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Financial Accounting 12e

Carl S. Warren James M. ReeveJonathan E. Duchac

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WARREN REEVE DUCHAC

FINANCIAL ACCOUNTING

12e

Carl S. WarrenProfessor Emeritus of Accounting

University of Georgia, Athens

James M. ReeveProfessor Emeritus of Accounting University of Tennessee, Knoxville

Jonathan E. DuchacProfessor of Accounting Wake Forest University

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This is an electronic version of the print textbook. Due to electronic rights restrictions, some third party content may be suppressed.

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iii

Carl S. WarrenDr. Carl S. Warren is Professor Emeritus of Accounting at the University of Georgia, Athens. Dr. Warren has taught classes at the University of Georgia, University of Iowa, Michigan State University, and University of Chicago. Professor Warren focused his teaching efforts on principles of accounting and auditing. He received his Ph.D. from Michigan State Uni-versity and his B.B.A. and M.A. from the University of Iowa. During his career, Dr. Warren published numerous articles in professional journals, including The Accounting Review, Journal of Accounting Research, Journal of Accountancy, The CPA Journal, and Auditing: A Journal of Practice & Theory. Dr. Warren has served on numerous committees of the American Accounting Association, the American Institute of Certified Public Accountants, and the Institute of Internal Auditors. He has also consulted with numerous companies and public accounting firms. Warren’s outside interests include playing handball, golfing, skiing, backpacking, and fly-fishing.

James M. ReeveDr. James M. Reeve is Professor Emeritus of Accounting and Information Management at the University of Tennessee. Professor Reeve taught on the accounting faculty for 25 years, after graduating with his Ph.D. from Oklahoma State University. His teaching effort focused on undergraduate accounting principles and graduate education in the Master of Accountancy and Senior Executive MBA programs. Beyond this, Professor Reeve is also very active in the Supply Chain Certification program, which is a major executive education and research effort of the College. His research interests are varied and include work in managerial accounting, supply chain management, lean manufactur-ing, and information management. He has published over 40 articles in academic and professional journals, including the Journal of Cost Management, Journal of Management Accounting Research, Accounting Review, Management Accounting Quarterly, Supply Chain Management Review, and Accounting Horizons. He has consulted or provided training around the world for a wide variety of organizations, including Boeing, Procter & Gamble, Norfolk Southern, Hershey Foods, Coca-Cola, and Sony. When not writing books, Professor Reeve plays golf and is involved in faith-based activities.

Jonathan DuchacDr. Jonathan Duchac is the Merrill Lynch and Co. Professor of Accounting and Director of the Program in Enterprise Risk Management at Wake Forest University. He earned his Ph.D. in accounting from the University of Georgia and currently teaches introductory and advanced courses in financial accounting. Dr. Duchac has received a number of awards during his career, including the Wake Forest University Outstanding Graduate Professor Award, the T.B. Rose Award for Instructional Innovation, and the University of Georgia Outstanding Teaching Assistant Award. In addition to his teaching responsibilities, Dr. Duchac has served as Accounting Advisor to Merrill Lynch Equity Research, where he worked with research analysts in reviewing and evaluating the financial reporting practices of public companies. He has testified before the U.S. House of Representatives, the Financial Accounting Standards Board, and the Securities and Exchange Commission; and has worked with a number of major public companies on financial reporting and accounting policy issues. In addition to his professional interests, Dr. Duchac is the Treasurer of The Special Children’s School of Winston-Salem; a private, nonprofit developmental day school serving children with special needs. Dr. Duchac is an avid long-distance runner, mountain biker, and snow skier. His recent events include the Grandfather Mountain Marathon, the Black Mountain Marathon, the Shut-In Ridge Trail run, and NO MAAM (Nocturnal Overnight Mountain Bike Assault on Mount Mitchell).

The Author Team

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iv

A History of Success

For nearly 85 years, Accounting has been used effectively to teach generations of businessmen and women. The text has been used by millions of business stu-dents. For many, this book provides the only exposure to accounting principles

that they will ever receive. As the most successful business textbook of all time, it continues to introduce students to accounting through a variety of time-tested ways.

The previous edition, 23e, started a new journey into learning more about the changing needs of accounting students through a variety of new and innovative research and development methods. Our Blue Sky Workshops brought accounting faculty from all over the country into our book development process in a very direct and creative way. Many of the features and themes present in this text are a result of the collaboration and countless conversations we have had with accounting in-structors over the last several years. 24e continues to build on this philosophy and strives to be reflective of the suggestions and feedback we receive from instructors and students on an ongoing basis. We are very happy with the results, and think you will be pleased with the improvements we have made to the text.

The original author of Accounting, James McKinsey, could not have imagined the success and influence this text has enjoyed or that his original vision would continue to lead the market into the twenty-first century. As the current authors, we appreci-ate the responsibility of protecting and enhancing this vision, while continuing to refine it to meet the changing needs of students and instructors. Always in touch with a tradition of excellence but never satisfied with yesterday’s success, this edition enthusiastically embraces a changing environment and continues to proudly lead the way. We sincerely thank our many colleagues who have helped to make it happen.

“The teaching of accounting is no longer designed to train professional accountants only. With the growing complexity of business and the constantly increasing dif-ficulty of the problems of management, it has become essential that everyone who aspires to a position of responsibility should have a knowledge of the fundamental principles of accounting.”

—James O. McKinsey, Author, first edition, 1929

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Textbooks continue to play an invaluable role in the teaching and learning environ-ments. Continuing our focus from previous editions, we reached out to accounting instructors in an effort to improve the textbook presentation. Our research informed us of the need to remain current in the areas of emerging topics/trends and to continue to look for ways to make the book more accessible to students. The results of this collaboration with hundreds of accounting instructors are reflected in the following major improvements made to the 24th edition:

International Financial Reporting Standards (IFRS)IFRS is on the minds of many accounting educators of today. While the future is still unclear, our research indicates a growing need to provide more basic aware-ness of these standards within the text. We have incorporated some elements of IFRS throughout the text as appropriate to provide this level of awareness, being careful not to encroach upon the core GAAP principles that remain the hallmark focus of the book. These elements include icons that have been placed throughout the financial chapters which point to specific IFRS-related content, outlined with more detail in Appendix D. This table outlines the IFRS impact on the accounting concept.

International ConnectionInternational Connection features highlight IFRS topics from a real-world perspective and appear in Chapters 1, 4, 7, 10, 13, and 16.

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New to the 12th Edition NEW

IFRS FOR STATEMENT OF CASH FLOWS

The statement of cash flows is required under International Financial Reporting Standards (IFRS). The statement of cash flows under IFRS is similar to that reported under U.S. GAAP in that the statement has separate sections for operating, investing, and financing activities. Like U.S. GAAP, IFRS also allow the use of either the indirect or direct method of reporting cash flows from operating activities. IFRS differ from U.S. GAAP in some minor areas, including:

• Interest paid can be reported as either an operating or a financing activity, while interest received can

be reported as either an operating or an investing activity. In contrast, U.S. GAAP reports interest paid or received as an operating activity.

• Dividends paid can be reported as either an op-erating or a financing activity, while dividends re-ceived can be reported as either an operating or an investing activity. In contrast, U.S. GAAP reports dividends paid as a financing activity and dividends received as an operating activity.

• Cash flows to pay taxes are reported as a separate line in the operating activities, in contrast to U.S. GAAP, which does not require a separate line disclosure.

InternationalConnection

* IFRS are further discussed and illustrated on pages 716-716G and in Appendix D.

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Financial Analysis and InterpretationNew Financial Analysis and Interpretation learning objectives have been added to the financial chapters and where appropriate, linked to real-world situations. FAI encour-ages students to go deeper into the material to analyze accounting information and improve critical thinking skills.

F•A•I

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New to the 12th Edition NEW

Nov. 30 NetSolutions paid creditors on account, $950.

This transaction decreases a liability account and decreases an asset account. It is recorded in the journal as a $950 decrease (debit) to Accounts Payable and a $950 decrease (credit) to Cash.

Transaction F

Analysis

Nov. 30 Accounts Payable 950Cash 950

Paid creditors on account.

Assets = Liabilities + Owner’s Equity

Cash Accounts Payable

Nov. 30 950 Nov. 30 950

Nov. 30 Chris Clark determined that the cost of supplies on hand at November 30 was $550.

NetSolutions purchased $1,350 of supplies on November 10. Thus, $800 ($1,350 – $550) of supplies must have been used during November. This transaction is recorded in the journal as an $800 increase (debit) to Supplies Expense and an $800 decrease (credit) to Supplies.

Transaction G

Analysis

Nov. 30 Supplies Expense 800Supplies 800

Supplies used during November.

Assets = Liabilities + Owner’s Equity (Expense)

Supplies Supplies Expense

Nov. 30 800 Nov. 30 800

Journal Entry

Accounting Equation

Impact

Journal Entry

Accounting Equation

Impact

Mornin’ Joe InternationalOur authors have prepared statements for Mornin’ Joe under IFRS guidelines as a basis for comparison with U.S.-prepared statements. This allows students to see how financial reporting differs under IFRS.

IFRS Training Video and IFRS PowerPoint PresentationA training video with the voice of our distinguished author, Jim Reeve, will walk an instructor through the nuances of this complex topic. A PowerPoint deck, based on the training video, will allow instructors to customize the presentation for delivery to their students.

The Accounting EquationA new format has been implemented in Chapter 2 for analyzing transactions. This new format includes the following elements: (1) transaction description, (2) analysis, (3) journal entry, and (4) accounting equation impact. This will help students understand that a transaction ultimately affects the accounting equation—Assets = Liabilities + Owner’s Equity.

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End-of-Chapter Exercises and ProblemsAll of our end-of-chapter materials have been updated, using new data, company names, and real-world data.

Test BankWith the assistance of over fifteen distinguished professors, we completely revamped our test bank. We created more multiple choice, matching, and problem type questions.

Excel TemplatesOur Excel templates have been enhanced to allow professors to turn off the “instant feedback” asterisks. Based on the file provided to them, students can complete the spreadsheet and email the file to their instructor. The instructor can then input a code that will automatically grade the student’s work. These Excel templates complement end-of-chapter problems. They are located on the companion website (URL) and also within CengageNOW.

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At a Glance 4 Describe the fl ow of accounting information from the unadjusted trial balance into the adjusted trial balance and fi nancial statements.

Key Points Exhibit 1 illustrates the end-of-period process by which accounts are adjusted and how the adjusted accounts flow into the financial statements.

Learning Outcomes

• Using an end-of-period spreadsheet, describe how the unadjustedtrial balance accounts are affected by adjustments and how the adjusted trial balance accounts flow into the income statement and balance sheet.

Example Practice Exercises Exercises EE4-1 PE4-1A, 4-1B

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Updated At a GlanceStudents prepare for homework and tests by referring to our end-of-chapter grid which outlines learning objectives, linking concept coverage to specific examples. Through our updated At a Glance, students can review the chapter’s learning objectives and key learning outcomes. In addition, all the Example Exercises and Practice Exercises have been indexed so that each learning objective and key outcomes can be viewed.

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The following specific content changes can be found in Financial Accounting, 12e.

Chapter 1: Introduction to Accounting and Business• Google replaces Starbucks in the chapter opening example.• Proprietorships, partnerships, corporations, and limited liability companies (LLC) are

now discussed with the business entity concept.• Added an International Connection feature to introduce students to IFRS.• New Financial Analysis and Interpretation (FAI): Ratio of Liabilities to Owner’s Equity

using real-world companies McDonald’s and Google.• Added new Example Exercise, Practice Exercise, and end-of-chapter exercises to

correspond with the new FAI.

Chapter 2: Analyzing Transactions• A new format has been implemented in Chapter 2 to help students better understand

how to analyze and record transactions. • A table summarizing common transaction terminology has also been added. This table

includes common transaction terms and the related accounts that would be debited and credited in a journal entry.

• New Financial Analysis and Interpretation: Horizontal Analysis using a fictitious com-pany, J. Holmes, Attorney at Law, and a real-world company, Apple, Inc.

• Added new Example Exercise, Practice Exercise, and end-of-chapter exercises to cor-respond with the new FAI.

Chapter 3: The Adjusting Process• The Accounting Equation Impact feature described in Chapter 2 is also used in Chapter

3 to describe and illustrate adjusting entries.• New chapter opener features Rhapsody, an Internet-based music service.• New Financial Analysis and Interpretation: Vertical Analysis continuing with fic-

titious company, J. Holmes, Attorney at Law, and adding a real-world company, RealNetworks, Inc.

Chapter 4: Completing the Accounting Cycle• The Flow of Accounting Information exhibit at the beginning of the chapter has been

revised to show the flow of accounting data from the adjusted trial balance directly into the income statement, statement of owner’s equity, and balance sheet.

• New Financial Analysis and Interpretation: Working Capital and Current Ratio using Electronic Arts, Inc. and Take-Two Interactive Software, Inc.

• Added new Example Exercise, Practice Exercise, and end-of-chapter exercises to correspond with the new FAI.

Chapter 5: Accounting Systems• An illustration of a computerized accounting system was updated using the screen

shots from Quickbooks® Pro 2010 edition.• Streamlined discussion of special journals.• Removed discussion of “Manual Accounting Systems.”• Added a Business Connection feature.

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Chapter-by-Chapter Enhancements

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• New Financial Analysis and Interpretation: Segment Analysis using real-world company Intuit, Inc.

• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 6: Accounting for Merchandising Businesses• The computation of cost of merchandise sold (under the periodic inventory system)

has been moved from the beginning of the chapter to an end-of-chapter appendix.• A new section has been added that summarizes the effects of merchandise transac-

tions on the merchandise inventory account. This is illustrated using a T account for merchandise inventory.

• Moved coverage of “Accounting Systems for Merchandisers” to our online site (www.cengage.com/accounting/warren).

• New Financial Analysis and Interpretation: Ratio of Net Sales to Assets using real-world company Dollar Tree, Inc.


Chapter 7: Inventories• New Financial Analysis and Interpretation: Inventory Turnover and Number of Days,

Sales in Inventory using real-world companies Best Buy and Zales.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 8: Sarbanes-Oxley, Internal Control, and Cash• Updated chapter graphic for better clarity and snapshot comprehension.• New Financial Analysis and Interpretation: Ratio of Cash to Monthly Cash Expenses

using real-world company Evergreen Solar, Inc.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 9: Receivables• New Financial Analysis and Interpretation: Accounts Receivable Turnover and Number

of Days’ Sales in Receivables using real-world company FedEx.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 10: Fixed Assets and Intangible Assets• Updated many chapter graphics for better clarity and snapshot comprehension.• New Financial Analysis and Interpretation: Fixed Asset Turnover Ratio using real-

world company Starbucks Corporation.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 11: Current Liabilities and Payroll• The example of Starbucks Corporation on long-term debt has been replaced by P.F.

Chang’s.• Updated Wage Bracket Withholding table, based on data from the 2010 Publication 15.• Removed discussion of social security cap on withholding (above $100,000).

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• Updated Business Connection feature to cover General Motors and its pension problems.• New Financial Analysis and Interpretation: Quick Ratio using real-world company

TechSolutions, Inc.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 12: Accounting for Partnerships andLimited Liability Companies• Razor replaces AgentBlaze LLC as the chapter opening example.• Updated Business Connection feature to Kristen Hall, founding member of the country

music group Sugarland and her lawsuit.• New Financial Analysis and Interpretation: Revenue per Employee showing McDonald’s

and Starbucks to understand evaluation within an industry.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.• Eliminated the section on “Errors in Liquidation” to reduce minor redundancy.

Chapter 13: Corporations: Organization, Stock Transactions, and Dividends• New Financial Analysis and Interpretation: On website they say JPMorgan Chase &

Co. Earnings per Share using Hasbro, Bank of America Corporation, and J.P. Morgan Chase & Co.


Chapter 14: Long-Term Liabilities: Bonds and Notes• Updated Business Connection feature on U.S. government debt.• Updated Business Connection feature to cover General Motors bonds.• Added an Integrity, Objectivity, and Ethics feature to discuss “Liar’s Loans.”• New Financial Analysis and Interpretation: Number of Times Interest Charges Are

Earned using Under Armour, Inc.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 15: Investments and Fair Value Accounting• Added an Integrity, Objectivity, and Ethics box titled “Loan Loss Woes” on mortgage

loans called “sub-prime” and “Alt-A” loans.• Updated Business Connection feature to “Apple’s Entrance to Streaming Music.”• Revised “Value and Reporting Investments” to simplify the reading process.• New Financial Analysis and Interpretation: Dividend Yield using News Corporation.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.• Moved “Accounting for Held-to-Maturity Investments” appendix to www.cengage.com/

accounting/warren.

Mornin’ Joe• To expand students’ understanding of financial statement preparation outside the United

States, the authors took our unique company example, Mornin’ Joe, and show how it goes international after Chapter 15. They prepared a set of financial statements fol-lowing IFRS guidelines. To aid in learning, callout features pinpoint the differences between U.S. GAAP and IFRS.

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Chapter-by-Chapter Enhancements

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http://www.cengage.com/

Chapter 16: Statement of Cash Flows• Updated Business Connection feature to “Cash Crunch!” featuring Chrysler Group LLC.• New Financial Analysis and Interpretation: Free Cash Flow using Research in Motion,

Inc., maker of BlackBerry® smartphones.• Added new Example Exercise and Practice Exercise to correspond with the new FAI.

Chapter 17: Financial Statement Analysis• Real-world financial statement analysis problem uses data from the Nike, Inc. 2010 10-K.

A portion of Nike’s 10-K is located in Appendix C.• Updated Integrity, Objectivity, and Ethics feature discusses “Chief Financial Officer

Bonuses.”• Updated Integrity, Objectivity, and Ethics feature to “Buy Low, Sell High.”

xi

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Financial Accounting, 12e, is unparalleled in pedagogical innovation. Our constant dialogue with accounting faculty continues to affect how we refine and improve the text to meet the needs of today’s students. Our goal is to provide a logical frame-work and pedagogical system that caters to how students of today study and learn.

Clear Objectives and Key Learning Outcomes To guide students, the authors provide clear chapter objectives and important learning outcomes. All the chapter materials relate back to these key points and outcomes, which keeps students fo-cused on the most important topics and concepts in order to succeed in the course.

Example Exercises Example Exercises reinforce concepts and procedures in a bold, new way. Like a teacher in the classroom, students follow the authors’ example to see how to complete accounting applications as they are presented in the text. This feature also provides a list of Practice Exercises that parallel the Example Exercises so students get the practice they need. In addition, the Practice Exercises include references to the chapter Example Exercises so that students can easily cross-reference when completing homework.

“At a Glance” Chapter Summary At the end of each chapter, the “At a Glance” summary grid ties everything together and helps students stay on track.

Hallmark Features ofFinancial Accounting, 12e

xiii

At a Glance 3Describe the nature of the adjusting process.

Key Points The accrual basis of accounting requires that revenues are reported in the period in which they are earned and expenses are matched with the revenues they generate. The updating of accounts at the end of the accounting period is called the adjusting process. Each adjusting entry affects an income statement and balance sheet account. The four types of accounts requiring adjusting entries are prepaid expenses, unearned revenues, accrued revenues, and accrued expenses.

Learning Outcomes

• Explain why accrual accounting requires adjusting entries.

• List accounts that do and do NOT require adjusting entries at the end of the accounting period.

• Give an example of a prepaid expense, unearned revenue, accrued revenue, and accrued expense.

Example Practice Exercises Exercises

EE3-1 PE3-1A, 3-1B

EE3-2 PE3-2A, 3-2B

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Real-World Chapter Openers Building on the strengths of past editions, these openers continue to relate the accounting and business concepts in the chapter to students’ lives. These openers employ examples of real companies and provide invaluable insight into real practice. Several of the openers created especially for this edition focus on interesting companies such as Rhapsody, Razor, E.W. Scripps Company, a diverse media concern, and Facebook.

Continuing Case Study Students follow a fictitious company, NetSolutions, throughout Chapters 1–6, which demonstrates a variety of transactions. The continuity of using the same company facilitates student learning especially for Chapters 1–4, which cover the accounting cycle. Also, using the same company allows students to follow the transition of the company from a service business in Chapters 1–4 to a merchandising business in Chapters 5 and 6.

Illustrative Problem and Solution A solved problem models one or more of the chapter’s assignment problems so that students can apply the modeled procedures to end-of-chapter materials.

Integrity, Objectivity, and Ethics in Business In each chapter, these cases help students develop their ethical compass. Often coupled with related end-of-chapter activities, these cases can be discussed in class or students can consider the cases as they read the chapter. Both the section and related end-of-chapter materials are indicated with a unique icon for a consistent presentation.

Integrity, Objectivity, and Ethics in BusinessCHIEF FINANCIAL OFFICER BONUSES

A recent study by compensation experts at Temple Univer-sity found that chief financial officer salaries are correlated with the complexity of a company’s operations, but chief financial officer bonuses are correlated with the company’s ability to meet analysts’ earnings forecasts. These results suggest that financial bonuses may provide chief financial officers with an incentive to use questionable accounting

practices to improve earnings. While the study doesn’t con-clude that bonuses lead to accounting fraud, it does suggest that bonuses give chief financial officers a reason to find ways to use accounting to increase apparent earnings.

Source: E. Jelesiewicz, “Today’s CFO: More Challenge but Higher Com-pensation,” News Communications (Temple University, August 2009).

Hallmark Features ofFinancial Accounting, 12e

CHAPTER

25

M any of the decisions that you make depend on comparing the estimated costs of alternatives. The payoff from such compari-

sons is described in the following report from a University of Michigan study.

Richard Nisbett and two colleagues quizzed Michigan faculty members and univer-sity seniors on such questions as how often they walk out on a bad movie, refuse to finish a bad meal, start over on a weak term paper, or abandon a research project that no longer looks promising. They believe that people who cut their losses this way are following sound economic rules: calculating the net benefits of alternative courses of action, writing off past costs that can't be recovered, and weighing the opportunity to use future time and effort more profitably elsewhere.

Among students, those who have learned to use cost-benefit analysis fre-quently are apt to have far better grades than their Scholastic Aptitude Test scores would have predicted. Again, the more economics courses the students have, the more likely they are to apply cost-benefit analysis outside the classroom.

Dr. Nisbett concedes that for many Ameri-cans, cost-benefit rules often appear to conflict with such traditional principles as “never give up” and “waste not, want not.”

Managers must also evaluate the costs and benefits of alternative actions. Facebook,

the largest social networking site in the world, was cofounded by 26-year-old Mark Zuckerberg in 2004. Since then, it has grown to over 350 million users and made Zuckerberg a multibillionaire.

Facebook has plans to grow to over 1 billion users worldwide. Such growth involves decisions about where to expand. For example, expand-ing the site to new languages and countries involves software program-ming, marketing, and computer hardware costs. The benefits include adding new users to Facebook.

Analysis of the benefits and costs might lead Facebook to expand in some languages before others. For example, such an analysis might lead Facebook to expand in Spanish before it expands in Tok Pisin (language of Papua New Guinea).

In this chapter, differential analysis, which reports the effects of decisions on total revenues and costs, is discussed. Practical approaches to setting product prices are also described and illustrated. Finally, how

production bottlenecks and activity-based costing influence pricing and other decisions are also discussed.

Source: Alan L. Otten, “Economic Perspective Produces Steady Yields,” from People Patterns, The Wall Street Journal, March 31,1992, p. B1.

Facebook

© AP Photo/Paul Sakumaul Sakuma

Differential Analysis, Product Pricing, and Activity-Based Costing

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xv

BusinessConnectionAVATAR: THE MOST EXPENSIVE MOVIE EVER MADE (AND THE MOST SUCCESSFUL)

Prior to the release of the blockbuster Avatar in December 2009, many were skeptical if the movie’s huge $500 million investment would pay off. After all, just to break even the movie would have to perform as one of the top 50 movies of all time. To provide a return that was double the investment, the movie would have to crack the top ten. Many thought this was a tall order, even though James Cameron, the force

behind this movie, already had the number one grossing movie of all time: Titanic, at $1.8 billion in worldwide box office revenues. Could he do it again? That was the question.

So, how did the film do? Only eight weeks after its re-lease, Avatar had become the number one grossing film of all time, with over $2.2 billion in worldwide box office revenue. Executives at Fox anticipated that the profit might double after the film was released on DVD in the summer of 2010. Needless to say, James Cameron, 20th Century Fox, and other investors are very pleased with their return on this investment.

Sources: Michael Cieply, “A Movie’s Budget Pops from the Screen,” New York Times, November 8, 2009; “Bulk of Avatar Profi t Still to Come,” The Age, February 3, 2010.

Business Connection and Comprehensive Real-World Notes Students get a close-up look at how accounting operates in the marketplace through a variety of Business Connection boxed features.

Market Leading End-of-Chapter Material Students need to practice account-ing so that they can understand and use it. To give students the greatest possible advantage in the real world, Financial Accounting, 12e, goes beyond presenting theory and procedure with comprehensive, time-tested, end-of-chapter material.

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Online Solutions

South-Western, a division of Cengage Learning, offers a vast array of online solutions to suit your course needs. Choose the product that best meets your classroom needs and course goals. Please check with your Cengage representative for more details or for ordering information.

CengageNow CengageNOW is a powerful course management and online homework tool that provides robust instructor control and customization to optimize the student learning experience and meet desired outcomes. CengageNOW offers:• Auto-graded homework (static and algorithmic varieties), test bank, Personalized Study

Plan, and eBook are all in one resource.• Easy-to-use course management options offer flexibility and continuity from one

semester to another.• Different levels of feedback and engaging student resources guide students through

material and solidify learning. • The most robust and flexible assignment options in the industry.• “Smart Entry” helps eliminate common data entry errors and prevents students from

guessing their way through the homework.• The ability to analyze student work from the gradebook and generate reports on learn-

ing outcomes. Each problem is tagged in the Solutions Manual and CengageNOW to AICPA, IMA, AACSB, and ACBSP outcomes so you can measure student performance.

CengageNOW Upgrades:• Our General Ledger Software is now being offered in a new online format. Your

students can solve selected end-of-chapter assignments in a format that emulates com-mercial general ledger software.

• For a complete list of CengageNOW upgrades, refer to page 6 in the brochure in front of the Instructor Edition.

• New Design: CengageNOW has been redesigned to enhance your experience.

For a CengageNOW demo, visit: www.cengage.com/community/warren

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ApliaAplia is a premier online homework product that successfully engages students and maximizes the amount of effort they put forth, creating more efficient learners. Aplia’s advantages are:• In addition to static and algorithmic end-of-chapter homework, Aplia offers an extra

problem set to give you more options!• Students can receive unique, detailed feedback and the full solution after each at-

tempt on homework.• “Grade It Now” maximizes student effort on each attempt and ensures students do

their own work. Students have three attempts. Each attempt produces an algorithmic variety. The final score is an average of the three attempts.

• “Smart Entry” helps eliminate common data entry errors and prevents students from guessing their way through the homework.

Aplia Upgrades:• Increased Instructor Control: Instructors now have more options in how they assign

materials from the question banks.• ApliaText: Interactive ApliaText allows students to use eBooks in a new way. This

unique flip-book also includes a Chapter Recap that helps students craft their own personal study guide.

For an Aplia demo, visit: www.cengage.com/community/warren

WebTutor™WebTutorTM on Blackboard® and WebCT®—Improve student grades with online review and test preparation tools in an easy-to-use course cartridge.

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

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http://www.cengage.com/community/warren

http://www.cengage.com/webtutor

When it comes to supporting instructors, South-Western is unsurpassed. Financial Accounting, 12e, continues the tradition with powerful print and digital ancillaries aimed at facilitating greater course successes.

Instructor’s Manual The Instructor’s Manual includes: Brief Synopsis, List of Objectives, Key Terms, Ideas for Class Discussion, Lecture Aids, Demonstration Problems, Group Learning Activities, Exercises and Problems for Reinforcement, and Internet Activities. Suggested Approaches incorporate many modern teaching initiatives, including active learning, collaborative learning, critical thinking, and writing across the curriculum.

Solutions Manual The Solutions Manual contains answers to all exercises, problems, and activities in the text. The solutions are author-written and verified multiple times for numerical accuracy and consistency.

Test Bank The Test Bank includes more than 2,800 True/False questions, Multiple-Choice questions, and Problems, each marked with a difficulty level, chapter objective, and AASCB/AICPA/ACBSP tagging.

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

PowerPoint® Each presentation, which is included on the IRCD and on the product support site, enhances lectures and simplifies class preparation. Each chapter contains objectives followed by a thorough outline of the chapter that easily provides an entire lecture model. Also, exhibits from the chapter, such as the new Example Exercises, have been recreated as colorful PowerPoint slides to create a powerful, customizable tool.

Instructor Excel® Templates These templates provide the solutions for the problems that have Enhanced Excel® templates for students. Through these files, instructors can see the solutions in the same format as the students. All problems with accompanying templates are marked in the book with an icon and are listed in the information grid in the solutions manual. These templates are available for download on www.cengage.com/accounting/warren or on the IRCD.

Instructor’s Resource CD The Instructor’s Resource CD includes the PowerPoint® Presentations, Instructor’s Manual, Solutions Manual, Test Bank, ExamView®, General Ledger Inspector, and Excel® Template Solutions.

For the Instructor

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Students come to accounting with a variety of learning needs. Financial Accounting, 12e, offers a broad range of supplements in both printed form and easy-to-use technology. We continue to refine our entire supplement package around the comments instructors have provided about their courses and teaching needs.

Study Guide This author-written guide provides students Quiz and Test Hints, Matching questions, Fill-in-the-Blank questions (Parts A & B), Multiple-Choice questions, True/False questions, Exercises, and Problems for each chapter.

Working Papers for Exercises and Problems The traditional working papers include problem-specific forms for preparing solutions for Exercises, A & B Problems, the Continuing Problem, and the Comprehensive Problems from the textbook. These forms, with preprinted headings, provide a structure for the problems, which helps students get started and saves them time.

Blank Working Papers These Working Papers are available for completing exercises and problems either from the text or prepared by the instructor. They have no preprinted headings. A guide at the front of the Working Papers tells students which form they will need for each problem and are available online in a .pdf, printable format.

Enhanced Excel® Templates These templates are provided for selected long or complicated end-of-chapter problems and provide assistance to the student as they set up and work the problem. Certain cells are coded to display a red asterisk when an incorrect answer is entered, which helps students stay on track. Selected problems that can be solved using these templates are designated by an icon.

General Ledger Software The CLGL software is now being offered in a new online format. Students can solve selected end-of-chapter assignments in a format that emulates commercial general ledger software. Students make entries into the general journal or special journals, track the posting of the entries to the general ledger, and create financial statements or reports. This gives students important exposure to commercial accounting software, yet in a manner that is more forgiving of student errors. Assignments are automatically graded online.

Product Support Web Site www.cengage.com/accounting/warren This site provides students with a wealth of introductory accounting resources, including quizzing and supplement downloads and access to the Enhanced Excel® Templates.

For the Student

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xx

Acknowledgments

Many of the enhancements made to Financial Accounting, 12e, are a direct result of count-less conversations we’ve had with principles of accounting professors and students over the past several years. We want to take this opportunity to thank them for their perspectives and feedback on textbook use. 12e represents our finest edition yet!

Rick AndrewsSinclair Community

College

Mia BreenDe Anza Community

College

Anne M. CardozoBroward College

James CieslakCuyahoga Community

College

Rebecca A. FooteMiddle Tennessee State

University

Gloria GraylessSam Houston State

University

Robert GronstalMetropolitan Community

College

Curtis GustafsonSouth Dakota State

University

Lynn P. HedgeNHTI—Concord’s

Community College

Audrey HunterBroward College

Phillip ImelNorthern Virginia

Community College—Annandale Campus

Christopher KwakDe Anza College

Bruce W. McClainCleveland State University

Jenny ResnickSanta Monica College

Lawrence A. RomanCuyahoga Community

College

Robert SmolinCitrus College

Robert C. UrellIrvine Valley College

The following instructors are members of our Blue Sky editorial board, whose helpful comments and feedback con-tinue to have a profound impact on the presentation and core themes of this text:

Stacy AppletonNorthern Kentucky

University

Danny BradfordXavier University

Steve BuseyXavier University

Brandon ButcherXavier University

Suzanne BuzekXavier University

Jenny DaughertyNorthern Kentucky

University

Richard FarmerSinclair Community

College

Bobby FrekingXavier University

Steve LatosXavier University

Cristi LiskaNorthern Kentucky

University

Mallory MalinoskiXavier University

Clare McGrathXavier University

Hecia MpangaXavier University

Jessica NicholsNorthern Kentucky University

Oscar OchiengNorthern Kentucky

University

Rick RivaSinclair Community

College

Max RobertsSinclair Community

College

Anthony SaxonXavier University

The following students attended our Blue Sky session, providing insights into the life of an accounting student:

The following individuals took the time to participate in surveys, online sessions, content reviews, and test bank revisions:

Bridget AnakweDelaware State University

Julia L. AngelNorth Arkansas College

Leah ArringtonNorthwest Mississippi

Community College

Donna T. AscenziBryant and Stratton

College—Syracuse Campus

Ed BagleyDarton College

James BakerHarford Community

College

Lisa Cooley BanksUniversity of Michigan

LuAnn BeanFlorida Institute of

Technology

Judy BeebeWestern Oregon University

Brenda J. BindschatelGreen River Community

College

Eric D. BostwickThe University of West

Florida

Bryan C. BouchardSouthern New Hampshire

University

Thomas M. BrantonAlvin Community College

Celestino CaicoyaMiami Dade College

John CallisterCornell University

Deborah ChabaudLouisiana Technical College

Marilyn G. CiolinoDelgado Community College

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xxi

Earl ClayCape Cod Community

College

Lisa M. ColeJohnson County

Community College

Cori Oliver CrewsWaycross College

Julie DaigleFt. Range Community

College

Julie DaileyCentral Virginia

Community College

John M. DaughertyPitt Community College

Becky DavisEast Mississippi

Community College

Ginger DennisWest Georgia Technical

College

Scott A. ElzaWisconsin Indianhead

Technical College

Patricia FellerNashville State Community

College

Mike FolandSouthwestern Illinois

College—Belleville

Brenda S. FowlerAlamance Community

College

Jeanne GerardFranklin Pierce University

Christopher GilbertEast Los Angeles College,

Montery Park, CA

Mark S. GleasonMetropolitan State

University, St. Paul, Minnesota

Marina GrauHouston Community

College

Judith GrenkowiczKirtland Community

College

Vicki GreshikJamestown College

Lillian S. GroseOur Lady of Holy Cross

College

Denise T. GuestGermanna Community

College

Bruce J. GunningKent State University at

East Liverpool

Rosie HaleSouthwest Tennessee

Community College

Sara HarrisArapahoe Community

College

Matthew P. HelinskiNortheast Lakeview College

Wanda HudsonAlabama Southern

Community College

Todd A. JensenSierra College

Paul T. JohnsonMississippi Gulf Coast

Community College

Mary KlineBlack Hawk College

Jan KraftNorthwest College

David W. KrugJohnson County

Community College

Cathy Xanthaky LarsonMiddlesex Community

College

Brenda G. LauerNortheastern Junior College

Ted LewisMarshalltown Community

College

Marion LoiolaSUNY—Orange County

Community College

Ming LuSanta Monica College

Don LucyIndian River State College

Debbie LunaEl Paso Community College

Anna L. LusherSlippery Rock University

Kirk LynchSandhills Community

College

Bridgette MahanHarold Washington

College

Irene MearesWestern New Mexico

University

James B. MeirCleveland State

Community College

John L. MillerMetropolitan Community

College

Peter MoloneyCerritos College

Janet MorrowEast Central Community

College

Pamela G. NeedhamNortheast Mississippi

Community College

Jeannie M. NeilOrange Coast College,

Costa Mesa, CA

Carolyn NelsonCoffeyville Community

College

Joseph Malino NicassioWestmoreland County

Community College

Robert L. OsborneOhio Dominican University

Scott PaxtonNorth Idaho College

Ronald PearsonBay College

Rachel PerniaEssex County College

Erick PiferLake Michigan College

Marianne G. PindarLackawanna College

Kenneth J. PlucinskiState University of New

York at Fredonia

Debbie PorterTidewater Community

College

Shirley J. PowellArkansas State

University—Beebe

Eric M. PrimuthCuyahoga Community

College

Michael PrindleGrand View University

Rita PritchettBrevard Community College

Judy RamsaySan Jacinto College—North

Patrick ReihingNassau Community College

Richard RickelSouth Mountain

Community College

Patricia G. RoshtoUniversity of

Louisiana—Monroe

Martin SaboCommunity College of

Denver

Tracy M. SchmeltzerWayne Community College

Dennis C. SheaSouthern New Hampshire

University

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xxii

Robert W. Smith (retired)formerly of Briarcliffe

College—Patchogue, NY Campus

Kimberly D. SmithCounty College of Morris

Richard SnappOlympic College—

Bremerton

John L. StancilFlorida Southern College

Barry StephensBemidji State University

Jeff StrawserSam Houston State

University

Stacie A. SurowiecHarford Community

College

Eric H. SussmanUCLA Anderson

Graduate School of Management

Bill TalbotMontgomery

College

Kenneth J. TaxFarmingdale State

College (SUNY)

Ronald TiddCentral Washington

University

Erol C. Tucker, Jr.The Victoria College

Henry VelardeMalcolm X College

Angela WaitsGadsden State

Community College

Dale WalkerArkansas State University

Shunda WareAtlanta Technical College

Cheryl C. WillinghamWisconsin Indianhead

Technical College

Patrick B. WilsonTennessee Board of

Regents

Jay E. WrightNew River Community

College

The following instructors created content for the supplements that accompany the text:

LuAnn BeanFlorida Institute of

Technology

Gary BowerCommunity College of

Rhode Island

Doug CloudPepperdine University

Ana Cruz & Blanca OrtegaMiami Dade College

Kurt FredricksValencia Community

College

Lori GradyBucks County Community

College

Jose Luis Hortensi Miami Dade College

Christine Jonick Gainesville State College

Patti Lopez Valencia Community

College

Don LucyIndian River State

College

Tracie NoblesAustin Community College

Craig PenceHighland Community College

Alice SineathForsyth Technical

Community College

Janice Stoudemire Midlands Technical

College

Acknowledgments

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xxiii

Chapter 1 Introduction to Accounting and Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Chapter 2 Analyzing Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Chapter 3 The Adjusting Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

Chapter 4 Completing the Accounting Cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149

Chapter 5 Accounting Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205

Chapter 6 Accounting for Merchandising Businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253

Chapter 7 Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311

Chapter 8 Sarbanes-Oxley, Internal Control, and Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355

Chapter 9 Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 401

Chapter 10 Fixed Assets and Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445

Chapter 11 Current Liabilities and Payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489

Chapter 12 Accounting for Partnerships and Limited Liability Companies . . . . . . . . . . . . . . . . . . . . 537

Chapter 13 Corporations: Organization, Stock Transactions, and Dividends . . . . . . . . . . . . . . . . . . . 581

Chapter 14 Long-Term Liabilities: Bonds and Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625

Chapter 15 Investments and Fair Value Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 667

Chapter 16 Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 717

Chapter 17 Financial Statement Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 773

Appendix A Interest Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-2

Appendix B Reversing Entries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B-1

Appendix C Nike, Inc. 2010 Annual Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C-1

Appendix D International Financial Reporting Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . D-1

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . G-1

Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1

Company Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-12

Brief Contents

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xxiv

Chapter 1 Introduction to Accounting and Business 1

Nature of Business and Accounting 2Types of Businesses 2The Role of Accounting in Business 3Role of Ethics in Accounting and Business 4Opportunities for Accountants 5

Generally Accepted Accounting Principles 6

International Connection: International Financial Reporting Standards (IFRS) 7

Business Entity Concept 7The Cost Concept 8

The Accounting Equation 9

Business Transactions and the Accounting Equation 9

Business Connection: The Accounting Equation 10

Financial Statements 15Income Statement 15Statement of Owner’s Equity 16Balance Sheet 16Statement of Cash Flows 18Interrelationships Among Financial Statements 20

Financial Analysis and Interpretation: Ratio of Liabilities to Owner’s Equity 21

Chapter 2 Analyzing Transactions 51

Using Accounts to Record Transactions 52Chart of Accounts 54

Business Connection: The Hijacking Receivable 54

Double-Entry Accounting System 55Balance Sheet Accounts 55Income Statement Accounts 56Owner Withdrawals 56Normal Balances 56Journalizing 57

Posting Journal Entries to Accounts 61

Business Connection: Computerized Accounting Systems 65

Trial Balance 70Errors Affecting the Trial Balance 71Errors Not Affecting the Trial Balance 72

Financial Analysis and Interpretation: Horizontal Analysis 73

Chapter 3 The Adjusting Process 103

Nature of the Adjusting Process 104The Adjusting Process 104Types of Accounts Requiring Adjustment 105

Adjusting Entries 110Prepaid Expenses 110Unearned Revenues 113Accrued Revenues 114Accrued Expenses 115Depreciation Expense 116

Business Connection: Ford Motor Company Warranties 117

Summary of Adjustment Process 119

Business Connection: Microsoft Corporation 121

Adjusted Trial Balance 123

Financial Analysis and Interpretation: Vertical Analysis 125

Chapter 4 Completing the Accounting Cycle 149

Flow of Accounting Information 150

Financial Statements 152Income Statement 152Statement of Owner’s Equity 154Balance Sheet 155

Contents

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International Connection: International Diff erences 156

Closing Entries 156Journalizing and Posting Closing Entries 157Post-Closing Trial Balance 159

Accounting Cycle 162

Illustration of the Accounting Cycle 163Step 1. Analyzing and Recording Transactions in

the Journal 164Step 2. Posting Transactions to the Ledger 164Step 3. Preparing an Unadjusted Trial

Balance 166Step 4. Assembling and Analyzing Adjustment

Data 167Step 5. Preparing an Optional End-of-Period

Spreadsheet 167Step 6. Journalizing and Posting

Adjusting Entries 167Step 7. Preparing an Adjusted Trial Balance 168Step 8. Preparing the Financial Statements 168Step 9. Journalizing and Posting

Closing Entries 170Step 10. Preparing a Post-Closing

Trial Balance 170

Fiscal Year 173

Business Connection: Choosing a Fiscal Year 174

Financial Analysis and Interpretation: Working Capital and Current Ratio 174

Appendix: End-of-Period Spreadsheet (Work Sheet) 176

Step 1. Enter the Title 176Step 2. Enter the Unadjusted Trial Balance 176Step 3. Enter the Adjustments 176Step 4. Enter the Adjusted Trial Balance 176AStep 5. Extend the Accounts to the Income

Statement and Balance Sheet Columns 176A

Step 6. Total the Income Statement and Balance Sheet Columns, Compute the Net Income or Net Loss, and Complete the Spread-sheet 176C

Preparing the Financial Statements from the Spreadsheet 176C

Comprehensive Problem 1 202

Chapter 5 Accounting Systems 205Basic Accounting Systems 206

Manual Accounting Systems 207Subsidiary Ledgers 207Special Journals 207Revenue Journal 209

Cash Receipts Journal 212Accounts Receivable Control Account and

Subsidiary Ledger 214Purchases Journal 214Cash Payments Journal 217Accounts Payable Control Account and Subsidiary

Ledger 219

Computerized Accounting Systems 220

Business Connection: Accounting Systems and Profi t Measurement 220

Business Connection: TurboTax 222

E-Commerce 223

Financial Analysis and Interpretation: Segment Analysis 223

Chapter 6 Accounting for Merchandising Businesses 253

Nature of Merchandising Businesses 254

Financial Statements for a Merchandising Business 255

Multiple-Step Income Statement 255Single-Step Income Statement 258Statement of Owner’s Equity 258Balance Sheet 258

Business Connection: H&R Block versus The Home Depot 260

Merchandising Transactions 260Chart of Accounts for a Merchandising

Business 260Sales Transactions 260Purchase Transactions 266Freight 268Summary: Recording Merchandise Inventory 271Sales Taxes and Trade Discounts 271

Business Connection: Sales Taxes 272Dual Nature of Merchandise Transactions 272

The Adjusting and Closing Process 274Adjusting Entry for Inventory Shrinkage 274Closing Entries 275

Financial Analysis and Interpretation: Ratio of Net Sales to Assets 276

Appendix: The Periodic Inventory System 278Cost of Merchandise Sold Using the Periodic

Inventory System 278Chart of Accounts Under the Periodic Inventory

System 278Recording Merchandise Transactions Under the

Periodic Inventory System 279

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xxvi Contents

Adjusting Process Under the Periodic Inventory System 281

Financial Statements Under the Periodic Inventory System 281

Closing Entries Under the Periodic Inventory System 281


Practice Set: Glorious Garden Lawn ServiceThis set is a service business operated as a propri-etorship. It includes a narrative of transactions and instructions for an optional solution with no debits and credits. This set can be solved manually or with the General Ledger software.

Chapter 7 Inventories 311

Control of Inventory 312Safeguarding Inventory 312Reporting Inventory 313

Inventory Cost Flow Assumptions 313

Inventory Costing Methods Under a Perpetual Inventory System 316

First-In, First-Out Method 316Last-In, First-Out Method 317


Average Cost Method 319Computerized Perpetual Inventory Systems 319

Inventory Costing Methods Under a Periodic Inventory System 319

First-In, First-Out Method 319Last-In, First-Out Method 320Average Cost Method 321

Comparing Inventory Costing Methods 322Reporting Merchandise Inventory in the Financial Statements 324

Valuation at Lower of Cost or Market 324Valuation at Net Realizable Value 325

Business Connection: Inventory Write-Downs 326Merchandise Inventory on the Balance Sheet 326Effect of Inventory Errors on the Financial

Statement 326

Business Connection: Rapid Inventory at Costco 329

Financial Analysis and Interpretation: Inventory Turnover and Number of Days’ Sales in Inventory 330

Appendix: Estimating Inventory Cost 332Retail Method of Inventory Costing 332Gross Profi t Method of Inventory Costing 333

Chapter 8 Sarbanes-Oxley, Internal Control, and Cash 355

Sarbanes-Oxley Act of 2002 356

Internal Control 358Objectives of Internal Control 358

Business Connection: Employee Fraud 358Elements of Internal Control 358Control Environment 359Risk Assessment 360Control Procedures 360Monitoring 362Information and Communication 362Limitations of Internal Control 363

Cash Controls Over Receipts and Payments 363Control of Cash Receipts 364Control of Cash Payments 366

Bank Accounts 366Bank Statement 366Using the Bank Statement as a Control

Over Cash 369

Bank Reconciliation 369

Special-Purpose Cash Funds 373

Financial Statement Reporting of Cash 374

Financial Analysis and Interpretation: Ratio of Cash to Monthly Cash Expenses 375

Business Connection: Microsoft Corporation 377

Chapter 9 Receivables 401

Classifi cation of Receivables 402Accounts Receivable 402Notes Receivable 402Other Receivables 403

Uncollectible Receivables 403

Direct Write-Off Method for Uncollectible Accounts 403

Allowance Method for Uncollectible Accounts 404

Write-Offs to the Allowance Account 405Estimating Uncollectibles 407

Business Connection: Allowance Percentages Across Companies 407

Comparing Direct Write-Off and Allowance Methods 412

Notes Receivable 413Characteristics of Notes Receivable 413Accounting for Notes Receivable 414

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Contents xxvii

Reporting Receivables on the Balance Sheet 416

Financial Analysis and Interpretation: Accounts Receivable Turnover and Number of Days’ Sales in Receivables 416

Business Connection: Delta Air Lines 418

Chapter 10 Fixed Assets and Intangible Assets 445

Nature of Fixed Assets 446Classifying Costs 447The Cost of Fixed Assets 448Capital and Revenue Expenditures 449Leasing Fixed Assets 450

Accounting for Depreciation 451Factors in Computing Depreciation

Expense 451Straight-Line Method 453Units-of-Production Method 454Double-Declining-Balance Method 455Comparing Depreciation Methods 456Depreciation for Federal Income

Tax 457

Business Connection: Depreciating Animals? 457

Revising Depreciation Estimates 458

Disposal of Fixed Assets 459Discarding Fixed Assets 459Selling Fixed Assets 460

Natural Resources 461

Intangible Assets 462Patents 462


Copyrights and Trademarks 463Goodwill 463

Financial Reporting for Fixed Assets and Intangible Assets 465

Financial Analysis and Interpretation: Fixed Asset Turnover Ratio 466

Business Connection: Hub-and-Spoke or Point-to-Point? 466

Appendix: Exchanging Similar Fixed Assets 468

Gain on Exchange 468Loss on Exchange 468

Chapter 11 Current Liabilities and Payroll 489

Current Liabilities 490Accounts Payable 490Current Portion of Long-Term Debt 491Short-Term Notes Payable 491

Payroll and Payroll Taxes 493Liability for Employee Earnings 493Deductions from Employee Earnings 494Computing Employee Net Pay 496Liability for Employer’s Payroll Taxes 497

Business Connection: The Most You Will Ever Pay 498

Accounting Systems for Payroll and Payroll Taxes 498

Payroll Register 498Employee’s Earnings Record 500Payroll Checks 501Payroll System Diagram 502Internal Controls for Payroll Systems 503

Employees’ Fringe Benefi ts 504Vacation Pay 504Pensions 505Postretirement Benefi ts Other than Pensions 506Current Liabilities on the Balance Sheet 506

Business Connection: General Motors Pension Problems 507

Contingent Liabilities 507Probable and Estimable 507Probable and Not Estimable 508Reasonably Possible 508Remote 508

Financial Analysis and Interpretation: Quick Ratio 509


Practice Set: Pumping IronThis set is a merchandising business operated as a proprietorship. It includes business documents, and it can be solved manually or with the General Ledger software.

Practice Set: Lucy’s Doggie CareThis set includes payroll transactions for a mer-chandising business operated as a proprietorship. It includes business documents, and it can be solved manually or with the General Ledger software.

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xxviii Contents

Chapter 12 Accounting for Partnerships and Limited Liability Companies 537

Proprietorships, Partnerships, and Limited Liability Companies 538

Proprietorships 538Partnerships 539

Business Connection: Breaking Up Is Hard to Do 539Limited Liability Companies 540Comparing Proprietorships, Partnerships,

and Limited Liability Companies 540

Business Connection: Organizational Forms in the Accounting Industry 541

Forming and Dividing Income of a Partnership 541

Forming a Partnership 541Dividing Income 542

Partner Admission and Withdrawal 545Admitting a Partner 545Withdrawal of a Partner 550Death of a Partner 550

Liquidating Partnerships 550Gain on Realization 551Loss on Realization 553Loss on Realization—Capital Defi ciency 555

Statement of Partnership Equity 557

Financial Analysis and Interpretation: Revenue per Employee 558

Chapter 13 Corporations: Organization, Stock Transactions, and Dividends 581

Nature of a Corporation 582Characteristics of a Corporation 582Forming a Corporation 583

Stockholders’ Equity 584

Paid-In Capital from Issuing Stock 585Characteristics of Stock 585Classes of Stock 585Issuing Stock 586Premium on Stock 588No-Par Stock 588

Business Connection: Cisco Systems, Inc. 589

International Connection: IFRS for SMEs 590

Accounting for Dividends 590Cash Dividends 590Stock Dividends 592

Treasury Stock Transactions 593

Reporting Stockholders’ Equity 595Stockholders’ Equity on the Balance Sheet 595Reporting Retained Earnings 596Statement of Stockholders’ Equity 598Reporting Stockholders’ Equity for Mornin’ Joe 598

Stock Splits 599

Business Connection: Buff et on Stock Splits 600

Financial Analysis and Interpretation: Earnings per Share 600

Practice Set: Art by DesignThis set is a service and merchandising business operated as a corporation. It includes narrative for six months of transactions, which are to be recorded in a general journal. The set can be solved manually or with the General Ledger software.

Practice Set: Digital Revolution ServicesThis set is a departmentalized merchandising busi-ness operated as a corporation. It includes a narrative of transactions, which are to be recorded in special journals. The set can be solved manually or with the General Ledger software.

Chapter 14 Long-Term Liabilities: Bonds and Notes 625

Financing Corporations 626

Nature of Bonds Payable 628Bond Characteristics and Terminology 628Proceeds from Issuing Bonds 629

Business Connection: U.S. Government Debt 629

Accounting for Bonds Payable 630Bonds Issued at Face Amount 630Bonds Issued at a Discount 630Amortizing a Bond Discount 631Bonds Issued at a Premium 632Amortizing a Bond Premium 633

Business Connection: General Motors Bonds 634Bond Redemption 635

Installment Notes 636Issuing an Installment Note 636Annual Payments 636

Reporting Long-Term Liabilities 638

Financial Analysis and Interpretation: Number of Times Interest Charges Are Earned 639

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Contents xxix

Appendix 1: Present Value Concepts and Pricing Bonds Payable 640

Present Value Concepts 641Pricing Bonds 643

Appendix 2: Eff ective Interest Rate Method of Amortization 644

Amortization of Discount by the Interest Method 645Amortization of Premium by the Interest Method 646

Chapter 15 Investments and Fair Value Accounting 667

Why Companies Invest 668Investing Cash in Current Operations 668Investing Cash in Temporary Investments 669Investing Cash in Long-Term Investments 669

Accounting for Debt Investments 669Purchase of Bonds 670Interest Revenue 670Sale of Bonds 671

Accounting for Equity Investments 672Less Than 20% Ownership 672Between 20%–50% Ownership 674More Than 50% Ownership 676

Business Connection: Apple’s Entrance to Streaming Music 677

Valuing and Reporting Investments 677Trading Securities 677Available-for-Sale Securities 679Held-to-Maturity Securities 681Summary 681

Business Connection: Warren Buff ett: The Sage of Omaha 683

Fair Value Accounting 684Trend to Fair Value Accounting 684Effect of Fair Value Accounting on the Financial

Statements 685

Financial Analysis and Interpretation: Dividend Yield 685

Appendix: Comprehensive Income 686


Financial Statements for Mornin’ Joe 713

Chapter 16 Statement of Cash Flows 717

Reporting Cash Flows 718Cash Flows from Operating Activities 719Cash Flows from Investing Activities 720Cash Flows from Financing Activities 721

Noncash Investing and Financing Activities 721No Cash Flow per Share 721

Statement of Cash Flows—The Indirect Method 722

Retained Earnings 723Adjustments to Net Income 723

Business Connection: Cash Crunch! 726Dividends 728Common Stock 729Bonds Payable 729Building 730Land 730Preparing the Statement of Cash Flows 731

Statement of Cash Flows—The Direct Method 732Cash Received from Customers 732Cash Payments for Merchandise 733Cash Payments for Operating Expenses 734Gain on Sale of Land 734Interest Expense 734Cash Payments for Income Taxes 735Reporting Cash Flows from Operating

Activities—Direct Method 735

International Connection: IFRS for Statements of Cash Flows 736

Financial Analysis and Interpretation: Free Cash Flow 737

Appendix: Spreadsheet (Work Sheet) for Statement of Cash Flows—The Indirect Method 738

Analyzing Accounts 739Retained Earnings 740Other Accounts 740Preparing the Statement of Cash Flows 741

Chapter 17 Financial Statement Analysis 773

Basic Analytical Methods 774Horizontal Analysis 774Vertical Analysis 777Common-Sized Statements 778Other Analytical Measures 779

Solvency Analysis 779Current Position Analysis 780Accounts Receivable Analysis 782Inventory Analysis 783Ratio of Fixed Assets to Long-Term Liabilities 785Ratio of Liabilities to Stockholders’ Equity 785Number of Times Interest Charges Earned 786

Profi tability Analysis 787Ratio of Net Sales to Assets 787Rate Earned on Total Assets 788

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xxx Contents

Rate Earned on Stockholders’ Equity 789Rate Earned on Common Stockholders’ Equity 789Earnings per Share on Common Stock 791Price-Earnings Ratio 792Dividends per Share 792Dividend Yield 793Summary of Analytical Measures 793

Corporate Annual Reports 795Management Discussion and Analysis 795Report on Internal Control 795Report on Fairness of the Financial Statements 795

Appendix: Unusual Items on the Income Statement 796

Unusual Items Affecting the Current Period’s Income Statement 796

Unusual Items Affecting the Prior Period’s Income Statement 798

Nike, Inc., Problem 823

Appendix A: Interest Tables A-2

Appendix B: Reversing Entries B-1

Appendix C: Nike, Inc. 2010 Annual Report C-1

Appendix D: International Financial Reporting Standards D-1

Glossary G-1

Subject Index I-1

Company Index I-12

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WARREN REEVE DUCHAC

FINANCIAL ACCOUNTING

12e

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cover & table of contents - financial accounting (12th edition).pdf

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