in financial condition, and results of operations The intent is to give investors the opportunity to look at the company from management’s perspective Management is asked to discuss the dynamics of the company’s business and to analyze the financial statements The discussion is intended to provide “forward-looking” information that does not clearly appear in the financial statements but is useful in evaluating cash flows from operations and from outside sources The major items covered should include, for instance, specific information about short-term and long-term liquidity and capital resources, a narrative discussion of the impact of inflation on sales and on income from continuing operations, a description of any significant unusual events and their effect on revenues and expenses, explanations of material changes in financial statement items between years, and known events and uncertainties expected to affect future operations Other kinds of forward-looking information (e.g., trends) are required as well Common Stock Market Prices and Dividends Several disclosures must be made These include the principal trading markets for the company’s common stock, the high and low market prices for each quarter in the last two years, the approximate number of stockholders, the dividends paid in the last two years, and any dividend restrictions Miscellaneous Disclosures In addition to the disclosures discussed throughout this chapter, a company must make many other disclosures to provide adequate information concerning its activities These include information about items such as the company’s stock (share) option, pension, and insurance plans, long-term lease and purchase commitments, bond indenture provisions, notes receivable, and notes payable provisions We discuss specific disclosure requirements as we address each topic in the remaining chapters Q U I C K C H E C K 4-3 • A statement of changes in stockholders’ equity discloses investments by and distributions to owners, as well as changes in retained earnings and accumulated other comprehensive income (Continued) Other Disclosure Issues • The notes accompanying the financial statements contain relevant information about a company’s activities that cannot be reported in the body of the financial statements • Examples of disclosures made in the notes include the accounting policies, practices, and methods used by a company, the fair values and risks of financial instruments, contingent losses and gains, the existence of subsequent events, and any related party transactions IFRS VS U.S GAAP The financial statements required by the IASB are similar to those in the United States They include a balance sheet, income statement, statement of changes in equity, and statement of cash flows, as well as related notes and other explanatory material Unlike U.S GAAP, in which a company typically presents either a classified or nonclassified balance sheet, IFRS not require a particular format; the appropriate format depends on the type of company IFRS require that companies classify assets on the balance sheet as either noncurrent or current (unless a liquidity presentation provides more relevant and reliable information) Noncurrent assets include property, plant, and equipment, as well as other items such as investments, long-term receivables, and intangibles Current assets are defined similarly to those under U.S GAAP Typically, noncurrent assets are presented first, followed by current assets The ordering of the liabilities and owners’ equity sections is usually different than under U.S GAAP “Capital and reserves,” which includes issued capital (capital stock and additional paidin capital), reserves, and accumulated profits or losses (retained earnings), is usually listed first A company is required to disclose the par value, as well as the number of shares authorized, issued and fully paid, and issued but not fully paid It must also disclose dividends that have been proposed but not formally approved for payment Reserves may result from upward revaluations of properties and investments, as well as currency translation differences (similar to the U.S GAAP classification of other comprehensive income) A company must provide a description of the nature and purpose of each reserve Noncurrent liabilities are usually listed next and include items such as interest-bearing borrowings, deferred income, deferred taxes, and retirement benefit obligations Current liabilities are listed last and are similar to those under U.S GAAP A company’s statement of changes in equity includes the company’s comprehensive income for the period, the changes in contributed capital, and dividends A company must also disclose any changes in accumulated profits (losses) due to changes in accounting policies, corrections of errors, and dividends In the notes to the financial statements, a company is required to disclose items similar to those under U.S GAAP These disclosures include its accounting policies, narrative descriptions of financial statement items, and contingencies For revaluations allowed under IFRS (e.g., the upward revaluation of property, plant, and equipment from cost to fair value), a company also includes the measurement basis used In the following chapters, we will discuss the major differences between U.S GAAP and IFRS as they apply to specific assets, liabilities, and income Source: IAS (See Appendix C at the end of this book.) 157 158 Chapter • The Balance Sheet and the Statement of Changes in Stockholders’ Equity 10 Explain the reporting techniques used in an annual report REPORTING TECHNIQUES Companies use several reporting techniques in the presentation of their annual reports We discuss the major ones relating to the financial statement presentations next Statement Format (Balance Sheet) The format that a company uses for its balance sheet depends upon its size, the industry in which it operates, certain regulatory requirements, and tradition Two basic formats are used: the report form or the account form Most companies use the report form Here the balance sheet is shown in a vertical format The asset accounts are listed first, and the liability and stockholders’ equity accounts are listed in sequential order directly below the assets In contrast, the account form of the balance sheet is organized in a horizontal fashion, with the asset accounts listed on the left-hand side and liabilities and stockholders’ equity accounts on the righthand side This is the format used in Example 4-1 Of 600 companies surveyed, the report form and account form are used by 524 and 76, respectively.25 Combined Amounts To reduce the size of a company’s financial statements, it may combine certain related amounts For instance, a company may list a single amount for property and equipment on the face of its balance sheet and then itemize the amounts applicable to land, buildings, and equipment in a note to the financial statements Frequently, the amounts for inventories are similarly combined and itemized, as we showed in Real Report 4-1 for Johnson & Johnson Generally, it is not proper to offset asset and liability accounts For instance, the amount in a special Bond Sinking Fund account to retire long-term bonds would not be offset against the Bonds Payable account balance In a few circumstances, a right of offset exists whereby a debtor (Company A) has a legal right to discharge all or some of the liability owed to another party (Company B) by applying an amount that the other party (Company B) owes to the debtor (i.e., a receivable of Company A) against the liability.26 For instance, when a bank loans money to a company in exchange for the company’s accounts receivable that are assigned to the bank, the company would offset the assigned accounts receivable on its balance sheet against the liability owed to the bank We discuss the right of offset in Chapter Rounding In Examples 4-1 and 4-2, the amounts presented for each account, subtotal and total, were rounded to the nearest hundred dollars Rounding is usually done to increase readability and to reduce the likelihood that readers will attach more precision to the numbers than is warranted In fact, many major companies round to the nearest million dollars In the Coca-Cola Company financial statements shown in Appendix A, the amounts are rounded as indicated Notes, Supporting Schedules, and Parenthetical Notations Additional information not included in the accounts reported on a company’s financial statements is disclosed in a note, supporting schedule, or parenthetical notation The notes (sometimes called footnotes) accompanying the financial statements are extremely useful ways of presenting additional information GAAP requires that a company disclose certain information (for instance, contingent liabilities that are reasonably possible) in the notes to the financial statements, and it is good accounting practice to include additional note disclosures when they add to the completeness of the annual report Notes 25 Accounting Trends and Techniques (New York: AICPA, 2007), p 127 26 For the criteria to be met for a right of offset to exist, see “Offsetting of Amounts Related to Certain Contracts,” FASB Interpretation No 39 (Norwalk, Conn.: FASB, 1992), par and “Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements,” FASB Interpretation No 41 (Norwalk, Conn.: FASB, 1994), par (FASB Cod # 210-20-45) International Balance Sheet 159 usually contain narrative discussion, additional monetary amounts, and sometimes supplemental schedules We illustrated several notes of actual companies earlier in this chapter We discuss required and suggested disclosures in notes throughout this book as they apply to specific topics Because notes must communicate technical accounting information in a narrative format, there are several ways to improve their clarity and readability When preparing and writing financial reporting notes, the accountant should (a) specify what data are to be disclosed, (b) outline the desired format of the note, (c) construct and use short sentences in the note, (d) use terminology understandable to the external user, and (e) be concise but complete Supporting schedules may be freestanding or part of the notes A supporting schedule may complement an entire financial statement (such as the retained earnings statement) or may explain a summary amount on a specific financial statement (such as the categories of inventories, as we showed in Real Report 4-1) We discuss and illustrate supporting schedules throughout the book Parenthetical notations following specific accounts are used to explain items such as the method of valuation (e.g., cost, lower of cost or market) or of determining the ending inventory (e.g., average cost), or to cross-reference certain related asset and liability accounts (e.g., bond sinking fund and bonds payable) INTERNATIONAL BALANCE SHEET Example 4-3 shows comparative balance sheets for Vodafone Group Plc, which provides voice and data communications services for both consumers and companies, with its headquarters in The Connection, Newbury, England These balance sheets were prepared using IFRS EXAMPLE 4-3 International Comparative Balance Sheets Vodafone Group Plc Consolidated Balance Sheet at 31 March Non-current assets Goodwill Other intangible assets Property, plant and equipment Investments in associated undertakings Other investments Deferred tax assets Post employment benefits Trade and other receivables Current assets Inventory Taxation recoverable Trade and other receivables Cash and cash equivalents Assets included in disposal group held for sale Total assets Equity Called up share capital Share premium account Own shares held Note 2007 $m 2007 £m 2006 £m 9 11 14 15 25 17 79,856 30,915 26,465 39,817 11,565 807 161 972 190,558 40,567 15,705 13,444 20,227 5,875 410 82 494 96,804 52,606 16,512 13,660 23,197 2,119 140 19 361 108,614 16 567 41 9,888 14,726 25,222 – 215,780 288 21 5,023 7,481 12,813 – 109,617 297 4,438 2,789 7,532 10,592 126,738 8,213 85,771 (15,841) 4,172 43,572 (8,047) 4,165 52,444 (8,198) 17 18 29 19 21 21 (Continued) 160 Chapter • The Balance Sheet and the Statement of Changes in Stockholders’ Equity EXAMPLE 4-3 (Continued) Additional paid-in capital Capital redemption reserve Accumulated other recognized income and expense Retained losses Total equity shareholders’ funds Minority interests Total equity Non-current liabilities Long term borrowings Deferred tax liabilities Post employment benefits Provisions Trade and other payables Current liabilities Short term borrowings: Third parties Related parties Current taxation liabilities Trade and other payables Provisions Note 21 21 22 23 2007 $m 197,214 17,976 6,508 (167,820) 132,021 445 132,466 2007 £m 100,185 9,132 3,306 (85,253) 67,067 226 67,293 24 25 26 27 35,035 9,106 242 583 1,053 46,019 17,798 4,626 123 296 535 23,378 16,750 5,670 120 265 566 23,371 24 24,36 7,825 1,657 10,016 17,272 525 37,295 – 215,780 3,975 842 5,088 8,774 267 18,946 – 109,617 3,070 378 4,448 7,477 139 15,512 2,543 126,738 27 26 Liabilities included in disposal group held for sale Total equity and liabilities 29 2006 £m 100,152 128 4,090 (67,356) 85,425 (113) 85,312 The Consolidated Financial Statements were approved by the Board of directors in 29 May 2007 and were signed on its behalf by: Arun Sarin Chief Executive Andy Halford Chief Financial Officer The accompanying notes are an integral part of these Consolidated Financial Statements The unaudited US dollar amounts are prepared on the basis set out in note Note that there are a number of differences in Vodafone’s balance sheets compared to those prepared under U.S GAAP First, Vodafone’s balance sheets have two categories of assets, Non-current assets and Current assets, with the Non-current assets listed first Second, the Non-current assets are not separated into categories such as investments or property, plant, and equipment, as we discussed earlier for U.S GAAP Third, after Total assets, the Equity category is listed first, followed by the Non-current liabilities and Current liabilities Fourth, there are a number of differences in account titles such as Taxation recoverable, Own shares held, and Capital redemption reserve (not allowed under U.S GAAP) Finally, Vodafone chooses to present two monetary amount columns for March 31, 2007, one in U.S dollars and the other in British pounds, although it is not required to so ILLUSTRATIVE FINANCIAL STATEMENTS Appendix A shows the actual financial statements and accompanying notes of the Coca-Cola Company for the year ended December 31, 2007 Although you may not understand all of these items at this point, pay particular attention to each statement’s format and content and, in particular, to the notes accompanying the reports Your understanding will increase as you study this book Answers to Real Report Questions 161 SUMMARY At the beginning of the chapter, we identified several objectives you would accomplish after reading the chapter The objectives are listed below, each followed by a brief summary of the key points in the chapter discussion Understand the purposes of the balance sheet A balance sheet summarizes the financial position of a corporation on a specific date by reporting on its assets, liabilities, and stockholders’ equity The balance sheet reports a corporation’s resource structure and its financial structure Define the elements of a balance sheet The elements of a balance sheet are the broad classes of items comprising it The elements include assets, liabilities, and stockholders’ equity Briefly, assets are a corporation’s economic resources, liabilities are its present obligations, and stockholders’ equity is the residual interest in the assets Explain how to measure (value) the elements of a balance sheet There are two alternatives for measuring (valuing) the elements (assets and liabilities) of a balance sheet These include: (1) historical cost and (2) fair value The historical cost (historical proceeds) is the exchange price in the transaction when the asset was acquired (or the liability incurred) After acquisition, the historical cost may be reduced due to adjustments such as depreciation The fair value is the price the company would receive to sell the asset (or transfer the liability) It may be measured by a quoted price for an identical asset (or liability), adjusted quoted price for a similar asset (or liability), or an unobservable value (e.g., present value) Classify the assets of a balance sheet The assets of a balance sheet may be classified into five groups: (1) current assets, (2) long-term investments, (3) property, plant, and equipment, (4) intangible assets, and (5) other assets Classify the liabilities of a balance sheet The liabilities of a balance sheet may be classified into three groups: (1) current liabilities, (2) long-term liabilities, and (3) other liabilities Report the stockholders’ equity of a balance sheet The stockholders’ equity of a balance sheet consists of contributed capital (capital stock and additional paid-in capital), retained earnings, and accumulated other comprehensive income Prepare a statement of changes in stockholders’ equity A statement of changes in stockholders’ equity starts with the beginning balances of capital stock, additional paid-in capital, retained earnings, and accumulated other comprehensive income It then reconciles these beginning balances to the ending balances by showing the changes (and reasons for the changes) in each of these items Understand the other disclosure issues for a balance sheet To help users understand the elements of its balance sheet (and other financial statements), a company also discloses useful information in the notes to the financial statements This information includes a summary of the company’s accounting policies, the fair value and risk of its financial instruments, any contingent liabilities and assets, any subsequent events, and any related party transactions The company also includes comparative financial statements, all of which must be audited Describe the SEC integrated disclosures A company can satisfy certain SEC 10-K disclosure requirements by including an “integrated” set of disclosures in its annual report The company must include comparative financial statements, selected financial information for a five-year period, a management’s discussion and analysis (MD&A), and common stock market prices and dividends 10 Explain the reporting techniques used in an annual report A company may use various reporting techniques in its annual report It may use a report form or account form of balance sheet It may combine amounts of certain elements, and may round the reported numbers It may provide additional information in the notes to the financial statements, supporting schedules, or parenthetical notations ANSWERS TO REAL REPORT QUESTIONS Real Report 4-1 Answers Below are the percentages of each type of inventory (calculated by dividing the type of inventory by total inventory for each respective year) 2007 2006 Raw materials and supplies 18% 20% Goods in process 27% 26% Finished goods 55% 54% The increase in the percentage of finished goods inventory and goods in process inventory, coupled with the decrease in raw materials inventory, could be interpreted as a signal that Johnson & Johnson is expecting lower future demand and sales, and is planning to decrease its production to meet this forecast Real Report 4-2 Answers Projects in progress represent 5.4% and 4.0% of the total cost of projects as of July 30, 2006, and July 29, 2007 respectively This indicates that Campbell’s capital expenditures on new projects have remained fairly steady and represent a small portion of its fixed assets 162 Chapter • The Balance Sheet and the Statement of Changes in Stockholders’ Equity Real Report 4-3 Answers Kimberly Clark has access to a significant source of cash through revolving credit facilities ($1.5 billion) which should be considered when evaluating the company’s liquidity and financial flexibility Additionally, the company, absent any refinancing of debt, will incur cash outflows of approximately $1.1 billion within the next year relating to the settlement of debt (both current maturities of long-term debt and other current debt) Finally, information on the scheduled maturities of long-term debt for the next five years is provided Interest expense (computed by multiplying the weighted average interest rate by the average debt outstanding) was approximately $177 million Assuming that the weighted average interest rate for 2008 remains the same as for 2007 and the average value of the notes and debentures for 2008 is equal to the value at December 31, 2007, interest expense relating to the notes and debentures is estimated to be $229.6 million ($3,958,600,000 ϫ 5.80%) These assumptions can be modified to take into account predicted economic activity (e.g., rising interest rates) Real Report 4-4 Answers Users of financial statements need to understand the accounting methods used in the preparation of the financial statements to facilitate intercompany as well as intracompany comparisons Because the use of different accounting methods can result in different valuations in the financial statements, the comparability and consistency of the information presented would be compromised if such disclosures were not made If the company had used accelerated depreciation instead of straight-line depreciation, the company would have recorded more depreciation expense than currently recorded This additional expense would have resulted in lower income Additionally, the book value of the company’s assets (property, plant, and equipment) and equity (retained earnings) would be lower Real Report 4-5 Answer If Pinnacle Entertainment were to lose this litigation and Jebaco, Inc., were to receive the damages it has asked for, Pinnacle would be forced to pay up to $102 million (a trebling of the asserted claim of $34 million in damages) Such a loss for Pinnacle would be devastating to its results of operations and future financial position, given its 2006 reported income of $77 million and its December 31, 2006 stockholders’ equity of $695 million In addition, Pinnacle may come under increased antitrust scrutiny if Jebaco’s arguments are upheld QUESTIONS Q4-1 What are the major financial statements of a company and what they show? Q4-2 What does a company’s financial position include? Q4-3 What are two purposes of a company’s balance sheet? Q4-4 Define liquidity, financial flexibility, and operating capability Q4-13 Define a company’s operating cycle How does working capital relate to this cycle? How is working capital computed? Q4-14 What items are classified as (a) long-term investments, (b) property, plant, and equipment, and (c) intangible assets? Q4-15 What items are classified as (a) long-term liabilities What is financial capital? Why is capital maintenance important? and (b) other liabilities? Q4-6 bonds payable would be disclosed on a company’s balance sheet Q4-5 What does “recognition” mean in accounting? Q4-7 Define an asset What are the three characteristics of an asset? Q4-16 What is a bond? Give an illustration of how Q4-17 Define (a) capital stock, (b) additional paid-in Define a liability What are the three characteristics of a liability? capital in excess of par, (c) treasury stock, (d) retained earnings, (e) deficit, and (f) accumulated other comprehensive income Q4-9 Q4-18 What are investments by owners? Distributions to Q4-8 What is stockholders’ equity? Q4-10 Identify and define the two alternatives for measuring (valuing) assets Q4-11 List the major sections (and the components of each section) of a company’s balance sheet Q4-12 How are current assets defined and what are the major items that may be included in current assets? How are current liabilities defined? Give three examples of such liabilities owners? In what statement many companies report these items? Q4-19 What accounting policies are disclosed in the notes accompanying a company’s financial statements? Why is this disclosure important? Q4-20 Give several examples of financial instruments and identify the required disclosures for a company’s financial instruments Multiple Choice 163 Q4-21 What is a loss contingency? What criteria have to be Q4-26 Briefly describe the SEC “integrated” disclosures that met for a company to accrue a loss contingency? If these criteria are not met, how does a company disclose a loss contingency? most regulated companies include in their annual reports Q4-22 Why is it necessary for a company to disclose subsequent events? What kinds of subsequent events are disclosed by an adjustment to the company’s financial statements and what kinds are disclosed in a note? Q4-23 What must a company disclose for related party Q4-27 Briefly list the format of a company’s balance sheet under IFRS Q4-28 What is the difference between the report form and the account form of the balance sheet? Q4-29 What alternative methods are used to disclose Q4-24 Why are comparative financial statements important? additional information not included in the accounts reported on a company’s financial statements? Give examples of the types of information disclosed by each method Q4-25 What is an audit and why is the auditor’s report an Q4-30 What factors should be considered when an important item of information? accountant prepares and writes financial reporting notes? transactions? M U LT I P L E C H O I C E ( A I C PA Ad a p t e d ) Select the best answer for each of the following M4-1 GAAP related to the disclosure of accounting policies a Requires a description of every accounting policy followed by a reporting entity b Provides a specific listing of all types of accounting policies that must be disclosed c Requires disclosure of the format for the statement of cash flows d Requires a description of all significant accounting policies to be included as an integral part of the financial statements M4-2 Which of the following contingencies should generally be accrued on the balance sheet when the occurrence of the contingent event is reasonably possible and its amount can be reasonably estimated? a b c d Gain Contingency Yes Yes No No Loss Contingency Yes No Yes No M4-3 A donated fixed asset (from a governmental unit) for which the fair value has been determined should be recorded as a debit to fixed assets and a credit to a Unrealized capital c Deferred income b Retained earnings d Other income M4-4 On October 2, 2008, a company borrowed cash and signed a 3-year interest-bearing note on which both the principal and interest are payable on October 2, 2011 At December 31, 2010 the accrued interest should a Be reported on the balance sheet as a current liability b Be reported on the balance sheet as a noncurrent liability c Be reported on the balance sheet as part of long-term notes payable d Not be reported on the balance sheet as a liability M4-5 Land reported in the property, plant, and equipment section of a manufacturing company’s balance sheet is reported at a Historical cost b Historical cost, less accumulated depreciation c Fair value d Lower of cost or market value M4-6 Rent revenue collected one month in advance should be accounted for as a Revenue in the month collected b A current liability c A separate item in stockholders’ equity d An accrued liability M4-7 Which of the following should be disclosed in the Summary of Significant Accounting Policies? a Rent expense amount b Maturity dates of long-term debt c Methods of amortizing intangibles d Composition of plant assets M4-8 A company receives an advance payment for specialorder goods to be manufactured and delivered within six months The advance payment should be reported on the company’s balance sheet as a a Deferred charge b Contra-asset account c Current liability d Noncurrent liability M4-9 Which of the following may be used to determine fair value based on Level inputs? a b c d Net Realizable Value No No Yes Yes Present Value No Yes No Yes 164 Chapter • The Balance Sheet and the Statement of Changes in Stockholders’ Equity M4-10 The balance sheet provides information about each of the following items, except a Operating capability of entity b Results of entity’s operations c Entity’s liquidity d Financial flexibility of entity REVIEW EXERCISES RE4-1 Match the following terms with the appropriate component of the accounting equation: (1) Assets (2) Liabilities (3) Stockholders’ Equity A The probable future sacrifices of economic benefits arising from the present obligations of a company to transfer assets or provide services in the future as a result of past transactions or events B The residual interest in the assets of a company that remains after deducting its liabilities C The probable future economic benefits obtained or controlled by a company as a result of past transactions or events RE4-2 Dorothy Corporation had the following accounts in its year-end adjusted trial balance: Inventories, $23,600; Accounts receivable, $7,600; Accounts payable, $7,200; Prepaid rent, $2,400; Marketable securities, $3,000; Allowance for doubtful accounts, $1,100; and Cash, $1,500 Prepare the current assets section of Dorothy Corporation’s year-end balance sheet RE4-3 Dorothy Corporation had the following accounts in its year-end adjusted trial balance: Accounts payable, $7,200; Salaries payable, $5,800; Income taxes payable, $4,000; Short-term notes payable, $2,500; Dividends payable, $750; and Investment in held-to-maturity bonds, $2,750 Prepare the current liabilities section of Dorothy Corporation’s balance sheet RE4-4 Based on the information in RE4-2 and RE4-3, calculate Dorothy Corporation’s working capital RE4-5 Toto Company reports the following on its year-end balance sheet: Investment in held-to-maturity bonds, $6,500; Fund to retire long-term bonds payable, $7,750; Trademarks, $5,500; and Long-term advances to unconsolidated affiliated companies, $3,500 Prepare the long-term investments section of Toto Company’s year-end balance sheet RE4-6 Oz Corporation has the following assets at year-end: Patents (net), $26,000; Land, $50,000; Buildings, $175,000; Accumulated depreciation: Buildings, $57,500; Investment in held-to-maturity bonds, $12,000; Equipment, $95,000; and Accumulated depreciation: Equipment, $25,000 Prepare the property, plant, and equipment section of Oz Corporation’s year-end balance sheet RE4-7 Glenda Corporation has the following assets at year-end: Prepaid rent, $6,000; Land, $58,000; Trademarks, $37,000; Computer software costs, $8,500; Patents, $13,000; Inventories, $17,000; and Goodwill, $11,000 Prepare the intangible assets section of Glenda Corporation’s year-end balance sheet RE4-8 Toto Company reports the following on its year-end balance sheet: Long-term bonds payable, $4,500; Unamortized bond discount, $600; Accrued pension cost, $9,000; Mortgage payable, $5,000; and Fund to retire long-term bonds payable, $8,500 Prepare the long-term liabilities section of Toto Company’s year-end balance sheet RE4-9 Scarecrow, Inc., issues 50,000 shares of $2 par value common stock The shares are sold for $25 per share Prepare the journal entry to record the issuance of the stock RE4-10 Tinman Corporation reports the following balances at the end of the current year: Common stock, $5 par, $50,000; Retained earnings, $120,000; Additional paid-in capital on common stock, $200,000; Income taxes payable, $9,800; and Accumulated other comprehensive income, $24,500 Prepare the stockholders’ equity section of Tinman Corporation’s yearend balance sheet EXERCISES E4-1 Current Assets Listed here are certain accounts of the Jenkins Company at the end of 2010: Account Land Prepaid insurance Cash on hand Debit (Credit) $12,000 1,530 1,120 (Continued) Exercises Notes receivable (due 2013) Cash in bank Allowance for doubtful accounts Marketable securities (short-term) Accumulated depreciation Accounts receivable Office supplies Buildings Inventory 165 4,300 5,400 (1,100) 3,380 (8,700) 15,600 970 27,200 19,700 Required Prepare the current asset section of Jenkins’ balance sheet at the end of 2010 E4-2 Plant and Equipment Your analysis of the fixed asset accounts at the end of 2010 for the Moen Corporation reveals the following information: The company owns two tracts of land The first, which cost $18,000, is being held as a future building site It has a current market value of $20,000 The second, which cost $19,000, was purchased 10 years ago On this site were built the current office and factory buildings The land has a current market value of $56,000 The company owns two buildings The office building and the factory building were both built 10 years ago at a cost of $50,000 and $120,000, respectively At that time each was expected to have a life of 30 years, and a residual value of 10% of original cost They are being depreciated on a straight-line basis The company owns factory machinery with a total cost of $51,000 and accumulated depreciation of $35,300 Included in factory machinery is one machine that cost $7,000 and has accumulated depreciation of $4,200 This machine is being held for resale and is not being used in operations The company owns office equipment that cost $14,500 and has a book value of $6,300 It owns office furniture that cost $17,900 and has a book value of $11,400 Required Prepare the property, plant, and equipment section of Moen’s 2010 ending balance sheet E4-3 Stockholders’ Equity The following are several accounts of the Graf Corporation at the end of 2010: Account Common stock, $10 par Bonds payable (due 2017) Premium on preferred stock Retained earnings Premium on bonds payable Unearned rent Preferred stock, $100 par Premium on common stock Unfunded accrued pension cost Treasury stock (cost) Accumulated other comprehensive income Credit Balance $ 47,100 126,000 39,600 209,000 12,300 4,800 65,400 53,900 18,400 (7,600) debit 8,200 Required Prepare the stockholders’ equity section of Graf ’s 2010 ending balance sheet E4-4 Classifications on Balance Sheet A balance sheet may contain the following major sections: A Current assets G Long-term liabilities B Long-term investments H Other liabilities C Property, plant, and equipment I Contributed capital D Intangible assets J Retained earnings E Other assets K Accumulated other comprehensive income F Current liabilities Required The following is a list of fifteen accounts Using the letters A through K, indicate in which section of the balance sheet each account would most likely be classified Place a check mark (ͱ) beside each item that is a contra account If an account cannot be classified in any of the preceding sections, indicate with an X and explain ... Hamilton, Terry Phillips, Theresa Spaedy, Kyle Newell, Carrie Hammond, Cassi Costner, Emily Kliethermes, Nathan Troup, Herman Eckerle, Kelli Strubinger, Sarah Hooper, Darius Fatemi, Jennifer Teel, and. .. graduate and undergraduate students, including Jenny Reed, Beth Adair, JoAnne Leuders, Stephen Underhill, Devra Niemann, Teresa Hickam, Cherie Wadlin, Trish Nikolai, Lori Thompson, Lisa Klempert, Lori... States Intermediate Accounting, Eleventh Edition Loren Nikolai, John Bazley, Jefferson Jones Vice President of Editorial, Business: Jack W Calhoun Publisher: Rob Dewey © 201 0, 2007 South-Western,