ntroduction to Accounting An Integrated Approach Sixth Edition Penne Ainsworth University of Wyoming Dan Deines Kansas State University McGraw-Hill Irwin
About the Authors xii Prologue xx PART ONE INTRODUCTION: BUSINESS OPERATING ACTIVITIES 1 Chapter 1 Accounting and Business 2 Accounting: Who Needs It? 3 Business Today 4 Customer-Focused Operations 5 Global Markets 6 Manufacturing and Communication Advances 7 E-Business 7 Business and Accounting: Together Forever 8 Ancient Babylonia 9 Commerce in Old Italy 9 Pacioli and the Method of Venice 11 Advent of the Corporation 12 The Stock Market Crash of 1929 13 Return to the Present 15 Generally Accepted Accounting Principles 16 Statements of Financial Accounting Concepts 16 International Accounting Standards 17 Financial Statements 19 Income Statement 19 Statement of Owners' (Shareholders') Equity 20 Statement of Cash Flows 20 Balance Sheet (Statement of Financial Position) 20 Report of the Independent Accountant (Auditor) 22 Relationship of the Financial Statements 22 Current Ratio 23 Return on Sales Ratio 24 Debt-to-Equity Ratio 24 XBRL Filing 25 Summary 25 Key Terms 25 Chapter 2 Business Processes and Accounting Information 34 Management Cycle 35 Planning Phase 35 Performing Phase 36 Evaluating Phase 36 Business Processes 37 Business Organization and Strategy Process 38 Operating Processes 39 Capital Resources Process 39 Performance Measurement and Management Process 40 Balanced Scorecard Approach 40 Financial Perspective 40 Internal Perspective 42 Customer Perspective 45 Learning and Growth Perspective 45 Internal Control 45 Requiring Proper Authorization 46 Separation of Duties 46 Maintaining Adequate Documentation 47 Physically Controlling Assets and Information 4 7 Providing Independent Checks on Performance 47 Applying Internal Control to Protect Cash 48 Cash Receipts 48 Cash Disbursements 49 Bank Reconciliation 49 Bank Statement 49 Bank Reconciliation Process 50 Summary 52 Key Terms 53 Chapter 3 Operating Processes: Planning and Control Revenue Process 64 Generate Sales 64 Receive and Accept Orders 65 Deliver Goods and/or Services 66 Receive Payment from Customers 67 Provide Customer Support 69 Relationship of the Revenue Process and the Information System 69 63
xv Expenditure Process 70 Determine the Company's Need for Goods 70 Select Suppliers and Order Goods 70 Receive Goods 72 Pay Suppliers 72 Relationship of the Expenditure Process and the Information System 73 Conversion Process 73 Schedule Production 73 Obtain Direct Materials 74 Use Labor and Other Manufacturing Resources to Make Products 75 Store Finished Goods Until Sold 76 Relationship between the Conversion Process and the Information System 76 Cost and Revenue Behavior 76 Behavior Patterns 78 Relevant Range 78 Activity Measures 78 Fixed Costs and Revenues 79 Variable Costs and Revenues 80 Mixed Costs and Revenues 81 Cost/Revenue Estimation Methods 82 High/Low Method 83 Linear Regression Analysis 85 Summary 87 Key Terms 88 PART TWO PLANNING: OPERATING ACTIVITIES 99 Chapter 4 Short-Term Decision Making 100 Short-Term Decisions 101 Cost-Volume-Profit Analysis 102 Determining the Breakeven Point 104 Determining the Target Profit Level 105 Determining the Target Profit Level After Taxes 105 Sensitivity Analysis 106 Change in Selling Price 106 Change in Variable Cost 107 Change in Fixed Cost 107 Change in Tax Rate 107 Relevant Variable Analysis 108 Sunk Costs Are Never Relevant 110 Opportunity Costs Are Always Relevant 110 Incremental Costs and Revenues May Be Relevant 111 Identify the Alternative Actions 111 Determine the Relevant Revenues, Costs, and Profit HI Choose the Best Alternative 112 Special Order (Accept-or-Reject) Decision 113 Outsourcing (Make-or-Buy) Decision 114 Product Mix (Keep-or-Drop) Decision 115 Another (More Difficult) Example 116 Summary 117 Key Terms 118 Chapter 5 Strategic Planning Regarding Operating Processes 128 Revenue Process: Determining the Selling Price 129 Customers: Customer Perspective 130 Competitors: Learning and Growth Perspective 130 Legal and Social Forces: Learning and Growth Perspective 131 Cost: Internal Process Perspective 131 Pricing Strategies 132 Penetration Pricing 132 Skimming Pricing 132 Life-Cycle Pricing' 133 Target Pricing 134 Conversion Process: Determining the Inventory Model 134 Reasons to Maintain Inventory 135 Reasons to Not Maintain Inventory 135 Balancing Ordering and Carrying Costs 135 Inventory Models 136 Comparison of Inventory Models 141 Expenditure Process: Determining the Employee Compensation Package 142 Paid Compensation 142 Health and Life Insurance 143 Paid Leave 144 Contingent Compensation: Bonuses 144 Summary 147 Key Terms 147 Chapter 6 Planning, the Balanced Scorecard, and Budgeting 154 Budgeting and Goal Setting 155 Planning 155 Communication and Coordination 155 Resource Allocation 156 Evaluation and Control 156 Time and Resource Requirements 156 Adaptability of Departments and Segments 156 Motivation and Behavior of Individuals 157 Mandated versus Participatory Budgeting 158 Mandated Budgeting 158 Participatory Budgeting 158 Incremental Budgeting versus Zero-Based Budgeting 159
xvi Contents Incremental Budgeting 159 Zero-Based Budgeting 159 Master Budget 160 Revenue Process Planning 161 Balanced Scorecard Goals 162 Sales Budget 162 Cash Receipts Schedule 162 Accounts Receivable Schedule 164 Marketing and Distribution Budget 165 Conversion Process Planning 165 Balanced Scorecard Goals 166 Production Budget 166 Expenditure Process Planning 166 Balanced Scorecard Goals 167 Budgeting for Human Resources 167 Administrative Budget 167 Direct Labor and Manufacturing Overhead Budget 167 Direct Materials Purchases Budget 168 Cash Disbursements Schedule 169 Accounts Payable Schedule 170 Summary 171 Key Terms 172 PART THREE RECORDING AND EVALUATING: OPERATING ACTIVITIES 181 Chapter 7 Accounting Information Systems 182 Manual Accounting Systems 183 Accounting Events 183 Chart of Accounts 184 Journalizing 187 Posting 188 Adjusting Entries 189 Closing Entries 192 Comprehensive Example 195 Computer-Based Transaction Systems 199 Database Systems 202 Summary 203 Key Terms 203 Chapter 8 Purchasing/Human Resources/Payment Process: Recording and Evaluating Expenditure Process Activities 215 Expenditure Process 216 Special Journals and Subsidiary Ledgers 218 Special Journals 218 Subsidiary Ledgers 219 Inventory 220 Perpetual versus Periodic Inventory Systems 220 Gross versus Net Price Methods 222 Reporting Inventory Purchase and Payment Events 224 Human Resources 226 Withholdings from Employees 228 Employer Taxes 228 Accounting Events in the Payroll Process 228 Reporting Human Resource Events 230 Other Expenditure Process Activities 230 Cash Outflow before Expense (Assets Created) 230 Expense before Cash Outflow (Liabilities Incurred) 232 Expense Concurrent with Payment 233 Reporting Other Expenditure Process Activities 233 Financial Statements and the Expenditure Process 234 Estimating Cash Paid for Inventory 234 Estimating Cash Paid for Operating Expenses 235 Internal Evaluation of Expenditure Process Events 236 Summary 236 Key Terms 236 Chapter 9 Recording and Evaluating Conversion Process Activities 246 Manufacturing Inventories 247 Recording Raw Material Activities 249 Recording Labor Activities 250 Recording Manufacturing Overhead Events 251 Actual Manufacturing Overhead 251 Applied Manufacturing Overhead 252 Overhead Application Process Using ABC 252 Over- and Underapplied Manufacturing Overhead 255 Recording Finished Goods 256 Reporting Conversion Process Events 257 Internal Evaluation of Conversion Process Events 258 Direct Labor Variance Analysis 259 Direct Materials Variances 260 Summary 262 Key Terms 263 Chapter 10 Marketing/Sales/Collection/Customer Support Process: Recording and Evaluating Revenue Process Activities 275 Revenue Recognition 276 Revenue Recognized When Cash Collected 279 Revenue Recognized before Cash Collected (Asset Created) 279 Revenue Recognized after Cash Received (Liability Incurred) 279
xvii Sales Returns and Allowances 280 Sales Discounts 281 Cost of Goods Sold 283 Specific Identification Method 283 First-In, First-Out (FIFO) Method 283 Last-In, First-Out (LIFO) Method 287 Periodic Inventory System and Cost Flow Assumptions 290 FIFO, LIFO, and GAPP External Reporting 291 Estimating Uncollectible Credit Sales 291 Proper Income Measurement 291 Proper Asset Valuation 292 Recording Estimated Uncollectible Accounts 292 Recording Actual Uncollectible Accounts 292 Reporting Revenue Process Events 293 Estimating Cash Receipts from Customers 293 Internal Evaluation of Revenue Process Events 294 Revenue Variances 295 Summary 296 Key Terms 296 PART FOUR INTRODUCTION: CAPITAL RESOURCE PROCESS ACTIVITIES 305 Chapter 11 Time Value of Money 306 Return 308 Time Considerations 308 Initial Investment Considerations 309 Rate of Return 309 Expected Rate of Return 310 Risk 310 Attitudes toward Risk 311 Types of Risk 311 Risk/Return Relationship 312 Risk Premiums 312 Risk/Return and Investors' Money 313 Time Value of Money 313 Simple and Compound Interest 313 Future Value of the Amount of $1 315 Present Value of the Amount of$l 316 Annuities 317 Future Value of an Annuity 317 Present Value of an Annuity 319 More Practice with Time Value of Money Problems 320 Step 1. Determine Whether the Problem Is an Annuity 320 Step 2. Determine Whether the Problem Is Present or Future Value 320 Step 3. Identify the Missing Element 321 Step 4. Solve for the Missing Element 321 More Time Value of Money Problems 322 Summary 323 Key Terms 324 Appendix: Time Value of Money Tables 325 PART FIVE PLANNING: CAPITAL RESOURCE PROCESS ACTIVITIES 339 Chapter 12 Planning Investments: Capital Budgeting 340 The Capital Budgeting Process 341 Identifying Long-Term Investment Opportunities 341 Tie to Business Organization and Strategy Process 342 Selecting Appropriate Investments 343 Net Present Value Analysis 345 Assumptions ofnpv 347 Source of Cash Flows 347 Uneven Cash Flows 348 Income Taxes 348 Tax Shield 350 MA CRS Depreciation 350 Gains and Losses on Disposal of Assets 351 Comprehensive Example 353 Other Issues 355 Human Judgment 355 Uncertainty 356 Qualitative/Ethical Factors 358 Capital Expenditures and Budgeting 358 Summary 359 Key Terms 359 Chapter 13 Planning Equity Financing 368 Tie to Business Organization and Strategy Process 369 Debt versus Equity Financing 369 Risk of Debt Financing 369 Debt-to-Equity Ratio 370 Times Interest Earned Ratio 3 70 Reward of Debt Financing 371 Return on Owners' Equity Ratio 3 72 Reward of Equity Financing 3 72 Risk of Equity Financing 3 73 Equity Financing 373 Sole Proprietorships and Partnerships 3 74 Corporations 374 Planning for Partnership Equity 375 Partnership Income Allocations 376 Other Changes in Capital 380 Planning Corporate Equity. 380
xviii Contents Common Stock 380 Preferred Stock 381 Return on Common Equity 383 Stock Shares 383 Stock Values 384 Dividends 385 Dividend Dates 386 Stock Splits 387 Corporate Equity Planning and Budgeting 388 Summary 388 Key Terms 389 Chapter 14 Planning Debt Financing 396 Debt Financing 397 Long-Term Debt Instruments 398 Periodic Payment (Installment) Note 398 Lump-Sum Payment (Noninterest-Bearing) Note 399 Periodic Payment and Lump-Sum Note 401 Comparison of the Three Types of Notes 405 Sources of Debt Financing 406 Nonpublic Funding 406 Collateral 407 Leases 407 Public Funding: Bonds 408 Comprehensive Example: Chapters 12 through 14 411 Summary 414 Key Terms 414 PART SIX RECORDING AND EVALUATING CAPITAL RESOURCE PROCESSES 421 Chapter 15 Recording and Evaluating Capital Resource Process Activities: Financing 422 Review of Transaction-Based Accounting Systems 423 Equity Financing Activities 423 Contributions by Owners (Shareholders) 423 Corporate Earnings 425 Corporate Distributions 426 Financial Statements and Owners' Equity Activities 430 Debt Financing Activities 430 Installment Notes Payable 430 Noninterest-Bearing Notes Payable 432 Bonds Payable: Market Rate Greater Than the Face Rate 434 Bonds Payable: Market Rate Less Than the Face Rate 436 Bonds Payable: Market Rate Equal to the Face Rate 439 Financial Statements and Financing Activities 440 Internal Evaluation of Financing Activities 441 Summary 441 Key Terms 441 Chapter 16 Recording and Evaluating Capital Resource Process Activities: Investing 449 Plant Assets 450 Acquisition ofppe 450 Use ofppe 451 Depreciation 453 Other PPE Usage Issues 456 Disposal of PPE 458 Discard PPE 458 Sell PPE 459 Exchange PPE 460 Exchanges When No Gains and Losses Are Recorded 463 Natural Resources 464 Intangible Assets 464 Reporting Investment Activities 465 Internal Evaluation of Investment Activities 467 Summary 467 Key Terms 468 PART SEVEN EVALUATING: OPERATING AND CAPITAL RESOURCE PROCESSES 475 Chapter 17 Company Performance: Profitability 476 Purpose of the Income Statement 477 GAAP and Comprehensive Income 477 What Are Earnings? 478 What Are Other Changes in Equity? 480 Earnings per Share 481 Calculating Earnings per Share 482 Calculating Diluted Earnings per Share 482 Other Earnings per Share Disclosures 483 Other Required Income Statement Disclosures 484 Reporting Issues Concerning the Income Statement 484 Historical Cost and Conservatism 484 Cost Allocations 485 Full-Absorption Costing 486 Internal Profitability Reporting 488 Variable and Throughput Costing Methods 488 Product Line (Divisional) Income Reports 491 Return on Investment for the Division 492 Du Pont Method of Return on Investment 493 Summary 494 Key Terms 494
xix Chapter 18 Company Performance: Owners' Equity and Financial Position 503 Statement of Owners'Equity 504 Comprehensive Income 504 Retained Earnings 505 Other Disclosures 506 Statement of Financial Position (Balance Sheet) 507 What Is Financial Position? 507 Why Is the Distinction between Current and Noncurrent Items Important? 508 Balance Sheet Classifications 508 Assets 510 Liabilities and Owners' (Shareholders') Equity 513 Internal Financial Position Reporting 518 Summary 519 Key Terms 519 Chapter 19 Company Performance: Cash Flows 529 GAAP and the Statement of Cash Flows 530 Purpose of the,statement of Cash Flows 530 Sections of the Statement of Cash Flows 530 Operating Activities: Cash Flows 532 Brief Comparison of the Direct and Indirect Methods 532 Calculation of Operating Cash Flows: Direct Method 535 Calculation of Operating Cash Flows: Indirect Method 540 Comparison of Direct and Indirect Methods 544 Apple's Operating Cash Flows 544 Investing Activities: Cash Flows 544 Calculating Investing Cash Flows 545 Investing Cash Flows of Apple 547 Financing Activities: Cash Flows 547 Calculating Financing Cash Flows 547 Financing Cash Flows of Apple 549 Net Change in Cash 549 Other Investing and Financing Activities 549 Internal Evaluation of Cash Flows 550 Summary 550 Key Terms 550 Chapter 20 Company Performance: Comprehensive Evaluation 563 External Stakeholders 564 Creditors and Investors 564 Society 565 Trading in Capital Markets 566 Information in Capital Markets 566 Issues to Consider 566 Role of Independent Auditor 567 Annual Report Analysis 568 Studying the Financial Statements 568 Industry Analysis 569 Statement Analyses 569 Vertical Analysis 5 70 Horizontal Analysis 571 Ratio Analysis 573 Other Information 580 Management's Letter to Shareholders 581 Segment and Quarterly Data 581 A uditor 's Report 581 Summary 582 Key Terms' 583 APPENDIX Apple's 2008 Financial Statements and Accompanying Notes 591 INDEX 637