Principles of accounting 11th edition

1 Uses of Accounting Information and the Financial Statements 2 2 Analyzing Business Transactions 48 3 Measuring Business Income 98 4 Completing the Accounting Cycle 142 5 Financial

Principles of Accounting, Eleventh Edition

Belverd Needles, Marian Powers,

Susan Crosson

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1 2 3 4 5 6 7 13 12 11 10 09

1 Uses of Accounting Information and the Financial Statements 2

2 Analyzing Business Transactions 48

3 Measuring Business Income 98

4 Completing the Accounting Cycle 142

5 Financial Reporting and Analysis 180

SUPPLEMENT TO CHAPTER 5 How to Read an Annual Report 226

6 The Operating Cycle and Merchandising Operations 266

SUPPLEMENT TO CHAPTER 6 Special-Purpose Journals 302

7 Internal Control 318

8 Inventories 350

9 Cash and Receivables 390

10 Current Liabilities and Fair Value Accounting 430

15 The Statement of Cash Flows 656

16 Financial Performance Measurement 706

iv Brief Contents

20 Costing Systems: Job Order Costing 882

21 Costing Systems: Process Costing 920

22 Value-Based Systems: ABM and Lean 958

23 Cost Behavior Analysis 988

24 The Budgeting Process 1040

25 Performance Management and Evaluation 1092

26 Standard Costing and Variance Analysis 1136

27 Short-Run Decision Analysis 1184

28 Capital Investment Analysis 1224

APPENDIX A Accounting for investments 1262

APPENDIX B Present Value Tables 1276

DECISION POINT A USER’S FOCUS KEEP-FIT CENTER 3

Accounting as an Information System 4

Business Goals, Activities, and Performance Measures 4

Financial and Management Accounting 7

Processing Accounting Information 7

Ethical Financial Reporting 8

Decision Makers: The Users of Accounting Information 10

Management 10

Users with a Direct Financial Interest 11

Users with an Indirect Financial Interest 12

Governmental and Not-for-Profit Organizations 12

Accounting Measurement 13

Business Transactions 14

Money Measure 14

Separate Entity 15

The Forms of Business Organization 15

Characteristics of Corporations, Sole Proprietorships, and Partnerships 15

Financial Position and the Accounting Equation 17

Statement of Owner’s Equity 20

The Balance Sheet 20

Statement of Cash Flows 21

Relationships Among the Financial Statements 21

Generally Accepted Accounting Principles 24

GAAP and the Independent CPA’s Report 25

Organizations That Issue Accounting Standards 26

Other Organizations That Influence GAAP 26

DECISION POINT A USER’S FOCUS PAWS AND HOOFS CLINIC 49

The T Account Illustrated 55

Rules of Double-Entry Accounting 55

Normal Balance 56

Owner’s Equity Accounts 56

Business Transaction Analysis 58

Owner’s Investment to Form the Business 58

Economic Event That Is Not a Business Transaction 59

Prepayment of Expenses in Cash 59

Purchase of an Asset on Credit 59

Purchase of an Asset Partly in Cash and Partly

vi Contents

Expense to Be Paid Later 63

Withdrawals 63

Summary of Transactions 65

The Trial Balance 65

Preparation and Use of a Trial Balance 65

Finding Trial Balance Errors 67

Cash Flows and the Timing

 PAWS AND HOOFS CLINIC: REVIEW PROBLEM 75 STOP & REVIEW 79

CHAPTER ASSIGNMENTS 81

DECISION POINT A USER’S FOCUS RELIABLE ANSWERING SERVICE 99

Profitability Measurement: Issues and Ethics 100

Net Income 100

Income Measurement Assumptions 101

Ethics and the Matching Rule 102

Accrual Accounting 104

Recognizing Revenues 104

Recognizing Expenses 105

Adjusting the Accounts 105

Adjustments and Ethics 106

The Adjustment Process 107

Type 1 Adjustment: Allocating Recorded Costs (Deferred Expenses) 107

Type 2 Adjustment: Recognizing Unrecorded, Incurred Expenses (Accrued Expenses) 111

Type 3 Adjustment: Allocating Recorded, Unearned Revenues (Deferred Revenues) 113

Type 4 Adjustment: Recognizing Unrecorded, Earned Revenues (Accrued Revenues) 114

A Note About Journal Entries 115

Using the Adjusted Trial Balance to Prepare Financial Statements 116

Cash Flows from Accrual-Based Information 119

 RELIABLE ANSWERING SERVICE: REVIEW PROBLEM 121

STOP & REVIEW 125 CHAPTER ASSIGNMENTS 127

DECISION POINT A USER’S FOCUS WESTWOOD MOVERS 143

From Transactions to Financial Statements 144

The Accounting Cycle 144

Closing Entries 144

Preparing Closing Entries 147

Step 1: Closing the Credit Balances 147

Step 2: Closing the Debit Balances 147

Step 3: Closing the Income Summary Account Balance 147

Step 4: Closing the Withdrawals Account Balance 147

The Accounts After Posting 148

The Post-Closing Trial Balance 150

Reversing Entries: An Optional First Step 152

The Work Sheet: An Accountant’s Tool 154

Preparing the Work Sheet 154

Using the Work Sheet 157

 WESTWOOD MOVERS: REVIEW PROBLEM 158 STOP & REVIEW 160

CHAPTER ASSIGNMENTS 162

Contents vii

DECISION POINT A USER’S FOCUS FONG COMPANY 267

Managing Merchandising Businesses 268

Operating Cycle 268

Choice of Inventory System 270

Foreign Business Transactions 270

Terms of Sale 272

Sales and Purchases Discounts 272

Transportation Costs 273

Terms of Debit and Credit Card Sales 274

Perpetual Inventory System 275

DECISION POINT A USER’S FOCUS FUN-FOR-FEET COMPANY 181

Foundations of Financial Reporting 182

Objective of Financial Reporting 182

Qualitative Characteristics of Accounting Information 182

Accounting Conventions 184

Ethical Financial Reporting 184

Accounting Conventions for Preparing Financial Statements 185

Dell’s Balance Sheets 194

Forms of the Income Statement 196

Multistep Income Statement 196

Dell’s Income Statements 199

Single-Step Income Statement 200

Using Classified Financial Statements 201

The Components of an Annual Report 226

Letter to the Stockholders 227

Financial Highlights 227

Description of the Company 227

Management’s Discussion and Analysis 227

Financial Statements 228

Notes to the Financial Statements 233

Reports of Management’s Responsibilities 234

Reports of Certified Public Accountants 234

Sales Journal 302

Purchases Journal 306

Cash Receipts Journal 308

Cash Payments Journal 311

viii Contents

DECISION POINT A USER’S FOCUS FISHER’S GRILL 319

Management Issues Related to Internal Control 320

The Need for Internal Controls 320

Management’s Responsibility for Internal Control 321

Independent Accountant’s Audit of Internal Control 322

Internal Control: Components, Activities, and Limitations 322

Components of Internal Control 322

Control Activities 323

Limitations of Internal Control 324

Internal Control over Merchandising Transactions 325

Internal Control and Management Goals 325

Control of Cash 326

Control of Cash Receipts 326

Control of Purchases and Cash Disbursements 327

Petty Cash Funds 332

Establishing the Petty Cash Fund 332

Making Disbursements from the Petty Cash Fund 333

Reimbursing the Petty Cash Fund 333

 FISHER’S GRILL: REVIEW PROBLEM 335 STOP & REVIEW 337

Evaluating the Level of Inventory 353

Effects of Inventory Misstatements on Income Measurement 355

Inventory Cost and Valuation 358

Goods Flows and Cost Flows 358

Lower-of-Cost-or-Market (LCM) Rule 359

Disclosure of Inventory Methods 360

Inventory Cost Under the Periodic Inventory System 361

Specific Identification Method 361

Average-Cost Method 362

First-In, First-Out (FIFO) Method 362

Last-In, First-Out (LIFO) Method 363

Summary of Inventory Costing Methods 364

Impact of Inventory Decisions 365

Effects on the Financial Statements 365

Effects on Income Taxes 365

Effects on Cash Flows 367

Inventory Cost Under the Perpetual Inventory System 367

Valuing Inventory by Estimation 370

Retail Method 370

Gross Profit Method 371

 SNUGS COMPANY: REVIEW PROBLEM 373 STOP & REVIEW 376

CHAPTER ASSIGNMENTS 378

DECISION POINT A USER’S FOCUS PENTE COMPUTER COMPANY 391

Management Issues Related to Cash and Receivables 392

Cash Management 392

Accounts Receivable and Credit Policies 393

Evaluating the Level of Accounts Receivable 394

Fair Value of Cash and Cash Equivalents 399

Cash Control Methods 400

Contents ix

DECISION POINT A USER’S FOCUS MEGGIE’S FITNESS CENTER 431

Management Issues Related to Current Liabilities 432

Managing Liquidity and Cash Flows 432

Evaluating Accounts Payable 432

Reporting Liabilities 434

Common Types of Current Liabilities 436

Definitely Determinable Liabilities 436

Interest and the Time Value of Money 448

Calculating Present Value 449

Applications Using Present Value 453

DECISION POINT A USER’S FOCUS CAMPUS CLEANERS 473

Management Issues Related to Long-Term Assets 474

Acquiring Long-Term Assets 476

Financing Long-Term Assets 477

Applying the Matching Rule 478

Acquisition Cost of Property, Plant, and Equipment 479

General Approach to Acquisition Costs 480

Specific Applications 480

Depreciation 483

Factors in Computing Depreciation 484

Methods of Computing Depreciation 484

Special Issues in Depreciation 488

Disposal of Depreciable Assets 490

Discarded Plant Assets 491

Plant Assets Sold for Cash 491

Exchanges of Plant Assets 493

Natural Resources 494

Depletion 494

Depreciation of Related Plant Assets 495

Development and Exploration Costs in the Oil and Gas Industry 495

Intangible Assets 497

Research and Development Costs 500

Computer Software Costs 500

The Allowance Method 404

Disclosure of Uncollectible Accounts 404

Estimating Uncollectible Accounts Expense 405

Writing Off Uncollectible Accounts 409

x Contents

DECISION POINT A USER’S FOCUS GAMMON, INC 519

Management Issues Related to Contributed Capital 520

The Corporate Form of Business 520

Advantages and Disadvantages of Incorporation 521

Equity Financing 522

Dividend Policies 524

Using Return on Equity to Measure Performance 526

Stock Options as Compensation 527

Cash Flow Information 527

Components of Stockholders’ Equity 528

Preferred Stock 531

Preference as to Dividends 531

Preference as to Assets 532

Convertible Preferred Stock 532

Callable Preferred Stock 533

Issuance of Common Stock 534

Par Value Stock 535

No-Par Stock 536

Issuance of Stock for Noncash Assets 537

Accounting for Treasury Stock 539

Purchase of Treasury Stock 539

Sale of Treasury Stock 540

Retirement of Treasury Stock 542

 GAMMON, INC.: REVIEW PROBLEM 544 STOP & REVIEW 547

CHAPTER ASSIGNMENTS 549

DECISION POINT A USER’S FOCUS WILSON MANUFACTURING COMPANY 563

Management Issues Related to Issuing Term Debt 564

Long-Deciding to Issue Long-Term Debt 564

Evaluating Long-Term Debt 565

Types of Long-Term Debt 566

Cash Flow Information 572

The Nature of Bonds 573

Bond Issue: Prices and Interest Rates 573

Characteristics of Bonds 574

Accounting for the Issuance of Bonds 575

Bonds Issued at Face Value 575

Bonds Issued at a Discount 576

Bonds Issued at a Premium 577

Bond Issue Costs 578

Using Present Value to Value a Bond 579

Case 1: Market Rate Above Face Rate 579

Case 2: Market Rate Below Face Rate 580

Amortization of Bond Discounts and Premiums 581

Amortizing a Bond Discount 581

Amortizing a Bond Premium 586

Retirement of Bonds 590

Calling Bonds 590

Converting Bonds 591

Other Bonds Payable Issues 592

Sale of Bonds Between Interest Dates 592

Year-End Accrual of Bond Interest Expense 593

 WILSON MANUFACTURING COMPANY:

REVIEW PROBLEM 596 STOP & REVIEW 599 CHAPTER ASSIGNMENTS 602

Gains and Losses 619

Write-Downs and Restructurings 619

Nonoperating Items 620

Income Taxes 621

Deferred Income Taxes 622

Contents xi

DECISION POINT A USER’S FOCUS LOPATA CORPORATION 657

Overview of the Statement

of Cash Flows 658

Purposes of the Statement of Cash Flows 658

Uses of the Statement of Cash Flows 658

Classification of Cash Flows 658

Required Disclosure of Noncash Investing and Financing Transactions 660

Format of the Statement of Cash Flows 660

Ethical Considerations and the Statement

of Cash Flows 662

Analyzing Cash Flows 663

Can a Company Have Too Much Cash? 663

Gains and Losses 671

Changes in Current Assets 671

Changes in Current Liabilities 672

Schedule of Cash Flows from Operating Activities 673

DECISION POINT A USER’S FOCUS WASHINGTON INVESTMENTS 707

Foundations of Financial Performance Measurement 708

Financial Performance Measurement: Management’s Objectives 708

Financial Performance Measurement:

Creditors’ and Investors’ Objectives 708

Evaluating Long-Term Solvency 726

Evaluating the Adequacy of Cash Flows 727

Evaluating Market Strength 729

 WASHINGTON INVESTMENTS: REVIEW PROBLEM 731 STOP & REVIEW 735

CHAPTER ASSIGNMENTS 737

Net of Taxes 623

Earnings per Share 625

Basic Earnings per Share 626

Diluted Earnings per Share 626

Comprehensive Income and the Statement

Advantages and Disadvantages of Partnerships 757

Limited Partnerships and Joint Ventures 757

Accounting for Partners’ Equity 759

Distribution of Partnership Income and Losses 761

Stated Ratios 761

Capital Balance Ratios 762

Salaries, Interest, and Stated Ratios 763

Gain on Sale of Assets 773

Loss on Sale of Assets 775

 HOLDER AND WILLIAMS PARTNERSHIP:

REVIEW PROBLEM 778 STOP & REVIEW 781 CHAPTER ASSIGNMENTS 783

DECISION POINT A MANAGER’S FOCUS GOOD FOODS STORE 795

The Role of Management Accounting 796

Management Accounting and Financial Accounting:

A Comparison 796

Management Accounting and the Management Process 797

Value Chain Analysis 803

Primary Processes and Support Services 803

Advantages of Value Chain Analysis 805

Managers and Value Chain Analysis 805

Continuous Improvement 807

Management Tools for Continuous Improvement 807

Achieving Continuous Improvement 809

Performance Measures: A Key to Achieving Organizational Objectives 811

Using Performance Measures in the Management Process 811

The Balanced Scorecard 812

Benchmarking 814

Standards of Ethical Conduct 814

 GOOD FOODS STORE: REVIEW PROBLEM 816 STOP & REVIEW 819

CHAPTER ASSIGNMENTS 821 Cookie Company (Continuing Case) 835

DECISION POINT A MANAGER’S FOCUS THE CHOICE CANDY COMPANY 837

Cost Information 838

Managers’ Use of Cost Information 838

Cost Information and Organizations 838

Cost Classifications and Their Uses 838

Inventory Accounts in Manufacturing Organizations 846

Document Flows and Cost Flows Through the Inventory Accounts 846

The Manufacturing Cost Flow 847

Elements of Product Costs 850

Prime Costs and Conversion Costs 851

Computing Product Unit Cost 852

Product Cost Measurement Methods 852

Computing Service Unit Cost 854

Contents xiii

DECISION POINT A MANAGER’S FOCUS AUGUSTA CUSTOM GOLF CARTS, INC 883

Product Unit Cost Information and the Management Process 884

Planning 884Performing 884Evaluating 884Communicating 884

Product Costing Systems 885 Job Order Costing in a Manufacturing Company 887

Materials 888Labor 890Overhead 890

Completed Units 891Sold Units 891Reconciliation of Overhead Costs 892

A Job Order Cost Card and the Computation

of Unit Cost 893

A Manufacturer’s Job Order Cost Card and the Computation of Unit Cost 893

Job Order Costing in a Service Organization 894

 AUGUSTA CUSTOM GOLF CARTS, INC.:

REVIEW PROBLEM 897

STOP & REVIEW 899 CHAPTER ASSIGNMENTS 901 Cookie Company (Continuing Case) 919

DECISION POINT A MANAGER’S FOCUS MILK PRODUCTS COMPANY 921

The Process Costing System 922 Patterns of Product Flows and Cost Flow Methods 923

Cost Flows Through the Work in Process Inventory Accounts 924

Computing Equivalent Production 925

Equivalent Production for Direct Materials 926

Equivalent Production for Conversion Costs 927

Summary of Equivalent Production 927

Preparing a Process Cost Report Using the FIFO Costing Method 928

Accounting for Units 928

Accounting for Costs 931

Accounting for Units 935

Accounting for Costs 937

Assigning Costs 937

 MILK PRODUCTS COMPANY: REVIEW PROBLEM 940

STOP & REVIEW 943 CHAPTER ASSIGNMENTS 945 Cookie Company (Continuing Case) 957

Cost Allocation 855

Allocating the Costs of Overhead 855Allocating Overhead: The Traditional Approach 857

Allocating Overhead: The ABC Approach 859

 THE CHOICE CANDY COMPANY:

REVIEW PROBLEM 861

STOP & REVIEW 863 CHAPTER ASSIGNMENTS 866 Cookie Company (Continuing Case) 880

xiv Contents

DECISION POINT A MANAGER’S FOCUS BEAN BAG CONVERTIBLES, INC 959

Value-Based Systems and Management 960

Value Chains and Supply Chains 961Process Value Analysis 962

Value-Adding and Non-Value-Adding Activities 963

Value-Based Systems 963Activity-Based Management 963Managing Lean Operations 964

Accounting for Product Costs in a JIT Operating Environment 970

Backflush Costing 972 Comparison of ABM and Lean 976

 BEAN BAG CONVERTIBLES, INC.: REVIEW PROBLEM 977

STOP & REVIEW 980 CHAPTER ASSIGNMENTS 982 Cookie Company (Continuing Case) 997

DECISION POINT A MANAGER’S FOCUS MY MEDIA PLACE 999

Cost Behavior and Management 1000

The Behavior of Costs 1001

Mixed Costs and the Contribution Margin Income Statement 1006

The Engineering Method 1006The Scatter Diagram Method 1006The High-Low Method 1007Statistical Methods 1009Contribution Margin Income Statements 1009

Cost-Volume-Profit Analysis 1010 Breakeven Analysis 1012

Using an Equation to Determine the Breakeven Point 1013

The Breakeven Point for Multiple Products 1014

Using C-V-P Analysis to Plan Future Sales, Costs, and Profits 1017

Applying C-V-P to Target Profits 1017

 MY MEDIA PLACE: REVIEW PROBLEM 1020

STOP & REVIEW 1023 CHAPTER ASSIGNMENTS 1025 Cookie Company (Continuing Case) 1038

DECISION POINT A MANAGER’S FOCUS FRAMECRAFT COMPANY 1041

The Budgeting Process 1042

Advantages of Budgeting 1042Budgeting and Goals 1043Budgeting Basics 1043

The Master Budget 1045

Preparation of a Master Budget 1045Budget Procedures 1048

Operating Budgets 1049

The Sales Budget 1049The Production Budget 1050The Direct Materials Purchases Budget 1051The Direct Labor Budget 1053

The Overhead Budget 1053The Selling and Administrative Expense Budget 1054

The Cost of Goods Manufactured Budget 1055

Financial Budgets 1057

The Budgeted Income Statement 1057The Capital Expenditures Budget 1058The Cash Budget 1058

The Budgeted Balance Sheet 1061

 FRAMECRAFT COMPANY: REVIEW PROBLEM 1063

STOP & REVIEW 1066 CHAPTER ASSIGNMENTS 1068 Cookie Company (Continuing Case) 1091

Contents xv

DECISION POINT A MANAGER’S FOCUS WINTER WONDERLAND RESORT 1093

Performance Evaluation of Cost Centers and Profit Centers 1102

Evaluating Cost Center Performance Using Flexible Budgeting 1102

Evaluating Profit Center Performance Using Variable Costing 1103

Performance Evaluation of Investment Centers 1105

Return on Investment 1105Residual Income 1107Economic Value Added 1108The Importance of Multiple Performance Measures 1110

Performance Incentives and Goals 1111

Linking Goals, Performance Objectives, Measures, and Performance Targets 1111

Performance-Based Pay 1112The Coordination of Goals 1112

 WINTER WONDERLAND RESORT:

REVIEW PROBLEM 1115

STOP & REVIEW 1118 CHAPTER ASSIGNMENTS 1120 Cookie Company (Continuing Case) 1135

DECISION POINT A MANAGER’S FOCUS ICU, INC 1137 Standard Costing 1138

Standard Costs and Managers 1138Computing Standard Costs 1139Standard Direct Materials Cost 1139Standard Direct Labor Cost 1139Standard Overhead Cost 1140Total Standard Unit Cost 1141

Variance Analysis 1142

The Role of Flexible Budgets in Variance Analysis 1142

Using Variance Analysis to Control Costs 1145

Computing and Analyzing Direct Materials Variances 1147

Computing Direct Materials Variances 1147Analyzing and Correcting Direct Materials Variances 1149

Computing and Analyzing Direct Labor Variances 1150

Computing Direct Labor Variances 1150Analyzing and Correcting Direct Labor Variances 1152

Computing and Analyzing Overhead Variances 1154

Using a Flexible Budget to Analyze Overhead Variances 1154

Computing Overhead Variances 1154Analyzing and Correcting Overhead Variances 1159

Using Cost Variances to Evaluate Managers’ Performance 1161

 ICU, INC.: REVIEW PROBLEM 1163

STOP & REVIEW 1168 CHAPTER ASSIGNMENTS 1170 Cookie Company (Continuing Case) 1183

DECISION POINT A MANAGER’S FOCUS HOME STATE BANK 1185

Short-Run Decision Analysis and the Management Process 1186

Incremental Analysis for Short-Run Decisions 1186

Incremental Analysis for Outsourcing Decisions 1189

Incremental Analysis for Sell or Further Decisions 1199

Process- HOME STATE BANK: REVIEW PROBLEM 1202

STOP & REVIEW 1205 CHAPTER ASSIGNMENTS 1207 Cookie Company (Continuing Case) 1223

Management Issues Related to Investments 1262

Trading Securities 1264

Available-for-Sale Securities 1267

Long-Term Investments in Equity Securities 1267

Investments in Debt Securities 1271

Long-Term Investments in Bonds 1272 STOP & REVIEW 1273

Endnotes 1280 Company Index 1284 Subject Index 1285

DECISION POINT A MANAGER’S FOCUS NEIGHBORHOOD COMMUNICATIONS 1225 The Capital Investment Process 1226

Capital Investment Analysis 1226Capital Investment Analysis in the Management Process 1227

The Minimum Rate of Return on Investment 1229Cost of Capital 1229

Other Measures for Determining Minimum Rate of Return 1230

Ranking Capital Investment Proposals 1230

Measures Used in Capital Investment Analysis 1231

Expected Benefits from a Capital Investment 1231Equal Versus Unequal Cash Flows 1232

Carrying Value of Assets 1232Depreciation Expense and Income Taxes 1232Disposal or Residual Values 1233

The Time Value of Money 1234

Interest 1234Present Value 1235Present Value of a Single Sum Due in the Future 1236

Present Value of an Ordinary Annuity 1236

The Net Present Value Method 1238

Advantages of the Net Present Value Method 1238The Net Present Value Method Illustrated 1238

Other Methods of Capital Investment Analysis 1241

The Payback Period Method 1241The Accounting Rate-of-Return Method 1242

 NEIGHBORHOOD COMMUNICATIONS:

REVIEW PROBLEM 1244

STOP & REVIEW 1246 CHAPTER ASSIGNMENTS 1248 Cookie Company (Continuing Case) 1260

Accounting

in Motion!

This revision of Principles of Accounting is based on an understanding of the

nature, culture, and motivations of today’s undergraduate students and on sive feedback from many instructors who use our book These substantial changes meet the needs of these students, who not only face a business world increasingly complicated by ethical issues, globalization, and technology but who also have more demands on their time To assist them to meet these challenges, the authors carefully show them how the effects of business transactions, which are the result

exten-of business decisions, are recorded in a way that will be reflected on the cial statements Instructors will find that building on the text’s historically strong pedagogy, the authors have strengthened transaction analysis and its link to the accounting cycle

finan-Updated Content,

Organization

and Pedagogy

Strengthened Transaction Analysis

Maintaining a solid foundation in double-entry accounting, we increased the number of in-text journal entries and have used T accounts linked to these journal-entry illustrations throughout the financial accounting chapters In Chapter 2, “Analyzing Business Transactions,” for example, we clarified the rela-tionship of transaction analysis to the accounting cycle In Chapter 6, “The Oper-ating Cycle and Merchandising Accounting,” we include transaction illustrations for all transactions mentioned in the chapter At the same time, we reduced exces-sive detail, shortened headings, simplified explanations, and increased readability

in an effort to reduce the length of each chapter

Content and Organization: Partnerships, Special-Purpose Journals, and Investments

Based on user input, Chapter 17 introduces a new topic of partnerships to the text To make room for this, the investments chapter is now located in Appendix A with ample assignment material to provide greater flexibility of coverage

xvii

Application of Double Entry:

Assets ⫽ Liabilities ⫹ Owner’s Equity

xviii Preface

Also based on user desires, we have inserted a supplement on special-purpose journals with assignment material after Chapter 6

Strong Pedagogical System

Principles of Accounting originated the pedagogical system of Integrated

Learn-ing Objectives The system supports both learnLearn-ing and teachLearn-ing by providLearn-ing

flexibility in support of the instructor’s teaching of first-year accounting The chapter review and all assignments identify the applicable learning objective(s) for easy reference

Each learning objective refers to a specific content area, usually either ceptual content or procedural techniques, in short and easily understandable seg-

con-ments Each segment is followed by a “Stop and Apply” section that illustrates

and solves a short exercise related to the learning objective

To make the text more visually appealing and readable, it is divided into student-friendly sections with brief bulleted lists, new art, photographs, and end-of-section review material

explaining inventory policies

3 Application of the LCM rule 4 Goods flow

5 Transportation charge for

mer-chandise shipped FOB shipping point

6 Cost flow 7 Choosing a method and sticking

with it 8 Transportation charge for mer-

chandise shipped FOB destination

SOLUTION

1 f; 2 c; 3 d; 4 b; 5 a; 6 f; 7 e; 8 f

To avoid financial distress, a company must be able to pay its bills on time Because the timing of cash flows is critical to maintaining adequate liquidity to pay bills, managers and other users of financial information must understand the difference between transactions that generate immediate cash and those that do not Con- sider the transactions of Miller Design Studio shown in Figure 2-3 Most of them involve either an inflow or outflow of cash.

As you can see in Figure 2-3, Miller’s Cash account has more transactions than any of its other accounts Look at the transactions of July 10, 15, and 22:

 July 10: Miller received a cash payment of $2,800.

 July 15: The firm billed a customer $9,600 for a service it had already formed.

per- July 22: The firm received a partial payment of $5,000 from the customer, but it had not received the remaining $4,600 by the end of the month Because Miller incurred expenses in providing this service, it must pay careful attention to its cash flows and liquidity.

One way Miller can manage its expenditures is to rely on its creditors to give

it time to pay Compare the transactions of July 3, 5, and 9 in Figure 2-3.

Cash Flows and the Timing

of Transactions

LO 5 Show how the timing

of transactions affects cash flows and liquidity.

IFRS, Fair Value, and Other Updates

International Financial Reporting Standards and fair value have been integrated throughout the book where accounting standards have changed and also in the

Business Focus features where applicable All current events, statistics, and tables

have been updated with the latest data

Further, to reduce distractions, the margins of the text include only Study

Notes, which alert students to common misunderstandings of concepts and

tech-niques; key ratio and cash flow icons, which highlight discussions of profitability and liquidity; and accounting equations Icons and equations appear in the finan-cial chapters (Chapters 1–17)

Study Note

After Step 1 has been completed,

the Income Summary account

reflects the account balance of

the Design Revenue account

before it was closed

Use of Small, Diverse Companies

Each chapter begins with a Decision Point, a real-world scenario about a small

company that challenges students to see the connection between accounting information and management decisions

 How can Pente Computer Company manage its cash needs?

 How can the company reduce the level of uncollectible accounts and increase the likelihood that accounts receivable will be paid on time?

 How can the company evaluate the effectiveness

of its credit policies and the level of its accounts receivable?

DECISION POINT  A USER’S FOCUS PENTE COMPUTER COMPANY

Pente Computer Company sells computer products for cash

or on credit The company’s peak sales occur in August and September, when students are shopping for computers and computer-related supplies, and during the pre-holiday season in November and December It is now January, and Andre Pente, the company’s owner, has been reviewing the company’s performance over the past two years He has determined that in those years, approximately 1.5 percent

of net sales have been uncollectible, and he is concerned that this year, the company may not have enough cash to cover operations before sales begin to increase again in late summer In this chapter, we discuss concepts and tech- niques that would help Pente manage his cash and accounts receivable so that the company maintains its liquidity.

FOCUS ON BUSINESS PRACTICE

IFRS: The Arrival of International Financial Reporting Standards in the United States

and Exchange Commission (SEC) recently voted to allow foreign registrants in the United States This

is a major development because in the past, the SEC required foreign registrants to explain how the standards used in their statements differed from U.S standards This change affects approximately 10 percent of all public U.S companies In addition, the SEC may in the near future allow U.S companies to use IFRS 11

Over the next few years, international financial reporting standards (IFRS) will become much more important in the United States and globally The International Accounting Standards Board (IASB) has been working with the Financial Accounting Standards Board (FASB) and similar boards in other nations to achieve identical or nearly identical stan- dards worldwide IFRS are now required in many parts of the world, including Europe The Securities-

xx Preface

These company examples come full circle at the end of the chapter by linking

directly to the Review Problem Smaller, diverse company examples illustrate

accounting concepts and encourage students to apply what they have learned

Use of Well-Known Public Companies

This textbook also offers examples from highly recognizable public companies, such as CVS Caremark, Southwest Airlines, Dell Computer, and Netflix, to relate

basic accounting concepts and techniques to the real world Chapter 5,

“Finan-cial Reporting and Analysis,” helps students interpret finan“Finan-cial information

The latest available data is used in exhibits to incorporate the most recent FASB pronouncements The authors illustrate current practices in financial reporting by

referring to data from Accounting Trends and Techniques (AICPA) and integrate

international topics wherever appropriate

 PENTE COMPUTER COMPANY: REVIEW PROBLEM

In this chapter’s Decision Point, we posed the following questions:

• How can Pente Computer Company manage its cash needs?

• How can the company reduce the level of uncollectible accounts and increase the likelihood that accounts receivable will be paid on time?

• How can the company evaluate the effectiveness of its credit policies and the level of its accounts receivable?

During the months when sales are at their peak, Pente Computer Company may have excess cash available that it can invest in a way that earns a return but still permits ready access to cash At other times, it may have to arrange for short-term borrowing To ensure that it can borrow funds when it needs to, the company must maintain good relations with its bank.

CVS Caremark Corporation Consolidated Statements of Operations

Fiscal Year Ended

Dec 31, 2008 Dec 29, 2007 Dec 30, 2006 (In millions, except per share amounts) (52 weeks) (52 weeks) (53 weeks)

Net revenues $87,471.9 $76,329.5 $43,821.4 Cost of revenues 69,181.5 60,221.8 32,079.2 Gross profit 18,290.4 16,107.7 11,742.2 Total operating expenses 12,244.2 11,314.4 9,300.6 Operating profit 1 6,046.2 4,793.3 2,441.6 Interest expense, net 2 509.5 434.6 215.8 Earnings before income tax provision 5,536.7 4,358.7 2,225.8 Loss from discontinued operations, (132) — — net of income tax benefit of $82.4

Income tax provision 2,192.6 1,721.7 856.9v Net earnings 3 3,212.1 2,637.0 1,368.9 Preference dividends, net of income tax benefit 4 14.1 14.2 13.9 Net earnings available to common shareholders $ 3,198.0 $ 2,622.8 $ 1,355.0

BASIC EARNINGS PER COMMON SHARE : 5

Net earnings $ 2.23 $ 1.97 $ 1.65 Weighted average common shares outstanding 1,433.5 1,328.2 820.6

DILUTED EARNINGS PER COMMON SHARE : Net earnings $ 2.18 $ 1.92 $ 1.60 Weighted average common shares outstanding 1,469.1 1,371.8 853.2

Consolidated means that data from all

companies owned by CVS are combined. CVS’s fiscal year ends on the Saturday closest to December 31.

Preface xxi

Revised and Expanded Assignments

Assignments have been carefully scrutinized for direct relevancy to the learning objectives in the chapters Names and numbers for all Short Exercises, Exercises, and Problems have been changed except those used on videos We have reversed the alternate and main problems from the previous edition Most importantly, alternative problems have been expanded so that there are ample problems for any course

All of the cases have been updated as appropriate and the number of cases in each chapter has been reduced in response to user preferences The variety of cases

in each chapter depends on their relevance to the chapter topics, but throughout the text there are cases involving conceptual understanding, ethical dilemmas, interpreting financial reports, group activities, business communication, and the Internet Annual report cases based on CVS Caremark and Southwest Airlines can be found at the end of the chapter

Specific Chapter Changes

The following chapter-specific changes have been made in this edition of

Principles of Accounting:

Chapter 1: Uses of Accounting Information and the Financial Statements

• Discussion of performance measures revised using CVS and General Motors

as examples of how these measures relate to profitability and liquidity

• Discussion of the statement of cash flows revised to relate the statement to business activities and goals

• Updated and enhanced coverage of the roles of the Financial ing Standards Board (FASB) and the International Accounting Standards Board (IASB)

Account-• New Focus on Business Practice box on SEC’s decision to let foreign panies registered in the United States use international financial reporting standards (IFRS)

com-• New study note on the role of the Public Company Accounting Oversight Board (PCAOB)

Chapter 2: Analyzing Business Transactions

• Learning Objective (LO) 3 revised to clarify and emphasize the role of

T accounts, journal form, and their relationship to the general ledger

• New example of recognition violation

• Section on valuation revised to address fair value and IFRS

• New Focus on Business Practice box on fair value accounting in an tional marketplace

interna-• Cash flow discussion edited for clearer delineation of the sequence of transactions

Chapter 3: Measuring Business Income

• New example of earnings management focusing on Dell Computer

• New Focus on Business Practice box describing the FASB’s rules for revenue recognition and the one broad principle (IFRS) that the IASB uses

Chapter 4: Completing the Accounting Cycle

• In-text examples focusing on Miller Design Studio simplified by using fewer accounts, thus clarifying the process of preparing closing entries and the worksheet

xxii Preface

Chapter 5: Financial Reporting and Analysis

• Section on the objective of financial reporting revised to reflect FASB’s sis on the needs of capital providers and other users of financial reports

empha-• Coverage of qualitative characteristics simplified and shortened

• New Focus on Business Practice box on convergence of U.S GAAP and IFRS and their effect on accounting standards

• New Focus on Business Practice box on how convergence of U.S GAAP and IFRS can make financial analysis more difficult

• New Focus on Business Practice box on the use of ratios (performance sures) in executive compensation

mea-Chapter 6: The Operating Cycle and Merchandising Transactions

• Discussion of the operating cycle revised for greater clarity

• T accounts and journal entries used to illustrate accounting for ing transactions under both the perpetual and periodic inventory systems

merchandis-• Updated Focus on Business Practice box on the increased use of credit and debit cards

• Clearer differentiation between the cost of goods available for sale and the cost of goods sold in LO4

• New supplement on Special-Purpose Journals

Chapter 7: Internal Control

• New Focus on Business Practice box on the effectiveness of the Oxley Act in preventing fraud

Sarbanes-• New Focus on Business Practice box on methods of preventing shoplifting

• Material reformatted to clarify discussion of documents used in an internal control plan for purchases and cash disbursements

Chapter 8: Inventories

• Discussion of disclosure of inventory methods shortened for greater clarity

• New Focus on Business Practice box on the lower-of-cost-or-market rule

• New Focus on Business Practice box on the use of LIFO inside and outside the United States

• New Focus on Business Practice box on how IFRS and U.S standards define fair value

Chapter 9: Cash and Receivables

• Concept of fair value introduced at various points throughout the chapter

• Revised Focus on Business Practice box on estimating cash collections

• New coverage of subprime loans

Chapter 10: Current Liabilities and Fair Value Accounting

• Chapter revised to include coverage of fair value accounting

• Discussion and assignments related to future value deleted to emphasize ent value and fair value, which are more directly related to this course

pres-• New study note on the disclosure of the fair value of short-term debt

Chapter 11: Long-Term Assets

• Coverage of tax laws revised to address the Economic Stimulus Act of 2008

• Coverage of intangible assets revised to reflect current standards

• Revised Focus on Business Practice box on customer lists

Preface xxiii Chapter 12: Contributed Capital

• Revised Focus on Business Practice box on politics and accounting for stock options

• Section on cash flow information added to LO1

• Updated Focus on Business Practice box on share buybacks

Chapter 13: Long-Term Liabilities

• Bonds interest rates changed so that they are more realistic and less cated than in previous edition

compli-• Updated discussion of accounting for defined pension plans

• New Focus on Business Practice box on post-retirement liabilities

• Section on cash flow information added to LO1

Chapter 14: The Corporate Income Statement and the Statement of holders’ Equity

Stock-• Nonoperating items, which were covered in LO3 in previous edition, now discussed in LO1

• New Focus on Business Practice box on looking beyond the bottom line

• Revised Focus on Business Practice box on pro-forma earnings

Chapter 15: The Statement of Cash Flows

• Clarification of required disclosure of noncash investing and financing ties in LO1

activi-• Sections on the risks of having too much cash and on interpreting the ment of cash flows added to LO2

state-• New Focus on Business Practice box on the IASB’s support of the direct method

Chapter 16: Financial Performance Measurement

• Updated Focus on Business Practice box on pro-forma earnings

• Revised Focus on Business Practice box on performance measurement

Chapter 17: Partnerships

• New chapter added in response to users’ requests

Chapter 18: The Changing Business Environment: A Manager’s Perspective

• Updated definition of management accounting

• Lean production introduced as a key term

• Sections on total quality management and activity based management revised

• Updated Focus on Business Practice box on how to blow the whistle on fraud

Chapter 19: Cost Concepts and Cost Allocation

• Discussions of costs in LO2 in previous edition incorporated in LO1

• Section on document and cost flows through the inventory accounts in new LO3 revised

• Introduction to methods of product cost measurement added and section on computing service unit cost shortened in new LO4

• LO7 and LO8 streamlined and incorporated in new LO5

Chapter 20: Costing Systems: Job Order Costing

• Chapter 20 in previous edition separated into two chapters, with new Chapter 20 focusing on job order costing and new Chapter 21 focusing on process costing

• Operations costing system introduced as a key concept

xxiv Preface

• Discussions of manufacturer’s job order cost card, computation of unit cost, and job order costing in a service organization included in new LO4

• New Focus on Business Practice box on the use of project costing

Chapter 21: Costing Systems: Process Costing

• New chapter (part of Chapter 20 in previous edition)

Chapter 22: Value-Based Systems: ABM and Lean

• LO1 and LO2 in last edition combined and revised

• Section on process value analysis included in LO1

• New listing of ABC’s disadvantages in LO2

• New focus on lean operations in LO3

Chapter 23: Cost Behavior Analysis

• LO1 and LO2 in last edition combined and revised

• Discussions of variable, fixed, and mixed costs and discussions of step costs and linear relationships included in LO1

• Discussion of contribution margin income statement included in LO2

• LO5 revised to clarify concepts

Chapter 24: The Budgeting Process

• Section on advantages of budgeting and three key terms—static budget, tinuous budget, and zero-based budgeting—added to revised LO1

con-Chapter 25: Performance Management and Evaluation

• LO1 and LO2 in last edition combined and revised

Chapter 26: Standard Costing and Variance Analysis

• LO1 and LO2 in last edition combined and revised

Chapter 27: Short-Run Decision Analysis

• Chapter revised to focus on short-run decisions and incremental analysis; ital investment analysis and time value of money now covered in Chapter 28

cap-Chapter 28: Capital Investment Analysis

solu-CengageNOW™

CengageNOW for Needles/Powers Principles of Accounting, 11e is a powerful

and fully integrated online teaching and learning system that provides you with flexibility and control This complete digital solution offers a comprehensive set

of digital tools to power your course CengageNOW offers the following:

 Homework, including algorithmic variations

 Integrated e-book

 Personalized study plans, which include a variety of multimedia assets (from exercise demonstrations to videos to iPod content) for students as they master the chapter materials

Preface xxv

 Assessment options, including the full test bank and algorithmic variations

 Reporting capability based on AACSB, AICPA, and IMA competencies and standards

 Course Management tools, including grade book

 WebCT and Blackboard IntegrationVisit www.cengage.com/tlc for more information

WebTutor™ on Blackboard® and WebCT™

WebTutor™ is available packaged with Needles/Powers Principles of Accounting,

11e or for individual student purchase Jump-start your course and customize rich, text-specific content with your Course Management System

 Jump-start: Simply load a WebTutor cartridge into your Course

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 Customize content: Easily blend, add, edit, reorganize, or delete content

Content includes media assets, quizzing, test bank, web links, discussion ics, interactive games and exercises, and more

top-Visit www.cengage.com/webtutor for more information

Teaching Tools

for Instructors

 Instructor’s Resource CD-ROM: Included on this CD set are the key

sup-plements designed to aid instructors, including the Solutions Manual, View Test Bank, Word Test Bank, and Lecture PowerPoint slides

Exam- Solutions Manual: The Solutions Manual contains answers to all exercises,

problems, and activities that appear in the text As always, the solutions are author-written and verified multiple times for numerical accuracy and consis-tency with the core text

 ExamView® Pro Testing Software: This intuitive software allows you to

easily customize exams, practice tests, and tutorials and deliver them over a network, on the Internet, or in printed form In addition, ExamView comes with searching capabilities that make sorting the wealth of questions from the printed test bank easy The software and files are found on the IRCD

 Lecture PowerPoint® Slides: Instructors will have access to PowerPoint

slides online and on the IRCD These slides are conveniently designed around learning objectives for partial chapter teaching and include art for dynamic presentations There are also lecture outline slides for each chapter for those instructors who prefer them

 Instructor’s Companion Website: The instructor website contains a

vari-ety of resources for instructors, including the Instructor’s Resource Manual (which has chapter planning matrices, chapter resource materials and outlines, chapter reviews, difficulty and time charts, etc.), and PowerPoint slides www.cengage.com/accounting/needles

 Klooster & Allen’s General Ledger Software: Prepared by Dale Klooster

and Warren Allen, this best-selling, educational, general ledger package introduces students to the world of computerized accounting through a more intuitive, user-friendly system than the commercial software they will use in the future In addition, students have access to general ledger files

xxvi Preface

with information based on problems from the textbook and practice sets This context allows them to see the difference between manual and com-puterized accounting systems firsthand Also, the program is enhanced with a problem checker that enables students to determine if their entries are correct Klooster & Allen emulates commercial general ledger pack-ages more closely than other educational packages Problems that can be used with Klooster/Allen are highlighted by an icon The Inspector Files found on the IRCD allow instructors to grade students’ work A free Net-work Version is available to schools whose students purchase Klooster/Allen’s General Ledger Software

Learning

Resources for

Students

CengageNOW™

CengageNOW for Needles/Powers Principles of Accounting, 11e is a powerful

and fully integrated online teaching and learning system that provides you with flexibility and control This complete digital solution offers a comprehensive set of digital tools to power your course CengageNOW offers the following:

 Homework, including algorithmic variations

 Integrated e-book

 Personalized study plans, which include a variety of multimedia assets (from exercise demonstrations to videos to iPod content) for students as they master the chapter materials

 Assessment options, including the full test bank and algorithmic variations

 Reporting capability based on AACSB, AICPA, and IMA competencies and standards

 Course Management tools, including grade book

 WebCT and Blackboard IntegrationVisit www.cengage.com/tlc for more information

WebTutor™ on Blackboard® and WebCT™

 WebTutor™ is available packaged with Needles/Powers Principles of ing, 11e or for individual student purchase Jump-start your course and cus-

Account-tomize rich, text-specific content with your Course Management System

 Jump-start: Simply load a WebTutor cartridge into your Course

Manage-ment System

 Customize content: Easily blend, add, edit, reorganize, or delete content

Content includes media assets, quizzing, test bank, web links, discussion ics, interactive games and exercises, and more

top-Visit www cengage.com/webtutor for more information

Klooster & Allen’s General Ledger Software: This best-selling, educational,

general ledger software package introduces you to the world of computerized accounting through a more intuitive, user-friendly system than the commercial software you’ll use in the future Also, the program is enhanced with a problem checker that provides feedback on selected activities and emulates commercial general ledger packages more closely than other educational packages Problems that can be used with Klooster/Allen are highlighted by an icon

Preface xxvii

Working Papers (Printed): A set of preformatted pages allow students to more

easily work end-of-chapter problems and journal entries

Student CD-ROM for Peachtree®: You will have access to Peachtree so you can

familiarize yourself with computerized accounting systems used in the real world You will gain experience from working with actual software, which will make you more desirable as a potential employee

Electronic Working Papers in Excel® Passkey Access (for sale online): Students

can now work end-of-chapter assignments electronically in Excel with easy-to follow, preformatted worksheets This option is available via an online download with a passkey

Companion Website: The student website contains a variety of educational

resources for students, including online quizzing, the Glossary, Flashcards, and Learning Objectives

www.cengage.com/accounting/needles

Acknowledgements A successful textbook is a collaborative effort We are grateful to the many

pro-fessors, other professional colleagues, and students who have taught and studied from our book, and we thank all of them for their constructive comments In the space available, we cannot possibly mention everyone who has been helpful, but

we do want to recognize those who made special contributions to our efforts in

preparing the eleventh edition of Principles of Accounting.

We wish to express deep appreciation to colleagues at DePaul University, who have been extremely supportive and encouraging

Very important to the quality of this book are our proofreaders, Margaret Kearney and Cathy Larson, to whom we give special thanks We also appreci-ate the support of our Supervising Development Editor, Katie Yanos; Execu-tive Editor, Sharon Oblinger; Senior Marketing Manager, Kristen Hurd; and Content Project Manager, Darrell Frye

Others who have had a major impact on this book through their reviews, suggestions, and participation in surveys, interviews, and focus groups are listed below We cannot begin to say how grateful we are for the feedback from the many instructors who have generously shared their responses and teaching experi-ences with us

Daneen Adams, Santa Fe College Sidney Askew, Borough of Manhattan Community CollegeNancy Atwater, College of St Scholastica

Algis Backaitis, Wayne County Community CollegeAbdul Baten, Northern Virginia Community CollegeRobert Beebe, Morrisville State College

Teri Bernstein, Santa Monica CollegeMartin Bertisch, York College

Tes Bireda, Hillsborough Community CollegeJames Bryant, Catonsville Community CollegeEarl Butler, Broward Community CollegeLloyd Carroll, Borough of Manhattan Community CollegeStanley Carroll, New York City College of TechnologyRoy Carson, Anne Arundel Community CollegeJanet Caruso, Nassau Community CollegeSandra Cereola, Winthrop UniversityJames J Chimenti, Jamestown Community College

xxviii Preface

Carolyn Christesen, SUNY Westchester Community CollegeStan Chu, Borough of Manhattan Community CollegeJay Cohen, Oakton Community College

Sandra Cohen, Columbia CollegeScott Collins, The Pennsylvania State UniversityJoan Cook, Milwaukee Area Tech College—DowntownBarry Cooper, Borough of Manhattan Community CollegeMichael Cornick, Winthrop University

Robert Davis, Canisius CollegeRon Deaton, Grays Harbor CollegeJim Delisa, Highline Community CollegeTim Dempsey, DeVry College of TechnologyVern Disney, University of South Carolina SumterEileen Eichler, Farmingdale State College

Mary Ewanechko, Monroe Community CollegeCliff Frederickson, Grays Harbor CollegeJohn Gabelman, Columbus State Community CollegeLucille Genduso, Kaplan University

Nashwa George, BerkeleyRom Gilbert, Santa Fe CollegeJanet Grange, Chicago State UniversityTom Grant, Kutztown

Tim Griffin, Hillsborough Community College—Ybor City CampusSara Harris, Arapahoe Community College

Lori Hatchell, Aims Community CollegeRoger Hehman, Raymond Walters College/University of CincinnatiSueann Hely, West Kentucky Community & Technical CollegeMany Hernandez, Borough of Manhattan Community CollegeMichele Hill, Schoolcraft College

Cindy Hinz, Jamestown Community CollegeJackie Holloway, National Park Community CollegePhillip Imel, Southwest Virginia Community CollegeJeff Jackson, San Jacinto College

Irene Joanette-Gallio, Western Nevada Community CollegeVicki Jobst, Benedictine University

Doug Johnson, Southwest Community CollegeJeff Kahn, Woodbury University

John Karayan, Woodbury UniversityMiriam Keller-Perkins, University of California-BerkeleyRandy Kidd, Longview Community College

David Knight, Borough of Manhattan Community CollegeEmil Koren, Saint Leo University

Bill Lasher, Jamestown Business CollegeJennifer LeSure, Ivy Tech State CollegeArchish Maharaja, Point Park UniversityHarvey Man, Borough of Manhattan Community CollegeRobert Maxwell, College Of The Canyons

Stuart McCrary, Northwestern UniversityNoel McKeon, Florida Community College—JacksonvilleTerri Meta, Seminole Community College

Roger Moore, Arkansas State University—BeebeCarol Murphy, Quinsigamond Community CollegeCarl Muzio, Saint John’s University

Mary Beth Nelson, North Shore Community College

Preface xxix

Andreas Nicolaou, Bowling Green State University

Patricia Diane Nipper, Southside Virginia Community College

Tim Nygaard, Madisonville Community College

Susan L Pallas, Southeast Community College

Clarence Perkins, Bronx Community College

Janet Pitera, Broome Community College

Eric Platt, Saint John’s University

Shirley Powell, Arkansas State University—Beebe

LaVonda Ramey, Schoolcraft College

Michelle Randall, Schoolcraft College

Eric Rothenburg, Kingsborough Community College

Rosemarie Ruiz, York College—CUNY

Michael Schaefer, Blinn College

Sarah Shepard, West Hills College Coalinga

Linda Sherman, Walla Walla Community College

Deborah Stephenson, Winston-Salem State University

Ira Stolzenberg, SUNY—Old Westbury

David Swarts, Clinton Community College

Linda Tarrago, Hillsborough Community College—Main Campus

Thomas Thompson, Savannah Technical College

Peter Vander Weyst, Edmonds Community College Lynnwood

Dale Walker, Arkansas State University—Beebe

Doris Warmflash, Westchester Community College

Wanda Watson, San Jacinto College—Central

Andy Williams, Edmonds Community College—Lynnwood

Josh Wolfson, Borough of Manhattan Community College

Paul Woodward, Santa Fe College

Allen Wright, Hillsborough Community College—Main Campus

Jian Zhou, SUNY at Binghamton

This page intentionally left blank

Belverd E Needles, Jr., Ph.D., C.P.A., C.M.A.

DePaul University

Belverd Needles is an internationally recognized expert in accounting education

He has published in leading journals and is the author or editor of more than

20 books and monographs His current research relates to international cial reporting, performance measurement, and corporate governance of high- performance companies in the United States, Europe, India, and Australia His textbooks are used throughout the world and have received many awards, includ-ing the 2008 McGuffey Award from the Text and Academic Authors Associa-tion Dr Needles was named Educator of the Year by the American Institute

finan-of CPAs, Accountant finan-of the Year for Education by the national honorary ety Beta Alpha Psi, and Outstanding International Accounting Educator by the American Accounting Association Among the numerous other awards he has received are the Excellence in Teaching Award from DePaul University and the Illinois CPA Society’s Outstanding Educator Award and Life-Time Achievement Award Active in many academic and professional organizations, he has served as the U.S representative on several international accounting committees, includ-ing the Education Committee of the International Federation of Accountants (IFAC) He is currently vice president of education of the American Accounting Association

soci-Marian Powers, Ph.D.

Northwestern University

Internationally recognized as a dynamic teacher in executive education, Marian Powers specializes in teaching managers how to read and understand financial reports, including the impact that international financial reporting standards have on their companies More than 1,000 executives per year from countries throughout the world, including France, the Czech Republic, Australia, India, China, and Brazil, attend her classes She has taught at the Kellogg’s Allen Cen-ter for Executive Education at Northwestern University since 1987 and at the Center for Corporate Financial Leadership since 2002 Dr Powers’s research

on international financial reporting, performance measurement, and corporate

governance has been published in leading journals, among them The Accounting Review; The International Journal of Accounting; Issues in Accounting Education; The Journal of Accountancy; The Journal of Business, Finance and Accounting; and Financial Management She has also coauthored three interactive multime-

dia software products: Fingraph Financial Analyst™ (financial analysis software); Financial Analysis and Decision Making, a goal-based learning simulation focused

on interpreting financial reports; and Introduction to Financial Accounting, a goal-based simulation that uses the Financial Consequences Model to introduce financial accounting and financial statements to those unfamiliar with account-ing Dr Powers is a member of the American Accounting Association, European Accounting Association, International Association of Accounting Education and Research, and Illinois CPA Society She currently serves on the board of directors

of the Illinois CPA Society and the board of the CPA Endowment Fund of nois She has served as vice president of Programs and secretary of the Educational Foundation

Illi-ABOUT THE AUTHORS

xxxi

xxxii About the Authors

Susan V Crosson, Santa Fe College

Susan V Crosson is the accounting program coordinator and a professor of accounting at Santa Fe College, Gainesville, FL Susan has also enjoyed teach-ing at the University of Florida, Washington University in St Louis, Univer-sity of Oklahoma, Johnson County Community College in Kansas, and Kansas City Kansas Community College She is known for her innovative application

of pedagogical strategies online and in the classroom She is a recipient of the Outstanding Educator Award from the American Accounting Association’s Two Year College Section, an Institute of Management Accountants’ Fac-ulty Development Grant to blend technology into the classroom, the Florida Association of Community Colleges Professor of the Year Award for Instruc-tional Excellence, and the University of Oklahoma’s Halliburton Education Award for Excellence Susan is active in many academic and professional organizations She served in the American Institute of CPA Pre- certification Education Executive Committee and is on the Florida Institute of CPAs Relations with Accounting Educators committee and the Florida Association

of Accounting Educators Steering Committee She has served as the can Accounting Association’s Vice President for Sections and Regions and as

Ameri-a council member-Ameri-at-lAmeri-arge, chAmeri-airperson of the Membership Committee, Ameri-and was chairperson of the Two-Year Accounting Section Previously she served

as chairperson of the Florida Institute of CPAs Accounting Careers and cation Committee and was chair of the Florida Institute of CPAs Relations with Accounting Educators Committee Susan was on the American Institute

Edu-of CPAs’ Core Competencies Best Practices Task Force also Susan co-authors

accounting textbooks for Cengage Learning: Principles of Accounting and Financial and Managerial Accounting, and Managerial Accounting with Bel

Needles and Marian Powers Susan holds a BBA in Economics and ing from Southern Methodist University and a MS in Accounting from Texas Tech University

Account-E L Account-E V Account-E N T H Account-E D I T I O N

Principles of

Accounting

impor-L E A R N I N G O B J E C T I V E S

LO1 Define accounting and describe its role in making informed

decisions, identify business goals and activities, and explain the importance of ethics in accounting (pp 4–10)

LO2 Identify the users of accounting information (pp 10–13)

LO3 Explain the importance of business transactions, money measure, and separate entity (pp 13–15)

LO4 Identify the three basic forms of business organization

(pp 15–16)

LO5 Define financial position, and state the accounting

equation (pp 17–19)

LO6 Identify the four basic financial statements (pp 19–23)

LO7 Explain how generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS) relate to financial statements and the independent CPA’s report, and identify the organizations that influence GAAP (pp 24–27)

STATEMENT OF CASH FLOWS

= Ending Cash Balance

 In deciding whether to make

a loan to Keep-Fit Center, what financial knowledge would a bank need to evaluate the company’s financial performance?

KEEP-FIT CENTER

On January 1, 2010, Lilian Jackson, an experienced fitness coach,

started a business called Keep-Fit Center, which offers classes and

private instruction in aerobics, yoga, and Pilates By December 31,

2010, the center had generated fees of $375,500, and its clients were

giving it high marks for excellent service Lilian is therefore now

con-sidering expanding the business To do so, she would need a bank

loan, and to qualify for one, both she and the bank would have to use

various financial measures to determine the business’s profitability

and liquidity (i.e., its ability to repay the loan)

Whether a business is small like Keep-Fit Center or large like CVS,

the same financial measures are used to evaluate it In this chapter,

as you learn more about accounting and the business environment,

you will become familiar with these financial measures and be able

to answer questions such as those on the right

4 CHAPTER 1 Uses of Accounting Information and the Financial Statements

Accounting as

an Information

System

LO1 Define accounting and

describe its role in making

informed decisions, identify

business goals and activities, and

explain the importance of ethics

in accounting

Accounting is an information system that measures, processes, and communicates

financial information about an economic entity.1 An economic entity is a unit that exists independently, such as a business, a hospital, or a governmental body Although the central focus of this book is on business entities, we include other economic units

at appropriate points in the text and end-of-chapter assignments

Accountants focus on the needs of decision makers who use financial tion, whether those decision makers are inside or outside a business or other economic entity Accountants provide a vital service by supplying the information decision mak-ers need to make “reasoned choices among alternative uses of scarce resources in the conduct of business and economic activities.”2 As shown in Figure 1-1, accounting is

informa-a link between business informa-activities informa-and decision minforma-akers

1 Accounting measures business activities by recording data about them for future use

2 The data are stored until needed and then processed to become useful information

3 The information is communicated through reports to decision makers

In other words, data about business activities are the input to the accounting system, and useful information for decision makers is the output

Business Goals, Activities, and Performance Measures

A business is an economic unit that aims to sell goods and services to customers

at prices that will provide an adequate return to its owners The list that follows contains the names of some well-known businesses and the principal goods or services that they sell

Purchase Order

FIGURE 1-1

Accounting as an Information System

Accounting as an Information System 5

Despite their differences, these businesses have similar goals and engage in similar activities, as shown in Figure 1-2

The two major goals of all businesses are profitability and liquidity

 Profitability is the ability to earn enough income to attract and hold

invest-ment capital

 Liquidity is the ability to have enough cash to pay debts when they are due.

For example, Toyota may meet the goal of profitability by selling many cars

at a price that earns a profit, but if its customers do not pay for their cars quickly enough to enable Toyota to pay its suppliers and employees, the company may fail to meet the goal of liquidity If a company is to survive and be successful, it must meet both goals

All businesses, including Lilian Jackson’s Keep-Fit Center, pursue their goals

by engaging in operating, investing, and financing activities

 Operating activities include selling goods and services to customers,

employ-ing managers and workers, buyemploy-ing and producemploy-ing goods and services, and paying taxes

 Investing activities involve spending the capital a company receives in

pro-ductive ways that will help it achieve its objectives These activities include buying land, buildings, equipment, and other resources that are needed to operate the business and selling them when they are no longer needed

Study Note

Users of accounting information

focus on a company’s

profitability and liquidity Thus,

more than one measure of

performance is of interest to

them For example, lenders are

concerned primarily with cash

flow, and owners are concerned

with earnings and withdrawals

BUSINESS ACTIVITIES BUSINESS GOALS

F INANCING

FIGURE 1-2

Business Goals

and Activities

6 CHAPTER 1 Uses of Accounting Information and the Financial Statements

 Financing activities involve obtaining adequate funds, or capital, to begin

operations and to continue operating These activities include obtaining tal from creditors, such as banks and suppliers, and from owners They also include repaying creditors and paying a return to the owners

capi-An important function of accounting is to provide performance measures,

which indicate whether managers are achieving their business goals and whether the business activities are well managed The evaluation and interpretation of

financial statements and related performance measures is called financial

analy-sis For financial analysis to be useful, performance measures must be well aligned

with the two major goals of business—profitability and liquidity

Profitability is commonly measured in terms of earnings or income, and cash flows are a common measure of liquidity In 2008, the drug and pharmacy chain

CVS projected earnings of $3.5 billion and cash flows from operating activities of

$4.5 billion in 2009 These figures indicate that CVS was achieving both ability and liquidity in difficult financial times.4 Not all companies were so fortu-nate in 2008 For instance, General Motors reported that it would have to curtail spending on new auto and truck models because its earnings (or profitability) and cash flows were negative; in fact, they were the largest in the history of the U.S auto industry Clearly, General Motors was not meeting either its profitability or liquidity goals to such an extent that management had to go to the government for a bailout in the billions of dollars In spite of the bailout, the company was forced to declare bankruptcy in 2009

profit-Although it is important to know the amounts of earnings and cash flows

in any given period and whether they are rising or falling, ratios of accounting measures are also useful tools of financial analysis For example, to assess Keep-Fit Center’s profitability, it would be helpful to consider the ratio of its earnings

to total assets, and for liquidity, the ratio of its cash flows to total assets In tion, ratios of accounting measures allow for comparisons from one period to another and from one company to another

addi-FOCUS ON BUSINESS PRACTICE

CVS, a major drug store chain, describes the company’s progress

in meeting its major business objectives as follows:

Liquidity: “Along with our strong free cash flow generation,

we faced virtually none of the liquidity issues that sent

shockwaves across so much of the business landscape in

2008 CVS Caremark has a solid balance sheet and an

invest-ment grade credit rating, and we maintain a commercial

paper program currently backed by $4 billion in committed

bank facilities.”

Profitability: “CVS Caremark generated record revenue and

earn-ings, achieved industry-leading same-store sales growth,

and continued to gain share across our businesses.”3

CVS’s main business activities are shown at the right

Sells Products and Services Through More Than 3,500 Drugstores and Pharmacies

Invests Funds in

— Furniture, Fixtures and Equipment

— Improvements

to Buildings

— Computer Equipment

F INANCING: O PERATING:

What Does CVS Have to Say About Itself?

Accounting as an Information System 7

Financial and Management Accounting

Accounting’s role of assisting decision makers by measuring, processing, and municating financial information is usually divided into the categories of manage-ment accounting and financial accounting Although the functions of management accounting and financial accounting overlap, the two can be distinguished by the principal users of the information they provide

com-Management accounting provides internal decision makers, who are

charged with achieving the goals of profitability and liquidity, with information about operating, investing, and financing activities Managers and employees who conduct the activities of the business need information that tells them how they have done in the past and what they can expect in the future For example, The Gap, a retail clothing business, needs an operating report on each outlet that tells how much was sold at that outlet and what costs were incurred, and it needs a budget for each outlet that projects the sales and costs for the next year

Financial accounting generates reports and communicates them to

exter-nal decision makers so they can evaluate how well the business has achieved its

goals These reports are called financial statements CVS, whose stock is traded

on the New York Stock Exchange, sends its financial statements to its owners

(called stockholders), its banks and other creditors, and government regulators

Financial statements report directly on the goals of profitability and ity and are used extensively both inside and outside a business to evaluate the business’s success It is important for every person involved with a business to understand financial statements They are a central feature of accounting and a primary focus of this book

liquid-Processing Accounting Information

It is important to distinguish accounting from the ways in which accounting information is processed by bookkeeping, computers, and management informa-tion systems

Accounting includes the design of an information system that meets users’ needs, and its major goals are the analysis, interpretation, and use of information

Bookkeeping, on the other hand, is mechanical and repetitive; it is the process of

recording financial transactions and keeping financial records It is a small—but important—part of accounting

Today, computers collect, organize, and communicate vast amounts of information with great speed They can perform both routine bookkeeping chores and complex calculations Accountants were among the earliest and most enthusiastic users of computers, and today they use computers in all aspects of their work

FOCUS ON BUSINESS PRACTICE

Cash Bonuses Depend on Accounting Numbers!

Nearly all businesses use the amounts reported in their

financial statements as a basis for rewarding management

Because managers act to achieve these accounting measures,

selecting measures that are not easily manipulated is tant Equally important is maintaining a balance of measures that reflect the goals of profitability and liquidity.5