Financial and Managerial. Accounting. Charles T. Horngren Stanford University. Walter T. Harrison Jr. Baylor University. M.

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1 Financial and Managerial Accounting SECOND EDITION Charles T. Horngren Stanford University Walter T. Harrison Jr. Baylor University M. Suzanne Oliver Northwest Florida State College Pearson Education International

Contents J» Accounting and the Business Environment 1 Accounting Vocabulary: The Language of Business 2 Decision Makers: The Users of Accounting Information 2 Individuals 2 Businesses 2 Investors 3

2 Contents J» Accounting and the Business Environment 1 Accounting Vocabulary: The Language of Business 2 Decision Makers: The Users of Accounting Information 2 Individuals 2 Businesses 2 Investors 3 Creditors 3 Taxing Authorities 3 Financial Accounting and Management Accounting 3 The Accounting Profession and the Organizations that Govern it 3 Governing Organizations 4 Ethics in Accounting and Business 5 Standards of Professional Conduct 5 Types of Business Organizations 5 Four Types of Business Organizations 5 Distinguishing Characteristics and Organization of a Corporation 7 Separate Legal Entity 7 Continuous Life and Transferability of Ownership 7 No Mutual Agency 8 Limited Liability of Stockholders 8 Separation of Ownership and Management 8 Corporate Taxation 8 Government Regulation 8 Organization of a Corporation 9 Accounting Concepts and Principles 9 The Entity Concept 10 The Reliability (Objectivity) Principle 10 The Cost Principle 10 The Going-Concern Concept 10 The Stable Monetary Unit Concept 11 The Accounting Equation 11 Assets and Liabilities 11 Owners' Equity 12 Accounting for Business Transactions 13 Transactions Analysis for Smart Touch Learning 14 Preparing the Financial Statements the User Perspective of Accounting 18 The Financial Statements 20 Headings 20 Using Financial Statements to Evaluate Business Performance 23 Relationships Among the Financial Statements 23 Decision Guidelines 25 Summary Problem 26 Review and Assignment Material 28 Chapter 1 Demo Doc: Transaction Analysis Using Accounting Equation/Financial Statement Preparation 54 MAP! fc.h ям Recording Business Transactions 63 The Account, the Journal, and the Ledger 64 Assets 64 Liabilities 65 Stockholders' Equity 66 Chart of Accounts 66 Debits, Credits, and Double-Entry Accounting 68 The T-Account 68 Increases and Decreases in the Accounts 69 List the Steps of the Transaction Recording Process 70 Posting (Copying Information) from the Journal to the Ledger 71 Expanding the Rules of Debit and Credit: Revenues and Expenses 72 The Normal Balance of An Account 73 Source Documents The Origin of the Steps 74 Journalizing Transactions and Posting to the Ledger 74 Practice Journalizing with Specific Examples 74 The Ledger Accounts After Posting 80 Preparing the Trial Balance from the T-Accounts 81 Correcting Trial Balance Errors 82 Details of Journals and Ledgers 83 The Four-Column Account: An Alternative to the T-Account 84 Decision Guidelines 85 Summary Problem 86 Review and Assignment Material 90 Chapter 2 Demo Doc: Debit/Credit Transaction Analysis 123 О The Adjusting Process 133 Accrual Accounting Versus Cash-Basis Accounting 134 Other Accounting Principles 135 The Accounting Period 135 The Revenue Principle 136 The Matching Principle 137 The Time-Period Concept 137 Why We Adjust the Accounts 138 Two Categories of Adjusting Entries 139 Prepaid Expenses 139 Depreciation 142 Accrued Expenses 144 Accrued Revenues 146 Unearned Revenues 146 Summary of the Adjusting Process 149 The Adjusted Trial Balance 152 The Financial Statements 153 Preparing the Statements 153 Relationships Among the Financial Statements 153

vi Contents Ethical Issues in Accrual Accounting 155 Decision Guidelines 156 Summary Problem 157 Review and Assignment Material 162 APPENDIX ЗА: Alternative Treatment of Prepaid Expenses and Unearned

3 vi Contents Ethical Issues in Accrual Accounting 155 Decision Guidelines 156 Summary Problem 157 Review and Assignment Material 162 APPENDIX ЗА: Alternative Treatment of Prepaid Expenses and Unearned Revenues 190 Chapter 3 Demo Doc: Preparation of Adjusting Entries, Adjusted Trial Balance, and Financial Statements 194 Completing the Accounting Cycle 206 The Work Sheet 207 Net Income 210 Net Loss 210 Summary Problem Completing the Accounting Cycle 213 Preparing the Financial Statements from a Worksheet 213 Recording the Adjusting Entries from a Worksheet 213 Closing the Accounts 216 Closing Temporary Accounts 217 Postclosing Trial Balance 219 Classifying Assets and Liabilities 219 Assets 220 Liabilities 220 The Classified Balance Sheet 221 Balance Sheet Forms 221 Accounting Ratios 222 Current Ratio 223 Debt Ratio 223 Decision Guidelines 224 Summary Problem Review and Assignment Material 229 APPENDIX 4A: Reversing Entries: An Optional Step 256 COMPREHENSIVE PROBLEM FOR S 1-4: Journalizing, Posting, Work Sheet, Adjusting, Closing the Financial Statements 260 * Chapter 4 Demo Doc: Accounting Work Sheets and Closing Entries 262 w Merchandising Operations 270 What Are Merchandising Operations? 272 The Operating Cycle of a Merchandising Business 272 Inventory Systems: Perpetual and Periodic 273 Perpetual Inventory Systems 273 Accounting for Inventory in the Perpetual System 274 Purchase of Inventory 274 Sale of Inventory 279 Summary Problem Adjusting and Closing the Accounts of a Merchandiser 286 Adjusting Inventory Based on a Physical Count 286 Closing the Accounts of a Merchandiser 287 Preparing a Merchandiser's Financial Statements 288 Income Statement Formats: Multi-Step and Single-Step 290 Two Ratios for Decision Making 290 The Gross Profit Percentage 290 The Rate of Inventory Turnover 291 Decision Guidelines 292 Summary Problem Review and Assignment Material 297 APPENDIX 5A: Work Sheet for a Merchandising Business 319 APPENDIX 5B: Accounting for Merchandise in a Periodic Inventory System 323 COMPREHENSIVE PROBLEM FOR S 1-5: Completing a Merchandiser's Accounting Cycle 329 CI Merchandise Inventory 331 Accounting Principles and Inventories 332 Inventory Costing Methods 333 Inventory Accounting in a Perpetual System 336 First-In, First-Out (FIFO) Method 336 Last-In, First-Out (LIFO) Method 338 Average Cost Method 340 Comparing FIFO, LIFO, and Average Cost 341 Summary Problem Lower-of-Cost-or-Market Rule 346 Effects of Inventory Errors 347 Estimating Ending Inventory 348 Ethical Issues 349 Decision Guidelines 350 Summary Problem Review and Assignment Material 352 APPENDIX 6A: Accounting for Inventory in a Periodic System Internal Control and Cash 378 Internal Control 379 The Sarbanes-Oxley Act (SOX) 380 The Components of Internal Control 380 Internal Control Procedures 381

Contents vii Internal Controls for E-Commerce 384 The Limitations of Internal Control Costs and Benefits 385 The Bank Account as a Control Device 386 The Bank Reconciliation 388 Preparing the Bank

4 Contents vii Internal Controls for E-Commerce 384 The Limitations of Internal Control Costs and Benefits 385 The Bank Account as a Control Device 386 The Bank Reconciliation 388 Preparing the Bank Reconciliation 389 Online Banking 392 Summary Problem Internal Control over Cash Receipts 396 Internal Control over Cash Payments 397 Controls over Payment by Check 397 Controlling Small Cash Payments 399 The Petty Cash Fund 399 Ethics and Accounting 402 Corporate and Professional Codes of Ethics 402 Ethical Issues in Accounting 403 Decision Guidelines 404 Summary Problem Review and Assignment Material 406 :^::.:-;:!y Receivables 429 Receivables: An Introduction 430 Types of Receivables 430 Internal Control over Collection of Receivables 431 Decision Guidelines 432 Accounting for Uncollectibles (Bad Debts) 433 The Allowance Method 433 Estimating Uncollectibles 434 Identifying and Writing Off Uncollectible Accounts 437 Recovery of Accounts Previously Written Off Allowance Method 437 The Direct Write-Off Method 439 Recovery of Accounts Previously Written Off Direct Write-Off Method 439 Reporting Receivables on the Balance Sheet 440 Credit-Card, Bankcard, and Debit-Card Sales 441 Credit-Card Sales 441 Bankcard Sales 442 Debit-Card Sales 442 Summary Problem Notes Receivable 445 Identifying Maturity Date 445 Computing Interest on a Note 446 Accruing Interest Revenue 447 Dishonored Notes Receivable 449 Computers and Receivables 450 Using Accounting Information for Decision Making 450 Acid-Test (or Quick) Ratio 451 Days' Sales in Receivables 451 Decision Guidelines 453 Summary Problem Review and Assignment Material 455 APPENDIX 8A: Discounting a Note Receivable Plant Assets and Intangibles 480 Measuring the Cost of a Plant Asset 482 Land and Land Improvements 482 Buildings 484 Machinery and Equipment 484 Furniture and Fixtures 484 A Lump-Sum (Basket) Purchase of Assets 484 Capital Expenditures 486 Depreciation 487 Causes of Depreciation 487 Measuring Depreciation 487 Depreciation Methods 488 Comparing Depreciation Methods 491 Other Issues in Accounting for Plant Assets 493 Summary Problem Disposing of a Plant Asset 497 Situation A - Scrap the Track 499 Accounting for Natural Resources 502 Accounting for Intangible Assets 502 Specific Intangibles 503 Accounting for Research and Development Costs 505 Ethical Issues 505 Decision Guidelines 506 Summary Problem Review and Assignment Material 508 i Current Liabilities, Payroll, and Long-Term Liabilities 524 Current Liabilities of Known Amount 525 Accounts Payable 525 Short-Term Notes Payable 526 Sales Tax Payable 526 Current Portion of Long-Term Notes Payable 527 Accrued Expenses (Accrued Liabilities) 527 Unearned Revenues 528 Current Liabilities that must be Estimated Estimated Warranty Payable 528 Contingent Liabilities 529 Decision Guidelines 531 Summary Problem Accounting for Payroll 533 Gross Pay and Net (Take-Home) Pay 533 Payroll Withholding Deductions 534 Employer Payroll Taxes

viii Contents Journalizing Payroll Transactions 537 Internal Control over Payroll 538 Decision Guidelines 539 Summary Problem 2 540 Bonds: An Introduction 542 Types of Bonds 542 Bond Prices 542

5 viii Contents Journalizing Payroll Transactions 537 Internal Control over Payroll 538 Decision Guidelines 539 Summary Problem Bonds: An Introduction 542 Types of Bonds 542 Bond Prices 542 Present Value 544 Bond Interest Rates 544 Accounting for Bonds Payable - Straight Line Method 545 Issuing Bonds Payable at Maturity (Par) Value 545 Issuing Bonds Payable at a Discount 546 Decision Guidelines 548 Issuing Bonds Payable at a Premium 549 Adjusting Entries for Bonds Payable 550 Issuing Bonds Payable Between Interest Dates 551 Reporting Liabilities on the Balance Sheet 552 Issuing Bonds Versus Stock 552 Ethical Issues in Reporting Liabilities 553 Decision Guidelines 554 Summary Problem Review and Assignment Material 556 APPENDIX 10A: The Time Value of Money: Present Value of a Bond and Effective-Interest Amortization 576 APPENDIX 10B: Retiring and Converting Bonds Payable 589 COMPREHENSIVE PROBLEM FOR S 7-10: Comparing Two Businesses Corporations: Paid-in Capital and the Balance Sheet 595 Corporations: An Overview 596 Capital Stock 596 Stockholders' Equity Basics 597 Stockholders' Rights 598 Classes of Stock 598 Issuing Stock 599 Issuing Common Stock 600 Issuing Preferred Stock 603 Ethical Considerations 603 Review of Accounting for Paid-in Capital 604 Decision Guidelines 605 Summary Problem Retained Earnings 608 Accounting for Cash Dividends 609 Dividend Dates 609 Declaring and Paying Dividends 610 Dividing Dividends Between Preferred and Common 611 Dividends on Cumulative and Noncumulative Preferred 611 Different Values of Stock 612 Market Value 612 Liquidation Value 613 Book Value 613 Evaluating Operations 614 Rate of Return on Total Assets 614 Rate of Return on Common Stockholders' Equity 615 Accounting for Income Taxes by Corporations 616 Decision Guidelines 617 Summary Problem Review and Assignment Material 620 Corporations: Effects on Retained Earnings and the Income Statement 641 Stock Dividends 642 Stock Splits 645 Stock Dividends and Stock Splits Compared 647 Treasury Stock 647 Treasury Stock Basics 647 Purchase of Treasury Stock 648 Sale of Treasury Stock 648 Retirement of Stock 650 Restrictions on Retained Earnings 650 Variations in Reporting Stockholders' Equity 651 Decision Guidelines 652 Summary Problem The Corporate Income Statement 656 Continuing Operations 656 Special Items 657 Earnings per Share 658 Statement of Retained Earnings 659 Combined Statement of Income and Retained Earnings 660 Prior-Period Adjustments 660 Reporting Comprehensive Income 661 Decision Guidelines 662 Summary Problem Review and Assignment Material 665 The Statement of Cash Flows 681 Introduction: The Statement of Cash Flows Cash Equivalents Operating, Investing, and Financing Activities 683 Two Formats for Operating Activities 684

Contents ix Preparing the Statement of Cash Flows by the Indirect Method 684 Cash Flows from Operating Activities 686 Cash Flows from Investing Activities 689 Cash Flows from Financing Activities 691

6 Contents ix Preparing the Statement of Cash Flows by the Indirect Method 684 Cash Flows from Operating Activities 686 Cash Flows from Investing Activities 689 Cash Flows from Financing Activities 691 Net Change in Cash and Cash Balances 693 Noncash Investing and Financing Activities 694 Measuring Cash Adequacy: Free Cash Flow 696 Decision Guidelines 697 *- Summary Problem 698 Review and Assignment Material 701 APPENDIX 13A: PreparingThe Statement Of Cash Rows By The Direct Method 721 APPENDIX 13B: Preparing the Indirect Statement of Cash Flows Using a Spreadsheet 739 Financial Statement Analysis 745 Horizontal Analysis 746 Illustration: Smart Touch Learning, Inc. 747 Horizontal Analysis of the Income Statement 748 Horizontal Analysis of the Balance Sheet 748 Trend Percentages 748 Vertical Analysis 749 How Do We Compare One Company with Another? 751 Benchmarking 752 Benchmarking Against a Key Competitor 752 Benchmarking Against the Industry Average 752 ^ Summary Problem Using Ratios to Make Decisions 755 Measuring Ability to Pay Current Liabilities 755 Measuring Ability to Sell Inventory and Collect Receivables 757 Measuring Ability to Pay Long-Term Debt 759 Measuring Profitability 760 Analyzing Stock Investments 762 Red Flags in Financial Statement Analysis 764 Decision Guidelines 765 Summary Problem Review and Assignment Material 769 COMPREHENSIVE PROBLEM FOR S 13 AND 14; Analyzing a Company for its Inventment Potential Introduction to Management Accounting 791 Management Accountability 792 Today's Business Environment 794 Service Companies 795 Merchandising Companies 796 Summary Problem Manufacturing Companies 801 Types of Costs 801 Ethical Standards 807 Decision Guidelines 809 Summary Problem Review and Assignment Material 812 о Job Order and Process Costing 831 How Much Does it Cost to Make a Product? Two Approaches 832 Job Order Costing 832 Process Costing 832 How Job Costs Flow Through the Accounts: An Overview 833 Decision Guidelines 839 Summary Problem Job Order Costing: Allocating Manufacturing Overhead 842 Accounting for Completion and Sale of Finished Goods and Adjusting Manufacturing Overhead 845 Accounting for the Completion and Sale of Finished Goods 846 Job Order Costing in a Service Company 848 Decision Guidelines 851» Summary Problem Review and Assignment Material 855 APPENDIX 16A: Process Costing-Weighted-Average Method 877 Activity-Based Costing and Other Cost Management Tools 901 Refining Cost Systems 902 Sharpening the Focus: Assigning Costs Based on the Activities That Caused the Costs 902 Developing an Activity-Based Costing System 904 Traditional Versus Activity-Based Costing Systems: Smart Touch Learning 905 Activity-Based Management: Using ABC for Decision Making 907 Pricing and Product Mix Decisions 908 Cutting Costs 909 Decision Guidelines 912 Summary Problem Just-In-Time (JIT) Systems 915 Just-in-Time Costing 916 JIT Costing Illustrated: Smart Touch Learning 917

x Contents Continuous Improvement and the Management of Quality 919 The Four Types of Quality Costs 920 Deciding Whether to Adopt a New Quality Program 921 Decision Guidelines 922 Summary Problem 2

7 x Contents Continuous Improvement and the Management of Quality 919 The Four Types of Quality Costs 920 Deciding Whether to Adopt a New Quality Program 921 Decision Guidelines 922 Summary Problem Review and Assignment Material 924 lj», af ink Cost-Volume-Profit Analysis 947 Cost Behavior 948 Variable Costs 948 Fixed Costs 949 Mixed Costs 950 High-Low Method to Separate Fixed Cost from Variable Costs 951 Relevant Range 952 Basic CVP Analysis: What Must We Sell To Break Even? 953 Assumptions 953 How Much Must Greg Sell to Break Even? Three Approaches 954 Using CVP To Plan Profits 957 How Much Must Greg's Sell to Earn a Profit? 957 Graphing Cost-Volume-Profit Relations 958 Summary Problem i 960 Using CVP For Sensitivity Analysis 962 Changing the Selling Price 962 Changing Variable Costs 962 Changing Fixed Costs 963 Margin of Safety 964 Information Technology and Sensitivity Analysis 964 Effect of Sales Mix on CVP Analysis 965 Decision Guidelines 967 Summary Problem Review and Assignment Material 971 APPENDIX ISA: Variable Costing and Absorption Costing 986 J Short-Term Business Decisions 994 How Managers Make Decisions 995 Relevant Information 995 Relevant Nonfinancial Information 997 Keys to Making Short-Term Special Decisions Special Sales Order and Regular Pricing Decisions 998 When to Accept a Special Sales Order 998 How to Set Regular Prices 1001 Decision Guidelines Summary Problem When to Drop Products, Departments, or Territories 1009 Dropping Products Under Various Assumptions 1010 Product Mix: Which Product to Emphasize? 1012 Outsourcing and Sell as is or Process Further Decisions 1014 When to Outsource 1014 Sell As Is or Process Further? 1018 Decision Guidelines 1020 Summary Problem Review and Assignment Material 1023 Щ 111 ИД BE Capital investment Decisions and the Time Value of Money 1042 Capital Budgeting 1043 Four Popular Methods of Capital Budgeting Analysis 1043 Focus on Cash Flows 1043 Capital Budgeting Process 1044 Using Payback and Accounting Rate of Return to Make Capital Investment Decisions 1045 Payback Period 1045 Accounting Rate of Return (ARR) 1048 Decision Guidelines 1051 Summary Problem A Review of the Time Value of Money 1053 Factors Affecting the Time Value of Money 1053 Future Values and Present Values: Points Along the Time Line 1054 Future Value and Present Factors 1055 Calculating Future Values of Single Sums and Annuities Using FV Factors 1055 Calculating Present Values of Single Sums and Annuities Using PV Factors 1056 Using Discounted Cash Flow Models to Make Capital Budgeting Decisions 1058 Net Present Value (NPV) 1058 Internal Rate of Return (IRR) 1063 Comparing Capital Budgeting Methods 1066 Decision Guidelines 1068 Summary Problem Review and Assignment Material 1070 The Master Budget and Responsibility Accounting 1083 Why Managers Use Budgets 1084 Using Budgets to Plan and Control 1085 Benefits of Budgeting 1086

Contents xi Understanding the Components of the Master Budget 1087 Components of the Master Budget 1088 Data for Greg's Groovy Tunes 1089 Preparing the Operating Budget 1091 The Sales Budget 1091 The

8 Contents xi Understanding the Components of the Master Budget 1087 Components of the Master Budget 1088 Data for Greg's Groovy Tunes 1089 Preparing the Operating Budget 1091 The Sales Budget 1091 The Inventory, Purchases, and Cost of Goods Sold Budget 1091 The Operating Expenses Budget 1092 The Budgeted Income Statement 1093 Summary Problem Preparing the Financial Budget 1096 Preparing the Cash Budget 1096 The Budgeted Balance Sheet 1099 The Budgeted Statement of Cash Flows 1100 Getting Employees to Accept the Budget 1100 Using Information Technology for Sensitivity Analysis and Rolling Up Unit Budgets 1101 Sensitivity Analysis 1101 Rolling Up Individual Unit Budgets into the Company wide Budget 1102 Responsibility Accounting 1103 Four Types of Responsibility Centers 1103 Responsibility Accounting Performance Reports 1104 Decision Guidelines 1108 Summary Problem Review and Assignment Material Flexible Budgets and Standard Costs 1131 How Managers Use Flexible Budgets 1132 What IsaFlexibleBudget? 1133 Using The Flexible Budget: Why Do Actual Results Differ From The Static Budget? 1134 Decision Guidelines 1137 Summary Problem Standard Costing 1139 Price Standards 1139 Application 1140 Quantity Standards 1140 Why Do Companies Use Standard Costs? 1141 Variance Analysis 1142 How Smart Touch Uses Standard Costing: Analyzing The Flexible Budget Variance 1143 Direct Material Variances 1143 Direct Labor Variances 1146 Manufacturing Overhead Variances 1147 Allocating Overhead in a Standard Cost System 1147 Overhead Flexible Budget Variance 1149 Overhead Production Volume Variance 1149 Summary of Overhead Variances 1150 Standard Cost Accounting Systems 1150 Journal Entries 1150 Standard Cost Income Statement for Management 1152 Decision Guidelines 1154 Summary Problem Review and Assignment Material Performance Evaluation and the Balanced Scorecard 1176 Decentralized Operations 1177 Advantages of Decentralization 1178 Disadvantages of Decentralization 1178 Responsibility Centers 1179 Performance Measurement 1180 Goals of Performance Evaluation Systems 1180 The В alanced Scorecard 1181 The Four Perspectives of the Balanced Scorecard 1182 Decision Guidelines 1187 Summary Problem Measuring the Financial Performance of Cost, Revenue, and Profit Centers 1189 Measuring the Financial Performance of Investment Centers 1191 Return on Investment (ROI) 1193 Residual Income (RI) 1195 Limitations of Financial Performance Measures 1199 Decision Guidelines 1201 Summary Problem Review and Assignment Material 1204 APPENDIX 23A: Allocating Service Department Costs 1216 APPENDIX A: Amazon.com Annual Report APPENDIX B: Present Value Tables APPENDIX C: Check Figures C-l B-l GLINDEX (COMBINED GLOSSARY/INDEX) COMPANY INDEX 1-1 A-l G-l

HORNGREN'S FIFTH EDITION. Tracie Miller-Nobles Austin Community College. Brenda Mattison Tri-County Technical College

HORNGREN'S FIFTH EDITION. Tracie Miller-Nobles Austin Community College. Brenda Mattison Tri-County Technical College HORNGREN'S Financial & Managerial Accounting FIFTH EDITION Tracie Miller-Nobles Austin Community College Brenda Mattison Tri-County Technical College Ella Mae Matsumura University of Wisconsin-Madison