Financial Accounting

1 Accounting in Action 1-1

Knowing the Numbers: Columbia Sportswear 1-1

1.1 Accounting Activities and Users 1-3

Three Activities 1-3

Data Analytics 1-4

Who Uses Accounting Data 1-5

1.2 The Building Blocks of Accounting 1-7

Ethics in Financial Reporting 1-8

Generally Accepted Accounting Principles 1-9

Measurement Principles 1-10

Assumptions 1-10

1.3 The Accounting Equation 1-13

Assets 1-13

Liabilities 1-13

Stockholders’ Equity 1-14

1.4 Analyzing Business Transactions 1-15

Accounting Transactions 1-16

Transaction Analysis 1-17

Summary of Transactions 1-21

1.5 The Four Financial Statements 1-22

Income Statement 1-23

Retained Earnings Statement 1-25

Balance Sheet 1-25

Statement of Cash Flows 1-25

Financial Statements: Order of Preparation 1-26

ESG Reporting: Beyond the Four Financial Statements 1-27

Appendix 1A: Career Opportunities in Accounting 1-28

Public Accounting 1-29

Private Accounting 1-29

Governmental Accounting 1-29

Forensic Accounting 1-30

“Show Me the Money” 1-30

2 The Recording Process 2-1

Accidents Happen: MF Global Holdings 2-1

2.1 Accounts, Debits, and Credits 2-3

Debits and Credits 2-3

Debit and Credit Procedures 2-4

Stockholders’ Equity Relationships 2-7

Summary of Debit/Credit Rules 2-8

2.2 The Journal 2-9

The Recording Process 2-9

The Journal 2-10

2.3 The Ledger and Posting 2-12

The Ledger 2-12

Posting 2-14

Chart of Accounts 2-15

The Recording Process Illustrated 2-16

Summary Illustration of Journalizing and Posting 2-22

2.4 The Trial Balance 2-24

Limitations of a Trial Balance 2-25

Locating Errors 2-25

Dollar Signs and Underlining 2-25

3 Adjusting the Accounts 3-1

Keeping Track of Groupons: Groupon 3-1

3.1 Accrual-Basis Accounting and Adjusting Entries 3-2

Fiscal and Calendar Years 3-3

Accrual- versus Cash-Basis Accounting 3-4

Recognizing Revenues and Expenses 3-4

The Need for Adjusting Entries 3-6

Types of Adjusting Entries 3-7

3.2 Adjusting Entries for Deferrals 3-8

Prepaid Expenses 3-8

Unearned Revenues 3-13

3.3 Adjusting Entries for Accruals 3-16

Accrued Revenues 3-17

Accrued Expenses 3-18

Summary of Basic Relationships 3-22

3.4 Adjusted Trial Balance and Financial Statements 3-24

Preparing the Adjusted Trial Balance 3-25

Preparing Financial Statements 3-25

Appendix 3A: Adjusting Entries for the Alternative Treatment of Deferrals 3-28

Prepaid Expenses 3-29

Unearned Revenues 3-30

Summary of Additional Adjustment Relationships 3-31

Appendix 3B: Financial Reporting Concepts 3-31

Qualities of Useful Information 3-32

Assumptions in Financial Reporting 3-33

Principles in Financial Reporting 3-33

Cost Constraint 3-34

4 Completing the Accounting Cycle 4-1

Everyone Likes to Win: Rhino Foods 4-1

4.1 The Worksheet 4-3

Steps in Preparing a Worksheet 4-4

Preparing Financial Statements from a Worksheet 4-6

Preparing Adjusting Entries from a Worksheet 4-8

4.2 Closing the Books 4-8

Preparing Closing Entries 4-9

Posting Closing Entries 4-11

Preparing a Post-Closing Trial Balance 4-12

4.3 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

4.4 The Classified Balance Sheet 4-19

Current Assets 4-19

Long-Term Investments 4-21

Property, Plant, and Equipment 4-21

Intangible Assets 4-22

Current Liabilities 4-23

Long-Term Liabilities 4-24

Stockholders’ (Owners’) Equity 4-24

Appendix 4A: Reversing Entries 4-25

Reversing Entries Example 4-26

5 Accounting for Merchandising Operations 5-1

Buy Now, Vote Later: REI 5-1

5.1 Merchandising Operations and Inventory Systems 5-3

Operating Cycles 5-3

Flow of Costs 5-4

5.2 Recording Purchases Under a Perpetual System 5-7

Freight Costs 5-8

Purchase Returns and Allowances 5-9

Purchase Discounts 5-10

Summary of Purchasing Transactions 5-11

5.3 Recording Sales Under a Perpetual System 5-11

Sales Returns and Allowances 5-13

Sales Discounts 5-14

Data Analytics and Credit Sales 5-15

5.4 The Accounting Cycle for a Merchandising Company 5-16

Adjusting Entries 5-16

Closing Entries 5-17

Summary of Merchandising Entries 5-17

5.5 Preparing the Multiple-Step Income Statement 5-19

Multiple-Step Income Statement 5-19

Single-Step Income Statement 5-22

Classified Balance Sheet 5-22

Appendix 5A: Merchandising Company Worksheet 5-24

Using a Worksheet 5-24

Appendix 5B: Periodic Inventory System 5-25

Determining Cost of Goods Sold Under a Periodic System 5-26

Recording Merchandise Transactions 5-27

Recording Purchases of Merchandise 5-27

Recording Sales of Merchandise 5-28

Journalizing and Posting Closing Entries 5-29

Using a Worksheet 5-30

Data Analytics in Action 5-54

6 Inventories 6-1

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

6.1 Classifying and Determining Inventory 6-2

Classifying Inventory 6-3

Determining Inventory Quantities 6-4

6.2 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

6.3 Effects of Inventory Errors 6-17

Income Statement Effects 6-17

Balance Sheet Effects 6-18

6.4 Inventory Presentation and Analysis 6-19

Presentation 6-19

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

Financial Analysis and Data Analytics 6-20

Appendix 6A: Inventory Cost Flow Methods in Perpetual Inventory Systems 6-24

First-In, First-Out (FIFO) 6-24

Last-In, First-Out (LIFO) 6-25

Average-Cost 6-25

Appendix 6B: Estimating Inventories 6-26

Gross Profit Method 6-27

Retail Inventory Method 6-27

Data Analytics in Action 6-50

7 Fraud, Internal Control, and Cash 7-1

Minding the Money in Madison: Barriques 7-2

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 7-5

Data Analytics and Internal Controls 7-10

Limitations of Internal Control 7-11

7.2 Cash Controls 7-12

Cash Receipts Controls 7-12

Cash Disbursements Controls 7-15

Petty Cash Fund 7-16

7.3 Control Features of a Bank Account 7-19

Making Bank Deposits 7-20

Writing Checks 7-20

Electronic Banking 7-21

Bank Statements 7-22

Reconciling the Bank Account 7-23

7.4 Reporting Cash 7-28

Cash Equivalents 7-29

Restricted Cash 7-29

Data Analytics in Action 7-49

8 Accounting for Receivables 8-1

What’s Cooking?: Nike 8-1

8.1 Recognition of Accounts Receivable 8-3

Types of Receivables 8-3

Recognizing Accounts Receivable 8-3

8.2 Valuation and Disposition of Accounts Receivable 8-5

Valuing Accounts Receivable 8-5

Disposing of Accounts Receivable 8-13

8.3 Notes Receivable 8-15

Determining the Maturity Date 8-16

Computing Interest 8-16

Recognizing Notes Receivable 8-17

Valuing Notes Receivable 8-17

Disposing of Notes Receivable 8-17

8.4 Presentation and Analysis of Receivables 8-20

Presentation 8-20

Analysis 8-21

Data Analytics and Receivables Management 8-22

Data Analytics in Action 8-42

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

A Tale of Two Airlines: American Airlines 9-1

9.1 Plant Asset Expenditures 9-3

Determining the Cost of Plant Assets 9-3

Expenditures During Useful Life 9-6

9.2 Depreciation Methods 9-8

Factors in Computing Depreciation 9-9

Depreciation Methods 9-9

Depreciation and Income Taxes 9-16

Revising Periodic Depreciation 9-16

Impairments 9-17

9.3 Plant Asset Disposals 9-18

Sale of Plant Assets 9-18

Retirement of Plant Assets 9-20

9.4 Natural Resources and Intangible Assets 9-21

Natural Resources 9-21

Depletion 9-21

Intangible Assets 9-22

Accounting for Intangible Assets 9-23

Types of Intangible Assets 9-23

Research and Development Costs 9-26

9.5 Statement Presentation and Analysis 9-27

Presentation 9-27

Analysis 9-28

Appendix 9A: Exchange of Plant Assets 9-29

Loss Treatment 9-29

Gain Treatment 9-30

Data Analytics in Action 9-51

10 Liabilities 10-1

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

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 10-6

Payroll and Payroll Taxes Payable 10-6

10.2 Characteristics of Bonds 10-9

Types of Bonds 10-9

Issuing Procedures 10-10

Bond Trading 10-10

Determining the Market Price of a Bond 10-11

10.3 Accounting for Bond Transactions 10-14

Issuing Bonds at Face Value 10-14

Discount or Premium on Bonds 10-14

Issuing Bonds at a Discount 10-15

Issuing Bonds at a Premium 10-17

Redeeming Bonds at Maturity 10-19

Redeeming Bonds Before Maturity 10-19

10.4 Accounting for Long-Term Notes Payable 10-20

Mortgage Notes Payable 10-20

Lease Liabilities 10-21

10.5 Presentation and Analysis 10-23

Presentation 10-23

Analysis 10-23

Debt and Equity Financing 10-26

Appendix 10A: Straight-Line Amortization 10-28

Amortizing Bond Discount 10-28

Amortizing Bond Premium 10-29

Appendix 10B: Effective-Interest Amortization 10-30

Amortizing Bond Discount 10-31

Amortizing Bond Premium 10-32

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

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

11.1 Corporate Form of Organization 11-3

Characteristics of a Corporation 11-3

Forming a Corporation 11-6

Stockholder Rights 11-7

Stock Issue Considerations 11-8

Corporate Capital 11-10

11.2 Accounting for Common, Preferred, and Treasury Stock 11-12

Accounting for Common Stock 11-12

Accounting for Preferred Stock 11-14

Accounting for Treasury Stock 11-15

11.3 Accounting for Dividends and Stock Splits 11-19

Cash Dividends 11-19

Dividend Preferences 11-21

Stock Dividends 11-24

Stock Splits 11-26

11.4 Reporting and Analyzing Stockholders’ Equity 11-28

Retained Earnings 11-28

Retained Earnings Restrictions 11-29

Balance Sheet Presentation of Stockholders’ Equity 11-30

Analysis of Stockholders’ Equity 11-31

Appendix 11A: Stockholders’ Equity Statement 11-33

Appendix 11B: Book Value per Share 11-34

Book Value per Share Example 11-35

Book Value versus Market Price 11-35

Data Analytics in Action 11-58

12 Statement of Cash Flows 12-1

Got Cash?: Microsoft 12-2

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

12.2 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

12.3 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 12-21

Step 2: Investing and Financing Activities 12-25

Step 3: Net Change in Cash 12-27

Appendix 12B: Worksheet for the Indirect Method 12-27

Preparing the Worksheet 12-28

Appendix 12C: Statement of Cash Flows—T-Account Approach 12-32

Data Analytics in Action 12-58

13 Financial Analysis: The Big Picture 13-1

It Pays to Be Patient: Warren Buffett 13-2

13.1 Sustainable Income and Quality of Earnings 13-3

Sustainable Income 13-3

Quality of Earnings 13-7

13.2 Horizontal Analysis and Vertical Analysis 13-9

Horizontal Analysis 13-10

Vertical Analysis 13-12

13.3 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 Time Value of Money F- 1

F.1 Interest and Future Values F- 2

Nature of Interest F- 2

Future Value of a Single Amount F- 3

Future Value of an Annuity F- 5

F.2 Present Values F- 8

Present Value Variables F- 8

Present Value of a Single Amount F- 9

Present Value of an Annuity F- 11

Time Periods and Discounting F- 13

Present Value of a Long-Term Note or Bond F- 13

F.3 Capital Budgeting Situations F- 16

F.4 Using Technological Tools F- 18

Present Value of a Single Sum F- 19

Present Value of an Annuity F- 20

Future Value of a Single Sum F- 21

Future Value of an Annuity F- 22

Internal Rate of Return F- 22

Useful Applications F- 23

Appendix G Reporting and Analyzing Investments G- 1

G.1 Accounting for Debt Investments G- 2

Why Corporations Invest G- 2

Accounting for Debt Investments G- 2

G.2 Accounting for Stock Investments G- 4

Holdings of Less Than 20% G- 5

Holdings Between 20% and 50% G- 6

Holdings of More Than 50% G- 7

G.3 Reporting Investments in Financial Statements G- 9

Debt Securities G- 9

Equity Securities G- 12

Balance Sheet Presentation G- 13

Presentation of Realized and Unrealized Gain or Loss G- 14

Company Index I- 1

Subject Index I- 3

Rapid Review: Chapter Content

Appendix H Payroll Accounting H- 1

H.1 Recording the Payroll H- 1

Determining the Payroll H- 2

Recording the Payroll H- 5

H.2 Employer Payroll Taxes H- 8

FICA Taxes H- 8

Federal Unemployment Taxes H- 8

State Unemployment Taxes H- 9

Recording Employer Payroll Taxes H- 10

Filing and Remitting Payroll Taxes H- 10

Appendix I Subsidiary Ledgers and Special Journals I- 1

I.1 Subsidiary Ledgers I- 1

Subsidiary Ledger Example I- 2

Advantages of Subsidiary Ledgers I- 3

I.2 Special Journals I- 4

Sales Journal I- 4

Cash Receipts Journal I- 7

Purchases Journal I- 10

Cash Payments Journal I- 12

Effects of Special Journals on the General Journal I- 15

Cybersecurity: A Final Comment I- 16

Appendix J Accounting for Partnerships J- 1

J.1 Forming a Partnership J- 1

Characteristics of Partnerships J- 1

Organizations with Partnership Characteristics J- 3

Advantages and Disadvantages of Partnerships J- 4

The Partnership Agreement J- 5

Accounting for a Partnership Formation J- 5

J.2 Accounting for Partnership Net Income or Net Loss J- 6

Dividing Net Income or Net Loss J- 6

Partnership Financial Statements J- 10

J.3 Accounting for Partnership Liquidation J- 11

No Capital Deficiency J- 11

Capital Deficiency J- 13

J.4 Admission and Withdrawal of Partners J- 15

Admission of a Partner J- 15

Withdrawal of a Partner J- 19

Appendix K Other Significant Liabilities K- 1

K.1 Contingent Liabilities K- 1

Reporting a Contingent Liability K- 2

Disclosure of Contingent Liabilities K- 3

K.2 Additional Employee Compensation Benefits K- 3

Paid Absences K- 3

Postretirement Benefits K- 4