coun rincipies f&hdfttan 1 ers 1- John Wiley & Sons, Inc. Arthur Andersen Alumni Professor of Accounting University of Wisconsin Madison, Wisconsin

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1 f&hdfttan coun rincipies 1 ers 1- Arthur Andersen Alumni Professor of Accounting University of Wisconsin Madison, Wisconsin KPMG Emeritus Professor of Accountancy Northern Illinois University DeKaib, Illinois Associate Professor of Accounting University of Wisconsin Milwaukee Milwaukee, Wisconsin ICENTEN N I A L 1 8 O 7 S WILEY 2 0 O 7 BICENTE N'N I A L John Wiley & Sons, Inc.

2 1 Accounting in Action 2 2 The Recording Process 46 3 Adjusting the Accounts 90 4 Completing the Accounting Cycle Accounting for Merchandising Operations Inventories Accounting Information Systems Internal Control and Cash N Accounting for Receivables Plant Assets, Natural Resources, and Intangible Assets Current Liabilities and Payroll Accounting Accounting for Partnerships Corporations: Organization and Capital Stock Transactions Corporations: Dividends, Retained Earnings, and Income Reporting Long-Term Liabilities Investments The Statement of Cash Flows Financial Statement Analysis Managerial Accounting Job Order Cost Accounting Process Cost Accounting Cost-Volume-Profit Budgetary Planning Budgetary Control and Responsibility Accounting Standard Costs and Balanced Scorecard 1086 v 26 Incremental Analysis and Capital Budgeting 1132 APPENDIXES / A Specimen Financial Statements: PepsiCo, Inc. A1 B f Specimen Financial Statements: The Coca-Cola Company, Inc. B1 C Present-Value Concepts C1 D Using Financial Calculators D1 E Standards of Ethical Conduct for Management Accountants E1 XXII

3 I Accounting in Action 2 Feature Story: KNOWING THE NUMBERS 2 What Is Accounting? 4 Three Activities 4 Who Uses Accounting Data 6 The Building Blocks of Accounting 7 Ethics in Financial Reporting 8 Generally Accepted Accounting Principles 9 Assumptions 9 The Basic Accounting Equation 11 Assets 12 Liabilities 12 Owner's Equity 1 2 Using the Basic Accounting Equation Transaction Analysis 15 Summary of Transactions Financial Statements 21 Income Statement 21 Owner's Equity Statement Balance Sheet 23 Statement of Cash Flows 14 All About You: ETHICS: MANAGING PERSONAL FINANCIAL REPORTING 25 APPENDIX: Accounting Career Opportunities 29 / Public Accounting 29 Private Accounting 29 Opportunities in Government Forensic Accounting 30 "Show Me the Money" L-4M The Recording Process 46 Feature Story: ACCIDENTS HAPPEN 46 The Account 48,/ Debits and Credits 49 Expansion of the Basic Equation 52 Steps in the Recording Process 53 The Journal 53 The Ledger 56 ji The Recording Process Illustrated 60 Summary Illustration of. Journalizing and Posting 66 ' The Trial Balance.67 Limitations of a Trial Balance 68 Locating Errors 68 Use of Dollar Signs 69 All About You: YOUR PERSONAL ANNUAL REPORT 7 0 Adjusting the Accounts 90 Feature Story: WHAT WAS YOUR PROFIT? 9 0 Timing Issues 92 Selecting an Accounting Time Period Fiscal and Calendar Years 92 Accrual- vs. Cash-Basis Accounting Recognizing Revenues and Expenses 92 The Basics of Adjusting Entries 95 Types of Adjusting Entries 95 Adjusting Entries for Deferrals 96 Adjusting Entries for Accruals 103 Summary of Journalizing and Posting 108 The Adjusted Trial Balance and Financial Statements 110 Preparing the Adjusted Trial Balance 110 Preparing Financial Statements 111 All About You: IS YOUR OLD COMPUTER A LIABILITY? 113 APPENDIX: Alternative Treatment of Prepaid Expenses and Unearned Revenues 115 Prepaid Expenses 116 Unearned Revenues 117 Summary of Additional Adjustment Relationships 118 Completing the Accounting Cycle 140 Feature Story: EVERYONE LIKES TO WIN Using a Worksheet Steps in Preparing a Worksheet 142 Preparing Financial Statements from a Worksheet 146 Preparing Adjusting Entries from a Worksheet 146 Closing the Books 148 Preparing Closing Entries 149 Posting Closing Entries 151 Preparing a Post-Closing Trial Balance 153 Summary of the Accounting Cycle 155 Reversing Entries An Optional Step 156 Correcting Entries An Avoidable Step 156 The Classified Balance Sheet 159 Current Assets 160 Long-Term Investments 161 Property, Plant, and Equipment 162 Intangible Assets 162- Current Liabilities 163 XXIII

4 xxiv Detailed Contents Long-Term Liabilities 164 Owner's Equity 164 All About You: YOUR PERSONAL BALANCE SHEET APPENDIX: Reversing Entries 169 Reversing Entries Example Accounting for Merchandising Operations 192 Feature Story: WHO DOESN'T SHOP AT WAL-MART? 192 Merchandising Operations 194 Operating Cycles 194 Inventory Systems 195 Recording Purchases of Merchandise 197 Freight Costs 198 Purchase Returns and Allowances 198 Purchase Discounts 198 Summary of Purchasing Transactions 200 Recording Sales of Merchandise 201 Sales Returns and Allowances 202 Sales Discounts 203 Completing the Accounting Cycle' 204 Adjusting Entries 204 Closing Entries 204 Summary of Merchandising Entries 206 Forms of Financial Statements 207 Multiple-Step Income Statement 207 Single-Step Income Statement 210 Classified Balance Sheet 211 All About You: WHEN IS A SALE A SALE? 213 Determining Cost of Goods Sold Under a Periodic System 214 APPENDIX 5A: Periodic Inventory System 217 Recording Merchandise Transactions 217 Recording Purchases of Merchandise 218 Recording Sales of Merchandise 219 APPENDIX 5B: Worksheet for a Merchandising Company 220 Using a Worksheet 220 Inventory Errors 257 Income Statement Effects 257 Balance Sheet Effects 258 Statement Presentation and Analysis 259 Presentation 259 Analysis 259 All About You: EMPLOYEE THEFT AN INSIDE JOB 261 APPENDIX 6A: Inventory Cost Flow Methods in Perpetual Inventory Systems 264 First-ln, First-Out (FIFO) 264 Last-In, First-Out (LIFO) 265 Average-Cost 265 APPENDIX 6B: Estimating Inventories 267 Gross Profit Method 268 Retail Inventory Method 269 Accounting Information Systems 290 Feature Story: QUICKBOOKS HELPS THIS RETAILER SELL GUITARS 290 Basic Concepts of Accounting Information Systems 292 Computerized Accounting Systems 292 Choosing a Software Package 293 Entry-Level Software 293 Enterprise Resource Planning Systems 294 Manual Accounting Systems 295 Subsidiary Ledgers 295 Subsidiary Ledger Example 296 Advantages of Subsidiary Ledgers 297 Special Journals 298 Sales Journal 299 Cash Receipts Journal 301 Purchases Journal 305 Cash Payments Journal 307 Effects of Special Journals on the General Journal 310 All About You: KEEPING TRACK OF THE DOCUMENTS IN YOUR LIFE 312 Inventories 242 Feature Story: WHERE IS THAT SPARE BULLDOZER BLADE? 242 Classifying Inventory 244 Determining Inventory Quantities 245 Taking a^physical Inventory 245 Determining Ownership of Goods 246 Inventory Costing 248 Specific Identification 248 Cost Flow Assumptions 249 Financial Statement and Tax Effects of Cost Flow Methods 253 Using Inventory Cost Flow Methods Consistently 255 Lower-of-Cost-or-Market 256 Internal Control and Cash 336 Feature Story: MINDING THE MONEY IN MOOSE JAW 336 Internal Control 338 The Sarbanes-Oxley Act 339 Principles of Internal Control 339 Limitations of Internal Control 344 Cash Controls 345 Internal Control over Cash Receipts 346 Internal Control over Cash Disbursements 349 Use of a Bank 353 Making Bank Deposits 353 Writing Checks 353

5 Detailed Contents xxv Bank Statements 355 Reconciling the Bank Account 357 Reporting Cash 361 All About You: PROTECTING YOURSELF FROM IDENTITY THEFT 362 Accounting for Receivables 382 Feature Story: A DOSE OF CAREFUL MANAGEMENT KEEPS RECEIVABLES HEALTHY 382 Types of Receivables 384 Accounts Receivable 384 Recognizing Accounts Receivable 385 Valuing Accounts Receivable 386 Disposing of Accounts Receivable 393 Notes Receivable 396 Determining the Maturity Date 397 Computing Interest 398 Recognizing Notes Receivable 398 Valuing Notes Receivable 398" Disposing of Notes Receivable 399 Statement Presentation and Analysis 401 Presentation 401 Analysis 401 All About You: SHOULD YOU BE CARRYING PLASTIC? Plant Assets, Natural Resources, and Intangible Assets 422 Feature Story: HOW MUCH FOR A RIDE TO THE BEACH? 422 SECTION 1 Plant Assets 424 Determining the Cost of Plant Assets 425 Land 425 Land Improvements 425 Buildings 426 Equipment 426 Depreciation 428 Factors in Computing Depreciation 429 Depreciation Methods 430 Depreciation and Income Taxes 434 Revising Periodic Depreciation 434 Expenditures During Useful Life 436 Plant Asset Disposals 437 Retirement of Plant Assets 437 Sale of Plarl.Assets 438 SECTION 2 Natural Resources 440 SECTION 3 IntangibleAssets 441 Accounting for Intangible Assets 441 Patents 442 / Copyrights 442 Trademarks and Trade Names 442 Franchises and Licenses 443 Goodwill 443 Research and Development Costs 444 Statement Presentation and Analysis 444 Presentation 444 Analysis 444 All About You: BUYING A WRECK OF.YOUR OWN 446 APPENDIX: Exchange of Plant Assets 450 Loss Treatment 450 Gain Treatment 450 Current Liabilities and Payroll Accounting 470 Feature Story: FINANCING HIS DREAMS 470 Accounting for Current Liabilities 472 Notes Payable 473 Sales Taxes Payable 474 Unearned Revenues 474 Current Maturities of Long-Term Debt 475 Statement Presentation and Analysis 475 Contingent Liabilities 477 Recording a Contingent Liability 478 Disclosure of Contingent Liabilities 479 Payroll Accounting 480 Determining the Payroll 481 Recording the Payroll 484 Employer Payroll Taxes 488 Filing and Remitting Payroll Taxes 489 Internal Control for Payroll 490 All About You: YOUR BOSS WANTS TO KNOW IF YOU JOGGED TODAY 492 APPENDIX: Additional Fringe Benefits 495 Paid Absences 495 Post-Retirement Benefits 496 Post-Retirement Health-Care and Life Insurance Benefits 496 Accounting for Partnerships 512 Feature Story: FROM TRIALS TO TOP TEN 512 Partnership Form of Organization 514 Characteristics of Partnerships 514 Organizations with Partnership Characteristics 515 Advantages and Disadvantages of Partnerships 516 The Partnership Agreement 518 Basic Partnership Accounting 519 Forming a Partnership 519 Dividing Net Income or Net Loss 520 Partnership Financial Statements 523 Liquidation of a Partnership 525 No Capital Deficiency 526 Capital Deficiency 527 All About You: HOW WELL DO YOU KNOW YOUR PARTNER? 530 APPENDIX: Admission and Withdrawal of Partners 532 Admission of a Partner 532 Withdrawal of a Partner 536

6 xxvi Detailed Contents Corporations: Organization and Capital Stock Transactions 554 Feature Story: "HAVE YOU DRIVEN A FORD LATELY?" 554 The Corporate Form of Organization 556 Characteristics of a Corporation 557 Forming a Corporation 560 Ownership Rights of Stockholders 560 Stock Issue Considerations 562 Corporate Capital 564 Accounting for Common Stock Issues 565 Issuing Par Value Common Stock for Cash 566 Issuing No-Par Common Stock for Cash 566 Issuing Common Stock for Services or Noncash Assets 567 > Accounting for Treasury Stock 568 Purchase of Treasury Stock 569 Disposal of Treasury Stock 570 Preferred Stock 572 Dividend Preferences 573 Liquidation Preference 574 Statement Presentation and Analysis 574 Presentation 574 Analysis Book Value per Share 575 All About You: HOME-EQUITY LOANS 577 Corporations: Dividends, Retained Earnings, and Income Reporting 594 Feature Story: WHAT'S COOKING? 594 Dividends 596 Cash Dividends 596 Stock Dividends 600 Stock Splits 602 Retained Earnings 604 Retained Earnings Restrictions 605 Prior Period Adjustments 605 Retained Earnings Statement 606 Statement Presentation and Analysis 607 Stockholders' Equity Presentation 607 Stockholders' Equity Analysis 608 Income Statement Presentation 609 Income Statement Analysis 610 All About You: CORPORATIONS HAVE GOVERNANCE ' STRUCTURES DO YOU? 61 2 Long-Term Liabilities 630 / Feature Story: THANKS GOODNESS FOR BANKRUPTCY Bond Basics 632 Types of Bonds 633 Issuing Procedures 634 Bond Trading 634 Determining the Market Value of Bonds Accounting for Bond Issues 637 Issuing Bonds at Face Value 637 Discount or Premium on Bonds 637 Issuing Bonds at.a Discount 638 Issuing Bonds at a Premium 639 Accounting for Bond Retirements 640 Redeeming Bonds at Maturity 641 Redeeming Bonds before Maturity 641 Converting Bonds into Common Stock 641 Accounting for Other Long-Term Liabilities 642 Long-Terrn Notes Payable 642 Lease Liabilities 644 Statement Presentation and Analysis 646 Presentation 646 Analysis 646 All About You: THE RISKS OF ADJUSTABLE RATES 648 APPENDIX 15A: Present Value Concepts Related to Bond Pricing 652 Present Value of Face Value 652 Present Value of Interest Payments (Annuities) 654 Time Periods and Discounting 655 Computing the Present Value of a Bond 655 APPENDIX 15B: Effective-Interest Method of Bond Amortization 657 Amortizing Bond Discount 657 Amortizing Bond Premium 659 APPENDIX 15C: Straight-Line Amortization 661 Amortizing Bond Discount 661 Amortizing Bond Premium 662 IM Investments 682 Feature Story: "IS THERE ANYTHING ELSE WE CAN BUY?" Why Corporations Invest 684 Accounting for Debt Investments 686 Recording Acquisition of Bonds 686 Recording Bond Interest 686 Recording Sale of Bonds 686 Accounting for Stock Investments 688 Holdings of Less than 20% 688 Holdings Between 20% and 50% 689 Holdings of More than 50% 690 Valuing and Reporting Investments 693 Categories of Securities 693 Balance Sheet Presentation 696 Presentation of Realized and Unrealized Gain or Loss 697 Classified Balance Sheet 698 All About You: A GOOD DAY TO START SAVING IM The Statement of Cash Flows 718 Feature Story: "GOT CASH?" 718 The Statement of Cash Flows: Usefulness and Format 720

7 Detailed Contents xxvii Usefulness of the Statement of Cash Flows 720 Classification of Cash Flows 721 Significant Noncash Activities 722 Format of the Statement of Cash Flows 723 Preparing the Statement of Cash Flows 724 Indirect and Direct Methods 725 SECTION 1 Preparing the Statement of Cash Flows Indirect Method 726 Step 1: Operating Activities 728 < Depreciation Expense 728 Loss on Sale of Equipment 729 Changes to Noncash Current Asset and Current Liability Accounts 729 Summary of Conversion to Net Cash Provided by Operating Activities Indirect Method 731 Step 2: Investing and Financing Activities 733 Statement of Cash Flows Step 3: Net Change in Cash 734 Using Cash Flows to Evaluate a Company 736 Free Cash Flow 736 All About You: WHERE DOES THE MONEY GO? 738 APPENDIX 17A: Using a Work Sheet to Prepare the Statement of Cash Flows Indirect Method 741 APPENDIX 17B: Statement of Cash Flows Direct Method 747 Preparing the Statement of Cash Flows Direct Method 748 Step 1: Operating Activities 748 Step 2: Investing and Financing Activities 752 Step 3: Net Change in Cash 753 *M Financial Statement Analysis 778 Feature Story: "FOLLOW THAT STOCK!" 778 Basics of Financial Statement Analysis 780 Meed for Comparative Analysis 780 Tools of Analysis 781 Horizontal Analysis 781 Balance Sheet 782 Income Statement 783 Retained Earnings Statement 784 Vertical Analysis 785 Balance Sheet 785 Income Statement 785 Ratio Analysis" 787 Liquidity Ratios 788 Profitability Ratios 792 Solvency Ratios 796 Summary of Ratios ^798 Earning Power and Irregular Items 799 Discontinued Operations 799 Extraordinary Items 800 Changes in Accounting Principle 802 Comprehensive Income 802 Quality of Earnings 803 Alternative Accounting Methods 803 Pro Forma Income 804 Improper Recognition 804 All About You: SHOULD I PLAY THE MARKET YET? 805 IITJ Managerial Accounting 830 Feature Story: WHAT A DIFFERENCE A DAY MAKES 830 Managerial Accounting Basics 832 Comparing Managerial and Financial Accounting 833 Management Functions 834 Business Ethics 835 Managerial Cost Concepts 836 Manufacturing Costs 836 Product versus Period Costs 838 Manufacturing Costs in Financial Statements 839 Income Statement 839 Balance Sheet 842 Cost Concepts A Review 842 Managerial Accounting Today 844 Service-Industry Trends 844 Managerial Accounting Practices 845 All About You: OUTSOURCING AND JOBS 848 Job Order Cost Accounting 870 Feature Story: "...AND WE'D LIKE IT IN RED" 870 Cost Accounting Systems 872 Job Order Cost System 872 Process Cost System 873 Job Order Cost Flow 874 Accumulating Manufacturing Costs 876 Assigning Manufacturing Costs to Work in Process 877 Assigning Costs to Finished Goods 884 Assigning Costs to Cost of Goods Sold 885 Summary of Job Order Cost Flows 886 Reporting Job Cost Data 887 Under- or Overapplied Manufacturing Overhead 888 Year-End Balance 888 All About You: MINDING YOUR OWN BUSINESS 890 Process Cost Accounting 910 Feature Story: BEN &'jerry's TRACKS ITS MIX-UPS 910 The Nature of Process Cost Systems 912 Uses of Process Cost Systems 912 Similarities and Differences between Job Order Cost and Process Cost Systems 913 Process Cost Flow 914 Assignment of Manufacturing Costs Journal Entries 915

8 xxviii Detailed Contents Equivalent Units 918 Weighted-Average Method 919 ' Refinements on the Weighted-Average Method 919 Production Cost Report 920 Comprehensive Example of Process Costing 921 Compute the Physical Unit Flow (Step 1) 922 Compute Equivalent Units of Production (Step 2) 922 Compute Unit Production Costs (Step 3) 923 Prepare a Cost Reconciliation Schedule (Step 4) 924 Preparing the Production Cost Report 924 Costing Systems Final Comments 926 Contemporary Developments 927 Just-in-Time Processing 927 Activity-Based Costing 929 All About You: WAL-MART IS ON THE PHONE 931 APPENDIX: Example of Traditional Costing versus Activity-Based Costing 935 Production and Cost Data 935 Unit Costs Under Traditional Costing 935 Comparing Unit"Costs 937 Benefits and Limitations of Activity-Based Costing 937 Cost-Volume-Profit 956 Feature Story: GROWING BY LEAPS AND LEOTARDS 956 Cost Behavior Analysis 958 Variable Costs 959 Fixed Costs 959 Relevant Range 960 Mixed Costs 962 Importance of Identifying Variable and Fixed Costs 964 Cost-Volume-Profit Analysis 965 Basic Components 965 CVP Income Statement 966 Break-Even Analysis 968 Target Net Income 972 Margin of Safety 973 CVP and Changes in the Business Environment 974 CVP Income Statement Revisited 976 All About You: A HYBRID DILEMMA 977 APPENDIX: Variable Costing 980 Effects of Variable Costing on Income 981 Rationale for Variable Costing 983 Budgeting and Long-Range Planning 1004 The Master Budget 1004 Preparing the Operating Budgets 1005 Sales Budget 1006 Production Budget 1006 Direct Materials Budget 1007 Direct Labor Budget 1008 Manufacturing Overhead Budget 1009 Selling and Administrative Expense Budget 1009 Budgeted Income Statement 1011 Preparing the Financial Budgets 1011 Cash Budget 1012 Budgeted Balance Sheet 1015 Budgeting in Non-Manufacturing Companies 1017 Merchandisers 1017 Service Enterprises 1018 Not-for-Profit Organizations 1018 All About You: AVOIDING PERSONAL FINANCIAL DISASTER 1019 Budgetary Control and Responsibility Accounting 1038 Feature Story: TRYING TO AVOID AN ELECTRIC SHOCK 1038 The Concept of Budgetary Control 1040 Static Budget Reports 1041 Examples 1042 Uses and Limitations 1043 Flexible Budgets 1043 Why Flexible Budgets? 1043 Developing the Flexible Budget 1045 Flexible Budget A Case Study 1046 Flexible Budget Reports 1048 Management by Exception 1049 The Concept of Responsibility Accounting 1051 Controllable versus Noncontrollable Revenues and Costs 1052 Responsibility Reporting System 1052 Types of Responsibility Centers 1055 Responsibility Accounting for Cost Centers 1056 Responsibility Accounting for Profit Centers 1056 Responsibility Accounting for Investment Centers 1058 Principles of Performance Evaluation 1062 All About You: BUDGETING FOR HOUSING COSTS 1063.Budgetary Planning 998 Feature Story: THE NEXT AMAZON.COM? NOT QUITE Budgeting Basics 1000 Budgeting and Accounting 1000 The Benefits of Budgeting '1001 Essentials of Effective Budgeting 1001 Length of the Budget Period 1001 The Budgeting Process 1002 L Budgeting and Human Behavior Standard Costs and Balanced Scorecard 1086 Feature Story: HIGHLIGHTING PERFORMANCE EFFICIENCY The Need for Standards 1088 Distinguishing between Standards and Budgets Why Standard Costs? 1089 Setting Standard Costs A Difficult Task 1090 Ideal versus Normal Standards 1090 A Case Study

9 Detailed Contents xxix Analyzing and Reporting Variances from Standards 1094 Direct Materials Variances 1095 Direct Labor Variances 1098 Manufacturing Overhead Variances 1100 Reporting Variances 1103 Statement Presentation of Variances 1103 Balanced Scorecard T104 All About You: BALANCING COSTS AND QUALITY IN HEALTH CARE APPENDIX: Standard Cost Accounting System 1111 Journal Entries 1112 Ledger Accounts 1113 Incremental Analysis and Capital Budgeting 1132 Feature Story: SOUP IS GOOD FOOD 1132 SECTION 1 Incremental Analysis 1134 Management's Decision-Making Process 1134 The Incremental Analysis Approach 1135 How Incremental Analysis Works 1135 Types of Incremental Analysis 1136 Accept an Order at a Special Price 1136 Make or Buy 1137 Sell or Process Further 1139 Retain or Replace Equipment 1140 Eliminate an Unprofitable Segment 1140 Allocate Limited Resources 1142 SECTION 2 Capital Budgeting 1144 Evaluation Process 1145 Annual Rate of Return 1145 Cash Payback 1146 Discounted Cash Flow 1148 Net Present Value Method 1148 Internal Rate of Return Method 1151 Comparison of Discounted Cash Flow Methods 1152 All About You: WHAT IS A DEGREE WORTH? 1153 APPENDIX A: Specimen Financial Statements: PepsiCo, Inc. A1 APPENDIX B: Specimen Financial Statements: The Coca-Cola Company B1 APPENDIX C: Present Value Concepts C1 Nature of Interest C1 Simple Interest C1 Compound Interest C2 Present Value Variables C3 Present Value of a Single Amount C3 Present Value of an Annuity C5 Time Periods and Discounting. C7 Computing the Present Value of a Long-Term Note or Bond C7 APPENDIX D: Using Financial Calculators D1 Present Value of a Single Sum D1 Plus and Minus D2 Compounding Periods.D2 Rounding D2 Present Value of an Annuity D2 Useful Applications of the Financial Calculator D3 Auto Loan D3 Mortgage Loan Amount D3 APPENDIX E: Standards of Ethical Conduct for Management Accountants E1 IMA Statement of Ethical Professional Practice E1 Principles E1 Standards E1 Resolution of Ethical Conflict E2 Photo Credits PC-1 Company Index C1-1 Subject Index S1-1