FINANCIAL ACCOUNTING. Jeffrey Waybright. Robert Kemp. Spokane Community College. University of Virginia

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1 FINANCIAL ACCOUNTING Jeffrey Waybright Spokane Community College Robert Kemp University of Virginia Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

2 Chapter 1 Business, Accounting, and You 2 Why Study Accounting? 4 Accounting Teaches the Language of Business 4 Accounting Emphasizes the importance of Ethical Business Behavior 4 An Understanding of Accounting Helps individuals Ensure That the Business Is Profitable 6 What Is Accounting? 6 How Are Businesses Organized? 7 Types of Businesses 7 Choice of Business Organizations 7 What Accounting Principles and Concepts Govern the Field of Accounting? 9 Generally Accepted Accounting Principles 9 The Business Entity Concept 9 The Reliability (Objectivity) Principle 10 The Cost Principle 10 International financial Reporting Standards 10 How Is the Accounting Equation Used to Record Business Transactions? 10 Transaction Analysis 11 Stockholders' Equity 12 What Do Financial Statements Report, and How Are They Prepared? 17 The Income Statement 17 The Statement of Retained Earnings 19 The Valance Sheet 20 The Statement of Cash Flows 20 Relationships Between the Financial Statements 20 Accounting Vocabulary 28 Accounting Practice 30 Apply Your Knowledge 48 Know Your Business 48 Chapter 2 Analyzing and Recording Business Transactions 52 How Are Accounts Used to Keep Business Transactions Organized? 54 Organizing Accounts Assets 54 Liabilities 55 Stockholders' Equity What Are Debits, Credits, and T-Accounts? 56 Normal Balance 57 How Are the General Journal and General Ledger Used to Keep Track of Business Transactions? 58 Transaction Analysis &0 Applying Transaction Analysis 60 Balancing the T-Accounts 67 How Is a Trial Balance Prepared and What Is It Used For? 68 Correcting Errors 70 Preparation of Financial Statements 70 Accounting Vocabulary 83 Accounting Practice 83 Apply Your Knowledge 105 Know Your Business 105 Chapter 3 Adjusting and Closing Entries 108 How Does a Company Accurately Report Its Income? 110 Revenue Recognition and Matching Principles 110 What Is the Role of Adjusting Entries, and When Are They Prepared? 111 Accruing Revenues 113 Accruing Expenses 113 Adjusting Deferred Revenues 114 Adjusting Deferred Expenses 115 How Are Financial Statements Prepared from an Adjusted Trial Balance? 120 The Adjusted Trial Balance 120 Preparing the Financial Statements 121 How Does a Company Prepare for a New Accounting Period? 123 Completing the Accounting Cycle 123 The Three Closing Entries: Revenues, Expenses, and Dividends 124 Post-Closing Trial Balance 126 Summary of the Adjusting and Closing Process 127 Accounting Vocabulary 142 Accounting Practice 143 Apply Your Knowledge 170 Know Your Business 171 Comprehensive Problem 173 IX

3 Chapter 4 Accounting for a Merchandising Business 174 What Is the Relationship Between Wholesalers, Retailers, and Customers? 176 How Do Periodic and Perpetual Inventory Systems Differ? 176 How Do You Account for the Purchase of Inventory? 178 Cash and Credit Purchases 178 Purchase Returns and Allowances 178 Purchase Discounts \79 How Do You Account for the Sale of Inventory? 181 Cash Sales 181 Credit Sales 182 Sales Returns and Allowances 183 Sales Returns 183 Sales Allowances 184 Sales Discounts 185 How Do You Account for Freight Charges and Other Selling Expenses? 185 Costs Related to the Receipt of Goods from Suppliers 187 Costs Related to Delivering Goods to Customers 188 Other Selling Costs 190 How Do You Prepare a Merchandiser's Financial Statements? 190 The Income Statement 190 The Statement of Retained Earnings 192 The Balance Sheet 192 Focus on Decision Making: Ratios 195 The Gross Profit Percentage 195 The Current Ratio 195 Accounting Vocabulary 202 Accounting Practice 203 Apply Your Knowledge 225 Know Your Business 225 Chapter 5 Inventory 228 What Inventory Costing Methods Are Allowed? 230 Cost Flow Versus Physical Flow of Inventory 231 How Are the Four Inventory Costing Methods Applied? 233 inventory Cost Plows 233 Specific-Identification Method 235 First-ln, First-Out (FIFO) Method 235 Last-In, First-Out (LIFO) Method 236 Average Cost Method 238 Journalizing Inventory Transactions 239 What Effect Do the Different Costing Methods Have on Net Income? 239 What Else Determines How Inventory Is Valued? 241 How Is Inventory Reported on the Balance Sheet? 243 Inventory Shrinkage 243 How Do Inventory Errors Affect the Financial Statements? 244 Is It Possible to Estimate the Value of Inventory If the Inventory Is Accidentally Destroyed? 246 Focus on Decision Making: Ratios 248 The Rate of Inventory Turnover 248 Accounting Vocabulary 263 Accounting Practice 263 Apply Your Knowledge 284 Know Your Business 284 Comprehensive Problem 286 Chapter 6 Ethics, Internal Control, and IFRS 288 Why Is Ethics Important in Business and Accounting? What Is Fraud and Who Commits It? 292 Management Fraud 292 Employee Embezzlement 292 What Factors Are Usually Present When Fraud Is Committed? 293 Perceived Pressure 294 Rationalization 294 Perceived Opportunity 295 What Is an Internal Control System? 296 Elements of an Internal Control System 296 Control Environment 296 Risk Assessment 296 Control Activities 297 Information and Communication 298 Monitoring 298 Internal Control limitations 299 Who Is Responsible for Internal Control? 300 Audit Opinions 301 The Sarbanes-Oxley Act 301 What Are International Financial Reporting Standards? 302 Accounting Vocabulary 306 Accounting Practice 307 Apply Your Knowledge 312 Know Your Business

4 XI Chapter 7 Cash and Receivables 318 What Are the Different Types of Sales? 320 Cash Sales 320 Credit Card Sales 320 Debit Card Sales 320 Credit/Debit Card Processing 321 Sales on Account 321 What Internal Control Procedures Should Be Used for Cash? 322 Internal Controls over Cash Receipts 322 Internal Control over Cash Payments 323 The Bank Reconciliation 325 Preparing the Bank Reconciliation 325 Online Banking 331 How Is Cash Reported on the Balance Sheet? 332 How Do You Account for Receivables? 332 Types of Receivables 332 Internal Control over Accounts Receivable 333 Accounting for Uncollectible Accounts Receivable 333 How Do You Account for Bad Debts? 333 The Direct Write-Off Method 333 Direct Write-Off Method: Recovery of Accounts Previously Written Off 334 The Allowance Method 335 Writing Off Uncollectible Accounts Under the Allowance Method 338 / Allowance Method: Recovery of Accounts Previously Written Off 339 How Are Accounts Receivable Reported on the Balance Sheet? 340 How Do You Account for Notes Receivable? 341 Identifying Maturity Date 341 Origination of Motes Receivable 342 Computing Interest on a Note 343 Accruing Interest Revenue 343 Focus on Decision Making: Ratios 344 Quick Ratio 344 Accounts Receivable Turnover 345 Accounting Vocabulary 352 Accounting Practice 353 Apply Your Knowledge 377 Know Your Business 378 Appendix 7A 381 What Is a Petty Cash Fund? 381 Setting Up the Petty Cash Fund 381 Replenishing the Petty Cash Fund 382 Changing the Petty Cash Fund 382 Accounting Practice 383 Chapter 8 Long-Term Assets 386 What Are the Different Types of Long-Term Assets? 388 How Is the Cost of a Plant Asset Calculated? 389 Land and Land Improvements 389 Buildings 390 Machinery and Equipment 390 Furniture and Fixtures 391 Lump-Sum (Basket) Purchase of Assets 391 How Are Plant Assets Depreciated? 393 Measuring Depreciation 394 Depreciation Methods 394 Comparing Depreciation Methods 398 Partial Year Depreciation 399 Changing the Useful Life of a Depreciable Asset 400 Using Fully-Depreciated Assets 401 How Are Costs of Repairing Plant Assets Recorded? 401 Ordinary Repairs 401 Extraordinary Repairs 402 Betterments 402 What Happens When an Asset Is Disposed? 403 How Do You Account for Intangible Assets? 406 Specific Intangibles 406 Accounting for Research and Development Costs 408 How Are Natural Resources Accounted For? 408 What Are the Other Types of Long-Term Assets? 409 How Are Long-Term Assets Recorded on the Balance Sheet? 410 Accounting Vocabulary 418 Accounting Practice 419 Apply Your Knowledge 435 Know Your Business 436 Chapter 9 Current Liabilities and Long-Term Debt 438 What Is the Difference Between Known, Estimated, and Contingent Liabilities? 440 How Do You Account for Current Liabilities of a Known Amount? 440 Accounts Payable 440 Notes Payable 441 Sales Tax Payable 442 Accrued Expenses {Accrued Liabilities) 443 Unearned Revenues 443 Current Portion of long-term Debt 443 How Do You Account for Current Liabilities of an Uncertain Amount? 444 Estimated Warranty Liability 444

5 XII Contents How Do You Account for a Contingent Liability? 446 How Do You Account for Long-Term Debt? 447 Notes Payable 447 Bonds Payable 449 Lease Liabilities 456 How Are Liabilities Reported on the Balance Sheet? 457 Focus on Decision Making: Ratios 458 Accounting Vocabulary 464 Accounting Practice 464 Apply Your Knowledge 482 Know Your Business 483 Appendix 9A available online Chapter 10 Corporations: Paid-in Capital and Retained Earnings 486 How Are Corporations Organized? 488 What Makes Up the Stockholders' Equity of a Corporation? 489 Stockholders' Rights 489 Classes of Stock 490 Par Value, Stated Value, and No-Par Stock 490 How Is the Issuance of Stock Recorded? 491 Issuing Common Stock 491 Issuing Preferred Stock 493 How Are Cash Dividends Accounted For? 493 Dividend Dates 494 Declaring and Paying Dividends 494 Dividing Dividends Between Preferred and Common Shareholders 495 Dividends on Cumulative and Noncumulative Preferred Stock 496 How Are Stock Dividends and Stock Splits Accounted For? 497 Stock Dividends 497 Recording Stock Dividends 498> Stock Splits 499 Stock Dividends and Stock Splits Compared 501 How Is Treasury Stock Accounted For? 502 Treasury Stock Basics 502 Purchase of Treasury Stock 502 Sale of Treasury Stock 503 How Is Stockholders' Equity Reported on the Balance Sheet? 505 Focus on Decision Making: Ratios 506 Rate of Return on Stockholders' Equity 506 Rate of Return on Common Stockholders' Equity 507 Accounting Vocabulary 512 Accounting Practice 512 Apply Your Knowledge 534 Know Your Business 535 Chapter 11 The Statement of Cash Flows 538 What Is the Statement of Cash Flows? 540 What Is the Difference Between Operating, Investing, and Financing Activities? 542 Operating Activities 542 investing Activities 542 Financing Activities 542 Two Formats for Operating Activities 543 How Is the Statement of Cash Flows Prepared Using the Indirect Method? 543 Cash Flows from Operating Activities 546 Cash Flows from Investing Activities 548 Cash Flows from Financing Activities 550 Net Change in Cash and Cash Balances 552 Noncash Investing and Financing Activities 552 How Is the Statement of Cash Flows Prepared Using the Direct Method? 555 Cash Flows from Operating Activities 556 Focus on Decision Making: Free Cash Flow and the Cash Conversion Cycle 560 Free Cash Flow 560 Cash Conversion Cycle 560 Accounting Vocabulary 570 Accounting Practice 570 Apply Your Knowledge 593 Know Your Business 594 Chapter 1 2 Financial Statement Analysis 596 What Is the Difference Between Operating Income and Net Income on the Income Statement? 599 Income from Continuing Operations 599 Discontinued Operations 600 Extraordinary Gains and Losses 600 Cumulative Effect of Changes in Accounting Principles 601 Earnings per Share 601 What Is Horizontal Analysis? 601 Horizontal Analysis of the Income Statement 603 Horizontal Analysis of the Balance Sheet 603 Trend Percentages 604 What Is Vertical Analysis? 605 Vertical Analysis of the Income Statement 606 Vertical Analysis of the Balance Sheet 607 How Do We Compare One Company with Another? 607 Benchmarking 60& What Is Ratio Analysis? 609 Liquidity Ratios 610 Asset Management Ratios 611 Solvency Ratios 613 Profitability Ratios 614

6 XIII Market Analysis Ratios 616 Red Flags in Financial Statement Analysis 617 Accounting Vocabulary 625 Accounting Practice 626 Apply Your Knowledge 648 Know Your Business 649 Comprehensive Problem 651 Appendix A Columbia Sportswear Company 2008 Annual Report to Shareholders 652 Appendix B Time Value of Money Future and Present Value Concepts 711 Future Value 711 Future-Value Tables 712 Future Value of an Annuity 713 Present Value 714 Present-Value Tables 715 Present Value of an Annuity 715 Accounting Vocabulary 717 Accounting Practice 717 Company Index 719 Glindex 724 Credits 740

Third Edition. Global Edition. Robert Kemp University of Virginia. Jeffrey Waybright Spokane Community College

Third Edition. Global Edition. Robert Kemp University of Virginia. Jeffrey Waybright Spokane Community College Financial Äccounting Third Edition Global Edition Robert Kemp University of Virginia Jeffrey Waybright Spokane Community College PEARSON Boston Columbus Indianapolis New York San Francisco Upper Saddle