fundamental financial and manageria accounting concepts

FundamentalFinancial and

ManageriaAccounting

Concepts

Univers

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ity||)f::Ajabama—Birmingham

Oniyersity of i

. Edmonds'

Birmingham

^i:^'-^tV-r' PhilipR..OldS':':v,Virgit1i:a:Commo«weatthi3niVers:ity

'IO;;.^^" Frances M. McNair

^';I'SC' Mississippi'StatesUriiversity

?'"Universi ty,6f A l a b a m a - — B i r m i h g h a m ... ''••:•••.! J ^

Nancy W. Schneider JJ«

.. •', Lynchburg College . x j« i

Edward E. Mi lam

Mississippi State University

McGraw-HillIrwin

Boston Burr Ridge, IL Dubuque, IA Madison, Wl New YorkSan Francisco St. Louis Bangkok Bogota Caracas Kuala LumpurLisbon London Madrid Mexico City Milan Montreal New Delhi

Santiago Seoul Singapore Sydney Taipei Toronto

Contents

Chapter 1 Elements of Financial Statements 2

Chapter Opening 3

Role of Accounting in Society 4

Using Free Markets to Set ResourcePriorities 4

Accounting Provides Information 5

Types of Accounting Information 6

Nonbusiness Resource Usage 6

Measurement Rules 6

Reporting Entities 8

Elements of Financial Statements 8

Accounting Equation 9

Recording Business Events Under theAccounting Equation 11

Asset Source Transactions 11

Asset Exchange Transactions 12

Another Asset Source Transaction 12

Asset Use Transactions 13

Historical Cost and ReliabilityConcepts 14

Recap: Types of Transactions 14

Summary of Transactions 14

Preparing Financial Statements 15

Income Statement and the MatchingConcept 17

Statement of Changes in Stockholders'Equity 17

Balance Sheet 18

22

Statement of Cash Flows 18

The Horizontal Financial StatementsModel 19

Careers in Accounting 20

Public Accounting 20

Private Accounting 21

The Financial Analyst 21

Importance of Ethics 21

Sarbanes-Oxley Act of 2002

Common Features of EthicalMisconduct 22

Real-World Financial Reports 24

Annual Report for The ToppsCompany, Inc. 25

Special Terms in Real-World

Reports 26

A Look Back 26

A Look Forward 26

Self-Study Review Problem

Key Terms 28

Questions 28

Exercises—Series A

Problems-Series A

Exercises-Series B

Problems-Series B

Analyze, Think, Communicate

Comprehensive Problem 56

26

29

36

41

48

52

eadersChapter 2 Understanding the Accounting Cycle 58

Chapter Opening 59

Accrual Accounting 60

Accounting for AccountsReceivable 60

Other Events 61

Accounting for Accrued Salary Expense(Adjusting Entry) 62

Summary of Events 63

The General Ledger 63

Vertical Statements Model 63

The C/os/'ng Process 66

Steps in an Accounting Cycle 67

The Matching Concept 67

The Conservatism Principle 67

Second Accounting Cycle 68

Prepaid Items (Cost versusExpense) 68

Accounting for Receipt of Unearned

Revenue 69

Accounting for Supplies Purchase 69

Other 2009 Events 69

Adjusting Entries 71

Accounting for Supplies (AdjustingEntry) 71

Accounting for Prepaid Rent (Adjusting

Entry) 72

Accounting for Unearned Revenue(Adjusting Entry) 72

Accounting for Accrued Salary Expense(Adjusting Entry) 73

Summary of Events 74


Vertical Statements Model 75


Price-earnings Ratio 77

Measuring Growth Through PercentageAnalysis 79

A Look Back 81

A Look Forward 82

Self-Study Review Problem 82

Key Terms 84

Questions 84

Exercises-Series A 85

Problems-Series A 93

Exercises-Series B 98

Problems-Series B 106

Analyze, Think, Communicate 111


Chapter 3 The Double-Entry Accounting System 116

Chapter Opening 117

Debit/Credit Terminology 118

Collins Consultants Case 118

Asset Source Transactions 118

Asset Exchange Transactions 121

Asset Use Transactions 123

Claims Exchange Transactions 125

Adjusting the Accounts 126

Overview of Debit/Credit

Relationships 128


The General Journal 128

Trial Balance 131

Financial Statements 131

Closing Entries 132

Trial Balance 136


Assessing the Effective Use ofAssets 136

Assessing Debt Risk 137

Real-World Data 138

Scope of Coverage 140

A Look Back 140

A Look Forward 141


Key Terms 145

Questions 145







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Chapter 4 Accounting for Merchandising Businesses 180

Chapter Opening 181

Product Costs Versus Selling andAdministrative Costs 182

Allocating Inventory Cost Between Assetand Expense Accounts 182

Perpetual Inventory System 184

Effects of 2006 Events on Financial

Statements 184

Recording and Reporting InventoryEvents in the Double-EntrySystem 185

Financial Statements for 2006 186

Transportation Cost, Purchase Returns andAllowances, and Cash Discounts Relatedto Inventory Purchases 187

Effects of 2007 Events on FinancialStatements 188

Recording and Reporting InventoryEvents in the Double-EntrySystem 193


Events Affecting Sales 195

Lost, Damaged, or Stolen Inventory 198

Adjustment for Lost, Damaged, or StolenInventory 198

Recognizing Gains and Losses 199


Common Size Financial Statements 200

Comparisons between Companies 201

Gross Margin Percentage 201

Net Income Percentage 202

Comparisons within a ParticularCompany 202

Real-World Data 202

Financing Merchandise Inventory 203

A Look Back 204

A Look Forward 205

Appendix 205


Key Terms 208

Questions 208

Exercises—Series A 209






Chapter 5 Accounting for Inventories 236

Chapter Opening 237

Inventory Cost Flow Methods 238

Specific Identification 238

First-ln, First-Out (FIFO) 238

Last-In, First-Out (UFO) 238

Weighted Average 238

Physical Flow 238

Effect of Cost Flow on FinancialStatements 239

Effect on Income Statement 239

Effect on Balance Sheet 239

inventory Cost Flow under a Perpetual

System 240

Multiple Layers with MultipleQuantities 240

Allocating Cost of Goods Available forSale 240

Effect of Cost Flow on Financial

Statements 242

Inventory Cost Flow When Sales andPurchases Occur Intermittently 244

FIFO Cost Flow 244

Weighted-Average and UFO CostFlows 245

Lower-of-Cost-or-Market Rule 246

Avoiding Fraud in MerchandisingBusinesses 248

Estimating the Ending InventoryBalance 249


/Average Number of Days to SellInventory 251

Is It a Marketing or an Accounting

Decision? 252

Real-World Data 252

Effects of Cost Flow on RatioAnalysis 253

A Look Back 253

A Look Forward 253

Appendix 253


Key Terms 259

Questions 260



Exercises—Series B 271




Chapter 6 Internal Control and Accounting for Cash 286

Chapter Opening 287

Key Features of Internal ControlSystems 288

Separation of Duties 288

Quality of Employees 288

Bonded Employees 288

Required Absences 288

Procedures Manual 289

Authority and Responsibility 289

Prenumbered Documents 289

Physical Control 289

Performance Evaluations 290

Limitations 290

Accounting for Cash 290

Controlling Cash 291

Cash Payments 291

Checking Account Documents 292

Reconciling the Bank Account 293

Illustrating a Bank Reconciliation 296

Cash Short and Over 298

Using Petty Cash Funds 299


The Financial Audit 302

Materiality and Financial Audits 302

Types of Audit Opinions 303

Confidentiality 304

A Look Back 304

A Look Forward 305


Key Terms 307

Questions 307







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Chapter 7 Accounting for Receivables 330

Chapter Opening 331

Allowance Method of Accounting forUncollectible Accounts 332

Accounting Events Affecting the 2006Period 332

Recording and Reporting UncollectibleAccounts Events in the Double-EntrySystem 334


Accounting Events Affecting the 2007Period 335

Estimating Uncollectible Accounts ExpenseUsing the Percent of Revenue (Sales)Method 337

Recording and Reporting UncollectibleAccounts Events in the Double-EntrySystem 338

Analysis of Financial Statements 338

Estimating Uncollectible Accounts ExpenseUsing the Percent of ReceivablesMethod 340

Matching Revenues and Expenses versusAsset Measurement 342

Recognizing Uncollectible AccountsExpense Using the Direct Write-OffMethod 342

Characteristics of Notes Receivable

(Promissory Notes) 343

Accounting for Notes Receivable 344


Accounting for Credit Card Sales 348


Costs of Credit Sales 349

/Average Number of Days to CollectAccounts Receivable 350

Real-World Data 351

A Look Back 353

A Look Forward 354


Key Terms 355

Questions 355







Chapter 8 Accounting for Long-Term Operational Assets 384

Chapter Opening 385

Tangible Versus Intangible Assets 386

Tangible Long-Term Assets 386

Intangible Assets 386

Determining the Cost of Long-Term

Assets 387

Basket Purchase Allocation 387

Methods of Recognizing Depreciation

Expense 388

Dryden Enterprises Illustration 389

Straight-Line Depreciation 389


Double-Declining-Balance

Depreciation 393

Units-of-Production Depreciation 395

Comparing the Depreciation

Methods 396

Income Tax Considerations 397

Revision of Estimates 399

Revision of Life 399

Revision of Salvage 399

Continuing Expenditures for Plant

Assets 399

Costs that Are Expensed 399

Costs that Are Capitalized 400

Natural Resources 402

Intangible Assets 403

Trademarks 403

Patents 403

Copyrights 403

Franchises 403

Goodwill 403

Expense Recognition for IntangibleAssets 405

Expensing Intangible Assets with

Identifiable Useful Lives 406

Impairment Losses for Intangible Assets

with Indefinite Useful Lives 406

Balance Sheet Presentation 407


Effect of Judgment and Estimation 407

Effect of Industry Characteristics 408

A Look Back 409

A Look Forward 410


Key Terms 411

Questions 411Exercises—Series A 412






Chapter 9 Accounting for Current Liabilities and Payroll 440

Chapter Opening 441

Accounting for Current Liabilities 442

Accounting for Notes Payable 442

Accounting for Sales Tax 444

Contingent Liabilities 445

Warranty Obligations 446

General Ledger T-Accounts and


Accounting for Payroll 449

Identifying Employees 449

Employees' Gross Earnings 450

Deductions from Employees' GrossEarnings 450

Federal Income Taxes 450

Federal Income Tax Documents 451

Social Security and Medicare Taxes(FICA) 452

Voluntary Withholdings

(Deductions) 453

Computing Employee Net Pay 454

Employer Payroll Taxes 455

Recording and Reporting Payroll

Taxes 455

Employee Fringe Benefits 456


Current Versus Noncurrent 456

Liquidity Versus Solvency 458

Current Ratio 459

Real-World Data 460

A Look Back 460

A Look Forward 461

Appendix 461


Key Terms 469

Questions 469







Chapter 1 0 Accounting For Long-Term Notes Payable and BondLiabilities 496

Chapter Opening 497

Installment Notes Payable 498

Line of Credit 501

Bond Liabilities 501

Advantages of Issuing Bonds 502

Security of Bonds 503

Timing of Maturity 503

Special Features 503

Bond Ratings 504

Bonds Issued at Face Value 504

Fixed-Rate, Fixed-Term, Annual Interest

Bonds 504

Recording Procedures 505

Effect of Events on Financial

Statements 505


Bonds Issued at a Discount 508

Effective Interest Rate 508

Bond Prices 508

Mason Company Revisited 508

Effect on Financial Statements 510

Effect of Semiannual Interest

Payments 512

Bonds Issued at a Premium 512

The Market Rate of Interest 513

Bond Redemptions 513

Security for Loan Agreements 514


Financial Leverage and Tax Advantage of

Debt Financing 515

EBIT and Ratio Analysis 516

Times Interest Earned Ratio 516

A Look Back 517

A Look Forward 518

Appendix 518


Key Terms 525

Questions 526







Chapter 11 Proprietorships, Partnerships, and Corporations 554

Chapter Opening 555

Forms of Business Organizations 556

Advantages and Disadvantages of DifferentForms of Business Organization 556

Regulation 556

Double Taxation 557

Limited Liability 558

Continuity 558

Transferability of Ownership 558

Management Structure 559

Ability to Raise Capital 559

Appearance of Capital Structure inFinancial Statements 559

Presentation of Equity in

Proprietorships 559

Presentation of Equity inPartnerships 560

Presentation of Equity in

Corporations 561

Characteristics of Capital Stock 561

Par Value 561

Stated Value 561

Other Valuation Terminology 562

Stock: Authorized, Issued, and

Outstanding 562

Classes of Stock 562

Common Stock 563

Preferred Stock 563

Accounting for Stock Transactions on the

Day of Issue 564

Issuing Par Value Stock 564

Stock Classification 565

Stock Issued at Stated Value 565

Stock Issued with No Par Value 565

Financial Statement Presentation 566

Stockholders' Equity Transactions after the

Day of Issue 566

Treasury Stock 566

Cash Dividend 568

Stock Dividend 569

Stock Split 570

Appropriation of Retained

Earnings 570

Financial Statement Presentation 570


Receiving Dividends 572

Increasing the Price of Stock 572

Price-earnings Ratio 573

Exercising Control through Stock

Ownership 573

A Look Back 574

A Look Forward 574

Appendix 575


Key Terms 579

Questions 579







Chapter 1 2 Statement of Cash Flows 602

Chapter Opening 603

Operating Activities 604 s

Investing Activities 604

Financing Activities 604

Noncash Investing and Financing

Activities 604

Reporting Format for the Statement ofCash Flows 604

Converting from Accrual to Cash-Basis

Accounting 605Operating Activities 605

Investing Activities 609

Financing Activities 609

Comprehensive Example Using the T-Account Approach 610

Preparing a Statement of CashFlows 611

Cash Flows from OperatingActivities 611

Cash Flows from InvestingActivities 614

Cash Flows from FinancingActivities 615

Presenting Information in the Statement ofCash Flows 616

Statement of Cash Flows Presented under

the Indirect Method 617


Real-World Data 620

A Look Back 621

A Look Forward 622


Key Terms 624

Questions 624

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Chapter 1 3 Financial Statement Analysis 648

• Chapter Opening 649I

Factors in Communicating UsefulInformation 650

The Users 650

The Types of Decisions 650

Information Analysis 650

Methods of Analysis 650

Horizontal Analysis 651

Vertical Analysis 653

Ratio Analysis 655

Measures of Debt-Paying Ability 655

Liquidity Ratios 655

Solvency Ratios 658

Measures of Profitability 661

Measures of ManagerialEffectiveness 661

Stock Market Ratios 663

Presentation of AnalyticalRelationships 665

Limitations of Financial StatementAnalysis 666

Different Industries 667

Changing Economic Environment 668

Accounting Principles 668

A Look Back 669

A Look Forward 669


Key Terms 671

Questions 671






Chapter 1 4 Management Accounting: A Value-AddedDiscipline 698

Chapter Opening 699

Differences Between Managerial andFinancial Accounting 700

Users and Types of Information 700

Level of Aggregation 700

Regulation 700

Information Characteristics 701

Time Horizon and Reporting

Frequency 701

Product Costing 702

Product Costs in ManufacturingCompanies 702

Tabor Manufacturing Company 702

Average Cost per Unit 703

Costs Can Be Assets or Expenses 703

Effect of Product Costs on Financial

Statements 704

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Manufacturing Product Cost

Summary 708

Importance of Cost Classification 708

Marion Manufacturing Company 709

Practical Implications 710

Ethical Considerations 711

Upstream and Downstream Costs 712

Product Costs in Service Companies 712

Emerging Trends in ManagerialAccounting 714

Total Quality Management 714

Activity-Based Management 714

Just-in-Time Inventory 715

Value Chain Analysis Across

Companies 717

A Look Back 717

A Look Forward 718


Key Terms 720

Questions 721







Chapter 1 5 Cost Behavior, Operating Leverage, and ProfitabilityAnalysis 744

Chapter Opening 745

Fixed Cost Behavior 746

Operating Leverage 746

Calculating Percentage Change 747

Risk and Reward Assessment 748

Variable Cost Behavior 748

Relationship Between Cost Behavior and

Revenue 749

Effect of Cost Structure on ProfitStability 749

An Income Statement under theContribution Margin Approach 751

Measuring Operating Leverage UsingContribution Margin 751

Using Fixed Cost to Provide a CompetitiveOperating Advantage 753

Cost Behavior Summarized 754

The Relevant Range 754

Context-Sensitive Definitions of Fixedand Variable 755

Cost Averaging 756

Use of Estimates in Real-WorldProblems 758

High-Low Method of Estimating Fixed andVariable Costs 758

Scattergraph Method of Estimating Fixedand Variable Costs 760

A Look Back 761

A Look Forward 762


Key Terms 765

Questions 765







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Chapter 1 6 Cost Accumulation, Tracing, and Allocation 792

Chapter Opening 793

Use of Cost Drivers to AccumulateCosts 794

Estimated Versus Actual Cost 794

Assignment of Cost to Objects in a Retail

Business 794

Identifying Direct Versus IndirectCosts 795

Cost Classifications—Independent andContext Sensitive 795

Allocating Indirect Costs toObjects 796

Selecting a Cost Driver 798

Behavioral Implications 800

Effects of Cost Behavior on Selecting the

Most Appropriate Cost Driver 802

Using Volume Measures to Allocate

Variable Overhead Costs 802

Allocating Fixed Overhead Costs 804

Allocating Costs to Solve Timing

Problems 805

Establishing Cost Pools 806

Allocating Joint Costs 806

Relative Sales Value as the Allocation

Base 807

By-Product Costs 808

Cost Allocation: The Human Factor 808

Using Cost Allocations in a BudgetingDecision 809

Using Cost Drivers to Make

Allocations 809

Choosing the Best Cost Driver 810

Controlling Emotions 810

A Look Back 810

A Look Forward 811


Key Terms 813

Questions 813







Chapter 1 7 Product Costing in Service and ManufacturingCompanies 832

Chapter Opening 833

Cost Flow in Manufacturing

Companies 834

Cost Flow in Service Companies 834

Manufacturing Cost Flow Illustrated 836

Events Affecting Manufacturing Cost

Flow in January 836

Flow of Overhead Costs 838

Manufacturing Overhead Account 838

Summary of January Events 842

Manufacturing Cost Flow Events for

February Through December 843

Analyzing Underapplied Overhead 844

Preparing the Schedule of Cost of Goods

Manufactured and Sold 846


Motive to Overproduce 848

Absorption Costing Versus Variable

Costing 848

Variable Costing 849

A Look Back 850

A Look Forward 851


Key Terms 853

Questions 853







Chapter 1 8 Job-Order, Process, and Hybrid Cost Systems 880

Chapter Opening 881

Cost Systems 882

Cost Systems and Type ofProduct 882

Job-Order Cost Flow 882

Process Cost Flow 883

Hybrid Accounting Systems 884

Documentation in a Job-Order CostSystem 884

Job-Order Cost System Illustrated 886

Process Cost System Illustrated 893

A Look Back 904

A Look Forward 904

Self-Study Review Problem 1 905

Self-Study Review Problem 2 905

Key Terms 906

Questions 906







Chapter 1 9 Analysis of Cost, Volume, and Pricing to IncreaseProfitability 930

Chapter Opening 931

Determining the Contribution Margin perUnit 932

Determining the Break-Even Point 932

Using the Contribution Approach toEstimate the Sales Volume Necessary toReach a Target Profit 933

Using the Contribution Approach toEstimate the Effects of Changes in SalesPrice 934

Target Pricing 935

Using the Contribution Approach toEstimate the Effects of Changes inVariable Costs 935

Using the Contribution Approach toEstimate the Effects of Changes in FixedCosts 936

Using the Cost-Volume Profit Graph 937

Calculating the Margin of Safety 938

Performing Sensitivity Analysis UsingSpreadsheet Software 941

Assessing the Pricing Strategy 941

Using the Contribution Approach to Assessthe Effect of Simultaneous Changes in CVPVariables 942

A Decrease in Sales PriceAccompanied by an Increase inSales Volume 942

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An Increase in Fixed CostAccompanied by an Increase inSales Volume 942

A Simultaneous Reduction in SalesPrice, Fixed Costs, Variable Costs, andSales Volume 943

Performing Cost-Volume-Profit (CVP)Analysis Using the Contribution MarginRatio 943

Performing Cost-Volume-Profit AnalysisUsing the Equation Method 944

Cost-Volume-Profit Limitations 945

A Look Back 946

A Look Forward 946

APPENDIX 947


Key Terms 950

Questions 950


Problems—Series A 954





Chapter 2 0 Relevant Information for Special Decisions 968

Chapter Opening 969

The Decision Environment 970

Relevant Information 970

Sunk Cost 970

Relevant (Differential) Revenues 971

Relevant (Avoidable) Costs 971

Relevance Is an IndependentConcept 972

Relevance of Opportunity Costs 973

Relevance Is Context-Sensitive 974

Relationship Between Relevance andAccuracy 974

Quantitative Versus QualitativeCharacteristics of DecisionMaking 975

Relevant Information and SpecialDecisions 975

Special Order Decisions 975

Outsourcing Decisions 977

Segment Elimination Decisions 980

Summary of RelationshipsBetween Avoidable Costs andthe Hierarchy of BusinessActivity 983

Equipment ReplacementDecisions 983

A Look Back 985

A Look Forward 985

Appendix 986


Key Terms 990

Questions 990



Exercises—Series B 1002




Chapter 2 1 Planning for Profit and Cost Control 1018

Chapter Opening 1019

The Planning Process 1020

Three Levels of Planning for BusinessActivity 1020

Advantages of Budgeting 1021

Planning 1021

Coordination 1021

Performance Measurement 1021

Corrective Action 1021

Budgeting and Human Behavior 1022

The Master Budget 1022

Hampton Hams BudgetingIllustration 1023

Sales Budget 1023

Inventory Purchases Budget 1025

..Selling and Administrative Expense•' Budget 1027

Cash Budget 1029

Pro Forma Income Statement 1031

Pro Forma Balance Sheet 1032

Pro Forma Statement of Cash

Flows 1032

A Look Back 1033

A Look Forward 1034


Key Terms 1036

Questions 1036







Chapter 2 2 Performance Evaluation 1060


Preparing Flexible Budgets 1062

Determining Variances for PerformanceEvaluation 1063

Sales Volume Variances 1063

Flexible Budget Variances 1065

The Human Element Associated withFlexible Budget Variances 1067

Establishing Standards 1068

Need for Standard Costs 1069

Selecting Variances to Investigate 1069

Flexible Budget Manufacturing CostVariances 1070

Price and Usage Variances 1072

Variable Overhead Variances 1075

Fixed Overhead Variances 1076

Summary of Manufacturing Cost

Variances 1077

General, Selling, and Administrative CostVariances 1077

A Look Back 1079

A Look Forward 1081


Key Terms 1082

Questions 1083







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Chapter 2 3 Responsibility Accounting 1108


Decentralization Concept 1110

Organization Chart 1111

Responsibility Centers 1111

Responsibility Reports 1111

Management by Exception and Degreeof Summarization 1111

Controllability Concept 1113

Qualitative Reporting Features 1114

Managerial Performance

Measurement 1114

Return on Investment 1115

Residual Income 1119

Responsibility Accounting and theBalanced Scorecard 1121

A Look Back 1122

A Look Forward 1122

Appendix 1123


Key Terms 1127

Questions 1127







Chapter 2 4 Planning for Capital Investments 1148


Capital Investment Decisions 1150

Time Value of Money 1150

Techniques for Analyzing Capital

Investment Proposals 1155

Wet Present Value 1155

Internal Rate of Return 1156

Techniques for Measuring Investment Cash

Flows 1157

Cash Inflows 1157

Cash Outflows 1157

Techniques for Comparing Alternative

Capital Investment Opportunities 1158

Net Present Value 1158

Internal Rate of Return 1160

Relevance and the Time Value of

Money 1162

Tax Considerations 1163

Appendix A Accessing the EDGAR

Database through the Internet 1189

Appendix B Topps Annual Report for

2003 1190

Techniques that Ignore the Time Value ofMoney 1164

Payback Method 1164

Real-World Reporting Practices 1166

Postaudits 1167

A Look Back 1167

A Look Forward 1168

Appendix 1168 v


Key Terms 1170

Questions 1170







Glossary 1224

Photo Credits 1241

Index 1242