Financial and Managerial Accounting

edition Financial and Managerial Accounting Information for Decisions -- -.I John J. Wild University of Wisconsin at Madison Ken W. Shaw University of Missouri at Columbia Barbara Chiappetta Nassau Community College McGraw-Hill Irwin Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis Bangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

Contents I Introducing Accounting in Business 2 Importance of Accounting 4 Users of Accounting Information 5 Opportunities in Accounting 6 Fundamentals of Accounting 7 Ethics A Key Concept 7 Generally Accepted Accounting Principles 8 Sarbanes-Oxley 11 Transaction Analysis and the Accounting Equation 12 Accounting Equation 12 Transaction Analysis 13 Summary of Transactions 17 Financial Statements 17 Income Statement 18 Statement of Retained Earnings 18 Balance Sheet 18 Statement of Cash Flows 18 Decision Analysis Return on Assets 20 Appendix 1A Return and Risk Analysis 23 Appendix IB Business Activities and the Accounting Equation 24 Analyzing and Recording Transactions 46 Analyzing and Recording Process 48 Source Documents 48 The Account and Its Analysis 49 Analyzing and Processing Transactions 52 Ledger and Chart of Accounts 52 Debits and Credits 53 Double-Entry Accounting 53 Journalizing and Posting Transactions 54 Analyzing Transactions An Illustration 57 Accounting Equation Analysis 61 Trial Balance 63 Preparing a Trial Balance 63 Using a Trial Balance to Prepare Financial Statements 64 Decision Analysis Debt Ratio 66 Adjusting Accounts and Preparing Financial Statements 90 Timing and Reporting 92 The Accounting Period 92 Accrual Basis versus Cash Basis 93 Recognizing Revenues and Expenses 94 Adjusting Accounts 94 Framework for Adjustments 94 Prepaid (Deferred) Expenses 95 Unearned (Deferred) Revenues 98 Accrued Expenses 99 Accrued Revenues 101 Links to Financial Statements 103 Adjusted Trial Balance 104 Preparing Financial Statements 104 Closing Process 106 Temporary and Permanent Accounts 106 Recording Closing Entries 106 Post-Closing Trial Balance 108 Accounting Cycle Summary 110 Classified Balance Sheet 111 Classification Structure 111 Classification Categories 111 Decision Analysis Profit Margin and Current Ratio 113 Appendix 3A Alternative Accounting for Prepayments 119 Appendix 3B Work Sheet as a Tool 120 Appendix 3C Reversing Entries 123 XXV

xxvi Contents Accounting for Merchandising Operations 152 Merchandising Activities 154 Reporting Income for a Merchandiser 154 Reporting Inventory for a Merchandiser 155 Operating Cycle for a Merchandiser 155 Inventory Systems 155 Accounting for Merchandise Purchases 156 Purchase Discounts 157 Purchase Returns and Allowances 158 Transportation Costs and Ownership Transfer 159 Accounting for Merchandise Sales 161 Sales of Merchandise 161 Sales Discounts 162 Sales Returns and Allowances 162 Completing the Accounting Cycle 163 Adjusting Entries for Merchandisers 164 Preparing Financial Statements 164 Closing Entries for Merchandisers 165 Summary of Merchandising Entries 165 Financial Statement Formats 166 Multiple-Step Income Statement 167 Single-Step Income Statement 168 Classified Balance Sheet 168 Decision Analysis Acid-Test and Gross Margin Ratios 169 Appendix 4A Periodic Inventory System 174 Appendix 4B Work Sheet Perpetual System 178 inventories and Cost of Sales 198 Inventory Basics 200 Determining Inventory Items 200 Determining Inventory Costs 201 Inventory Controls and Taking a Physical Count 201 Inventory Costing Under a Perpetual System 201 Inventory Cost Flow Assumptions 202 Inventory Costing Illustration 203 Specific Identification 203 First-In, First-Out 205 Last-In, First-Out 205 Weighted Average 206 Financial Statement Effects of Costing Methods 208 Consistency in Using Costing Methods 209 Valuing Inventory at LCM and the Effects of Inventory Errors 209 Lower of Cost or Market 209 Financial Statement Effects of Inventory Errors 211 Decision Analysis Inventory Turnover and Days' Sales in Inventory 212 Appendix 5A Inventory Costing Under a Periodic System 218 Appendix 5B Inventory Estimation Methods 223

Contents xxvii Cash and Internal Controls 242 Internal Control 244 Purpose of Internal Control 244 Principles of Internal Control 245 Technology and Internal Control 246 Limitations of Internal Control 248 Control of Cash 248 Cash, Cash Equivalents, and Liquidity 249 Cash Management 249 Control of Cash Receipts 250 Control of Cash Disbursements 252 Banking Activities as Controls 256 Basic Bank Services 256 Bank Statement 257 Bank Reconciliation 259 Decision Analysis Days' Sales Uncollected 262 Appendix 6A Documentation and Verification 265 Appendix 6B Control of Purchase Discounts 268 Accounts and Notes Receivable 286 Accounts Receivable 288 Recognizing Accounts Receivable 288 Valuing Accounts Receivable Direct Write-Off Method 291 Valuing Accounts Receivable Allowance Method 292 Estimating Bad Debts Percent of Sales Method 294 Estimating Bad Debts Percent of Receivables Method 295 Estimating Bad Debts Aging of Receivables Method 296 Notes Receivable 298 Computing Maturity and Interest 298 Recognizing Notes{Receivable 299 Valuing and Settling Notes 300 Disposing of Receivables 301 Selling Receivables 301 Pledging Receivables 301 Decision Analysis Accounts Receivable Turnover 302 8 Long-Term Assets 320 SECTION 1 PLANT ASSETS 322 Cost Determination 323 Land 323 Land Improvements 324 Buildings 324 Machinery and Equipment 324 Lump-Sum Purchase 324 Depreciation 325 Factors in Computing Depreciation 325 Depreciation Methods 326 Partial-Year Depreciation 330 Change in Estimates for Depreciation 331 Reporting Depreciation 331 Additional Expenditures 332 Ordinary Repairs 332 Betterments and Extraordinary Repairs 333 Disposals of Plant Assets 333 Discarding Plant Assets 334 Selling Plant Assets 334 SECTION 2 NATURAL RESOURCES 336 Cost Determination and Depletion 336 Plant Assets Used in Extracting 337 SECTION 3 INTANGIBLE ASSETS 337 Cost Determination and Amortization 337 Types of Intangibles 338 Decision Analysis Total Asset Turnover 340 Appendix 8A Exchanging Plant Assets 343

xxviii Contents 9 Current Liabilities 362 Characteristics of Liabilities 364 Defining Liabilities 364 Classifying Liabilities 364 Uncertainty in Liabilities 365 Known Liabilities 366 Accounts Payable 366 Sales Taxes Payable 366 Unearned Revenues 367 Short-Term Notes Payable 367 Payroll Liabilities 369 Multi-Period Known Liabilities 372 Estimated Liabilities 373 Health and Pension Benefits 373 Vacation Benefits 374 Bonus Plans 374 Warranty Liabilities 374 Multi-Period Estimated Liabilities 375 Contingent Liabilities 375 Accounting for Contingent Liabilities 376 Reasonably Possible Contingent Liabilities 376 Uncertainties That Are Not Contingencies 377 Decision Analysis Times Interest Earned Ratio 377 Appendix 9A Payroll Reports, Records, and Procedures 380 Appendix 9B Corporate Income Taxes 386 I 0 Long-Term Liabilities 406 Basics of Bonds 408 Bond Financing 408 Bond Trading 409 Bond-Issuing Procedures 410 Bond Issuances 410 Issuing Bonds at Par 410 Bond Discount or Premium 411 Issuing Bonds at a Discount 411 Issuing Bonds at a Premium 414 Bond Pricing 416 Bond Retirement 417 Bond Retirement at Maturity 417 Bond Retirement before Maturity 417 Bond Retirement by Conversion 418 Long-Term Notes Payable 418 Installment Notes 418 Mortgage Notes and Bonds 420 Decision Analysis Debt Features and the Debt-to-Equity Ratio 421 Appendix 10A Present Values of Bonds and Notes 425 Appendix 10B Effective Interest Amortization 427 Appendix IOC Issuing Bonds between Interest Dates 429 Appendix 10D Leases and Pensions 431 I 1 Corporate Reporting and Analysis 448 Corporate Form of Organization 450 Characteristics of Corporations 450 Corporate Organization and Management 451 Stockholders of Corporations 452 Basics of Capital Stock 453 Common Stock 454 Issuing Par Value Stock 454 Issuing No-Par Value Stock 455 Issuing Stated Value Stock 456 Issuing Stock for Noncash Assets 456 Dividends 457 Cash Dividends 457 Stock Dividends 458 Stock Splits 460 Preferred Stock 460 Issuance of Preferred Stock 461 Dividend Preference of Preferred Stock 461 Convertible Preferred Stock 462 Callable Preferred Stock 463 Reasons for Issuing Preferred Stock 463 Treasury Stock 464 Purchasing Treasury Stock 464 Reissuing Treasury Stock 465 Retiring Stock 466 Reporting of Equity 466 Statement of Retained Earnings 466 Statement of Stockholders' Equity 467 Reporting Stock Options 467 Decision Analysis Earnings per Share, Price-Earnings Ratio, Dividend Yield, and Book Value per Share 468

Contents xxix 12 Reporting and Analyzing Cash Flows 492 Basics of Cash Flow Reporting 494 Purpose of the Statement of Cash Flows 494 Importance of Cash Flows 494 Measurement of Cash Flows 495 Classification of Cash Flows 495 Noncash Investing and Financing 497 Format of the Statement of Cash Flows 497 Preparing the Statement of Cash Flows 498 Cash Flows from Operating 500 Indirect and Direct Methods of Reporting 500 Application of the Indirect Method of Reporting 501 Summary of Adjustments for Indirect Method 506 Cash Flows from Investing 507 Three-Stage Process of Analysis 507 Analysis of Noncurrent Assets 507 Analysis of Other Assets 508 Cash Flows from Financing 509 Three-Stage Process of Analysis 509 Analysis of Noncurrent Liabilities, 509 Analysis of Equity 510 Proving Cash Balances 511 Decision Analysis Cash Flow Analysis 511 Appendix 12A Spreadsheet Preparation of the Statement of Cash Flows 515 Appendix 12B Direct Method of Reporting Operating Cash Flows 518 Vertical Analysis 553 Common-Size Statements 553 Common-Size Graphics 555 Ratio Analysis 556 Liquidity and Efficiency 557 Solvency 561 Profitability 562 Market Prospects 563 Summary of Ratios 564 Decision Analysis Analysis Reporting 566 Appendix 13A Sustainable Income 569 1 4 Managerial Accounting Concepts and Principles 590 Managerial Accounting Basics 592 Purpose of Managerial Accounting 592 Nature of Managerial Accounting 593 Managerial Decision Making 595 Managerial Accounting in Business 595 Fraud and Ethics in Managerial Accounting 597 Managerial Cost Concepts 598 Types of Cost Classifications 598 Identification of Cost Classifications 600 Cost Concepts for Service Companies 600 Reporting Manufacturing Activities 601 Manufacturer's Balance Sheet 601 Manufacturer's Income Statement 603 Flow of Manufacturing Activities 605 Manufacturing Statement 606 Decision Analysis Cycle Time and Cycle Efficiency 608 13 Analyzing Financial Statements 544 Basics of Analysis 546 Purpose of Analysis 546 Building Blocks of Analysis 547 Information for Analysis 547 Standards for Comparisons 548 Tools of Analysis 548 Horizontal Analysis 548 Comparative Statements 548 Trend Analysis 551

XXX Contents 8 5 Job Order Costing and Analysis 634 Job Order Cost Accounting 636 Cost Accounting System 636 Job Order Production 636 Events in Job Order Costing 637 Job Cost Sheet 638 Job Order Cost Flows and Reports 639 Materials Cost Flows and Documents 639 Labor Cost Flows and Documents 641 Overhead Cost Flows and Documents 642 Summary of Cost Flows 644 Adjustment of Overapplied or Underapplied Overhead 647 Underapplied Overhead 647 Overapplied Overhead 648 Decision Analysis Pricing for Services 648 i 6 Process Costing and Analysis 672 Process Operations 674 Comparing Job Order and Process Operations 675 Organization of Process Operations 675 GenX Company An Illustration 675 Process Cost Accounting 677 Direct and Indirect Costs 677 Accounting for Materials Costs 678 Accounting for Labor Costs 679 Accounting for Factory Overhead 679 Equivalent Units of Production 681 Accounting for Goods in Process 681 Differences in Equivalent Units for Materials, Labor, and Overhead 681 Process Costing Illustration 682 Step 1: Determine the Physical Flow of Units 683 Step 2: Compute Equivalent Units of Production 683 Step 3: Compute the Cost per Equivalent Unit 684 Step 4: Assign and Reconcile Costs 684 17 18 Transfers to Finished Goods Inventory and Cost of Goods Sold 687 Effect of the Lean Business Model on Process Operations 689 Decision Analysis Hybrid Costing System 689 Appendix 16A FIFO Method of Process Costing 693 Activity-Based Costing and Analysis 716 Assigning Overhead Costs 718 Plantwide Overhead Rate Method 719 Departmental Overhead Rate Method 721 Activity-Based Costing Rates and Method 723 Applying Activity-Based Costing 724 Step 1: Identify Activities and Cost Pools 724 Step 2: Trace Overhead Costs to Cost Pools 726 Step 3: Determine Activity Rate 727 Step 4: Assign Overhead Costs to Cost Objects 728 Assessing Activity-Based Costing 730 Advantages of Activity-Based Costing 730 Disadvantages of Activity-Based Costing 731 Decision Analysis Customer Profitability 731 Cost Behavior and Cost-Volume- Profit Analysis 754 Identifying Cost Behavior 756 Fixed Costs 756 Variable Costs 757 Mixed Costs 757 Step-Wise Costs 758 Curvilinear Costs 758 Measuring Cost Behavior 759 Scatter Diagrams 759 High-Low Method 760 Least-Squares Regression 761 Comparison of Cost Estimation Methods 761

Contents xxxi Using Break-Even Analysis 762 Contribution Margin and Its Measures 762 Computing the Break-Even Point 763 Preparing a Cost-Volume-Profit Chart 764 Making Assumptions in Cost-Volume-Profit Analysis 765 Applying Cost-Volume-Profit Analysis 766 Computing Income from Sales and Costs 767 Computing Sales for a Target Income 767 Computing the Margin of Safety 768 Using Sensitivity Analysis 769 Computing a Multiproduct Break-Even Point 769 Decision Analysis Degree of Operating Leverage 772 Appendix 18A Using Excel to Estimate Least-Squares Regression 774 Budgeting and Human Behavior 827 Budgeting as a Management Tool 827 Budgeting Communication 827 Budget Administration 828 Budget Committee 828 Budget Reporting 828 Budget Timing 828 Master Budget 830 Master Budget Components 830 Operating Budgets 832 Capital Expenditures Budget 835 Financial Budgets 835 Decision Analysis Activity-Based Budgeting 839 Appendix 20A Production and Manufacturing Budgets 845 19 20 Variable Costing and Performance Reporting 792 Introducing Variable Costing and Absorption Costing 794 Absorption Costing 794 Variable Costing 795 Computing Unit Cost 795 Performance Reporting (Income) Implications 796 Units Produced Equal Units Sold 797 Units Produced Exceed Units Sold 798 Units Produced Are Less Than Units Sold 799 Summarizing Income Reporting 800 Converting Reports under Variable Costing to Absorption Costing 801 Comparing Variable Costing and Absorption Costing 801 Planning Production 801 Setting Prices 803 Controlling Costs 804 Limitations of Reports Using Variable Costing 805 Decision Analysis Break-Even Analysis 805 Master Budgets and Performance Planning 824 Budget Process 826 Strategic Budgeting 826 Benchmarking Budgets 826 2 1 Flexible Budgets and Standard Costing 864 SECTION 1 FLEXIBLE BUDGETS 866 Budgetary Process 866 Budgetary Control and Reporting 866 Fixed Budget Performance Report 867 Budget Reports for Evaluation 868 Flexible Budget Reports 868 Purpose of Flexible Budgets 868 Preparation of Flexible Budgets 868 Flexible Budget Performance Report 870 SECTION 2 STANDARD COSTS 871 Materials and Labor Standards 871 Identifying Standard Costs 871 Setting Standard Costs 872 Cost Variances 872 Cost Variance Analysis 873 Cost Variance Computation 873 Computing Materials and Labor Variances 874 Overhead Standards and Variances 876 Setting Overhead Standards 876 Computing Overhead Cost Variances 878 Extensions of Standard Costs 882 Standard Costs for Control 882 Standard Costs for Services 882 Standard Cost Accounting System 882 Decision Analysis Sales Variances 884

xxxii Contents 22 23 Decentralization and Performance Evaluation 908 Departmental Accounting 910 Motivation for Departmentalization 910 Departmental Evaluation 910 Departmental Reporting and Analysis 911 Departmental Expense Allocation 912 Direct and Indirect Expenses 912 Allocation of Indirect Expenses 912 Departmental Income Statements 914 Departmental Contribution to Overhead 917 Investment Centers 919 Financial Performance Evaluation Measures 919 Nonfinancial Performance Evaluation Measures 920 Responsibility Accounting 921 Controllable versus Direct Costs 922 Responsibility Accounting System 922 Decision Analysis Investment Center Profit Margin and Investment Turnover 924 Appendix 22A Transfer Pricing 927 Appendix 22B Joint Costs and Their Allocation 929 Relevant Costing for Managerial Decisions 950 Decisions and Information 952 Decision Making 952 Relevant Costs 952 Managerial Decision Scenarios 953 Additional Business 953 Make or Buy 955 Scrap or Rework 956 Sell or Process 957 Sales Mix Selection 957 Segment Elimination 959 Qualitative Decision Factors 960 Decision Analysis Setting Product Price 960 24 Capital Budgeting and Investment Analysis 978 Introduction to Capital Budgeting 980 Methods Not Using Time Value of Money 980 Payback Period 981 Accounting Rate of Return 983 Methods Using Time Value of Money 984 Net Present Value 985 Internal Rate of Return 987 Comparison of Capital Budgeting Methods 989 Decision Analysis Break-Even Time 990 Appendix 24A Using Excel to Compute Net Present Value and Internal Rate of Return 993 Appendix A Appendix B Appendix C Financial Statement Information A-l Best Buy A-2 Circuit City A-19 RadioShack A-24 Apple A-29 Applying Present and Future Values B Investments and International Operations C Appendix D* Accounting for Partnerships Appendix E* Accounting with Special Journals Glossary G-l Credits CR-1 Index IND-1 Chart of Accounts CA * Appendixes D & E are available on the book's Website, mhhe.com/wildfinman3e, and as print copy from a McGraw-Hill representative.