Financial Accounting

1 Introduction to Financial Statements 1-1

Knowing the Numbers: Columbia Sportswear Company 1-1

Business Organization and Accounting Information Uses 1-2

Forms of Business Organization 1-3

Users and Uses of Financial Information 1-3

Ethics in Financial Reporting 1-5

The Three Types of Business Activity 1-7

Financing Activities 1-7

Investing Activities 1-8

Operating Activities 1-8

The Four Financial Statements 1-9

Income Statement 1-10

Retained Earnings Statement 1-11

Balance Sheet 1-11

Statement of Cash Flows 1-12

Interrelationships of Statements 1-13

Other Elements of an Annual Report 1-16

A Look at IFRS 1-42

2 A Further Look at Financial Statements 2-1

Just Fooling Around?: The Motley Fool 2-2

The Classified Balance Sheet 2-3

Current Assets 2-3

Long-Term Investments 2-5

Property, Plant, and Equipment 2-5

Intangible Assets 2-5

Current Liabilities 2-7

Long-Term Liabilities 2-7

Stockholders’ Equity 2-7

Analyzing the Financial Statements Using Ratios 2-8

Ratio Analysis 2-8

Using the Income Statement 2-9

Using a Classified Balance Sheet 2-10

Using the Statement of Cash Flows 2-13

Financial Reporting Concepts 2-15

The Standard-Setting Environment 2-16

Qualities of Useful Information 2-16

Assumptions in Financial Reporting 2-17

Principles in Financial Reporting 2-18

Cost Constraint 2-19

A Look at IFRS 2-45

3 The Accounting Information System 3-1

Accidents Happen: MF Global Holdings Ltd 3-1

Using the Accounting Equation to Analyze Transactions 3-3

Accounting Transactions 3-3

Analyzing Transactions 3-4

Summary of Transactions 3-10

Accounts, Debits, and Credits 3-11

Debits and Credits 3-11

Debit and Credit Procedures 3-12

Stockholders’ Equity Relationships 3-15

Summary of Debit/Credit Rules 3-16

Using a Journal 3-17

The Recording Process 3-17

The Journal 3-18

The Ledger and Posting 3-20

The Ledger 3-20

Chart of Accounts 3-20

Posting 3-21

The Recording Process Illustrated 3-22

Summary Illustration of Journalizing and Posting 3-28

The Trial Balance 3-30

Limitations of a Trial Balance 3-31

A Look at IFRS 3-61

4 Accrual Accounting Concepts 4-1

Keeping Track of Groupons: Groupon 4-1

Accrual-Basis Accounting and Adjusting Entries 4-2

The Revenue Recognition Principle 4-3

The Expense Recognition Principle 4-4

Accrual versus Cash Basis of Accounting 4-5

The Need for Adjusting Entries 4-5

Types of Adjusting Entries 4-6

Adjusting Entries for Deferrals 4-7

Prepaid Expenses 4-7

Unearned Revenues 4-11

Adjusting Entries for Accruals 4-14

Accrued Revenues 4-14

Accrued Expenses 4-16

Summary of Basic Relationships 4-19

The Adjusted Trial Balance and Closing Entries 4-21

Preparing the Adjusted Trial Balance 4-21

Preparing Financial Statements 4-22

Quality of Earnings 4-23

Closing the Books 4-26

Summary of the Accounting Cycle 4-28

Appendix 4A: Using a Worksheet 4-33

A Look at IFRS 4-65

5 Merchandising Operations and the Multiple-Step Income Statement 5-1

Buy Now, Vote Later: REI 5-1

Merchandising Operations and Inventory Systems 5-3

Operating Cycles 5-3

Flow of Costs 5-4

Recording Purchases Under a Perpetual System 5-6

Freight Costs 5-8

Purchase Returns and Allowances 5-9

Purchase Discounts 5-9

Summary of Purchasing Transactions 5-10

Recording Sales Under a Perpetual System 5-11

Sales Returns and Allowances 5-12

Sales Discounts 5-13

Data Analytics and Credit Sales 5-14

Multiple-Step and Comprehensive Income Statements 5-15

Single-Step Income Statement 5-15

Multiple-Step Income Statement 5-16

Comprehensive Income Statement 5-19

Cost of Goods Sold Under a Periodic System 5-21

Gross Profit Rate and Profit Margin 5-22

Gross Profit Rate 5-22

Profit Margin 5-23

Appendix 5A: Periodic Inventory System 5-26

Recording Merchandise Transactions 5-26

Recording Purchases of Merchandise 5-27

Freight Costs 5-27

Recording Sales of Merchandise 5-27

Comparison of Entries—Perpetual vs. Periodic 5-28

Appendix 5B: Adjusting Entries for Credit Sales with Returns and Allowances 5-29

A Look at IFRS 5-54

6 Reporting and Analyzing Inventory 6-1

“Where Is That Spare Bulldozer Blade?”: Caterpillar 6-1

Classifying and Determining Inventory 6-2

Classifying Inventory 6-2

Determining Inventory Quantities 6-4

Inventory Methods and Financial Effects 6-6

Specific Identification 6-7

Cost Flow Assumptions 6-7

Financial Statement and Tax Eff ects of Cost Flow Methods 6-12

Using Inventory Cost Flow Methods Consistently 6-14

Inventory Presentation and Analysis 6-15

Presentation 6-15

Lower-of-Cost-or-Net Realizable Value 6-16

Analysis 6-16

Adjustments for LIFO Reserve 6-18

Appendix 6A: Inventory Cost Flow Methods in Perpetual Inventory Systems 6-21

First-In, First-Out (FIFO) 6-22

Last-In, First-Out (LIFO) 6-22

Average-Cost 6-23

Appendix 6B: Eff ects of Inventory Errors 6-23

Income Statement Eff ects 6-24

Balance Sheet Eff ects 6-25

A Look at IFRS 6-48

7 Fraud, Internal Control, and Cash 7-1

Minding the Money in Madison: Barriques 7-1

Fraud and Internal Control 7-3

Fraud 7-3

The Sarbanes-Oxley Act 7-3

Internal Control 7-4

Principles of Internal Control Activities 7-4

Data Analytics and Internal Controls 7-10

Limitations of Internal Control 7-11

Cash Controls 7-12

Cash Receipts Controls 7-12

Cash Disbursements Controls 7-14

Petty Cash Fund 7-16

Control Features of a Bank Account 7-17

Electronic Funds Transfer (EFT) System 7-17

Bank Statements 7-18

Reconciling the Bank Account 7-19

Reporting Cash and Cash Management 7-24

Reporting Cash 7-24

Managing and Monitoring Cash 7-25

Cash Budgeting 7-27

Appendix 7A: Operation of a Petty Cash Fund 7-30

Establishing the Petty Cash Fund 7-30

Making Payments from the Petty Cash Fund 7-31

Replenishing the Petty Cash Fund 7-31

A Look at IFRS 7-56

8 Reporting and Analyzing Receivables 8-1

What’s Cooking? Nike 8-1

Recognition of Accounts Receivable 8-3

Types of Receivables 8-3

Recognizing Accounts Receivable 8-3

Valuation and Disposition of Accounts Receivable 8-5

Valuing Accounts Receivable 8-5

Disposing of Accounts Receivable 8-12

Notes Receivable 8-14

Determining the Maturity Date 8-15

Computing Interest 8-15

Recognizing Notes Receivable 8-16

Valuing Notes Receivable 8-16

Disposing of Notes Receivable 8-16

Receivables Presentation and Management 8-18

Financial Statement Presentation of Receivables 8-19

Managing Receivables 8-19

Evaluating Liquidity of Receivables 8-21

Accelerating Cash Receipts 8-23

Data Analytics and Receivables Management 8-24

A Look at IFRS 8-47

9 Reporting and Analyzing Long-Lived Assets 9-1

A Tale of Two Airlines: American Airlines 9-1

Plant Asset Expenditures 9-3

Determining the Cost of Plant Assets 9-3

Expenditures During Useful Life 9-6

To Buy or Lease? 9-7

Depreciation Methods 9-8

Factors in Computing Depreciation 9-8

Depreciation Methods 9-9

Revising Periodic Depreciation 9-13

Impairments 9-14

Plant Asset Disposals 9-15

Sale of Plant Assets 9-16

Retirement of Plant Assets 9-17

Intangible Assets 9-18

Accounting for Intangible Assets 9-18

Types of Intangible Assets 9-19

Statement Presentation and Analysis 9-21

Presentation 9-21

Analysis 9-23

Appendix 9A: Other Depreciation Methods 9-27

Declining-Balance Method 9-27

Units-of-Activity Method 9-28

A Look at IFRS 9-54

10 Reporting and Analyzing Liabilities 10-1

And Then There Were Two: Maxwell Car Company 10-1

Accounting for Current Liabilities 10-3

What Is a Current Liability? 10-3

Notes Payable 10-3

Sales Taxes Payable 10-4

Unearned Revenues 10-5

Current Maturities of Long-Term Debt 10-5

Payroll and Payroll Taxes Payable 10-6

Major Characteristics of Bonds 10-8

Types of Bonds 10-8

Issuing Procedures 10-9

Bond Trading 10-9

Determining the Market Price of a Bond 10-10

Accounting for Bond Transactions 10-12

Issuing Bonds at Face Value 10-13

Discount or Premium on Bonds 10-13

Issuing Bonds at a Discount 10-14

Issuing Bonds at a Premium 10-15

Redeeming Bonds at Maturity 10-17

Redeeming Bonds Before Maturity 10-17

Presentation and Analysis 10-18

Presentation 10-18

Analysis 10-20

Appendix 10A: Straight-Line Amortization 10-24

Amortizing Bond Discount 10-24

Amortizing Bond Premium 10-26

Appendix 10B: Effective-Interest Amortization 10-27

Amortizing Bond Discount 10-27

Amortizing Bond Premium 10-29

Appendix 10C: Accounting for Long-Term

Notes Payable 10-30

A Look at IFRS 10-58

11 Reporting and Analyzing Stockholders’ Equity 11-1

Oh Well, I Guess I’ll Get Rich: Facebook 11-1

Corporate Form of Organization 11-3

Characteristics of a Corporation 11-3

Forming a Corporation 11-6

Stockholder Rights 11-6

Stock Issue Considerations 11-7

Corporate Capital 11-9

Accounting for Common, Preferred, and Treasury Stock 11-11

Accounting for Common Stock 11-11

Accounting for Preferred Stock 11-12

Accounting for Treasury Stock 11-13

Cash Dividends, Stock Dividends, and Stock Splits 11-15

Cash Dividends 11-15

Dividend Preferences 11-17

Stock Dividends 11-19

Stock Splits 11-20

Presentation and Analysis 11-22

Retained Earnings 11-22

Retained Earnings Restrictions 11-23

Balance Sheet Presentation of Stockholders’ Equity 11-24

Analysis of Stockholders’ Equity 11-26

Debt Versus Equity Decision 11-27

Appendix 11A: Entries for Stock Dividends 11-30

A Look at IFRS 11-54

12 Statement of Cash Flows 12-1

Got Cash?: Microsoft 12-1

Usefulness and Format of the Statement of Cash Flows 12-3

Usefulness of the Statement of Cash Flows 12-3

Classification of Cash Flows 12-3

Significant Noncash Activities 12-4

Format of the Statement of Cash Flows 12-5

Preparing the Statement of Cash Flows— Indirect Method 12-6

Indirect and Direct Methods 12-7

Indirect Method—Computer Services Company 12-7

Step 1: Operating Activities 12-9

Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method 12-12

Step 2: Investing and Financing Activities 12-13

Step 3: Net Change in Cash 12-14

Analyzing the Statement of Cash Flows 12-17

The Corporate Life Cycle 12-17

Free Cash Flow 12-19

Appendix 12A: Statement of Cash Flows—Direct Method 12-22

Step 1: Operating Activities 12-23

Step 2: Investing and Financing Activities 12-28

Step 3: Net Change in Cash 12-29

Appendix 12B: Worksheet for the Indirect Method 12-29

Preparing the Worksheet 12-30

Appendix 12C: Statement of Cash Flows—T-Account Approach 12-34

A Look at IFRS 12-61

13 Financial Analysis: The Big Picture 13-1

It Pays to Be Patient: Warren Buffett 13-2

Sustainable Income and Quality of Earnings 13-3

Sustainable Income 13-3

Quality of Earnings 13-7

Horizontal Analysis and Vertical Analysis 13-9

Horizontal Analysis 13-10

Vertical Analysis 13-12

Ratio Analysis 13-14

Liquidity Ratios 13-15

Solvency Ratios 13-16

Profitability Ratios 13-16

Financial Analysis and Data Analytics 13-17

Comprehensive Example of Ratio Analysis 13-17

A Look at IFRS 13-54

APPENDIX A Specimen Financial Statements: Apple Inc. A-1

APPENDIX B Specimen Financial Statements: Columbia Sportswear Company B-1

APPENDIX C Specimen Financial Statements: VF Corporation C-1

APPENDIX D Specimen Financial Statements: Amazon.com, Inc. D-1

APPENDIX E Specimen Financial Statements: Wal-Mart Stores, Inc. E-1

APPENDIX F Specimen Financial Statements: Louis Vuitton F-1

APPENDIX G Time Value of Money G-1

Interest and Future Values G-1

Nature of Interest G-1

Future Value of a Single Amount G-3

Future Value of an Annuity G-5

Present Values G-7

Present Value Variables G-7

Present Value of a Single Amount G-7

Present Value of an Annuity G-9

Time Periods and Discounting G-11

Present Value of a Long-Term Note or Bond G-11

Capital Budgeting Situations G-14

Using Financial Calculators G-15

Present Value of a Single Sum G-16

Present Value of an Annuity G-17

Future Value of a Single Sum G-17

Future Value of an Annuity G-17

Internal Rate of Return G-18

Useful Applications of the Financial Calculator G-18

APPENDIX H Reporting and Analyzing Investments H-1

Accounting for Debt Investments H-1

Why Corporations Invest H-1

Accounting for Debt Investments H-3

Accounting for Stock Investments H-4

Holdings of Less Than 20% H-4

Holdings Between 20% and 50% H-5

Holdings of More Than 50% H-6

Reporting Investments in Financial Statements H-7

Debt Securities H-7

Equity Securities H-10

Balance Sheet Presentation H-11

Presentation of Realized and Unrealized Gain or Loss H-12

Company Index I-1

Subject Index I-3