Financial Accounting

1 Accounting in Action 1-1

Knowing the Numbers: Columbia Sportswear 1-1

Accounting Activities and Users 1-3

Three Activities 1-3

Who Uses Accounting Data 1-4

The Building Blocks of Accounting 1-6

Ethics in Financial Reporting 1-6

Generally Accepted Accounting Principles 1-8

Measurement Principles 1-8

Assumptions 1-9

The Accounting Equation 1-11

Assets 1-11

Liabilities 1-12

Stockholders’ Equity 1-12

Analyzing Business Transactions 1-13

Accounting Transactions 1-14

Transaction Analysis 1-15

Summary of Transactions 1-19

The Financial Statements 1-21

Income Statement 1-21

Retained Earnings Statement 1-23

Balance Sheet 1-23

Statement of Cash Flows 1-23

Appendix 1A: Career Opportunities in Accounting 1-25

Public Accounting 1-25

Private Accounting 1-25

Governmental Accounting 1-26

Forensic Accounting 1-26

“Show Me the Money” 1-26

2 The Recording Process 2-1

Accidents Happen: MF Global Holdings 2-1

Accounts, Debits, and Credits 2-3

Debits and Credits 2-3

Stockholders’ Equity Relationships 2-7

Summary of Debit/Credit Rules 2-7

The Journal 2-8

The Recording Process 2-8

The Journal 2-9

The Ledger and Posting 2-11

The Ledger 2-11

Posting 2-12

Chart of Accounts 2-13

The Recording Process Illustrated 2-14

Summary Illustration of Journalizing and Posting 2-20

The Trial Balance 2-22

Limitations of a Trial Balance 2-23

Locating Errors 2-23

Dollar Signs and Underlining 2-23

3 Adjusting the Accounts 3-1

Keeping Track of Groupons: Groupon 3-1

Accrual-Basis Accounting and Adjusting Entries 3-2

Fiscal and Calendar Years 3-3

Accrual- versus Cash-Basis Accounting 3-3

Recognizing Revenues and Expenses 3-3

The Need for Adjusting Entries 3-5

Types of Adjusting Entries 3-6

Adjusting Entries for Deferrals 3-7

Prepaid Expenses 3-7

Unearned Revenues 3-11

Adjusting Entries for Accruals 3-14

Accrued Revenues 3-14

Accrued Expenses 3-15

Summary of Basic Relationships 3-18

Adjusted Trial Balance and Financial Statements 3-21

Preparing the Adjusted Trial Balance 3-22

Preparing Financial Statements 3-22

Appendix 3A: Adjusting Entries for the Alternative Treatment of Deferrals 3-25

Prepaid Expenses 3-26

Unearned Revenues 3-27

Summary of Additional Adjustment Relationships 3-28

Appendix 3B: Financial Reporting Concepts 3-28

Qualities of Useful Information 3-28

Assumptions in Financial Reporting 3-29

Principles in Financial Reporting 3-29

Cost Constraint 3-31

4 Completing the Accounting Cycle 4-1

Everyone Likes to Win: Rhino Foods 4-1

The Worksheet 4-3

Steps in Preparing a Worksheet 4-3

Preparing Financial Statements from a Worksheet 4-7

Preparing Adjusting Entries from a Worksheet 4-8

Closing the Books 4-8

Preparing Closing Entries 4-9

Posting Closing Entries 4-11

Preparing a Post-Closing Trial Balance 4-12

The Accounting Cycle and Correcting Entries 4-15

Summary of the Accounting Cycle 4-15

Reversing Entries—An Optional Step 4-15

Correcting Entries—An Avoidable Step 4-15

Classified Balance Sheet 4-18

Current Assets 4-20

Long-Term Investments 4-20

Property, Plant, and Equipment 4-20

Intangible Assets 4-21

Current Liabilities 4-22

Long-Term Liabilities 4-23

Stockholders’ (Owners’) Equity 4-23

Appendix 4A: Reversing Entries 4-24

Reversing Entries Example 4-25

5 Accounting for Merchandising Operations 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

The Accounting Cycle for a Merchandising Company 5-15

Adjusting Entries 5-15

Closing Entries 5-16

Summary of Merchandising Entries 5-16

Multiple-Step Income Statement 5-18

Multiple-Step Income Statement 5-18

Single-Step Income Statement 5-21

Classified Balance Sheet 5-21

Appendix 5A: Merchandising Company Worksheet 5-23

Using a Worksheet 5-23

Appendix 5B: Periodic Inventory System 5-24

Determining Cost of Goods Sold Under a Periodic System 5-25

Recording Merchandise Transactions 5-26

Recording Purchases of Merchandise 5-26

Recording Sales of Merchandise 5-27

Journalizing and Posting Closing Entries 5-28

Using a Worksheet 5-29

6 Inventories 6-1

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

Classifying and Determining Inventory 6-2

Classifying Inventory 6-3

Determining Inventory Quantities 6-4

Inventory Methods and Financial Effects 6-7

Specific Identification 6-7

Cost Flow Assumptions 6-8

Financial Statement and Tax Effects of Cost Flow Methods 6-13

Using Inventory Cost Flow Methods Consistently 6-15

Effects of Inventory Errors 6-16

Income Statement Effects 6-17

Balance Sheet Effects 6-18

Inventory Presentation and Analysis 6-18

Presentation 6-18

Lower-of-Cost-or-Net Realizable Value 6-19

Analysis 6-20

Appendix 6A: Inventory Cost Flow Methods in Perpetual Inventory Systems 6-22

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

Last-In, First-Out (LIFO) 6-23

Average-Cost 6-23

Appendix 6B: Estimating Inventories 6-24

Gross Profit Method 6-24

Retail Inventory Method 6-25

7 Fraud, Internal Control, and Cash 7-1

Minding the Money in Madison: Barriques 7-2

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 7-15

Petty Cash Fund 7-16

Control Features of a Bank Account 7-19

Making Bank Deposits 7-19

Writing Checks 7-20

Electronic Funds Transfer (EFT) System 7-21

Bank Statements 7-21

Reconciling the Bank Account 7-22

Reporting Cash 7-27

Cash Equivalents 7-27

Restricted Cash 7-28

8 Accounting for 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 8-16

Recognizing Notes Receivable 8-16

Valuing Notes Receivable 8-16

Disposing of Notes Receivable 8-16

Presentation and Analysis of Receivables 8-19

Presentation 8-19

Analysis 8-20

Data Analytics and Receivables Management 8-21

9 Plant Assets, Natural Resources, and Intangible Assets 9-1

A Tale of Two Airlines: American Airlines 9-2

Plant Asset Expenditures 9-3

Determining the Cost of Plant Assets 9-3

Expenditures During Useful Life 9-5

Depreciation Methods 9-7

Factors in Computing Depreciation 9-8

Depreciation Methods 9-9

Depreciation and Income Taxes 9-14

Revising Periodic Depreciation 9-15

Impairments 9-16

Plant Asset Disposals 9-16

Sale of Plant Assets 9-17

Retirement of Plant Assets 9-18

Natural Resources and Intangible Assets 9-19

Natural Resources 9-19

Depletion 9-20

Intangible Assets 9-20

Accounting for Intangible Assets 9-21

Types of Intangible Assets 9-22

Research and Development Costs 9-23

Statement Presentation and Analysis 9-24

Presentation 9-24

Analysis 9-25

Appendix 9A: Exchange of Plant Assets 9-27

Loss Treatment 9-27

Gain Treatment 9-28

10 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

Accounting for Long-Term Notes Payable 10-18

Mortgage Notes Payable 10-18

Lease Liabilities 10-19

Reporting and Analyzing Liabilities 10-21

Presentation 10-21

Analysis 10-21

Debt and Equity Financing 10-23

Appendix 10A: Straight-Line Amortization 10-25

Amortizing Bond Discount 10-25

Amortizing Bond Premium 10-26

Appendix 10B: Effective-Interest Amortization 10-27

Amortizing Bond Discount 10-28

Amortizing Bond Premium 10-29

11 Corporations: Organization, Stock Transactions, and Stockholders’ Equity 11-1

Oh Well, I Guess I’ll Get Rich: Facebook 11-2

Corporate Form of Organization 11-3

Characteristics of a Corporation 11-3

Forming a Corporation 11-6

Stockholder Rights 11-6

Stock Issue Considerations 11-8

Corporate Capital 11-10

Accounting for Stock Issuances 11-11

Accounting for Common Stock 11-11

Accounting for Preferred Stock 11-14

Accounting for Treasury Stock 11-15

Cash Dividends, Stock Dividends, and Stock Splits 11-18

Cash Dividends 11-19

Dividend Preferences 11-21

Stock Dividends 11-23

Stock Splits 11-25

Reporting and Analyzing Stockholders’ Equity 11-27

Retained Earnings 11-27

Retained Earnings Restrictions 11-28

Balance Sheet Presentation of Stockholders’ Equity 11-29

Analysis of Stockholders’ Equity 11-30

Appendix 11A: Stockholders’ Equity Statement 11-32

Appendix 11B: Book Value per Share 11-33

Book Value per Share Example 11-33

Book Value versus Market Price 11-34

12 Statement of Cash Flows 12-1

Got Cash?: Microsoft 12-2

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 12-15

Analyzing the Statement of Cash Flows 12-17

Free Cash Flow 12-17

Appendix 12A: Statement of Cash Flows—Direct Method 12-19

Step 1: Operating Activities 12-19

Step 2: Investing and Financing Activities 12-24

Step 3: Net Change in Cash 12-26

Appendix 12B: Worksheet for the Indirect Method 12-26

Preparing the Worksheet 12-27

Appendix 12C: Statement of Cash Flows—T-Account Approach 12-31

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 13-15

Liquidity Ratios 13-16

Solvency Ratios 13-17

Profitability Ratios 13-17

Financial Analysis and Data Analytics 13-18

Comprehensive Example of Ratio Analysis 13-18

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

Appendix B Specimen Financial Statements: PepsiCo, Inc. B-1

Appendix C Specimen Financial Statements: The Coca-Cola Company C-1

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

Appendix E Specimen Financial Statements: Walmart 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-2

Nature of Interest G-2

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-8

Present Value of an Annuity G-10

Time Periods and Discounting G-12

Present Value of a Long-Term Note or Bond G-12

Capital Budgeting Situations G-15

Using Financial Calculators G-16

Present Value of a Single Sum G-17

Present Value of an Annuity G-18

Future Value of a Single Sum G-18

Future Value of an Annuity G-18

Internal Rate of Return G-19

Useful Applications of the Financial Calculator G-19

Appendix H Reporting and Analyzing Investments H-1

Accounting for Debt Investments H-1

Why Corporations Invest H-2

Accounting for Debt Investments H-3

Accounting for Stock Investments H-4

Holdings of Less Than 20% H-5

Holdings Between 20% and 50% H-6

Holdings of More Than 50% H-7

Reporting Investments in Financial Statements H-8

Debt Securities H-9

Equity Securities H-12

Balance Sheet Presentation H-12

Presentation of Realized and Unrealized Gain or Loss H-14

Company Index / Subject Index I-1