Appendix A Accessing the EDGAR Database Through the Internet 595
Appendix B Annual Report for The Topps Company, Inc. 596
Appendix C The Double-Entry Accounting System 651
Glossary 659
Photo Credits 671
Index 672
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xxiv
C O N T E N T S
Chapter Opening 2 Careers in Accounting 4
Public Accounting 4 Private Accounting 4 Measurement Rules 5 Reporting Entities 6 Elements of Financial Statements 6
Using Accounts to Gather Information 7
Assets, Income, and Claims on Assets 7
The Accounting Equation 8 Recording Business Events Under the Accounting Equation 9
Asset Source Transactions 9 Asset Exchange Transactions 10 Another Asset Source Transaction 11
Asset Use Transactions 11 Historical Cost and Reliability Concepts 13
Recap: Types of Transactions 13
Summary of Transactions 13
Preparing Financial Statements 14
Income Statement and the Matching Concept 14 Statement of Changes in Stockholders’ Equity 16 Balance Sheet 17
Statement of Cash Flows 17 The Closing Process 18 The Horizontal Financial Statements Model 19 The Financial Analyst 20
Real-World Financial Reports 20
Annual Report for The Topps Company, Inc. 21
Special Terms in Real-World Reports 21
A Look Back 22 A Look Forward 23 Self-Study Review Problem 23
Key Terms 24 Questions 25 Exercises 25 Problems 33 Analyze, Think, Communicate 37 An Introduction to
Accounting 2
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Contents xxv
Chapter Opening 42 Accrual Accounting 44
Accounting for Accounts Receivable 44
Other Events 45
Accounting for Accrued Salary Expense (Adjusting Entry) 45 Summary of Events 47 The General Ledger 47
Vertical Statements Model 47 The Closing Process 50 Steps in an Accounting Cycle 50
The Matching Concept 51 The Conservatism Principle 51 Second Accounting Cycle 51
Prepaid Items (Cost versus Expense) 52
Accounting for Receipt of Unearned Revenue 53 Accounting for Supplies Purchase 53
Other 2011 Events 53 Adjusting Entries 56 Accounting for Supplies (Adjusting Entry) 56
Accounting for Prepaid Rent (Adjusting Entry) 56
Accounting for Unearned Revenue (Adjusting Entry) 57 Accounting for Accrued Salary Expense (Adjusting Entry) 58 Summary of Events 58 The General Ledger 61
Vertical Statements Model 61 The Financial Analyst 64 Corporate Governance 64
Importance of Ethics 64 Sarbanes-Oxley Act of 2002 64
Common Features of Criminal and Ethical Misconduct 66 A Look Back 68
A Look Forward 69
Self-Study Review Problem 69 Key Terms 71
Questions 71 Exercises 71 Problems 80 Analyze, Think, Communicate 86
Chapter Opening 90
Product Costs Versus Selling and Administrative Costs 92 Allocating Inventory Cost Between Asset and Expense Accounts 93
Perpetual Inventory System 93
Effects of 2010 Events on Financial Statements 94 Financial Statements for 2010 95
Understanding the Accounting Cycle 42
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Accounting for Merchandising Businesses 90
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xxvi Contents
Transportation Cost, Purchase Returns and Allowances, and Cash Discounts Related to Inventory Purchases 96 Effects of 2011 Events on Financial Statements 96 Accounting for Purchase Returns and Allowances 97 Purchase Discounts 98 The Cost of Financing Inventory 98
Accounting for Transportation Costs 99
Recognizing Gains and Losses 102
Multistep Income Statement 102
Lost, Damaged, or Stolen Inventory 104
Adjustment for Lost, Damaged, or Stolen Inventory 105
Events Affecting Sales 105 Accounting for Sales Returns and Allowances 106
Accounting for Sales Discounts 106
The Financial Analyst 107 Common Size Financial Statements 108 Ratio Analysis 108
Comparisons within a Particular Company 109
Comparisons between Companies 109 Real-World Data 110 A Look Back 111 A Look Forward 112 Appendix 112
Self-Study Review Problem 113 Key Terms 115 Questions 115 Exercises 116 Problems 123 Analyze, Think, Communicate 127
Chapter Opening 132 Inventory Cost Flow Methods 134
Specifi c Identifi cation 134 First-In, First-Out (FIFO) 134 Last-In, First-Out (LIFO) 134 Weighted Average 134 Physical Flow 134
Effect of Cost Flow on Financial Statements 134
Effect on Income Statement 134
Effect on Balance Sheet 135
Inventory Cost Flow under a Perpetual System 136
Multiple Layers with Multiple Quantities 136
Allocating Cost of Goods Available for Sale 136
Effect of Cost Flow on Financial Statements 137
Key Features of Internal Control Systems 140
Separation of Duties 140 Quality of Employees 141 Bonded Employees 141 Required Absences 141 Accounting for
Inventories 132
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Contents xxvii
Procedures Manual 141
Authority and Responsibility 141 Prenumbered Documents 141 Physical Control 142
Performance Evaluations 142 Limitations 142
Accounting for Cash 143 Controlling Cash 143 Checking Account Documents 144 Reconciling the Bank Account 145
Illustrating a Bank Reconciliation 148
The Financial Analyst 150 Average Number of Days to Sell Inventory 151
Is It a Marketing or an Accounting Decision? 151 Real-World Data 151
Effects of Cost Flow on Ratio Analysis 152
A Look Back 152 A Look Forward 153 Self-Study Review Problem 1 154 Self-Study Review Problem 2 155 Key Terms 155 Questions 155 Exercises 156 Problems 162 Analyze, Think, Communicate 166
Chapter Opening 170
Allowance Method of Accounting for Uncollectible Accounts 172
Accounting Events Affecting the 2010 Period 172
Accounting Events Affecting the 2011 Period 175
Estimating Uncollectible Accounts Expense Using the Percent of Revenue (Sales) Method 177
Analysis of Financial Statements 177
Estimating Uncollectible Accounts Expense Using the Percent of Receivables Method 178
Matching Revenues and Expenses versus Asset Measurement 180
Accounting for Notes Receivable (Promissory Notes) 180
How Accounting for Notes Receivable Affects Financial Statements 181
Financial Statements 183 Accounting for Credit Card Sales 184
The Financial Analyst 185 Costs of Credit Sales 185
Average Number of Days to Collect Accounts Receivable 185 Real-World Data 186 A Look Back 188 A Look Forward 189 Self-Study Review Problem 189 Accounting for
Receivables 170
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xxviii Contents
Key Terms 190 Questions 191 Exercises 191
Problems 198 Analyze, Think, Communicate 203
Chapter Opening 208 Tangible versus Intangible Assets 210
Tangible Long-Term Assets 210 Intangible Assets 210
Determining the Cost of Long-Term Assets 211
Basket Purchase Allocation 211
Methods of Recognizing Depreciation Expense 212
Dryden Enterprises Illustration 213 Straight-Line Depreciation 213
Financial Statements 215 Double-Declining-Balance Depreciation 216 Units-of-Production Depreciation 219
Comparing the Depreciation Methods 220
Revision of Estimates 221 Revision of Life 221 Revision of Salvage 221 Continuing Expenditures for Plant Assets 222
Costs That Are Expensed 222 Costs That Are
Capitalized 222
Natural Resources 224 Intangible Assets 224
Trademarks 224 Patents 225 Copyrights 225 Franchises 226 Goodwill 226
Expense Recognition for Intangible Assets 227
Expensing Intangible Assets with Identifi able Useful Lives 227 Impairment Losses for
Intangible Assets with Indefi nite Useful Lives 227
Balance Sheet Presentation 228
The Financial Analyst 228 Effect of Judgment and Estimation 229
Effect of Industry Characteristics 230 A Look Back 230 A Look Forward 231 Self-Study Review Problem 231 Key Terms 232 Questions 232 Exercises 233 Problems 240 Analyze, Think, Communicate 245 Accounting for Long-Term Operational Assets 208
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Contents xxix
Chapter Opening 250 Accounting for Current Liabilities 252
Accounting for Notes Payable 252
Accounting for Sales Tax 253 Contingent Liabilities 254 Warranty Obligations 255 Financial Statements 256 Accounting for Long-Term Debt 257
Installment Notes Payable 258 Line of Credit 261
Bond Liabilities 261 Security for Loan Agreements 266
The Financial Analyst 266 Current versus Noncurrent 266 Liquidity versus Solvency 267 Real-World Data 269
A Look Back 270 A Look Forward 270 Self-Study Review Problem 271 Key Terms 272 Questions 272 Exercises 272 Problems 278 Analyze, Think, Communicate 283
Chapter Opening 286 Forms of Business Organizations 288
Advantages and Disadvantages of Different Forms of Business Organization 288
Regulation 288 Double Taxation 289 Limited Liability 290 Continuity 290 Transferability of Ownership 291
Management Structure 291 Ability to Raise Capital 291 Appearance of Capital Structure in Financial Statements 291
Presentation of Equity in Proprietorships 292 Presentation of Equity in Partnerships 292
Presentation of Equity in Corporations 293
Characteristics of Capital Stock 293
Par Value 293 Stated Value 294
Other Valuation Terminology 294 Stock: Authorized, Issued, and Outstanding 294 Classes of Stock 294 Accounting for Stock Transactions on the Day of Issue 296
Accounting for Liabilities 250
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Proprietorships, Partnerships, and Corporations 286
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xxx Contents
Issuing Par Value Stock 296 Stock Classifi cation 297 Stock Issued at Stated Value 297
Stock Issued with No Par Value 297
Financial Statement Presentation 298
Stockholders’ Equity Transactions after the Day of Issue 298
Treasury Stock 298 Cash Dividend 300 Stock Dividend 300 Stock Split 301
Appropriation of Retained Earnings 301
Financial Statement Presentation 302
The Financial Analyst 303 Receiving Dividends 303 Increasing the Price of Stock 303
Price-earnings Ratio 304 Exercising Control through Stock Ownership 304 A Look Back 305 A Look Forward 305
Self-Study Review Problem 307 Key Terms 307
Questions 307 Exercises 308 Problems 312 Analyze, Think, Communicate 316
Chapter Opening 322 Factors in Communicating Useful Information 324
The Users 324
The Types of Decisions 324 Information Analysis 324 Methods of Analysis 324 Horizontal Analysis 325 Vertical Analysis 328 Ratio Analysis 328 Measures of Debt-Paying Ability 329
Liquidity Ratios 329 Solvency Ratios 333
Measures of Profitability 335 Measures of Managerial Effectiveness 335
Stock Market Ratios 337
Presentation of Analytical Relationships 340
Limitations of Financial Statement Analysis 341
Different Industries 342 Changing Economic Environment 342
Accounting Principles 342 A Look Back 343
A Look Forward 343 Self-Study Review Problem 343 Key Terms 345 Questions 345 Exercises 346 Problems 351 Analyze, Think, Communicate 357 Financial Statement Analysis 322
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Contents xxxi
Chapter Opening 362
Differences between Managerial and Financial Accounting 364
Users and Types of Information 364
Level of Aggregation 364 Regulation 365
Information Characteristics 365 Time Horizon and Reporting Frequency 365
Product Costing in
Manufacturing Companies 366 Tabor Manufacturing
Company 366
Average Cost per Unit 366 Costs Can Be Assets or Expenses 367
Effect of Product Costs on Financial Statements 368
Materials Costs (Event 2) 369 Labor Costs (Event 4) 369 Overhead Costs (Event 8) 370 Total Product Cost 370
General, Selling, and Administrative Costs 371
Overhead Costs: A Closer Look 371
Manufacturing Product Cost Summary 372
Upstream and Downstream Costs 373
Product Costing in Service and Merchandising Companies 374 Just-in-Time Inventory 375
Just-in-Time Illustration 375 Statement of Ethical
Professional Practice 376 A Look Back 378
A Look Forward 378 Appendix A 379
Self-Study Review Problem 380 Key Terms 382
Questions 382 Exercises 383 Problems 389 Analyze, Think, Communicate 393
Chapter Opening 396 Fixed Cost Behavior 398 Operating Leverage 398
Calculating Percentage Change 400
Risk and Reward Assessment 400
Variable Cost Behavior 401 Risk and Reward
Assessment 401
An Income Statement under the Contribution Margin Approach 402
Measuring Operating Leverage Using Contribution Margin 403 An Introduction to
Managerial Accounting 362
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Cost Behavior, Operating Leverage, and Profitability Analysis 396
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xxxii Contents
Cost Behavior Summarized 404
Mixed Costs (Semivariable Costs) 405
The Relevant Range 405 Context-Sensitive Defi nitions of Fixed and Variable 406 Determining the Break-Even Point 406
Equation Method 407
Contribution Margin per Unit Method 408
Determining the Sales Volume Necessary to Reach a Desired Profit 409
Calculating the Margin of Safety 410
A Look Back 411 A Look Forward 412 Self-Study Review Problem 1 412 Self-Study Review Problem 2 414 Key Terms 415 Questions 416 Exercises 416 Problems 422 Analyze, Think, Communicate 427
Chapter Opening 430
Determine the Cost of Cost Objects 432
Estimated versus Actual Cost 432
Assignment of Costs to Objects in a Retail Business 432
Identifying Direct and Indirect Costs 433
Cost Classifi cations—
Independent and Context Sensitive 434
Allocating Indirect Costs to Objects 434
Selecting a Cost Driver 436 Behavioral Implications 439 Effects of Cost Behavior on Selecting the Most Appropriate Cost Driver 440
Using Volume Measures to Allocate Variable Overhead Costs 440
Allocating Fixed Overhead Costs 443
Allocating Costs to Solve Timing Problems 444
Aggregating and Disaggregating Individual Costs into Cost
Pools 445
Cost Allocation: The Human Factor 445
Using Cost Allocations in a Budgeting Decision 445 Using Cost Drivers to Make Allocations 446
Choosing the Best Cost Driver 447
Controlling Emotions 447 A Look Back 448
A Look Forward 448
Self-Study Review Problem 448 Key Terms 450
Questions 450
Cost Accumulation, Tracing, and Allocation 430
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Contents xxxiii
Chapter Opening 462 Relevant Information 464
Sunk Cost 464
Opportunity Costs 464 Relevance Is an Independent Concept 465
Relevance Is
Context Sensitive 466
Relationship Between Relevance and Accuracy 466
Quantitative versus Qualitative Characteristics of Decision Making 466
Differential Revenue and Avoidable Cost 467
Relationship of Cost Avoidance to a Cost Hierarchy 467 Relevant Information and Special Decisions 468
Special Order Decisions 468
Outsourcing Decisions 471 Segment Elimination
Decisions 473
Summary of Relationships Between Avoidable Costs and the Hierarchy of Business Activity 476
Equipment Replacement Decisions 477
A Look Back 478 A Look Forward 479 Self-Study Review Problem 479 Key Terms 481 Questions 482 Exercises 482 Problems 489 Analyze, Think, Communicate 493
Chapter Opening 498 The Planning Process 500 Three Levels of Planning for Business Activity 500
Advantages of Budgeting 501 Planning 501
Coordination 501
Performance Measurement 501 Corrective Action 501
Budgeting and Human Behavior 501
The Master Budget 502 Hampton Hams Budgeting Illustration 503
Exercises 451 Problems 455
Analyze, Think, Communicate 458
Relevant Information for Special Decisions 462
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Planning for Profit and Cost Control 498
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xxxiv Contents
Chapter Opening 530
Decentralization Concept 532 Responsibility Centers 532 Controllability Concept 532 Preparing Flexible
Budgets 533
Determining Variances for Performance Evaluation 535 Sales and Variable Cost Volume Variances 535
Interpreting the Sales and Variable Cost Volume Variances 535
Fixed Cost Considerations 536 Flexible Budget Variances 537
Calculating the Sales Price Variance 538
The Human Element Associated with Flexible Budget
Variances 539
Need for Standards 540 Managerial Performance Measurement 540
Return on Investment 540 Qualitative Considerations 541 Factors Affecting Return on Investment 542
Residual Income 543 Calculating Multiple ROIs and/or RIs for the Same Company 545
Responsibility Accounting and the Balanced Scorecard 545 A Look Back 546
A Look Forward 546 Self-Study Review Problem 1 546 Self-Study Review Problem 2 548 Key Terms 549 Questions 549 Exercises 550 Problems 555 Analyze, Think, Communicate 558 Sales Budget 503
Inventory Purchases Budget 505
Selling and Administrative Expense Budget 507 Cash Budget 508 Pro Forma Income Statement 511
Pro Forma Balance Sheet 512 Pro Forma Statement of
Cash Flows 512
A Look Back 513 A Look Forward 514 Self-Study Review Problem 514 Key Terms 516 Questions 516 Exercises 516 Problems 522 Analyze, Think, Communicate 526
Performance Evaluation 530
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Contents xxxv
Appendix A Accessing the EDGAR Database Through the Internet 595
Appendix B Annual Report for The Topps Company, Inc. 596 Appendix C The Double-Entry Accounting System 651
Glossary 659 Photo Credits 671 Index 672
Chapter Opening 562 Capital Investment Decisions 564
Time Value of Money 564 Determining the Minimum Rate of Return 564
Converting Future Cash Inflows to Their Equivalent Present Values 565
Present Value Table for
Single-Amount Cash Infl ows 566 Present Value Table for
Annuities 566
Software Programs That Calculate Present Values 567 Ordinary Annuity
Assumption 568
Reinvestment Assumption 568 Techniques for Analyzing Capital Investment Proposals 569
Net Present Value 569 Internal Rate of Return 570 Techniques for Measuring Investment Cash Flows 571
Cash Infl ows 571 Cash Outfl ows 572
Techniques for Comparing Alternative Capital Investment Opportunities 572
Net Present Value 572 Internal Rate of Return 574 Relevance and the Time Value of Money 576
Tax Considerations 577 Techniques That Ignore the Time Value of Money 578
Payback Method 578 Unadjusted Rate of Return 579
Real-World Reporting Practices 580
Postaudits 581 A Look Back 581 Appendix 582
Self-Study Review Problem 583 Key Terms 584
Questions 585 Exercises 585 Problems 589 Analyze, Think, Communicate 592 Planning for Capital Investments 562
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1
C H A P T E R
An Introduction to
Accounting