Financial accounting information for decisions

sa, Financial Accounting Information for Decisions edition John J.. Contents Preface iii | Introducing Accounting in Business 2 Importance of Accounting 4 Users of Accounting Infor

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sa, Financial

Accounting

Information

for Decisions

edition

John J Wild

University of Wisconsin at Madison

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NOT FOR

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Library of Congress Cataloging-in-Pu

Wild, John J Aa

Financial accounting: information for decisions [J

Sueauiditu

ISBN 0-07-284317-9

1, Accounting I Title

HF5635.W695 2005

657—dc22 :

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

Decision Analysis—Debt Ratio 67

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 Decision Analysis—Acid-Test and Gross Margin

Ratios 167

Appendix 4A Periodic (and Perpetual) Inventory

System 172

Appendix 4B Work Sheet—Perpetual System 176

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

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

Appendix 10C Leases and Pensions 421

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