financial and managerial accounting - gbv

Financial and Managerial

Accounting S E C O N D E D I T I O N

Charles T. Horngren Stanford University

Walter T. Harrison Jr. Baylor University

M. Suzanne Oliver Northwest Florida State College

Pearson Education International

Contents CHAPTER J» Accounting and the Business Environment 1 Accounting Vocabulary: The Language of Business 2 Decision Makers: The Users of Accounting

Information 2 Individuals 2 Businesses 2 Investors 3 Creditors 3 Taxing Authorities 3 Financial Accounting and Management Accounting 3

The Accounting Profession and the Organizations that Govern it 3

Governing Organizations 4 Ethics in Accounting and Business 5 Standards of Professional Conduct 5

Types of Business Organizations 5 Four Types of Business Organizations 5

Distinguishing Characteristics and Organization of a Corporation 7

Separate Legal Entity 7 Continuous Life and Transferability of Ownership 7 No Mutual Agency 8 Limited Liability of Stockholders 8 Separation of Ownership and Management 8 Corporate Taxation 8 Government Regulation 8 Organization of a Corporation 9

Accounting Concepts and Principles 9 The Entity Concept 10 The Reliability (Objectivity) Principle 10 The Cost Principle 10 The Going-Concern Concept 10 The Stable Monetary Unit Concept 11

The Accounting Equation 11 Assets and Liabilities 11 Owners' Equity 12

Accounting for Business Transactions 13 Transactions Analysis for Smart Touch Learning 14

Preparing the Financial Statements—the User Perspective of Accounting 18

The Financial Statements 20 Headings 20

Using Financial Statements to Evaluate Business Performance 23

Relationships Among the Financial Statements 23 • Decision Guidelines 25 • Summary Problem 26

Review and Assignment Material 28 • Chapter 1 Demo Doc: Transaction Analysis Using Accounting

Equation/Financial Statement Preparation 54

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Recording Business Transactions 63 The Account, the Journal, and the Ledger 64

Assets 64 Liabilities 65 Stockholders' Equity 66 Chart of Accounts 66

Debits, Credits, and Double-Entry Accounting 68 The T-Account 68 Increases and Decreases in the Accounts 69

List the Steps of the Transaction Recording Process 70 Posting (Copying Information) from the Journal to the Ledger 71 Expanding the Rules of Debit and Credit: Revenues and Expenses 72 The Normal Balance of An Account 73 Source Documents—The Origin of the Steps 74

Journalizing Transactions and Posting to the Ledger 74 Practice Journalizing with Specific Examples 74 The Ledger Accounts After Posting 80

Preparing the Trial Balance from the T-Accounts 81 Correcting Trial Balance Errors 82 Details of Journals and Ledgers 83 The Four-Column Account: An Alternative to the T-Account 84

• Decision Guidelines 85 • Summary Problem 86

Review and Assignment Material 90 • Chapter 2 Demo Doc: Debit/Credit Transaction Analysis 123

CHAPTER О The Adjusting Process 133 Accrual Accounting Versus Cash-Basis

Accounting 134 Other Accounting Principles 135

The Accounting Period 135 The Revenue Principle 136 The Matching Principle 137 The Time-Period Concept 137

Why We Adjust the Accounts 138 Two Categories of Adjusting Entries 139

Prepaid Expenses 139 Depreciation 142 Accrued Expenses 144 Accrued Revenues 146 Unearned Revenues 146 Summary of the Adjusting Process 149

The Adjusted Trial Balance 152 The Financial Statements 153

Preparing the Statements 153 Relationships Among the Financial Statements 153

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Ethical Issues in Accrual Accounting 155 • Decision Guidelines 156 • Summary Problem 157

Review and Assignment Material 162

CHAPTER APPENDIX ЗА: Alternative Treatment of Prepaid Expenses and Unearned Revenues 190

• Chapter 3 Demo Doc: Preparation of Adjusting Entries, Adjusted Trial Balance, and Financial Statements 194

CHAPTER Completing the Accounting Cycle 206 The Work Sheet 207

Net Income 210 Net Loss 210

• Summary Problem 1 211

Completing the Accounting Cycle 213 Preparing the Financial Statements from a Worksheet 213 Recording the Adjusting Entries from a Worksheet 213

Closing the Accounts 216 Closing Temporary Accounts 217

Postclosing Trial Balance 219

Classifying Assets and Liabilities 219 Assets 220 Liabilities 220 The Classified Balance Sheet 221 Balance Sheet Forms 221

Accounting Ratios 222 Current Ratio 223 Debt Ratio 223

• Decision Guidelines 224 • Summary Problem 2 225 Review and Assignment Material 229

CHAPTER APPENDIX 4A: Reversing Entries: An Optional Step 256

COMPREHENSIVE PROBLEM FOR CHAPTERS 1-4: Journalizing, Posting, Work Sheet, Adjusting, Closing the Financial Statements 260

*• Chapter 4 Demo Doc: Accounting Work Sheets and Closing Entries 262

CHAPTER w Merchandising Operations 270 What Are Merchandising Operations? 272

The Operating Cycle of a Merchandising Business 272 Inventory Systems: Perpetual and Periodic 273 Perpetual Inventory Systems 273

Accounting for Inventory in the Perpetual System 274 Purchase of Inventory 274

Sale of Inventory 279 • Summary Problem 1 284

Adjusting and Closing the Accounts of a Merchandiser 286

Adjusting Inventory Based on a Physical Count 286 Closing the Accounts of a Merchandiser 287

Preparing a Merchandiser's Financial Statements 288 Income Statement Formats: Multi-Step and Single-Step 290

Two Ratios for Decision Making 290 The Gross Profit Percentage 290 The Rate of Inventory Turnover 291

• Decision Guidelines 292 • Summary Problem 2 294


CHAPTER APPENDIX 5A: Work Sheet for a Merchandising Business 319

CHAPTER APPENDIX 5B: Accounting for Merchandise in a Periodic Inventory System 323

COMPREHENSIVE PROBLEM FOR CHAPTERS 1-5: Completing a Merchandiser's Accounting Cycle 329

CHAPTER CI Merchandise Inventory 331 Accounting Principles and Inventories 332

Inventory Costing Methods 333

Inventory Accounting in a Perpetual System 336 First-In, First-Out (FIFO) Method 336 Last-In, First-Out (LIFO) Method 338 Average Cost Method 340

Comparing FIFO, LIFO, and Average Cost 341 • Summary Problem 1 343

Lower-of-Cost-or-Market Rule 346

Effects of Inventory Errors 347 Estimating Ending Inventory 348 Ethical Issues 349



CHAPTER APPENDIX 6A: Accounting for Inventory in a Periodic System 371

CHAPTER 7 Internal Control and Cash 378 Internal Control 379

The Sarbanes-Oxley Act (SOX) 380

The Components of Internal Control 380 Internal Control Procedures 381

Contents vii

Internal Controls for E-Commerce 384 The Limitations of Internal Control—Costs and Benefits 385

The Bank Account as a Control Device 386

The Bank Reconciliation 388 Preparing the Bank Reconciliation 389 Online Banking 392

• Summary Problem 1. 394

Internal Control over Cash Receipts 396

Internal Control over Cash Payments 397 Controls over Payment by Check 397 Controlling Small Cash Payments 399

The Petty Cash Fund 399

Ethics and Accounting 402 Corporate and Professional Codes of Ethics 402 Ethical Issues in Accounting 403



CHAPTER : ^ : : . : - ; : ! y

Receivables 429 Receivables: An Introduction 430

Types of Receivables 430

Internal Control over Collection of Receivables 431

• Decision Guidelines 432

Accounting for Uncollectibles (Bad Debts) 433

The Allowance Method 433 Estimating Uncollectibles 434 Identifying and Writing Off Uncollectible Accounts 437 Recovery of Accounts Previously Written Off— Allowance Method 437

The Direct Write-Off Method 439 Recovery of Accounts Previously Written Off—Direct Write-Off Method 439

Reporting Receivables on the Balance Sheet 440

Credit-Card, Bankcard, and Debit-Card Sales 441 Credit-Card Sales 441 Bankcard Sales 442 Debit-Card Sales 442


Notes Receivable 445 Identifying Maturity Date 445 Computing Interest on a Note 446 Accruing Interest Revenue 447 Dishonored Notes Receivable 449 Computers and Receivables 450

Using Accounting Information for Decision Making 450

Acid-Test (or Quick) Ratio 451 Days' Sales in Receivables 451




CHAPTER APPENDIX 8A: Discounting a Note Receivable 477

CHAPTER 9 Plant Assets and Intangibles 480 Measuring the Cost of a Plant Asset 482

Land and Land Improvements 482 Buildings 484 Machinery and Equipment 484 Furniture and Fixtures 484 A Lump-Sum (Basket) Purchase of Assets 484 Capital Expenditures 486

Depreciation 487 Causes of Depreciation 487 Measuring Depreciation 487 Depreciation Methods 488 Comparing Depreciation Methods 491 Other Issues in Accounting for Plant Assets 493


Disposing of a Plant Asset 497 Situation A - Scrap the Track 499

Accounting for Natural Resources 502

Accounting for Intangible Assets 502 Specific Intangibles 503 Accounting for Research and Development Costs 505

Ethical Issues 505




CHAPTER i Current Liabilities, Payroll, and Long-Term Liabilities 524 Current Liabilities of Known Amount 525

Accounts Payable 525 Short-Term Notes Payable 526 Sales Tax Payable 526 Current Portion of Long-Term Notes Payable 527 Accrued Expenses (Accrued Liabilities) 527 Unearned Revenues 528

Current Liabilities that must be Estimated Estimated Warranty Payable 528 Contingent Liabilities 529


Accounting for Payroll 533 Gross Pay and Net (Take-Home) Pay 533 Payroll Withholding Deductions 534 Employer Payroll Taxes 536

528

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Journalizing Payroll Transactions 537 Internal Control over Payroll 538



Bonds: An Introduction 542 Types of Bonds 542 Bond Prices 542 Present Value 544 Bond Interest Rates 544

Accounting for Bonds Payable - Straight Line Method 545

Issuing Bonds Payable at Maturity (Par) Value 545 Issuing Bonds Payable at a Discount 546


Issuing Bonds Payable at a Premium 549 Adjusting Entries for Bonds Payable 550 Issuing Bonds Payable Between Interest Dates 551

Reporting Liabilities on the Balance Sheet 552

Issuing Bonds Versus Stock 552

Ethical Issues in Reporting Liabilities 553 • Decision Guidelines 554



CHAPTER APPENDIX 10A: The Time Value of Money: Present Value of a Bond and Effective-Interest Amortization 576

CHAPTER APPENDIX 10B: Retiring and Converting Bonds Payable 589

COMPREHENSIVE PROBLEM FOR CHAPTERS 7-10: Comparing Two Businesses 593

CHAPTER 11

Corporations: Paid-in Capital and the Balance Sheet 595 Corporations: An Overview 596

Capital Stock 596

Stockholders' Equity Basics 597 Stockholders' Rights 598 Classes of Stock 598

Issuing Stock 599 Issuing Common Stock 600 Issuing Preferred Stock 603 Ethical Considerations 603 Review of Accounting for Paid-in Capital 604



Retained Earnings 608

Accounting for Cash Dividends 609 Dividend Dates 609 Declaring and Paying Dividends 610

Dividing Dividends Between Preferred and Common 611 Dividends on Cumulative and Noncumulative Preferred 611

Different Values of Stock 612 Market Value 612 Liquidation Value 613 Book Value 613

Evaluating Operations 614 Rate of Return on Total Assets 614 Rate of Return on Common Stockholders' Equity 615

Accounting for Income Taxes by Corporations 616 • Decision Guidelines 617



Corporations: Effects on Retained Earnings and the Income Statement 6 4 1 Stock Dividends 642

Stock Splits 645 Stock Dividends and Stock Splits Compared 647

Treasury Stock 647 Treasury Stock Basics 647 Purchase of Treasury Stock 648 Sale of Treasury Stock 648 Retirement of Stock 650

Restrictions on Retained Earnings 650 Variations in Reporting Stockholders' Equity 651



The Corporate Income Statement 656 Continuing Operations 656 Special Items 657 Earnings per Share 658 Statement of Retained Earnings 659 Combined Statement of Income and Retained Earnings 660 Prior-Period Adjustments 660 Reporting Comprehensive Income 661




CHAPTER

The Statement of Cash Flows 6 8 1 Introduction: The Statement of Cash Flows

Cash Equivalents 682

Operating, Investing, and Financing Activities 683 Two Formats for Operating Activities 684

682

Contents ix

Preparing the Statement of Cash Flows by the Indirect Method 684

Cash Flows from Operating Activities 686 Cash Flows from Investing Activities 689 Cash Flows from Financing Activities 691 Net Change in Cash and Cash Balances 693 Noncash Investing and Financing Activities 694

Measuring Cash Adequacy: Free Cash Flow 696 • Decision Guidelines 697 *- Summary Problem 698


CHAPTER APPENDIX 13A: PreparingThe Statement Of Cash Rows By The Direct Method 721

CHAPTER APPENDIX 13B: Preparing the Indirect Statement of Cash Flows Using a Spreadsheet 739

CHAPTER Financial Statement Analysis 745 Horizontal Analysis 746

Illustration: Smart Touch Learning, Inc. 747 Horizontal Analysis of the Income Statement 748 Horizontal Analysis of the Balance Sheet 748 Trend Percentages 748

Vertical Analysis 749

H o w D o We Compare One Company with Another? 751

Benchmarking 752 Benchmarking Against a Key Competitor 752 Benchmarking Against the Industry Average 752

^ Summary Problem 1 753

Using Ratios to Make Decisions 755 Measuring Ability to Pay Current Liabilities 755 Measuring Ability to Sell Inventory and Collect Receivables 757 Measuring Ability to Pay Long-Term Debt 759 Measuring Profitability 760 Analyzing Stock Investments 762

Red Flags in Financial Statement Analysis 764 • Decision Guidelines 765 • Summary Problem 2 767


COMPREHENSIVE PROBLEM FOR CHAPTERS 13 AND 14; Analyzing a Company for its Inventment Potential 790

CHAPTER 1 5 Introduction to Management Accounting 791 Management Accountability 792

Today's Business Environment 794

Service Companies 795

Merchandising Companies 796 • Summary Problem 1 799

Manufacturing Companies 801 Types of Costs 801

Ethical Standards 807 • Decision Guidelines 809 • Summary Problem 2 811


о Job Order and Process Costing 831 How Much Does it Cost to Make a Product? Two

Approaches 832 Job Order Costing 832 Process Costing 832

How Job Costs Flow Through the Accounts: An Overview 833


Job Order Costing: Allocating Manufacturing Overhead 842

Accounting for Completion and Sale of Finished Goods and Adjusting Manufacturing Overhead 845

Accounting for the Completion and Sale of Finished Goods 846

Job Order Costing in a Service Company 848 • Decision Guidelines 851 »• Summary Problem 2 852


CHAPTER APPENDIX 16A: Process Costing-Weighted-Average Method 877

CHAPTER Activity-Based Costing and Other Cost Management Tools 901 Refining Cost Systems 902

Sharpening the Focus: Assigning Costs Based on the Activities That Caused the Costs 902 Developing an Activity-Based Costing System 904 Traditional Versus Activity-Based Costing Systems: Smart Touch Learning 905

Activity-Based Management: Using ABC for Decision Making 907

Pricing and Product Mix Decisions 908 Cutting Costs 909


Just-In-Time (JIT) Systems 915 Just-in-Time Costing 916 JIT Costing Illustrated: Smart Touch Learning 917

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Continuous Improvement and the Management of Quality 919

The Four Types of Quality Costs 920 Deciding Whether to Adopt a New Quality Program 921



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Cost-Volume-Profit Analysis 947 Cost Behavior 948

Variable Costs 948 Fixed Costs 949 Mixed Costs 950 High-Low Method to Separate Fixed Cost from Variable Costs 951 Relevant Range 952

Basic CVP Analysis: What Must We Sell To Break Even? 953

Assumptions 953 How Much Must Greg Sell to Break Even? Three Approaches 954

Using CVP To Plan Profits 957 How Much Must Greg's Sell to Earn a Profit? 957 Graphing Cost-Volume-Profit Relations 958

• Summary Problem i 960

Using CVP For Sensitivity Analysis 962 Changing the Selling Price 962 Changing Variable Costs 962 Changing Fixed Costs 963 Margin of Safety 964 Information Technology and Sensitivity Analysis 964

Effect of Sales Mix on CVP Analysis 965 • Decision Guidelines 967 • Summary Problem 2 969


CHAPTER APPENDIX ISA: Variable Costing and Absorption Costing 986

994 CHAPTER J Short-Term Business Decisions

995 H o w Managers Make Decisions Relevant Information 995 Relevant Nonfinancial Information 997 Keys to Making Short-Term Special Decisions

Special Sales Order and Regular Pricing Decisions 998

When to Accept a Special Sales Order 998 How to Set Regular Prices 1001


997


When to Drop Products, Departments, or Territories 1009

Dropping Products Under Various Assumptions 1010 Product Mix: Which Product to Emphasize? 1012

Outsourcing and Sell as is or Process Further Decisions 1014

When to Outsource 1014 Sell As Is or Process Further? 1018



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Capital investment Decisions and the Time Value of Money 1042 Capital Budgeting 1043

Four Popular Methods of Capital Budgeting Analysis 1043 Focus on Cash Flows 1043 Capital Budgeting Process 1044

Using Payback and Accounting Rate of Return to Make Capital Investment Decisions 1045

Payback Period 1045 Accounting Rate of Return (ARR) 1048


A Review of the Time Value of Money 1053 Factors Affecting the Time Value of Money 1053 Future Values and Present Values: Points Along the Time Line 1054 Future Value and Present Factors 1055 Calculating Future Values of Single Sums and Annuities Using FV Factors 1055 Calculating Present Values of Single Sums and Annuities Using PV Factors 1056

Using Discounted Cash Flow Models to Make Capital Budgeting Decisions 1058

Net Present Value (NPV) 1058 Internal Rate of Return (IRR) 1063

Comparing Capital Budgeting Methods 1066 • Decision Guidelines 1068 • Summary Problem 2 1069 Review and Assignment Material 1070

CHAPTER The Master Budget and Responsibility Accounting 1083 Why Managers Use Budgets 1084

Using Budgets to Plan and Control 1085 Benefits of Budgeting 1086

Contents x i

Understanding the Components of the Master Budget 1087

Components of the Master Budget 1088 Data for Greg's Groovy Tunes 1089

Preparing the Operating Budget 1091 The Sales Budget 1091 The Inventory, Purchases, and Cost of Goods Sold Budget 1091 The Operating Expenses Budget 1092 The Budgeted Income Statement 1093


Preparing the Financial Budget 1096 Preparing the Cash Budget 1096 The Budgeted Balance Sheet 1099 The Budgeted Statement of Cash Flows 1100 Getting Employees to Accept the Budget 1100

Using Information Technology for Sensitivity Analysis and Rolling Up Unit Budgets 1101

Sensitivity Analysis 1101 Rolling Up Individual Unit Budgets into the Company wide Budget 1102

Responsibility Accounting 1103 Four Types of Responsibility Centers 1103 Responsibility Accounting Performance Reports 1104



CHAPTER 22 Flexible Budgets and Standard Costs 1131 How Managers Use Flexible Budgets 1132

What IsaFlexibleBudget? 1133 Using The Flexible Budget: Why Do Actual Results

Differ From The Static Budget? 1134 • Decision Guidelines 1137 • Summary Problem 1 1138

Standard Costing 1139 Price Standards 1139 Application 1140 Quantity Standards 1140 Why Do Companies Use Standard Costs? 1141 Variance Analysis 1142

How Smart Touch Uses Standard Costing: Analyzing The Flexible Budget Variance 1143

Direct Material Variances 1143 Direct Labor Variances 1146

Manufacturing Overhead Variances 1147 Allocating Overhead in a Standard Cost System 1147 Overhead Flexible Budget Variance 1149 Overhead Production Volume Variance 1149 Summary of Overhead Variances 1150

Standard Cost Accounting Systems 1150 Journal Entries 1150 Standard Cost Income Statement for Management 1152



CHAPTER 4 Performance Evaluation and the Balanced Scorecard 1176 Decentralized Operations 1177

Advantages of Decentralization 1178 Disadvantages of Decentralization 1178 Responsibility Centers 1179

Performance Measurement 1180 Goals of Performance Evaluation Systems 1180

The В alanced Scorecard 1181 The Four Perspectives of the Balanced Scorecard 1182


Measuring the Financial Performance of Cost, Revenue, and Profit Centers 1189

Measuring the Financial Performance of Investment Centers 1191

Return on Investment (ROI) 1193 Residual Income (RI) 1195 Limitations of Financial Performance Measures 1199



CHAPTER APPENDIX 23A: Allocating Service Department Costs 1216

APPENDIX A: Amazon.com Annual Report A-l APPENDIX B: Present Value Tables B-l APPENDIX C: Check Figures C-l GLINDEX (COMBINED GLOSSARY/INDEX) G-l COMPANY INDEX 1-1