FINANCIAL STATEMENTS DEMYSTIFIED A SELF-TEACHING GUIDE BONITA K KRAMER CHRISTIE W JOHNSON New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto Copyright © 2009 by Bonita K Kramer and Christie W Johnson All rights reserved Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher ISBN: 978-0-07-154388-0 MHID: 0-07-154388-0 The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-154387-3, MHID: 0-07-154387-2 All trademarks are trademarks of their respective owners Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringement of the trademark Where such 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free Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom McGraw-Hill has no responsibility for the content of any information accessed through the work Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise From Bonita K Kramer: For Mark, David, and Kyle—all of whom have demystified the meaning of life in my mind From Christie W Johnson: For Pat and Swithin—you believe in me, always From both of us: And for Gil W Crain, Ph.D., who unexpectedly passed away in July of 2008 A great friend, colleague, mentor, and professor who encouraged and supported us in all our endeavors This page intentionally left blank CONTENTS ACKNOWLEDGMENTS vii INTRODUCTION CHAPTER Four Basic Financial Statements CHAPTER Basic Concepts 19 CHAPTER The Income Statement 31 CHAPTER The Balance Sheet: Classifications and Concepts 55 CHAPTER The Balance Sheet: A Closer Examination 81 CHAPTER Statement of Cash Flows 159 CHAPTER Reading the Financial Statements: The Auditors’ Reports and Financial Statement Footnotes 193 CHAPTER Analysis of Financial Statements 211 CHAPTER Additional Issues 235 CHAPTER 10 Fraudulently Misstated Financial Statements 245 Final Exam 267 Answers to Quiz and Final Exam Questions 285 Index 289 v This page intentionally left blank Acknowledgments From Bonita K Kramer: I doubt I would have undertaken this project without the support of my coauthor, Christie Johnson Christie is an extraordinary writer who has a wealth of information about financial accounting She has been a faculty member at Montana State University since I was an undergraduate accounting student here many years ago Then, as now, she had a stellar reputation as an educator, and to coauthor this book with her as a colleague truly has been one of the highlights of my career Additionally, however, I could not have written this book without the patience of my husband, Mark, who is my best friend, and our boys, David and Kyle While my husband never doubted my ability to write this book, he was concerned about the time I would invest in it Finally, I want to thank my parents, Rod and Betty Peterson, for their encouragement throughout my life to continue my education and to pursue various professional challenges over the years They never doubted my abilities and always quietly cheered me on Yet they also instilled in me a sense of what is truly important in life, and I am grateful vii viii Financial Statements Demystified From Christie W Johnson: Bonita flatters me with her remarks describing why our collaboration on this project took place, but I should set the record straight The opportunity actually arose from Bonita’s reputation as an expert in the area of fraud education and contributions to this specialized field and her outstanding reputation as a teacher and scholar She has garnered numerous teaching and research-related honors during her career as an accounting educator Bonita is a teaching role model and an incredibly patient and effective mentor when it comes to publishing endeavors She has a talent for teaching an old dog (like me) some new tricks, and I was honored by her invitation to collaborate I appreciate and am very grateful for this opportunity, one I probably would not have enjoyed had it not been for Bonita’s faith and interest in working with me Bonita and I both very much enjoy getting to know our students in person and teaching to a live audience We are motivated to come up with many different ways to illustrate or explain a concept, knowing that individual student learning styles vary considerably If we see a few foreheads and eyebrows scrunching, we have a visual cue that our students are struggling to understand a difficult or important concept In a classroom setting, we can react to these cues, ask and answer questions, and meet with students one on one In writing Financial Statements Demystified, it was our joint goal to connect with individuals we probably won’t meet in person, a prospect both exciting and a bit daunting! We organized this book by presenting the topics and concepts we both felt to be most relevant to your understanding of financial accounting and reporting while avoiding the accounting system details found in most traditional textbooks We hope that you find our explanations and illustrations provide useful information and that the benefits you gain by reading this book exceed the cost of its purchase! I too would like to acknowledge my family’s support in this endeavor My husband, Pat, was remarkably patient, especially during marathon writing episodes when I would become so focused and paused just long enough to share the meals he prepared My daughter, Swithin, plays an important supporting role in my writing and publishing endeavors In an interesting reversal of roles, I now seek Swithin’s input and advice I think she must take great delight when she has an opportunity to wield a bold-line red pen, much like the one I drew out of my bag and used to critique her written work when she was in junior high and high school Bonita’s parents and my own instilled many virtues we both appreciate and honor, and they believed deeply in our talents and abilities While we each grieved over the loss of a parent last year, we knew they would be proud of our collaborative efforts on this book INTRODUCTION This book is intended for people who want to understand the information provided in financial statements We don’t describe all the accounting details of preparing financial statements, which is an approach typically employed in many accounting courses Since many accounting students, upon graduation, will hold positions requiring that they prepare their employers’ financial statements or audit their clients’ financial statements, the preparer approach employed in college makes sense for accounting majors However, that is not our goal here Instead, we focus on a user approach to understanding financial statements Because of the user approach we take in this book, you don’t need any accounting courses or background to learn this material Instead, this book is meant to help people base decisions on the information provided in financial statements What kinds of decisions might you be thinking of making in which financial statements can be useful? Well, perhaps you are an investor thinking about your future retirement and are wondering whether you might like to purchase some stock in a particular company Or perhaps you already own stock in a company and are trying to decide if this is a good time to sell that stock Or perhaps you are a creditor wondering whether you should lend some money to an organization Perhaps you are a union official involved in negotiations with a business and want to have a thorough understanding of the business’s financial health Perhaps you own a business and, regardless of its size, want to understand the financial statements compiled by your accountants better to help you make future business decisions Perhaps you are a manager in an organization that has its own accounting department, which routinely prepares financial statements for your use, and you want to comprehend better the statements they are sending to your office Or perhaps you are about to enter a graduate business program without an accounting undergraduate degree and want a reference guide to the content and terminology of financial statements .. .FINANCIAL STATEMENTS DEMYSTIFIED A SELF-TEACHING GUIDE BONITA K KRAMER CHRISTIE W JOHNSON New York Chicago San Francisco Lisbon London Madrid... Bonita K Kramer: For Mark, David, and Kyle—all of whom have demystified the meaning of life in my mind From Christie W Johnson: For Pat and Swithin—you believe in me, always From both of us: And. .. financial statements by acquainting you with accounting and financial statement terminology, the underlying concepts on which financial statements are based, and the form and content of those statements