Financial accounting 11e by albrecht and stice

P R E F A C EWhat, Why, and How of Accounting Th e eleventh edition of Financial Accounting guides you through the what, why, and how of fi nancial accounting in today’s business world

11th edition Financial

•••

James D Stice

PhD Brigham Young University

This page intentionally left blank

About the Authors iii

11th edition Financial

•••

James D Stice

PhD Brigham Young University

© 2011, 2008 South-Western, Cengage Learning ALL RIGHTS RESERVED No part of this work covered by the copyright herein may be reproduced, transmitted, stored, or used in any form or by any means graphic, electronic, or mechanical, including but not limited to photocopying, recording, scanning, digitizing, taping, web distribution, information networks,

or information storage and retrieval systems, except as permitted under Section

107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the publisher.

ExamView® is a registered trademark of eInstruction Corp Windows is a registered trademark of the Microsoft Corporation used herein under license Macintosh and Power Macintosh are registered trademarks of Apple Computer, Inc used herein under license © 2008 Cengage Learning All Rights Reserved.

Cengage Learning WebTutor™ is a trademark of Cengage Learning.

Library of Congress Control Number: 2009942075 ISBN-13: 978-0-538-74695-3

ISBN-10: 0-538-74695-5

South-Western Cengage Learning

5191 Natorp Boulevard Mason, OH 45040 USA

Cengage Learning products are represented in Canada by Nelson Education, Ltd.

For your course and learning solutions, visit www.cengage.com

Purchase any of our products at your local college store or at our preferred online

store www.ichapters.com

Financial Accounting, Eleventh Edition

W Steve Albrecht, Earl K Stice, and James D Stice

Vice President of Editorial, Business: Jack W Calhoun

Publisher: Rob Dewey

Executive Editor: Sharon Oblinger

Developmental Editor: Krista Kellman

Editorial Assistant: Julie Warwick

Marketing Manager: Natalie Livingston

Marketing Coordinator: Heather Mooney

Marketing Communications Manager: Libby Shipp

Senior Content Project Manager: Diane Bowdler

Media Editor: Amir Nasiri

Frontlist Buyer, Manufacturing: Doug Wilke

Production Service: LEAP Publishing Services, Inc.

Compositor: Knowledgeworks Global Limited

Senior Art Director: Stacy Shirley

Internal Designer: Beckmeyer Design

Cover Designer: Beckmeyer Design

Cover Image: iStock Photo

Text Permissions Acquisitions Manager: Roberta Broyer

Photo Permissions Acquisitions Manager: Deanna Ettinger

Image Researcher: Diahanne Dowridge

For product information and technology assistance, contact us at

Cengage Learning Customer & Sales Support, 1-800-354-9706

For permission to use material from this text or product, submit all

requests online at www.cengage.com/permissions

Further permissions questions can be emailed to

permissionrequest@cengage.com

Printed in the United States of America

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

About the Authors v

P A R T O N E

Financial Reporting and the Accounting Cycle 1

3 THE ACCOUNTING CYCLE: THE MECHANICS OF ACCOUNTING 70

5 INTERNAL CONTROLS: ENSURING THE INTEGRITY OF FINANCIAL INFORMATION 179

P A R T T W O

Operating Activities 213

6 RECEIVABLES: SELLING A PRODUCT OR SERVICE 214

P A R T T H R E E

Investing and Financing Activities 375

9 INVESTMENTS: PROPERTY, PLANT, AND EQUIPMENT AND INTANGIBLE ASSETS 376

P A R T F O U R

Other Dimensions of Financial Reporting 609

Appendix A: Wal-Mart 2009 Annual Report A-1

Appendix B: Present Value Tables B-1

About the Authors vii

C O N T E N T S

P A R T O N E

CHAPTER 1 AC C O U N T I N G IN F O R M A T I O N : US E R S A N D US E S 2

What’s the Purpose of Accounting? 4

Th e Relationship of Accounting to Business _ 6

Who Uses Accounting Information? _ 7

Lenders _ 9

Investors 9

Management 10

Other Users of Financial Information _ 10

Within What Kind of Environment Does Accounting Operate? 11

Th e Signifi cance and Development of Accounting Standards _ 12

Th e Financial Accounting Standards Board _ 12

Th e Statement of Cash Flows _ 37

How the Financial Statements Tie Together 40

Notes to the Financial Statements _ 41

Summary of Signifi cant Accounting Policies 41

Additional Information about Summary Totals 42

Disclosure of Information Not Recognized _ 42

Supplementary Information 42

Th e External Audit _ 44Fundamental Concepts and Assumptions 46

Th e Separate Entity Concept 46

Th e Assumption of Arm’s-Length Transactions 47

Th e Cost Principle _ 47

Th e Monetary Measurement Concept _ 47

Th e Going Concern Assumption _ 47End-of-Chapter Materials 48

Expenses, and Dividends _ 77How Do We Record the Eff ects of Transactions? 79Acquiring Cash, Either from Owners or by Borrowing 80Acquiring Other Assets 82Selling Goods or Providing Services 85Collecting Cash and Paying Obligations _ 87

A Note on Journal Entries 89Posting Journal Entries and Preparing a Trial Balance _ 92Determining Account Balances 93Illustration of the First Th ree Steps in the Accounting Cycle 94Where Do Computers Fit In All Th is? 99End-of-Chapter Materials _ 101

CHAPTER 4 CO M P L E T I N G T H E AC C O U N T I N G CY C L E 123

Accrual Accounting _ 124 Periodic Reporting 125Accrual- versus Cash-Basis Accounting _ 126Adjusting Entries _ 129 Unrecorded Receivables 130 Unrecorded Liabilities 131 Prepaid Expenses 132 Unearned Revenues 134

About the Authors ix

Preparing Financial Statements _ 138

Financial Statement Preparation 138

Th e Notes _ 140

Th e Audit _ 141

Closing the Books 144

Real and Nominal Accounts _ 144

Closing Entries _ 144

Preparing a Post-Closing Trial Balance _ 146

A Summary of the Accounting Cycle 148

End-of-Chapter Materials _ 149

CHAPTER 5 INTERNAL CONTROLS: ENSURING THE INTEGRITY

Th e Types of Problems Th at Can Occur 180

Types of Errors in the Reporting Process 181

Disagreements in Judgment _ 182

Fraudulent Financial Reporting _ 183

Safeguards Designed to Minimize Problems _ 184

Th e Control Environment _ 186

Control Activities (Procedures) _ 186

Reasons for Earnings Management 188

Meet Internal Targets 188

Meet External Expectations 189

Income Smoothing 189

Window Dressing for an IPO or a Loan 190

Th e Earnings Management Continuum 190

Is Earnings Management Ethical? _ 191

What Do Auditors Do? _ 196

Are External (Independent) Auditors Independent? _ 197

Th e Securities and Exchange Commission 198

Th e Eff ect of the 1934 Act on Independent Accountants _ 199

End-of-Chapter Materials _ 200

Comprehensive Problem Chapters 1–5 _ 210

Contents ix

Th e Allowance Method _ 226Real-World Illustration of Accounting for Bad Debts 229Assessing How Well Companies Manage Th eir Receivables _ 231Recording Warranty and Service Costs Associated with a Sale _ 233

Reconciling the Bank Account _ 235Foreign Currency Transactions _ 239Foreign Currency Transaction Example _ 240End-of-Chapter Materials _ 242

Inventory and Cost of Goods Sold 271What is Inventory? 272What Costs Are Included in Inventory Cost? 272Who Owns the Inventory? 272Ending Inventory and Cost of Goods Sold 273Accounting for Inventory Purchases and Sales _ 274Overview of Perpetual and Periodic Systems _ 274Perpetual and Periodic Journal Entries _ 275Counting Inventory and Calculating Cost of Goods Sold 280Taking a Physical Count of Inventory 280

Th e Income Eff ect of an Error in Ending Inventory _ 282

About the Authors xi

Inventory Cost Flow Assumptions 283

Specifi c Identifi cation Inventory Cost Flow 284

FIFO Cost Flow Assumption 285

LIFO Cost Flow Assumption 286

Average Cost Flow Assumption _ 286

A Comparison of All Inventory Costing Methods _ 287

Assessing How Well Companies Manage Th eir Inventories _ 290

Evaluating the Level of Inventory _ 290

Number of Days’ Purchases in Accounts Payable 291

Inventory Errors 294

Complications of the Perpetual Method with LIFO and Average Cost _ 297

Reporting Inventory at Amounts Below Cost 298

Inventory Valued at Net Realizable Value _ 299

Inventory Valued at Lower of Cost or Market 299

Method of Estimating Inventories 302

Th e Gross Margin Method 302

Capitalize versus Expense _ 347

Research and Development 348

Advertising 349

Contents xi

Summarizing Operations on an Income Statement 350Other Revenues and Expenses 350 Extraordinary Items _ 350Earnings per Share 352 Diff ering Income Statement Formats 352End-of-Chapter Materials _ 353

Comprehensive Problem Chapters 6–8 _ 373

A Comparison of Depreciation Methods 390Partial-Year Depreciation Calculations _ 391Units-of-Production Method with Natural Resources 391Repairing and Improving Property, Plant, and Equipment 393Recording Impairments of Asset Value _ 396Recording Decreases in the Value of Property, Plant, and Equipment 396Recording Increases in the Value of Property, Plant, and Equipment _ 398Disposal of Property, Plant, and Equipment _ 399Discarding Property, Plant, and Equipment _ 399Selling Property, Plant, and Equipment _ 400Exchanging Property, Plant, and Equipment _ 401Accounting for Intangible Assets _ 402Amortization of Intangible Assets _ 405Impairment of Intangible Assets 406Measuring Property, Plant, and Equipment Effi ciency _ 407Evaluating the Level of Property, Plant, and Equipment 407 Industry Diff erences in Fixed Asset Turnover 407

About the Authors Contents xiii xiii

Accelerated Depreciation Methods 409

Declining-Balance Method of Depreciation _ 409

Sum-of-the-Years’-Digits Method of Depreciation _ 411

A Comparison of Depreciation Methods 412

Changes in Depreciation Estimates and Methods _ 414

End-of-Chapter Materials _ 416

CHAPTER 10 FINANCING: LONG-TERM LIABILITIES 446

Measuring Long-Term Liabilities _ 447

Present Value and Future Value Concepts _ 448

Computing the Present Value of an Annuity _ 452

Using Excel Spreadsheets for Time Value of Money Calculations _ 453

Accounting for Long-Term Liabilities 456

Determining a Bond’s Issuance Price _ 465

Accounting for Bonds Payable Issued at Face Value 469

Bond Retirements before Maturity 470

Using Debt-Related Financial Ratios 472

Debt Ratio and Debt-to-Equity Ratio 472

Interest Earned Ratio 473

Bonds Issued at a Discount or at a Premium 474

Accounting for Bonds Issued at a Discount 474

Accounting for Bonds Issued at a Premium 476

Eff ective-Interest Amortization _ 477

End-of-Chapter Materials _ 480

CHAPTER 11 FINANCING: EQUITY 505

Raising Equity Financing _ 507

Diff erence between a Loan and an Investment _ 508

Proprietorships and Partnerships 508

Corporations and Corporate Stock 509Starting a Corporation _ 510 Common Stock _ 511 Preferred Stock _ 511Accounting for Stock 512Issuance of Stock 512Accounting for Stock Repurchases 514Balance Sheet Presentation 516Retained Earnings 517 Cash Dividends _ 518Dividend Payout Ratio _ 521Other Equity Items _ 523Equity Items that Bypass the Income Statement 523Statement of Stockholders’ Equity _ 524End-of-Chapter Materials _ 526

CHAPTER 12 INVESTMENTS: DEBT AND EQUITY SECURITIES 552

Why Companies Invest in Other Companies 554Classifying a Security 556 Held-to-Maturity Securities _ 556Equity Method Securities _ 557Trading and Available-for-Sale Securities 558Why the Diff erent Classifi cations? 558Accounting for Trading and Available-for-Sale Securities _ 560Accounting for the Purchase of Securities _ 560Accounting for the Return Earned on an Investment 561Accounting for the Sale of Securities _ 562Accounting for Changes in the Value of Securities 563Changes in the Value of Trading Securities 564Changes in the Value of Available-for-Sale Securities _ 564Subsequent Changes in Value 565

Accounting for Held-to-Maturity Securities _ 568Accounting for the Initial Purchase 568Accounting for Bonds Purchased between Interest Dates _ 569Accounting for the Amortization of Bond Discounts and Premiums _ 570Accounting for the Sale or Maturity of Bond Investments _ 572Accounting for Equity Investments Using the Equity Method _ 575Illustrating the Equity Method _ 576Consolidated Financial Statements 578End-of-Chapter Materials _ 581

Comprehensive Problem Chapters 9–12 606

About the Authors xv

P A R T F O U R

What’s the Purpose of a Statement of Cash Flows? 612

What Information Is Reported in the Statement of Cash Flows? _ 613

Major Classifi cations of Cash Flows _ 613

Noncash Investing and Financing Activities _ 615

Cash Flow Patterns 616

Preparing a Statement of Cash Flows—A Simple Example 617

Analyzing the Other Primary Financial Statements to Prepare a Statement

of Cash Flows 621

A Six-Step Process for Preparing a Statement of Cash Flows _ 622

An Illustration of the Six-Step Process 623

Using Information from the Statement of Cash Flows to Make Decisions 633

End-of-Chapter Materials _ 634

CHAPTER 14 ANALYZING FINANCIAL STATEMENTS 663

Th e Need for Financial Statement Analysis 664

Widely Used Financial Ratios 666

Profi tability Ratios 678

Effi ciency Ratios 679

Leverage Ratios _ 679

More Effi ciency Ratios _ 681

Accounts Receivable Effi ciency _ 681

Inventory Effi ciency _ 682

Property, Plant, and Equipment Effi ciency 683

More Leverage Ratios 684

Debt-to-Equity Ratio 685

Times Interest Earned Ratio _ 686

Cash Flow Ratios _ 687

Usefulness of Cash Flow Ratios _ 687

Cash Flow to Net Income _ 688

Cash Flow Adequacy _ 688

Potential Pitfalls 690Financial Statements Don’t Contain All Information 690Lack of Comparability _ 691Search for the Smoking Gun _ 691Anchoring, Adjustment, and Timeliness 691End-of-Chapter Materials _ 692

Appendix A: Wal-Mart 2009 Annual Report A-1

Appendix B: Present Value Tables B-1

This page intentionally left blank

P R E F A C E

What, Why, and How of Accounting

Th e eleventh edition of Financial Accounting guides you through the what, why, and how of

fi nancial accounting in today’s business world Th rough a solid presentation of concepts and cedures blended with a wealth of real company examples and solved exercises, you can ensure your success!

pro-Financial Accounting, 11e continues to build a stronger foundation with its new what, why, how framework At the beginning of each learning objective, you are shown what each section will teach you, why it is important, and how to use the related accounting practices or methods

WHY A physical inventory count checks the accuracy of accounting records and allows a business

to follow up on unexplained differences

HOW Conduct a physical quantity count of inventory, assign each type of merchandise a unit cost, multiply the quantity by its unit cost, and (for perpetual systems) compare to the recorded inventory balance.

CHE-ALBRECHT-09-0516-007.indd 280 11/20/09 11:47:08 AM

Praised for their emphasis on decision-making and the real-world, the authors continue to ent features that encourage critical thinking, highlight ethical considerations, and consider global implications by showcasing real companies Emphasizing the relevancy of accounting to the business world, this edition is designed to address your diverse learning styles and career needs

pres-By combining the pedagogical features that help you grasp the numbers with the many nities for critical thinking and applying the knowledge you have learned, you will leave your course ready to compete in the business world!

opportu-WHAT

Students like you have told us they benefi t from a structured, clear presentation of material Too much information at once or an ill-defi ned learning path can get you off track If information is instead provided in digestible chunks and the organization sets the expectation for what you should learn in each section, you’ll be able to absorb more information

Streamlined Presentation for superior readability Th is textbook has always engaged its readers with

a lively and accessible writing style, and in this edition, the authors have carefully edited the text to further enhance the presentation of the material Th is edition now provides you with a more concise explanation of accounting principles without sacrifi cing topical coverage or quantity of examples

Visual Presentation In addition to tightening the writing style, the book has been redesigned to make your job of navigating through the content even easier Th e clean, fresh design allows you to focus on the most important elements and color-coded exhibit references make fl ipping through the text to fi nd information a breeze

Learning Objective Framework Now in an easy to read what, why, how format, learning objectives strategically guide you through mastering the chapter material while reinforcing the relevance and

NEW

NEW

NEW

application of these fundamental concepts With each learning objective, you understand exactly

what you are expected to learn from each section

A Review of Learning Objectives Th is review is located at

the end of the chapter to give you a big-picture glance at the

chapter’s topics Th is gives you a valuable starting point for

your study and review

Caution Boxes Caution boxes highlight important points

to consider when contemplating more complex concepts and

emphasize the typical pitfalls associated with those types of

decisions

WHY

Understanding why a fi nancial accounting concept is important, why it’s necessary, and why it’s

done the way it is allows you to be fully engaged with the topic Instead of memorizing equations,

this textbook will challenge you to think conceptually and consider how accounting relates to the

business world

Relevancy in Today’s Business World Th is text off ers multiple features to relate core accounting

concepts to real life Its unique and realistic approach provides a solid framework for understanding

how an organization performs its primary business activities and accounting’s role in those

func-tions Every chapter begins with a Setting the Stage narrative that provides a real business example

as a jumping off point for the rest of the chapter concepts

Updated Real Company Examples Real company data and examples are interspersed throughout

the chapters Wal-Mart serves as the fl agship company for this edition, with the 10K fi nancial

in-formation and notes to the fi nancial statements available in Appendix A Assignable Real Company

Analysis questions appear in the end of chapter as well

FYI FYI boxes point out interesting facts about the current business environment that relate to

the topics being discussed

Ethics and Critical Thinking Skills Th e need for you to be able to analyze business situations and

make informed, ethical decisions is essential in today’s world Ethical considerations are woven

throughout the text and in the end-of-chapter materials Ethics

and Judgment Call questions train you to respond to various

business situations and provide your recommendation,

en-couraging independent decision making In addition, Chapter

5 is solely devoted to the importance of ethical behavior

Stop and Think Th ese reminders provide thought-provoking

real business issues and ask you to analyze the situation and

comment with your evaluation

International Feature As businesses increasingly operate in a global economy, new International

boxes have been included in this edition to compare U.S accounting standards with practices

abroad and highlight shifts in ideology

NEW

C A U T I O N

“Prepaid Expenses” is a tricky name for an asset Assets are reported in the balance sheet Don’t make the mistake of including Prepaid Expenses with the expenses on the income statement.

S T O P & T H I N K

Who

Preface xix

xx Preface

I N T E R N A T I O N A L

The FASB-IASB Teamwork on Stock Option Accounting

The FASB has long stated that the fair value

of executive stock options should be ported as part of compensation expense

re-Many business executives vehemently have agreed, arguing that because the granting of the options does not involve any cash outfl ow from the company, the options cannot possibly be an expense When the FASB proposed the expens- ing of stock options in 1994, the U.S business community went berserk The FASB was even burned in effi gy during a protest in Silicon Valley

dis-So the FASB backed down and said that the value

of stock options did not have to be reported as

an expense in the income statement.

A few years later, the International ing Standards Board (IASB) took up the exact same issue and came to the exact same con- clusion reached initially by the FASB: executive stock options are a form of compensation and should be reported as an expense in the income statement In 2004, the IASB adopted its fi nal rule requiring the expensing of stock options Be- cause the granting of employee stock options is much less common outside the United States, the IASB did not experience nearly as much busi- ness community opposition to its stock option expensing proposal as did the FASB.

Account-By using the IASB standard as a shield, the FASB was able to get its desired accounting treatment accepted in the United States as well.

HOW

After you have learned the conceptual meaning behind a topic and have seen how it relates to the real world, you need to be able to complete calculations and apply what you have learned in a practical sense Th e actual repetition and practice of accounting closes the gap, solidifying your knowledge of accounting principles

Remember This Th ese summary boxes at the conclusion of each section provide an eff ective point to ensure understanding Summaries use bulleted lists to focus on key information and lead into a Do Th is exercise (where applicable)

check-Do This Th is edition now directly connects concepts with application by including brief solved exercises at the end of relevant sections You are asked to work out a problem and check your work against the solution Th is provides you with an eff ective framework to apply to similar exercises or problems in homework assignments

2 Revenue on Sam’s Club memberships is recognized over the term of the membership, which is 12 months.

The notes to the fi nancial statements

Th is text’s superior end-of-chapter materials are the best tools to help you understand the what of

accounting Practice and application are key to your success in accounting!

End-of-Chapter Content

Th e end-of-chapter material is consistent with the what, why, how framework—further tightening

the connection between concepts and practice

WHAT Each question lists which learning objective(s) it covers to help you navigate and to show the

relevance of practicing that concept

WHY An entire section of questions called Analytical Assignments incorporate the real world,

eth-ics, and international considerations

HOW Exercises and problems help you practice your accounting skills in various ways.

Pedagogical EOC

Practice Exercises Practice Excercises off er quick concept checks ideal for in-class practice or

quick reviews before exams

Exercises & Problems Exercises and Problems delve deeper into concepts, testing your retention

of critical topics and procedures Assignments utilizing Excel or Klooster & Allen General Ledger

software are marked with an icon

L O 4

P 6 - 4 4

Accounting for Accounts Receivable

Assume that Dominum Company had the following balances in its receivable accounts on ber 31, 2011:

Cumulative Spreadsheet Projects Cumulative Spreadsheet Projects allow you to build your

spreadsheet profi ciency with assignments that progress in diffi culty as they move through the text

Analytical Assignments

Discussion Questions Discussion Questions ask you how you would tackle a particular

situa-tion—giving you real-world practice

Judgment Call Questions Judgment Call Questions get you to go beyond memorization to

criti-cally analyze a situation and provide your recommended course of action

Real Company Analysis Questions Real Company Analysis Questions ask you to review real

companies’ fi nancial information to answer questions and make decisions

Preface xxi

A A 5 - 2 3

R e a l C o m p a n y

A n a l y s i s

Locate the 2009 Form 10-K for Wal-Mart in Appendix A and consider the following questions:

1 With respect to the report of the external auditors to “the Board of Directors and holders of Wal-Mart Stores, Inc.”:

Share-a Who is Wal-Mart’s external auditor?

b How long after the end of Wal-Mart’s fi scal year did the external auditor complete the audit?

2 With respect to the report of management concerning the fi nancial statements:

a Who is responsible for the fi nancial statements?

b After reading the paragraph on internal control, indicate whether you agree or agree with the following statement: “Th e purpose of an internal control system is to ensure that all transactions are always recorded and that all assets are always com- pletely safeguarded.”

dis-c After looking at the description of the members of the audit committee (in the ond paragraph), do you think that any members of the Walton family are members

Should You Go the Extra Mile?

You work in a small convenience store Th e store is very low-tech; you ring up the sales on an style cash register that merely records the amount of the sale Th e store owner uses this cash register tape at the end of each day to verify that the correct amount of cash is in the cash register drawer

old-On a day-to-day basis, no other fi nancial information is collected about store operations.

Since you started studying accounting, you see many ways that store operations could be proved through the gathering and use of fi nancial information Even though you are not an expert, you are quite certain that you could help the store owner set up an improved information system

im-However, you also know that this will take extra eff ort on your part, with no real possibility of receiving an increase in pay.

Should you say anything to the store owner, or should you just keep quiet and save yourself the trouble?

bank reconciliation, 237 foreign currency transaction, 240 NSF (not suffi cient funds) check, 235

61 What are the major reasons that the balance of a bank statement is usually diff erent from the cash book balance (Cash per the general ledger)?

62 Why don’t the additions and deductions from the bank balance on a bank reconciliation require adjustment by the company?

63 Do all transactions by U.S companies with foreign parties require special accounting procedures by the U.S companies? Explain.

K e y T e r m s & C o n c e p t s

D i s c u s s i o n Q u e s t i o n s

xxii Preface

Even More Tools to Succeed!

C e n g a g e N O W

ISBN: 0538736895

Description:

Ensure that you have the understanding you need of the accounting procedures and concepts you

need to know with CengageNOW Th is integrated, online course management and learning system

combines the best of current technology to allow you access to all of the text’s available resources in

one place Detailed feedback accompanies your homework assignments and helps you from getting

stuck when you need it the most A personalized study plan is available so that you can focus in

on your personal areas of weakness You can also track your progress with the detailed gradebook

included To purchase this resource and for more information please visit www.cengagebrain.com

K l o o s t e r & A l l e n : G e n e r a l L e d g e r S o f t w a r e

ISBN: 0538750839

Description:

Prepared by Dale Klooster and Warren Allen, this best-selling, educational, general ledger 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 In addition, you will have access to

general ledger fi les with information based on problems from the textbook and practice sets Th is

context allows you to see the diff erence between manual and computerized accounting systems

fi rsthand, while alleviating the stress of an empty screen Also, the program is enhanced with a

problem checker that enables you to determine if your entries are correct 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

W o r k i n g P a p e r s

ISBN: 0538750197

Description:

Verifi ed to ensure accuracy and quality consistent with the text, the working papers for the

prob-lems are provided together in one convenient resource

Preface xxiii

This page intentionally left blank

More Online Resources to Help You Earn the Grade You Deserve! xxv

Interactive fl ashcards are provided for you to help you study key

concepts and terms Set them to start the term and provide the

defi nition or have the defi nition provided and guess the term

Depending on the way you learn, use these fl ashcards to get the

grade you want

K e y T e r m s :

Key terms and defi nitions are listed chapter by chapter in an easy

list so that you can quickly locate the important terms for each

chapter

I n t e r a c t i v e Q u i z :

Take the interactive quiz for each chapter to test your knowledge

along the way After reading the chapter, you can quiz yourself to

see how well you know the concepts before taking a test or quiz

in class

F i n a l E x a m : Before taking your fi nal exam in this class, make sure you are prepared by fi rst taking the provided online exam that tests you

on content from all of the chapters

This page intentionally left blank

Texas A&M University, Kingsville

Dell Ann Janney

Th e eleventh edition of Financial Accounting refl ects many comments from colleagues and students, all of which are deeply

appreciated In particular, we would like to thank the following:

In addition, we would like to thank the following content providers and verifi ers for their professional services and ation in providing a more concise, higher-quality product:

consider-Acknowledgments xxvii

This page intentionally left blank

About the Authors xxix

A B O U T T H E A U T H O R S

W Steve Albrecht

W Steve Albrecht is the Andersen Alumni Professor of Accountancy in the Marriott School of Management at Brigham Young University Dr Albrecht, a certifi ed public accountant (CPA), certifi ed internal auditor (CIA), and certifi ed fraud examiner (CFE), came to BYU in 1977 after teaching at Stanford and at the University of Illinois Earlier, he worked as a staff accountant for Deloitte & Touche Until July 1, 2008, he was the associate dean of the Marriott School, a posi-tion he held for 10 years For the previous nine years, Dr Albrecht was director of the School of Accountancy at BYU

Dr Albrecht received a bachelor’s degree in accounting from Brigham Young University and his MBA and PhD degrees from the University of Wisconsin He is past President of the American Accounting Association, the Association of Certifi ed Fraud Examiners, Beta Alpha Psi and the Accounting Program Leadership Group Until recently, he served as the U.S representative on the International Federation of Accountants (IFAC) Education Committee and as a trustee of the Financial Accounting Foundation Dr Albrecht has done extensive research on business fraud and ethics His research has resulted in the publication of over one hundred articles in professional and academic journals He is the author or co-author of 20 books or monographs In 2000, he com-pleted a major study (Accounting Education: Charting the Course through a Perilous Future) on the future of accounting education in the U.S

Dr Albrecht has received numerous awards and honors, including BYU’s highest faculty honor, the Karl G Maeser Distinguished Faculty Lecturer Award, for superior scholarship and teaching

He has also received the BYU School of Management’s Outstanding Faculty Award He has been recognized by Beta Alpha Psi, the Federation of Schools of Accountancy, the Auditing Section of the American Accounting Association, the Utah Association of CPAs and the AICPA as Educator

of the Year He also received awards for outstanding teaching at Stanford University, the University

of Illinois, and the University of Wisconsin In 1997, 2001, 2002 and 2003, and 2004 he was sen as one of the 100 most infl uential accounting professionals in the United States by Accounting Today magazine In 1998, he received the Cressey Award from the Association of Certifi ed Fraud Examiners, the highest award given for a lifetime of achievement in fraud detection and deter-rence In 2002, in honor of his contribution in fi ghting fraud, the Association of Certifi ed Fraud Examiners named one of its headquarter buildings in Austin, Texas after Dr Albrecht In 2001,

FM_Head

Pictured left to right are W Steve Albrecht, Earl K Stice, and James D Stice

in recognition of his contributions to BYU and to academia, an anonymous donor endowed the

W Steve Albrecht Professorship in Accounting and the LeAnn Albrecht fellowship in accounting

Dr Albrecht has consulted with numerous organizations, including Fortune 500 companies, major fi nancial institutions, the United Nations, FBI, and other organizations, and has been an ex-pert witness in over 35 major fraud cases Dr Albrecht is married to the former LeAnn Christiansen and they have six children and sixteen grandchildren

Earl K Stice

Earl K Stice is the PricewaterhouseCoopers Professor of Accounting in the School of Accountancy

at Brigham Young University, where he has been on the faculty since 1998 He holds bachelor’s and master’s degrees from Brigham Young University and a PhD from Cornell University Dr Stice has taught at Rice University, the University of Arizona, Cornell University, and the Hong Kong University of Science and Technology (HKUST) He won the Phi Beta Kappa teaching award at Rice University, was twice selected as one of the ten best lecturers on campus at HKUST, and has won the Marriott School Teaching Award at BYU Dr Stice also has taught in a variety of executive education and corporate training programs in the United States, Hong Kong, China, Malaysia, and South Africa, and he has been on the executive MBA faculty of the China Europe International Business School in Shanghai, HKUST, the University of Illinois, and INSEAD (in Singapore) He

has published papers in the Journal of Financial and Quantitative Analysis, Th e Accounting Review, Review of Accounting Studies, Journal of Business, Finance, and Accounting, and Issues in Accounting Education Dr Stice has presented his research results at seminars in the United States, Finland, Tai- wan, Australia, and Hong Kong He has coauthored several accounting texts including Intermediate Accounting, 17th edition Dr Stice and his wife, Ramona, have seven children — Derrald, Han,

Ryan Marie, Lorien, Lily, Taraz, and Kamila – and one adorable granddaughter

James D Stice

James D Stice is the Distinguished Teaching Professor in the Marriott School of Management at Brigham Young University He is currently Associate Dean of the Marriott School Dr Stice served for eight years as the director of BYU’s MBA Program He holds bachelor’s and master’s degrees

in accounting from BYU and a PhD in accounting from the University of Washington sor Stice has been on the faculty at BYU since 1988 During that time, he has been selected by graduating accounting students as “Teacher of the Year” on numerous occasions; he was selected by his peers in the Marriott School at BYU to receive the “Outstanding Teaching Award” and he was selected by the University to receive its highest teaching award, the Maeser Excellence in Teaching Award Professors Stice has taught in academic and executive education programs in the United States, Europe, South Africa and China for such companies as IBM, Bank of America, and Ernst

Profes-& Young Professor Stice has published articles in Journal of Accounting Research, Th e Accounting Review, Decision Sciences, Issues in Accounting Education, Th e CPA Journal, and other academic and

professional journals and has written several accounting textbooks In addition to his teaching and research, he currently serves on the board of directors of Nutraceutical Corporation Dr Stice and his wife, Kaye, have seven children and eight grandchildren

About the Authors xxxi

11th edition Financial

•••

James D Stice

PhD Brigham Young University

This page intentionally left blank

© JOSÉ CARLOS PIRES PEREIRA/ISTOCKPHOTO.COM

Accounting

of Financial Information

Users and Uses

After studying this chapter, you should be able to:

1

L O 1 Describe the purpose of accounting, and

explain its role in business and society. Accounting is the

recording of the day-to-day fi nancial activities of a company

and the organization of that information into summary reports

used by people inside and outside the company to make

decisions.

L O 2 Identify the primary users of accounting

information. Among the users of accounting information

are lenders, investors, company management, suppliers,

customers, employees, competitors, government agencies,

politicians, and the press.

L O 3 Describe the environment of accounting, including the effects of generally accepted accounting principles, international business, ethical consider- ations, and technology The practice of accounting involves adherence to the established national and (increasingly) international accounting rules as well as the use of judgment Because accounting data are typically captured and sum- marized by computer systems, the practice of accounting requires familiarity with information technology.

L O 4 Analyze the reasons for studying ing Every job requires you to prepare, use, respond to, or

account-be evaluated using accounting data Those people who account-better understand accounting are better able to function in any organization.

Accounting Information: Users and Uses Chapter 1 3

S E T T I N G T H E S TA G E

Suddenly, homeowners who had planned on using the increasing equity in their homes to help them make their mortgage payments found their equity vanishing They could not make their mortgage payments Banks found themselves with repossessed homes that were worth less than the mortgages on those homes and investment banks were hold- ing mortgage-backed investment securities that were now insolvent Four of the biggest investment banks in the world were soon out of the investment banking business—Lehman Brothers (founded in 1850),

Goldman Sachs (founded in 1869), Bear Sterns (founded in 1923), and Morgan Stanley (founded in 1935) all collapsed or stopped doing investment banking within six months of each other in 2008.

American Insurance Group, Inc (AIG) was also heavily vested in these subprime mortgages because of the potential for such high returns On March 2, 2009, AIG reported the largest quar- terly loss in history—$61.7 billion, virtually all of it related to the subprime credit crisis Rather than let AIG (at the time the 18th larg- est company in the world) collapse, the U.S government invested billions of dollars into the company, reasoning that AIG’s collapse would have long-term ramifi cations for the global economy As of March 2009, the U.S government (and the taxpayers) owned 80%

in-of AIG

During the last half of 2008, a series of events began that

resulted in an economic crisis that has been felt around the

world The Dow Jones Industrial Average (a common

mea-sure of U.S stock market performance) dropped 42% in

value from July of 2008 to March of 2009 Over the same time period,

the major index on the London Stock Exchange dropped 36% in value,

and the major stock index in Japan dropped 47% What brought about

this sudden and major drop in the value of these major stock markets?

A combination of factors really

In the United States, a run up in housing prices resulted in

every-one wanting to get into the real estate business Banks, assuming that

housing prices would continue to rise and that any increased equity in

a home would reduce their potential exposure to credit losses, began

providing loans to individuals who, in hindsight, were not creditworthy

(these loans would come to be called subprime mortgages) Banks

then combined those subprime mortgages into packages (or

port-folios) and began selling those portfolios to investors—who also

as-sumed that housing prices would continue to rise Investment banks,

attracted by these high-return mortgage-backed securities, invested

heavily in these subprime loan portfolios And then housing prices

began to level off and even fall

In this textbook, you will begin your study of accounting You will learn to speak and understand accounting, “the language of business.” Without

an understanding of accounting, business investments, taxes, and money management will be like a foreign language to you In brief, an standing of accounting facilitates the interpretation of fi nancial information, which allows for better economic decisions.

under-The major objectives of this text are to provide you with a basic understanding of the language of accounting and with the ability to interpret and use fi nancial information prepared using accounting techniques and procedures With the knowledge you obtain from this exposure to ac- counting, you will be able to “read” the fi nancial statements of companies, understand the information that is being conveyed, and use accounting information to make good business decisions Also, through discussion of the business environment in which accounting is used, you will increase your understanding of general business concepts such as corporations, leases, annuities, leverage, investments, and so forth.

You will become convinced that accounting is not “bean counting.” Time after time, you will see that accountants must exercise judgment about how to best summarize and report the results of business transactions This judgment was at the heart of the diffi culties of Lehman Broth- ers, Goldman Sachs, Bear Sterns, and Morgan Stanley As a result, you will gain a respect for the complexity of accounting and develop a healthy skepticism about the precision of any fi nancial reports you see.

Finally, you will see the power of accounting Financial statements are not just paper reports that get fi led away and forgotten As an ple, the $61.7 billion loss reported by AIG resulted in stock markets suffering signifi cant declines around the world, with the Dow Jones Industrial Average reaching its lowest point in 12 years You will see that fi nancial statement numbers and, indirectly, the accountants who prepare them determine who receives loans and who doesn’t, which companies attract investors and which don’t, which managers receive salary bonuses and which don’t, and which companies are praised in the fi nancial press and which aren’t.

exam-So, let’s get started.

L O 1 What’s the Purpose of Accounting?

WHAT Describe the purpose of accounting and explain its role in business and society.

WHY To understand how accounting impacts business and society.

HOW Use accounting information to make better business decisions.

Imagine a long-distance telephone company with no system in place to document who calls whom and how long they talk Or a manager of a 300-unit apartment complex who has forgotten to write down which tenants have and have not paid this month’s rent Or an accounting professor who, the day before fi nal grades are due, loses the only copy of the disk containing the spreadsheet of all the homework, quiz, and exam scores Each of these scenarios illustrates a problem with book-keeping, the least glamorous aspect of accounting Bookkeeping is the preservation of a systematic, quantitative record of an activity Bookkeeping systems can be very primitive—cutting notches in a stick to tally how many sheep you have or moving beads on a string to track the score in a billiards game But the importance of routine bookkeeping cannot be overstated; without bookkeeping, business is impossible

Rudimentary bookkeeping is ancient, probably predating both language and money Th e ern system of double-entry bookkeeping still in use today (described in Chapter 3) was developed

mod-in the 1300s–1400s mod-in Italy Th e key development in accounting in the last 500 years has been the use of the bookkeeping data not just to keep track of things, but to evaluate the performance and health of a business

Th is use of bookkeeping data as an evaluation tool may seem obvious to you, but it is a step that is often not taken Let’s consider a bookkeeping system with which most of us are familiar—a checking account Your checking account involves (or should involve) careful record-ing of the dates and amounts of all checks written and all deposits made, the maintenance of a running account total, and reconciliations with the monthly bank statement Now, assume that you have a perfect checking account bookkeeping system Will the system answer the following questions?

• Are you spending more for groceries this year than you did last year?

• What proportion of your monthly expenditures is fi xed, meaning that you can’t change

it except through a drastic change in lifestyle?

• You plan to study abroad next year; will you be able to save enough between now and then to pay for it?

In order to answer these kinds of questions, each check must be analyzed to determine the type

of expenditure, your checks must then be coded by type of expenditure, the data must be boiled down into summary reports, and past data must be used to forecast future patterns How many of

us use our checking account data like this? Not many We do the bookkeeping (usually), but we don’t structure the information to be used for evaluation

In summary, an accounting system is used by a business to

1 analyze transactions,

2 handle routine bookkeeping tasks, and

3 structure information so it can be used to evaluate the performance and health of the business

Exhibit 1.1 illustrates the three functions of the accounting system.

bookkeeping The preservation of a

systematic, quantitative record of an

activity.

accounting system The procedures

and processes used by a business to

analyze transactions, handle routine

bookkeeping tasks, and structure

information so it can be used to

evaluate the performance and

health of the business.

Accounting Information: Users and Uses Chapter 1 5

Accounting is formally defi ned as a system for providing “quantitative information,

pri-marily fi nancial in nature, about economic entities that is intended to be useful in making

economic decisions.” 1 The key components of this defi nition are:

• Quantitative Accounting relates to numbers This is a strength because numbers

can be easily tabulated and summarized It is a weakness because some important

business events, such as a toxic waste spill and the associated lawsuits and

coun-tersuits, cannot be easily described by one or two numbers.

• Financial The health and performance of a business are affected by and refl ected

in many dimensions—fi nancial, personal relationships, community and environmental

impact, and public image Accounting focuses on just the fi nancial dimension.

• Useful The practice of accounting is supported by a long tradition of theory U.S

accounting rules have a theoretical conceptual framework Some people actually

make a living as accounting theorists However, in spite of its theoretical beauty,

accounting exists only because it is useful.

• Decisions Although accounting is the structured reporting of what has already occurred,

this past information can only be useful if it impacts decisions about the future.

Making good decisions is critical for success in any business When an important decision

must be made, it is essential to use a rational decision-making process Th e process is basically the

same no matter how complex the issue First, the issue or question must be clearly identifi ed Next,

the facts surrounding the situation must be gathered and analyzed Th en, several alternative courses

of action should be identifi ed and considered before a decision is reached Exhibit 1.2 summarizes

this decision-making process

1 Statement of the Accounting Principles Board No 4, “Basic Concepts and Accounting Principles Underlying Financial Statements of Business

Enter-prises,” New York: American Institute of Certifi ed Public Accountants, 1970, par 40.

accounting A system for providing quantitative, fi nancial information about economic entities that is useful for making sound economic deci- sions Accounting provides the means

of recording and communicating business activities and the results of those activities.

E X H I B I T 1 1 F u n c t i o n s o f a n A c c o u n t i n g S y s t e m

Analyze business events

to determine if information should be captured by the accounting system

Day-to-day keeping track of things

Use summary information

to evaluate the financial health and performance

Step1

Step

Gather information.

Select the option that will most likely result

in the desired objective.

Identify alternatives.

Identify the issue.

One must be careful to make a distinction between a good decision and a good outcome Often, factors outside the decision maker’s control affect the outcome of a decision The decision-making process does not guarantee a certain result; it only ensures that a good decision is made The outcome always has an element of chance Part of business is learn- ing how to protect yourself against bad outcomes The fi rst step in achieving a favorable outcome begins with making a good decision.

Accounting plays a vital role in the decision-making process An accounting system provides information that can be used to make knowledgeable fi nancial decisions Th e information supplied

by accounting is in the form of quantitative data, primarily fi nancial in nature, and relates to specifi c economic entities An economic entity may be an individual, a business enterprise, or a nonprofi t organization A business, such as a grocery store or a car dealership, is operated with the objective of making a profi t for its owners Th e goal of a nonprofi t organization, such as a city government or a university, is to provide services in an eff ective and effi cient manner Every entity, regardless of its size

or purpose, must have a way to keep track of its economic activities and measure how well it is complishing its goals Accounting provides the means for tracking activities and measuring results

ac-The Relationship of Accounting to Business

Business is the general term applied to the activities involved in the production and distribution of goods and services Accounting is used to record and report the fi nancial eff ects of business activities and, as mentioned earlier, is called the “language of business.” Without accounting information, many important fi nancial decisions would be made blindly Investors, for example, would have no way to dis-tinguish between a profi table company and one that is on the verge of failure; bankers could not evalu-ate the riskiness of potential loans; corporate managers would have no basis for controlling costs, setting prices, or investing the company’s resources; and governments would have no basis for taxing income.All business enterprises have some activities in common As shown in Exhibit 1.3, one com-mon activity is the acquisition of monetary resources Th ese resources, often referred to as “capital,” come from three sources:

1 investors (owners),

2 creditors (lenders), and

3 the business itself in the form of earnings that have been retained

Once resources are obtained, they are used to buy land, buildings, and equipment; purchase rials and supplies; pay employees; and meet any other operating expenses involved in the produc-tion and marketing of goods or services When the product or service is sold, additional monetary resources (revenues) are generated Th ese resources can be used to pay loans or taxes, and buy new materials, equipment, and other items needed to continue business operations In addition, some

mate-of the resources may be distributed to owners as a return on their investment Wal-Mart, for ample, uses the earnings from its operations to open new stores and purchase inventory for those new stores Once the new stores are opened, they produce more funds that can then be used to open more stores Wal-Mart also distributes many of its resources back to its owners Owners also receive a return on their investment through increases in the value of the stock

ex-Accountants play two roles with regard to these activities

• Measuring and reporting Accountants measure and communicate (report) the

results of business activities—in other words, accountants keep score To measure these results accurately, accountants follow a standard set of procedures referred to

as the accounting cycle The cycle includes several steps, which involve analyzing, recording, classifying, summarizing, and reporting the transactions of a business.

• Advising Accountants advise managers on how to structure these activities so as

to achieve the goals of the business, such as generating a profi t, minimizing costs, providing effi cient services, etc.

businessAn organization operated

with the objective of making a profi t

from the sale of goods or services.

nonprofi t organization An entity

without a profi t objective, oriented

toward providing services effi ciently

and effectively.

accounting cycle The procedure for

analyzing, recording, classifying,

sum-marizing, and reporting the

transac-tions of a business.

Accounting Information: Users and Uses Chapter 1 7

Loans from creditors Investments by owners

Pay a return to owners

Monetary resources (capital)

Produce and market goods and services

used to

Monetary resources (revenues) from sale of

goods and services

results in

Purchase materials and

Continue business activity (buy materials, pay wages, etc.)

Accounting is designed to accumulate, measure, and communicate fi nancial

informa-tion about businesses and other organizainforma-tions.

Accounting provides information for making informed decisions about how to best

use available resources.

WHAT Identify the primary users of accounting information.

WHY To understand the variety of ways in which accounting information is used.

HOW Consider internal and external stakeholders who would benefi t from having accounting

information.

Th e accounting system generates output in the form of fi nancial reports As shown in Exhibit 1.4,

there are two major categories of reports: internal and external Internal reports are used by those