Financial accounting information for decisions

sa, Financial Accounting Information for Decisions edition John J Wild University of Wisconsin at Madison GIFT OF THE As] NOT FOR QUA TANG CUA UỶ KHÔNG DUO, ch HẦU A A FOUNDATI RESALE SN 8 Mc6raw-Hill ie Irwin

Boston Burr Ridge, |L Dubuque, IA Madison, WI New York San Francisco St.Louis Bangkok Bogota Caracas Kuala Lumpur

To my wife Gail and children, Kimberly kí i1 McGraw-Hill cima Irwin :

FINANCIAL ACCOUNTING: INFORMATION FOR DECISIONS =

Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Compan re n Americas, New York, NY, 10020 Copyright © 2005, 2003, 2000 by The McGr Hil

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4567890 VNH/VNH 098765 ISBN 0-07-284317-9

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Contents Preface iii | Introducing Accounting in Business 2 Importance of Accounting 4 Users of Accounting Information 5 Opportunities in Accounting 6 Fundamentals of Accounting 8

Ethics—A Key Concept 8

Generally Accepted Accounting Principles 9

Transaction Analysis and the Accounting Equation 12 Accounting Equation 12 Transaction Analysis 13 Summary of Transactions 16 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 Analyzing and Recording Business Transactions 46 Analyzing and Recording Process 48 Source Documents 49

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

xxvi Contents

3 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 93

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 102

Adjusted Trial Balance 103

Preparing Financial Statements 104 Closing Process 104

Temporary and Permanent Accounts 104 Recording Closing Entries 106

Post-Closing Trial Balance 109

Accounting Cycle Summary 109

Classified Balance Sheet 110 Classification Structure 110 Classification Categories 111 Decision Analysis—Profit Margin and Current Ratio 113 Profit Margin 113 Current Ratio 113 Appendix 3A Alternative Accounting for Prepayments 118 Recording the Prepayment of Expenses in Expense Accounts 118 Recording the Prepayment of Revenues in Revenue Accounts 119

Appendix 3B Work Sheet as a Tool 119 Benefits of a Work Sheet 120 Use of a Work Sheet 120

Work Sheet Application and Analysis 122 Appendix 3C Reversing Entries 122

Accounting without Reversing Entries 122 Accounting with Reversing Entries 122 Reporting and Analyzing Merchandising Operations 150 Merchandising Activities 152 :

Reporting Income for a Merchandiser 152 Reporting Inventory for a Merchandiser 153 Operating Cycle for a Merchandiser 153 Inventory Systems 153

Accounting for Merchandise Purchases 154 Trade Discounts 154

Purchase Discounts 155

Purchase Returns and Allowances 156

Transportation Costs and Ownership Transfer 157 Accounting for Merchandise Sales 158

Sales of Merchandise 159 Sales Discounts 159

Sales Returns and Allowances 160 Completing the Accounting Cycle 161

Adjusting Entries for Merchandisers 162 Preparing Financial Statements 162 Closing Entries for Merchandisers 162 Summary of Merchandising Entries 162 Financial Statement Formats 164

Multiple-Step Income Statement 164 Single-Step Income Statement 166

Classified Balance Sheet 166

F ) Reporting and Analyzing

Inventories 194

Inventory Basics 196

Determining Inventory Items 196 Determining Inventory Costs 197

Inventory Controls and Taking a Physical Count 197 Inventory Costing under a Perpetual System 198

Inventory Cost Flow A ssumptions 198 Inventory Costing Illustration 199 Specific Identification 199 First-In, First-Out 201 Last-In, First-Out 201 Weighted Average 202

Financial Statement Effects of Costing Methods 203 Consistency in Using Costing Methods 204

Valuing Inventory at LCM and the Effects of Inventory Errors 205

Lower of Cost or Market 205

Financial Statement Effects of Inventory Errors 206

Decision Analysis—Inventory Turnover and Days’ Sales in Inventory 207 Appendix 5A Inventory Costing under a Periodic System 213 Appendix 5B Inventory Estimation Methods 217 Reporting and Analyzing Cash and Internal Controls 234 Internal Control 236

Purpose of Internal Control 236

Principles of Internal Control 237 Technology and Internal Control 238 Limitations of Internal Control 239 Control of Cash 240

Cash, Cash Equivalents, and Liquidity 240 Control of Cash Receipts 241

Control of Cash Disbursements 242 Banking Activities as Controls 247

Basic Bank Services 247

Bank Statement 248

Bank Reconciliation 250

Decision Analysis—Days’ Sales Uncollected 253

Appendix 6A Documents in a Voucher System 256 Appendix 6B Control of Purchase Discounts 259 xxvii Contents Reporting and Analyzing Receivables 276 ms Accounts Receivable 278

Recognizing Accounts Receivable 278 Valuing Accounts Receivable 281 Estimating Bad Debts Expense 284 Notes Receivable 287

Computing Maturity and Interest 288

Recognizing Notes Receivable 289 Valuing and Settling Notes 289 Disposing of Receivables 291 Selling Receivables 291 Pledging Receivables 291] Decision Analysis—Accounts Receivable Turnover 292 Reporting and Analyzing Long-Term Assets 308 SECTION 1—Plant Assets 310 Cost Determination 311 Land 311 Land Improvements 312 Buildings 312 Machinery and Equipment 312 Lump-Sum Purchase 312 Depreciation 313 Factors in Computing Depreciation 313 Depreciation Methods 314 Partial-Year Depreciation 318 Change in Estimates for Depreciation 319 Reporting Depreciation 319 Additional Expenditures 320 Ordinary Repairs 321

Betterments and Extraordinary Repairs 321 Disposals of Plant Assets 321

Discarding Plant Assets 322 Selling Plant Assets 322 Exchanging Plant Assets 323

xxvill

9

Contents

SECTION 2—Natural Resources 325 Cost Determination and Depletion 325 Plant Assets Used in Extracting Resources 326

SECTION 3—Intangible Assets 326

Cost Determination and Amortization 326 Types of Intangibles 327

Decision Analysis—Total Asset Turnover 329

Appendix 8A Goodwill Estimation 332 Reporting and Analyzing Current Liabilities 350 Characteristics of Liabilities 352 Defining Liabilities 352 Classifying Liabilities 352 Uncertainty in Liabilities 353 Known (Determinable) Liabilities 354 Accounts Payable 354 Sales Taxes Payable 354 Unearned Revenues 355 Short-Term Notes Payable 355 Payroll Liabilities 357 Estimated Liabilities 361 Health and Pension Benefits 361 Vacation Benefits 362 Bonus Plans 362 Warranty Liabilities 362 Multi-Period Estimated Liabilities 363 Contingent Liabilities 364

Accounting for Contingent Liabilities 364

Reasonably Possible Contingent Liabilities 364 Decision Analysis—Times Interest Earned Ratio 365 Appendix 9A Payroll Reports, Records, and Procedures 368 Appendix 9B Income Taxes 374 10 Reporting and Analyzing Long-Term Liabilities 394 Basics of Bonds 396 Bond Financing 396 Types of Bonds 397 Bond Trading 398 Bond-Issuing Procedures 399 Bond Issuances 399

Issuing Bonds at Par 399 Bond Discount or Premium 400 Issuing Bonds at a Discount 400

Issuing Bonds at a Premium 403

Issuing Bonds between Interest Dates 405 Accruing Bond Interest Expense 406 Bond Pricing 406

Bond Retirement 408

Bond Retirement at Maturity 408 Bond Retirement before Maturity 408 Bond Retirement by Conversion 408

Long-Term Notes Payable 409

Installment Notes 409

Mortgage Notes and Bonds 412

Decision Analysis—Pledged Assets to Secured Liabilities Ratio 413

Appendix 10A Present Values of Bonds and Notes 416

Appendix 10B Effective Interest Amortization 419

11 Reporting and Analyzing Equity 438 Corporate Form of Organization 440 Characteristics of Corporations 440 Corporate Organization and Management 441 Stockholders of Corporations 442 Basics of Capital Stock 443 Common Stock 444

Issuing Par Value Stock 444

Issuing No-Par Value Stock 445 Issuing Stated Value Stock 445

Issuing Stock for Noncash Assets 446

Preferred Stock 447

Issuance of Preferred Stock 447

Dividend Preference of Preferred Stock 447 Convertible Preferred Stock 449

Callable Preferred Stock 449

Reasons for Issuing Preferred Stock 449 Dividends 450 Cash Dividends 450 Stock Dividends 451 Stock Splits 453 Treasury Stock 454

Purchasing Treasury Stock 454 Reissuing Treasury Stock 455 Retiring Stock 455 Reporting Income and Equity 456 Continuing Operations 456 Discontinued Segments 456 Extraordinary Items 456

Changes in Accounting Principles 457 Earnings per Share 458

Stock Options 460

Statement of Retained Earnings 460 Statement of Stockholders’ Equity 461

Decision Analysis—Book Value per Share, Dividend Yield, and Price-Earnings Ratio 462 12 Contents Reporting and Analyzing Cash Flows 490

Basics of Cash Flow Reporting 492

Purpose of the Statement of Cash Flows 492 Importance of Cash Flows 492

Measurement of Cash Flows 493 Classification of Cash Flows 493

Noncash Investing and Financing 494 Format of the Statement of Cash Flows 495 Preparing the Statement of Cash Flows 496 Cash Flows from Operating 498

Indirect and Direct Methods of Reporting 498 Application of the Indirect Method of

Reporting 500

Summary of Adjustments for Indirect Method 504 Cash Flows from Investing 505

Three-Stage Process of Analysis 505 Analysis of Noncurrent Assets 505 Analysis of Other Assets 506 Cash Flows from Financing 507

Three-Stage Process of Analysis 507 Analysis of Noncurrent Liabilities 507 Analysis of Equity 508

Proving Cash Balances 509

Decision Analysis—Cash Flow Analysis 509 Appendix 12A Spreadsheet Preparation of the Statement of Cash Flows 513

Appendix 12B Direct Method of Reporting Operating Cash Flows 516