Financial accounting information for decisions 8e wild 1

www.freebookslides.com Financial Accounting Information for Decisions 8e John J Wild www.freebookslides.com Financial Accounting th edition INFORMATION FOR DECISIONS John J Wild University of Wisconsin at Madison www.freebookslides.com To my students and family, especially Kimberly, Jonathan, Stephanie, and Trevor FINANCIAL ACCOUNTING: INFORMATION FOR DECISIONS, EIGHTH EDITION Published by McGraw-Hill Education, Penn Plaza, New York, NY 10121 Copyright © 2017 by McGraw-Hill Education All rights reserved Printed in the United States of America Previous editions © 2015, 2013, and 2011 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper DOW/DOW 6  ISBN 978-1-259-53300-6 MHID 1-259-53300-X Senior Vice President, Products & Markets:  Kurt L Strand Vice President, General Manager, Products & Markets:  Marty Lange Vice President, Content Design & Delivery:  Kimberly Meriwether David Managing Director:  Tim Vertovec Brand Manager:  Steve Schuetz Director, Product Development:  Rose Koos Director of Digital Content:  Patricia Plumb Lead Product Developer:  Ann Torbert Product Developer:  Michael McCormick Marketing Manager:  Kyle Burdette Digital Product Analyst:  Xin Lin Director, Content Design & Delivery:  Linda Avenarius Program Manager:  Daryl Horrocks Content Project Managers:  Lori Koetters, Brian Nacik Buyer:  Sandy Ludovissy Design:  Debra Kubiak Content Licensing Specialists:  Shawntel Schmitt, Beth Thole Cover Images:  Google: © Bloomberg/Getty Images; Tesla: © Bloomberg/Getty Images; Bull: â xPACIFICA/Getty Images Compositor: Aptarađ, Inc Printer:  R.R Donnelley All credits appearing on page or at the end of the book are considered to be an extension of the copyright page Library of Congress Cataloging-in-Publication Data Wild, John J., author    Financial accounting : information for decisions / John J Wild.—8th edition    pages cm    ISBN 978-1-259-53300-6 (alk paper) — ISBN 1-259-53300-X (alk paper)   1 Accounting I Title   HF5635.W695 2017  657—dc23 2015033848 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites mheducation.com/highered  www.freebookslides.com Adapting to Today’s Students Financial Accounting, 8e Enhancements in technology have changed how we live and learn Working with learning resources across devices, whether smartphones, tablets, or laptop computers, empowers students to drive their own learning by putting increasingly intelligent technology into their hands Connect also includes digitally based, interactive, adaptive learning tools that provide an opportunity to engage ­students more effectively by offering varied instructional methods and more personalized learning paths that build on different learning styles, interests, and abilities Whether the goal is to become an accountant, a businessperson, or simply an informed consumer of accounting information, Financial Accounting (FA) has helped generations of students succeed Its leading-edge accounting content, paired with state-of-the-art technology, supports student learning and elevates understanding of key accounting principles The revolutionary technology of SmartBook® is available only from McGraw-Hill Education Based on an intelligent learning system, Smartbook uses a series of adaptive questions to pinpoint each student’s knowledge gaps and then provides an optimal learning path Students spend less time in areas they already know and more time in areas they don’t The result: Students study more efficiently, learn faster, and retain more knowledge Valuable reports provide insights into how students are progressing through textbook content and information useful for shaping inclass time or assessment FA excels at engaging students with content that will help them see the relevance of accounting Its chapter-opening vignettes showcase dynamic, successful entrepreneurial individuals and companies and highlight the usefulness of accounting This edition’s featured c­ompanies—Apple, Google, and Samsung—capture student interest with their products, and their annual reports serve as a pathway for learning financial statements Need-to-Know illustrations in each chapter demonstrate how to apply key accounting concepts and procedures The illustrations are supported by guided video presentations FA also delivers innovative technology to help student performance Connect provides students with a media-rich eBook version of the textbook and offers instant grading and feedback for assignments that are completed online Our system for completing exercise and problem material takes accounting content to the next level, delivering assessment material in a more intuitive, less restrictive format that adapts to the needs of today’s students This technology features: • a general journal interface that looks and feels more like that found in practice • an auto-calculation feature that allows students to focus on concepts rather than rote tasks • a smart (auto-fill) drop-down design The end result is content that better prepares students for the real world Interactive Presentations teach each chapter’s core learning objectives in a rich, multimedia format, bringing the content to life Your students will come to class prepared when you assign Interactive Presentations Students can also review the Interactive Presentations as they study Further, Guided Examples provide students with narrated, animated, step-by-step walk-throughs of algorithmic versions of assigned exercises Students appreciate the Guided Examples, which help them learn accounting and complete assignments outside of class A General Ledger (GL) application offers students the ability to see how transactions post from the general journal all the way through the financial statements It uses the intuitive, less restrictive format used for other homework, and it adds critical thinking components to each GL question, to ensure understanding of the entire process The first and only analytics tool of its kind, Connect Insight® is a series of visual data displays—each framed by an intuitive question—to provide at-a-glance information about how your class is doing Connect Insight provides a quick analysis on five key dimensions, available at a moment’s notice from a tablet device “A great enhancement! I love the fact that GL makes the student choose from an entire chart of accounts.” —TAMMY METZKE, Milwaukee Area Technical College iii www.freebookslides.com About the Author JOHN J WILD is a distinguished professor of accounting at the University of Wisconsin at Madison He previously held appointments at Michigan State University and the University of Manchester in England He received his BBA, MS, and PhD from the University of Wisconsin Professor Wild teaches accounting courses at both the undergraduate and graduate levels He has received numerous teaching honors, including the Mabel W Chipman Excellence-in-Teaching Award, the departmental Excellence-in-Teaching Award, and the Teaching Excellence Award (multiple times) from the business graduates at the University of Wisconsin He also received the Beta Alpha Psi and Roland F Salmonson Excellence-in-Teaching Award from Michigan State University Professor Wild has received several research honors, is a past KPMG Peat Marwick National Fellow, and is a recipient of fellowships from the American Accounting Association and the Ernst and Young Foundation iv Professor Wild is an active member of the American Accounting Association and its sections He has served on several committees of these organizations, including the Outstanding Accounting Educator Award, Wildman Award, National Program Advisory, Publications, and Research Committees Professor Wild is author of Fundamental Accounting Principles, Financial and Managerial Accounting, and College Accounting, each published by McGrawHill Education His research articles on accounting and analysis appear in The Accounting Review; Journal of Accounting Research; Journal of Accounting and Economics; Contemporary Accounting Research; Journal of Accounting, Auditing and Finance; Journal of Accounting and Public Policy; and other journals He is past associate editor of Contemporary Accounting Research and has served on several editorial boards including The Accounting Review Professor Wild is a recognized expert in accounting and financial analysis, and is known for his teaching innovations within an active learning classroom environment In his leisure time, Professor Wild enjoys hiking, sports, travel, people, and spending time with family and friends www.freebookslides.com Dear Colleagues and Friends, As I roll out the new edition of Financial Accounting, I thank each of you who provided suggestions to improve the textbook and its teaching resources This new edition reflects the advice and wisdom of many dedicated reviewers, symposium and workshop participants, students, and instructors Throughout the revision process, I steered this textbook and its teaching tools in the manner you directed As you’ll find, the new edition offers a rich set of features—especially digital features— to improve student learning and assist instructor teaching and grading I believe you and your students will like what you find in this new edition Many talented educators and professionals have worked hard to create the materials for this textbook, and for their efforts, I’m grateful I extend a special thankyou to our contributing and technology supplement authors, who have worked so diligently to support this textbook and its teaching aids: Contributing Author: Kathleen O’Donnell, Onondaga Community College Accuracy Checkers: Dave Krug, Johnson County Community College; and Beth Woods LearnSmart Author: April Mohr, Jefferson Community and Technical College, SW Interactive Presentations: Jeannie Folk, College of DuPage PowerPoint Presentations: April Mohr, Jefferson Community and Technical College, SW Instructor Resource Manual: April Mohr, Jefferson Community and Technical College, SW Test Bank Contributor: Brenda J McVey, University of Mississippi Digital Contributor, Connect Content, General Ledger Problems, and Exercise PowerPoints: Kathleen O’Donnell, Onondaga Community College In addition to the invaluable help from the colleagues listed above, I thank the entire FA, 8e, team at McGraw-Hill Education: Tim Vertovec, Steve Schuetz, Kyle Burdette, Michael McCormick, Lori Koetters, Ann Torbert, Patricia Plumb, Xin Lin, Kevin Moran, Debra Kubiak, Sandy Ludovissy, Shawntel Schmitt, Beth Thole, Brian Nacik, and Daryl Horrocks I could not have completed this new edition without your efforts John J Wild v The process of adjusting accounts is intended bring an asset or liability to its plastic and paper bags, gift boxes and cartons,toand cleaning materials Theaccount costs ofbalance these unused correct It also updates a related expense revenue account These adjustments are suppliesamount can be recorded in an Office Supplies or a or Store Supplies asset account When supplies necessary for transactions and eventsfrom that extend over more than one period (Adjusting entries are used, their costs are transferred the asset accounts to expense accounts are posted like any other entry.) Exhibit 3.12 summarizes the four types of transactions requiringisadjustment Understanding Equipment Accounts Equipment is an asset When equipment used and gets worn down, this exhibit is important to understanding the(called adjusting process andEquipment its importance to financial its cost is gradually reported as an expense depreciation) is often grouped statements Remember that each adjusting entry and affects one or more income by its purpose—for example, office equipment store equipment Office statement equipmentaccounts includes and one or more balance sheet accounts (but never the Cash account) computers, printers, desks, chairs, and shelves Costs incurred for these items are recorded in an Office Equipment asset account The Store Equipment account includes the costs of assets used in a store, such as counters, showcases, ladders, hoists, and cash registers EXHIBIT 3.12 BEFORE Adjusting www.freebookslides.com Buildings such as stores, offices, warehouses, assets Category Accounts Buildings Balance Sheet Income Statement and factories Adjustingare Entry because they provide expected future benefits to those who control or own them Their costs † Prepaid expenses Asset overstated Expense understated Dr Expense are recorded in a Buildings asset account When several buildings are owned, separate accounts overstated Cr Asset* are sometimes kept for eachEquity of them Innovative Textbook Features Unearned revenues † Liability overstated Summary of Adjustments Point: Some assets are and Financial Statement described as intangible because Links they not have physical existence or their benefits are highly uncertain A recent balance sheet for Coca-Cola Company shows nearly $15 billion in intangible assets Dr Liability Revenue understated Equityby understated Cr.cost Revenue Land The cost of land owned a business is recorded in a Land account The of buildAccrued expenses Liability understated Expense understated Dr Expense ings located on the land is separately recorded in one or more building accounts Accrued revenues Decision Insight Whether we prepare, analyze, or apply accounting information, one skill remains essential: decision making To help develop good decision-making habits and to illustrate the relevance of accounting, we use a learning framework we call the Decision Center This framework encompasses a variety of approaches and subject areas, giving students insight into every aspect of business decision making; see the four125nearby Sustainability and Accounting GoPro, as introduced in this of decision boxes, including examples for the different types chapter’s opening feature, emphasizes a reduced environmental footprint as part of its sustainability plan Specifically, GoPro, in partnership with Goal those that to through fraud to Decision 126 Maker and Zero, has reduced itsrelate environmental impact the use ofAnswers renewable energy Together, the two companies offered solar panel charging stations for spectators at the GoPro are Mountainat Games Further, end the company powered its Ethics boxes the of each chapter product display stations using the renewable solar panel energy “We’ve seen Chapter Adjusting Accounts for Financial Statements $3,500 $3,000 $2,500 $2,000 © Ashley Cooper/Corbis $1,500 of SPANX, has to donate halfrecorded her wealth to and charity The Center forare Women’s Exhibit assumes thatpromised prepaid expenses are initially as assets that unearned revenues initially recorded as liabilities Business Research reports that women-owned businesses are growing and that they: Information some always available until several days or even weeks •  Total more thanabout 11 million andadjustments employ nearlyis 20not million workers after the period-end This means sometoadjusting and closing entries are recorded later than, •  Generate $2.5 trillion in annual salesthat and tend embrace technology but dated as of, the lastofday of the period.atOne is a company that receives a utility bill •  Are philanthropic—70% owners volunteer least example once per month on January 10 for costs incurred for the month of December When it receives the bill, the com•   Are more likely funded by individual investors (73%) than venture firms (15%) ■ pany records the expense and the payable as of December 31 Other examples Paul include Morigi/GettylongImages for FORTUNE reflects distance phone usage and costs of many web billings The December income statement these additional expenses incurred, and the December 31 balance sheet includes these payables, although the amounts were not actually known on December 31 2014 Limited: A useful measure of a company’s operating results is the ratio of its net income to net sales This ratio is called profit margin, or return on sales, and is computed as in Exhibit 3.22 Officer At year-end, the president instructs you, the financial officer, not to record accrued exRatio Limited Brands’s current ratio 1.9then for its yearsalso 2009 through current 2.5 penses until next year because they will notaveraged be paid until Thefiscal president directs you to2014 recordThe in currentfor each of these that therequires company’s short-term obligations canweeks be covered year salesratio a recent purchase orderyears from suggests a customer that merchandise to be delivered two after 2.0 withYour its short-term assets.report However, if its ratio would Limited would to face the year-end company would a net income instead of approach a net loss 1.0, if you carry out theseexpect instructions challenges covering liabilities If the ratio were less than 1.0, current liabilities would exceed [Answers follow the chapter’s Summary.] What you do? ■ in 1.5 2013 2012 Current Liabilities ($) 2011 2010 Current Assets ($) Current Ratio Decision Maker Profit Margin This ratio is interpreted as reflecting the percent of profit in each dollar of sales To illustrate how we compute and use profit margin, let’s look at the results of Limited Brands, Inc., in Exhibit 3.23 for its fiscal years 2010 through 2014 11/26/15 9: current assets, and the company’s ability to pay short-term obligations could be in doubt Limited Brands’s liquidity, as evidenced by its current ratio, declined in 2011, 2012, and 2013, which roughly matches the industry decline; but it rose to the norm in 2014 2009 EXHIBIT 3.22 Net income Net sales Point: CFOs often feel compelled to pursue fraudulent accounting due to pressure applied by their superiors, such as overbearing CEOs or aggressive boards Chapter Adjusting Accounts for Financial Statements Decision Ethics 1.0 $0 Profit margin = *Women For depreciation, the credit is to Accumulated Depreciation (contrathe asset) Entrepreneurs Sara Blakely (in photo), billionaire entrepreneur/owner $500 Profit Margin Dr Asset Cr Revenue Revenue understated † $1,000 Decision Analysis Profit margin and current ratio Asset understated Equity understated wiL3300x_ch02_050-097.indd 55 Financial Millions strong interest since announcing this exciting new solution,” says Nick Woodman, founder of GoPro “Helping the world is one of the most satisfying aspects of our business and we believe it instills our brand with an invaluable degree of goodwill and good karma.” Cr Liability Equity overstated Using Accounting for Decisions Analyst You are analyzing the financial condition of a company to assess its ability to meet upcoming loan payments You compute its current ratio as 1.2 You also find that a major portion of accounts receivable is due from one client who has not made any payments in the past 12 months Removing this receivable from current assets lowers the current ratio to 0.7 What you conclude? ■ [Answers follow the chapter’s Summary.] wiL3300x_ch03_098-163.indd 113 A1 Compute profit margin and describe its use in analyzing company performance 13 11/26/15 9:0 Analyzing and “This Analyzing textbook does address many learning styles and at the same time allows and Interpreting for many teaching styles our faculty have been very pleased with the Interpreting ­continued revisions and supplements I’mFinancial a ‘Wild’ fan!” Financial Statements Statements Chapter Preview 2014 Net income $ Net sales Profit margin Industry profit margin $10,773 8.4% 2.5% 13 2013 903 $ 2012 753 2011 2010 850 $ 805 $ 448 $10,364 8.2% 2.2% $9,613 8.4% 2.1% $8,632 5.2% 1.2% $ $10,459 7.2% 2.0% EXHIBIT 3.23 Limited Brands’s Profit Margin Millions Limited’s average profit margin is 7.5% during this five-year period This favorably compares to the average industry profit margin of 2.0% Moreover, we see that Limited’s profit margin has rebounded from the recent recessionary period and is at the 7% to 8% margin for the past four years (see margin graph) Future success depends on Limited maintaining its market share and increasing its profit margin Ratio $11,000 $10,000 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 NEED-TO-KNOW 3-8 7.5% 5.0% COMPREHENSIVE 2.5% 0.0% 2014 Limited: 2013 Net Income ($) Current Ratio chapter An important use of financial statements is to help assess a company’s ability to pay its debts in the near future Such analysis affects decisions by suppliers when allowing a company to buy on credit It also affects decisions by creditors when lending money to a company, including loan terms such as interest rate, due date, and collateral requirements It can also affect a manager’s decisions about using cash to pay debts when they come due The current ratio is one measure of a company’s ability to pay its short-term obligations It is defined in Exhibit 3.24 as current assets divided by current liabilities Current ratio = chapter $ millions A2 2012 2011 Net Sales ($) 2010 Profit Margin (%) Compute the current ratio and describe what it reveals about a company’s financial condition —RITA HAYS, Southwestern Oklahoma State University EXHIBIT 3.24 Current assets Current liabilities Current Ratio Using financial information from Limited Brands, Inc., we compute its current ratio for the recent sixyear period The results are in Exhibit 3.25 $ millions 2014 2013 2012 2011 2010 2009 Current assets Current liabilities Current ratio $3,150 $1,826 1.7 $2,205 $1,538 1.4 $2,368 $1,526 1.6 $2,592 $1,504 1.7 $3,250 $1,322 2.5 $2,867 $1,255 2.3 Industry current ratio 1.7 1.5 1.6 1.7 1.9 2.0 EXHIBIT 3.25 Limited Brands’s Current Ratio wiL3300x_ch03_098-163.indd 125 comparisons, and analysis tools Required Chapter Preview Each chapter opens with a visual chapter preview Students can begin their reading Chapter Preview with a clear understanding of what they BASICS OF HORIZONTAL VERTICAL will learn and when, allowing them to stay ANALYSIS ANALYSIS ANALYSIS more focused and organized along the way C1 Analysis: Its purpose, P1 Application of: P2 Application of: building blocks, and Learning objective numbers the Comparative highlight balance Common-size information needs sheets balance sheet location of for related content C2 Standards Comparative income Common-size Prepare any necessary adjusting entries on December 31, 2016, in relation to transactions and events a through e BASICS OF ANALYSIS T-accounts for the accounts affected by adjusting entries, and RATIO post the ANALYSIS adjusting entries Prepare HORIZONTAL VERTICAL Determine ANALYSIS the adjusted balances for the Unearned Revenue and the Prepaid Insurance accounts ANALYSIS AND REPORTING Complete the following table and determine the amounts and effects of your adjusting entries on the C1 Analysis: Its purpose, yearP1 P2 Application P3 up Application of: Liquidity 2016 income statement and the December 31, 2016,of: balance sheet Use (down) and arrows to indibuilding blocks, and cate an increase (decrease) in the Effect columns balance Common-size information needs 11/26/15 9:05RATIO AM ANALYSIS Comparative sheets balance sheet AND C2 Standards for REPORTING Comparative income Common-size comparisons, and Amount in Effect onincome statement Effect on statements P3 Liquidity and analysis tools Entry the Entry Net Income Total Assets efficiency Trend analysis Common-size graphics Solvency statements income statement Trend analysis Common-size graphics efficiency Solvency Effect on Effect on Profitability Total Total Market prospects Liabilities Equity A1 Analysis reports Profitability Market prospects PLANNING THE SOLUTION A1 Analysis reports Analyze each situation to determine which accounts need to be updated with an adjustment Learning Objectives Calculate the amount of each adjustment and prepare the necessary journal entries CONCEPTUAL C1 Learning Objectives The following information relates to Fanning’s Electronics on December 31, 2016 The company, which uses the calendar year as its annual reporting period, initially records prepaid and unearned items in balance sheet accounts (assets and liabilities, respectively) a The company’s weekly payroll is $8,750, paid each Friday for a five-day workweek Assume December 31, 2016, falls on a Monday, but the employees will not be paid their wages until Friday, January 4, 2017 b Eighteen months earlier, on July 1, 2015, the company purchased equipment that cost $20,000 Its useful life is predicted to be five years, at which time the equipment is expected to be worthless (zero salvage value) c On October 1, 2016, the company agreed to work on a new housing development The company is paid $120,000 on October in advance of future installation of similar alarm systems in 24 new homes That amount was credited to the Unearned Services Revenue account Between October and December 31, work on 20 homes was completed d On September 1, 2016, the company purchased a 12-month insurance policy for $1,800 The transaction was recorded with an $1,800 debit to Prepaid Insurance e On December 29, 2016, the company completed a $7,000 service that has not been billed or recorded as of December 31, 2016 CAP Model Show the amount of each adjustment in the designated accounts, determine the adjusted balance, and ANALYTICAL PROCEDURAL identify the balance sheet classification of the account Explain the purpose and identify the A1 Summarize and report results of P1 Explain and apply methods of horizontal effect on net income for the year and on analysis total assets, total liabilities, and total building blocks of analysis Determine each entry’s analysis The Conceptual/Analytical/Procedural (CAP) and applydesigned methods of verticalto to P2 beDescribe specially assess the content of a complete analysis incomethe statement meet teaching needs of a diverse faculty P3 Define and apply ratio analysis This model identifies learning objectives, textual materials, assignments, and test items by C, A, or P, allowing different instructors to teach from the same materials, yet easily customize their courses toward a conceptual, analytical, or procedural approach (or a combination thereof) based on personal preferences equity at the end of the year C2 CONCEPTUAL ANALYTICAL Describe standards for comparisons in analysis PROCEDURAL C1 Explain the purpose and identify the building blocks of analysis A1 Summarize and report results of analysis P1 C2 Describe standards for comparisons in analysis A2 P2 Describe and apply methods of vertical Appendix 13A—Explain the form and assess the content of a complete analysis income statement wiL3300x_ch03_098-163.indd 126 P3 Define and apply ratio analysis Explain and apply methods of horizontal analysis Appendixallows 13A—Explaincourses the form and A2 model 11/26/15 9:05 AM vi wiL3300x_ch13_590-636.indd 590 01/08/16 5:47 PM imposed by the SEC Another nearly million corporations in the United States not trade their shares publicly and are called private or closely held corporations, which are not subject to SEC oversight Appendix A, near the end of this book, shows key excerpts from the www.freebookslides.com annual Point: Statement of cash flowsreport of Apple This appendix also reproduces financial statements from the annual has three main sections: operat-of Google and Samsung The key excerpts are identified and explained on page A-1 reports ing, investing, and financing We review and use the annual report for many business decisions, especially for valuing Point: Payment forofsupplies is Point: Statement cash flows corporate stock and assessing a company’s ability to pay off its debts an operating activity because has three main sections: operat- Equity of $34,200 top, followed by liabilities and then equity at the bottom Either presentation is acceptable.) As always, we see accounting equation applies: Assets of $40,400 = Liabilities of $6,200 + Statement oftheCash Flows Equity of $34,200 FastForward’s statement of cash flows is the final report in Exhibit 1.10 The first section reports cash flows of fromCash operating activities It shows the $6,100 cash received from clients and Statement Flows the $5,100 cash paid for supplies, rent, and employee salaries Outflows are in parentheses to FastForward’s statement of cash flows by is the final report in Exhibit 1.10 The section redenote subtraction Net cash provided operating activities for December is first $1,000 If cash ports cash flows operating activities.weIt would shows call the $6,100 from clients and paid exceeded thefrom $5,100 cash received, it “cashcash usedreceived by operating activities.” the $5,100 cash paid for supplies, rent, and employee salaries Outflows are in parentheses to The second section reports investing activities, which involve buying and selling assets such as denote subtraction provided by operating December $1,000 If only cash land and equipmentNet thatcash are held for long-term use activities (typicallyfor more than oneis year) The paid exceeded the is$5,100 cash received, call it The “cashthird usedsection by operating activities.” investing activity the $26,000 purchaseweofwould equipment shows cash flows The section reportswhich investing activities, which involve buyingand andrepaying selling assets such as fromsecond financing activities, include the long-term borrowing of cash from land andand equipment are held for long-term use (typically more than FastForward one year) The only lenders the cashthat investments from, and dividends to, stockholders reports investing activity is the $26,000 purchase ofand equipment The dividend third section cash flows $30,000 from the owner’s initial investment the $200 cash Theshows net cash effect of from financing activities, iswhich include theinflow long-term borrowing cash Fastfrom all financing transactions a $29,800 cash The final part ofand the repaying statementofshows lenders the cash and dividends to, stockholders FastForward reports Forwardand increased its investments cash balancefrom, by $4,800 in December Since it started with no cash, the $30,000 from the owner’s initial investment andsee thethat $200 cash flow dividend The are net different cash effect of its cash numbers from ending balance is also $4,800—see line We all financing transactions is numbers, a $29,800which cash inflow The final part of the statement shows Fastincome statement (accrual) is common Forward increased its cash balance by $4,800 in December Since it started with no cash, the ending balance is also $4,800—see line We see that its cash flow numbers are different from income statement (accrual) numbers, which is common supplies are expected to be used ing, investing, and financing up in short-term operations Point: (typicallyPayment less thanfor onesupplies year) is an operating activity because Point: are Investing activities supplies expected to be refer used a trial balance for Apple using the following condensed data from its fiscal year ended Prepare to long-term asset investments up in short-term operations September 27, 2014 ($ in millions) by the company, toyear) owner (typically less thannot one investments Point: Investing activities refer to long-term asset investments Common stock $ 23,313 Dividends $ 11,215 by the company, not to owner investments Accounts payable 30,196 Securities investments and other assets 179,911 Bring Accounting to Life Prepare the (a) income statement, (b) statement of retained earnings, and (c) balance sheet for Apple using the following condensed data from its fiscal year ended September 27, 2014 ($ in millions) (Its prior fiscal year ended September 28, 2013.) Prepare the (a) income statement, (b) statement of retained earnings, and (c) balance sheet for Apple using the Accounts following condensed year ended September 2014 ($ in prior fispayable data from its fiscal$ 30,196 Investments and27, other assets millions) (Its $179,911 cal Other year ended September liabilities 28, 2013.) 90,096 Land and equipment (net) 20,624 Cost of sales Accounts Cash payable Other liabilities Sep 28, 2013 Retained earnings, 112,258 $ 30,196 13,844 90,096 104,256 Retained earnings, Sep 28, 2013 104,256 Cost of sales year 2014  Dividends in fiscal Cash Revenues 112,258 56,614 13,844 182,795 Selling, general, and other expenses 31,027 Investments and other .assets Accounts receivable $179,911 17,460 Land and equipment (net) 20,624 Net income 39,510 Selling, general, andSep other 31,027 Retained earnings, 27,expenses 2014 87,152 Accounts 17,460 Common receivable stock 24,395 Net income 39,510 Dividends year 2014  Solution ($ ininfiscal millions) 56,614 Retained earnings, Sep 27, 2014 87,152 Revenues 182,795 Common stock 24,395 Solution ($ in millions) Other liabilities 90,096 Land and equipment (net) 20,624 Cost of sales (and other expenses) 126,231 Selling and other expense 17,054 13,844 Accounts receivable 17,460 Cash APPLE Income Statement Expenses For Fiscal Year Ended September 27, 2014 Cost of sales $112,258 Revenues and other expenses Selling, general, 31,027 _ Expenses Total expenses Cost of sales $112,258 Net income Selling, general, and other expenses _ 31,027 Total expenses Net income NEED-TO-KNOW 1-5 P2NEED-TO-KNOW 182,795 Retained earnings 59,939 Need-to-Know illustrations are located at key APPLEchapter These illustrations junctures in each Trial Balance pose questions about the material just preSeptember 27, 2014 sented—content that Debit students “need to Credit know” learn accounting Cash to successfully $ 13,844 Accounts receivable 17,460 Accompanying solutions walk students Land and equipment (net) 20,624 Securities investments and other assets and 179,911analysis necessary through key procedures Accounts payable $ 30,196 to be successful with homework and test maOther liabilities 90,096 Common stock Need-to-Know illustrations 23,313 are suppleterials Retained earnings 59,939 mented with narrated, animated, step-by-step Dividends 11,215 Revenues 182,795 walk-through videos led by an instructor and Cost of sales and other expenses 126,231 available via Connect Selling and other expense 17,054 1-5 APPLE Financial Statements P2 APPLE $182,795 143,285 _ $ 39,510 To next page statement of retained earnings 143,285 _ $ 39,510 To next page statement of retained earnings Totals $386,339 $386,339 Do More: E 2-8 GLOBAL VIEW wiL3300x_ch01_002-049.indd 21 11/20/15 1:33 PM wiL3300x_ch01_002-049.indd 21 11/20/15 1:33 PM The Global View section explains internaFinancial accounting according to U.S GAAP is similar, but not identical, to IFRS This section tional accounting practices relating to the discusses differences in analyzing and recording transactions, and with the preparation of financial statements material covered in that chapter The aim of this section is to describe accounting Analyzing and Recording Transactions Both U.S GAAP and IFRS include broad and 74 Chapter Financial Statements and the Accounting System similar guidance for financial accounting Further, both U.S GAAP and IFRS apply transaction analpractices and to identify the similarities and ysis and recording as shown in this chapter—using the same debit and credit system and accrual differences in international accounting accounting Although some variations exist in revenue and expense recognition and other accounting principles, all of the transactions in this chapter are accounted for identically under these two practices versus those in the United States systems As we move toward global convergence in Financial Statements Both U.S GAAP and IFRS prepare the same four basic financial stateaccounting practices, and as we witness the ments A few differences within each statement exist and we will discuss those throughout the book For example, both U.S GAAP and IFRS require balance sheets to separate current items from noncurrent likely convergence of U.S GAAP to IFRS, items However, while U.S GAAP balance sheets report current items first, IFRS balance sheets normally (but are not required to) present noncurrent items first, and equity before liabilities To illustrate, a conthe importance of student familiarity with PIAGGIO densed version of Piaggio’s balance sheet follows Piaggio is an Italian manufacturer of scooters and international accounting grows This innocompact vehicles vative section helps us begin down that PIAGGIO path This section is purposefully Chapter located at Financial Statements Balance Sheet (in thousands of euros) Introducing 23 December 31, 2014 the end of each chapter so that each inAssets Equity and Liabilities Samsung structor can decide what SAMSUNG emphasis, if at all, Noncurrent assets €1,079,117 Total equity € 413,069 Income Statement ($ thousands) is to be assigned toFor it.Year Ended December 31, 2014 Current assets 477,491 Noncurrent liabilities 581,366 wiL3300x_ch02_050-097.indd 73 Revenues Cost of sales $195,882,955 121,856,939 Cost of selling, wages, depreciation, and other expenses, net Tax expense Net income (profit) 47,546,456 4,256,366 $ 22,223,194 Total assets Status of IFRS IFRS is now adopted or accepted in over 115 countries, including over 30 memberstates of the EU The FASB and IASB continue to work on the convergence of IFRS and U.S GAAP €1,556,608 Current liabilities 562,173 Total equity and liabilities €1,556,608 Accounting Controls and Assurance Accounting systems depend on control procedures that assure proper principles were applied The passage of SOX legislation strengthened U.S controls However, global standards for controls are diverse and so are enforcement activities Consequently, while global accounting standards are converging, their application in different countries can yield different outcomes depending on the quality of their auditing standards and enforcement Sustainability and Accounting kg CO2e per $ of revenue Sustainability and Accounting The Sustainability Accounting Standards Board (SASB) is a nonprofit entity engaged in creating and disseminating sustainability acFraud counting standards for use by companies Sustainability refers to environmental, social, and governance (ESG) aspects of a company A company’s social aspects include donations to Percent Citing Misconduct Data Quality Recording valid and hospitals, colleges, community programs, and law enforcement Environmental aspects inaccurate transactions enhances the quality 40% clude programs to reduce pollution, increase product safety, improve worker conditions, and of financial statements The graph here shows the support “green” activities Governance aspects include social responsibility programs, com30% percentage of employees in information technology who munity relations, and use of sustainable materials Sustainability accounting standards are intended to complement financial accounting standards The SASB has its own Conceptual report observing specific types of misconduct and the 20% Framework to guide the development of sustainability standards It has also developed a set © Xinhua/Alamy increased risk of such misconduct in recent years 10% of principles, which serve as a set of minimum criteria (Source: KPMG 2013) Apple, as introduced in this chapter’s opening feature, focuses on sustainability Apple hired a 0% Vice President of Environmental Initiatives, Lisa Jackson (in photo), to oversee its sustainability Breaching Mishandling Falsifying initiative Lisa has set high goals for Apple, including powering all of its facilities with 100% redatabase private accounting 0.3 controls information data Apple’s Carbon Efficiency newable energy and making its products 100% recyclable “We are swinging for the fences [on sustainability],” proclaims Lisa, which has resulted in some home runs for Apple In Apple’s 0.25 Years: 2013 2009 sustainability report, Lisa points out that it powers data centers with 100% renewable energy and relies solely on renewable energy to power 80% of its corporate facilities and 50% of its retail 0.2 stores As Lisa stresses, “[Sustainability] is really important at Apple.” Apple is also committed to Sustainability and Accounting Twitter, as introduced in this chapter’s opening feature, is reducing carbon emissions “We would like to eliminate certain toxins,” explains Lisa Apple’s 0.15 committed to connecting people interested in sustainability and saving the earth Twitter co-founder sustainability report asserts that it has markedly improved its carbon efficiency and reduced the 2008 2009 2010 2011 2012 2013 2014 BizApple Stone insists that, “to be judged successful, a company needs to make money, make the world a amount of carbon dioxide produced per dollar of revenue—see graphic Lisa insists, “Leave the Source: Greenbiz, October 2014; Sustainability Report, Januarybetter 2015 place and bring joy to the people who work there.” Twitter has made the world a better place by world better than how we found it this is what really inspires people at Apple.” providing a space for people with similar interests in sustainability to connect with one another Sustainability gatherings like cleaning up the park and planting trees are organized on Twitter The Decision Insight Twitter website has also become a source of news for individuals interested in sustainability For example, when a new U.S law was in-process that requires companies to report their use of minerals 115 Sustainability Returns Virtue is not always its own re114 from conflict regions in the Congo, the director of corporate responsibility at AMD, Tim Mohin, $14,300Hasbrun/Redux Pictures Gabriela ward Compare the S&P 500 with the Domini Social Index 113 DSEFX DSEFX 112 learned about it through Twitter (DSEFX), which covers 400 companies that have especially 111 S&P 500 In addition to believing the earth deserves respect, Twitter believes in treating employees with respect 110 good records for sustainability We see that returns for com19 Glassdoor ranked Twitter as one of best places to work Glassdoor chief executive Robert Hohman 18 panies with sustainable behavior are roughly on par with, or $12,400 New in this edition are brief sections that highlight the importance of sustainability within the broader context of global accounting (and accountability) Companies increasingly address sustainability in their public reporting and consider the sustainability accounting standards (from the Sustainability Accounting Standards Board) and the expectations of our global society These boxes, located near the end of the Global View section, cover different aspects of sustainability, often within the context of the chapter’s featured entrepreneurial company Thousands) vii 17 APPL Solution ($ in millions) Financial Statements $182,795 Global View P2 Need-to-Know Illustrations Revenues APPLE Income Statement For Fiscal Year Ended September 27, 2014 Revenues NEED-TO-KNO Preparing Trial www.freebookslides.com Outstanding Assignment Material Chapter 10 461 Reporting and Analyzing Long-Term Liabilities Decision Maker Bond Investor You plan to purchase debenture bonds from one of two companies in the same industry that Once a student has finished reading the chapter, how wellThehe she retains theandmaterial can depend greatly are similar in size and performance first or company has $350,000 in total liabilities $1,750,000 in equity The second company has $1,200,000 in total liabilities and $1,000,000 in equity Which company’s debenture on the questions, exercises, and problems that reinforce it This book leads the way in comprehensive, accubonds are less risky based on the debt-to-equity ratio? ■ rate assignments [Answers follow the chapter’s Summary.] Comprehensive Need-to-Know Problems pre­sent both a problem and a complete solution, allowing students to review the entire problem-solving process and achieve success The problems draw on material from the entire chapter Water Sports Company (WSC) patented and successfully test-marketed a new product To expand its ability to produce and market the new product, WSC needs to raise $800,000 of financing On January 1, 2016, the company obtained the money in two ways: a WSC signed a $400,000, 10% installment note to be repaid with five equal annual installments to be made on December 31 of 2016 through 2020 b WSC issued five-year bonds with a par value of $400,000 The bonds have a 12% annual contract rate and pay interest on June 30 and December 31 The bonds’ annual market rate is 10% as of January 1, 2016 NEED-TO-KNOW 10-4 COMPREHENSIVE Required For the installment note, (a) compute the size of each annual payment, (b) prepare an amortization ta- ble similar to Exhibit 10.14, and (c) prepare the journal entry for the first payment For the bonds, (a) compute their issue price; (b) prepare the January 1, 2016, journal entry to record their issuance; (c) prepare an amortization table using the straight-line method; (d) prepare the June 30, 2016, journal entry to record the first interest payment; and (e) prepare a journal entry to record retiring the bonds at a $416,000 call price on January 1, 2018 3.B Redo parts 2(c), 2(d), and 2(e) assuming the bonds are amortized using the effective interest method 135 Chapter Adjusting Accounts for Financial Statements PLANNING THE SOLUTION For the installment note, divide the borrowed amount by the annuity factor (from Table B.3) using the because the debt has been settled The disadvantage of this approach is the slightly more complex entry 10% rate and five payments to compute the amount of each payment Prepare a table similar to Exhibit required on January Paying the accrued liability means that this entry differs from the routine entries Point: Firms thatinuse 10.14 the numbers the table’s first line for the journal entry made on all other paydays To construct the proper entry on January 9, we must recall the effect of and the usereversing entries hope that Compute thethis bonds’ issue price by using the market rate to find the present value of their cash flows December 31 adjusting entry Reversing entries overcome this disadvantage simplification will reduce errors.in Appendix B) Then use this result to record the bonds’ issuance Next, prepare an (use tables found Accounting with Reversing Entries The right side of Exhibit 3C.1 shows how a amortization reversing table like Exhibit 10.11 (and Exhibit 10B.2) and use it to get the numbers needed for the journal entry Also use the table to find the carrying value as of the date of the bonds’ retirement that entry on January overcomes the disadvantage of the January entry when not using reversing entries youliabilneed for the journal entry A reversing entry is the exact opposite of an adjusting entry For FastForward, the Salaries Payable ity account is debited for $210, meaning that this account now has a zero balance after the entry is SOLUTION posted The Salaries Payable account temporarily understates the liability, but this is not a problem since financial statements are not prepared before the liability is settled on January The credit to the Salaries Part 1: Installment Note Expense account is unusual because it gives the account an abnormal credit balance We highlight an a.payment Annual is payment = Note balance/PV annuity factor = $400,000/3.7908 = $105,519 (The present value abnormal balance by circling it Because of the reversing entry, the January entry to record annuity factor is for five payments and a rate of 10%.) straightforward This entry debits the Salaries Expense account and credits Cash for the full $700 paid It is the same as all other entries made to record 10 days’ salary for the employee Notice b thatAn after the amortization table for the long-term note payable follows payment entry is posted, the Salaries Expense account has a $490 balance that reflects seven days’ salary of $70 per day (see the lower right side of Exhibit 3C.1) The zero balance in the Salaries Payable acA B C D E F G H count is now correct The lower section of Exhibit 3C.1 shows that the expense and liability accounts Payments have exactly the same balances whether reversing entries are used or not This means that both approaches (d ) (e) (a) (b) (c) Credit Debit Debit yield identical results Annual Beginning Balance Interest Expense 10% (a) $400,000 334,481 $ 40,000 33,448 12/31/2018 accounts Prepaid expenses refer to (3) items paid for in advance262,410 of (4) 12/31/2019 183,132 receiving their benefits Prepaid expenses are assets Adjusting 26,241 18,313 Summary C1 Explain the importance of periodic reporting and the role of accrual accounting The value of information is often linked to its timeliness To provide timely information, accounting systems prepare periodic reports at regular intervals The time period assumption presumes that an organization’s activities can be divided into specific time periods for periodic reporting Accrual accounting recognizes revenue when earned and expenses when incurred—not necessarily when cash inflows and outflows occur C2 Identify steps in the accounting cycle The accounting cycle consists of 10 steps: (1) analyze transactions, (2) journalize, (3) post, (4) prepare an unadjusted trial balance, (5) adjust accounts, (6) prepare an adjusted trial balance, (7) prepare statements, (8) close, (9) prepare a post-closing trial balance, and (10) prepare (optional) reversing entries C3 Explain and prepare a classified balance sheet Classified balance sheets report assets and liabilities in two categories: current and noncurrent Noncurrent assets often include long-term investments, plant assets, and intangible assets A corporation separates equity into common stock and retained earnings A1 Compute profit margin and describe its use in analyzing company performance Profit margin is defined as the reporting period’s net income divided by its net sales Profit margin reflects on a company’s earnings activities by showing how much income is in each dollar of sales A2 Compute the current ratio and describe what it reveals about a company’s financial condition A company’s current ratio is defined as current assets divided by current liabilities We use it to evaluate a company’s ability to pay its current liabilities out of current assets Period Ending (1) 12/31/2016 (2) 12/31/2017 Notes Ending Payable Cash Balance Chapter Summaries provide stu(computed) (a) (c) (d ) (b) $ 65,519 with $105,519 $334,481organized by learning dents a review 72,071 105,519 262,410 objectives Chapter 79,278 105,519 183,132Summaries are a com87,206 95,926 ponent of105,519 the CAP model (as discussed in 95,926 105,519 $400,000 $527,595 the “Innovative Textbook Features” section), which recaps each conceptual, analytical, and procedural objective (5) (debiting) 12/31/2020expenses and95,926 9,593 entries for prepaids involve10increasing 11 Unearned (or prepaid) revenues $127,595 decreasing (crediting) assets 12 refer to cash received in advance of providing products and services Unearned revenues are liabilities Adjusting entries for unearned revenues involve increasing (crediting) revenues and decreasing (debiting) unearned revenues Accrued expenses refer to costs incurred in a period that are both unpaid and 472 Chapter 10 Reporting and Analyzing Long-Term Liabilities unrecorded Adjusting entries for recording accrued expenses involve increasing (debiting) expenses and increasing (creditwiL3300x_ch10_442-487.indd 461 refer to revenues earned in a 12/28/15 8:30 PM ing) liabilities Accrued revenues Guidance Answers to Decision Maker period that are both unrecorded and not yet received in cash Adjusting entries for recording accrued revenues involve increasing (debiting) assets and increasing (crediting) revenues.This is a “present value” question The market Entrepreneur of the second company is more risky than that of the first com- P2 interest rate (10%) Explain and prepare an adjusted trial balance An and present value ($3,000) are known, but the payment required two years later is unknown This amount adjusted trial balance is a list of accounts and balances ($3,630) canFinancial be computed as $3,000 × 1.10 × 1.10 Thus, the prepared after recording and posting adjusting entries sale price is $3,630 when no payments are received for two statements are often prepared from the adjusted trial balance P3 years The $3,630 received two years from today is equivalent to Prepare financial statements from an adjusted trial $3,000 cash today balance Revenue and expense balances are reported on the income statement Asset, liability, and equity Bondbalances Investorare The debt-to-equity ratio for the first company is 0.2 ($350,000/$1,750,000) and for the second company is 1.2 reported on the balance sheet We usually prepare statements in ($1,200,000/$1,000,000), suggesting that the financing structure the following order: income statement, statement of retained earnings, balance sheet, and statement of cash flows pany Consequently, as a buyer of unsecured debenture bonds, you prefer the first company (all else equal) Bond Rater Bonds with longer repayment periods (life) have higher risk Also, bonds issued by companies in financial difficulties or facing higher-than-normal uncertainties have higher risk Moreover, companies with higher than normal debt and large fluctuations in earnings are considered to be higher risk Discount bonds are riskier on one or more of these factors P4 Describe and prepare closing entries Closing entries involve four steps: (1) close credit balances in revenue (and gain) accounts to Income Summary, (2) close debit balances in expense (and loss) accounts to Income KeySummary, Terms (3) close Income Summary to the Retained Earnings account, and (4) close the Dividends account to Retained Earnings Annuity Key Terms are bolded in the text and repeated at the end of the chapter A complete glossary of bonds A Explain and prepare a post-closing Bearer trial balance Prepare and adjusting entries Accounting adkeyP1terms is explain available online through P5Connect post-closing trial balance is a list of permanent accounts Bond justments bring an asset or liability account balance to its correct amount They also update related expense or revenue wiL3300x_ch03_098-163.indd 135 and their balances after all closing entries have journalized Bondbeen certificate Bond indenture Callable bonds Capital leases Carrying (book) value of bonds Contract rate Convertible bonds Coupon bonds 11/26/15 9:05 AM Debt-to-equity ratio Discount on bonds payable Effective interest method Fair value option Installment note Lease Market rate Mortgage Off-balance-sheet financing Operating leases Par value of a bond Pension plan Premium on bonds Registered bonds Secured bonds Serial bonds Sinking fund bonds Straight-line bond amortization Term bonds Unsecured bonds viii Multiple Choice Quiz A bond traded at 971⁄2 means that a The bond pays 971⁄2% interest Answers at end of chapter a $40,000 b $0 c $20,000 d $800,000 e $400,000 Chapter 10 475 Reporting and Analyzing Long-Term Liabilities www.freebookslides.com Compute the debt-to-equity ratio for each of the following companies Which company appears to have a riskier financing structure? Explain Atlanta Company Spokane Company Total liabilities $429,000 $  549,000 Total equity 572,000 1,830,000 QS 10-13 Debt-to-equity ratio A3 Helps Students Master Key Concepts Garcia Company issues 10%, 15-year bonds with a par value of $240,000 and semiannual interest payments On the issue date, the annual market rate for these bonds is 14%, which implies a selling price of 751⁄4 The effective interest method is used to allocate interest expense What are the issuer’s cash proceeds from issuance of these bonds? What total amount of bond interest expense will be recognized over the life of these bonds? What amount of bond interest expense is recorded on the first interest payment date? QS 10-14B Garcia Company issues 10%, 15-year bonds with a par value of $240,000 and semiannual interest payments On the issue date, the annual market rate for these bonds is 8%, which implies a selling price of 1171⁄4 The effective interest method is used to allocate interest expense What are the issuer’s cash proceeds from issuance of these bonds? What total amount of bond interest expense will be recognized over the life of these bonds? What amount of bond interest expense is recorded on the first interest payment date? QS 10-15B Multiple Choice Quiz questions quickly test chapter knowledge before a student moves on to complete Quick Studies, Exercises, and Problems Effective Interest: Bond discount computations P5 Chapter Adjusting Accounts for Financial Statements Effective Interest: Multiple Choice Quiz Answers at Bond premium computations A company forgot to record accrued and unpaid em- 137 end of chapter On November 1, 2016, Stockton Co receives $3,600 cash from Hans Co for consulting services to be provided evenly over the period November 1, 2016, to April 30, 2017— would at which Stockton credited $3,600 to Unearned a Understate net income by $350,000 Chapter Adjusting Accounts for time Financial Statements 145 Consulting Fees The adjusting entry on December 31, b Overstate net income by $350,000 2016 (Stockton’s year-end), would include a HaveC no effect on net income 10-16 Madrid Company plans to issue 8% bonds on January 1, 2016, with a par value of $4,000,000 The com- QS c a Debit to Unearned Consulting Fees for $1,200 d Overstate assets bybalance $350,000 bonds between pany sells $3,600,000 of the bonds on January 1, 2016 The remaining $400,000 sells at par on MarchUse 1, theIssuing 3-7 following adjusted trial of Wilson Trucking Company to prepare the (1) income statement Exercise b Debit to Unearned Consulting Fees for $2,400 e Understate by $350,000 C3 assetsearnings dates 2016 The bonds pay interest semiannually as of June 30 and December 31 Record the entry for and the (2)interest statement of retained for the year ended December 31, 2016 The Retained Earnings ac- Preparing financial c Credit to Consulting Fees Earned for $2,400 Prior to recording adjusting entries, the Supplies account March cash sale of bonds statements count balance is $155,000 at December 31, 2015 d Debit to Consulting Fees Earned for $1,200 has a $450 debit balance A physical count of supplies P3 e Credit to Cash for $3,600 shows $125 of unused supplies still available The required If a company had $15,000 in net income for the year, and 10-17D entry is: Jin Li, an employee of ETrain.com, leases a car at O’Hare airport for a three-day business trip The rental QSadjusting Account TitleCredit Supplies Expense $125 Debit itsCredit sales were $300,000 for the same year, what is its profit a Debit Supplies $125; Recording operating cost is $250 Prepare the entry by ETrain.com to record Jin Li’s short-term car lease cost margin? b Debit $325; Credit Supplies Expense $325 C4 Supplies leases Cash $ 8,000 a 20% c $285,000 e 5% c Debit Supplies Expense $325; Credit Supplies $325 AccountsExpense receivable .Credit Supplies $125 17,500 b 2,000% d $315,000 d Debit Supplies $325; Office supplies $125; Credit Supplies $125 3,0006 Based on the following information from Repicor Company’s 10-18 Algoma, Inc., signs a five-year lease for office equipment with Office Solutions The present value of the QS e DebitD Supplies Expense a two-year insurance policy was pur172,000 balance sheet, what is Repicor Company’s current ratio? capital leases lease payments is $15,499 Prepare the journal entry that Algoma records at the inception of this capital Recording On May 1,Trucks 2016, C4 chased for Accumulated lease $24,000 with coverage to begin immediately depreciation—Trucks $ 36,000 What is theLand amount Current liabilities $ 50,000 of insurance expense that appears 85,000 Current assets $ 75,000 on the company’s Investments 30,000 Long-term liabilities 60,000 Accountsincome payable statement for the year ended 12,000 2016? 10-19 31, Vodafone Group Plc reports the following information among its bonds payable as of March 31, 2015 QSDecember Plant assets 300,000 Common stock 295,000 Interest payable 4,000 a $4,000liabilities c $12,000 e $24,000 International (pounds in millions) Long-term notes payable 53,000 b $8,000 d $20,000 a 2.10 c 1.00 e 0.67 disclosures Common stock 20,000 b 1.50 d 0.95 Financial Long-Term Liabilities Measured at Amortized Cost P6 ployee wages of $350,000 at period-end This oversight P1 £ millions 4.625% (US dollar 500 million) bond due July 2018 Nominal (par) Value Carrying Value Fair Value £337 £375 £367 a What is the par value of the 4.625% bond issuance? What is its book (carrying) value? b Was the 4.625% bond sold at a discount or a premium? Explain A(B, C) Quick Study assignments are short exercises that often focus on one learning objective Most are155,000 included in Connect There are Retained earnings Dividends at least 20,000 10–15 Quick Study assignments per Trucking fees earned 130,000 Superscript Depreciation letter A(B, C) denotes assignments based 3C) expense—Trucks chapter on Appendix 3A (3B, 23,500 Icon denotes Salaries assignments expense that involve decision making 61,000 Office supplies expense Totals DiscussionRepairs Questions expense—Trucks 8,000 12,000 $410,000 $410,000 requires adjustment before annual financial statements can be What is the difference between the cash basis and the acQS 10-20 prepared What would be the effect on the income statement if crual basis of accounting? International liabilities this asset account were not adjusted? (Number not required, Whyand is the accrual basis of accounting generally predisclosures but comment on over- or understating of net income.) ferred over the cash basis? interpretations Exercise 3-8 Following are Nintendo’s revenue and expense accounts for a recent11 calendar year the (yen in millions) Review balance sheet of Google What type of business is most likely to select a fiscal year Price Contract Rate (coupon) Maturity Date Market Rate (YTM) closing entries PrepareP1thethat company’s closing its revenues and its of expenses in Appendix A Identify the amountPreparing for GOOGLE corresponds to itsentries naturalfor business year instead the property and equipment What adjusting calendar year? P4 entry is necessary 111.67 4.625% 15-Jul-2018 1.710% and the Accounting System Chapter Financial Statements 87 (no numbers required) for this account when preparing What is a prepaid expense and where is it reported in the financial statements? Net sales ¥571,726 financial statements? Cost of sales adjusting entries to .record 12.408,506Refer to Samsung’s balance sheet b Of the six companies, which business relies most heavily on creditor financing? What type of assets requires in Appendix A If it made an adjust- Samsung 70,264 depreciation? Advertising expense c Of the six companies, which business relies most heavily on equity financing? ment for unpaid wages at year-end, where would the acOther expense, net when recording and re 156,786 What contra account is used d Which two companies indicate the greatest risk? crued wages be reported on its balance sheet? porting the effects of depreciation? Why is it used? 13 What are the steps in recording closing entries? e Which two companies earn the highest return on assets? Assume Samsung has unearned wiL3300x_ch10_442-487.indd 475 one company would investors likely prefer based on the risk-return relation? 8:30 PM f Which revenue What is 12/28/15 unearned revenue Samsung 14 What accounts are affected by closing entries? What acare notWilson affected? and where isinitthe reported in financial statements? Use the information adjusted trial balance reported in Exercise 3-7counts to prepare Trucking Exercise 3-9 15 What two purposes are accomplished recording Preparing abyclassified Company’s classified balancerevenue? sheet as Give of December 31, 2016 What is an accrued an example 90 Chapter Financial Statements and the Accounting System closing entries? balance sheet 9.A If a company initially records prepaid expenses with debits Summary account? to expense accounts, what type of account is debited in the 16 What is the purpose of the Income C3 Karla Tanner opens a web consulting business called Linkworks and completes the following transactions PROBLEM SET A 17 Explain whether an error has occurred if a post-closing adjusting entries for those prepaid expenses? Required Check Total assets, in its first month of operations trial balance includes a Depreciation Expense account 10 Review the balance sheet of Apple in $249,500 Check (1) Trial balance Prepare a trial balance for this business as of the end of May Problem 2-1A Appendix A Identify one asset account that APPLE 18 What tasks are aided by a work sheet? April totals, Tanner invests $80,000 cash along with office equipment valued at $26,000 in the company $66,900 Preparing and posting in exchange for common Analysis stock Components journal entries; preparing The company prepaid $9,000 cash for months’ rentbalances for office Debit Analyze thetwelve accounts and their andspace prepare(Hint: a listthe that describes each of the seven most likely Exercise 3-10 Use following information a trial balanceto compute profit margin for each separate company a through e Prepaid Rent for $9,000.) Refer to the information in QS 10-19 for Vodafone Group Plc The following price quotes (from Yahoo! Finance Bond Center) relate to its bonds payable The price quote indicates that the 4.625% bonds have a market price of 111.67 (111.67% of par value), resulting in a yield to maturity of 1.710% Exercises are one of this book’s many strengths and a competitive advantage There are at least 10–15 per chapter, and most are included in Connect Problem Sets A & B are proven problems that can be assigned as homework or for in-class projects All problems are coded according to the CAP model (see the “Innovative TextComputing and Net Sales interpreting profit margin book Features” section), and Set A is $1,458,800 435,500 included in Connect A1 transactions and their amounts IncomeC3 Net Net Income The company made credit purchases for $8,000 in office equipment and $3,600 inNet office C4 Sales A1 P1 P2 Prepare a report of cash received and cash paid showing how the seven transactions in part yield the (3) Cash paid, supplies Payment is due within 10 days a $ 4,361 $ 44,500 d $65,646 $37,641 ending Cash balance The company completed services for a client and immediately received $4,000 cash b 97,706 398,800 e 80,132 The company completed a $6,000 project for a client, who must pay within 30 days c 111,281 257,000 wiL3300x_ch03_098-163.indd 137 13 The company paid $11,600 cash to settle the account payable created on April WhichDebit of the fivetransactions companies isinthe most profitable according to the profit margin ratio? Interpret that Services opensinsurance for business and (Hint: completes these September 19 PROBLEM The companySET paid $2,400 cash for Management the premium on a 12-month policy B Humble company’s profit margin ratio Prepaid Insurance for $2,400.) Sept Henry Humble, the owner, invested $38,000 cash along with office equipment valued at 22Problem The company partial payment for the work completed on April 2-1B received $4,400 cash as $15,000 in the company in exchange for common stock 25Preparing The company completed work for another client for $2,890 on credit and posting The company prepaid $9,000 cash for 12 months’ rent for office space (Hint: Debit Prepaid 28journal The company paid $5,500 cash in dividends entries; preparing Rent for $9,000.) 29a trial Thebalance company purchased $600 of additional office supplies on credit The company made credit purchases for $8,000 in office equipment and $2,400 in office sup30 The company paid $435 cash for this month’s utility bill plies Payment is due within 10 days C3 C4 A1 P1 P2 The company completed work for a client and immediately received $3,280 cash Required wiL3300x_ch03_098-163.indd 145 who must pay within 30 days 12 The company completed a $15,400 project for a client, Prepare general journal entries to record13 these transactions (use $10,400 account titles listed in the partpayable 2) The company paid cash to settle created on September Check (2) Ending balances: Open the following ledger accounts—their numbers are$1,900 in parentheses (use the balance 19 account The company paid cash for the premium on ancol18-month insurance policy (Hint: Debit umn format): Cash (101); Accounts Receivable (106);Insurance Office Supplies (124); Prepaid Insurance (128); Cash, $59,465; Accounts Prepaid for $1,900.) Receivable, $4,490; Accounts Prepaid Rent (131); Office Equipment Accountsreceived Payable (201); Common (307); 22 (163); The company $7,700 cash as partialStock payment for the work completed on September 12 Payable, $600 Dividends (319); Services Revenue (403); Expense (690) Postfor journal entries part on 24 and TheUtilities company completed work another clientfrom for $2,100 credit to the ledger accounts and enter the balance after each posting 28 The company paid $5,300 cash in dividends (3) Total debits, credit Prepare a trial balance as of April 30 29 The company purchased $550 of additional office supplies on $119,490 30 The company paid $860 cash for this month’s utility bill $16,359 11/26/15 9:05 AM 11/26/15 9:05 AM “I like the layout of the text and the readability The illustrations and comics in the book make the Problem Aracel Engineering following transactions in the month text completed seem theless intimidating andof June boring for students The2-2A PowerPoint slides are easy to understand and Required a Jenna Aracel, the owner, invested $100,000 cash, office equipment with a value of $5,000, and Prepare general journal entriesfor to record these transactions (use account titles listed in part 2) $60,000 of drafting equipment to launch the company in exchange common stock use, the pictorials are great, and the text has great coverage of accounting material The addition of $49,000 Open the following accounts—their numbers are in parentheses (use the balance colb The company purchased land worth for an officeledger by paying $6,300 cashaccount and signing a longumn format): Cash (101); Accounts Receivable (106); Office Supplies (128); C3 (124); C4 Prepaid A1 P1 Insurance P2 term note payable for $42,700 Prepaid Rentthe (131);updates Office Equipment (163); Accounts Payablestories (201); Common (307); I like that the Decision Insights IFRSpurchased information to the the opening areStock great c The company a portable buildingand with $55,000 cash and moved it onto land acquired in b Dividends (319); Services Revenue (401); and Utilities Expense (690) Post journal entries from d The company paid $3,000 cash for the premium an 18-month part to theon ledger accounts insurance and enter policy the balance after each posting are completed aboutandbusinesses the can relate to.” e The company delivered a set of plans for astudents client collected $6,200 cash Prepare a trial balance as of and the end of September Check (2) Ending balances: Cash, $21,520; Accounts Receivable, $9,800; Accounts Payable, $550 Preparing and posting journal entries; preparing a trial balance (3) Total debits, $74,330 f The company purchased $20,000 of additional drafting equipment by paying $9,500 cash and signing a long-term note payable for $10,500 2-2B beginningservices of April, Grechus launched custom computer solutions company called g The Problem company completed $14,000Atofthe engineering forBernadette a client This amount is to be areceived h i j k l m Softworks The company had the following transactions during April in 30Preparing days and posting journal entries; preparing Bernadette Grechus invested $65,000 cash, office equipment with a value of $5,750, and $30,000 of The company purchased $1,150 ofa.additional office equipment on credit a trial balance computer equipment in the company in exchange for common stock The company completed engineering services for $22,000 on credit C3 C4 A1 P1 P2 b The company purchased land worth $22,000 for an office by paying $5,000 cash and signing a longThe company received a bill for rent of equipment that was used on a recently completed job The term note payable for $17,000 $1,333 rent cost must be paid within 30 days c The company purchased a portable building with $34,500 cash and moved it onto the land acquired The company collected $7,000 cash in partial payment from the client described in transaction g in b The company paid $1,200 cash for wages to a drafting assistant d The company paid $5,000 cash for the premium on a two-year insurance policy The company paid $1,150 cash to settle the account payable created in transaction h —JEANNIE LIU, Chaffey College ix www.freebookslides.com 61 Chapter 2  Financial Statements and the Accounting System Step 1: Identify transactions and source documents EXHIBIT 2.9 Step 2: Analyze transactions using the accounting equation Services Contract Client Billing Note Payable Purchase Ticket Bank Statement Deposit 30,000 Assets Debit for increases Credit for es decreas h Cas Assets s Liabilitie Debit for es decreas 2 Debit for es Credit for increases decreas = Liab ilities + Credit for increases Steps in Processing Transactions Equity Equity TOTAL Step 3: Record journal entry Step 4: Post entry to ledger General Journal Dec Cash 30,000 Common Stock 30,000 Dec Supplies Cash 2,500 l General Journa Ledger 2,500 To record entries in a general journal, apply these steps; refer to the entries in Exhibit 2.10 when reviewing these steps a Date the transaction: Enter the year at the top of the first column and the month and day on the first line of each journal entry b Enter titles of accounts debited and then enter amounts in the Debit column on the same line Account titles are taken from the chart of accounts and are aligned with the left margin of the Account Titles and Explanation column c Enter titles of accounts credited and then enter amounts in the Credit column on the same line Account titles are from the chart of accounts and are indented from the left margin of the Account Titles and Explanation column to distinguish them from debited accounts d Enter a brief explanation of the transaction on the line below the entry (it often references a source document) This explanation is indented about half as far as the credited account titles to avoid confusing it with accounts, and it is italicized A blank line is left between each journal entry for clarity When a transaction is first recorded, the posting reference (PR) column is left blank (in a manual system) Later, when posting entries to the ledger, the identification numbers of the individual ledger accounts are entered in the PR column EXHIBIT 2.10 General Journal Entry File Edit Go To Window Help Partial General Journal for FastForward General Journal Date a Dec Account Titles and Explanation PR Debit Credit 2016 Dec b Point: There are no exact rules for writing journal entry explanations An explanation should be short yet describe why an entry is made 30,000 Cash Common Stock Receive investment by owner Supplies Cash Purchase supplies for cash c 30,000 d 2,500 2,500 www.freebookslides.com 62 Chapter 2  Financial Statements and the Accounting System IFRS IFRS requires that companies report the following four basic financial statements with explanatory notes: •  Balance sheet •  Income statement •  Statement of changes in equity (or statement of recognized revenue and expense) •  Statement of cash flows IFRS does not prescribe specific formats, and comparative information is required for the preceding period only ■ Balance Column Account  T-accounts are simple and direct means to show how the a­ ccounting process works However, actual accounting systems need more structure and therefore use balance column accounts, such as that in Exhibit 2.11 EXHIBIT 2.11 Cash Account in Balance Column Format Date Point: Computerized systems often provide a code beside a balance such as dr or cr to identify its balance Posting is automatic and immediate with accounting software Point: A journal is often referred to as the book of ­original entry The ledger is ­referred to as the book of final entry ­because financial statements are prepared from it Account No 101 Credit Balance 2016 Dec Dec Dec Dec Point: Explanations are typically included in ledger accounts only for unusual transactions or events Explanation General Ledger Cash PR Debit 10 G1 G1 G1 G1 30,000 2,500 26,000 4,200 30,000 27,500 1,500 5,700 The balance column account format is similar to a T-account in having columns for debits and credits It is different in including transaction date and explanation columns It also has a column with the balance of the account after each entry is recorded To illustrate, FastForward’s Cash account in Exhibit 2.11 is debited on December for the $30,000 owner investment, yielding a $30,000 debit balance The account is credited on December for $2,500, yielding a $27,500 debit balance On December 3, it is credited again, this time for $26,000, and its debit balance is reduced to $1,500 The Cash account is debited for $4,200 on December 10, and its debit balance increases to $5,700; and so on The heading of the Balance column does not show whether it is a debit or credit balance Instead, an account is assumed to have a normal balance Unusual events can sometimes temporarily give an account an abnormal balance An abnormal balance refers to a balance on the side where decreases are recorded For example, a customer might mistakenly overpay a bill This gives that customer’s account receivable an abnormal (credit) balance An abnormal balance is often identified by highlighting it, setting it in brackets, or entering it in red or some other unusual color A zero balance for an account is usually shown by writing zeros or a dash in the Balance column to avoid confusion between a zero balance and one omitted in error Posting Journal Entries  Step of processing transactions is to post journal entries to ledger accounts (see Exhibit 2.9) All entries must be posted to the ledger before financial statements are prepared to ensure that account balances are up to date When entries are posted to the ledger, the debits in journal entries are transferred into ledger accounts as debits, and credits are transferred into ledger accounts as credits Exhibit 2.12 shows the four parts to the process of posting a journal entry First, the ledger account that is debited in the entry is identified; then, in the ledger, the entry date, the journal and page from the journal, the debit amount, and the new balance of the ledger account are entered (The letter G shows it came from the General Journal.) Second, the ledger account number is entered in the PR column of the journal The process repeats for credit entries and amounts Analyzing Transactions—An Illustration A1 Analyze the impact of transactions on accounts and financial statements We return to the activities of FastForward to show how double-entry accounting is useful in analyzing and processing transactions Analysis of each transaction follows the four steps of Exhibit 2.9 Step 1  Identify the transaction and any source documents Step 2  Analyze the transaction using the accounting equation Step 3  Record the transaction in journal entry form applying double-entry accounting Step 4  Post the entry (for simplicity, we use T-accounts to represent ledger accounts) www.freebookslides.com 63 Chapter 2  Financial Statements and the Accounting System EXHIBIT 2.12 Process of Posting an Entry to the Ledger General Journal Entry General Journal Date Account Titles and Explanation PR Debit 101 307 30,000 Credit 2016 Dec Cash Common Stock Receive investment by owner 30,000 General Ledger Cash Date 2016 Dec Explanation PR Debit G1 30,000 Credit Account no 101 Balance 30,000 Common Stock Date 2016 Dec Key: Explanation PR Debit G1 Credit Account no 307 Balance 30,000 30,000 Point: The fundamental ­concepts of a manual (penciland-paper) system are identical to those of a computerized ­information system Identify debit account in Ledger: enter date, journal page, amount, and balance Enter the debit account number from the Ledger in the PR column of the journal Identify credit account in Ledger: enter date, journal page, amount, and balance Enter the credit account number from the Ledger in the PR column of the journal Study each transaction thoroughly before proceeding to the next The first 11 transactions are from Chapter 1, and we analyze five additional December transactions of FastForward (numbered 12 through 16) that were omitted earlier 1.  Receive Investment by Owner Identify  FastForward receives $30,000 cash from Chas Taylor in exchange for common stock Analyze Cash Common Stock +30,000 = 0 +30,000 Record Date Account Titles and Explanation PR Debit Credit FAST Forward Post = Liabilities + Equity Assets Cash 101 (1) 30,000 Common Stock 307 (1) 30,000 (1) Cash 101 30,000   Common Stock 307 30,000 2.  Purchase Supplies for Cash Identify FastForward pays $2,500 cash for supplies Analyze Assets Cash Supplies −2,500 +2,500 Account Titles and Explanation (2) Supplies   Cash Supplies 126 (2) 2,500 = 0 + 0 Changes the composition of assets but not the total Date Record Post = Liabilities + Equity PR Debit 126 2,500 101 Credit 2,500 Point: In this chapter’s Comprehensive Need-ToKnow we show how to use “balance column accounts” for the ledger Cash 101 (1) 30,000 (2) 2,500 www.freebookslides.com 64 Chapter 2  Financial Statements and the Accounting System 3.  Purchase Equipment for Cash Identify FastForward pays $26,000 cash for equipment Analyze = Liabilities + Equity Assets Post Cash Equipment −26,000 +26,000 = 0 + 0 Changes the composition of assets but not the total Date Account Titles and Explanation PR Record (3) Equipment   Cash Debit Equipment 167 (3) 26,000 Cash 101 (1) 30,000 (2) 2,500 (3) 26,000 Credit 167 26,000 101 26,000 4.  Purchase Supplies on Credit Post Identify FastForward purchases $7,100 of supplies on ­credit from a supplier Analyze Supplies Accounts Payable +7,100 = +7,100 + 0 Date (2) 2,500 (4) 7,100 = Liabilities + Equity Assets Account Titles and Explanation PR Record (4) Supplies   Accounts Payable Debit Supplies 126 Credit Accounts Payable 201 (4) 7,100 126 7,100 201 7,100 5.  Provide Services for Cash Post Identify FastForward provides consulting services and immediately collects $4,200 cash Analyze Assets Date (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 = Liabilities + Equity Cash Consulting Revenue +4,200 = 0 +4,200 Account Titles and Explanation PR Record (5) Cash   Consulting Revenue Debit 101 4,200 403 Cash 101 Credit Consulting Revenue 403 (5) 4,200 4,200 6.  Payment of Expense in Cash Identify FastForward pays $1,000 cash for December rent Analyze Assets = Liabilities + Equity Cash Rent Expense −1,000 = 0 −1,000 Date Account Titles and Explanation PR Record (6) Rent Expense   Cash Debit 640 1,000 101 Post Rent Expense 640 (6) 1,000 Credit Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (6) 1,000 1,000 7.  Payment of Expense in Cash Identify FastForward pays $700 cash for employee salary Point: Salary usually refers to compensation for an employee who receives a fixed amount for a given time period, whereas wages usually refers to compensation based on time worked Analyze Assets = Liabilities + Equity Cash Salaries Expense −700 = 0 −700 Date Record Account Titles and Explanation (7) Salaries Expense   Cash PR Debit 622 700 101  Credit 700 Post Salaries Expense 622 (7) 700 Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (6) 1,000 (7) 700 www.freebookslides.com 65 Chapter 2  Financial Statements and the Accounting System 8.  Provide Consulting and Rental Services on Credit Identify FastForward provides consulting services of $1,600 and rents its test facilities for $300 The customer is billed $1,900 for these services Analyze Assets Accounts Receivable 106 (8) 1,900 = Liabilities + Equity Accounts Consulting Rental Receivable Revenue Revenue +1,900 = 0 +1,600 +300 Date Post Account Titles and Explanation Record PR (8) Accounts Receivable   Consulting Revenue   Rental Revenue Debit Consulting Revenue 403 (5) 4,200 (8) 1,600 Credit 106 1,900 403 406 1,600 300 Rental Revenue 406 (8) 300 Point: The revenue recognition principle requires revenue to be recognized when the company provides products and services to a customer This is not necessarily the same time that the customer pays A customer can pay before or after products or services are provided Point: Transaction is a compound journal entry, which affects three or more accounts 9.  Receipt of Cash on Account Identify FastForward receives $1,900 cash from the client billed in transaction Analyze Record Assets Post (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 = Liabilities + Equity Accounts Cash Receivable +1,900 −1,900 = 0 + 0 Date (9) Account Titles and Explanation PR Debit Cash 101 1,900   Accounts Receivable 106 Credit Cash 101 (9) 1,900 (6) (7) 1,900 1,000 700 Accounts Receivable 106 (8) 1,900 (9) 1,900 10.  Partial Payment of Accounts Payable Post Identify FastForward pays CalTech Supply $900 cash ­toward the payable of transaction Analyze Assets = Liabilities + Equity Cash Accounts Payable −900 = −900 + 0 Date Account Titles and Explanation Record (10) Accounts Payable   Cash PR Debit 201 900 101  Credit 900 Accounts Payable (10) 900 (4) 201 7,100 Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (7) 700 (10) 900 11.  Payment of Cash Dividend Post Identify  FastForward pays $200 cash for dividends Analyze Assets Cash Dividends −200 = 0 −200 Date Record = Liabilities + Equity Account Titles and Explanation (11) Dividends   Cash PR Debit 319 200 101 Credit 200 Dividends 319 (11) 200 Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (7) 700 (10) 900 (11) 200 Point: Dividends always decrease equity www.freebookslides.com 66 Chapter 2  Financial Statements and the Accounting System 12.  Receipt of Cash for Future Services Identify FastForward receives $3,000 cash in advance of providing consulting services to a customer Point: “Unearned” accounts are liabilities that must be ­fulfilled Analyze Assets Unearned Cash Consulting Revenue +3,000 = +3,000 + 0 Date Account Titles and Explanation PR Debit Credit Record (12) Cash 101 3,000   Unearned Consulting      Revenue 236  3,000 Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900 (11) 200 = Liabilities + Equity Accepting $3,000 cash obligates FastForward to perform future services and is a liability No ­revenue is earned until services are provided Point: Luca Pacioli, a 15th-­ century monk, is considered a pioneer in accounting and the first to devise double-entry ­accounting Post Unearned Consulting Revenue 236 (12) 3,000 13.  Pay Cash for Future Insurance Coverage Identify  FastForward pays $2,400 cash (insurance premium) for a 24-month insurance policy Coverage begins on December Analyze Assets Prepaid Cash Insurance −2,400 +2,400 = 0 + 0 Date Prepaid Insurance 128 (13) 2,400 = Liabilities + Equity Changes the composition of assets from cash to prepaid insurance Expense is incurred as insurance coverage expires Record Post Account Titles and Explanation (13) Prepaid Insurance   Cash PR Debit 128 2,400 101 Credit 2,400 Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900 (11) 200 (13) 2,400 14.  Purchase Supplies for Cash Post Identify FastForward pays $120 cash for supplies Analyze Cash Supplies −120 +120 Date Record Assets = Liabilities + Equity = 0 + 0 Account Titles and Explanation (14) Supplies   Cash PR Debit 126 120 101 Credit 120 Supplies 126 (2) 2,500 (4) 7,100 (14) 120 Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900 (11) 200 (13) 2,400 (14) 120 www.freebookslides.com 67 Chapter 2  Financial Statements and the Accounting System 15.  Payment of Expense in Cash Post Identify FastForward pays $305 cash for December utilities expense Analyze Assets Date Account Titles and Explanation Record (15) Utilities Expense   Cash PR Debit 690 101 690 (15) 305 = Liabilities + Equity Utilities Cash Expense −305 = 0 −305 Utilities Expense Point: Expenses always ­decrease equity Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900 (11) 200 (13) 2,400 (14) 120 (15) 305 Credit 305 305 16.  Payment of Expense in Cash Identify  FastForward pays $700 cash in employee salary for work performed in the latter part of December Analyze Assets = Liabilities + Equity Cash −700 = 0 Date Record Account Titles and Explanation (16) Salaries Expense   Cash PR 622 101 Accounting Equation Analysis Salaries Expense −700 Debit Credit 700 700 Post Salaries Expense 622 (7) 700 (16) 700 Point: We could merge transactions 15 and 16 into one compound entry Cash 101 (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900 (11) 200 (13) 2,400 (14) 120 (15) 305 (16) 700 Point: Technology does not Exhibit 2.13 shows the ledger accounts (in T-account form) of FastForward after all 16 transac- provide the judgment required tions are recorded and posted and the balances computed The accounts are grouped into three to analyze most business transmajor columns corresponding to the accounting equation: assets, liabilities, and equity Note actions Analysis requires the expertise of skilled and ethical several important points First, as with each transaction, the totals for the three columns professionals must obey the accounting equation Specifically, assets equal $42,395 ($4,275 + $0 + Debit and Credit Rules $9,720 + $2,400 + $26,000); liabilities equal $9,200 ($6,200 + $3,000); and equity equals $33,195 ($30,000 − $200 + $5,800 + $300 − $1,400 − $1,000 − $305) These Increase Accounts (normal bal.) Decrease numbers prove the accounting equation: Assets of $42,395 = Liabilities of $9,200 + Asset Debit Credit Equity of $33,195 Second, the common stock, dividends, revenue, and expense ac- Liability Credit Debit counts reflect the transactions that change equity These account categories underlie the Common  Stock Credit Debit statement of retained earnings Third, the revenue and expense account balances will be Dividends Debit Credit summarized and reported in the income statement Fourth, increases and decreases in Revenue Credit Debit Expense Debit Credit the Cash account make up the elements reported in the statement of cash flows www.freebookslides.com 68 Chapter 2  Financial Statements and the Accounting System EXHIBIT 2.13 FAST Forward Ledger for FastForward (in T-Account Form) General Ledger Assets = Liabilities + Equity Cash 101 (1) 30,000 (2) (5) 4,200 (3) (9) 1,900 (6) (12) 3,000 (7) (10) (11) (13) (14) (15) (16) Balance 4,275 (10) 900 (4) Balance (8) Balance 2,500 26,000 1,000 700 900 200 2,400 120 305 700 Accounts Receivable 106 1,900 (9) 1,900 Accounts Payable 201 7,100 6,200 Unearned Consulting Revenue 236 (12) (2) 2,500 (4) 7,100 (14) 120 Balance 9,720 (13) Prepaid Insurance Common Stock (1) 307 30,000 Dividends 319 (11) 200 3,000 Supplies 126 Consulting Revenue 403 (5) (8) Balance 4,200 1,600 5,800 Rental Revenue 406 (8) 300 622 Salaries Expense (7) 700 (16) 700 Balance 1,400 Rent Expense (6) 1,000 640 128 2,400 Utilities Expense (15) 690 305 Equipment 167 (3) Accounts in this white area reflect those reported on the income statement 26,000 $42,395 = $9,200 + NEED-TO-KNOW 2-3 Recording Transactions P1  A1 $33,195 Assume Tata Company began operations on January and completed the following transactions during its first month of operations For each transaction, (a) analyze the transaction using the accounting equation, (b) record the transaction in journal entry form, and (c) post the entry using T-accounts to represent ledger accounts Tata Company has the following (partial) chart of accounts—account numbers in parentheses: Cash (101); Accounts Receivable (106); Equipment (167); Accounts Payable (201); Common Stock (307); Dividends (319); Services Revenue (403); and Wages Expense (601) Jan Jamsetji Tata invested $4,000 cash in the Tata Company in exchange for common stock   Tata Company purchased $2,000 of equipment on credit 14 Tata Company provided $540 of services for a client on credit www.freebookslides.com 69 Chapter 2  Financial Statements and the Accounting System Solution Jan 1  Receive Investment by Owner a Analyze = Liabilities + Equity Assets Cash Common Stock +4,000 = 0 +4,000 Date b Record Account Titles and Explanation Jan 1 Cash PR Debit 101 4,000 307   Common Stock Credit c Post Cash 101 Jan 1 4,000 Common Stock 4,000 307 Jan 1 4,000 Jan 5  Purchase Equipment on Credit a Analyze c Post Assets = Liabilities + Equity Equipment Accounts Payable +2,000 = +2,000 + 0 Date Account Titles and Explanation b Record Jan 5 Equipment   Accounts Payable PR Debit Credit Equipment 167 2,000 Jan 167 2,000 201 2,000 Accounts Payable 201 Jan 2,000 Jan 14  Provide Services on Credit a Analyze Assets = Liabilities + Equity Accounts Services Receivable Revenue +540 = 0 +540 Date Account Titles and Explanation b Record Jan.14 Accounts Receivable   Services Revenue PR 106 403 Debit Credit 540 540 c Post Accounts Receivable 106 Jan 14 540 Services Revenue Jan 14 403 540 Do More: QS 2-6, E 2-7, E 2-9, E 2-11, E 2-12 TRIAL BALANCE Double-entry accounting requires the sum of debit account balances to equal the sum of credit account balances A trial balance is used to confirm this A trial balance is a list of ledger accounts and their balances (either debit or credit) at a point in time Exhibit 2.14 shows the trial balance for FastForward after its 16 entries have been posted to the ledger (This is an unadjusted trial balance—Chapter explains the necessary adjustments.) P2 Prepare and explain the use of a trial balance Preparing a Trial Balance Preparing a trial balance involves three steps: List each account title and its amount (from ledger) in the trial balance If an account has a zero balance, list it with a zero in its normal balance column (or omit it entirely) Compute the total of debit balances and the total of credit balances Verify (prove) total debit balances equal total credit balances The total of debit balances equals the total of credit balances for the trial balance in ­Exhibit 2.14 Equality of these two totals does not guarantee that no errors were made For ­example, the column totals will be equal when a debit or credit of a correct amount is made to a Point: A trial balance is not a financial statement but a mechanism for checking equality of debits and credits in the ledger Financial statements not have debit and credit columns www.freebookslides.com 70 Chapter 2  Financial Statements and the Accounting System EXHIBIT 2.14 Trial Balance (Unadjusted) FASTFORWARD Trial Balance December 31, 2016 FAST Forward Credit Debit Cash $ 4,275 Accounts receivable 9,720 Supplies 2,400 Prepaid insurance 26,000 Equipment $ Accounts payable 30,000 Common stock Dividends 200 5,800 Consulting revenue 300 Rental revenue Point: The ordering of accounts in a trial balance follows their identification number from the chart of accounts: asset, liability, equity, revenue, and expense accounts Point: IRS requires ­companies to keep records that can be audited Salaries expense 1,400 Rent expense 1,000 Utilities expense Totals 6,200 3,000 Unearned consulting revenue 305 $ 45,300 $ 45,300 wrong account Another error not identified with a trial balance is when equal debits and credits of an incorrect amount are entered Searching for and Correcting Errors  If the trial balance does not balance (when its Example: If a credit to Unearned Revenue was incorrectly posted from the journal as a credit to the Revenue ledger account, would the ledger still balance? Would the financial statements be correct? Answers: The ledger would balance, but liabilities would be understated, equity would be overstated, and income would be overstated (all because of overstated revenues) c­ olumns are not equal), the error(s) must be found and corrected An efficient way to search for an error is to check the journalizing, posting, and trial balance preparation in reverse order Step is to verify that the trial balance columns are correctly added If step fails to find the error, step 2 is to verify that account balances are accurately entered from the ledger Step is to see whether a debit (or credit) balance is mistakenly listed in the trial balance as a credit (or debit) A clue to this error is when the difference between total debits and total credits equals twice the amount of the incorrect account balance If the error is still undiscovered, step is to recompute each account balance in the ledger Step is to verify that each journal entry is properly posted Step is to verify that the original journal entry has equal debits and credits At this point, the errors should be uncovered.3 Using a Trial Balance to Prepare Financial Statements P3 Prepare financial statements from business transactions This section shows how to prepare financial statements from the trial balance Financial Statements and Time  How financial statements are linked in time is illustrated in Exhibit 2.15 A balance sheet reports on an organization’s financial position at a point in Transposition occurs when two digits are switched, or transposed, within a number If transposition is the only error, it yields a difference between the two trial balance totals that is evenly divisible by For example, assume that a $691 debit in an entry is incorrectly posted to the ledger as $619 Total credits in the trial balance are then larger than total debits by $72 ($691 − $619) The $72 error is evenly divisible by (72/9 = 8) The first digit of the quotient (in our example it is 8) equals the difference between the digits of the two transposed numbers (the and the 1) The number of digits in the quotient also tells the location of the transposition, starting from the right The quotient in our example had only one digit (8), so it tells us the transposition is in the first digit Consider another example where a transposition error involves posting $961 instead of the correct $691 The difference in these numbers is $270, and its quotient is 30 (270/9) The quotient has two digits, so it tells us to check the second digit from the right for a transposition of two numbers that have a difference of www.freebookslides.com 71 Chapter 2  Financial Statements and the Accounting System time The income statement, statement Income of retained earnings, and statement of statement cash flows report on financial performance over a period of time The three statements in the middle column of Statement Exhibit 2.15 link balance sheets from of retained the beginning to the end of a reporting earnings Beginning Ending period They explain how financial posibalance balance sheet sheet tion changes from one point to another Preparers and users (including regulaStatement tory agencies) determine the length of the of cash flows reporting period A one-year, or annual, reporting period is common, as are semiannual, quarterly, and monthly periods The one-year reporting period is known as the accounting, or fiscal, year Businesses whose accounting year begins on January and ends on ­December 31 are known as calendar-year companies Point in time Point in time Period of time Google is a calendar-year company Many companies choose a fiscal year ending on a date other than December 31 Apple is a noncalendar-year company as reflected in the headings of its September 27, 2014, year-end ­financial statements in Appendix A near the end of the book Income Statement* For period Ended date Net sales (revenues) Cost of goods sold (cost of sales) Gross margin (gross profit) Operating expenses Examples: Depreciation, salaries, wages, rent, utilities, interest, amortization, advertising, taxes Total operating expenses Nonoperating gains and losses Net income (net profit or earnings) $ $ # # # EXHIBIT 2.15 Links between Financial Statements across Time # # # $ # # # * A typical chart of accounts is at the end of the book and classifies all accounts by financial statement categories Statement of retained earnings For period Ended date Retained earnings, beginning Add: Net income Less: Dividends Retained earnings, ending Balance Sheet Date ASSETS Current assets Examples: cash, cash equivalents, short-term investments, accounts receivable, current portion of notes $ receivable, inventory, prepaid expenses Total current assets Long-term investments Examples: investment in stock, investment in bonds, Land for expansion Total long-term investments Plant assets Examples: equipment, machinery, buildings, land Total plant assets, net of depreciation Intangible assets Examples: patent, trademark, copyright, license, goodwill Total intangible assets, net of amortization Total assets LIABILITIES AND EQUITY Current liabilities Examples: accounts payable, wages payable, salaries $ payable, current notes payable, taxes payable, interest payable, unearned revenues Total current liabilities Long-term liabilities Examples: notes payable, bonds payable, lease liability Total long-term liabilities Total liabilities Equity* Common stock Retained earnings Total liabilities and equity # # $ # # # $ $ # # # # # Balance Sheet Date * For a corporation, statement of owner’s equity becomes statement of retained earnings with these changes: “owner, capital” is retained earnings; “investments by owner” is deleted; and “withdrawals by owner” is dividends # # # # $ # # # # # $ # # # # $ # # # ASSETS Current assets Examples: cash, cash equivalents, short-term investments, accounts receivable, current portion of notes $ receivable, inventory, prepaid expenses Total current assets Long-term investments Examples: investment in stock, investment in bonds, Land for expansion Total long-term investments Plant assets Examples: equipment, machinery, buildings, land Total plant assets, net of depreciation Intangible assets Examples: patent, trademark, copyright, license, goodwill Total intangible assets, net of amortization Total assets LIABILITIES AND EQUITY Current liabilities Examples: accounts payable, wages payable, salaries $ payable, current notes payable, taxes payable, interest payable, unearned revenues Total current liabilities Long-term liabilities Examples: notes payable, bonds payable, lease liability Total long-term liabilities Total liabilities Equity* Common stock Retained earnings Total liabilities and equity # # $ # $ # # $ # # # # # # # # # # # # # $ # # # Statement of Cash Flows For period Ended date Cash flows from operating activities [Prepared using the indirect (see below)† or direct method] Net cash provided (used) by operating activities Cash flows from investing activities [List of individual investing inflows and outflows] Net cash provided (used) by investing activities Cash flows from financing activities [List of individual financing inflows and outflows] Net cash provided (used) by financing activities Net increase (decrease) in cash Cash (and equivalents) balance at beginning of period Cash (and equivalents) balance at end of period $ # # $ $ # # # # Attach separate schedule or note disclosure of “Noncash investing and financing transactions.” Point: A statement’s heading lists the W’s: Who—name of organization, What—name of statement, When—statement’s point in time or period of time Financial Statements from Trial Balance  The FastForward financial statements differ from those in Chapter because of several additional transactions These statements are also more precisely called unadjusted statements because we need to make some further accounting adjustments (described in Chapter 3) Income Statement  An income statement reports the revenues earned less the expenses in- curred by a business over a period of time FastForward’s income statement for December is shown at the top of Exhibit 2.16 Information about revenues and expenses is taken from the trial balance in Exhibit 2.14 Net income of $3,395 is reported at the bottom of the statement Owner investments and dividends are not part of income Statement of Retained Earnings  The statement of retained earnings conveys how re- Point: An income statement is also called an earnings statement, a statement of operations, or a P&L (profit and loss) statement A balance sheet is also called a statement of financial position tained earnings change over the reporting period FastForward’s statement of retained earnings is the second report in Exhibit 2.16 It shows the $3,395 of net income, the $200 dividend, and the $3,195 end-of-period balance (The beginning balance in the statement of retained earnings is rarely zero; an exception is for the first period of operations The beginning balance in January 2017 is $3,195, which is December 2016’s ending balance.) Point: While revenues ­increase equity, and expenses decrease equity, the amounts are not reported in detail in the statement of retained earnings Instead, their effects are ­reflected through net income Balance Sheet  The balance sheet shows the financial position of a company at a point in time, usually at the end of a month, quarter, or year FastForward’s balance sheet is the third report in Exhibit 2.16 This statement refers to financial condition at the close of business on December 31 The left side of the balance sheet lists its assets: cash, supplies, prepaid insurance, and equipment The upper right side of the balance sheet shows that it owes $6,200 to creditors and $3,000 in services to customers who paid in advance The equity section shows an ending balance of $33,195 Notice the link between the ending balance of the statement of retained earnings and the retained earnings balance (Recall that this presentation of the balance sheet is called the account form: ­assets on the left and liabilities and equity on the right Another presentation is the report form: assets on top, followed by liabilities and then equity Either presentation is acceptable.) Point: Knowing how financial statements are prepared improves our analysis of them Decision Maker Entrepreneur  You open a wholesale business selling entertainment equipment to retail outlets You find that most of your customers demand to buy on credit How can you use the balance sheets of customers to decide which ones to extend credit to? ■  [Answers follow the chapter’s Summary.] www.freebookslides.com 72 Chapter 2  Financial Statements and the Accounting System EXHIBIT 2.16 Financial Statements Prepared from Trial Balance FASTFORWARD Trial Balance December 31, 2016 Debit Credit Cash $ 4,275 Accounts receivable Supplies 9,720 Prepaid insurance 2,400 Equipment 26,000 Accounts payable $ 6,200 Unearned consulting revenue 3,000 Common stock 30,000 Dividends 200 Consulting revenue 5,800 Rental revenue 300 Salaries expense 1,400 Rent expense 1,000 Utilities expense 305 Totals $45,300 $45,300 Each account on the trial balance is either an asset (to balance sheet), liability (to balance sheet), or equity (to income statement or to statement of retained earnings) Point: Arrow lines show how the statements are linked FASTFORWARD Income Statement For Month Ended December 31, 2016 Revenues    Consulting revenue ($4,200 + $1,600) $5,800   Rental revenue 300   Total revenues $  6,100 Expenses   Salaries expense 1,400   Rent expense 1,000   Utilities expense 305   Total expenses 2,705 Net income $ 3,395 FASTFORWARD Statement of Retained Earnings For Month Ended December 31, 2016 Retained earnings, December 1, 2016 $     0 Plus:  Net income 3,395 3,395 Less:   Cash dividends 200 Retained earnings, December 31, 2016 $ 3,195 FASTFORWARD Balance Sheet December 31, 2016 Assets Liabilities Cash $  4,275 Accounts payable $  6,200 Supplies 9,720 Unearned consult revenue 3,000 Prepaid insurance 2,400 Total liabilities 9,200 Equipment 26,000 Equity Common stock 30,000 Retained earnings 3,195 Total equity 33,195 Total assets $42,395 Total liabilities and equity $42,395 Point: To foot a column of numbers is to add them Presentation Issues  Dollar signs are not used in journals and ledgers They appear in Point: The terms “Debit” and “Credit” not appear on financial statements financial statements and other reports such as trial balances The usual practice is to put dollar signs beside only the first and last numbers in a column Apple’s financial statements in Appendix A show this When amounts are entered in a journal, ledger, or trial balance, commas are optional to indicate thousands, millions, and so forth However, commas are always used in financial statements Companies also commonly round amounts in reports to the nearest dollar, or even to a higher level Apple is typical of many companies in that it rounds its financial statement amounts to the nearest million This decision is based on the perceived impact of rounding for users’ business decisions Reading and Using an Annual Report  An annual report is required of more than 10,000 corporations in the United States that trade their stock publicly This requirement is www.freebookslides.com 73 Chapter 2  Financial Statements and the Accounting System imposed by the SEC Another nearly million corporations in the United States not trade their shares publicly and are called private or closely held corporations, which are not subject to SEC oversight Appendix A, near the end of this book, shows key excerpts from the annual report of Apple This appendix also reproduces financial statements from the annual reports of Google and Samsung The key excerpts are identified and explained on page A-1 We review and use the annual report for many business decisions, especially for valuing corporate stock and assessing a company’s ability to pay off its debts Prepare a trial balance for Apple using the following condensed data from its fiscal year ended September 27, 2014 ($ in millions) NEED-TO-KNOW 2-4 Preparing Trial Balance Common stock $ 23,313 Dividends $ 11,215 Accounts payable 30,196 Securities investments and other assets 179,911 Other liabilities 90,096 Land and equipment (net) 20,624 Cost of sales (and other expenses) 126,231 Selling and other expense 17,054 Cash 13,844 Accounts receivable 17,460 Revenues 182,795 Retained earnings 59,939 P2 APPLE Solution  ($ in millions) APPLE Trial Balance September 27, 2014 Debit Credit Cash Accounts receivable Land and equipment (net) Securities investments and other assets Accounts payable Other liabilities Common stock Retained earnings Dividends Revenues Cost of sales and other expenses Selling and other expense Totals $ 13,844 17,460 20,624 179,911 $ 30,196 90,096 23,313 59,939 11,215 182,795 126,231 17,054 $386,339 $386,339 GLOBAL VIEW Financial accounting according to U.S GAAP is similar, but not identical, to IFRS This section discusses differences in analyzing and recording transactions, and with the preparation of financial statements Analyzing and Recording Transactions  Both U.S GAAP and IFRS include broad and similar guidance for financial accounting Further, both U.S GAAP and IFRS apply transaction analysis and recording as shown in this chapter—using the same debit and credit system and accrual Do More: E 2-8, E 2-10 www.freebookslides.com 74 Chapter 2  Financial Statements and the Accounting System a­ ccounting Although some variations exist in revenue and expense recognition and other accounting principles, all of the transactions in this chapter are accounted for identically under these two ­systems PIAGGIO Financial Statements  Both U.S GAAP and IFRS prepare the same four basic financial statements A few differences within each statement exist and we will discuss those throughout the book For example, both U.S GAAP and IFRS require balance sheets to separate current items from noncurrent items However, while U.S GAAP balance sheets report current items first, IFRS balance sheets normally (but are not required to) present noncurrent items first, and equity before liabilities To illustrate, a condensed version of Piaggio’s balance sheet follows Piaggio is an Italian manufacturer of scooters and compact vehicles PIAGGIO Balance Sheet (in thousands of euros) December 31, 2014 Assets Noncurrent assets €1,079,117 Current assets 477,491 Total assets €1,556,608 Equity and Liabilities Total equity Noncurrent liabilities Current liabilities Total equity and liabilities € 413,069 581,366 562,173 €1,556,608 Accounting Controls and Assurance  Accounting systems depend on control procedures that assure proper principles were applied The passage of SOX legislation strengthened U.S controls However, global standards for controls are diverse and so are enforcement activities Consequently, while global accounting standards are converging, their application in different countries can yield different outcomes depending on the quality of their auditing standards and enforcement Fraud Data Quality Recording valid and accurate transactions enhances the quality of financial statements The graph here shows the percentage of employees in information technology who report observing specific types of misconduct and the increased risk of such misconduct in recent years (Source: KPMG 2013) Percent Citing Misconduct 40% 30% 20% 10% 0% Breaching database controls Years: Gabriela Hasbrun/Redux Pictures Mishandling private information 2013 Falsifying accounting data 2009 Sustainability and Accounting  Twitter, as introduced in this chapter’s opening feature, is committed to connecting people interested in sustainability and saving the earth Twitter co-founder Biz Stone insists that, “to be judged successful, a company needs to make money, make the world a better place and bring joy to the people who work there.” Twitter has made the world a better place by providing a space for people with similar interests in sustainability to connect with one another Sustainability gatherings like cleaning up the park and planting trees are organized on Twitter The Twitter website has also become a source of news for individuals interested in sustainability For example, when a new U.S law was in-process that requires companies to report their use of minerals from conflict regions in the Congo, the director of corporate responsibility at AMD, Tim Mohin, learned about it through Twitter In addition to believing the earth deserves respect, Twitter believes in treating employees with respect Glassdoor ranked Twitter as one of best places to work Glassdoor chief executive Robert Hohman ­explains, “What people say [at Twitter] is that their work has a global impact.” Biz Stone responded by asserting that, “If you don’t set the bar high, you’re never going to get there.” www.freebookslides.com 75 Chapter 2  Financial Statements and the Accounting System Decision Analysis Debt Ratio A2 An important business objective is gathering information to help assess a company’s risk of failing to pay its debts Companies finance their assets with either liabilities or equity A company that finances a relatively larger portion of its assets with liabilities is said to have higher financial leverage Higher financial leverage involves greater risk because liabilities must be repaid and often require regular interest payments (equity financing does not) One measure to assess the risk associated with liabilities is the debt ratio, seen in Exhibit 2.17 Debt ratio = Compute the debt ratio and describe its use in analyzing financial condition EXHIBIT 2.17 Total liabilities Total assets Debt Ratio Point: Compare the equity amount to the liability amount to assess the extent of owner versus nonowner financing To apply the debt ratio, let’s look at Skechers’s liabilities and assets Skechers designs, markets, and sells footwear for men, women, and children Exhibit 2.18 reports its debt ratio at each year-end from 2010 to 2014 $ in millions 2014 Total liabilities $  541 Total assets $1,675 Debt ratio 0.32 Industry debt ratio 0.49 2013 2012 2011 2010 $  429 $1,409 0.30 0.47 $  421 $1,340 0.31 0.46 $  389 $1,282 0.30 0.47 $  359 $1,305 0.28 0.49 EXHIBIT 2.18 Computation and Analysis of Debt Ratio Ratio Millions Skechers’s debt ratio ranges from a low of 0.28 to a high of 0.32—also, see graph in margin Its ratio is lower than the industry norm, suggesting a lower than average risk from financial leverage So, is financial leverage good or bad for Skechers? The answer: If Skechers is making more money with this debt than it is paying the lenders, then it is successfully borrowing money to make more money A company’s use of debt can quickly turn unprofitable if its return from that money drops below the rate it is paying lenders Decision Maker Investor  You consider buying stock in Converse As part of your analysis, you compute its debt ratio for 2013, 2014, and 2015 as: 0.35, 0.74, and 0.94, respectively Based on the debt ratio, is Converse a low-risk investment? Has the risk of buying Converse stock changed over this period? (The industry debt ratio averages 0.40.) ■  [Answers follow the chapter’s Summary.] (This problem extends the Comprehensive Need-To-Know of Chapter 1.) After several months of planning, Jasmine Worthy started a haircutting business called Expressions The following events occurred during its first month a On August 1, Worthy invested $3,000 cash and $15,000 of equipment in Expressions in exchange for common stock On August 2, Expressions paid $600 cash for furniture for the shop On August 3, Expressions paid $500 cash to rent space in a strip mall for August On August 4, it purchased $1,200 of equipment on credit for the shop (using a long-term note payable) On August 5, Expressions opened for business Cash received from haircutting services in the first week and a half of business (ended August 15) was $825 f On August 15, it provided $100 of haircutting services on account g On August 17, it received a $100 check for services previously rendered on account h On August 17, it paid $125 to an assistant for hours worked during the grand opening i Cash received from services provided during the second half of August was $930 b c d e $1800 $1600 $1400 $1200 $1000 $800 $600 45% $400 30% $200 15% $0 0.0% 2014 Skechers: 2013 Liabilities($) 2012 2011 Assets($) 2010 Debt ratio(%) NEED-TO-KNOW 2-5 COMPREHENSIVE ... (in Thousands) Decision Insight 11 5 11 4 11 3 11 2 11 1 11 0 19 18 17 16 15 14 13 12 11 21 22 $14 ,300 DSEFX DSEFX S&P 500 $12 ,400 S&P 500 2009 2 010 2 011 2 012 2 013 2 014 Decision Analysis (a section... 2 016 , unadjusted trial balance of Business Solutions (reflecting its transactions for October and November of 2 016 ) follows No Account Title Debit 10 1 10 6 12 6 12 8 13 1 16 3 16 4 16 7 16 8 2 01 210 ... 6 ,10 0 −   1, 700 (11 ) -   200 - $200 _ _ _ _ _ _ Bal $ 4,800 + $    0 NEED-TO-KNOW 1- 4 Transaction Analysis P1 Do More: QS 1- 10, QS 1- 11, E 1- 10, E 1- 11,