Accounting tools for business decision making 5e by kimmel kieso

Brief Contents 1 Introduction to Financial Statements 2 2 A Further Look at Financial Statements 46 3 The Accounting Information System 100 4 Accrual Accounting Concepts 162 5 Mercha

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Paul D Kimmel PhD, CPA

Donald E Kieso PhD, CPA

Northern Illinois University DeKalb, Illinois

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ISBN-13 978-1-118-12816-9Binder-Ready Version ISBN 978-1-118-34276-3Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

Brief Contents

1 Introduction to Financial Statements 2

2 A Further Look at Financial Statements 46

3 The Accounting Information System 100

4 Accrual Accounting Concepts 162

5 Merchandising Operations and the

Multiple-Step Income Statement 228

6 Reporting and Analyzing Inventory 282

7 Fraud, Internal Control, and Cash 334

8 Reporting and Analyzing Receivables 396

9 Reporting and Analyzing Long-Lived Assets 446

10 Reporting and Analyzing Liabilities 504

11 Reporting and Analyzing Stockholders’ Equity 568

12 Statement of Cash Flows 624

13 Financial Analysis: The Big Picture 688

22 Budgetary Control and Responsibility Accounting 1132

23 Standard Costs and Balanced Scorecard 1192

24 Planning for Capital Investments 1244 APPENDICES

A Specimen Financial Statements:

Tootsie Roll Industries, Inc A-1

B Specimen Financial Statements:

The Hershey Company B-1

C Specimen Financial Statements: Zetar plc C-1

D Time Value of Money D-1

E Reporting and Analyzing Investments E-1

*F Payroll Accounting F-1

*G Subsidiary Ledgers and Special Journals G-1

*H Accounting for Partnerships H-1

*I Accounting for Sole Proprietorships I-1

*J Pricing J-1 Company Index I-1 Subject Index I-3

* Available at the book’s companion website, www.wiley.com/college/kimmel

From the Authors

Dear Student,

Why This Course? Remember your biology course in high school? Did you have one of those “invisible man” models (or maybe something more high-tech than that) that gave you the opportunity to look “inside” the human body? This accounting course offers something similar To understand a business, you have to understand the financial insides of a business organization An accounting course will help you understand the essential financial components of businesses Whether you are looking at a large multinational company like Apple or Starbucks or a single-owner software consulting business or coffee shop, knowing the fundamentals of accounting will help you understand what is happening As an employee, a manager, an investor,

a business owner, or a director of your own personal finances—any of which roles you will have at some point

in your life—you will make better decisions for having taken this course.

Why This Book? Hundreds of thousands of students have used this textbook Your instructor has chosen it for you because of its trusted reputation The authors have worked hard to keep the book fresh, timely, and accurate.

This textbook contains features to help you learn best, whatever your learning style

We invite you to browse through pages xxvi–xxx These pages describe the main features you will find in this textbook and explain their purpose.

How To Succeed? We’ve asked many students and many instructors whether there

is a secret for success in this course The nearly unanimous answer turns out to be not much of a secret: “Do the homework.” This is one course where doing is learning.

The more time you spend on the homework assignments—using the various tools that this textbook provides—the more likely you are to learn the essential concepts, techniques, and methods of accounting Besides the textbook itself, the book’s companion website also offers various support resources.

Good luck in this course We hope you enjoy the experience and that you put to good use throughout a lifetime of success the knowledge you obtain in this course We are sure you will not be disappointed.

Paul D Kimmel Jerry J Weygandt Donald E Kieso

“Whether you are looking at a large multinational company like Apple or Starbucks or a single-owner software consulting business or coffee shop, knowing the fundamentals of account- ing will help you understand what is happening.”

Wiley Accounting is your partner in accounting education

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After decades of success as authors of textbooks like this one, Paul Kimmel, Jerry Weygandt, and Don Kieso understand that teaching accounting goes beyond simply presenting data The authors are truly effective because they know that teaching is about telling compelling stories in ways that make each concept come-to-life.

Teacher / Author / Professional

Through their textbooks, supplements, online learning tools, and classrooms, these authors have developed a comprehensive pedagogy that engages students in learning and faculty

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These authors collaborate throughout the entire process The end result is a true collaboration where each author brings his individual experience and talent to the development of every paragraph, page, and chapter, thus creating a truly well-rounded, thorough view on any given accounting topic.

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Jerry Weygandt

Jerry J Weygandt, PhD, CPA, is Arthur

Andersen Alumni Emeritus Professor of

Accounting at the University of Wisconsin—

Madison He holds a Ph.D in accounting

from the University of Illinois Articles by

Professor Weygandt have appeared in the

Accounting Review, Journal of Accounting

Research, Accounting Horizons, Journal of

Accountancy, and other academic and

professional journals These articles have

examined such financial reporting issues

as accounting for price-level adjustments,

pensions, convertible securities, stock option

contracts, and interim reports Professor

Weygandt is author of other accounting and

financial reporting books and is a member

of the American Accounting Association,

the American Institute of Certified Public

Accountants, and the Wisconsin Society of

Certified Public Accountants He has served

on numerous committees of the American

Accounting Association and as a member

of the editorial board of the Accounting

Review; he also has served as President

and Secretary-Treasurer of the American

Accounting Association In addition, he has

been actively involved with the American

Institute of Certified Public Accountants

and has been a member of the Accounting

Standards Executive Committee (AcSEC) of

that organization He has served on the FASB

task force that examined the reporting issues

related to accounting for income taxes

and served as a trustee of the Financial

Accounting Foundation Professor Weygandt

has received the Chancellor’s Award for

Excellence in Teaching and the Beta Gamma

Sigma Dean’s Teaching Award He is on

the board of directors of M & I Bank of

Southern Wisconsin He is the recipient of

the Wisconsin Institute of CPA’s Outstanding

Educator’s Award and the Lifetime

Achievement Award In 2001 he received

the American Accounting Association’s

Outstanding Educator Award

Paul Kimmel

Paul D Kimmel, PhD, CPA, received his bachelor’s degree from the University of Minnesota and his doctorate in accounting from the University of Wisconsin He is an Associate Professor at the University of Wisconsin—Milwaukee, and haspublic accounting experience with Deloitte

& Touche (Minneapolis) He was the ent of the UWM School of Business Advisory Council Teaching Award, the Reggie Taite Excellence in Teaching Award and

recipi-a three-time winner of the Outstrecipi-anding Teaching Assistant Award at the University

of Wisconsin He is also a recipient of the Elijah Watts Sells Award for Honorary Distinction for his results on the CPA exam

He is a member of the American Accounting Association and the Institute of Management Accountants and has published articles in

Accounting Review, Accounting Horizons, Advances in Management Accounting, Managerial Finance, Issues in Accounting Education, Journal of Accounting Education,

as well as other journals His research interests include accounting for financial instruments and innovation in accounting education He has published papers and given numerous talks on incorporating critical thinking into accounting education, and helped prepare a catalog of critical thinking resources for the Federated Schools

of Accountancy

Don Kieso

Donald E Kieso, PhD, CPA, received his bachelor’s degree from Aurora University and his doctorate in accounting from the University of Illinois He has served as chairman of the Department of Accountancy and is currently the KPMG Emeritus Professor

of Accountancy at Northern Illinois University

He has public accounting experience with Price Waterhouse & Co (San Francisco and Chicago) and Arthur Andersen & Co

(Chicago) and research experience with the Research Division of the American Institute of Certified Public Accountants (New York) He has done post doctorate work as a Visiting Scholar at the University of California at Berkeley and is a recipient of NIU’s Teaching Excellence Award and four Golden Apple Teaching Awards Professor Kieso is the author of other accounting and business books and is a member of the American Accounting Association, the American Institute of Certified Public Accountants, and the Illinois CPA Society He has served

as a member of the Board of Directors

of the Illinois CPA Society, then AACSB’s Accounting Accreditation Committees, the State of Illinois Comptroller’s Commission, as Secretary-Treasurer of the Federation

of Schools of Accountancy, and as Secretary-Treasurer of the American Accounting Association Professor Kieso is currently serving on the Board of Trustees and Executive Committee of Aurora University, as a member of the Board

of Directors of Kishwaukee Community Hospital, and as Treasurer and Director of Valley West Community Hospital From 1989

to 1993 he served as a charter member of the national Accounting Education Change Commission He is the recipient of the Outstanding Accounting Educator Award from the Illinois CPA Society, the FSA’s Joseph A Silvoso Award of Merit, the NIU Foundation’s Humanitarian Award for Service

to Higher Education, a Distinguished Service Award from the Illinois CPA Society, and

in 2003 an honorary doctorate from Aurora University

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The market-leading homework experience in WileyPLUS offers:

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The WileyPLUS homework experience, which includes type-ahead for account title entry, imitates a blank

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The professional, worksheet-style problem layouts help students master accounting skills while doing

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The Fifth Edition expands our emphasis on student learning and improves upon a teaching and learning package that instructors and students have rated the highest in customer satisfaction in the following ways:

Increased Managerial Accounting Coverage

This edition reflects our continuing commitment to provide thorough coverage of all managerial accounting topics We now offer separate chapters on incremental analysis (Chapter 20) and capital budgeting (Chapter 24), as well as a new Appendix J on pricing

Continued Emphasis on Helping Students Learn Accounting Concepts

Especially with this edition of the textbook, we have carefully scrutinized all chapter material to help students learn accounting concepts We revised existing explanations and illustrations as well as added more explanations, examples, and illustrations For example, we have added T-accounts in the margin to illustrate the effect of accounting procedures as well as discussed how tight credit policies nearly prevented Apple from fulfilling its first sale

Corporate Social Responsibility

Today’s companies are evaluating not just their profitability but also their corporate social sibility In this edition, we have profiled some of these companies in the new People, Planet, and Profit Insight boxes, such as PepsiCo, to highlight their sustainable business practices We have also

respon-added a new Broadening Your Perspective problem, Considering People, Planet, and Profit, which

offers students the opportunity to analyze current business practices

Student-Friendly Companies

One of the goals of the financial accounting course is to orient students to the application of accounting principles and techniques in practice Accordingly, we have expanded our practice of using numerous examples from real companies throughout the textbook to add more high-interest enterprises that we hope will increase student engagement, such as Clif Bar, Groupon, REI, and Skechers Also, beginning

in Chapter 14, we introduce Current Designs, a kayak-making company, and then follow-up with a new decision-making problem in every chapter based on this real-world company

Managerial Accounting Video Series

Through the use of real-world, cutting-edge companies, these videos (available in WileyPLUS)

engage students with a dynamic overview of managerial accounting topics Students are then motivated to further review the detailed tools, examples, and discussions presented in their

textbook, WileyPLUS course, and classroom lectures.

Enhanced Homework Material

In each chapter, we have updated Self-Test Questions, Questions, Brief Exercises, Do it! Review, Exercises, Problems, and Research Cases Financial analysis and reporting problems have been updated in accordance with the new Tootsie Roll and Hershey financial statements New Considering People, Planet, and Profit problems are included to offer students experience in evalu-ating corporate social responsibility, and new Considering Your Costs and Benefits problems require students to weigh the pros and cons of two alternatives

Accuracy and Relevance

This edition was also subject to an overall, comprehensive revision to ensure that it is technically accurate, relevant, and up-to-date A chapter-by-chapter summary of content changes is provided in the chart on the next two pages

xi

What’s New?

Chapter 1: Introduction to Financial Statements

• New Feature Story, on Clif Bar and its ESOP and

open-book management program.

• New discussion of LLCs and S corporations, to

reflect more current business practices.

• New People, Planet, and Profit Insight, on

evaluating companies on social practices as well

as on financial results.

• New Research Case on possible expanding role

of auditors.

Chapter 2: A Further Look at Financial Statements

• Updated to reflect new conceptual framework

terminology.

Chapter 3: The Accounting Information System

• Heavily revised Feature Story, now on MF

Global ’s failure to segregate company accounts from customer accounts.

• New Ethics Insight, on Credit Suisse Group ’s

failure to properly write down value of its securities.

• New Research Case based on Green Bay Packers ’

annual report publication.

Chapter 4: Accrual Accounting Concepts

• New Feature Story, on Groupon and complexity

of accounting for its revenues.

• New People, Planet, and Profit Insight, on costs

of disposing discarded, possibly toxic, materials.

Chapter 5: Merchandising Operations and the

Multiple-Step Income Statement

• New Feature Story, on REI and its unique

business model.

• New use of recent REI and Dick’s Sporting

Goods financial statement information.

• Revised Ethics Insight box on improving

company clarity of financial disclosures by citing

eBay ’s recent sale of Skype.

• New People, Planet, and Profit Insight, about

whether PepsiCo should market green.

Chapter 6: Reporting and Analyzing Inventory

• Added new Accounting Across the Organization

box, on Sony ’s inventory management practices.

• New Research Case, on U.S companies use of

LIFO.

• New Considering People, Planet, and Profit

Insight, about Caterpillar ’s annual Sustainability Report.

Chapter 7: Fraud, Internal Control, and Cash

• New People, Planet and Profit Insight, about the need for an effective system of internal controls for sustainability reporting.

• New Interpreting Financial Statements problem, based on recent Ernst & Young global survey on fraud.

Chapter 8: Reporting and Analyzing Receivables

• New Feature Story, about Nike , its products, and its receivables management.

• Featured companies in chapter are now Nike and

Skechers , to increase student engagement.

• New example of Apple ’s first sale, to demonstrate importance of extending credit.

Chapter 9: Reporting and Analyzing Long-Lived

Assets

• Revised Feature Story and in-chapter examples,

to focus on JetBlue as well as include more recent information about the airline industry.

• New People, Planet, and Profit Insight, about

Billiton ’s sustainability report.

• New Research Cases, about goodwill and Best Buy ’s profitability.

Chapter 10: Reporting and Analyzing Liabilities

• Expanded EOC material: 2 new Questions, 3 new Brief Exercises, 2 new Exercises, new Real- World Focus problem, new Interpreting Financial Statements problem, new Considering People, Planet, and Profit problem, and new All About You problem.

Chapter 11: Reporting and Analyzing Stockholders’

• New Accounting Across the Organization box, about how the recent financial crisis affected companies’ dividend payouts.

• New Research Case, new Considering People, Planet, and Profit problem, and new IFRS Concepts and Application problem.

Content Changes by Chapter

Chapter 12: Statement of Cash Flows

• Revamped Feature Story, to include more recent

information about Apple ’s cash flow status.

• New Accounting Across the Organization box,

about Kodak ’s need to sell plant assets to raise cash.

• New Investor Insight, about how 42% of

com-panies going public had audit opinions warning about the companies’ risk of failure.

Chapter 13: Financial Analysis: The Big Picture

• Revised Feature Story, to include more recent

information about Warren Buffett as well as to improve readability.

• New Investor Insight, about how recently some

companies have altered their pension-plan accounting to avoid prior-year events to distort current-year results.

• New Do it! box on ratio analysis.

Chapter 14 Managerial Accounting

• New Feature Story, on history and operations of

Current Designs (kayak-making company).

• New Management Insight, about importance of

U.S factory jobs.

• New Corporate Social Responsibility section.

• Deleted chapter appendix (Accounting Cycle for

a Manufacturing Company).

Chapter 15 Job Order Costing

• New Feature Story, on Lynn Tilton, founder and

CEO of Patriarch Partners , the largest, owned U.S business.

• Added more explanations and details (such as

T-accounts), to increase student understanding.

Chapter 16 Process Costing

• Changed example of company in Process Cost

Flow section to roller blade/skateboard wheel manufacturer, to increase student appeal.

• New People, Planet, and Profit Insight, about

costs/benefits of remanufactured goods.

Chapter 17 Activity-Based Costing

• New Feature Story, on why Precor switched from

traditional costing to activity-based costing.

• Changed example company, in Example of ABC

versus Traditional Costing section, to producing abdominal trainers to tie in with Precor.

• Rewrote definition/explanation of value-added

and non–value-added activities, as well as of activity levels, to ensure student understanding.

• New Management Insight, summarizing a recent survey of ABC practices by companies worldwide.

• New Real-World Focus problem, on use of ABC

in the financial services industry.

• New Real-World Focus problem, on how Barnes and Noble ’s current structure left it ill-prepared for an e-book environment.

Chapter 19 Cost-Volume-Profit Analysis:

Additional Issues

• New Feature Story, still about Intel , but now explaining why the computer chip giant experi- ences huge swings in its earnings.

• Provided more step-by-step explanations and illustrations, so students will improve their under- standing of why and how to compute break-even points, target net income, and margin of safety.

• New Service Company Insight, about why Warren Buffett acquired Burlington Northern Railroad

• New Real-World Focus problem, on Smart Balance ’s employment and cost structure.

Chapter 20 Incremental Analysis (previously part of

Chapter 23)

• New Service Company Insight, about the relevant revenues and costs of Amazon.com ’s Prime free shipping program.

• Expanded sunk cost discussion and illustrations,

to improve student understanding.

• New material on how behavioral decision-making can affect whether or not to replace equipment.

• Expanded discussion of elimination of an unprofitable segment to include fixed cost analysis.

• New section on other considerations in making, e.g., qualitative factors and relationship

decision-of incremental analysis and ABC.

Chapter 21 Budgetary Planning (previously Chapter 20)

• Added more detailed explanation to the Budgeting and Human Behavior section about participative budgeting.

• Added marginal T-accounts to Production

Budget and Direct Materials Budget sections,

to illustrate flow of costs.

• New Service Company Insight, on the

implica-tions of budgetary optimism as it pertains to governments.

• New Management Insight, on the potential

costs and benefits of a company stockpiling raw materials.

• Added a second Comprehensive Do It! problem

on budgeted income statement and balance sheet.

• New Considering Your Costs and Benefits

problem about whether student loans should

be considered as a source of income.

Chapter 22 Budgetary Control and Responsibility

• New Service Company Insight, about

NBCUniversal ’s response to Fox wanting to reduce its TV licensing fee.

• Added graph to the solution for the Do It! on

flexible budgets, to increase student understanding.

• Moved Management by Exception to within

Performance Evaluation discussion, for better flow of chapter topics.

Chapter 23 Standard Costs and Balanced Scorecard

(previously Chapter 22)

• New Feature Story (and accompanying video) on

Starbucks’ origins and vision.

• New material and illustrations added, to enhance

explanation of the components of variances as well as how to compute them.

• New People, Planet, and Profit Insight, ing Starbucks’ 10th annual Global Responsibility Report and the company’s commitment to corpo- rate social responsibility.

• New Real-World Focus problem referencing the

Wall Street Journal article, “In Risky Move, GM to

Run Plants Around Clock.”

• New Considering Your Costs and Benefits lem, addressing the extent to which financial measures should influence medical care.

prob-Chapter 24 Planning for Capital Investments

(previ-ously part of Chapter 23)

• New Feature Story, on how timing can affect capital investments by the cruise-line industry.

• New section on additional considerations for capital budgeting, such as intangible benefits, profitability index for mutually exclusive projects, risk analysis, and post-audit of invest- ment projects.

• New Management Insights, about whether

Verizon ’s investment in its 4G wireless service will pay off and whether there is too much plant capacity for manufacturing big-screen TVs.

• New Considering Your Costs and Benefits problem, about calculating the NPVs of solar panels.

Appendix J Pricing

• New appendix that discusses pricing goods for external sales, pricing services, transfer pricing for internal sales, transfers between divisions in different countries, and other cost approaches

to pricing.

Active Teaching and Learning Supplementary Material

For Students Textbook Companion Website On this website, www.wiley.com/college/kimmel, students will find support

materials that include Exercises: Set B, Challenge Exercises, Problems: Set C, Continuing Cookie Chronicle and

Waterways Continuing Problems, Appendices F–J, and Cases for Managerial Decision-Making.

Study Guide The Study Guide includes a chapter review and provides opportunities for practice through prob-lems and multiple-choice exercises

Working Papers The working papers are partially completed accounting templates that will help students correctly format their textbook accounting solutions

Working paper templates are available for all chapter brief exercises, exercises, problems, and cases

end-of-Excel working papers are available in WileyPLUS.

Quantum Tutors. Adaptive learning and assessment software that will help students master the core

accounting topics and skills necessary to be successful

in this course

Mobile Applications. Quizzing and reviewing content

is available for download on iTunes

For Instructors

In addition to the support instructors receive from WileyPLUS

and the Wiley Faculty Network, we offer the following useful

supplements

Textbook Companion Website On this website,

www.wiley.com/college/kimmel, instructors will find

the Solutions Manual, Test Bank, Instructor’s Manual,

Computerized Test Bank, and other resources

Solutions Manual The Solutions Manual contains

detailed solutions to all questions, brief exercises,

exer-cises, and problems in the textbook, as well as suggested

answers to the questions and cases The estimated time

to complete exercises, problems, and cases is provided

Instructor’s Manual Included in each chapter are

lecture outlines with teaching tips, chapter reviews, and

review quizzes

Test Bank and Computerized Test Bank The test

bank and computerized test bank allow instructors to tailor

examinations according to learning objectives and learning

outcomes, including AACSB, AICPA, and IMA professional

standards Achievement tests, comprehensive examinations,

and a final exam are included

PowerPoint™ The PowerPoint™ presentations

con-tain a combination of key concepts, images, and problems

from the textbook They are a useful, animated tool for

classroom lectures

xv

Managerial Accounting Video Series. Through the examples of real-world, cutting-edge companies,

these videos (available in WileyPLUS) engage students

with a dynamic overview of managerial accounting topics

Students are then motivated to further review the detailed tools, examples, and discussions presented in their

textbook, WileyPLUS course, and classroom lectures.

Acknowledgments

Accounting, Fifth Edition, has benefitted greatly from the input of focus group participants,

manu-script reviewers, those who have sent comments by letter or e-mail, ancillary authors, and proofers

We greatly appreciate the constructive suggestions and innovative ideas of reviewers and the

creativ-ity and accuracy of the ancillary authors and checkers.

Prior Edition

Thanks to the following reviewers, focus group participants,

and others who provided suggestions for the Fourth Edition:

Juanita Ardavany Los Angeles Valley College

Evangelie Brodie North Carolina State University

Cheryl Copeland California State University—Fresno

Cheryl Crespi Central Connecticut State University

Sue Counte St Louis Community College—Meramec

Robin D’Agati Palm Beach Community College

Rafik Elias University of California, Los Angeles

Valencia Community College

Hassan Hefzi California State PolyTech University—Pomona

M.A “Maggie” Houston Wright State University

Mehmet Kocakulah University of Southern Indiana

Florence McGovern Bergen Community College

Noel McKeon Florida Community College at Jacksonville

Paul Mihalek Central Connecticut State University

William J Nealon Schenectady County Community College

Joseph M Nicassio Westmoreland County Community College

Rosemary Nurre San Mateo Community College

Rod Ridenour Montana State University—Bozeman

Cecile M Roberti Community College of Rhode Island

Luther L Ross Central Piedmont Community College

Vic Stanton University of California, Berkley

Howard Switkay Community College of Philadelphia

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Melanie Yon

Contents

Chapter 1 Introduction to Financial Statements 2

Knowing the Numbers 3

Forms of Business Organization 4 Users and Uses of Financial Information 6 Internal Users 6

External Users 6 Ethics in Financial Reporting 8 Business Activities 9

Financing Activities 9 Investing Activities 10 Operating Activities 10 Communicating with Users 11 Income Statement 12 Retained Earnings Statement 13 Balance Sheet 14

Statement of Cash Flows 15 Interrelationships of Statements 16 Other Elements of an Annual Report 19

A Look at IFRS 43

Chapter 2

A Further Look at Financial Statements 46

Just Fooling Around? 47

The Classified Balance Sheet 48 Current Assets 49

Long-Term Investments 50 Property, Plant, and Equipment 51 Intangible Assets 51

Current Liabilities 52 Long-Term Liabilities 53 Stockholders’ Equity 53 Using the Financial Statements 54 Ratio Analysis 54

Using the Income Statement 54 Using the Statement of Stockholders’ Equity 56 Using a Classified Balance Sheet 57

Keeping an Eye on Cash 61

Financial Reporting Concepts 63 The Standard-Setting Environment 63 Qualities of Useful Information 64 Assumptions in Financial Reporting 65 Principles in Financial Reporting 66 Cost Constraint 66

A Look at IFRS 95

Chapter 3 The Accounting Information System 100

Accidents Happen 101

The Accounting Information System 102 Accounting Transactions 102

Analyzing Transactions 103 Summary of Transactions 109 The Account 111

Debits and Credits 111 Debit and Credit Procedures 112 Stockholders’ Equity Relationships 115 Summary of Debit/Credit Rules 116 Steps in the Recording Process 116 The Journal 117

The Ledger 119 Chart of Accounts 120 Posting 120

The Recording Process Illustrated 121 Summary Illustration of Journalizing and Posting 127

The Trial Balance 129 Limitations of a Trial Balance 129

Keeping an Eye on Cash 130

A Look at IFRS 159

Chapter 4 Accrual Accounting Concepts 162

Keeping Track of Groupons 163

Timing Issues 164 The Revenue Recognition Principle 164 The Expense Recognition Principle 165 Accrual versus Cash Basis of Accounting 166 The Basics of Adjusting Entries 167

Types of Adjusting Entries 168 Adjusting Entries for Deferrals 169 Adjusting Entries for Accruals 175 Summary of Basic Relationships 181 The Adjusted Trial Balance and Financial Statements 183

Preparing the Adjusted Trial Balance 183 Preparing Financial Statements 184 Quality of Earnings 185

Closing the Books 188 Preparing Closing Entries 188 Preparing a Post-Closing Trial Balance 189 Summary of the Accounting Cycle 191

Keeping an Eye on Cash 191

APPENDIX 4A: Adjusting Entries in an Automated

World–Using a Worksheet 195

A Look at IFRS 225

Chapter 5

Merchandising Operations and

the Multiple-Step Income Statement 228

Buy Now, Vote Later 229

Merchandising Operations 230

Operating Cycles 231 Flow of Costs 231 Recording Purchases of Merchandise 233

Freight Costs 234 Purchase Returns and Allowances 235 Purchase Discounts 236

Summary of Purchasing Transactions 237 Recording Sales of Merchandise 238

Sales Returns and Allowances 239 Sales Discounts 240

Income Statement Presentation 241

Sales Revenues 243 Gross Profit 243 Operating Expenses 243 Nonoperating Activities 244 Determining Cost of Goods Sold Under

a Periodic System 246 Evaluating Profitability 247

Gross Profit Rate 247 Profit Margin 249

Keeping an Eye on Cash 251

APPENDIX 5A: Periodic Inventory System 253

Recording Merchandise Transactions 253 Recording Purchases of Merchandise 254 Freight Costs 254

Recording Sales of Merchandise 254 Comparison of Entries—Perpetual vs Periodic 255

A Look at IFRS 279

Chapter 6

Reporting and Analyzing

Inventory 282

“Where Is That Spare Bulldozer Blade?” 283

Classifying and Determining Inventory 284

Classifying Inventory 284 Determining Inventory Quantities 286 Inventory Costing 288

Specific Identification 288 Cost Flow Assumptions 289 Financial Statement and Tax Effects

of Cost Flow Methods 294

Keeping an Eye on Cash 296

Using Inventory Cost Flow Methods Consistently 297

Lower-of-Cost-or-Market 298 Analysis of Inventory 299 Inventory Turnover 299 Analysts’ Adjustments for LIFO Reserve 301 APPENDIX 6A: Inventory Cost Flow Methods

in Perpetual Inventory Systems 305 First-In, First-Out (FIFO) 306

Last-In, First-Out (LIFO) 306 Average-Cost 307

APPENDIX 6B: Inventory Errors 308 Income Statement Effects 308 Balance Sheet Effects 309

A Look at IFRS 331

Chapter 7 Fraud, Internal Control, and Cash 334

Minding the Money in Moose Jaw 335

Fraud and Internal Control 336 Fraud 336

The Sarbanes-Oxley Act 337 Internal Control 337

Principles of Internal Control Activities 338 Limitations of Internal Control 345

Cash Controls 347 Cash Receipts Controls 347 Cash Disbursements Controls 350 Control Features: Use of a Bank 352 Bank Statements 352

Reconciling the Bank Account 353 Reporting Cash 358

Cash Equivalents 359 Restricted Cash 359 Managing and Monitoring Cash 360 Basic Principles of Cash Management 361

Keeping an Eye on Cash 362

APPENDIX 7A: Operation of the Petty Cash Fund 367 Establishing the Petty Cash Fund 367

Making Payments from Petty Cash 367 Replenishing the Petty Cash Fund 368

A Look at IFRS 393

Chapter 8 Reporting and Analyzing Receivables 396

What’s Cooking? 397

Types of Receivables 398 Accounts Receivable 399 Recognizing Accounts Receivable 399 Valuing Accounts Receivable 400

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Notes Receivable 407 Determining the Maturity Date 408 Computing Interest 408

Recognizing Notes Receivable 409 Valuing Notes Receivable 409 Disposing of Notes Receivable 410 Financial Statement Presentation

of Receivables 411 Managing Receivables 412 Extending Credit 412 Establishing a Payment Period 413 Monitoring Collections 413 Evaluating Liquidity of Receivables 415 Accelerating Cash Receipts 417

Keeping an Eye on Cash 420

A Look at IFRS 444

Chapter 9 Reporting and Analyzing Long-Lived Assets 446

A Tale of Two Airlines 447

Plant Assets 448 Determining the Cost of Plant Assets 449

To Buy or Lease? 452 Accounting for Plant Assets 453 Depreciation 453

Factors in Computing Depreciation 454 Depreciation Methods 454

Revising Periodic Depreciation 459 Expenditures During Useful Life 460 Impairments 461

Plant Asset Disposals 461 Analyzing Plant Assets 464 Return on Assets 464 Asset Turnover 465 Profit Margin Revisited 466 Intangible Assets 467

Accounting for Intangible Assets 468 Types of Intangible Assets 469 Financial Statement Presentation

of Long-Lived Assets 472

Keeping an Eye on Cash 473

APPENDIX 9A: Calculation of Depreciation Using Other Methods 476

Declining-Balance 476 Units-of-Activity 477

A Look at IFRS 500

Chapter 10 Reporting and Analyzing Liabilities 504

And Then There Were Two 505

Current Liabilities 506 What Is a Current Liability? 506 Notes Payable 507

Sales Taxes Payable 507 Unearned Revenues 508 Current Maturities of Long-Term Debt 509 Payroll and Payroll Taxes Payable 510 Bonds: Long-Term Liabilities 512 Types of Bonds 512

Issuing Procedures 513 Determining the Market Price of Bonds 513 Accounting for Bond Issues 515

Issuing Bonds at Face Value 516 Discount or Premium on Bonds 516 Issuing Bonds at a Discount 517 Issuing Bonds at a Premium 519 Accounting for Bond Redemptions 520 Redeeming Bonds at Maturity 520 Redeeming Bonds before Maturity 521 Financial Statement Presentation

and Analysis 521 Balance Sheet Presentation 521

Keeping an Eye on Cash 522

Analysis 523 Off-Balance-Sheet Financing 525 APPENDIX 10A: Straight-Line Amortization 530 Amortizing Bond Discount 530

Amortizing Bond Premium 531 APPENDIX 10B: Effective-Interest Amortization 532 Amortizing Bond Discount 533

Amortizing Bond Premium 535 APPENDIX 10C: Accounting for Long-Term Notes Payable 536

A Look at IFRS 564

Chapter 11 Reporting and Analyzing Stockholders’ Equity 568

Oh Well, I Guess I’ll Get Rich 569

The Corporate Form of Organization 570 Characteristics of a Corporation 571 Forming a Corporation 574

Stockholder Rights 574 Stock Issue Considerations 575 Authorized Stock 576 Issuance of Stock 576 Par and No-Par Value Stocks 577 Accounting for Issues of Common Stock 577 Accounting for Treasury Stock 579

Purchase of Treasury Stock 580 Preferred Stock 581

Dividend Preferences 582 Liquidation Preference 583

Dividends 584

Cash Dividends 584 Stock Dividends 586 Stock Splits 588 Retained Earnings 590

Retained Earnings Restrictions 590 Financial Statement Presentation of

Stockholders’ Equity 591 Balance Sheet Presentation 591

Keeping an Eye on Cash 592

Measuring Corporate Performance 593

Dividend Record 593 Earnings Performance 594 Debt versus Equity Decision 595 APPENDIX 11A: Entries for Stock Dividends 599

Significant Noncash Activities 628 Format of the Statement of Cash Flows 629 The Corporate Life Cycle 630

Preparing the Statement of Cash Flows 632 Indirect and Direct Methods 632

Preparation of the Statement of Cash

Flows–Indirect Method 633 Step 1: Operating Activities 635 Summary of Conversion to Net Cash Provided by Operating Activities–Indirect Methods 638 Step 2: Investing and Financing Activities 640 Step 3: Net Change in Cash 641

Using Cash Flows to Evaluate a Company 642

Free Cash Flow 642

Keeping an Eye on Cash 644

Assessing Liquidity and Solvency Using Cash Flows 645

APPENDIX 12A: Statement of Cash Flows–Direct

Method 649 Step 1: Operating Activities 651 Step 2: Investing and Financing Activities 655 Step 3: Net Change in Cash 656

APPENDIX 12B: Statement of Cash Flows—T-Account

Improper Recognition 707 Price-Earnings Ratio 707 APPENDIX 13A: Comprehensive Illustration

of Ratio Analysis 712 Liquidity Ratios 714 Solvency Ratios 716 Profitability Ratios 719

A Look at IFRS 748

Chapter 14 Managerial Accounting 752

Just Add Water and Paddle 753

Managerial Accounting Basics 754 Comparing Managerial and Financial Accounting 755

Management Functions 755 Organizational Structure 757 Business Ethics 758

Managerial Cost Concepts 759 Manufacturing Costs 760 Product versus Period Costs 761 Manufacturing Costs in Financial Statements 762 Income Statement 762

Cost of Goods Manufactured 763 Cost of Goods Manufactured Schedule 764 Balance Sheet 766

Cost Concepts—A Review 767 Product Costing for Service Industries 768 Managerial Accounting Today 769

Focus on the Value Chain 770 Balanced Scorecard 771 Corporate Social Responsibility 771

Chapter 15 Job Order Costing 798

She Succeeds Where Others Have Failed 799

Cost Accounting Systems 800 Job Order Cost System 800 Process Cost System 801 Job Order Cost Flow 802 Accumulating Manufacturing Costs 803

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Assigning Manufacturing Costs to Work

in Process 805 Manufacturing Overhead Costs 809 Assigning Costs to Finished Goods 813 Assigning Costs to Cost of Goods Sold 814 Summary of Job Order Cost Flows 815 Job Order Costing for Service Companies 816 Advantages and Disadvantages of

Job Order Costing 818 Reporting Job Cost Data 819 Under- or Overapplied Manufacturing Overhead 820

Chapter 16 Process Costing 844

Ben & Jerry’s Tracks Its Mix-Ups 845

The Nature of Process Cost Systems 846 Uses of Process Cost Systems 846 Process Costing for Service Companies 847 Similarities and Differences Between Job Order Cost and Process Cost Systems 847

Process Cost Flow 849 Assigning Manufacturing Costs—Journal Entries 850

Equivalent Units 853 Weighted-Average Method 853 Refinements on the Weighted-Average Method 854

Production Cost Report 856 Compute the Physical Unit Flow (Step 1) 857

Compute the Equivalent Units of Production (Step 2) 858

Compute Unit Production Costs (Step 3) 858 Prepare a Cost Reconciliation Schedule (Step 4) 859

Preparing the Production Cost Report 860 Costing Systems—Final Comments 862 APPENDIX 16A: FIFO Method 866

Equivalent Units Under FIFO 866 Comprehensive Example 867 FIFO and Weighted-Average 871

Chapter 17 Activity-Based Costing 894

Precor Is on Your Side 895

Traditional Costing and Activity-Based Costing 896

Traditional Costing Systems 896 The Need for a New Approach 897 Activity-Based Costing 897

Example of ABC versus Traditional Costing 900 Identify and Classify Activities and Allocate Overhead to Cost Pools (Step 1) 900 Identify Cost Drivers (Step 2) 901

Compute Activity-Based Overhead Rates (Step 3) 901

Assign Overhead Costs to Products (Step 4) 901

Comparing Unit Costs 903 Activity-Based Costing: A Closer Look 905 Benefits of ABC 905

Limitations of ABC 906 When to Use ABC 907 Value-Added versus Non–Value-Added Activities 907

Classification of Activity Levels 909 Activity-Based Costing in Service Industries 911

Traditional Costing Example 912 Activity-Based Costing Example 912 APPENDIX 17A: Just-in-Time Processing 916 Objective of JIT Processing 917

Elements of JIT Processing 918 Benefits of JIT Processing 918

Chapter 18 Cost-Volume-Profit 944

Don’t Worry—Just Get Big 945

Cost Behavior Analysis 946 Variable Costs 946 Fixed Costs 947 Relevant Range 948 Mixed Costs 950 Importance of Identifying Variable and Fixed Costs 953

Cost-Volume-Profit Analysis 954 Basic Components 954 CVP Income Statement 955 Break-Even Analysis 958 Target Net Income 962 Margin of Safety 963

Chapter 19 Cost-Volume-Profit Analysis:

Additional Issues 984

Rapid Replay 985

Cost-Volume-Profit (CVP) Review 986 Basic Concepts 986

Basic Computations 988 CVP and Changes in the Business Environment 989

Sales Mix 992 Break-Even Sales in Units 992 Break-Even Sales in Dollars 994 Determining Sales Mix with Limited Resources 997

Cost Structure and Operating Leverage 1000 Effect on Contribution Margin Ratio 1001

Effect on Break-Even Point 1001 Effect on Margin of Safety Ratio 1001 Operating Leverage 1001

APPENDIX 19A: Absorption Costing versus

Variable Costing 1005 Example Comparing Absorption Costing with Variable Costing 1005

An Extended Example 1008 Decision-Making Concerns 1012 Potential Advantages of Variable Costing 1014

Chapter 20

Incremental Analysis 1040

Make It or Buy It? 1041

Management’s Decision-Making Process 1042

Incremental Analysis Approach 1043 How Incremental Analysis Works 1043 Types of Incremental Analysis 1045

Accept an Order at a Special Price 1045 Make or Buy 1046

Sell or Process Further 1049 Repair, Retain, or Replace Equipment 1052 Eliminate an Unprofitable Segment

or Product 1054 Other Considerations in Decision- Making 1056

Preparing the Operating Budgets 1087

Sales Budget 1087 Production Budget 1088 Direct Materials Budget 1090 Direct Labor Budget 1093 Manufacturing Overhead Budget 1094 Selling and Administrative Expense Budget 1095

Budgeted Income Statement 1095 Preparing the Financial Budgets 1097

Cash Budget 1097 Budgeted Balance Sheet 1101 Budgeting in Nonmanufacturing Companies 1102

Merchandisers 1102

Service Companies 1103 Not-for-Profit Organizations 1104

Chapter 22 Budgetary Control and Responsibility Accounting 1132

Turning Trash Into Treasure 1133

Budgetary Control 1134 Static Budget Reports 1135 Examples 1135

Uses and Limitations 1136 Flexible Budgets 1137 Why Flexible Budgets? 1137 Developing the Flexible Budget 1139 Flexible Budget—A Case Study 1140 Flexible Budget Reports 1143 Responsibility Accounting 1145 Controllable versus Noncontrollable Revenues and Costs 1147

Principles of Performance Evaluation 1147 Responsibility Reporting System 1149 Types of Responsibility Centers 1152 Responsibility Accounting for Cost Centers 1153 Responsibility Accounting for Profit

Centers 1153 Responsibility Accounting for Investment Centers 1156

APPENDIX 22A: Residual Income—Another Performance Measurement 1163

Residual Income Compared to ROI 1164 Residual Income Weakness 1164

Chapter 23 Standard Costs and Balanced Scorecard 1192

80,000 Different Caffeinated Combinations 1193

The Need for Standards 1194 Distinguishing Between Standards and Budgets 1194

Why Standard Costs? 1195 Setting Standard Costs 1196 Ideal versus Normal Standards 1196

A Case Study 1196 Analyzing and Reporting Variances from Standards 1200

Direct Materials Variances 1201 Direct Labor Variances 1204 Manufacturing Overhead Variances 1207 Reporting Variances 1209

Statement Presentation of Variances 1210 Balanced Scorecard 1210

APPENDIX 23A: Standard Cost Accounting System 1216

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Journal Entries 1216 Ledger Accounts 1218 APPENDIX 23B: A Closer Look at Overhead Variances 1219

Overhead Controllable Variance 1219 Overhead Volume Variance 1220

Chapter 24 Planning for Capital Investments 1244

Floating Hotels 1245

The Capital Budgeting Evaluation Process 1246 Cash Flow Information 1246

Illustrative Data 1248 Cash Payback 1248 Net Present Value Method 1250 Equal Annual Cash Flows 1251 Unequal Annual Cash Flows 1251 Choosing a Discount Rate 1252 Simplifying Assumptions 1253 Comprehensive Example 1254 Additional Considerations 1255 Intangible Benefits 1255 Profitability Index for Mutually Exclusive Projects 1257

Risk Analysis 1258 Post-Audit of Investment Projects 1259 Other Capital Budgeting Techniques 1260 Internal Rate of Return Method 1260 Comparing Discounted Cash Flow Methods 1262

Annual Rate of Return Method 1263

Appendix A Specimen Financial Statements:

Tootsie Roll Industries, Inc A-1

The Annual Report A-1 Letter to the Stockholders A-2 Financial Highlights A-3 Management Discussion and Analysis A-6 Financial Statements and Accompanying Notes A-14

Auditor’s Report A-28

Appendix B Specimen Financial Statements:

The Hershey Company B-1 Appendix C

Specimen Financial Statements:

Zetar plc C-1

Appendix D Time Value of Money D-1

Nature of Interest D-1 Simple Interest D-1 Compound Interest D-2 Future Value Concepts D-2 Future Value of a Single Amount D-2 Future Value of an Annuity D-4 Present Value Concepts D-7 Present Value Variables D-7 Present Value of a Single Amount D-7 Present Value of an Annuity D-9 Time Periods and Discounting D-11 Computing the Present Value of a Long-Term Note or Bond D-11

Using Financial Calculators D-14 Present Value of a Single Sum D-14 Present Value of an Annuity D-15 Useful Applications of the Financial Calculator D-15

Appendix E Reporting and Analyzing Investments E-1

Why Corporations Invest E-1 Accounting for Debt Investments E-2 Recording Acquisition of Bonds E-2 Recording Bond Interest E-3 Recording Sale of Bonds E-3 Accounting for Stock Investments E-4 Holdings of Less Than 20% E-4 Holdings Between 20% and 50% E-5 Holdings of More Than 50% E-7 Valuing and Reporting Investments E-7 Categories of Securities E-8

Balance Sheet Presentation E-10 Presentation of Realized and Unrealized Gain or Loss E-12 Statement of Cash Flows Presentation E-12

Appendix F (available online at

www.wiley.com/college/kimmel)

Payroll Accounting F-1

Accounting for Payroll F-1 Determining the Payroll F-1 Recording the Payroll F-5 Employer Payroll Taxes F-8 FICA Taxes F-8

Federal Unemployment Taxes F-8 State Unemployment Taxes F-8 Recording Employer Payroll Taxes F-9 Filing and Remitting Payroll Taxes F-9 Internal Control of Payroll F-10

Journals G-3 Sales Journal G-4 Cash Receipts Journal G-6 Purchases Journal G-10 Cash Payments Journal G-12 Effects of Special Journals on General Journal G-14

Appendix H (available online at

www.wiley.com/college/kimmel)

Accounting for Partnerships H-1

Partnership Form of Organization H-1

Characteristics of Partnerships H-1 Organizations with Partnership Characteristics H-3 Advantages and Disadvantages of

Partnerships H-3 The Partnership Agreement H-4 Basic Partnership Accounting H-4

Forming a Partnership H-4 Dividing Net Income or Net Loss H-6 Partnership Financial Statements H-9 Admission and Withdrawal of Partners H-9 Liquidation of a Partnership H-10

No Capital Deficiency H-10 Capital Deficiency H-12

Appendix I (available online at

Appendix J (available online at

Transfer Pricing for Internal Sales J-8 Negotiated Transfer Prices J-9 Cost-Based Transfer Prices J-12 Market-Based Transfer Prices J-13 Effect of Outsourcing on Transfer Pricing J-14 Transfers Between Divisions in Different Countries J-14

Other Cost Approaches to Pricing J-15 Absorption-Cost Pricing J-16

Variable-Cost Pricing J-17 Company Index I-1

Subject Index I-3

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Student success is a team effort.

The Team for Success is focused on helping students get the most out of their accounting courses in the digital age

The powerful combination of quality text, visual approach to learning, and highly intuitive homework experience supports the digital student workfl ow preparing them for class, exams, and future study.

Illustrations and interactive tutorials bring the content to life and make accounting concepts easier to understand.

Access the right amount of information for each course anytime, anywhere on any device.

Students

Students

Students

Students

The Do it! exercises throughout the textbook will help students

apply their understanding of accounting The WileyPLUS homework

experience imitates a blank sheet of paper experience using ahead for account entry, and helps students catch mistakes early by providing feedback at the part level

type-y

xxvi

Issues that affect

today’s business world are highlighted in the textbook.

Insight Boxes frame real-world company issues through inter- national, ethical, and other perspectives.

Feature Stories introduce chapter topics in

fun ways using real-world companies that are

engaging.

REAL-WORLD CONTEXT

Real-world companies and business situations give you glimpses

into how real companies use accounting

!

xxvii

Equation Analysis Illustrations

visually walk you through the steps

of journal transactions

Cash Flow Analyses visually

summarize the effects of

transactions on cash flows.

Infographics reinforce important textual concepts Infographics were revised in the Fifth Edition.

Illustrations are clearly identified and often present data in a real-world format.

I

p

CONTENT FOR ALL LEARNING STYLES

In addition to a textbook consistently reviewed as

very readable, over 50% of the textbook provides visual

presentations and interpretations of content.

xxviii

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Clear Do it! exercises

in the textbook narrative provide step-by-step applications of a concept

at the precise moment you acquire the

knowledge Each Do it! in the textbook narrative includes a solution, an Action Plan, and a path of related homework exercises.

Comprehensive

Do it!’s at the end

of each chapter apply

the Do it! and address

multiple topics.

End-of-Chapter Do it!

exercises provide further practice with alternate versions of the in-chapter Do It! exercises.

KNOW THE FUNDMENTALS

Knowing the fundamentals of accounting will help you

understand what is happening in all areas of a business Do it!

exercises throughout the textbook will help you practice your

understanding of accounting.

xxix

The Decision Toolkit and the Decision Toolkit

Summary direct you to the tools and information

you need when evaluating business issues.

Using the Decision Toolkit asks

you to apply toolkit lessons to

a financial statement analysis

exercise Suggested solutions

are provided.

A wrench icon next to select end-of-chapter homework exercises highlights opportunities where you will practice

decision-making tools.

TOOLS FOR DECISION-MAKING

As an employee, manager, or even a director of

your own personal finances, you will make better decisions by

learning how to analyze and solve business problems using tools

provided throughout each chapter.

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FMTOC.indd Page xxxi 9/29/12 2:46 PM F-400

The Navigator

● ✔

1

INTRODUCTION

TO FINANCIAL STATEMENTS

CHAPTER

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

1 Describe the primary forms of business organization

2 Identify the users and uses of accounting information

3 Explain the three principal types of business activity

4 Describe the content and purpose of each of the fi nancial statements

5 Explain the meaning of assets, liabilities, and stockholders’

equity, and state the basic accounting equation

6 Describe the components that supplement the fi nancial statements in an annual report

● ✓

• Scan Learning Objectives

• Read Feature Story

• Scan Preview

• Work Using the Decision Toolkit

• Answer Self-Test Questions

The Navigator is a learning system designed to prompt you to use the

learning aids in the chapter and to set priorities as you study

Many students who take this course do not plan

to be accountants If you are in that group, you

might be thinking, “If I’m not going to be an

accountant, why do I need to know accounting?”

Well, consider this quote from Harold Geneen,

the former chairman of IT&T : “To be good at your

business, you have to know the numbers—cold.”

In business, accounting and financial statements

are the means for communicating the numbers If

you don’t know how to read

financial statements, you can’t

really know your business.

Many businesses agree with

this view They see the value of

their employees being able to

read financial statements and understand how

their actions affect the company’s financial results

For example, consider Clif Bar & Company The

original Clif Bar® energy bar was created in 1990

after six months of experimentation by Gary

Erickson and his mother in her kitchen Today, the

company has almost 300 employees and is

con-sidered one of the leading Landor’s Breakaway

Brands®.

Clif Bar is guided by what it calls its Five

Aspirations—Sustaining Our Business, Our

Brands, Our People, Our Community, and the

Planet Its website documents its efforts and

accomplishments in these five areas Just a few

examples include the company’s use of organic

products to protect soil, water, and biodiversity;

the “smart” solar array (the largest in North

Amer-ica), which provides nearly all the electrical needs

for its 115,000-square-foot building; and the incentives Clif Bar provides to employees to reduce their personal environmental impact, such

as $6,500 toward the purchase of an efficient car or $1,000 per year for eco-friendly improve- ments toward their homes.

One of the company’s proudest moments was the creation of an employee stock owner- ship plan (ESOP) in 2010 This plan gives its

employees 20% ownership of the company (Gary and his wife Kit own the other 80%) The ESOP also resulted in Clif Bar enacting an open-book man- agement program, including the commitment to educate all employee-owners about its finances Armed with this basic finan- cial knowledge, employees are more aware of the financial impact of their actions, which leads

to better decisions.

Even in companies that do not practice book management, today’s employers generally assume that managers in all areas of the com- pany are “financially literate.” To help prepare you for that, in this textbook you will learn how to read and prepare financial statements, and how to use basic tools to evaluate financial results In this first chapter, we will introduce you to the financial statements of a real company whose products you are probably familiar with— Tootsie Roll Tootsie Roll’s presentation of its financial results is com- plete, yet also relatively easy to

open-understand.

INSIDE CHAPTER 1

• The Scoop on Accounting (p 6)

• Spinning the Career Wheel (p 7)

• The Numbers Behind Not-for-Profit Organizations (p 9)

• Beyond Financial Statements (p 16)

KNOWING THE NUMBERS

Feature Story

The Navigator

● ✔

How do you start a business? How do you determine whether your business is making or losing money? How should you finance expansion—should you borrow, should you issue stock, should you use your own funds? How do you convince banks to lend you money or investors to buy your stock? Success in business requires making countless decisions, and decisions require financial information.

The purpose of this chapter is to show you what role accounting plays in providing financial information The content and organization of the chapter are as follows.

● ✔

Introduction to Financial Statements

Forms of Business

Organization

Users and Uses of Financial

1

Describe the primary forms

of business organization

Suppose you graduate with a business degree and decide you want to start your own business But what kind of business? You enjoy working with people, espe- cially teaching them new skills You also spend most of your free time outdoors, kayaking, backpacking, skiing, rock climbing, and mountain biking You think you might be successful in opening an outdoor guide service where you grew up,

in the Sierra Nevada mountains.

Your next decision is to determine the organizational form of your business You have three choices—sole proprietorship, partnership, or corporation.

You might choose the sole proprietorship form for your outdoor guide vice A business owned by one person is a sole proprietorship It is simple to set

ser-up and gives you control over the business Small owner-operated businesses

such as barber shops, law offices, and auto repair shops are often sole ships, as are farms and small retail stores.

proprietor-Another possibility is for you to join forces with other individuals to form a partnership A business owned by two or more persons associated as partners is

a partnership Partnerships often are formed because one individual does not

have enough economic resources to initiate or expand the business Sometimes

partners bring unique skills or resources to the partnership You and your

partners should formalize your duties and contributions in a written partnership agreement Retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certified public accountants), often organize as partnerships.

As a third alternative, you might organize as a corporation A business ized as a separate legal entity owned by stockholders is a corporation Investors

organ-in a corporation receive shares of stock to organ-indicate their ownership claim Buyorgan-ing

-Easier to transfer ownership

-Easier to raise funds

-No personal liability

Corporation

4

Forms of Business Organization 5

stock in a corporation is often more attractive than investing in a partnership

because shares of stock are easy to sell (transfer ownership) Selling a

proprie-torship or partnership interest is much more involved Also, individuals can

become stockholders by investing relatively small amounts of money Therefore,

it is easier for corporations to raise funds Successful corporations often have

thousands of stockholders, and their stock is traded on organized stock exchanges

like the New York Stock Exchange Many businesses start as sole

proprietor-ships or partnerproprietor-ships and eventually incorporate For example, in 1896 Leo

Hirshfield started Tootsie Roll as a sole proprietorship, and by 1919 the company

had incorporated.

Other factors to consider in deciding which organizational form to choose

are taxes and legal liability If you choose a sole proprietorship or partnership,

you generally receive more favorable tax treatment than a corporation However,

proprietors and partners are personally liable for all debts and legal obligations

of the business; corporate stockholders are not In other words, corporate

stock-holders generally pay higher taxes but have no personal legal liability We will

discuss these issues in more depth in a later chapter.

Finally, while sole proprietorships, partnerships, and corporations

repre-sent the main types of business organizations, hybrid forms are now allowed

in all states These hybrid business forms combine the tax advantages of

part-nerships with the limited liability of corporations Probably the most

com-mon acom-mong these hybrids types are limited liability companies (LLCs) and

subchapter S corporations These forms are discussed extensively in business

law classes.

The combined number of proprietorships and partnerships in the United

States is more than five times the number of corporations However, the revenue

produced by corporations is eight times greater Most of the largest businesses in

the United States—for example, Coca-Cola , ExxonMobil , General Motors ,

Citigroup , and Microsoft —are corporations Because the majority of U.S

busi-ness is done by corporations, the emphasis in this textbook is on the corporate

In choosing the organizational form for your outdoor guide service, you should consider the pros and cons of each Identify each of the following organizational

characteristics with the organizational form or forms with which it is associated

1 Easier to raise funds

1 Easier to raise funds: Corporation

2 Simple to establish: Sole proprietorship and partnership

3 No personal legal liability: Corporation

4 Tax advantages: Sole proprietorship and partnership

5 Easier to transfer ownership: Corporation

BUSINESS ORGANIZATION FORMS

Do it! exercises prompt

you to stop and review the key points you have just studied

Action Plans give you tips

about how to approach the problem

The Navigator

● ✔

Identify the users and uses

of accounting information

LEARNING OBJECTIVE

Users and Uses of Financial Information

The purpose of financial information is to provide inputs for decision-making

Accounting is the information system that identifies, records, and communicates the

economic events of an organization to interested users Users of accounting

informa-tion can be divided broadly into two groups: internal users and external users.

INTERNAL USERS

Internal users of accounting information are managers who plan, organize, and

run a business These include marketing managers, production supervisors,

finance directors, and company officers In running a business, managers

must answer many important questions, as shown in Illustration 1-1.

STOCK

ON STRIKE

ON STRIKE

ON STRIKE

Snack chips Beverages

Questions Asked by Internal Users

Is cash sufficient to pay

dividends to

Microsoft stockholders?

Finance

Can General Motors afford

to give its employees pay raises this year?

Human Resources

Which PepsiCo product line is the most profitable? Should anyproduct lines be eliminated?

Management

What price should Apple chargefor an iPod to maximize the company's net income?

Marketing

Illustration 1-1 Questions

that internal users ask

Illustrations help you

visualize and apply the

ideas as you study

To answer these and other questions, you need detailed information on a timely basis For internal users, accounting provides internal reports, such as financial comparisons of operating alternatives, projections of income from new sales cam- paigns, and forecasts of cash needs for the next year In addition, companies present summarized financial information in the form of financial statements.

Accounting Across the

Organization stories

show applications of

accounting information

in various business

There are several types of external users of accounting information Investors

(owners) use accounting information to make decisions to buy, hold, or sell stock

Creditors such as suppliers and bankers use accounting information to evaluate

What are the benefits to the company and to the employees of making the financial statements available to all employees? (See page 42.)

?

Accounting Across the Organization

The Scoop on Accounting

Accounting can serve as a useful recruiting tool even for the human resources department Rhino Foods , located in Burlington, Vermont, is a manufacturer of specialty ice cream Its corporate website includes the following:

“Wouldn’t it be great to work where you were part of a team? Where your input and hard work made a difference? Where you weren’t kept in the dark about what management was thinking? Well—it’s not a dream! It’s the way we do business Rhino Foods believes in family, honesty and open communication—

we really care about and appreciate our employees—and it shows Operating results are posted and monthly group meetings inform all employees about what’s happening in the Company Employees also share in the Company’s

profits, in addition to having an excellent comprehensive benefits package.”

Source: www.rhinofoods.com/workforus/workforus.html.

© Agnieszka

Pastuszak-Maksim/iStockphoto

Users and Uses of Financial Information 7

The information needs and questions of other external users vary considerably

Taxing authorities, such as the Internal Revenue Service, want to know whether

the company complies with the tax laws Customers are interested in whether a

company like General Motors will continue to honor product warranties and

oth-erwise support its product lines Labor unions, such as the Major League Baseball

Players Association, want to know whether the owners have the ability to pay

increased wages and benefits Regulatory agencies, such as the Securities and

Exchange Commission or the Federal Trade Commission, want to know whether

the company is operating within prescribed rules For example, Enron , Dynegy ,

Duke Energy , and other big energy-trading companies reported record profits at

the same time as California was paying extremely high prices for energy and

suf-fering from blackouts This disparity caused regulators to investigate the energy

traders to make sure that the profits were earned by legitimate and fair practices.

What do we do

if they catch us?

BILL COLLECTOR

Yeah!

Questions Asked by External Users

Is General Electric earning

Will United Airlines be able

to pay its debts as they come due?

Creditors

Illustration 1-2 Questions that external users ask

Accounting Across the Organization

Spinning the Career Wheel

How will the study of accounting help you? A working knowledge of

account-ing is desirable for virtually every field of business Some examples of how accountaccount-ing is

used in business careers include:

General management: Managers of Ford Motors , Massachusetts General Hospital,

California State University–Fullerton, a McDonald’s franchise, and a Trek bike shop all

need to understand accounting data in order to make wise business decisions.

Marketing: A marketing specialist at Procter & Gamble must be sensitive to costs and

benefits, which accounting helps them quantify and understand Making a sale is

mean-ingless unless it is a profitable sale.

Finance: Do you want to be a banker for Citicorp , an investment analyst for Goldman

Sachs , or a stock broker for Merrill Lynch ? These fields rely heavily on accounting

knowl-edge to analyze financial statements In fact, it is difficult to get a good job in a finance

function without two or three courses in accounting.

Real estate: Are you interested in being a real estate broker for Prudential Real Estate ?

Because a third party—the bank—is almost always involved in financing a real estate

transaction, brokers must understand the numbers involved: Can the buyer afford to

make the payments to the bank? Does the cash flow from an industrial property justify the

purchase price? What are the tax benefits of the purchase?

Josef Volavka/iStockphoto

How might accounting help you? (See page 42.)

?

the risks of selling on credit or lending money Some questions that investors and

creditors may ask about a company are shown in Illustration 1-2.

ETHICS IN FINANCIAL REPORTING

People won’t gamble in a casino if they think it is “rigged.” Similarly, people won’t “play” the stock market if they think stock prices are rigged At one time, the financial press was full of articles about financial scandals at Enron , WorldCom ,

HealthSouth , and AIG As more scandals came to light, a mistrust of financial

reporting in general seemed to be developing One article in the Wall Street Journal noted that “repeated disclosures about questionable accounting prac-

tices have bruised investors’ faith in the reliability of earnings reports, which in turn has sent stock prices tumbling.”1 Imagine trying to carry on a business or invest money if you could not depend on the financial statements to be honestly prepared Information would have no credibility There is no doubt that a sound, well-functioning economy depends on accurate and dependable finan- cial reporting.

United States regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting Congress passed the Sarbanes-Oxley Act (SOX) to reduce unethical corporate behavior and decrease the likelihood

of future corporate scandals As a result of SOX, top management must now certify the accuracy of financial information In addition, penalties for fraudulent financial activity are much more severe Also, SOX increased the independence of the outside auditors who review the accuracy of corporate financial statements, and increased the oversight role of boards of directors.

Effective financial reporting depends on sound ethical behavior To tize you to ethical situations and to give you practice at solving ethical dilem- mas, we address ethics in a number of ways in this textbook (1) A number of

sensi-the Feature Stories and osensi-ther parts of sensi-the text discuss sensi-the central importance of ethical behavior to financial reporting (2) Ethics Insight boxes and marginal Ethics Notes highlight ethics situations and issues in actual business settings (3) Many of the People, Planet, and Profit Insight boxes focus on ethical issues

that companies face in measuring and reporting social and environmental

issues (4) At the end of the chapter, an Ethics Case simulates a business

situa-tion and asks you to put yourself in the posisitua-tion of a decision-maker in that case.

When analyzing these various ethics cases and your own ethical experiences, you should apply the three steps outlined in Illustration 1-3.

1“U.S Share Prices Slump,” Wall Street Journal (February 21, 2002).

Ethics Note Circus-founder

P.T Barnum is alleged to have

said, “Trust everyone, but cut

the deck.” What Sarbanes-Oxley

does is to provide measures

that (like cutting the deck of

playing cards) help ensure that

fraud will not occur

Solving an Ethical Dilemma

Identify the stakeholders—

persons or groups who may

be harmed or benefited Askthe question: What are theresponsibilities and obligations

of the parties involved?

3 Identify the alternatives, and weigh the impact of each alternative on various stakeholders.

Select the most ethicalalternative, considering all theconsequences Sometimes therewill be one right answer Othersituations involve more thanone right solution; thesesituations require you to evaluate each alternative andselect the best one

1 Recognize an ethical situation and the ethical issues involved.

Use your personal ethics toidentify ethical situations andissues Some businesses andprofessional organizationsprovide written codes ofethics for guidance in somebusiness situations

Illustration 1-3 Steps in

analyzing ethics cases