Accounting Tools for Business Decision Making [8 ed.] 9781119791034

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Paul Kimmel’s

Accounting Course Design with WileyPLUS Paul Kimmel, author of several Wiley courses, teaches at The University of Wisconsin—Madison and uses WileyPLUS in a flipped classroom format.

Ignite student potential

with WileyPLUS

See how Paul uses four key elements to focus his course on developing his students’ success.

Guided Learning

Information Retention

Personalized Practice

Just-in-Time Homework Help

EXAMPLE: Paul sets up his learning path to highlight and structure preassignments, post-assignments and discussions, adaptive assignments, exam practice, and quizzing.

EXAMPLE: Paul assigns Interactive Tutorial Assignments ahead of pre-lecture activities so students come to class ready to actively participate.

EXAMPLE: Paul uses Adaptive Assignments as a capstone activity at the end of each week to improve retention.

EXAMPLE: Paul assigns post-assignment problems supported by Solution Walkthrough Videos.

Interactive Tutorial Assignments provide students with self-paced lecture walkthroughs of each chapter. Broken into smaller chunks with Knowledge Check questions and Do It!s, students must watch the videos and respond to associated questions correctly or exhaust attempts before moving on, enhancing the retention of information. Trying to solve a problem before being taught the solution is frustrating but improves retention.

Adaptive Assignments effectively close knowledge gaps through personalized adaptive experiences that provide just-intime instruction, immediate feedback, and remediation to previous learning objectives. To improve learning, employ dynamic (adaptive) testing rather than static testing. Without feedback, students often overestimate their competence and don’t see a need to try to improve.

A guided learning path enables you to control what your students see, when they see it, and in what order. This makes it very clear for students to understand what they’re supposed to complete. This is especially vital for online classes. Having a clear path to learning reduces the risk of “losing” students, keeping them engaged and on track in your course.

Solution Walkthrough Videos provide students with 24/7 just-in-time homework support and enable you to assign more difficult homework questions. Longer, multi-learning objective problems with video support help students consolidate their understanding.

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Paul Kimmel’s

Accounting Course Design with WileyPLUS Course Design Suggestions from Make It Stick* Trying to solve a problem before being taught the solution improves retention. Testing (active retrieval) doesn’t just measure learning, it strengthens memory. Spaced “testing” results in greater retention. Providing feedback strengthens learning more than testing alone. *Make It Stick; Brown, Roediger, and McDaniel, 2014.

Considerations for a Flipped Classroom Based on Paul Kimmel’s course with two in-person lectures per week. EXAMPLE WEEKLY SCHEDULE SUNDAY

Online

Complete first pre-assignment. Due Monday before class.

MONDAY

In Class

Students do at least two exercises in class on blank sheet (i.e., conditions faced in a test).

TUESDAY

Online

Complete second pre-assignment. Due Wednesday before class.

WEDNESDAY

In Class

Students do at least two exercises in class on blank sheet.

THURSDAY/FRIDAY

Online

Complete post-assignment. Due Friday night.

FRIDAY/SATURDAY

Online

Complete adaptive assignment. Due Saturday night.

Want to learn more about Paul Kimmel’s course? Scan this QR code to sign up for a WileyPLUS demo

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Accounting Tools for Business Decision Making

Eighth Edition

PAUL D. KIMMEL PhD, CPA University of Wisconsin—Madison Madison, Wisconsin

JERRY J. WEYGANDT PhD, CPA University of Wisconsin—Madison Madison, Wisconsin

JILL E. MITCHELL MS , MEd, CIA Northern Virginia Community College Annandale, Virginia

Download Complete eBook By email at [email protected] D E D I C AT E D T O Our spouses, Enid, Merlynn, and Sean, for their love, support, and encouragement. VICE PRESIDENT, EDITORIAL PRODUCT MANAGEMENT ASSOCIATE EDITORIAL DIRECTOR SENIOR COURSE CONTENT DEVELOPER INSTRUCTIONAL DESIGNER SENIOR PRODUCT MARKETING MANAGER EDITORIAL SUPERVISOR PROGRAM ASSISTANT SENIOR MANAGER, COURSE DEVELOPMENT AND PRODUCTION EXECUTIVE MANAGING EDITOR SENIOR PRODUCTION EDITOR SENIOR DESIGNER COVER IMAGE

Michael McDonald Zoe Craig Jenny Welter Matt Origoni Christina Koop Minarik Terry Ann Tatro Natalie Munoz Ed Brislin Karen Staudinger Rachel Conrad Jon Boylan © Annika Gültzow/EyeEm/Getty Images

This book was set in 9.5/12 STIX Two Text by Lumina Datamatics, Inc. Founded in 1807, John Wiley & Sons, Inc. has been a valued source of knowledge and understanding for more than 200 years, helping people around the world meet their needs and fulfill their aspirations. Our company is built on a foundation of principles that include responsibility to the communities we serve and where we live and work. In 2008, we launched a Corporate Citizenship Initiative, a global effort to address the environmental, social, economic, and ethical challenges we face in our business. Among the issues we are addressing are carbon impact, paper specifications and procurement, ethical conduct ­within our business and among our vendors, and community and charitable support. For more information, please visit our website: www.wiley.com/go/ citizenship. Copyright © 2022 John Wiley & Sons, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc. 222 Rosewood Drive, Danvers, MA 01923, website www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, (201)748-6011, fax (201)748-6008, website http://www.wiley.com/go/permissions. ISBN-13: 978-1-119-79103-4 The inside back cover will contain printing identification and country of origin if omitted from this page. In addition, if the ISBN on the back cover differs from the ISBN on this page, the one on the back cover is correct. Printed in America. 10     9    8    7    6    5    4    3    2    1

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Brief Contents

1 Introduction to Financial Statements  1-1

20 Incremental Analysis  20-1

2 A Further Look at Financial Statements  2-1

21 Pricing  21-1

3 The Accounting Information System  3-1

22 Budgetary Planning  22-1

4 Accrual Accounting Concepts  4-1 5 Merchandising Operations and the Multiple-Step Income Statement   5-1

23 Budgetary Control and Responsibility Accounting  23-1

6 Reporting and Analyzing Inventory   6-1

24 Standard Costs and Balanced Scorecard   24-1

7 Fraud, Internal Control, and Cash   7-1

25 Planning for Capital Investments  25-1

8 Reporting and Analyzing Receivables   8-1 9 Reporting and Analyzing Long-Lived Assets  9-1

A PPE NDIX A   Specimen Financial Statements:

Apple Inc.  A-1 A PPE NDIX B   Specimen Financial Statements:

10 Reporting and Analyzing Liabilities   10-1 11 Reporting and Analyzing Stockholders’ Equity  11-1

Columbia Sportswear Company  B-1 A PPE NDIX C   Specimen Financial Statements:

Under Armour, Inc.  C-1

12 Statement of Cash Flows   12-1 13 Financial Analysis: The Big Picture   13-1 14 Managerial Accounting  14-1

A PPE NDIX D   Specimen Financial Statements:

Amazon.com, Inc.  D-1 A PPE NDIX E   Specimen Financial Statements:

Walmart Inc.  E-1

15 Job Order Costing  15-1 16 Process Costing  16-1 17 Activity-Based Costing  17-1 18 Cost-Volume-Profit  18-1 19 Cost-Volume-Profit Analysis: Additional Issues  19-1

A PPE NDIX F  

Time Value of Money  F-1

A PPE NDIX G   Reporting and Analyzing

Investments  G-1 COMPANY INDEX   I-1 SUBJECT INDEX   I-5 RAPID REVIEW: CHAPTER CONTENT

v

Download Complete eBook By email at [email protected] vi  B RIEF CO N TEN TS

Available in Wiley Course Resources and Wiley Custom: C H APT E R 15A 

Job Order Costing (non-debit-and-credit approach)  15A-1

C H APT E R 16A  Process Costing (non-debit-and-credit approach)  AP P E N D I X H 

Payroll Accounting  H-1

AP P E N D I X I 

Subsidiary Ledgers and Special Journals  I-1

AP P E N D I X J 

Accounting for Partnerships  J-1

AP P E N D I X K 

Accounting for Sole Proprietorships  K-1

Cases for Management Decision Making

16A-1

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From the Authors

Dear Student, Why This Course? Remember your biology course in high school? Did you have one of those “invisible man” models (or maybe something more high-tech than that) that gave you the opportunity to look “inside” the human body? This accounting course offers something similar. To understand a business, you have to understand the financial insides of a business organization. An accounting course will help you understand the essential financial components of businesses. Whether you are looking at a large multinational company like Apple or Starbucks or a single-owner software consulting business or coffee shop, knowing the fundamentals of accounting will help you understand what is happening. As an employee, a manager, an investor, a business owner, or a director of your own “Whether you are looking at a large multinapersonal finances—any of which roles you will have at some point in your tional company like Apple or Starbucks or life—you will make better decisions for having taken this course. a single-owner software consulting business or coffee shop, knowing the fundamentals of Why This Text? Your instructor has chosen this text for you because of its accounting will help you understand what is trusted reputation. We have worked hard to provide instructional material happening.” that is engaging, timely, and accurate. How to Succeed? We’ve asked many students and many instructors whether there is a secret for success in this course. The nearly unanimous answer turns out to be not much of a secret: “Do the homework.” This is one course where doing is learning. The more time you spend on the homework assignments—using the various tools that this text provides—the more likely you are to learn the essential concepts, techniques, and methods of accounting. Good luck in this course. We hope you enjoy the experience and that you put to good use throughout a lifetime of success the knowledge you obtain in this course. We are sure you will not be disappointed. Paul D. Kimmel Jerry J. Weygandt Jill E. Mitchell

vii

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Author Commitment

Paul D. Kimmel

PA U L D. K I M M E L , P h D, C PA , ­received his bachelor’s degree from the University of Minnesota and his doctorate in accounting from the University of Wisconsin. He was an Associate Professor at the University of Wisconsin—Milwaukee for more than 25 years and is now a Senior Lecturer at the University of Wisconsin—Madison. He has public accounting experience with Deloitte & Touche (Minneapolis). He was the recipient of the UWM School of Business Advisory Council Teaching Award and the Reggie Taite Excellence in Teaching Award, and a three-time winner of the Outstanding Teaching Assistant Award at the University of Wisconsin. He is also a recipient of the Elijah Watts Sells Award for Honorary Distinction for his results on the CPA exam. He is a member of the American Accounting Association and the Institute of Management Accountants and has published articles in Accounting Review, Accounting ­Horizons, Advances in Management Accounting, Managerial Finance, Issues in Accounting Education, and Journal of Accounting Education, as well as other journals. His research interests include accounting for financial instruments and innovation in accounting education.

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Jerry J. Weygandt

JERRY J. WEYGANDT, PhD, CPA, is Arthur Andersen Alumni Emeritus Professor of Accounting at the University of Wisconsin— Madison. He holds a Ph.D. in ­accounting from the University of Illinois. ­Articles by Professor Weygandt have ­appeared in The Accounting Review, Journal of Accounting Research, Accounting Horizons, Journal of Accountancy, and other academic and professional journals. These articles have examined such financial reporting issues as accounting for price-level adjustments, pensions, convertible securities, stock option contracts, and ­interim reports. Professor Weygandt is author of other accounting and financial ­reporting texts and is a member of the American ­Accounting Association, the ­American Institute of Certified Public Accountants, and the Wisconsin Society of Certified Public ­Accountants. He has served on numerous committees of the American Accounting Association and as a member of the editorial board of the ­Accounting ­Review; he also has served as President and Secretary-Treasurer of the ­American ­Accounting Association. In addition, he has been actively involved with the American ­Institute of Certified Public Accountants and has been a member of the Accounting Standards Executive Committee (AcSEC) of that organization. He has served on the FASB task force that ­examined the ­reporting issues related to ­accounting for income taxes and served as a trustee of the Financial Accounting Foundation. Professor Weygandt has received the Chancellor’s Award for Excellence in Teaching and the Beta Gamma Sigma Dean’s Teaching Award. He is on the board of directors of M & I Bank of Southern Wisconsin. He is the recipient of the Wisconsin Institute of CPA’s Outstanding Educator’s Award and the Lifetime Achievement Award. In 2001 he received the American Accounting Association’s Outstanding Educator Award.

Jill E. Mitchel

JILL E. MITCHELL, MS, MEd, CIA, is a Professor of Accounting at Northern Virginia Community College (NOVA), where she has taught face-to-face, hybrid, and online courses since 2008. Since 2009, she has been an adjunct instructor at George Mason University (GMU). She is a past president of the Washington, D.C. Chapter of the Accounting and Financial Women’s Alliance (AFWA), and she served on the board of directors of the Virginia Society of CPAs (VSCPA). She is a member of the American Accounting Association (AAA) and the Institute of Internal Auditors. Jill serves on the AAA Education Committee and is the co-chair for the Conference on Teaching and Learning in Accounting (CTLA). Prior to joining the faculty at NOVA, Jill was a senior auditor with Ernst & Young’s Business Risk Services practice in Miami, Florida. She is a certified internal auditor and earned an MS in Accountancy from the University of Virginia and a BBA in Management Information Systems from the University of Georgia honors program. Recently, she earned an MEd in Instructional Design Technology from GMU. Jill is a recipient of the Outstanding Faculty Award, the Commonwealth’s highest honor for faculty of Virginia’s universities and colleges presented by the State Council of Higher Education for Virginia; the Virginia Community College System Chancellor’s Award for Teaching Excellence; the AFWA’s Women Who Count Award; the AAA Two-Year College Educator of the Year Award; and the AAA/J. Michael and Mary Anne Cook/Deloitte Foundation Prize, the foremost recognition of an individual who consistently demonstrates the attributes of a superior teacher in the discipline of accounting.

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New to This Edition: Data Analytics

The authors carefully considered how to thoughtfully and meaningfully integrate data analytics into the accounting course, and are pleased to provide the following data analytics resources.

Data Analytics and Decision-Making The text provides numerous discussions on how decision-makers are increasingly relying on data analytics to make decisions using accounting information.

Accounting software systems collect vast amounts of data about a company’s economic events as well as its suppliers and customers. Business decision-makers take advantage of this wealth of data by using data analytics to gain insights and therefore make more informed business decisions. •  Data analytics involves analyzing data, often employing both software and statistics, to draw inferences. •  As both data access and analytical software improve, the use of data analytics to support decisions is becoming increasingly common at virtually all types of companies.

Data Analytics in the Real World Real-world examples that illustrate engaging situations in companies are provided throughout the text.

Data Analytics Insight  Netflix Using Data Science to Create Art Technology provides decision-makers and problem-solvers with access to a large volBogdan Glisik/ Bogdan Glisik/ Shutterstock.com ume of information called “big data.” And Shutterstock.com Netflix, the world’s leading subscription streaming entertainment service, is tapping into this big data as part of its efforts to ramp up its original content production. In a recent year, Netflix planned to spend $8 billion on content creation. Producing content involves a blend of creativity, technology, and business decisions, all of which result in costs. And by analyzing the large amounts of data from past ­productions, such as filming locations and production

s­ chedules, Netflix can more precisely estimate costs for future productions. Further, consider that the production of a TV show or film involves hundreds of tasks. Here again, Netflix uses data science, in this case to visualize where bottlenecks might occur or where opportunities might exist to increase the efficiency of the production process. Source: Ritwik Kumar et. al., “Data Science and the Art of Producing Entertainment at Netflix,” The Netflix Tech Blog (March 26, 2018).

How can “big data” improve decision-making? (Answer is available at the end of the chapter.)

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NE W TO TH IS EDITION : DATA AN ALYTICS

Data Analytics in Action Data Analytics in Action problems provide students with the opportunity to see how to use data analytics to help solve realistic business problems. Excel templates for each Data Analytics in Action problem provide students a framework for solving the problem. Data Analytics in Excel videos provide students with step-by-step guidance to perform theData Excel skills they need Analytics in Action 6-49 to solve these problems. Data Analytics in Action Using Data Visualization to Analyze Changes over Time DA6.1 Data visualization can be used to analyze company changes over time. Example: Recall the Feature Story “Where Is That Spare Bulldozer Blade?” presented in the chapter. Caterpillar continues to enhance its inventory management by improving its product sustainability in two ways. First, it is rebuilding used parts to like-new condition. Second, the company is remanufacturing usable inventory parts when customers trade-in or dispose of their used equipment. These actions not only reduce inventory costs but also enable Caterpillar to participate in the circular economy, where manufacturers take responsibility for their products at the end of the product lives. As noted in its 2019 sustainability report, Caterpillar has a goal of 20% growth in both rebuilding and remanufacturing. Has Caterpillar reached this goal? A line chart can help you visualize the company’s progress over time. What information can you obtain by examining the following chart?

Excel

Caterpillar Remanufacturing and Rebuilding Changes 25% 20 15 10 Percentage Changes

5 0 −5 −10 −15

2016 Goal 20%

2017

2018

Remanufacturing % change from 2013

2019 Rebuild % change from 2013

Source: Data from “ESG Data Center,” Caterpillar 2019 Sustainability Report.

The chart indicates that while Caterpillar’s goal has remained at 20%, the remanufacturing and rebuilding businesses are growing. The biggest increase in the growth of rebuilding occurred from 2016 to 2017. There was a decline from 2018 to 2019 in these initiatives as Caterpillar may have reached a peak that is leveling off due to new production that is more sustainable. For this case, you will look more closely at specific Caterpillar data regarding its end-of-life returned materials and the percentage usable for recycling. You will create and analyze a combination column and line chart to determine how Caterpillar can increase its gross profit as it relates to these end-of-life materials. Go to Wiley Course Resources for complete case details and instructions.

Using Data Analytics to Compare Companies’ Inventory Turnover DA6.2 Inventory turnover shows the number of times during the period a firm sells the entire dollar amount of its inventory. It is advantageous to turn over inventory more quickly to reduce the risk of obsolescence and spoilage. As such, companies often have a goal of increasing inventory turnover. For this case, you will use inventory turnover data for Costco, Walmart, Target, and Amazon to create and analyze scatter plots, as well as to calculate days’ sales in inventory, to determine which company is managing its inventory levels most effectively.

Excel

Go to Wiley Course Resources for complete case details and instructions.

Data Visualization Homework Assignments PowerBI and Tableau visualizations accompanied by assignable questions are available with most chapters. PowerBI and Tableau visualizations allow students to interpret visualizations and think critically about data.

Data Analytics Module An accounting-specific data analytics module with interactive lessons, case studies, and videos is part of the Wiley online course. The module has been prepared using industry-­ validated content to help students develop the professional competencies needed for the changing workforce.

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New to This Edition: Chapter-by-Chapter Changes Chapter 1: Introduction to Financial Statements •  NEW discussions of hybrid forms of organization and critical audit matters.

Chapter 5: Merchandising Operations and the MultipleStep Income Statement •  EXPANDED discussion of FOB shipping/destination for improved student understanding.

•  NEW section on overview of data analytics, including Data Analytics Insight box on how Netflix relies on data science to streamline production costs on content creation.

•  ADDED discussion of new technology, such as use of artificial intelligence and algorithms, to Data Analytics and Credit Sales section.

•  NEW DO IT!s on using financial information and components of annual reports.

•  UPDATED People, Planet, and Profit Insight box to focus on REI, for greater continuity throughout chapter.

•  NEW chapter appendix on career opportunities in accounting.

•  MOVED discussion of the comprehensive income statement to Chapter 13.

•  ADDED Questions, Do It’s, Exercises, and Ethics Case to end-of-chapter (EOC) problem material.

•  ADDED Exercises, Ethics Case, and Data Analytics in Action to EOC problem material.

Chapter 2: A Further Look at Financial Statements

Chapter 6: Reporting and Analyzing Inventory

•  MOVED discussion of free cash flow/using a statement of cash flows to Chapter 12.

•  ADDED separate DO IT’s after each cost flow method discussion.

•  NEW discussion of why receivables are considered more liquid than inventory.

•  NEW illustration on the impact on cost flow assumptions when costs change.

•  DELETED partial balance sheet illustrations showing classifications for more streamlined presentation.

•  NEW discussion of how companies can use data analytics when determining NRV of products.

•  NEW Investor Insight box, on reliability of investor bulletin board postings. •  UPDATED definitions of materiality and the full disclosure principle per recent FASB actions. •  NEW illustrations on (1) world view of the standard-setting environment, (2) enhancing qualities of accounting information, and (3) summary of the conceptual framework. •  ADDED Exercises to EOC problem material. Chapter 3: The Accounting Information System •  NEW discussion of recent technologies used, such as cloud-based storage and data automation tools. •  NEW DO IT! on accounts, debits, and credits. •  ADDED Practice Brief Exercise, DO IT!, Exercises, and Ethics Case to EOC problem material. Chapter 4: Accrual Accounting Concepts •  NEW discussion of recent technologies used, such as the use of robotic process automation (RPA) in the closing process. •  NEW illustration of a post-closing trial balance.

•  NEW Data Analytics Insight box on value of dashboards. •  ADDED Exercises, Critical Thinking Case, and Data Analytics in Action to EOC problem material. Chapter 7: Fraud, Internal Control, and Cash •  UPDATED discussion and illustrations of cash receipts controls, to reflect current practices and technology. •  NEW section on electronic banking. •  NEW illustration on how to determine outstanding checks in a bank reconciliation. •  ADDED Real-World Focus Case and Data Analytics in Action to EOC problem material. Chapter 8: Reporting and Analyzing Receivables •  NEW Data Analytics Insight box on how companies are making increasingly more sophisticated credit decisions using data analytics. •  NEW illustration on the use of Tableau dashboards to provide tracking and analysis of a company’s receivables. •  ADDED Exercises Data Analytics in Action to EOC problem material.

•  ADDED Exercises and Problem to EOC problem material.

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Download Complete eBook By email at [email protected] xii   NE W TO THIS EDITION : CHAPTER- BY- CHA PT E R CH A N G E S

Chapter 9: Reporting and Analyzing Long-Lived Assets •  UPDATED People, Planet, and Profit Insight box to now focus on Nike’s sustainability report. •  ADDED Exercises, Critical Thinking Case, and Data Analytics in Action to EOC problem material. Chapter 10: Reporting and Analyzing Liabilities •  NEW Investor Insight box on how Ford issued bonds to raise cash for operations and new products. •  ADDED Tesla as comparative company in analyzing the liquidity and solvency of General Motors. •  ADDED Critical Thinking Case to EOC problem material. Chapter 11: Reporting and Analyzing Stockholders’ Equity •  UPDATED People, Planet, and Profit Insight box to highlight latest information on corporate social responsibility proposals. •  ADDED new discussion of liquidating dividends. •  NEW Investor Insight box on stock dividends. •  ADDED Exercises, Critical Thinking Case, and Data Analytics in Action to EOC problem material. Chapter 12: Statement of Cash Flows •  ADDED Data Analytics in Action to EOC problem material. Chapter 13: Financial Analysis: The Big Picture •  NEW presentation of discontinued operations on the income statement (previously on the statement of comprehensive income) as well as discussion and format of the statement of comprehensive income. •  ADDED Critical Thinking Case to EOC problem material. Chapter 14: Managerial Accounting •  NEW section on the value of data analytics in helping managers understand the relationship between CVP variables and business trends. •  NEW Data Analytics Insight box on how Disney uses its MagicBands as a source of data to analyze the behavior of its customers. •  EXPANDED discussion within “Manufacturing Costs” section to ensure student understanding of raw materials versus direct materials as well as what is considered to be manufacturing overhead. Also updated Illustration 1.4 (assignment of costs to cost categories) to include an explanation for each cost classification, again to ensure student understanding. •  MOVED UP discussion of balance sheet (before income statement) in “Manufacturing Costs in Financial Statements” section for more logical presentation of topics. •  UPDATED each “Managerial Accounting Today” section subtopic for the latest information on service industries, lean manufacturing, balanced scorecard, ethics, and social responsibility. •  NEW Data Analytics in Action problems allow students to perform basic data analytics and data visualization. Chapter 15: Job Order Costing •  NEW Data Analytics Insight box on how Autodesk uses data analytics to improve its software and profitability.

•  ADDED discussion on assigning raw materials costs and assigning factory labor costs, to improve student understanding. •  UPDATED time ticket discussion for more recent process involving scanning of employee identification codes. •  NEW Data Analytics in Action problems allow students to perform basic data analytics and data visualization. Chapter 16: Process Costing •  UPDATED production cost report so that the “Cost Reconciliation Schedule” section now includes costs to be accounted for, not just costs accounted for. •  EDITED discussion throughout to ensure complete student understanding. For example, in the “Transfer to Next Department” section, have added explanation of what department transfers entail. Chapter 17: Activity-Based Costing •  NEW data analytics discussion added to section of identifying cost drivers. •  NEW Data Analytics Insight box on how companies such as GE and UPS use data analytics to help reduce non– value-added activities. •  NEW section (“Assigning Nonmanufacturing Overhead Costs”) and income statement presentations, to help highlight differences between traditional costing and activitybased costing. Chapter 18: Cost-Volume-Profit •  NEW discussion on CVP and the use of data analytics, using DHL Express as an example. •  NEW expanded highlighted equations, to show more detailed calculations for improved understanding. •  NEW expanded explanation of what CVP analysis is. •  NEW illustration and discussion on how a GAAP income statement differs from a CVP income statement. •  NEW discussion on the variable cost ratio. •  UPDATED Service Company Insight box to feature more recent information on the business of music promotion (and using Drake as an example instead of the Rolling Stones) and computing the break-even point. •  ENHANCED EOC assignments by offering students more opportunities to prepare CVP income statements, as well as a new problem on regression analysis. •  NEW Data Analytics in Action problems allow students to perform basic data analytics and data visualization. Chapter 19: Cost-Volume-Profit Analysis: Additional Issues •  NEW Data Analytics Insight box on how Caesars Entertainment uses data analytics to determine how to maximize profits from its customers. •  NEW Data Analytics in Action problems allow students to perform basic data analytics and data visualization. Chapter 20: Incremental Analysis •  HIGHLIGHTED the decision rules, as well as additional factors to consider, for incremental analysis decisions.

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Chapter 21: Pricing •  NEW Data Analytics Insight box on how Big Data Pricing helps customers use data analytics to improve dynamic pricing practices. •  NEW Data Analytics in Action problem allows students to perform basic data analytics and data visualization. Chapter 22: Budgetary Planning •  NEW Data Analytics Insight box on how Dickey’s Barbecue Pit uses data analytics to improve restaurant sales performance. •  NEW Data Analytics in Action problem allows students to perform basic data analytics and data visualization. Chapter 23: Budgetary Control and Responsibility Accounting •  NEW Data Analytics Insight boxes on rolling forecasts and zero-based budgeting. •  UPDATED section on “Judgmental Factors in ROI” with “Alternative Measures of ROI Inputs” for more precise discussion and improved student understanding. •  NEW Data Analytics in Action problems allow students to perform basic data analytics and data visualization. Chapter 24: Standard Costs and Balanced Scorecard •  NEW Data Analytics Insight box on how manufacturing companies are using technology such as 5G cellular to improve the amount and speed of data collection to improve operations.

•  NEW highlighted applications of determining standard costs in “A Case Study” section, for improved student understanding. •  NEW Data Analytics in Action problem allows students to perform basic data analytics and data visualization. Chapter 25: Planning for Capital Investments •  NEW Data Analytics Insight box on how Electronic Arts uses data from its current online video games to help it develop future products. •  IMPROVED illustration showing computation of cash payback period by including detailed steps and computations. •  NEW Management Insight box on 5G and how it presents a risky investment to telecom companies. •  NEW Data Analytics in Action problems allow students to perform basic data analytics and data visualization. Appendix F: Time Value of Money (previously Appendix G) •  NEW discussion of using Excel function to solve time value of money problems. Appendix G: Reporting and Analyzing Investments (previously Appendix H) •  NEW DO IT!s added to appendix discussion as well as EOC problem material. •  NEW Review and Practice section includes multiplechoice questions followed by annotated solutions, practice brief exercises with solutions, practice exercises with solutions, and a practice problem with solution.

New to This Edition in Your Wiley Course Lecture Videos Lecture Videos, narrated by an accounting instructor for every section in the text, talk through the PowerPoint slides, including embedded application videos where applicable, providing support for online courses, flipped classrooms, and student study and review.

Interactive Tutorial Assignments Interactive Tutorial Assignments provide students a guided walkthrough and review of the chapter content and topics, including Chapter Overview Videos, Lecture Videos for each learning objective, and selected Real World Videos. Interactive Knowledge Check and Do It! questions in the assignments check student understanding and knowledge acquisition. In applicable questions, values change algorithmically, to support student practice and integrity. The Interactive Tutorial Assignments are available to students as practice, and may be separately customized and assigned by instructors.

Animations Short, animated videos engage students and simplify major concepts in the text, making the concepts easier to understand. They offer an alternative approach to understanding the written material.

Brief Exercise Solution Walkthrough Videos Additional Solution Walkthrough Videos developed for this edition, now also including selected Brief Exercises, continue to build scaffolding for student understanding and 24/7 problem-solving support.

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Proven Pedagogical Features

When you think of accounting, you probably don’t think of athletics. So why do we have a photo of bicycles on our cover? It’s because this image represents active learning that’s best accomplished through full engagement, commitment, and practice. In this new edition, all content has been carefully reviewed and revised to ensure maximum student understanding. At the same time, the time-tested features that have proven to be of most help to students have been retained, such as the following.

Infographic Learning Over half of the text is visual, providing students alternative ways of learning about accounting. ILLUSTRATION 6.4 Specific identification method $750

$700

Sold

+

$800

Transaction Date Inventory 06-01-2025 Sold 06-01-2025 Sold In Stock

Price $700 $800 $750

Sold

Cost of goods sold = $700 + $800 = $1,500 Ending inventory = $750

Real-World Decision-Making Real-world examples, which illustrate engaging situations in companies, are provided throughout the text. Answers to the critical thinking questions posed to readers within the real-world examples are now available at the end of each chapter.

People, Planet, and Profit Insight Got Junk? Do you have an old computer or two in your garage? How about an old TV that needs replacing? Many people do. Approximately 163,000 computers and televisions become obsolete each day. Yet, in a recent year, only 11% of com© Nathan Gleave/ njgphoto/Getty Images puters were recycled. iStockphoto It is estimated that 75% of all computers ever sold are sitting in storage somewhere, waiting

xiv

to be disposed of. Each of these old TVs and computers is loaded with lead, cadmium, mercury, and other toxic chemicals. If you have one of these electronic gadgets, you have a responsibility, and a probable cost, for disposing of it. Companies have the same problem, but their discarded materials may include lead paint, asbestos, and other toxic chemicals.

What accounting issue might this cause for companies? (Answer is available at the end of the chapter.)

• This agrees with our calculation of the cost of ending inventory, where 50 of these units Download Complete eBook By unsold email atincluded [email protected] were assumed and thus in ending inventory. ILLUSTRATION 6.7

Date Jan. 1 Apr. 15 Aug. 24

Proof of cost of goods sold— FIFO method

DO IT! Exercises

PROV E N PE DAG OG I C A L FEATU RES   xv Unit Cost Total Cost $10 $1,000 11 2,200 12 3,000

Units 100 200 250

DO IT! Exercises in the body of the text prompt students to stop Totaland review 550 key concepts. They $6,200 US INGa detailed T H E D ECsolution. IS ION TOOLS Eastman Chemical outline the Action Plan necessary to complete the exercise as well as show

Eastman Chemical is a global specialty materials company that produces a broad range of products found in items people use every day. Eastman employs approximately 14,500 people around the world and serves customers in more than 100 countries. The company is headquartered in Kingsport, Tennessee. Here is the inventory note taken from recent financial statements.

DO IT! 2a

ACTION PLAN • Understand the periodic inventory system.

Cost Flow Methods—FIFO Method

The accounting records of Shumway Ag Implements show the following data. Eastman Chemical Company

Notes4,000 to the Financial Beginning inventory units atStatements $3 Inventories: The components inventories Purchases 6,000of units at are $4summarized as follows: (in millions) Sales 7,000 units at $12

• Allocate costs between goods sold and goods on hand (ending inventory) for the FIFO method.

Inventories—gross:

Raw period materials under a periodic inventory system $using 576 the Determine the cost of goods sold during the Work in process 220 FIFO method. Finished goods 1,114

• Compute cost of goods sold for the FIFO method.

Total inventories—at FIFO or average cost Less: LIFO reserve

Solution

1,910 248

Inventories—net (as reported on balance sheet)

$1,662

Eastman determines the cost of most raw materials, work in process, and finished goods Cost of goods available for sale = (4,000 × $3) + (6,000 × $4) = $36,000 inventories in the United States and Switzerland by the LIFO method. The cost of all other inven-

is determined Ending inventory = 10,000 – 7,000tories = 3,000 unitsby the average-cost method, which approximates the FIFO method. Additional facts (amounts in millions):

Cost of goods sold FIFO: $36,000 – (3,000 × $4) = $24,000 Related exercise material: BE6.3, BE6.4, BE6.5,

Decision Tools

Last-In, First-Out (LIFO)

Current liabilities Current assets (as reported) Cost of goods sold BE6.6, DO IT! 6.2, E6.5, Beginning inventory

E.6.6,

$1,789 3,321 7,039 E6.7, and 1,583

E6.8.

Instructions Answer the following questions. a. Why does the company report its inventory in three components?

The last-in, first-out (LIFO) method assumes that the latest goods purchased are the first b. Why might the company use three methods (LIFO, FIFO and average-cost) to account for its inventory?are highlighted to befor sold.management decision-making Accounting concepts that are useful c. Perform each of the following. throughout the text. A summary of Decision Tools is included in each chapter as well as a 1. Calculate the inventory turnover and days in inventory using the LIFO inventory. • LIFO seldom coincides with the actual physical flow of inventory. (Exceptions include practice exercise and solution called Using the Decision Tools. 2.Decision Calculate the current Tools 6-23 ratio using LIFO and the current ratio using FIFO. Discuss the goods stored in piles, suchUsing as the coal or hay, where goods are removed from the top of the difference. pile as they are sold.) However, the actual physical flow does not dictate that a company USING T HE DECIS ION TOOLS Eastman Chemical Solution must chose FIFO or LIFO. a. Eastern Chemical is a manufacturer, so it purchases raw materials and makes them into finished products. At the end of each period, it has some goods that have been started but are • Under the LIFO method, the costs of the latest goods purchased are the first to be recognot yet complete (work in process). reporting all three components of inventory, a company reveals important informanized in determining cost of goodsBysold.

Eastman Chemical is a global specialty materials company that produces a broad range of products found in items people use every day. Eastman employs approximately 14,500 people around the world and serves customers in more than 100 countries. The company is headquartered in Kingsport, Tennessee. Here is the inventory note taken from recent financial statements.

tion about its inventory position. For example, if amounts of raw materials have increased significantly compared to the previous year, we might assume the company is planning to step up production. On the other hand, if levels of finished goods have increased relative to last year and raw materials have declined, we might conclude that sales are slowing down—that the company has too much inventory on hand and is cutting back production.

Illustration 6.8 shows the allocation of the cost of goods available for sale at Houston Electronics under LIFO.

Eastman Chemical Company Notes to the Financial Statements

Inventories: The components of inventories are summarized as follows: (in millions)

6-24

Inventories—gross: Raw materials Work in process Finished goods

CH A PTE R 6

b. Companies are free to choose different cost flow assumptions for different types of inventory. A company might choose to use FIFO for a product that is expected to decrease in price over time. One common reason for choosing a method other than LIFO is that many foreign countries do not allow LIFO; thus, the company cannot use LIFO for its foreign operations.

Reporting and Analyzing Inventory

$ 576 220 1,114

Total inventories—at FIFO or average cost Less: LIFO reserve

c. 1. Inventory turnover =

Days in 365 365 = = = 84.9 days inventory Inventory turnover 4.3

1,910 248

Inventories—net (as reported on balance sheet)

Cost of goods sold $7,039 = 4.3 times = ($1,583 + $1,662) ÷ 2 Average inventory

2. Current ratio

$1,662

Eastman determines the cost of most raw materials, work in process, and finished goods inventories in the United States and Switzerland by the LIFO method. The cost of all other inventories is determined by the average-cost method, which approximates the FIFO method.

LIFO

Current assets $3,321 = = 1.86:1 Current liabilities $1,789

FIFO $3,321 + $248 = 1.99:1 $1,789

This represents a 7% increase in the current ratio [(1.99 − 1.86) ÷ 1.86].

Additional facts (amounts in millions): Current liabilities Current assets (as reported) Cost of goods sold Beginning inventory

$1,789 3,321 7,039 1,583

Instructions Answer the following questions. a. Why does the company report its inventory in three components? Appendix 6A

Inventory Cost Flow Methods in Perpetual Inventory Systems

b. Why might the company use three methods (LIFO, FIFO and average-cost) to account for its inventory? c. Perform each of the following. 1. Calculate the inventory turnover and days in inventory using the LIFO inventory.

2. Calculate the current ratio using LIFO and the current ratio using FIFO. Discuss the difference.

LEA RN IN G OBJ ECT IV E *4 Apply the inventory cost flow methods to perpetual inventory records.

Solution a. Eastern Chemical is a manufacturer, so it purchases raw materials and makes them into finished products. At the end of each period, it has some goods that have been started but are

What inventory cost flow methods can companies employ if they use a perpetual inventory system? Simple—they can use any of the inventory cost flow methods described in the

Using the D

means that companies value assets at the original cost, (c) materiality average of unit costs, not an average of unit costs; and (c) a new avermeans that an amount is large enough to affect a decision-maker, and the effect Companies can determine ending under inventory errors on the balance using age is of computed the average-cost method aftersheet each by purchase, (d) economic entity means to keep thethe company’s transactionsequation: sepabasic accounting Assets not sale.= Liabilities + Stockholders’ Equity. Errors in the endxvi rate   PROVE N PEDAGOGICAL F EATU Ring ES inventory have the effects shown in Illustration 6B.4. from the transactions of other entities. *16. b. Because ending inventory is too low, cost of goods sold will be 11. d. Decreasing the amount of inventoryThe on hand cause thein ending effectwill of an error inventory on the periodsold was(anshown in Illustoo high (overstated) and subsequent since cost of goods expense) is too denominator to decrease, causing inventory turnover tothat increase. tration 6B.3. Note if the error is not corrected, combined total net income for the theother two high, net income willthe be too low (understated). Therefore, Increasing sales will cause the numerator of the ratiobetocorrect. increase periods would Thus, choices total stockholders’ are incorrect. equity reported on the balance sheet at the (higher sales means higher COGS), thus turnoend causing of 2025 inventory will also be correct. b. Stockholders’ is overstated by $15,000 at December chapter concludes with a *17. Review and Practiceequity section which includes a review of learnver to increase even more. The otherEach choices are incorrect because 31, 2024, and is properly stated at December 31, 2025. An ending ing objectives, Decision Tools review, key terms glossary, practice multiple-choice questions (a) increasing the amount of inventory on hand causes the denomILLUSTRATION 6B.4 inventory error in one period will have an equal and opposite effect Ending inator of the ratio to increase whilewith the numerator the same, annotatedstays solutions, practice brief exercises with solutions, practice exercises after withtwo soluonAssets cost of goods sold and net income in the next period; Effects of ending inventory Inventory Error Stockholders’ Equity causing inventory turnover to decrease; (b)and keeping the amount of with a solution. Liabilities tions, a practice problem years, the errors have other choices are incorerrors on balance sheet but increasing sales willOverstated Overstated No offset effect each other. The Overstated inventory on hand constant cause inventory rect because stockholders’ equity (a) is properly stated, not underUnderstated Understated No effect Understated turnover to increase because the numerator of the ratio will increase stated, at December 31, 2025; (c) is overstated, not understated, (higher sales means higher COGS) while the denominator stays the by $15,000 at December 31, 2024, and is properly stated, not same, which will result in a lesser inventory turnover increase than understated, at December 31, 2025; and (d) is properly stated at decreasing amount of inventory on hand and increasing sales; and December 31, 2025, not overstated. (c) keeping the amount of inventory on hand constant but decreasing sales will cause inventory turnover to decrease because the numerator

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Review and Practice Practice Brief Exercises Learning Objectives Review Determine ending inventory amount.

1

1. (LO 1) Fylus Company took a physical inventory on December 31 and determined that goods

Discuss how to classify and determine Applyininventory cost flowwere methods and their costing inventory. $180,000 were on hand. Not 2included the physical count $18,000 ofdiscuss goods purchased financial from Rake Corporation, FOB destination, andeffects. $27,000 of goods sold to Shovel Company for $40,000,

destination.merchandise Both the Rake purchase and the Shovel sale were in transit year-end. What amount Merchandisers need only one inventoryFOB classification, should as its December 31primary inventory? inventory, to describe the different items that Fylus makereport up total invenThe basis of accounting for inventories is cost. Cost includes tory. Manufacturers, on the other hand, usually classify inventory into all expenditures necessary to acquire goods and place them in a conthree categories: finished goods, work in process, and raw materials. dition ready for sale. Cost of goods available for sale includes (a) cost Solution To determine inventory quantities, companies (1) take a physical of beginning inventory and (b) cost of goods purchased. The inven1. Physical inventoryof goods $180,000are specific identification and three assumed inventory of goods on hand and (2) determine the ownership tory cost flow methods Add: Goods sold to Shovel 27,000 LIFO, and average-cost. in transit or on consignment. cost flow methods—FIFO, Fylus ending inventory $207,000 The $18,000 of goods purchased from Rake are excluded from ending inventory because the terms are FOB destination which means Fylus takes title at the time the goods are received. Goods sold to Shovel FOB destination means that the goods are still Fylus’s until delivered. Compute ending inventory using FIFO and LIFO.

2. (LO 2) In its first month of operations, Moncada Company made three purchases of merchandise in the following sequence: (1) 200 units at $7, (2) 300 units at $8, and (3) 150 units at $9. Assuming there are 220 units on hand, compute the cost of the ending inventory under the (a) FIFO method and (b) LIFO method. Moncada use a periodic inventory system.

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Engaging Digital Tools

Digital study tools in Wiley’s online course include the following.

Lecture Videos Lecture Videos, narrated by an accounting instructor for every section in the text, talk through the PowerPoint slides, including embedded application videos where applicable, providing support for online courses, flipped classrooms, and student study and review.

Interactive Tutorial Assignments Interactive Tutorial Assignments provide students with guided instruction of the chapter content and topics, including Chapter Overview Videos, Lecture Videos for each learning objective, and selected Real World Videos. Knowledge Check questions in the assignments check student understanding and knowledge acquisition. The Interactive Tutorial Assignments are available to students as practice, and may be separately customized and assigned by instructors.

xvii

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Animations Short, animated videos engage students and simplify major concepts in the text, making the concepts easier to understand. They offer an alternative approach to understanding the written material.

Real-World Company Videos Real-world company videos feature both small businesses and larger companies to help students apply content and see how business owners apply concepts from the text in the real world. Many of the videos have associated questions available to be assigned.

Source: YouTube. Source: YouTube.

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Solution Walkthrough Videos Solution Walkthrough Videos are available as question assistance and to help students develop problem-solving techniques. These videos walk students through solutions step-by-step and are based on the most regularly assigned exercises and problems in the text.

Source: YouTube. Source: YouTube.

Gradable Excel Questions Gradable Excel questions for each chapter provide students an opportunity to practice Excel skills in the context of solving accounting problems.

AutoSave

fx

A

B

C

D

1 2

Function: IF; Formula: Subtract, Multiply; Cell Referencing

3 4 5 6

Brief Exercise - Using Excel to Determine Variances PROBLEM In October, Pine Company was determining its overhead variance. Its predetermined overhead rate is based on direct labor hours. The following

7

E

F

G

Manufacturing overhead costs incurred Actual direct labor hours

$ 118,000 21,000

Actual overhead Overhead applied

11 12

Standard hours allowed for work done Predetermined overhead rate

20,600 $ 6.00

Total overhead variance Nature of variance

Compute the amount of the total overhead variance and designate if the variance is favorable or unfavorable using Excel’s IF function. Sheet1

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Student Work Area Required: Provide input into cells shaded in yellow in this template. Use cell references to the Problem area with mathematical formulas in the input cells. In the last input field, input an IF function with cell references to your work area.

8 9 10

13 14 15 16

H

Answer Field 15.4% of your score. Formula: Multiply; Cell reference. Use a mathematical formula and cell referencing to the Problem area to determine the overhead applied.

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E NGAG ING DIGITAL TOOLS

Data Visualization Homework Assignments PowerBI and Tableau visualizations accompanied by questions are available with most chapters. PowerBI and Tableau visualizations allow students to interpret visualizations and think critically about data.

Other Learning Opportunities Other learning opportunities in Wiley’s online course include the following. •  Accounting-Specific Data Analytics Module offers interactive lessons, case studies, and videos. The module has been prepared using industry-validated content to help students develop the professional competencies needed for the changing workforce. •  Cookie Creations is a continuing case that spans across the financial accounting chapters and offers students the opportunity to see how a small business might use financial accounting to operate effectively. •  Waterways Corporation is a continuing case that spans across the managerial accounting chapters and offers students the opportunity to see how a small business might use managerial accounting to operate effectively. •  Wiley Accounting Updates (wileyaccountingupdates.com) provide faculty and students with weekly curated news articles and suggested discussion questions. •  Flashcards and Crossword Puzzles help students study and master basic vocabulary and concepts. •  Student Practice quickly and effectively assesses student understanding of the material they have just covered. •  Adaptive Assignments encourage students to persist so that they can succeed in this course and beyond. By continuously adapting to each student’s needs and providing achievable goals with just-in-time instruction, Adaptive Assignments close knowledge gaps to accelerate learning.

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Contents

1 Introduction to Financial Statements 

1-1

Knowing the Numbers: Columbia Sportswear Company  1-1 1.1  Business Organization and Accounting Information Uses  1-2 Forms of Business Organization  1-3 Users and Uses of Financial Information  1-4 Data Analytics  1-6 Ethics in Financial Reporting  1-7 1.2  The Three Types of Business Activity  1-8 Financing Activities  1-9 Investing Activities  1-9 Operating Activities  1-10 1.3  The Four Financial Statements  1-11 Income Statement  1-12 Retained Earnings Statement  1-13 Balance Sheet  1-14 Statement of Cash Flows  1-16 Interrelationships of Statements  1-17 Elements of an Annual Report  1-20 Appendix 1A: Career Opportunities in Accounting  1-23 “Show Me the Money”  1-24

2 A Further Look at Financial Statements 

2-1

Just Fooling Around?: The Motley Fool  2-2 2.1  The Classified Balance Sheet  2-3 Current Assets  2-3 Long-Term Investments  2-5 Property, Plant, and Equipment  2-5 Intangible Assets  2-5 Current Liabilities  2-7 Long-Term Liabilities  2-7 Stockholders’ Equity  2-7 2.2  Analyzing the Financial Statements Using Ratios  2-8 Ratio Analysis  2-8 Using the Income Statement  2-9 Using a Classified Balance Sheet  2-10 2.3  Financial Reporting Concepts  2-14 The Standard-Setting Environment  2-14 Qualities of Useful Information  2-16 Assumptions in Financial Reporting  2-17 Principles in Financial Reporting  2-18 Cost Constraint  2-18

3 The Accounting Information System 

3-1

Accidents Happen: MF Global Holdings Ltd  3-1 3.1  Using the Accounting Equation to Analyze Transactions  3-3 Accounting Transactions  3-3 Analyzing Transactions  3-4 Summary of Transactions  3-10 3.2  Accounts, Debits, and Credits  3-11 Debits and Credits  3-11 Debit and Credit Procedures  3-12 Stockholders’ Equity Relationships  3-15 Summary of Debit/Credit Rules  3-16 3.3  Using a Journal  3-17 The Recording Process  3-17 The Journal  3-18 3.4  The Ledger and Posting  3-20 The Ledger  3-20 Chart of Accounts  3-21 Posting  3-21 The Recording Process Illustrated  3-22 Summary Illustration of Journalizing and Posting  3-28 3.5  The Trial Balance  3-30 Limitations of a Trial Balance  3-31

4 Accrual Accounting Concepts 

4-1

Keeping Track of Groupons: Groupon  4-1 4.1  Accrual-Basis Accounting and Adjusting Entries  4-2 The Revenue Recognition Principle  4-3 The Expense Recognition Principle  4-4 Accrual versus Cash Basis of Accounting  4-5 The Need for Adjusting Entries  4-5 Types of Adjusting Entries  4-6 4.2  Adjusting Entries for Deferrals  4-7 Prepaid Expenses  4-7 Unearned Revenues  4-12 4.3  Adjusting Entries for Accruals  4-15 Accrued Revenues  4-15 Accrued Expenses  4-17 Summary of Basic Relationships  4-20 4.4  The Adjusted Trial Balance and Closing Entries  4-23 Preparing the Adjusted Trial Balance  4-23 Preparing Financial Statements  4-24 Quality of Earnings  4-24 Closing the Books  4-27 xxi

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CONTE N TS

Summary of the Accounting Cycle  4-30 Appendix 4A: Using a Worksheet  4-34

5 Merchandising Operations

and the Multiple-Step Income Statement  5-1

Buy Now, Vote Later: REI  5-1 5.1  Merchandising Operations and Inventory Systems  5-2 Operating Cycles  5-3 Flow of Costs  5-4 5.2  Recording Purchases Under a Perpetual System  5-6 Freight Costs  5-8 Purchase Returns and Allowances  5-9 Purchase Discounts  5-10 Summary of Purchasing Transactions  5-11 5.3  Recording Sales Under a Perpetual System  5-11 Sales Returns and Allowances  5-13 Sales Discounts  5-14 Data Analytics and Credit Sales  5-15 5.4  Preparing the Multiple-Step Income Statement  5-16 Single-Step Income Statement  5-16 Multiple-Step Income Statement  5-17 5.5  Cost of Goods Sold Under a Periodic System  5-21 5.6  Gross Profit Rate and Profit Margin  5-23 Gross Profit Rate  5-23 Profit Margin  5-24 Appendix 5A: Periodic Inventory System  5-27 Recording Merchandise Transactions  5-27 Recording Purchases of Merchandise  5-28 Freight Costs  5-28 Recording Sales of Merchandise  5-28 Comparison of Entries—Perpetual vs. Periodic  5-29 Appendix 5B: Adjusting Entries for Credit Sales with Returns and Allowances  5-30 Data Analytics in Action  5-52

6 Reporting and Analyzing Inventory 

6-1

“Where Is That Spare Bulldozer Blade?”: Caterpillar  6-1 6.1  Classifying and Determining Inventory  6-2 Classifying Inventory  6-2 Determining Inventory Quantities  6-4 6.2  Inventory Methods and Financial Effects  6-7 Specific Identification  6-7 Cost Flow Assumptions  6-8 Financial Statement and Tax Effects of Cost Flow Methods  6-13 Using Inventory Cost Flow Methods Consistently  6-15 6.3  Inventory Presentation and Analysis  6-17 Presentation  6-17

Lower-of-Cost-or-Net Realizable Value  6-17 Financial Analysis and Data Analytics  6-18 Adjustments for LIFO Reserve  6-21 Appendix 6A: Inventory Cost Flow Methods in Perpetual Inventory Systems  6-24 First-In, First-Out (FIFO)  6-24 Last-In, First-Out (LIFO)  6-25 Average-Cost  6-26 Appendix 6B: Effects of Inventory Errors  6-27 Income Statement Effects  6-27 Balance Sheet Effects  6-28 Data Analytics in Action  6-49

7 Fraud, Internal Control, and Cash 

7-1

Minding the Money in Madison: Barriques  7-1 7.1  Fraud and Internal Control  7-3 Fraud  7-3 The Sarbanes-Oxley Act  7-3 Internal Control  7-4 Principles of Internal Control Activities  7-5 Data Analytics and Internal Controls  7-10 Limitations of Internal Control  7-11 7.2  Cash Controls  7-12 Cash Receipts Controls  7-12 Cash Disbursements Controls  7-14 Petty Cash Fund  7-16 7.3  Control Features of a Bank Account  7-17 Electronic Banking  7-18 Bank Statements  7-18 Reconciling the Bank Account  7-20 7.4  Reporting Cash  7-25 Cash Equivalents  7-26 Restricted Cash  7-26 Managing and Monitoring Cash  7-27 Cash Budgeting  7-29 Appendix 7A: Operation of a Petty Cash Fund  7-32 Establishing the Petty Cash Fund  7-33 Making Payments from the Petty Cash Fund  7-33 Replenishing the Petty Cash Fund  7-34 Data Analytics in Action  7-56

8 Reporting and Analyzing Receivables 

8-1

What’s Cooking?: Nike  8-1 8.1  Recognition of Accounts Receivable  8-3 Types of Receivables  8-3 Recognizing Accounts Receivable  8-3 8.2  Valuation and Disposition of Accounts Receivable  8-5 Valuing Accounts Receivable  8-5 Disposing of Accounts Receivable  8-13

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8.3  Notes Receivable  8-15 Determining the Maturity Date  8-16 Computing Interest  8-16 Recognizing Notes Receivable  8-17 Valuing Notes Receivable  8-17 Disposing of Notes Receivable  8-17 8.4  Receivables Presentation and Management  8-20 Financial Statement Presentation of Receivables  8-20 Managing Receivables  8-21 Evaluating Liquidity of Receivables  8-23 Accelerating Cash Receipts  8-24 Data Analytics and Receivables Management  8-25 Data Analytics in Action  8-46

9 Reporting and Analyzing Long-Lived Assets 

9-1

A Tale of Two Airlines: American Airlines  9-1 9.1  Plant Asset Expenditures  9-3 Determining the Cost of Plant Assets  9-3 Expenditures During Useful Life  9-6 To Buy or Lease?  9-7 9.2  Depreciation Methods  9-8 Factors in Computing Depreciation  9-9 Depreciation Methods  9-9 Revising Periodic Depreciation  9-14 Impairments  9-15 9.3  Plant Asset Disposals  9-16 Sale of Plant Assets  9-16 Retirement of Plant Assets  9-18 9.4  Intangible Assets  9-19 Accounting for Intangible Assets  9-19 Types of Intangible Assets  9-20 Research and Development Costs  9-22 9.5  Statement Presentation and Analysis  9-23 Presentation  9-23 Analysis  9-25 Appendix 9A: Other Depreciation Methods  9-30 Declining-Balance Method  9-30 Units-of-Activity Method  9-31 Data Analytics in Action  9-55

10 Reporting and Analyzing Liabilities 

10-1

And Then There Were Two: Maxwell Car Company  10-1 10.1  Accounting for Current Liabilities  10-3 What Is a Current Liability?  10-3 Notes Payable  10-3 Sales Taxes Payable  10-4 Unearned Revenues  10-5 Current Maturities of Long-Term Debt  10-6 Payroll and Payroll Taxes Payable  10-6

10.2  Characteristics of Bonds  10-9 Types of Bonds  10-9 Issuing Procedures  10-10 Bond Trading  10-10 Determining the Market Price of a Bond  10-11 10.3  Accounting for Bond Transactions  10-14 Issuing Bonds at Face Value  10-14 Discount or Premium on Bonds  10-14 Issuing Bonds at a Discount  10-15 Issuing Bonds at a Premium  10-17 Redeeming Bonds at Maturity  10-19 Redeeming Bonds Before Maturity  10-19 10.4  Presentation and Analysis  10-20 Presentation  10-20 Analysis  10-22 Appendix 10A: Straight-Line Amortization  10-26 Amortizing Bond Discount  10-26 Amortizing Bond Premium  10-28 Appendix 10B: Effective-Interest Amortization  10-29 Amortizing Bond Discount  10-29 Amortizing Bond Premium  10-31 Appendix 10C: Accounting for Long-Term Notes Payable  10-32

11 Reporting and Analyzing Stockholders’ Equity 

11-1

Oh Well, I Guess I’ll Get Rich: Facebook  11-1 11.1  Corporate Form of Organization  11-3 Characteristics of a Corporation  11-3 Forming a Corporation  11-6 Stockholder Rights  11-7 Stock Issue Considerations  11-8 Corporate Capital  11-10 11.2  Accounting for Common, Preferred, and   Treasury Stock  11-12 Accounting for Common Stock  11-12 Accounting for Preferred Stock  11-13 Accounting for Treasury Stock  11-14 11.3  Accounting for Dividends and Stock Splits  11-16 Cash Dividends  11-16 Dividend Preferences  11-19 Stock Dividends  11-21 Stock Splits  11-22 11.4  Presentation and Analysis  11-24 Retained Earnings  11-24 Retained Earnings Restrictions  11-25 Balance Sheet Presentation of Stockholders’ Equity  11-26 Analysis of Stockholders’ Equity  11-28 Debt versus Equity Decision  11-29 Appendix 11A: Entries for Stock Dividends  11-32 Data Analytics in Action  11-55

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CONTENTS

12 Statement of Cash Flows 

12-1

Got Cash?: Microsoft  12-2 12.1  Usefulness and Format of the Statement of Cash Flows  12-3 Usefulness of the Statement of Cash Flows  12-3 Classification of Cash Flows  12-3 Significant Noncash Activities  12-4 Format of the Statement of Cash Flows  12-5 12.2  Preparing the Statement of Cash Flows— Indirect Method  12-6 Indirect and Direct Methods  12-7 Indirect Method—Computer Services Company  12-7 Step 1: Operating Activities  12-9 Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method  12-12 Step 2: Investing and Financing Activities  12-13 Step 3: Net Change in Cash  12-15 12.3  Analyzing the Statement of Cash Flows  12-17 The Corporate Life Cycle  12-17 Free Cash Flow  12-19 Appendix 12A: Statement of Cash Flows—Direct Method  12-22 Step 1: Operating Activities  12-24 Step 2: Investing and Financing Activities  12-28 Step 3: Net Change in Cash  12-30 Appendix 12B: Worksheet for the Indirect Method  12-30 Preparing the Worksheet  12-31 Appendix 12C: Statement of Cash Flows—T-Account Approach  12-35 Data Analytics in Action  12-61

13 Financial Analysis: The Big Picture 

13-1

It Pays to Be Patient: Warren Buffett  13-2 13.1  Sustainable Income and Quality of Earnings  13-3 Sustainable Income  13-3 Quality of Earnings  13-7 13.2  Horizontal Analysis and Vertical Analysis  13-9 Horizontal Analysis  13-10 Vertical Analysis  13-12 13.3  Ratio Analysis  13-15 Liquidity Ratios  13-16 Solvency Ratios  13-17 Profitability Ratios  13-17 Financial Analysis and Data Analytics  13-18 Comprehensive Example of Ratio Analysis  13-18

14 Managerial Accounting 

14-1

Just Add Water . . . and Paddle: Current Designs  14-1 14.1  Managerial Accounting Basics  14-3

Comparing Managerial and Financial Accounting  14-3 Management Functions  14-4 Organizational Structure  14-5 14.2  Managerial Cost Concepts  14-7 Manufacturing Costs  14-8 Product versus Period Costs  14-9 Illustration of Cost Concepts  14-10 14.3  Manufacturing Costs in Financial Statements  14-12 Balance Sheet  14-12 Income Statement  14-13 Cost of Goods Manufactured  14-14 Cost of Goods Manufactured Schedule  14-15 14.4  Managerial Accounting Today  14-16 Service Industries  14-16 Focus on the Value Chain  14-17 Balanced Scorecard  14-19 Business Ethics  14-19 Corporate Social Responsibility  14-20 The Value of Data Analytics  14-20 Data Analytics in Action  14-45

15 Job Order Costing 

15-1

Profiting from the Silver Screen: Disney  15-1 15.1  Cost Accounting Systems  15-3 Process Cost System  15-3 Job Order Cost System  15-4 Job Order Cost Flow  15-5 Accumulating Manufacturing Costs  15-6 15.2  Assigning Manufacturing Costs  15-8 Raw Materials Costs  15-8 Factory Labor Costs  15-11 15.3  Predetermined Overhead Rates  15-13 15.4  Entries for Jobs Completed and Sold  15-16 Assigning Costs to Finished Goods  15-17 Assigning Costs to Cost of Goods Sold  15-17 Summary of Job Order Cost Flows  15-18 Job Order Costing for Service Companies  15-19 Advantages and Disadvantages of Job Order Costing  15-20 15.5  Applied Manufacturing Overhead  15-22 Under- or Overapplied Manufacturing Overhead  15-22 Data Analytics in Action  15-43

16 Process Costing 

16-1

The Little Guy Who Could: Jones Soda  16-1 16.1  Overview of Process Cost Systems  16-3 Uses of Process Cost Systems  16-3 Process Costing for Service Companies  16-4 Similarities and Differences Between Job Order Cost and Process Cost Systems  16-4 16.2  Process Cost Flow and Assigning Costs  16-6

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Process Cost Flow  16-6 Assigning Manufacturing Costs—Journal Entries  16-7 16.3  Equivalent Units  16-10 Weighted-Average Method  16-10 Refinements on the Weighted-Average Method  16-11 16.4  The Production Cost Report  16-13 Compute the Physical Unit Flow (Step 1)  16-14 Compute the Equivalent Units of Production (Step 2)  16-15 Compute Unit Production Costs (Step 3)  16-15 Prepare a Cost Reconciliation Schedule (Step 4)  16-16 Preparing the Production Cost Report  16-17 Costing Systems—Final Comments  16-18 Appendix 16A: FIFO Method for Equivalent Units  16-21 Equivalent Units Under FIFO  16-21 Comprehensive Example  16-22 FIFO and Weighted-Average  16-26

Mixed Costs  18-7 18.2  Mixed Costs Analysis  18-8 High-Low Method  18-8 Importance of Identifying Variable and Fixed Costs  18-10 18.3  Cost-Volume-Profit Analysis  18-11 Basic Components  18-11 CVP Income Statement  18-12 18.4  Break-Even Analysis  18-16 Mathematical Equation  18-16 Contribution Margin Techniques  18-17 Graphic Presentation  18-19 18.5  Target Net Income and Margin of Safety  18-20 Target Net Income  18-20 Margin of Safety  18-21 CVP and Data Analytics 18-22 Appendix 18A: Regression Analysis  18-24 Data Analytics in Action  18-46

17 Activity-Based Costing 

19 Cost-Volume-Profit Analysis:

17-1

Precor Is on Your Side: Precor­  17-1 17.1  Traditional vs. Activity-Based Costing  17-3 Traditional Costing Systems  17-3 Illustration of a Traditional Costing System  17-3 The Need for a New Approach  17-4 Activity-Based Costing  17-5 17.2  ABC and Manufacturers  17-7 Identify and Classify Activities and Allocate Overhead to Cost Pools (Step 1)  17-8 Identify Cost Drivers (Step 2)  17-8 Compute Activity-Based Overhead Rates (Step 3)  17-9 Assign Overhead Costs to Products (Step 4)  17-10 Comparing Unit Costs  17-10 17.3  ABC Benefits and Limitations  17-13 The Advantage of Multiple Cost Pools  17-13 The Advantage of Enhanced Cost Control  17-15 The Advantage of Better Management Decisions  17-18 Some Limitations and Knowing When to Use ABC  17-18 17.4  ABC and Service Industries  17-20 Traditional Costing Example  17-20 Activity-Based Costing Example  17-21 Appendix 17A: Just-in-Time Processing  17-24 Objective of JIT Processing  17-25 Elements of JIT Processing  17-26 Benefits of JIT Processing  17-26

18 Cost-Volume-Profit 

18-1

Don’t Worry—Just Get Big: Amazon.com  18-1 18.1  Cost Behavior Analysis  18-3 Variable Costs  18-3 Fixed Costs  18-4 Relevant Range  18-5

Additional Issues 

19-1

Not Even a Flood Could Stop It: Whole Foods Market  19-1 19.1  Basic CVP Concepts  19-3 Basic Concepts  19-3 CVP and Changes in the Business Environment  19-5 19.2  Sales Mix and Break-Even Sales  19-7 Break-Even Sales in Units  19-8 Break-Even Sales in Dollars  19-10 19.3  Sales Mix with Limited Resources  19-13 19.4  Operating Leverage and Profitability  19-15 Effect on Contribution Margin Ratio  19-16 Effect on Break-Even Point  19-17 Effect on Margin of Safety Ratio  19-17 Operating Leverage  19-17 Appendix 19A: Absorption Costing versus Variable Costing  19-20 Example Comparing Absorption Costing with Variable Costing  19-21 Net Income Effects  19-23 Decision-Making Concerns  19-28 Potential Advantages of Variable Costing  19-30 Data Analytics in Action  19-51

20 Incremental Analysis 

20-1

Keeping It Clean: Method Products  20-1 20.1  Decision-Making and Incremental Analysis  20-3 Incremental Analysis Approach  20-3 How Incremental Analysis Works  20-4 Qualitative Factors  20-5 Relationship of Incremental Analysis and Activity-Based Costing  20-5 Types of Incremental Analysis  20-6

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CONTENTS

20.2  Special Orders  20-6 20.3  Make or Buy  20-8 Opportunity Cost  20-9 20.4  Sell or Process Further  20-11 Single-Product Case  20-11 Multiple-Product Case  20-12 20.5  Repair, Retain, or Replace Equipment  20-14 20.6  Eliminate Unprofitable Segment or Product  20-16

21 Pricing 

23 Budgetary Control and

Responsibility Accounting 

21-1

They’ve Got Your Size—and Color: Zappos.com  21-1 21.1  Target Costing  21-3 Establishing a Target Cost  21-4 21.2  Cost-Plus and Variable-Cost Pricing  21-5 Cost-Plus Pricing  21-5 Limitations of Cost-Plus Pricing  21-7 Variable-Cost Pricing  21-8 21.3  Time-and-Material Pricing  21-10 21.4  Transfer Prices  21-13 Negotiated Transfer Prices  21-14 Cost-Based Transfer Prices  21-18 Market-Based Transfer Prices  21-19 Effect of Outsourcing on Transfer Pricing  21-19 Transfers Between Divisions in Different Countries  21-20 Appendix 21A: Absorption-Cost and Variable-Cost Pricing  21-22 Absorption-Cost Pricing  21-23 Variable-Cost Pricing  21-24 Appendix 21B: Transfers Between Divisions in Different Countries  21-26 Data Analytics in Action  21-45

22 Budgetary Planning 

Budgeted Balance Sheet  22-21 22.5  Budgeting in Nonmanufacturing Companies  22-23 Merchandisers  22-23 Service Companies  22-24 Not-for-Profit Organizations  22-25 Data Analytics in Action  22-48

22-1

What’s in Your Cupcake?: Erin McKennaʼs Bakery NYC  22-1 22.1  Effective Budgeting and the Master Budget  22-3 Budgeting and Accounting  22-3 The Benefits of Budgeting  22-3 Essentials of Effective Budgeting  22-4 The Master Budget  22-7 22.2  Sales, Production, and Direct Materials Budgets  22-8 Sales Budget  22-8 Production Budget  22-10 Direct Materials Budget  22-10 22.3  Direct Labor, Manufacturing Overhead, and S&A Expense Budgets  22-14 Direct Labor Budget  22-14 Manufacturing Overhead Budget  22-15 Selling and Administrative Expense Budget  22-15 Budgeted Income Statement  22-16 22.4  Cash Budget and Budgeted Balance Sheet  22-18 Cash Budget  22-18

23-1

Pumpkin Madeleines and a Movie: The Roxy Hotel Tribeca   23-1 23.1  Budgetary Control and Static Budget Reports  23-3 Budgetary Control  23-3 Static Budget Reports  23-4 23.2  Flexible Budget Reports  23-7 Why Flexible Budgets?  23-7 Developing the Flexible Budget  23-9 Flexible Budget—A Case Study  23-10 Flexible Budget Reports  23-12 23.3  Responsibility Accounting and Responsibility Centers  23-14 Controllable versus Noncontrollable Revenues and Costs  23-16 Principles of Performance Evaluation  23-16 Responsibility Reporting System  23-18 Types of Responsibility Centers  23-19 23.4  Investment Centers  23-24 Return on Investment (ROI)  23-24 Responsibility Report  23-25 Alternative Measures of ROI Inputs  23-26 Improving ROI  23-26 Appendix 23A: ROI versus Residual Income  23-30 Residual Income Compared to ROI  23-31 Residual Income Weakness  23-31 Data Analytics in Action  23-52

24 Standard Costs and Balanced Scorecard 

24-1

80,000 Different Caffeinated Combinations: Starbucks  24-2 24.1  Overview of Standard Costs  24-3 Distinguishing Between Standards and Budgets  24-4 Setting Standard Costs  24-4 24.2  Direct Materials Variances  24-8 Analyzing and Reporting Variances  24-8 Calculating Direct Materials Variances  24-10 24.3  Direct Labor and Manufacturing Overhead Variances  24-13 Direct Labor Variances  24-13 Manufacturing Overhead Variances  24-16

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24.4  Variance Reports and Balanced Scorecards  24-18 Reporting Variances  24-18 Income Statement Presentation of Variances  24-19 Balanced Scorecard  24-20 Appendix 24A: Standard Cost Accounting System  24-24 Journal Entries  24-24 Ledger Accounts  24-26 Appendix 24B: Overhead Controllable and Volume Variances  24-26 Overhead Controllable Variance  24-27 Overhead Volume Variance  24-28 Data Analytics in Action  24-47

25 Planning for Capital Investments 

25-1

Floating Hotels: Holland America Line  25-2 25.1  Capital Budgeting and Cash Payback  25-3 Cash Flow Information  25-3 Illustrative Data  25-4 Cash Payback  25-4 25.2  Net Present Value Method  25-6 Equal Annual Cash Flows  25-7 Unequal Annual Cash Flows  25-8 Choosing a Discount Rate  25-9 Simplifying Assumptions  25-10 Comprehensive Example  25-10 25.3  Capital Budgeting Challenges and Refinements  25-12 Intangible Benefits  25-12 Profitability Index for Mutually Exclusive Projects  25-14 Risk Analysis  25-15 Post-Audit of Investment Projects  25-16 25.4  Internal Rate of Return  25-17 Comparing Discounted Cash Flow Methods  25-18 25.5  Annual Rate of Return  25-20 Data Analytics in Action  25-38 AP P E ND IX A   Specimen Financial Statements:

Apple Inc.  A-1

AP P E ND IX B   Specimen Financial Statements:

Columbia Sportswear Company  B-1

A PPE NDIX C   Specimen Financial Statements:

Under Armour, Inc.  C-1

A PPE NDIX D   Specimen Financial Statements:

Amazon.com, Inc.  D-1

A PPE NDIX E   Specimen Financial Statements:

Walmart Inc.  E-1

A PPE NDIX F Time Value of Money  F-1

F.1  Interest and Future Values  F-2 Nature of Interest  F-2 Future Value of a Single Amount  F-3 Future Value of an Annuity  F-5 F.2  Present Values  F-8 Present Value Variables  F-8 Present Value of a Single Amount  F-9 Present Value of an Annuity  F-11 Time Periods and Discounting  F-13 Present Value of a Long-Term Note or Bond  F-13 F.3  Capital Budgeting Situations  F-16 F.4  Using Technological Tools  F-18 Present Value of a Single Sum  F-19 Present Value of an Annuity  F-20 Future Value of a Single Sum  F-21 Future Value of an Annuity  F-22 Internal Rate of Return  F-22 Useful Applications  F-23 A PPE NDIX G  Reporting and Analyzing

Investments  G-1

G.1  Accounting for Debt Investments  G-2 Why Corporations Invest  G-2 Accounting for Debt Investments  G-2 G.2  Accounting for Stock Investments  G-4 Holdings of Less Than 20%  G-5 Holdings Between 20% and 50%  G-6 Holdings of More Than 50%  G-7 G.3  Reporting Investments in Financial Statements  G-9 Debt Securities  G-9 Equity Securities  G-12 Balance Sheet Presentation  G-13 Presentation of Realized and Unrealized Gain or Loss  G-14 Company Index  I-1 Subject Index  I-5 RAPID REVIEW: CHAPTER CONTENT

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Available in Wiley Course Resources and Wiley Custom: * A PPEN DIX

H 

Payroll Accounting 

H-1

H.1  Recording the Payroll  H-1 Determining the Payroll  H-2 Recording the Payroll  H-5 H.2  Employer Payroll Taxes  H-8 FICA Taxes  H-8 Federal Unemployment Taxes  H-8 State Unemployment Taxes  H-9 Recording Employer Payroll Taxes  H-10 Filing and Remitting Payroll Taxes H-10 H.3  Internal Control for Payroll  H-11

* A PPEN DIX

I

* A P P END IX K   Accounting for Sole

  Subsidiary Ledgers and Special Journals 

I-1

I.1  Subsidiary Ledgers  I-1 Subsidiary Ledger Example  I-2 Advantages of Subsidiary Ledgers  I-3 I.2  Special Journals  I-4 Sales Journal  I-4 Cash Receipts Journal  I-7 Purchases Journal  I-10 Cash Payments Journal I-12 Effects of Special Journals on the General Journal  I-15 Cybersecurity: A Final Comment  I-16

* A PPEN DIX

J

J.2  Accounting for Partnership Net Income or   Net Loss J-6 Dividing Net Income or Net Loss  J-6 Partnership Financial Statements  J-10 J.3  Accounting for Partnership Liquidation  J-11 No Capital Deficiency  J-11 Capital Deficiency  J-13 J.4  Admission and Withdrawal of Partners  J-15 Admission of a Partner  J-15 Withdrawal of a Partner  J-19

  Accounting for Partnerships  J-1

J.1  Forming a Partnership  J-1 Characteristics of Partnerships  J-1 Organizations with Partnership Characteristics  J-3 Advantages and Disadvantages of Partnerships  J-4 The Partnership Agreement  J-5 Accounting for a Partnership Formation  J-5

Proprietorships  K-1

K.1 Corporation versus Sole Proprietorship Equity Accounts  K-1 K.2  Accounts that Change Owner’s Equity  K-2 Owner’s Equity in a Sole Proprietorship  K-2 Recording Transactions of a Sole Proprietorship  K-3 K.3 Retained Earnings Statement versus Owner’s Equity Statement  K-4 K.4  Closing the Books for a Sole Proprietorship  K-5 Preparing a Post-Closing Trial Balance for a Proprietorship  K-7 CH A PTER 15A

Job Order Costing (non-

CH A PTER 16A

Process Costing (non-

debit-and-credit approach)

debit-and-credit-approach)

Cases for Management Decision Making

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Acknowledgments

Accounting has benefitted greatly from the input of focus group participants, manuscript reviewers, those who have sent comments by letter or e-mail, ancillary authors, and proofers. We greatly appreciate the constructive suggestions and innovative ideas of reviewers and the creativity and accuracy of the ancillary authors and checkers. Dawn Addington Central New Mexico Community College Joe Atallah Coastline Community College Dennis Avola Northeastern University Melody Barta Evergreen Valley College Ellen Bartley Farmingdale State College Thomas Bednarcik Robert Morris University Illinois Linda Bell Park University Martin Blaine Columbus State Community College Bradley Blaylock Oklahoma State University Isaac Bonaparte Towson University Gary Bower Community College of Rhode Island Bruce Bradford Fairfield University Robert Braun Southeastern Louisiana University Lou Bravo North Lake College Ann K. Brooks University of New Mexico Robert Brown Evergreen Valley College Myra Bruegger Southeastern Community College Barry Buchoff Towson University Leroy Bugger Edison State College Brian Bunce Bellevue University Melodi Bunting Edgewood College Jacqueline Burke Hofstra University Matthew Calderisi Fairleigh Dickinson University Julia Camp Providence College Marian Canada Ivy Tech Community College at Franklin Lisa Capozzoli College of DuPage Renee Castrigano Cleveland State University

Wanda Causseaux Siena College Sandy Cereola James Madison University Gayle Chaky Dutchess Community College Julie Chenier Louisiana State University—Baton Rouge James Chiafery University of Massachusetts—Boston Bea Chiang The College of New Jersey Carolyn Christesen Westchester Community College Colleen Chung Miami Dade College Shifei Chung Rowan University Tony Cioffi Lorain County Community College Cheryl Clark Point Park University Toni Clegg Delta College Leslie Cohen University of Arizona Maxine Cohen Bergen Community College Stephen Collins University of Massachusetts—Lowell Solveg Cooper Cuesta College William Cooper North Carolina A&T State University Cheryl Copeland California State University, Fresno Jim Coughlin Robert Morris University Patricia Crenny Villanova University Dori Danko Grand Valley State University Alan E. Davis Community College of Philadelphia Larry DeGaetano Montclair State University Mingcherng Deng Baruch College Michael Deschamps MiraCosta College Bettye Desselle Texas Southern University Judy Dewitt Central Michigan University

Cyril Dibie Tarrant County College—Arlington Jean Dunn Rady School of Management at University of California—San Diego Kathy Dunne Rider University Barbara Durham University of Central Florida Ron Dustin Fresno City College Jeanne Eibes Creighton University Barbara Eide University of Wisconsin—La Crosse David Emerson Salisbury University Dennis Elam Texas A&M University—San Antonio James Emig Villanova University Caroline Falconetti Nassau Community College Nancy Fan California State Polytechnic University, Pomona Magdy Farag California State Polytechnic University, Pomona Linda Flaming Monmouth University Janet Farler Pima Community College Anthony Fortini Camden County College Joseph Fournier University of Rhode Island Jeanne Franco Paradise Valley Community College Chad Frawley Viterbo University Patrick Geer Hawkeye Community College Amy Geile University of Arizona Alan Glaser Franklin & Marshall College J. D. Golub Northeastern University Liz Grant Northern Illinois University Rita Grant Grand Valley State University

xxix

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Steve Groves Ivy Tech Community College Konrad Gunderson Missouri Western State University Marcye Hampton University of Central Florida Deborah Hanks Cardinal Stritch University Qian Hao Wilkes University Jacory Hickerson University of Phoenix Huong Higgins Worcester Polytechnic Institute John Hogan Fisher College Yongtao Hong North Dakota State University Bambi Hora University of Central Oklahoma Jana Hosmer Blue Ridge Community College M.A. Houston Wright State University Jeff Hsu St. Louis Community College—Meramec Robert Hurst Franklin University Wayne Ingalls University of Maine K. Harold Jackson Tarrant County College Janet Jamieson University of Dubuque Jennifer Joe University of Delaware James B. Johnson Community College of Philadelphia Patricia Johnson Canisius College Kevin Jones Drexel University Jordan Kanter University of Rhode Island Ann Galligan Kelley Providence College Robert Kenny The College of New Jersey Don Kovacic California State University—San Marcos Emil Koren Saint Leo University Leah Kratz Eastern Mennonite University Lynn Krausse Bakersfield College Craig Krenek Elmhurst College Steven LaFave Augsburg College Faith Lamprey Providence College

Claudia Larocque Manchester Community College Gary Laycock Ivy Tech Community College Eric Lee University of Northern Iowa Jason Lee SUNY Plattsburgh Charles Leflar University of Arkansas Jennifer LeSure Ivy Tech Community College Harold Little Western Kentucky University Dennis Lopez University of Texas—San Antonio Claudia Lubaski Lorain County Community College Susan Lynn University of Baltimore Yuanyuan Ma University of Minnesota Suneel Maheshwari Marshall University Lois Mahoney Eastern Michigan University Diane Marker University of Toledo Tom Marsh Northern Virginia Community College Christian Mastilak Xavier University Josephine Mathias Mercer County Community College Don McFall Hiram College Edward McGinnis American River College Florence McGovern Bergen Community College Allison McLeod University of North Texas Pamela Meyer University of Louisiana—Lafayette Mary Michel Manhattan College Joan Miller William Paterson University Don Minyard University of Alabama—Tuscaloosa Jill Misuraca University of Tampa Earl Mitchell Santa Ana College Maha Mitrelis Providence College Louella Moore Washburn University Syed Moiz University of Wisconsin—Platteville Linda Mullins Georgia State University Perimeter College

Johnna Murray University of Missouri—St. Louis Sia Nassiripour William Paterson University Joseph Nesi Monmouth University Michael Newman University of Houston Lee Nicholas University of Northern lowa Cindy Nye Bellevue University Judith Pagnette Bellevue College Obeua Parsons Rider University Glenn Pate Palm Beach State College Suzy Pearse Clemson University Nori Pearson Washington State University Joe Pecore Rady School of Management at University of California—San Diego Rachel Pernia Essex County College Dawn Peters Southwestern Illinois College DeAnne Peterson University of Wisconsin—Eau Claire Judy Peterson Monmouth College Timothy Peterson Gustavus Adolphus College Bob Picard Idaho State University George Psaras Aurora University Robert Rambo Roger Williams University Smrity Randhawa University of Southern California Patrick Reihing Nassau Community College Jim Resnik Bergen Community College John Ribezzo Community College of Rhode Island Barbara Rice Gateway Community and Technical College Vernon Richardson University of Arkansas Patrick Rogan Consumnes River College Juan Roman Saint Leo University Jorge Romero Towson University Luther Ross Central Piedmont Community College

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Maria Roxas Central Connecticut State University John Rude Bloomsburg University Martin Rudnick William Paterson University Christina Ryan College of New Jersey Susan Sadowski Shippensburg University August Saibeni Consumnes River College Barbara Sandler Queens College Richard Sarkisian Camden County College Karl Schindl University of Wisconsin—Manitowoc Barbara Scofield Washburn University Debbie Seifert Illinois State University Chris Severson Franklin University Suzanne Seymoure Saint Leo University Abdus Shahid The College of New Jersey Mike Shapeero Bloomsburg University Todd Shawver Bloomsburg University Eileen Shifflett James Madison University Kathy Simmons Bryant University Valerie Simmons University of Southern Mississippi Ladd Simms Mississippi Valley State University Mike Skaff College of the Sequoias Charles Skender University of North Carolina—Chapel Hill Karyn Smith Georgia Perimeter College Patrick Stegman College of Lake County Richard Steingart San Jose State University Doug Stives Monmouth University Gracelyn Stuart-Tuggle Palm Beach State University Karen Tabak Maryville University Diane Tanner University of North Florida Tom Thompson Savannah Technical College Karen Tower Ivy Tech Community College

Daniel Tschopp Saint Leo University Mike Tyler Barry University Jin Ulmer Angelina College Mark Ulrich St. John’s University Linda Vaello University of Texas—San Antonio Manuel Valle City College of San Francisco Ski Vanderlean Delta College Huey L. Van Dine Bergen Community College Joan Van Hise Fairfield University Claire Veal University of Texas—San Antonio Sheila Viel University of Wisconsin—Milwaukee Suzanne Ward University of Louisiana—Lafayette Dan Way Central Piedmont Community College Andrea Weickgenannt Xavier University Nancy Wilburn Northern Arizona University Wayne W. Williams Community College of Philadelphia Leon Wlazlo SUNY Broome Community College Hannah Wong William Paterson University Kenneth Zheng University at Buffalo

Ancillary Authors, Contributors, Proofers, and Accuracy Checkers Ellen Bartley St. Joseph’s College LuAnn Bean Florida Institute of Technology Debby Bloom Queens University Jack Borke University of Wisconsin—Platteville Ann K. Brooks University of New Mexico Melodi Bunting Edgewood College Bea Chiang The College of New Jersey Lawrence Chui University of St. Thomas (Minnesota) Laura De Luca Fanshawe College

Judy Dewitt Central Michigan University Carleton Donchess Bridgewater State University Dina El Mahdy Morgan State University James Emig Villanova University Mary Ewanechko Monroe Community College Larry Falcetto Emporia State University Michael P. Griffin University of Massachusetts Dartmouth Vicki Greshik University of Jamestown Heidi Hansel Kirkwood Community College Coby Harmon University of California—Santa Barbara William Heninger Brigham Young University Lisa Hewes Northern Arizona University Kimberly J. Hurt Central Community College Derek Jackson St. Mary’s University of Minnesota Craig Krenek Elmhurst College Y. Robert Lin California State University—East Bay Cynthia Lovick Austin Community College Lisa L. Ludlum Western Illinois University Kirk Lynch Sandhills Community College Donald R. Majors II Elmhurst College and Utica College Susanna Matson Southern New Hampshire University Jill Misuraca University of Tampa Barbara Muller Arizona State University Linda Mullins Georgia State University—Perimeter College Yvonne Phang Borough of Manhattan Community College David Polster Oakton Community College Laura Prosser Black Hills State University Angela Sandberg Shorter University Vincent Shea St. John’s University Margaret Shackell Forsyth Technical Community College Alice Sineath Forsyth Technical Community College

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ACKNOWLEDGMEN TS

Teresa Speck St. Mary’s University of Minnesota Lynn Stallworth Appalachian State University Diane Tanner University of North Florida

Sheila Viel University of Wisconsin—Milwaukee Dick Wasson Southwestern College Catherine Wyatt Lumina Datamatics

We appreciate the exemplary support and commitment given to us by associate director Zoe Craig, marketing manager Carolyn Wells, course content developer Jenny Welter, editorial supervisor Terry Ann Tatro, designer Wendy Lai, senior production editor Rachel Conrad, and Julie Perry at Lumina. All of these professionals provided innumerable services that helped the text take shape. We also thank Margaret Shackell of Forsyth Technical Community College and Diane Tanner of University of North Florida for their creativity and efforts in the development of the Data Analytics in Action problems. We thank Benjamin Huegel and Teresa Speck of St. Mary’s University for their extensive efforts in the preparation of the homework materials

Lori Grady Zaher Bucks County Community College Aleksandra Zimmerman Florida State University

related to Current Designs. We also appreciate the considerable support provided to us by the following people at Current Designs: Mike Cichanowski, Jim Brown, Diane Buswell, and Jake Greseth. We also benefited from the assistance and suggestions provided to us by Joan Van Hise in the preparation of materials related to sustainability. Finally, we appreciate suggestions and comments from users—instructors and students alike. We welcome your thoughts and ideas about the text. Paul D. Kimmel

Jerry J. Weygandt

Jill E. Mitchell

Cedarburg, Wisconsin   Madison, Wisconsin   Annandale, Virginia

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My Good Images/Shutterstock.com.

CHAPTER 1

Introduction to Financial Statements Chapter Preview If you own a business, how do you determine whether it is making or losing money? How should you finance expansion—should you borrow, should you issue stock, should you use your own funds? How do you convince banks to lend you money or investors to buy your stock? Success in business requires making countless decisions, and decisions require financial information. The purpose of this chapter is to show you what role accounting plays in providing financial information.

Feature Story Knowing the Numbers Many students who take this course do not plan to be accountants. If you are in that group, you might be thinking, “If I’m not going to be an accountant, why do I need to

The Chapter Preview describes the purpose of the chapter and highlights major topics. The Feature Story helps you picture how the chapter topic relates to the real world of accounting and business.

­ arold know accounting?” Well, consider this quote from H Geneen, the former chairman of IT&T: “To be good at your business, you have to know the numbers—cold.” In ­business, accounting financial statements are the means for communicating the numbers. If you don’t know how to read financial statements, you can’t really know your ­business. 1-1

Download Complete eBook By email at [email protected] 1-2  CH A PT ER 1   Introduction to Financial Statements

Knowing the numbers is sometimes even a matter of corporate survival. Consider the story of Columbia Sportswear Company, headquartered in Portland, Oregon. Gert Boyle’s family fled Nazi Germany when she was 13 years old and then purchased a small hat company in Oregon, Columbia Hat Company. In 1971, Gert’s husband, who was then running the company, died suddenly. Gert took over the small, struggling company with help from her son Tim, who was then a senior at the University of Oregon. Somehow, they kept the

Chapter Outline

c­ ompany afloat. Today, Columbia has more than 4,000 employees and annual sales in excess of $1 billion. Its brands include ­Columbia, Mountain Hardwear, Sorel, and Montrail. Employers such as Columbia Sportswear generally assume that managers in all areas of the company are “financially literate.” To help prepare you for that, in this text you will learn how to read and prepare financial statements, and how to use key tools to evaluate financial results using basic data analytics.

The Chapter Outline presents the chapter’s topics and subtopics, as well as practice opportunities.

LEARNING OBJECTIVES

REVIEW

LO 1  Identify the forms of business organization and the uses of accounting information.

• Forms of business organization • Users and uses of financial information

PRACTICE DO IT!  1a Business Organization

Forms

1b Using Financial Information

• Data analytics • Ethics in financial reporting LO 2  Explain the three principal types of business activity.

• Financing activities

DO IT!  2  Business Activities

• Investing activities • Operating activities

LO 3  Describe the four financial statements and how they are prepared.

• Income statement • Retained earnings statement • Balance sheet • Statement of cash flows

DO IT!  3a Financial Statements:

Parts 1–4

3b Components of Annual Reports

• Interrelationships of statements • Elements of an annual report Go to the Review and Practice section at the end of the chapter for a targeted summary and practice applications with solutions. Visit Wiley Course Resources for additional tutorials and practice opportunities.

Business Organization and Accounting Information Uses

1.1

LEARNING OBJECTIVE 1 Identify the forms of business organization and the uses of accounting information. Suppose you graduate with a business degree and decide you want to start your own business. But what kind of business? You enjoy working with people, especially teaching them new skills. You spend most of your free time outdoors, kayaking, backpacking, skiing, rock climbing, and mountain biking. You think you might successfully combine your teaching skills and outdoor interest by starting an outdoor guide service.

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1.1  Business Organization and Accounting Information Uses  1-3

Forms of Business Organization What organizational form should you choose for your business? You have three choices—sole proprietorship, partnership, or corporation.

Sole Proprietorship You might choose the sole proprietorship form for your outdoor guide service.

Sole Proprietorship Simple to establish Owner-controlled Tax advantages

•  A business owned by one person is a sole proprietorship. •  It is simple to set up and gives you control over the business. Small owner-operated businesses such as barber shops, law offices, and auto repair shops are often sole proprietorships, as are farms and small retail stores.

Partnership

Partnership Another possibility is for you to join forces with other individuals to form a partnership. •  A business owned by two or more persons associated as partners is a partnership. •  Partnerships often are formed because one individual does not have enough economic resources or other unique skills or resources to initiate or expand the business. You and your partners should formalize your duties and contributions in a written partnership agreement. Retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certified public accountants), often organize as partnerships.

Simple to establish Shared control Broader skills and resources Tax advantages

Corporation

Corporation As a third alternative, you might organize as a corporation. •  A business organized as a separate legal entity owned by stockholders is a corporation. •  Investors in a corporation receive shares of stock to indicate their ownership claim. Buying stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell (transfer ownership). Selling a proprietorship or partnership interest is much more involved. Also, individuals can become stockholders by investing relatively small amounts of money (see Alternative Terminology). Therefore, it is easier for corporations to raise funds compared to sole proprietorships or partnerships. Successful corporations often have thousands of stockholders, and their stock is traded on organized stock exchanges like the New York Stock Exchange. Many businesses start as sole proprietorships or partnerships and eventually incorporate. Other factors to consider in deciding which organizational form to choose are taxes and legal liability. Sole proprietorships or partnerships, generally receive more favorable tax treatment than corporations. However, proprietors and partners are personally liable for all debts and legal obligations of the business; corporate stockholders are not. In other words, corporate stockholders generally pay higher taxes but have no personal legal liability. We will discuss these issues in more depth in a later chapter.

Hybrid Forms of Organization Finally, while sole proprietorships, partnerships, and corporations represent the main types of business organizations, hybrid forms are now allowed in all states. •  Hybrid business forms combine the tax advantages of partnerships with the limited liability of corporations. •  Probably the most common among these hybrid types are limited liability companies (LLCs) and subchapter S corporations (these forms are discussed extensively in business law classes). The combined number of proprietorships and partnerships in the United States far exceeds the number of corporations. However, the revenue produced by corporations is many times greater. Most of the largest businesses in the United States—for example, Apple, G ­ oogle, Verizon, Visa, and Microsoft—are corporations. Because the majority of U.S. business is done by corporations, the emphasis in this text is on the corporate form of organization.

Easier to transfer ownership Easier to raise funds No personal liability

ALTERNATIVE TERMINOLOGY Stockholders are sometimes called shareholders.

Alternative Terminology notes present synonymous terms that you may come across in practice.

Download Complete eBook By email at [email protected] 1-4  CH A PT ER 1   Introduction to Financial Statements DO IT! exercises prompt you to stop and review the key points you have just studied. The Action Plan offers you tips about how to approach the problem. ACTION PLAN • Know which organizational form best matches the business type, size, and preferences of the owner(s).

DO IT! 1a    Business Organization Forms In choosing the organizational form for your outdoor guide service, you should consider the pros and cons of each. Identify each of the following organizational characteristics with the organizational form or forms with which it is associated (sole proprietorship, partnership, or corporation). 1. Easier to raise funds. 4.  Tax advantages. 2. Simple to establish.

5.  Easier to transfer ownership.

3. No personal legal liability.

Solution 1. Easier to raise funds: Corporation. 2. Simple to establish: Sole proprietorship and partnership. 3. No personal legal liability: Corporation. 4. Tax advantages: Sole proprietorship and partnership. 5. Easier to transfer ownership: Corporation. Related exercise material: BE1.1, DO IT! 1.1a, and E1.2.

Users and Uses of Financial Information The purpose of financial information is to provide inputs for decision-making. •  Accounting is the information system that identifies, records, and communicates the economic events of an organization to interested users. •  Users of accounting information can be divided broadly into two groups: internal users and external users.

Internal Users Internal users of accounting information are managers who plan, organize, and run a business. These include marketing managers, production supervisors, finance directors, and company officers. In running a business, managers must answer many important questions, as shown in Illustration 1.1.   ILLUSTRATION 1.1   Questions that internal users ask

Questions Asked by Internal Users Is cash sufficient to pay dividends to our stockholders?

Finance

What price should we charge for our newest smartphone model to maximize the company's net income?

Marketing

Can we afford to give our employees pay raises this year?

Human Resources

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

Management

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1-5

To answer these and other questions, you need detailed information on a timely basis. For internal users, accounting provides internal reports, such as financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. In addition, companies present summarized financial information in the form of financial statements. Accounting Across the Organization boxes show applications of accounting information in various business functions.

Accounting Across the Organization Clif Bar & Company Owning a Piece of the Bar The original Clif Bar® energy bar was created in 1990 after six months of experimentation by Gary Erickson and his mother in her kitchen. Today, the company has approximately 1,000 employees and was named one of Landor’s Breakaway Brands®. One of Clif carterdayne/Getty Images Bar & Company’s proudest moments was the creation of an employee stock ownership plan (ESOP). This plan

gives its employees 20% ownership of the company. The ESOP also resulted in Clif Bar enacting an open-book management program, including the commitment to educate all employee-owners about its finances. Armed with basic accounting knowledge, employees are more aware of the financial impact of their actions, which leads to better decisions. What are the benefits to the company and to the employees of making the financial statements available to all employees? (Answer is available at the end of the chapter.)

External Users There are several types of external users of accounting information. Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. Creditors, such as suppliers and bankers, use accounting information to evaluate the risks of selling on credit or lending money. Some questions that investors and creditors may ask about a company are shown in Illustration 1.2.

Questions Asked by External Users Is Apple earning satisfactory income?

How does Apple compare in size and profitability with Samsung?

Headquarters

ILLUSTRATION 1.2 Questions that external users ask Will Apple be able to pay its debts as they come due?

The information needs and questions of other external users vary considerably. • Taxing authorities, such as the Internal Revenue Service, want to know whether the company complies with the tax laws. • Customers are interested in whether a company like Tesla will be able to honor product warranties and otherwise support its product lines. • Labor unions, such as the Major League Baseball Players Association, want to know whether the owners have the ability to pay increased wages and benefits. • Regulatory agencies, such as the Securities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules.

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For example, Enron, Dynegy, Duke Energy, and other big energy-trading companies reported record profits at the same time as California was paying extremely high prices for energy and suffering from blackouts. This disparity caused regulators to investigate the energy traders to make sure that the profits were earned by legitimate and fair practices.

Data Analytics Helpful Hints further clarify concepts being discussed. HELPFUL HINT Throughout this text, we will highlight examples where accounting information is used to support business decisions using data analytics.

Accounting software systems collect vast amounts of data about a company’s economic events as well as its suppliers and customers. Business decision-makers take advantage of this wealth of data by using data analytics to gain insights and therefore make more informed business decisions. •  Data analytics involves analyzing data, often employing both software and statistics, to draw inferences. •  As both data access and analytical software improve, the use of data analytics to support decisions is becoming increasingly common at virtually all types of companies (see ­Helpful Hint). Illustration 1.3 shows the four most common types of data analytics that help answer questions ranging from what happened and why did it happen, to what is likely to happen and what should we do about it? Analytics range from simple analysis that can be performed using spreadsheets with tools like pivot tables and graphs, to complex statistical software and even artificial intelligence. More complex analysis provides greater value to the business.

Four Types of Data Analytics

  ILLUSTRATION 1.3   

Four types of data analytics

Future Prescriptive

Greater Predictive Past

What should we do about it?

What is likely to happen?

Diagnostic Value

Why did it happen? Foresight

Descriptive What happened? Insight

Hindsight

Less Less

Greater Complexity

Insight boxes provide examples of business situations from various perspectives—ethics, investor, i­ nternational, corporate social responsibility, and data analytics.

Data Analytics Insight  Netflix Using Data Science to Create Art

Bogdan Glisik/ Bogdan Glisik/ Shutterstock.com Shutterstock.com

Technology provides decision-makers and problem-solvers with access to a large volume of information called “big data.” And Netflix, the world’s leading subscription streaming entertainment service, is tapping

into this big data as part of its efforts to ramp up its original content production. In a recent year, Netflix planned to spend $8 billion on content creation. Producing content involves a blend of creativity, technology, and business decisions, all of which result in costs. And by analyzing the large amounts of data from past ­productions, such as filming locations and production ­schedules,

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Netflix can more precisely estimate costs for future productions. Further, consider that the production of a TV show or film involves hundreds of tasks. Here again, Netflix uses data science, in this case to visualize where bottlenecks might occur or where opportunities might exist to increase the efficiency of the production process.

Source: Based on Ritwik Kumar et. al., “Data Science and the Art of Producing Entertainment at Netflix,” The Netflix Tech Blog (March 26, 2018).

How can “big data” improve decision-making? (Answer is available at the end of the chapter.)

Ethics in Financial Reporting People won’t gamble in a casino if they think it is “rigged.” Similarly, people won’t “play” the stock market if they think stock prices are rigged. At one time, major financial scandals at Enron, WorldCom, HealthSouth, and AIG led to a mistrust of financial reporting in general. A Wall Street Journal article noted that “repeated disclosures about questionable accounting practices have bruised investors’ faith in the reliability of earnings reports, which in turn has sent stock prices tumbling.” Imagine trying to carry on a business or invest money if you could not depend on the financial statements to be honestly prepared. Information would have no credibility. A well-functioning economy depends on accurate and reliable financial ­reporting. U.S. regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting. •  Congress passed the Sarbanes-Oxley Act (SOX) to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals (see Ethics Note). •  As a result of SOX, top management must now certify the fairness of financial information. •  In addition, penalties for fraudulent financial activity are much more severe. •  Also, SOX increased both the independence of the outside auditors who review the accuracy of corporate financial statements and the oversight role of boards of directors. Effective financial reporting depends on sound ethical behavior. When analyzing ethics cases and your own ethical experiences, you should apply the three steps outlined in Illustration 1.4.

ETHICS NOTE Circus-founder P.T. Barnum is alleged to have said, “Trust everyone, but cut the deck.” What Sarbanes-Oxley does is to provide measures that (like cutting the deck of playing cards) help ensure that fraud will not occur.

Ethics Notes help sensitize you to some of the ethical issues in accounting.

  ILLUSTRATION 1.4    Steps in analyzing ethics cases

Solving an Ethical Dilemma

ALT 1

ALT 2

1

2

3

Recognize an ethical situation and the ethical issues involved. Use your personal ethics to identify ethical situations and issues. Some businesses and professional organizations provide written codes of ethics for guidance in some business situations.

Identify and analyze the principal elements in the situation. Identify the stakeholders— persons or groups who may be harmed or benefited. Ask the question: What are the responsibilities and obligations of the parties involved?

Identify the alternatives, and weigh the impact of each alternative on various stakeholders. Select the most ethical alternative, considering all the consequences. Sometimes there will be one right answer. Other situations involve more than one right solution; these situations require you to evaluate each alternative and select the best one.

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Ethics Insight  Dewey & LeBoeuf LLP I Felt the Pressure—Would You?

Alliance Images/ Shutterstock.com

“I felt the pressure.” That’s what some of the employees of the now-defunct law firm of Dewey & LeBoeuf LLP indicated when they helped to overstate revenue and use accounting tricks to hide losses and cover up cash shortages. These employees worked for the former finance director and former chief financial officer (CFO) of the firm. Here are some of their comments:

•  “I was instructed by the CFO to create invoices, knowing they would not be sent to clients. When I created these invoices, I knew that it was inappropriate.” •  “I intentionally gave the auditors incorrect information in the course of the audit.”

ACTION PLAN • Review forms of business organization, users of financial information, approach to ethical dilemmas, and definition of data analytics.

What happened here is that a small group of lower-level employees over a period of years carried out the instructions of their bosses. Their bosses, however, seemed to have no concern about unethical practices as evidenced by various e-mails with  one another in which they referred to their financial manipulations as accounting tricks, cooking the books, and fake income. Sources: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the Alleged Fraud,” Wall Street Journal (March 28, 2014); and Sara Randazzo, “Dewey CFO Escapes Jail Time in Fraud Case Sentencing,” Wall Street Journal (October 10, 2017).

Why did these employees lie, and what do you believe should be their penalty for these lies? (Answer is available at the end of the chapter.)

DO IT! 1b    Using Financial Information There are a variety of users and uses of financial information. Match each of the following terms with its definition, classification type, or associated phrase. a. ____ Data analytics.

1. Marketing managers, finance directors.

Management must certify the fairness of b. ____ Internal users of financial information. 2.  financial information. c. ____ Element of Sarbanes-Oxley Act.

3. Often employs both software and statistics to d. ____ External users of financial information. draw inferences. e. ____ Steps in solving an ethical dilemma. 4. Identify the alternatives and weigh the impact of each alternative on various stakeholders.

5. Investors, labor unions.

Solution a. 3 b. 1 c. 2 d. 5 e. 4 Related exercise material: BE1.2, DO IT! 1.1b, and E1.3.

The Three Types of Business Activity

1.2

LEARNING OBJECTIVE 2 Explain the three principal types of business activity. Businesses engage in three types of activity—financing, investing, and operating. For example, consider Gert Boyle’s parents, the founders of Columbia Sportswear. 1. The Boyles obtained cash through financing (from personal savings and outside sources like banks) to start and grow their business.

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2. The family then invested the cash in equipment to run the business, such as sewing equipment and delivery vehicles. 3. Once this equipment was in place, they began the operating activities of making and selling clothing. The accounting information system keeps track of the results of each of the various business activities—financing, investing, and operating. Let’s look at each type of business activity in more detail.

Financing Activities It takes money to make money. Financing activities involve raising money from outside sources. The two primary sources of outside funds for corporations are borrowing money (debt financing) and issuing (selling) shares of stock in exchange for cash (equity financing). Columbia Sportswear may borrow money in a variety of ways. For example, it can take out a loan at a bank or borrow directly from investors by issuing debt securities called bonds. Persons or entities to whom Columbia owes money are its creditors. • Amounts owed to creditors—in the form of debt and other obligations—are called liabilities.

The Stock Exchange

Equity Financing

• Specific names are given to different types of liabilities, depending on their source. Columbia may have a note payable to a bank for the money borrowed to purchase delivery trucks. • Debt securities sold to investors that must be repaid at a particular date some years in the future are bonds payable.

Debt Financing

Corporations also obtain funds by selling shares of stock to investors. Common stock is the term used to describe the total amount paid in by stockholders for the shares they purchase. The claims of creditors differ from those of stockholders. If you loan money to a company, you are one of its creditors. In lending money, you specify a payment schedule (e.g., payment at the end of three months). As a creditor, you have a legal right to be paid at the agreed time. In the event of nonpayment, you may legally force the company to sell property to pay its debts. In the case of financial difficulty, creditor claims must be paid before stockholders’ claims. Stockholders, on the other hand, have no claim to corporate cash until the claims of creditors are satisfied. Suppose you buy a company’s stock instead of loaning it money. You have no legal right to expect any payments from your stock ownership until all of the company’s creditors are paid amounts currently due. However, many corporations make payments to stockholders on a regular basis as long as there is sufficient cash to cover required payments to creditors. These cash payments to stockholders are called dividends.

Investing Activities Once the company has raised cash through financing activities, it uses that cash in investing activities. Investing activities involve the purchase of the resources a company needs in order to operate. Resources owned by a business are called assets. A growing company purchases many assets, such as computers, delivery trucks, furniture, and buildings. • Different types of assets are given different names; Columbia Sportswear’s sewing equipment is a type of asset referred to as property, plant, and equipment (see Alternative Terminology). • Cash is one of the more important assets owned by Columbia or any other business. • If a company has excess cash that it does not need for a while, it might choose to invest in securities (stocks or bonds) of other corporations, a type of asset referred to as investments.

Investing ALTERNATIVE TERMINOLOGY Property, plant, and equipment is sometimes called fixed assets.

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C H A PT E R 1

Introduction to Financial Statements

Operating Activities Once a business has the assets it needs to get started, it begins operating activities. Operating activities are the day-to-day actions taken by a company to produce and sell a product, or provide a service. Columbia Sportswear is in the business of selling outdoor clothing and footwear. It sells TurboDown jackets, Millennium snowboard pants, Sorel® snow boots, Bugaboots™, rainwear, and anything else you might need to protect you from the elements. We call amounts earned from the sale of these products revenues.

Operating

• Revenue is the increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the normal course of business; Columbia records revenue when it sells a footwear product. • Revenues arise from different sources and are identified by various names depending on the nature of the business; Columbia’s primary source of revenue is the sale of sportswear (but it also generates interest revenue on debt securities held as investments). • Sources of revenue common to many businesses are sales revenue, service revenue, and interest revenue. The company purchases its longer-lived assets through investing activities as described earlier. Other assets with shorter lives, however, result from operating activities. • Supplies are assets used in day-to-day operations (rather than sold to customers). • Goods available for future sales to customers are assets called inventory. • The right to receive money in the future is called an account receivable. If Columbia sells goods to a customer and does not receive cash immediately, then the company has a right to expect payment from that customer in the near future. Before Columbia can sell a single Sorel® boot, it must purchase wool, rubber, leather, metal lace loops, laces, and other materials. It then must process, wrap, and ship the finished product. It also incurs costs like salaries, rents, and utilities. All of these costs, referred to as expenses, are necessary to produce and sell the product. • In accounting language, expenses are the cost of assets consumed or services used in the process of generating revenues. • Expenses take many forms and are identified by various names depending on the type of asset consumed or service used. For example, Columbia keeps track of these types of expenses: cost of goods sold (such as the cost of materials), selling expenses (such as the cost of salespersons’ salaries), marketing expenses (such as the cost of advertising), administrative expenses (such as the salaries of administrative staff, and telephone and heating costs incurred at the corporate office), interest expense (amounts of interest paid on various debts), and income tax expense (corporate taxes paid to the government). Columbia may also have liabilities arising from these expenses. • For example, Columbia may purchase goods on credit from suppliers. The obligations to pay for these goods are called accounts payable. • Additionally, Columbia may have interest payable on the outstanding amounts owed to the bank. • It may also have wages payable to its employees and sales taxes payable, property taxes payable, and income taxes payable to the government. Columbia compares the revenues of a period with the expenses of that period to determine whether it earned a profit. When revenues exceed expenses, net income results. When expenses exceed revenues, a net loss results.

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DO IT! 2    Business Activities Classify each item as an asset, liability, common stock, revenue, or expense. 1. Cost of renting property. 4.  Issuance of ownership shares. 2. Truck purchased.

5.  Amount recorded from performing services.

3. Notes payable.

6.  Amounts owed to suppliers.

ACTION PLAN • Classify each item based on its economic characteristics. Proper classification of items is critical if accounting is to provide useful information.

Solution 1. Cost of renting property: Expense. 2. Truck purchased: Asset. 3. Notes payable: Liability. 4. Issuance of ownership shares: Common stock. 5. Amount recorded from performing services: Revenue. 6. Amounts owed to suppliers: Liability. Related exercise material: BE1.3, DO IT! 1.2, and E1.7.

The Four Financial Statements

1.3

LEARNING OBJECTIVE 3 Describe the four financial statements and how they are prepared. Assets, liabilities, expenses, and revenues are of interest to users of accounting information. This information is arranged in the format of four different financial statements, which form the backbone of financial accounting: 1. Income statement. Shows how successfully your business performed during a period of time, by subtracting expenses from revenues. 2. Retained earnings statement. Indicates how much of previous income was distributed to owners of your business in the form of dividends, and how much was retained in the business to allow for future growth. 3. Balance sheet. Presents a picture at a point in time of what your business owns (its assets) and what it owes (its liabilities). 4. Statement of cash flows. Shows where your business obtained cash during a period of time and how that cash was used. To introduce you to these statements, we have prepared the financial statements for your outdoor guide service, Sierra Corporation, after your first month of operations (see International Note). To summarize, you officially started your business in Truckee, California, on October 1, 2025. Sierra provides guide services in the Lake Tahoe area of the Sierra Nevada mountains. Its promotional materials describe outdoor day trips, such as rafting, snowshoeing, and hiking, as well as multi-day backcountry experiences. To minimize your initial investment, your customers either bring their own equipment or rent equipment through local outfitters. The financial statements for Sierra’s first month of business are provided in the following pages.

International Note The primary types of financial statements required by International Financial Reporting Standards (IFRS) and U.S. generally accepted accounting principles (GAAP) are the same. However, in practice, some format differences do exist in presentations commonly employed by IFRS companies as compared to GAAP companies.

International Notes highlight differences between U.S. and international accounting standards.

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Income Statement HELPFUL HINT The financial statement heading identifies the company, the type of statement, and the time period covered.   ILLUSTRATION 1.5    Sierra Corporation’s income statement

Decision Tools The income statement helps users determine if the company’s operations are profitable. Decision Tools that are useful for business decision-making are highlighted throughout the text. A summary of the Decision Tools is also provided in each chapter.

The income statement reports a company’s revenues and expenses and resulting net income or loss for a period of time (see Decision Tools). To indicate that its income statement reports the results of operations for a specific period of time, Sierra Corporation dates the income statement “For the Month Ended October 31, 2025.” The income statement lists the company’s revenues followed by its expenses. Finally, Sierra determines the net income (or net loss) by deducting expenses from revenues. Sierra’s income statement is shown in Illustration 1.5 (see Helpful Hint). Congratulations, you are already showing a profit!

Sierra Corporation

Income Statement For the Month Ended October 31, 2025 Revenues   Service revenue Expenses   Salaries and wages expense   Supplies expense   Rent expense   Interest expense   Insurance expense   Depreciation expense    Total expenses Net income

$10,600 $5,200 1,500 900 50 50 40

7,740 $ 2,860

Why are financial statement users interested in net income? •  Investors are interested in a company’s past net income because it provides useful information for predicting future net income. Investors buy and sell stock based on their beliefs about a company’s future performance. If investors believe that Sierra will be successful in the future and that this will result in a higher stock price, they will buy its stock.

ETHICS NOTE When companies find errors in previously released income statements, they restate those numbers. Perhaps because of the increased scrutiny shortly after Sarbanes-Oxley was implemented, companies filed a record 1,195 restatements. ACTION PLAN • Report the revenues and expenses for a period of time in an income statement.

•  Creditors use the income statement to predict future earnings. When a bank loans money to a company, it believes that it will be repaid in the future. If it didn’t think it would be repaid, it wouldn’t loan the money. Therefore, prior to making the loan the bank loan officer uses the income statement as a source of information to predict whether the company will be profitable enough to repay its loan. Thus, reporting a strong profit will make it easier for Sierra to raise additional cash either by issuing shares of stock or borrowing. Amounts received from issuing stock are not revenues, and amounts paid out as dividends are not expenses. As a result, they are not reported on the income statement. For example, Sierra Corporation does not treat as revenue the $10,000 of cash received from issuing new stock (see Illustration 1.8), nor does it regard as a business expense the $500 of dividends paid (see Illustration 1.6) (see Ethics Note).

DO IT! 3a Part 1   Financial Statements—The Income Statement Part 1: CSU Corporation began operations on January 1, 2025. The following information is available for CSU on December 31, 2025. Accounts receivable $ 1,800 Accounts payable 2,000 Rent expense 9,000 Notes payable 5,000 Common stock 10,000 Prepare an income statement.

Retained earnings $     0 Equipment 16,000 Insurance expense 1,000 Service revenue 17,000 Supplies 4,000

Supplies expense $  200 Cash 1,400 Dividends 600

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Solution

CSU Corporation Income Statement For the Year Ended December 31, 2025 Revenues   Service revenue Expenses   Rent expense   Insurance expense   Supplies expense    Total expenses Net income

$17,000 $9,000 1,000    200

 10,200 $ 6,800

Related exercise material: BE1.6, BE1.7, BE1.8, DO IT! 1.3a, E1.9, E1.10, E1.14, E1.15, E1.16, E1.18, and E1.19.

Retained Earnings Statement

Decision Tools

If Sierra Corporation is profitable, at the end of each period it must decide what portion of profits to pay to shareholders in dividends. In theory, it could pay all of its current-period profits, but few companies do this. Why? Because they want to retain part of the profits to allow for further expansion. High-growth companies, such as Google and Facebook, often pay no dividends. Retained earnings is the net income retained in the corporation. The retained earnings statement shows the amounts and causes of changes in retained earnings for a specific time period (see Decision Tools). The time period is the same as that covered by the income statement. The beginning retained earnings amount appears on the first line of the statement. Then, the company adds net income and deducts dividends to determine the retained earnings at the end of the period. If a company has a net loss, it deducts (rather than adds) that amount in the retained earnings statement. Illustration 1.6 presents Sierra’s retained earnings statement (see Helpful Hint).

The heading of this statement identifies the company, the type of statement, and the time period covered by the statement.

Sierra Corporation’s retained earnings statement

Retained Earnings Statement For the Month Ended October 31, 2025

Less: Dividends Retained earnings, October 31

HELPFUL HINT

  ILLUSTRATION 1.6   

Sierra Corporation

Retained earnings, October 1 Add: Net income

The retained earnings statement helps users determine the company’s policy toward dividends and growth.

$    0  2,860  2,860    500 $2,360

By monitoring the retained earnings statement, financial statement users can evaluate dividend payment practices. •  Some investors seek companies, such as Dow Chemical, that have a history of paying high dividends. •  Other investors seek companies, such as Amazon.com, that reinvest earnings to increase the company’s growth instead of paying dividends. •  Lenders monitor their corporate customers’ dividend payments because any money paid in dividends reduces a company’s ability to repay its debts.

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ACTION PLAN • Show the amounts and causes (net income and dividends) of changes in retained earnings during the period in the retained earnings statement.

DO IT! 3a Part 2    Financial Statements—The Retained Earnings Statement Part 2: CSU Corporation began operations on January 1, 2025. The following information is available for CSU on December 31, 2025. Accounts receivable Accounts payable Rent expense Notes payable Common stock

$  1,800 2,000 9,000 5,000 10,000

Retained earnings Equipment Insurance expense Service revenue Supplies

$    0 16,000 1,000 17,000 4,000

Supplies expense $  200 Cash 1,400 Dividends 600

Prepare a retained earnings statement. Refer to DO IT! 3a Part 1 for net income.

Solution

CSU Corporation Retained Earnings Statement For the Year Ended December 31, 2025 Retained earnings, January 1 Add: Net income Less: Dividends Retained earnings, December 31

$    0  6,800 6,800    600 $6,200

Related exercise material: BE1.7, BE1.10, DO IT! 1.3a, E1.9, E1.10, E1.13, E1.16, E1.17, and E1.18.

Balance Sheet Decision Tools The balance sheet helps users determine whether the company relies on debt or stockholders’ equity to finance its assets.

The balance sheet reports assets and claims to assets at a specific point in time (see Decision Tools). Claims to assets are subdivided into two categories: claims of creditors and claims of owners. As noted earlier, claims of creditors are called liabilities. The owners’ claim to assets is called stockholders’ equity. Illustration 1.7 shows the relationship among the categories on the balance sheet in equation form. •  This equation is referred to as the basic accounting equation. •  This relationship is where the name “balance sheet” comes from. Assets must balance with the claims to assets.

  ILLUSTRATION 1.7 

Basic accounting equation

Assets = Liabilities + Stockholders’ Equity

HELPFUL HINT The heading of a balance sheet must identify the company, the statement, and the date. ALTERNATIVE TERMINOLOGY Liabilities are also referred to as debt.

As you can see from looking at Sierra Corporation’s balance sheet in Illustration 1.8, the balance sheet presents the company’s financial position as of a specific date—in this case, October 31, 2025 (see Helpful Hint). It lists assets first. Assets are listed in the order of their liquidity, that is, how quickly they could be converted to cash. Assets are followed by liabilities and stockholders’ equity (see Alternative Terminology). Stockholders’ equity is comprised of two parts: (1) common stock and (2) retained earnings. As noted earlier, common stock results when the company sells new shares of stock;

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retained earnings is the net income retained in the corporation. Sierra has common stock of $10,000 and retained earnings of $2,360, for total stockholders’ equity of $12,360.

  ILLUSTRATION 1.8 

Sierra Corporation

Sierra Corporation’s balance sheet

Balance Sheet October 31, 2025

Cash Accounts receivable Supplies Prepaid insurance Equipment, net Total assets

Assets

$15,200 200 1,000 550 4,960 $21,910

Liabilities and Stockholders’ Equity Liabilities   Notes payable $ 5,000   Accounts payable 2,500   Unearned service revenue 800   Salaries and wages payable 1,200      50   Interest payable    Total liabilities Stockholders’ equity   Common stock 10,000   2,360   Retained earnings    Total stockholders’ equity Total liabilities and stockholders’ equity

$ 9,550

 12,360 $21,910

Creditors analyze a company’s balance sheet to determine the likelihood that they will be repaid. •  Creditors carefully evaluate the nature of the company’s assets and liabilities. •  In operating Sierra’s guide service, the balance sheet will be used to determine whether cash on hand is sufficient for immediate cash needs. •  The balance sheet will also be used to evaluate the relationship between debt and stockholders’ equity to determine whether the company has a satisfactory proportion of debt and common stock financing.

DO IT! 3a Part 3    Financial Statements—The Balance Sheet Part 3: CSU Corporation began operations on January 1, 2025. The following information is available for CSU on December 31, 2025. Accounts receivable $  1,800 Accounts payable 2,000 Rent expense 9,000 Notes payable 5,000 Common stock 10,000

Retained earnings $   0 Equipment 16,000 Insurance expense 1,000 Service revenue 17,000 Supplies 4,000

Supplies expense $  200 Cash 1,400 Dividends 600

Prepare a balance sheet. Refer to DO IT! 3a Part 2 for the ending balance in Retained Earnings.

ACTION PLAN • Present the assets and claims to those assets (liabilities and equity) at a specific point in time in the balance sheet.

Download Complete eBook By email at [email protected] 1-16  C H A PTE R 1   Introduction to Financial Statements

Solution

CSU Corporation Balance Sheet December 31, 2025 Assets

Cash Accounts receivable Supplies Equipment Total assets

$ 1,400 1,800 4,000  16,000 $23,200

Liabilities and Stockholders’ Equity Liabilities   Notes payable $ 5,000   2,000   Accounts payable    Total liabilities Stockholders’ equity   Common stock 10,000   6,200   Retained earnings    Total stockholders’ equity Total liabilities and stockholders’ equity

$ 7,000

 16,200 $23,200

Related exercise material: BE1.5, BE1.6, BE1.7, BE1.8, BE1.9, BE1.10, DO IT! 1.3a, E1.12, E1.16, E1.17, and E1.22.

Statement of Cash Flows Decision Tools The statement of cash flows helps users determine if the company generates enough cash from operations to fund its investing activities. HELPFUL HINT The heading of this statement identifies the company, the type of statement, and the time period covered by the statement. Negative numbers are shown in parentheses.   ILLUSTRATION 1.9 

Sierra Corporation’s statement of cash flows

The primary purpose of a statement of cash flows is to provide financial information about the cash receipts and cash payments of a business for a specific period of time (see Decision Tools). To help investors, creditors, and others in their analysis of a company’s cash position, the statement of cash flows reports the cash effects of a company’s operating, investing, and financing activities. In addition, the statement shows the net increase or decrease in cash during the period, and the amount of cash at the end of the period. Users are interested in the statement of cash flows because they want to know what is happening to a company’s most important resource. The statement of cash flows provides answers to these simple but important questions: •  Where did cash come from during the period? •  How was cash used during the period? •  What was the change in the cash balance during the period? The statement of cash flows for Sierra Corporation, in Illustration 1.9, shows that cash increased $15,200 during the month (see Helpful Hint). This increase resulted because operating activities (services to clients) increased cash $5,700, and financing activities increased cash $14,500. Investing activities used $5,000 of cash for the purchase of equipment.

Sierra Corporation Statement of Cash Flows For the Month Ended October 31, 2025 Cash flows from operating activities   Cash receipts from operating activities   Cash payments for operating activities    Net cash provided by operating activities

$11,200    (5,500) $ 5,700

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Cash flows from investing activities   Purchased office equipment    Net cash used by investing activities Cash flows from financing activities   Issuance of common stock   Issuance of note payable   Payment of dividend    Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period

  ILLUSTRATION 1.9 

   (5,000) (5,000)

(continued)

10,000 5,000     (500)  14,500 15,200       0 $15,200

People, Planet, and Profit Insight Beyond Financial ­Statements Columbia Sportswear doesn’t just focus on financial success. Several of its factories continue to participate in a project to increase health awareness of female marekuliasz/Getty factory workers in developing countries. Images Columbia is also a founding member of the Sustainable Apparel Coalition, which strives to reduce the environmental and social impact of the apparel industry. In addition, the company monitors all of the independent factories that produce its products to ensure that they comply with the company’s Standards of Manufacturing Practices. These standards address such issues as forced labor, child labor, harassment, wages and benefits, health and safety, and the environment.

With that in mind, should we expand our financial statements to take into account ecological and social performance, in addition to financial results, in evaluating a company? The idea is that a company’s responsibility lies with anyone who is influenced by its actions. In other words, a company should be interested in benefiting many different parties, instead of only maximizing stockholders’ interests. A socially responsible business does not exploit or endanger any group of individuals. It follows fair trade practices, provides safe environments for workers, and bears responsibility for environmental damage. Measurement of these factors is difficult, but many interesting and useful efforts are underway. Why might a company’s stockholders be interested in its environmental and social performance? (Answer is available at the end of the chapter.)

Interrelationships of Statements Illustration 1.10 shows the financial statements of Sierra Corporation (see Helpful Hints). Because the results on some financial statements become inputs to other statements, the ­statements are interrelated. These interrelationships can be seen in Sierra’s financial statements, as follows. 1. The retained earnings statement uses the results of the income statement. Sierra reported net income of $2,860 for the period. Net income is added to the beginning amount of retained earnings to determine ending retained earnings. 2. The balance sheet and retained earnings statement are also interrelated. Sierra reports the ending amount of $2,360 on the retained earnings statement as the retained earnings amount on the balance sheet. 3. The statement of cash flows relates to information on the balance sheet. The statement of cash flows shows how the Cash account changed during the period. It shows the amount of cash at the beginning of the period, the sources and uses of cash during the period, and the $15,200 of cash at the end of the period. The ending amount of cash shown on the statement of cash flows must agree with the amount of cash on the balance sheet. Study these interrelationships carefully. To prepare financial statements, you must understand the sequence in which these amounts are determined and how each statement impacts the next.

Download Complete eBook By email at [email protected]   ILLUSTRATION 1.10 

Sierra Corporation

Sierra Corporation’s financial statements

HELPFUL HINT Note that final sums are double-underlined.

Income Statement For the Month Ended October 31, 2025 Revenues   Service revenue Expenses   Salaries and wages expense   Supplies expense   Rent expense   Interest expense   Insurance expense   Depreciation expense    Total expenses Net income

$10,600 $5,200 1,500 900 50 50     40

  7,740 $ 2,860

Sierra Corporation Retained Earnings Statement For the Month Ended October 31, 2025

HELPFUL HINT The arrows in this illustration show the interrelationships of the four financial statements.

Retained earnings, October 1 Add: Net income

$    0 2,860 2,860    500 $2,360

Less: Dividends Retained earnings, October 31

Sierra Corporation Balance Sheet October 31, 2025 Cash Accounts receivable Supplies Prepaid insurance Equipment, net Total assets

Assets

Liabilities and Stockholders’ Equity Liabilities   Notes payable $ 5,000   Accounts payable 2,500   Unearned service revenue 800   Salaries and wages payable 1,200   Interest payable      50    Total liabilities Stockholders’ equity   Common stock 10,000   Retained earnings   2,360    Total stockholders’ equity Total liabilities and stockholders’ equity

$15,200 200 1,000 550   4,960 $21,910

$ 9,550

 12,360 $21,910

Sierra Corporation Statement of Cash Flows For the Month Ended October 31, 2025 HELPFUL HINT Negative amounts are presented in parentheses.

Cash flows from operating activities   Cash receipts from operating activities   Cash payments for operating activities    Net cash provided by operating activities Cash flows from investing activities   Purchased office equipment    Net cash used by investing activities Cash flows from financing activities   Issuance of common stock   Issuance of note payable   Payment of dividend    Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period

$11,200   (5,500)   (5,000) 10,000 5,000     (500)

$ 5,700 (5,000)

 14,500 15,200       0 $15,200

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DO IT! 3a Part 4    Financial Statements

ACTION PLAN

Part 4: BRB Corporation began operations on January 1, 2025. The following information is available for BRB on December 31, 2025. Accounts receivable $  1,600 Accounts payable 3,000 7,000 Rent expense Notes payable 4,000 Common stock 12,000

Retained earnings $   0 Equipment 21,000 Insurance expense 2,000 Service revenue 21,000 Supplies 5,000

Supplies expense $  300 Cash 2,400 Dividends 700

Prepare an income statement, a retained earnings statement, and a balance sheet.

Solution Income Statement For the Year Ended December 31, 2025 $21,000 $7,000 2,000    300

  9,300 $11,700

BRB Corporation

Retained Earnings Statement For the Year Ended December 31, 2025 Retained earnings, January 1 Add: Net income

$     0  11,700  11,700     700 $11,000

Less: Dividends Retained earnings, December 31

BRB Corporation Balance Sheet December 31, 2025 Cash Accounts receivable Supplies Equipment Total assets

• Show the amounts and causes (net income and dividends) of changes in retained earnings during the period in the retained earnings statement. • Present the assets and claims to those assets (liabilities and equity) at a specific point in time in the balance sheet.

BRB Corporation

Revenues   Service revenue Expenses   Rent expense   Insurance expense   Supplies expense    Total expenses Net income

• Report the revenues and expenses for a period of time in an income statement.

Assets

Liabilities and Stockholders’ Equity Liabilities   Notes payable $ 4,000   Accounts payable 3,000    Total liabilities Stockholders’ equity   Common stock 12,000   Retained earnings 11,000    Total stockholders’ equity Total liabilities and stockholders’ equity

$ 2,400 1,600 5,000  21,000 $30,000

$ 7,000

 23,000 $30,000

Related exercise material: BE1.5, BE1.6, BE1.7, BE1.8, BE1.9, BE1.10, DO IT! 1.3a, E1.9, E1.10, E1.11, E1.12, E1.13, E1.14, E1.15, E1.16, E1.17, E1.18, E1.19, and E1.22.

Download Complete eBook By email at [email protected] 1-20  C H A PTE R 1   Introduction to Financial Statements

Elements of an Annual Report Publicly traded U.S. companies must provide shareholders with an annual report. The annual report always includes the financial statements introduced in this chapter. The annual report also includes other important information such as a management discussion and analysis section, notes to the financial statements, and an independent auditor’s report. No analysis of a company’s financial situation and performance is complete without a review of these items.

Management Discussion and Analysis The management discussion and analysis (MD&A) section presents management’s views on the company’s: •  Ability to pay near-term obligations. •  Ability to fund operations and expansion. •  Results of operations. Management must highlight favorable or unfavorable trends and identify significant events and uncertainties that affect these three factors. This discussion obviously involves a number of subjective estimates and opinions. A brief excerpt from the MD&A section of a recent Columbia Sportswear annual report, which addresses its liquidity requirements, is presented in ­Illustration 1.11.

  ILLUSTRATION 1.11 

Columbia Sportswear’s management discussion and analysis

Real World

Columbia Sportswear Company Management’s Discussion and Analysis of Seasonality and Variability of Business Our business is affected by the general seasonal trends common to the industry, including discretionary consumer shopping and spending patterns, as well as seasonal weather. Our products are marketed on a seasonal basis, and our sales are weighted substantially toward the third and fourth quarters, while our operating costs are more equally distributed throughout the year.

Notes to the Financial Statements Explanatory notes and supporting schedules accompany every set of financial statements and are an integral part of the statements. The notes to the financial statements clarify the financial statements and provide additional detail. Information in the notes does not have to be quantifiable (numeric). Examples of notes are: •  Descriptions of the significant accounting policies and methods used in preparing the statements. •  Explanations of uncertainties and contingencies. •  Various statistics and details too voluminous to be included in the statements. The notes are essential to understanding a company’s operating performance and financial position. Illustration 1.12 is an excerpt from the notes to recent Columbia Sportswear financial statements. It describes the methods that the company uses to account for revenues.

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Columbia Sportswear Company Notes to Financial Statements Revenue Recognition Revenues are recognized when our performance obligations are satisfied as evidenced by transfer of control of promised goods to our customers, in an amount that reflects the consideration we expect to be entitled to receive in exchanges for those goods or services. Within our wholesale channel, control generally transfers to the customer upon shipment to, or upon receipt by, the customer depending on the terms of sale with the customer. Within our DTC channel, control generally transfers to the customer at the time of sale within our retail stores and concessionbased arrangements and upon shipment to the customer with respect to e-commerce transactions.

  ILLUSTRATION 1.12 

Notes to Columbia Sportswear’s financial statements

Real World

Auditor’s Report An auditor’s report is prepared by an independent outside auditor. It states the auditor’s opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles. An auditor is an accounting professional who conducts an independent examination of a company’s financial statements. Only accountants who meet certain criteria and thereby attain the designation certified public accountant (CPA) may certify audits. •  If the auditor is satisfied that the financial statements provide a fair representation of the company’s financial position and results of operations in accordance with generally accepted accounting principles, then the auditor expresses an unqualified opinion. •  If the auditor expresses anything other than an unqualified opinion, then readers should only use the financial statements with caution. •  That is, without an unqualified opinion, we cannot have complete confidence that the financial statements give a fair picture of the company’s financial health. •  A new auditing standard requires the auditor to report any critical audit matters. These are items that are material in size that involve challenging, subjective, or complex auditor judgment. For example, Blockbuster once dominated movie rentals in the United States with over 9,000 stores. But it faltered when the upstart Netflix rapidly took over the movie-rental business. Blockbuster’s auditor then stated that its financial situation raised “substantial doubt about the Company’s ability to continue as a going concern.” Shortly after that, the company filed for bankruptcy. Illustration 1.13 is an excerpt from the auditor’s report from Columbia Sportswear’s 2019 annual report. Columbia received an unqualified opinion from its auditor, Deloitte & Touche.

Columbia Sportswear Company Excerpt from Auditor’s Report We have audited the accompanying consolidated balance sheets of Columbia Sportswear Company and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

  ILLUSTRATION 1.13 

Excerpt from auditor’s report on Columbia Sportswear’s financial statements

Real World

Download Complete eBook By email at [email protected] 1-22  C H A PTE R 1   Introduction to Financial Statements

Accounting Across the Organization Spinning the Career Wheel

Prostock-studio/Shutterstock.com

How will the study of accounting help you? A working knowledge of accounting is desirable for virtually every field of business. Some examples of how accounting is used in business careers include the following.

General management:  Managers of Harley-Davidson, a Qdoba franchise, and a Trek bike shop all need to understand accounting data in order to make wise business decisions. Marketing:  Marketing specialists at Hulu must be sensitive to costs and benefits to ensure that marketing efforts increase company profits. Finance:  Do you want to work for Robinhood, E-Trade, or Goldman Sachs? Financial fields rely heavily on accounting knowledge to analyze financial statements. In fact, it is difficult to

ACTION PLAN • Realize that financial statements provide information about a company’s performance and financial position. • Be familiar with the other elements of the annual report in order to gain a fuller understanding of a company.

get a good job in a finance function without two or three courses in accounting. Real estate:  Because a third party—the bank—is almost always involved in financing a real estate transaction, brokers at Prudential Real Estate must understand the numbers involved. Accounting:  Certified public accountants (CPAs) examine (audit) the financial statements and issue opinions on the accuracy of the financial presentation. Some CPAs offer tax advice and planning. Others work for for-profit companies such as Starbucks or Google, or for non-profit entities such as the Red Cross, where they manage the accounting information systems and prepare financial statements. Opportunities also exist in government, including the Federal Bureau of Investigation (FBI). Finally, forensic accountants conduct investigations into theft and fraud. How might accounting help you? (Answer is available at the end of the chapter.)

DO IT! 3b    Components of Annual Reports State whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to the financial statements, or the auditor’s report. 1. Descriptions of significant accounting policies. 2. Unqualified opinion. 3. Explanations of uncertainties and contingencies. 4. Description of ability to fund operations and expansion. 5. Description of results of operations. 6. Certified public accountant (CPA).

Solution 1. Descriptions of significant accounting policies: Notes. 2. Unqualified opinion: Auditor’s report. 3. Explanations of uncertainties and contingencies: Notes. 4. Description of ability to fund operations and expansion: MD&A. 5. Description of results of operations: MD&A. 6. Certified public accountant (CPA): Auditor’s report. Related exercise material: BE1.11, DO IT! 1.3b, and E1.25.

USING T H E D EC I S I O N TO O LS    Under Armour, Inc. Using the Decision Tools comprehensive exercises ask you to apply business information and the decision tools presented in the chapter. Most of these exercises are based on the companies highlighted in the Feature Story.

There is a good chance that you are wearing one of Under Armour, Inc.’s products right now. Under Armour is a competitor to Columbia Sportswear. Suppose that you are considering investing in shares of Under Armour’s common stock.

Instructions Answer these questions related to your decision whether to invest. a. What financial statements should you evaluate? b. What should these financial statements tell you?

Download Complete eBook By email at [email protected] Appendix 1A: Career Opportunities in Accounting  1-23



c. Do you care if the financial statements have been audited? Explain. d. Appendix B contains financial statements for Columbia, and Appendix C contains those for Under Armour. You can make many comparisons between Columbia and Under Armour in terms of their respective results from operations and financial position. Compare their respective total assets, total revenues, and net cash provided by operating activities for 2020.

Solution a. Before you invest, you should evaluate the income statement, retained earnings statement, balance sheet, and statement of cash flows. b. You would probably be most interested in the income statement because it summarizes past performance and thus gives an indication of future performance. The retained earnings statement provides a record of the company’s dividend history. The balance sheet reveals the relationship between assets and liabilities. The statement of cash flows reveals where the company is getting and spending its cash. This is especially important for a company that wants to grow. c. You would want audited financial statements. These statements indicate that a CPA (certified public accountant) has examined and expressed an opinion whether the statements present fairly the financial position and results of operations of the company. Investors and creditors should not make decisions without studying audited financial statements. d. Many interesting comparisons can be made between the two companies (all numbers are in thousands). Columbia is smaller, with total assets of $2,836,571 versus $5,030,628 for Under Armour, and it has lower revenue—$2,501,554 versus $4,474,667 for Under Armour. However, Columbia’s net cash provided by operating activities of $276,077 is greater than Under Armour’s $212,864. However, while useful, these basic measures are not enough to determine whether one company is a better investment than the other. In later chapters, you will learn tools that will allow you to compare the relative profitability and financial health of these and other companies.

Appendix 1A

  Career Opportunities in Accounting

LEARNING OBJECTIVE *4 Explain the career opportunities in accounting. Why is accounting such a popular major and career choice? 1. There are a lot of jobs. In many cities in recent years, the demand for accountants exceeded the supply. Not only are there a lot of jobs, but there are a wide array of opportunities. As one accounting organization observed, “accounting is one degree with 360 degrees of opportunity.” 2. Accounting matters. Interest in accounting has increased, ironically, because of the attention caused by the accounting failures of companies such as Enron and WorldCom. These widely publicized scandals revealed the important role that accounting plays in society. Most people want to make a difference, and an accounting career provides many opportunities to contribute to society. 3. The Sarbanes-Oxley Act (SOX) significantly increased the accounting and internal control requirements for corporations. This dramatically increased demand for professionals with accounting training. 4. Emerging technologies such as automation, blockchain, and data analytics are changing the way accountants work. With those skills, accountants add value to business decision-making. Accountants are in such demand that it is not uncommon for accounting students to have accepted a job offer a year before graduation. As Illustration 1A.1 reveals, the job options of people with accounting degrees are virtually unlimited.

Download Complete eBook By email at [email protected] 1-24  C H A PTE R 1   Introduction to Financial Statements   ILLUSTRATION 1A.1    Career options in accounting

Areas of Accounting Type of Work Careers Public accounting •  In auditing, accountants examine (audit) the ­financial statements and issue opinions on the fairness of the financial presentation.

Deloitte, EY, KPMG, PwC, Grant Thornton, BDO, Baker Tilly

Certification Opportunities Certified public accountants (CPAs), enrolled agent (EA), certified information systems auditor (CISA)

For-profit: Starbucks, Google, Under Armour Non-profit: Salvation Army, Red Cross

Certified management accountant (CMA), certified internal auditor (CIA)

Examples of Employers

•  In taxation, CPAs offer tax advice and planning. •  In management consulting, accountants design and install accounting software and enterprise resource planning systems and support mergers and acquisitions. Private accounting

•  Financial accountants manage the accounting information system and prepare financial ­statements. •  Managerial accountants manage costs and budgets. •  Internal auditors ensure compliance with policies and regulations.

Governmental accounting

•  There are opportunities in government at the local, state, and federal levels.

Internal Revenue Service (IRS), Federal Bureau of Investigation (FBI)

Certified government financial manager (CGFM)

Forensic accounting

•  In forensic accounting, accountants conduct ­investigations into theft and fraud.

Insurance companies, law firms, FBI

Certified fraud examiner (CFE)

“Show Me the Money” How much can a new accountant make? Take a look at the average salaries for college graduates in public and private accounting shown in Illustration 1A.2.1 Keep in mind if you also have a CPA license, you’ll make 10–15% more when you start out.   ILLUSTRATION 1A.2 

Salary estimates for jobs in public and corporate accounting

Employer

Jr. Level (0–3 yrs.)

Sr. Level (4–6 yrs.)

Public accounting (large firm) Public accounting (medium firm) Public accounting (small company) Corporate accounting (large company)

$63,250–$83,250 $56,500–$67,750 $51,500–$60,500 $53,750–$69,500

$78,500–$106,500 $70,500–$96,000 $63,750–$81,500 $68,750–$87,750

Illustration 1A.3 lists some examples of upper-level salaries for managers in corporate accounting. Note that geographic region, experience, education, CPA certification, and company size each play a role in determining salary.

  ILLUSTRATION 1A.3 

Position

Upper-level management salaries in corporate accounting

Chief financial officer Corporate controller Tax manager

1

Large Company

Small to Medium Company

$207,000–$465,750 $140,000–$224,750 $112,000–$158,250

$105,250–$208,750 $92,000–$161,250 $88,000–$124,750

See startheregoplaces.com/students/why-accounting/salary-and-demand/ for information regarding the salaries listed in Illustrations 1A.2 and 1A.3.

Download Complete eBook By email at [email protected] Decision Tools Review  1-25 The Review and Practice section provides opportunities for students to review key concepts and terms as well as complete multiple-choice questions, brief exercises, exercises, and a comprehensive problem. Detailed solutions are also included.

Review and Practice Learning Objectives Review 1  Identify the forms of business organization and the uses of accounting information. A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more people associated as partners. A corporation is a separate legal entity for which evidence of ownership is provided by shares of stock. Internal users are managers who need accounting information to plan, organize, and run business operations. The primary external users are investors and creditors. Investors (stockholders) use accounting information to decide whether to buy, hold, or sell shares of a company’s stock. Creditors (suppliers and bankers) use accounting information to assess the risk of granting credit or loaning money to a business. Other groups who have an indirect interest in a business are taxing authorities, customers, labor unions, and regulatory agencies. 2  Explain the three principal types of business activity. Financing activities involve collecting the necessary funds to support the business. Investing activities involve acquiring the resources necessary to run the business. Operating activities involve putting the resources of the business into action to generate a profit. 3  Describe the four financial statements and how they

are prepared. An income statement presents the revenues and expenses of a company for a specific period of time. A retained earnings statement

summarizes the changes in retained earnings that have occurred for a specific period of time. A balance sheet reports the assets, liabilities, and stockholders’ equity of a business at a specific date. A statement of cash flows summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time. Assets are resources owned by a business. Liabilities are the debts and obligations of the business. Liabilities represent claims of creditors on the assets of the business. Stockholders’ equity represents the claims of owners on the assets of the business. Stockholders’ equity is subdivided into two parts: common stock and retained earnings. The basic accounting equation is Assets = Liabilities + Stockholders’ Equity. Within the annual report, the management discussion and analysis provides management’s interpretation of the company’s results and financial position as well as a discussion of plans for the future. Notes to the financial statements provide additional explanation or detail to make the financial statements more informative. The auditor’s report expresses an opinion as to whether the financial statements present fairly the company’s results of operations and financial position. *4  Explain the career opportunities in accounting. Accounting offers many different jobs in fields such as public and private accounting, governmental, and forensic accounting. Accounting is a popular major because there are many different types of jobs, with unlimited potential for career advancement.

Decision Tools Review Decision Checkpoints

Info Needed for Decision

Tool to Use for Decision

How to Evaluate Results

Are the company’s operations profitable?

Income statement

The income statement reports a company’s revenues and expenses and resulting net income or loss for a period of time.

If the company’s revenues exceed its expenses, it will report net income; otherwise, it will report a net loss.

What is the company’s policy toward dividends and growth?

Retained earnings statement

The retained earnings statement reports how much of this year’s income the company paid out in dividends to shareholders.

A company striving for rapid growth will pay a low (or no) dividend.

(continues)

Download Complete eBook By email at [email protected] 1-26  C H A PTE R 1   Introduction to Financial Statements (continued)

Decision Checkpoints

Info Needed for Decision

Tool to Use for Decision

How to Evaluate Results

Does the company rely primarily on debt or stockholders’ equity to finance its assets?

Balance sheet

The balance sheet reports the company’s resources and claims to those resources; there are two types of claims: liabilities and stockholders’ equity.

Compare the amount of debt versus the amount of stockholders’ equity to determine whether the company relies more on creditors or owners for its financing.

Does the company generate sufficient cash from operations to fund its investing activities?

Statement of cash flows

The statement of cash flows shows the amount of net cash provided or used by operating activities, investing activities, and financing activities.

Compare the amount of net cash provided by operating activities with the amount of net cash used by investing activities. Any deficiency in cash from operating activities must be made up with cash from financing activities.

Glossary Review Accounting  The information system that identifies, records, and communicates the economic events of an organization to interested users. (p. 1-4). Annual report  A report prepared by corporate management that presents financial information including financial statements, a management discussion and analysis section, notes, and an independent auditor’s report. (p. 1-20). Assets  Resources owned by a business. (p. 1-9).

*Auditing  The examination of financial statements by a certified public accountant in order ro express an opinion as to the fairness of presentation. (p. 1-24). Auditor’s report  A report prepared by an independent outside auditor stating the auditor’s opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles. (p. 1-21). Balance sheet  A financial statement that reports the assets and claims to those assets at a specific point in time. (p. 1-14). Basic accounting equation  Assets = Liabilities + Stockholders’ Equity. (p. 1-14). Certified public accountant (CPA)  An individual who has met certain criteria and is thus allowed to perform audits of corporations. (p. 1-21). Common stock  Term used to describe the total amount paid in by stockholders for the shares they purchase. (p. 1-9). Corporation  A business organized as a separate legal entity owned by stockholders. (p. 1-3). Data analytics  The evaluation of data, often employing both software and statistics, to draw inferences. (p. 1-6). Dividends Payments of cash from a corporation to its stockholders. (p. 1-9). Expenses  The cost of assets consumed or services used in the process of generating revenues. (p. 1-10).

*Forensic accounting  An area of accounting that uses accounting, auditing, and investigative skills to conduct investigations into theft and fraud. (p. 1-24).

Income statement  A financial statement that reports a company’s revenues and expenses and resulting net income or net loss for a specific period of time. (p. 1-12).

Liabilities  Amounts owed to creditors in the form of debts and other obligations. (p. 1-9).

*Management consulting  An area of public accounting ranging from

development of accounting and computer systems to support services for marketing projects and merger and acquisition activities. (p. 1-24). Management discussion and analysis (MD&A) A section of the annual report that presents management’s views on the company’s ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations. (p. 1-20). Net income  The amount by which revenues exceed expenses. (p. 1-10).

Net loss  The amount by which expenses exceed revenues. (p. 1-10). Notes to the financial statements  Notes that clarify information presented in the financial statements and provide additional detail. (p. 1-20). Partnership  A business owned by two or more persons associated as partners. (p. 1-3). Retained earnings  The amount of net income retained in the corporation. (p. 1-13). Retained earnings statement  A financial statement that summarizes the amounts and causes of changes in retained earnings for a specific time period. (p. 1-13). Revenue  The increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the normal course of business. (p. 1-10). Sarbanes-Oxley Act (SOX)  Regulations passed by Congress to reduce unethical corporate behavior. (p. 1-7). Sole proprietorship  A business owned by one person. (p. 1-3). Statement of cash flows  A financial statement that provides financial information about the cash receipts and cash payments of a business for a specific period of time. (p. 1-16). Stockholders’ equity  The owners’ claim to assets. (p. 1-14).

*Taxation  An area of public accounting involving tax advice, tax plan-

ning, preparing tax returns, and representing clients before governmental agencies. (p. 1-24).

Download Complete eBook By email at [email protected] Practice Multiple-Choice Questions  1-27

Practice Multiple-Choice Questions 1.  (LO 1) Which is not one of the three forms of business ­organization? a.  Sole proprietorship.

c. Partnership.

b. Creditorship.

d. Corporation.

2.  (LO 1)  Which is an advantage of corporations relative to partnerships and sole proprietorships? a. Lower taxes. b. Harder to transfer ownership. c. Reduced legal liability for investors. d. Most common form of organization. 3.  (LO 1)  Which statement about users of accounting information is incorrect? a. Management is considered an internal user. b. Taxing authorities are considered external users. c. Present creditors are considered external users. d. Regulatory authorities are considered internal users. 4.  (LO 1)  Which of the following did not result from the Sarbanes-­ Oxley Act? a. Top management must now certify the accuracy of financial information. b. Penalties for fraudulent activity increased. c. Independence of auditors increased. d. Tax rates on corporations increased. 5.  (LO 2)  Which is not one of the three primary business activities? a. Financing.

c. Advertising.

b. Operating.

d. Investing.

6.  (LO 2)  Which of the following is an example of a financing activity? a. Issuing shares of common stock. b. Selling goods on account. c. Buying delivery equipment. d. Buying inventory. 7.  (LO 2)  Net income will result during a time period when:

What was Macias Corporation’s net income? a. $60,000.

c. $65,000.

b. $15,000.

d. $45,000.

9.  (LO 3)  What section of a statement of cash flows indicates the cash spent on new equipment during the past accounting period? a. The investing activities section. b. The operating activities section. c. The financing activities section. d. The statement of cash flows does not give this information. 10.  (LO 3)  Which statement presents information as of a specific point in time? a. Income statement. b. Balance sheet. c. Statement of cash flows. d. Retained earnings statement. 11.  (LO 3)  Which financial statement reports assets, liabilities, and stockholders’ equity? a. Income statement. b. Retained earnings statement. c. Balance sheet. d. Statement of cash flows. 12.  (LO 3)  Stockholders’ equity represents: a. claims of creditors. b. claims of employees. c. the difference between revenues and expenses. d. claims of owners. 13.  (LO 3)  As of December 31, 2025, Rockford Corporation has assets of $3,500 and stockholders’ equity of $1,500. What are the liabilities for Rockford as of December 31, 2025? a. $1,500.

c. $2,500.

b. $1,000.

d. $2,000.

14.  (LO 3)  The element of a corporation’s annual report that describes the corporation’s accounting methods is/are the:

a. assets exceed liabilities.

a. notes to the financial statements.

b. assets exceed revenues.

b. management discussion and analysis.

c. expenses exceed revenues.

c. auditor’s report.

d. revenues exceed expenses.

d. income statement.

8.  (LO 3)  The financial statements for Macias Corporation contained the following information. Accounts receivable $  5,000 Sales revenue 75,000 Cash 15,000 Salaries and wages expense 20,000 Rent expense 10,000

15.  (LO 3)  The element of the annual report that presents an opinion regarding the fairness of the presentation of the financial position and results of operations is/are the: a. income statement. b. auditor’s opinion. c. balance sheet. d. comparative statements.

Download Complete eBook By email at [email protected] 1-28  C H A PTE R 1   Introduction to Financial Statements 8.  d.  Net income = Sales revenue ($75,000) − Salaries and wages expense ($20,000) − Rent expense ($10,000) = $45,000. The other choices are therefore incorrect.

Solutions 1.  b.  Creditorship is not a form of business organization. The other choices are incorrect because (a) sole proprietorship, (c) partnership, and (d) corporation are all forms of business organization.

9.  a.  The investing activities section of the statement of cash flows provides information about property, plant, and equipment accounts, not (b) the operating activities section or (c) the financing activities section. Choice (d) is incorrect as the statement of cash flows does provide this information.

2.  c.  An advantage of corporations is that investors are not personally liable for debts of the business. The other choices are incorrect because (a) lower taxes, (b) harder to transfer ownership, and (d) most common form of organization are not true of corporations.

10.  b.  The balance sheet presents information as of a specific point in time. The other choices are incorrect because the (a) income statement, (c) statement of cash flows, and (d) retained earnings statement all cover a period of time.

3.  d.  Regulatory authorities are considered external, not internal, users. The other choices are true statements. 4.  d.  The Sarbanes-Oxley Act (SOX) was created to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals, not to address tax rates. The other choices are incorrect because (a) top management must now certify the accuracy of financial information, (b) penalties for fraudulent activity increased, and (c) increased independence of auditors all resulted from SOX.

11.  c.  The balance sheet is a formal presentation of the accounting equation, such that Assets = Liabilities + Stockholders’ Equity, not the (a) income statement, (b) retained earnings statement, or (d) statement of cash flows. 12.  d.  Stockholders’ equity represents claims of owners. The other choices are incorrect because (a) claims of creditors and (b) claims of employees are liabilities. Choice (c) is incorrect because the difference between revenues and expenses is net income.

5.  c.  Advertising is a type of operating activity. The other choices are incorrect because (a) financing, (b) operating, and (d) investing are the three primary business activities.

13.  d.  Using the accounting equation, liabilities can be computed by subtracting stockholders’ equity from assets, or $3,500 − $1,500 = $2,000, not (a) $1,500, (b) $1,000, or (c) $2,500.

6.  a.  Issuing shares of common stock is a financing activity. The other choices are incorrect because (b) selling goods on account is an operating activity, (c) buying delivery equipment is an investing activity, and (d) buying inventory is an operating activity.

14.  a.  The corporation’s accounting methods are described in the notes to the financial statements, not in the (b) management discussion and analysis, (c) auditor’s report, or (d) income statement.

7.  d.  When a company earns more revenues than expenses, it will report net income during a time period. The other choices are incorrect because (a) assets and liabilities are on the balance sheet, not the income statement; (b) assets are on the balance sheet, not the income statement; and (c) net income results when revenues exceed expenses, not when expenses exceed revenues.

15.  b.  The element of the annual report that presents an opinion regarding the fairness of the presentation of the financial position and results of operations is the auditor’s opinion, not the (a) income statement, (c) balance sheet, or (d) comparative statements.

Practice Brief Exercises Use basic accounting equation.

1.  (LO 3)  At the beginning of the year, Ortiz Company had total assets of $900,000 and total liabilities of $440,000. Answer the following questions. a. If total assets decreased $100,000 during the year and total liabilities increased $80,000 during the year, what is the amount of stockholders’ equity at the end of the year? b. During the year, total liabilities decreased $100,000 during the year and stockholders’ equity increased $200,000. What is the amount of total assets at the end of the year? c. If total assets increased $50,000 during the year and stockholders’ equity increased $60,000 during the year, what is the amount of total liabilities at the end of the year?

Solution

Determine where items appear on financial statements.

1.  a.

Assets ($900,000 – $100,000)

– –

Liabilities ($440,000 + $80,000)

= =

Stockholders’ Equity $280,000

b.

Liabilities ($440,000 – $100,000)

+ +

Stockholders’ Equity ($900,000 – $440,000 + $200,000)

= =

Assets $1,000,000

c.

Assets ($900,000 + $50,000)

– –

Stockholders’ Equity ($900,000 – $440,000 + $60,000)

= =

Liabilities $430,000

2.  (LO 3)  Indicate whether the following items would appear on the income statement (IS), balance sheet (BS), or retained earnings statement (RES). a.  ______ Common stock.

d.  ______ Service revenue.

b.  ______ Cash.

e.  ______ Accounts payable.

c.  ______ Salaries and wages expense.

Download Complete eBook By email at [email protected] Practice Brief Exercises  1-29

Solution 2.  a.   BS  Common stock. d.    IS  

Service revenue.

b.   BS  Cash. e.   BS  Accounts payable. c.    IS   Salaries and wages expense.

3.  (LO 3)  Presented below in alphabetical order are balance sheet items for Feagler Company at December 31, 2025. Prepare a balance sheet following the format of Illustration 1.8. Accounts receivable Cash Common stock Notes payable Retained earnings

Prepare a balance sheet.

$12,500 38,000 5,000 40,000 5,500

Solution 3.

Feagler Company Balance Sheet December 31, 2025 Cash Accounts receivable

Assets

$38,000  12,500 $50,500

Total assets Liabilities and Stockholders’ Equity Liabilities   Notes payable

$40,000

   Total liabilities Stockholders’ equity   Common stock   Retained earnings

$40,000 5,000   5,500

   Total stockholders’ equity

 10,500

Total liabilities and stockholders’ equity

$50,500

4.  (LO 3)  Identify whether the following items would appear on the balance sheet (BS) or income statement (IS) of a corporation. a.  ______ Income taxes payable.

f.  ______ Service revenue.

b.  ______ Cost of goods sold.

g.  ______ Depreciation expense.

c.  ______ Supplies.

h.  ______ Prepaid insurance.

d.  ______ Notes payable.

i.  ______ Interest payable.

e.  ______ Salaries and wages expense.

Solution 4. a.   BS  Income taxes payable.

f.    IS  

Service revenue.

b.    IS  

Cost of goods sold.

g.    IS  

Depreciation expense.

c.    BS 

Supplies.

h.   BS  Prepaid insurance.

d.   BS  Notes payable. e.    IS  

Salaries and wages expense.

i.   BS  Interest payable.

Determine where items appear on financial statements.

Download Complete eBook By email at [email protected] 1-30  C H A PTE R 1   Introduction to Financial Statements

Practice Exercises Prepare an income statement.

1.  (LO 3)  The following items and amounts were taken from Ricardo Inc.’s 2025 income statement and balance sheet. Cash Retained earnings Cost of goods sold Salaries and wages expense Prepaid insurance Interest expense

$ 84,700 123,192 483,854 125,000 7,818 994

Inventory Accounts receivable Sales revenue Income taxes payable Accounts payable Service revenue

$ 64,618 88,419 693,485 6,499 49,384 8,998

Instructions Prepare an income statement for Ricardo Inc. for the year ended December 31, 2025.

Solution 1.

Ricardo Inc. Income Statement For the Year Ended December 31, 2025 Revenues   Sales revenue   Service revenue    Total revenues Expenses   Cost of goods sold   Salaries and wages expense   Interest expense    Total expenses Net income

Compute net income and prepare a balance sheet.

$693,485    8,998

483,854 125,000      994

$702,483

 609,848 $ 92,635

2.  (LO 3)  Cozy Bear is a private camping ground near the Mountain Home Recreation Area. It has compiled the following financial information as of December 31, 2025. Service revenue (from camping fees) Sales revenue (from general store) Accounts payable Cash Equipment

$148,000 35,000 16,000 18,500 129,000

Dividends Bonds payable Expenses during 2025 Supplies Common stock Retained earnings (1/1/2025)

$  9,000 50,000 135,000 12,500 40,000 15,000

Instructions a. Determine net income from Cozy Bear for 2025. b. Prepare a retained earnings statement and a balance sheet for Cozy Bear as of December 31, 2025.

Solution 2.  a. Service revenue Sales revenues   Total revenue

$148,000  35,000 183,000

Expenses

 135,000

Net income

$ 48,000

Download Complete eBook By email at [email protected] Practice Problem  1-31 b.

Cozy Bear Retained Earnings Statement For the Year Ended December 31, 2025 Retained earnings, January 1

$15,000

Add: Net income

48,000 63,000 9,000 $54,000

Less: Dividends Retained earnings, December 31

Cozy Bear Balance Sheet December 31, 2025 Assets

Cash Supplies Equipment Total assets

$ 18,500 12,500  129,000 $160,000

Liabilities and Stockholders’ Equity Liabilities   Accounts payable   Bonds payable    Total liabilities Stockholders’ equity   Common stock   Retained earnings    Total stockholders’ equity Total liabilities and stockholders’ equity

$16,000  50,000

40,000  54,000

$ 66,000

  94,000 $160,000

Practice Problem (LO 3)  Jeff Andringa, a former college hockey player, quit his job and started Ice Camp, a hockey camp for kids ages 8 to 18. Eventually, he would like to open hockey camps nationwide. Jeff has asked you to help him prepare financial statements at the end of 2025, his first year of operations. He relates the following facts about his business activities. In order to get the business off the ground, Jeff decided to incorporate. He sold shares of common stock to a few close friends, as well as bought some of the shares himself. He initially raised $25,000 through the sale of these shares. In addition, the company took out a $10,000 loan at a local bank. Ice Camp purchased, for $12,000 cash, a bus for transporting kids. The company also bought hockey goals and other miscellaneous equipment with $1,500 cash. The company earned camp tuition of $100,000 during the year but had collected only $80,000 of this amount. Thus, at the end of the year, its customers still owed $20,000. The company rents time at a local rink for $50 per hour. Total rink rental costs during the year were $8,000, insurance was $10,000, salary expense was $20,000, and supplies used totaled $9,000, all of which were paid in cash. The company incurred $800 in interest expense on the bank loan, which it still owed at the end of the year. The company paid dividends during the year of $5,000 cash. The balance in the corporate bank account at December 31, 2025, was $49,500.

Prepare financial statements.

Download Complete eBook By email at [email protected] 1-32  C H A PTE R 1   Introduction to Financial Statements

Instructions Using the format of the Sierra Corporation statements in this chapter, prepare an income statement, retained earnings statement, balance sheet, and statement of cash flows. (Hint: Prepare the statements in the order stated to take advantage of the flow of information from one statement to the next, as shown in Illustration 1.10.)

Solution

Ice Camp Income Statement For the Year Ended December 31, 2025 Revenues   Service revenue Expenses   Salaries and wages expense   Insurance expense   Supplies expense   Rent expense   Interest expense    Total expenses Net income

$100,000 $20,000 10,000 9,000 8,000     800

  47,800 $ 52,200

Ice Camp Retained Earnings Statement For the Year Ended December 31, 2025 Retained earnings, January 1, 2025 Add: Net income

$     0  52,200  52,200   5,000 $47,200

Less: Dividends Retained earnings, December 31, 2025

Ice Camp Balance Sheet December 31, 2025

Cash Accounts receivable Equipment ($12,000 + $1,500) Total assets

Assets

Liabilities and Stockholders’ Equity Liabilities   Notes payable $10,000   Interest payable   800    Total liabilities Stockholders’ equity   Common stock 25,000   Retained earnings 47,200    Total stockholders’ equity Total liabilities and stockholders’ equity

$49,500 20,000   13,500 $83,000

$10,800

 72,200 $83,000

Download Complete eBook By email at [email protected] Questions  1-33

Ice Camp Statement of Cash Flows For the Year Ended December 31, 2025 Cash flows from operating activities    Cash receipts from operating activities    Cash payments for operating activities      Net cash provided by operating activities Cash flows from investing activities    Purchase of equipment      Net cash used by investing activities Cash flows from financing activities    Issuance of common stock    Issuance of notes payable   Dividends paid      Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period

$80,000  (47,000)

 (13,500)

25,000 10,000   (5,000)

$33,000

(13,500)

 30,000 49,500       0 $49,500

Brief Exercises, DO IT! Exercises, Exercises, Problems, Data Analytics Activities, A Look at IFRS, and many additional resources are available for practice in Wiley Course Resources.

Questions 1.  What are the three basic forms of business organizations? 2.  What are the advantages to a business of being formed as a corporation? What are the disadvantages? 3.  What are the advantages to a business of being formed as a partnership or sole proprietorship? What are the disadvantages? 4.  Is it possible to create a company using an organizational form that has the advantages of both a partnership and a corporation? Explain. 5.  “Accounting is ingrained in our society and is vital to our economic system.” Do you agree? Explain. 6.  Who are the internal users of accounting data? How does accounting provide relevant data to the internal users? 7.  Who are the external users of accounting data? Give examples.

11.  Why would a bank want to monitor the dividend payment practices of the corporations to which it lends money? 12.  “A company’s net income appears directly on the income statement and the retained earnings statement, and it is included indirectly in the company’s balance sheet.” Do you agree? Explain. 13.  What is the primary purpose of the statement of cash flows? 14.  What are the three main categories of the statement of cash flows? Why do you think these categories were chosen? 15.  What is retained earnings? What items increase the balance in retained earnings? What items decrease the balance in retained earnings? 16.  What is the basic accounting equation?

8.  What are the four most common types of data analytics, and what basic question does each address?

17.  a.  Define the terms assets, liabilities, and stockholders’ equity.

9.  What are the three main types of business activity? Give examples of each activity.

18.  Which of these items are liabilities of White Glove Cleaning ­Service?

10.  Listed here are some items found in the financial statements of Finzelberg. Indicate in which financial statement(s) each item would appear. a.  Service revenue. b. Equipment. c.  Advertising expense. d.  Accounts receivable. e.  Common stock. f.  Interest payable.

b.  What items affect stockholders’ equity?

a. Cash.

f. Equipment.

b.  Accounts payable.

g.  Salaries and wages

e. Supplies.

i.  Rent expense.

c.  Dividends. payable. h.  Service revenue. d.  Accounts receivable.

19.  How are each of the following financial statements interrelated? (a) Retained earnings statement and income statement. (b) Retained earnings statement and balance sheet. (c) Balance sheet and statement of cash flows.

Download Complete eBook By email at [email protected] 1-34  C H A PTE R 1   Introduction to Financial Statements 20.  What is the purpose of the management discussion and analysis section (MD&A)?

23.  The accounting equation is Assets = Liabilities + Stockholders’ Equity. Appendix A reproduces Apple’s financial statements. Replacing words in the equation with dollar amounts, what is Apple’s accounting equation at September 26, 2020?

21.  Why is it important for financial statements to receive an unqualified auditor’s opinion?

24.  What are the characteristics of a “critical audit matter”?

22.  What types of information are presented in the notes to the financial statements?

Brief Exercises Describe forms of business organization.

BE1.1  (LO 1), K  Match each of the following forms of business organization with a set of characteristics: sole proprietorship (SP), partnership (P), and corporation (C). a.  _____ Shared control, tax advantages, increased skills and resources. b.  _____ Simple to set up and maintains control with owner. c.  _____ Easier to transfer ownership and raise funds, no personal liability.

Identify users of accounting information.

BE1.2  (LO 1), K  The following lists situations that require the use of accounting information. 1.  Trying to determine whether the company complied with tax laws. 2.  Trying to determine whether the company can pay its obligations. 3.  Trying to determine whether an advertising proposal will be cost-effective. 4.  Trying to determine whether the company’s net income will result in a stock price increase. 5.  Trying to determine whether the company should employ debt or equity financing. Match each of the situations with the following users of accounting information. a.  _____ Investors in common stock.

d.  _____ Chief financial officer.

b.  _____ Marketing managers.

e.  _____ Internal Revenue Service.

c.  _____ Creditors. Classify items by activity.

BE1.3  (LO 2), K  Indicate to which business activity, operating activity (O), investing activity (I), or financing activity (F), each item relates. a.  _____ Cash received from customers. b.  _____ Cash paid to stockholders (dividends). c.  _____ Cash received from issuing new common stock. d.  _____ Cash paid to suppliers. e.  _____ Cash paid to purchase a new office building.

Determine effect of transactions on stockholders’ equity.

BE1.4  (LO 3), C  Presented below are a number of transactions. Determine whether each transaction affects common stock (C), dividends (D), revenues (R), expenses (E), or does not affect stockholders’ equity (NSE). Provide titles for the revenues and expenses. a. _____ Costs incurred for advertising. b. _____ Cash received for services performed. c. _____ Costs incurred for insurance. d. _____ Amounts paid to employees. e. _____ Cash distributed to stockholders. f. _____ Cash received in exchange for allowing the use of the company’s building. g. _____ Costs incurred for utilities used. h. _____ Cash purchase of equipment. i. _____ Cash received from investors.

Prepare a balance sheet.

BE1.5  (LO 3), AP  In alphabetical order below are balance sheet items for Karol Company at December 31, 2025. Prepare a balance sheet following the format of Illustration 1.8. Accounts payable $65,000 Accounts receivable 71,000 Cash 22,000 Common stock 18,000 Retained earnings 10,000

Download Complete eBook By email at [email protected] DO IT! Exercises  1-35 BE1.6  (LO 3), K  Eskimo Pie Corporation markets a broad range of frozen treats, including its famous Eskimo Pie ice cream bars. The following items were taken from a recent income statement and balance sheet. In each case, identify whether the item would appear on the balance sheet (BS) or income statement (IS). a. _____ Income tax expense.

f. _____ Sales revenue.

b. _____ Inventory.

g. _____ Cost of goods sold.

c. _____ Accounts payable.

h. _____ Common stock.

d. _____ Retained earnings.

i. _____ Accounts receivable.

e. _____ Equipment.

j. _____ Interest expense.

BE1.7  (LO 3), K  Indicate which statement you would examine to find each of the following items: income statement (IS), balance sheet (BS), retained earnings statement (RES), or statement of cash flows (SCF).

Determine where items appear on financial statements.

Determine proper financial statement.

a. _____ Revenue during the period. b. _____ Supplies on hand at the end of the year. c. _____ Cash received from issuing new bonds during the period. d. _____ Total debts outstanding at the end of the period. BE1.8  (LO 3), AP  Use the basic accounting equation to answer these questions.

Use basic accounting equation.

a. The liabilities of Lantz Company are $90,000 and the stockholders’ equity is $230,000. What is the amount of Lantz’s total assets? b. The total assets of Salley Company are $170,000 and its stockholders’ equity is $80,000. What is the amount of its total liabilities? c. The total assets of Brandon Co. are $800,000 and its liabilities are equal to one-fourth of its total assets. What is the amount of Brandon’s stockholders’ equity? BE1.9  (LO 3), AP  At the beginning of the year, Morales Company had total assets of $800,000 and total liabilities of $500,000. (Treat each item independently.)

Use basic accounting equation.

a. If total assets increased $150,000 during the year and total liabilities decreased $80,000, what is the amount of stockholders’ equity at the end of the year? b. During the year, total liabilities increased $100,000 and stockholders’ equity decreased $70,000. What is the amount of total assets at the end of the year? c. If total assets decreased $80,000 and stockholders’ equity increased $110,000 during the year, what is the amount of total liabilities at the end of the year? BE1.10  (LO 3), K  Indicate whether each of these items is an asset (A), a liability (L), or part of stockholders’ equity (SE). a. _____ Accounts receivable.

d. _____ Supplies.

b. _____ Salaries and wages payable.

e.  _____ Common stock.

c. _____ Equipment.

f. _____ Notes payable.

BE1.11  (LO 3), K  Which is not a required part of an annual report of a publicly traded company? a. Statement of cash flows.

c. Management discussion and analysis.

b. Notes to the financial statements.

d. All of these are required.

Identify assets, liabilities, and stockholders’ equity.

Determine required parts of annual report.

DO IT! Exercises DO IT! 1.1a  (LO 1), C  Identify each of the following organizational characteristics with the business organizational form or forms with which it is associated. a. Easier to transfer ownership.

d. Tax advantages.

b. Easier to raise funds.

e. No personal legal liability.

Identify benefits of business organization forms.

c. More owner control. DO IT 1.1b  (LO 1), C  Match each of the following terms with its definition, classification type, or associated phrase. a. _____ Accounting.

1. Creditors, regulatory authorities.

b. _____ Internal users of financial information. 2. Increased independence of outside auditors.

Identify accounting terms.

Download Complete eBook By email at [email protected] 1-36  C H A PTE R 1   Introduction to Financial Statements

c. _____ Element of Sarbanes-Oxley Act.

3. Information system that identifies, records, and communicates the economic events of an organization to interested users.

d. _____ External users of financial information. 4. Identify the stakeholders. e. _____ Steps in solving an ethical dilemma. 5. Production supervisors, company officers. Classify financial statement elements.

Prepare financial statements.

DO IT! 1.2  (LO 2), K  Classify each item as an asset, liability, common stock, revenue, or expense. a. Issuance of ownership shares.

d. Bonds payable.

b. Land purchased.

e. Amount recorded from selling a product.

c. Amounts owed to suppliers.

f. Cost of advertising.

DO IT! 1.3a  (LO 3), AP  Gray Corporation began operations on January 1, 2025. The following information is available for Gray on December 31, 2025. $ 5,000 Accounts payable 2,000 Accounts receivable Advertising expense 4,000 3,100 Cash Common stock 15,000 2,500 Dividends Equipment 26,800

Notes payable Rent expense Retained earnings Service revenue Supplies Supplies expense

$  7,000 10,000 ? 25,000 1,900 1,700

Prepare an income statement, a retained earnings statement, and a balance sheet for Gray Corporation. Identify components of annual reports.

DO IT! 1.3b  (LO 3), K  Indicate whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to the financial statements, or the auditor’s report. a. Description of ability to pay near-term obligations. b. Unqualified opinion. c. Details concerning liabilities, too voluminous to be included in the statements. d. Description of favorable and unfavorable trends. e. Certified public accountant (CPA). f. Descriptions of significant accounting policies.

Exercises Match items with descriptions.

E1.1  (LO 1, 2, 3), K  Here is a list of words or phrases discussed in this chapter: 1.  Corporation.

4. Partnership.

7.  Accounts payable.

2.  Creditor.

5. Stockholder.

8.  Auditor’s opinion.

3.  Accounts receivable.

6.  Common stock.

9.  Hybrid organizational forms.

Instructions Match each word or phrase above with the best description of it. ______ a. An expression about whether financial statements conform with generally accepted accounting principles. ______ b. A business that raises money by issuing shares of stock. ______ c. The portion of stockholders’ equity that results from receiving cash from investors. ______ d. Obligations to suppliers of goods. ______ e. Amounts due from customers. ______ f. A party to whom a business owes money. ______ g. Combines tax advantages with limited liability. ______ h. A party that invests in common stock. ______ i. A business that is owned jointly by two or more individuals but does not issue stock.

Download Complete eBook By email at [email protected] Exercises  1-37 E1.2  (LO 1), C  Consider the following statements.

Identify forms of business organization.

Sole Proprietorship Partnership

1. No personal liability.

Corporation

2. Owners pay personal income tax on company income. 3. Generally the easiest form of organization to raise capital. 4. Ownership indicated by shares. 5. Owned by one person. 6. Limited life. 7. Usually the easiest form of organization to set up.

Instructions Complete the above by indicating if each of the statements is normally true (T) or false (F) for each type of business organization: sole proprietorship, partnership, and corporation. E1.3  (LO 1), C  The following list presents different types of evaluations made by various users of accounting information.

Identify users of accounting information.

1.  Determining if the company can pay for purchases made on account. 2.  Determining if the company has complied with income tax regulations. 3.  Determining if the company might afford a 1% hourly wage increase. 4.  Determining if an advertising campaign was cost-effective. 5.  Determining if the company’s net income might result in a share price increase. 6.  Determining if the company should use debt or equity financing.

Instructions Complete the following by indicating (a) the number of the evaluation (1 to 6) that the user would most likely make, and (b) if the user is internal or external.

Investor

(a) Type of Evaluation (b) Type of User

Marketing manager Creditor Chief financial officer Internal Revenue Service Labor union E1.4  (LO 1, 2, 3), K  The following terms or phrases are discussed in this chapter. 1.  Certified public accountant (CPA).

7. Sole proprietorship.

2.  Management discussion and analysis (MD&A).

8. Basic accounting equation.

3.  Revenue.

9. Expenses.

4.  Dividends.

10. Liabilities.

5.  Stockholders’ equity.

11. Sarbanes-Oxley Act (SOX).

6.  Net loss.

Instructions Match each term or phrase to its description below. a. ______ Assets = Liabilities + Stockholders’ Equity. b. ______ An individual who has met certain criteria and is thus allowed to perform audits of corporations.

Match items with descriptions.

Download Complete eBook By email at [email protected] 1-38  C H A PTE R 1   Introduction to Financial Statements c. ______ Payments of cash from a corporation to its stockholders. d. ______ The cost of assets consumed or services used in the process of generating revenues. e. ______ Amounts owed to creditors in the form of debts and other obligations. f. ______ A section of the annual report that presents management’s views on the company’s ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations. g. ______ The amount by which expenses exceed revenues. h. ______ The increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the normal course of business. i. ______ Regulations passed by Congress to reduce unethical corporate behavior. j. ______ A business owned by one person. k. ______ The owners’ claim to assets. Identify business activities.

E1.5  (LO 2), C  All businesses are involved in three types of activities—financing, investing, and operating. Listed below are the names and descriptions of companies in several different industries. Abitibi-Consolidated Inc.—manufacturer and marketer of newsprint California State University—Northridge Student Union—university student union Oracle Corporation—computer software developer and retailer Aquilini Investment Group—owner of the Vancouver Canucks ice hockey team Grant Thornton LLP—professional accounting and business advisory firm Southwest Airlines—low-cost airline

Instructions a. For each of the above companies, provide examples of (1) a financing activity, (2) an investing activity, and (3) an operating activity that the company likely engages in. b. Which of the activities that you identified in (a) are common to most businesses? Which activities are not? Classify business activities.

E1.6  (LO 2), K  Consider the following business activities that occur at a Colorado ski area. 1.  ______  Cash receipts from customers paying for daily ski passes. 2.  ______  Payments made to purchase additional snow-making equipment. 3.  ______  Payments made to repair the snow-grooming machines. 4.  ______  Receipt of funds from the bank to finance the purchase of additional snow-making equipment. 5.  ______  Issue of shares to raise funds for a planned expansion. 6.  ______  Repayment of a portion of the bank loan (see item 4). 7.  ______  Payment of salaries to the ski-lift operators. 8.  ______  Payment of dividend to shareholders.

Instructions Classify each of the above items by type of business activity: operating (O), investing (I), or financing (F). Classify accounts.

E1.7  (LO 2, 3), C  The Bonita Vista Golf & Country Club details the following accounts in its financial statements. _____ Accounts payable Accounts receivable _____ Equipment _____ Sales revenue _____ Service revenue _____ Inventory _____ Mortgage payable _____ Supplies expense _____ Rent expense _____ Salaries and wages expense _____

Instructions Classify each of the accounts as an asset (A), liability (L), stockholders’ equity (SE), revenue (R), or expense (E) item.

Download Complete eBook By email at [email protected] Exercises  1-39 Identify financial statements.

E1.8  (LO 3), K  Consider the following typical accounts and statement items. 1. ______ Interest income. 2. ______ Cash. 3. ______ Cash provided by operating activities. 4. ______  Service revenue. 5. ______ Common stock. 6. ______ Dividends. 7. ______ Retained earnings, beginning of period. 8. ______ Accounts receivable.

9. ______ Inventory. 10. ______ Income tax expense. 11. ______ Interest expense. 12. ______  Net cash used by investing activities. 13. ______ Equipment. 14. ______ Total stockholders’ equity. 15. ______ Bank loan payable.

Instructions Indicate on which statement—income statement (IS), balance sheet (BS), retained earning statement (RE), and/or statement of cash flows (SCF)—you would find each of the above accounts or items. E1.9  (LO 3), AP  This information relates to Benser Co. for the year 2025.

Prepare income statement and retained earnings statement.

$67,000 Retained earnings, January 1, 2025 Advertising expense 1,800 Dividends 6,000 Rent expense 10,400 58,000 Service revenue Utilities expense 2,400 Salaries and wages expense 30,000

Instructions Prepare an income statement and a retained earnings statement for the year ending December 31, 2025. E1.10  (LO 3), AP  Suppose the following information was taken from the 2025 financial statements of pharmaceutical giant Merck & Co. (All dollar amounts are in millions.)

Prepare income statement and retained earnings statement.

Retained earnings, January 1, 2025 $43,698.8 9,018.9 Cost of goods sold Selling and administrative expenses 8,543.2 Dividends 3,597.7 Sales revenue 38,576.0 Research and development expense 5,845.0 2,267.6 Income tax expense

Instructions a. After analyzing the data, prepare an income statement and a retained earnings statement for the year ending December 31, 2025. b. Suppose that Merck decided to reduce its research and development expense by 50%. What would be the short-term implications? What would be the long-term implications? How do you think the stock market would react? E1.11  (LO 3), AP  Presented here is information for Zheng Inc. for 2025.

Prepare a retained earnings statement.

$130,000 Retained earnings, January 1 Service revenue 400,000 Total expenses 175,000 Dividends 65,000

Instructions Prepare the 2025 retained earnings statement for Zheng Inc. E1.12  (LO 3), AP  The following information is available for Randall Inc. Accounts receivable Accounts payable Interest payable Salaries and wages expense Notes payable Common stock Inventory

$ 2,400 Cash 3,700 Supplies 580 Unearned service revenue 4,500 Salaries and wages payable 31,500 Depreciation expense 50,700 Equipment (net) 2,840

Prepare a balance sheet.

$  6,250 3,760 850 745 670 108,200

Download Complete eBook By email at [email protected] 1-40  C H A PTE R 1   Introduction to Financial Statements

Instructions Using the information above, prepare a balance sheet as of December 31, 2025. (Hint: Solve for the missing retained earnings amount after first determining total assets and total liabilities.) Interpret financial data.

E1.13  (LO 3), AN  Consider each of the following independent situations. a. The retained earnings statement of Lee Corporation shows dividends of $68,000, while net income for the year was $75,000. b. The statement of cash flows for Steele Corporation shows that cash provided by operating activities was $10,000, cash used in investing activities was $110,000, and cash provided by financing activities was $130,000.

Instructions For each company, provide a brief discussion interpreting these financial data. For example, you might discuss the company’s financial health or its apparent growth philosophy. Identify financial statement components and prepare income statement.

E1.14  (LO 3), AP  The following items and amounts were taken from Lonyear Inc.’s 2025 income statement and balance sheet. ______ Cash ______ Retained earnings ______ Cost of goods sold ______ Salaries and wages expense ______ Prepaid insurance ______ Inventory

$  84,700 123,192 438,458 115,131 7,818 64,618

______ Accounts receivable ______ Sales revenue ______ Notes payable ______ Accounts payable ______ Service revenue ______ Interest expense

$  88,419 584,951 6,499 49,384 4,806 1,882

Instructions a. In each, case, identify on the blank line whether the item is an asset (A), liability (L), stockholders’ equity (SE), revenue (R), or expense (E) item. b. Prepare an income statement for Lonyear Inc. for the year ended December 31, 2025. Identify financial statement components and prepare income statement.

E1.15  (LO 3), AP  The following items and amounts were taken from Familia Inc.’s 2025 income statement and balance sheet, the end of its first year of operations. ______ Interest expense ______ Interest payable ______ Notes payable ______ Sales revenue ______ Cash ______ Salaries and wages expense

$  2,200 700 11,800 44,300 2,900 15,600

______ Equipment, net ______ Depreciation expense ______ Supplies ______ Common stock ______ Supplies expense

$54,700 3,200 4,100 26,800 900

Instructions a. In each case, identify on the blank line whether the item is an asset (A), liability (L), stockholders’ equity (SE), revenue (R), or expense (E) item. b. Prepare an income statement for Familia Inc. for December 31, 2025. Calculate missing amounts.

E1.16  (LO 3), AN  Here are incomplete financial statements for Donavan, Inc.

Donavan, Inc. Balance Sheet Assets

Liabilities and Stockholders’ Equity

$ 7,000 Cash Inventory 10,000 Buildings (net) 45,000 Total assets

$62,000

Liabilities   Accounts payable Stockholders’ equity   Common stock   Retained earnings Total liabilities and   stockholders’ equity

$ 5,000 (a) (b) $62,000

Download Complete eBook By email at [email protected] Exercises  1-41 Income Statement Revenues $85,000 (c) Cost of goods sold Salaries and wages expense 10,000 Net income

$ (d)

Retained Earnings Statement Beginning retained earnings Add: Net income Less: Dividends

$12,000 (e) 5,000

Ending retained earnings

$27,000

Instructions Calculate the missing amounts. E1.17  (LO 3), AN  Here are incomplete financial statements for Oway Corporation.

Calculate missing amounts.

Oway Corporation Balance Sheet Assets

Liabilities and Stockholders’ Equity

$ 29,000 Cash Supplies (a) 65,000 Equipment (net)

Liabilities   Notes payable $22,000 Stockholders’ equity   Common stock   38,000   Retained earnings (c) Total liabilities and   stockholders’ equity $ (d)

Total assets

$ (b)

Income Statement Revenues $53,000 Depreciation expense (e) 10,000 Salaries and wages expense Interest expense 1,000 Net income

$25,000

Retained Earnings Statement Beginning retained earnings Add: Net income Less: Dividends

$  (f) (g) 6,000

Ending retained earnings

$37,000

Instructions Calculate the missing amounts. E1.18  (LO 3), AP  Otay Lakes Park is a private camping ground near the Mount Miguel Recreation Area. It has compiled the following financial information as of December 31, 2025. $132,000 Dividends Service revenue (from camping fees) Sales revenue (from general store) 25,000 Notes payable Accounts payable 11,000 Expenses during 2025 Cash 8,500 Supplies Equipment 114,000 Common stock Retained earnings (1/1/2025)

$ 9,000 50,000 126,000 5,500 40,000 5,000

Compute net income and prepare a retained earnings statement and balance sheet.

Download Complete eBook By email at [email protected] 1-42  C H A PTE R 1   Introduction to Financial Statements

Instructions a. Determine Otay Lakes Park’s net income for 2025. b. Prepare a retained earnings statement and a balance sheet for Otay Lakes Park as of December 31, 2025. c. Upon seeing this income statement, Walt Jones, the campground manager, immediately concluded, “The general store is more trouble than it is worth—let’s get rid of it.” The marketing director isn’t so sure this is a good idea. What do you think? Identify financial statement components and prepare an income statement.

E1.19  (LO 3), AP  Kellogg Company is the world’s leading producer of ready-to-eat cereal and a leading producer of grain-based convenience foods such as frozen waffles and cereal bars. Suppose the following items were taken from its 2025 income statement and balance sheet. (All dollars are in millions.) ____ Retained earnings $5,481 7,184 ____ Cost of goods sold ____ Selling and    administrative expenses 3,390 334 ____ Cash ____ Notes payable 44 295 ____ Interest expense

____ Bonds payable ____ Inventory ____ Sales revenue ____ Accounts payable ____ Common stock ____ Income tax expense

$  4,835 910 12,575 1,077 105 498

Instructions a. In each case, identify whether the item is an asset (A), liability (L), stockholders’ equity (SE), revenue (R), or expense (E). b. Prepare an income statement for Kellogg Company for the year ended December 31, 2025. Prepare a statement of cash flows.

E1.20  (LO 3), AP  This information is for Williams Corporation for the year ended December 31, 2025. Cash received from lenders Cash received from customers Cash paid for new equipment Cash dividends paid Cash paid to suppliers Cash balance 1/1/25

$20,000 50,000 28,000 8,000 16,000 12,000

Instructions a. Prepare the 2025 statement of cash flows for Williams Corporation. b. Suppose you are one of Williams’ creditors. Referring to the statement of cash flows, evaluate Williams’ ability to repay its creditors. Prepare a statement of cash flows.

E1.21  (LO 3), AP Suppose the following data are derived from the 2025 financial statements of ­Southwest Airlines. (All dollars are in millions.) Southwest has a December 31 year-end. Cash balance, January 1, 2025 Cash paid for repayment of debt Cash received from issuance of common stock Cash received from issuance of long-term debt Cash received from customers Cash paid for property and equipment Cash paid for dividends Cash paid for repurchase of common stock Cash paid for goods and services

$1,390 122 144 500 9,823 1,529 14 1,001 6,978

Instructions a. After analyzing the data, prepare a statement of cash flows for Southwest Airlines for the year ended December 31, 2025. b. Discuss whether the company’s net cash provided by operating activities was sufficient to finance its investing activities. If it was not, how did the company finance its investing activities? Correct an incorrectly prepared balance sheet.

E1.22  (LO 3), AP  Wayne Holtz is the bookkeeper for Beeson Company. Wayne has been trying to get the balance sheet of Beeson Company to balance. It finally balanced, but now he’s not sure it is correct.

Download Complete eBook By email at [email protected] Exercises  1-43 Beeson Company Balance Sheet December 31, 2025 Assets

Liabilities and Stockholders’ Equity

Cash $18,000 Supplies 9,500 Equipment 40,000 Dividends 8,000 Total assets

Accounts payable Accounts receivable Common stock Retained earnings Total liabilities and   stockholders’ equity

$75,500

$16,000 (12,000) 40,000 31,500 $75,500

Instructions Prepare a correct balance sheet. E1.23  (LO 3), AP  Suppose the following items were taken from the balance sheet of Nike, Inc. (All dollars are in millions.)

1. 2. 3. 4. 5. 6.

____ Cash ____ Accounts receivable ____ Common stock ____ Notes payable ____ Buildings ____ Mortgage payable

$2,291.1 2,883.9 2,874.2 342.9 3,759.9 1,311.5

7. 8. 9. 10. 11.

____ Inventory ____ Income taxes payable ____ Equipment ____ Retained earnings ____ Accounts payable

$2,357.0 86.3 1,957.7 5,818.9 2,815.8

Classify items as assets, liabilities, and stockholders’ equity, and prepare accounting equation.

Excel

Instructions Perform each of the following. a. Classify each of these items as an asset (A), liability (L), or stockholders’ equity (SE) item. b. Determine Nike’s accounting equation by calculating the value of total assets, total liabilities, and total stockholders’ equity. c. To what extent does Nike rely on debt versus equity financing? E1.24  (LO 3), AN  The summaries of data from the balance sheet, income statement, and retained earnings statement for two corporations, Walco Corporation and Gunther Enterprises, are presented as ­follows for 2025. Walco Corporation Gunther Enterprises Beginning of year   Total assets $110,000 $150,000   Total liabilities 70,000 (d)   Total stockholders’ equity (a) 70,000 End of year   Total assets (b) 180,000   Total liabilities 120,000 55,000   Total stockholders’ equity 60,000 (e) Changes during year in retained   earnings  Dividends (c) 5,000   Total revenues 215,000 (f )   Total expenses 165,000 80,000

Use financial statement relationships to determine missing amounts.

Instructions Determine the missing amounts. Assume all changes in stockholders’ equity are due to changes in retained earnings. E1.25  (LO 3), K  The annual report provides financial information in a variety of formats, including the following. Management discussion and analysis (MD&A) Financial statements Notes to the financial statements Auditor’s opinion

Classify various items in an annual report.

Download Complete eBook By email at [email protected] 1-44  C H A PTE R 1   Introduction to Financial Statements

Instructions For each of the following, state in what area of the annual report the item would be presented. If the item would probably not be found in an annual report, state “Not disclosed.” a. The total cumulative amount received from stockholders in exchange for common stock. b. An independent assessment concerning whether the financial statements present a fair depiction of the company’s results and financial position. c. The interest rate that the company is being charged on all outstanding debts. d. Total revenue from operating activities. e. Management’s assessment of the company’s results. f. The names and positions of all employees hired in the last year. Classify accounts and prepare balance sheet.

E1.26  (LO 3), AP  The following list of accounts, in alphabetical order, is for Aventura Inc. at November 30, 2025. ____ Accounts payable $ 26,200 ____ Inventory $18,000 19,500 ____ Land 44,000 ____ Accounts receivable 100,000 ____ Mortgage payable 97,500 ____ Buildings ____ Cash 20,000 ____ Notes payable 34,000 20,000 ____ Retained earnings 48,500 ____ Common stock ____ Equipment, net 30,000 ____ Supplies       700 ____ Income taxes payable  6,000

Instructions a. For each of the above accounts, identify whether it is an asset (A), liability (L), or stockholders’ equity (SE) item. b. Prepare a balance sheet at November 30, 2025.

Problems Determine forms of business organization.

P1.1  (LO 1), C  Writing   Presented below are five independent situations. a. Three physics professors at MIT have formed a business to improve the speed of information transfer over the Internet for stock exchange transactions. Each has contributed an equal amount of cash and knowledge to the venture. Although their approach looks promising, they are concerned about the legal liability that their business might confront. b. Bob Colt, a college student looking for summer employment, opened a bait shop in a small shed at a local marina. c. Alma Ortiz and Jaime Falco each owned separate shoe manufacturing businesses. They have decided to combine their businesses. They expect that within the coming year they will need significant funds to expand their operations. d. Alice, Donna, and Sam recently graduated with marketing degrees. They have been friends since childhood. They have decided to start a consulting business focused on marketing sporting goods over the Internet. e. Don Rolls has developed a low-cost GPS device that can be implanted into pets so that they can be easily located when lost. He would like to build a small manufacturing facility to make the devices and then sell them to veterinarians across the country. Don has no savings or personal assets. He wants to maintain control over the business.

Instructions In each case, explain what form of organization the business is likely to take—sole proprietorship, partnership, or corporation. Give reasons for your choice. Identify users and uses of financial statements.

P1.2  (LO 3), C  Writing   Financial decisions often place heavier emphasis on one type of financial statement over the others. Consider each of the following hypothetical situations independently. a. The North Face is considering extending credit to a new customer. The terms of the credit would require the customer to pay within 30 days of receipt of goods. b. An investor is considering purchasing common stock of Amazon.com. The investor plans to hold the investment for at least 5 years.

Download Complete eBook By email at [email protected] Problems  1-45 c. JPMorgan Chase is considering extending a loan to a small company. The company would be required to make interest payments at the end of each year for 5 years, and to repay the loan at the end of the fifth year. d. The president of Campbell Soup is trying to determine whether the company is generating enough cash to increase the amount of dividends paid to investors in this and future years, and still have enough cash to buy equipment as it is needed.

Instructions In each situation, state whether the decision-maker would be most likely to place primary emphasis on information provided by the income statement, balance sheet, or statement of cash flows. In each case provide a brief justification for your choice. Choose only one financial statement in each case. P1.3  (LO 3), AP  On June 1, 2025, Elite Service Co. was started with an initial investment in the company of $22,100 cash. Here are the assets, liabilities, and common stock of the company at June 30, 2025, and the revenues and expenses for the month of June, its first month of operations: Cash Accounts receivable Service revenue Supplies Advertising expense Equipment Common stock

$ 4,600 4,000 7,500 2,400 400 26,000 22,100

Notes payable Accounts payable Supplies expense Maintenance and repairs expense Utilities expense Salaries and wages expense

$12,000 500 1,000 600 300 1,400

Prepare an income statement, retained earnings statement, and balance sheet; discuss results.

Excel

Check figures provide a key number to let you know you are on the right track.

During June, the company issued no additional stock but paid dividends of $1,400.

Instructions a. Prepare an income statement and a retained earnings statement for the month of June and a balance sheet at June 30, 2025. b. Briefly discuss whether the company’s first month of operations was a success.

a.  Net income Ret. earnings Tot. assets

$ 3,800 $ 2,400 $37,000

c. Discuss the company’s decision to distribute a dividend. P1.4  (LO 3), AP  Reese Inc., a provider of consulting services, was founded on October 1, 2025. At the end of the first month of operations, the company decided to prepare an income statement, retained earnings statement, and balance sheet using the following information. Accounts payable $ 3,300 Interest expense 410 48,200 Equipment (net) Salaries and wages expense 2,500 Bonds payable 21,500 4,065 Unearned service revenue 1,300 Accounts receivable Cash 3,950

Supplies Supplies expense Depreciation expense Service revenue Salaries and wages payable Common stock Interest payable

Prepare an income statement, retained earnings statement, and balance sheet.

$ 2,460 380 270 20,920 445 9,100 140

Instructions Using the information, prepare an income statement and retained earnings statement for the month of October 2025 and a balance sheet as of October 31, 2025.

End. retained earnings$17,360

P1.5  (LO 3), AP  Presented below is selected financial information for Rojo Corporation for December 31, 2025.

Determine items included in a statement of cash flows, prepare the statement, and comment.

Inventory Cash paid to suppliers Buildings Common stock Cash dividends paid Cash at beginning of period

$ 25,000 Cash paid to purchase equipment 104,000 Equipment 200,000 Service revenue 50,000 Cash received from customers 7,000 Cash received from issuing 9,000   common stock

$ 12,000 40,000 100,000 132,000 22,000

Instructions a. Prepare the statement of cash flows for Rojo Corporation. b. Comment on the adequacy of net cash provided by operating activities to fund the company’s investing activities and dividend payments.

a.  Net cash increase

$31,000

Download Complete eBook By email at [email protected] 1-46  C H A PTE R 1   Introduction to Financial Statements Comment on proper accounting treatment and prepare a corrected balance sheet.

P1.6  (LO 3), AN    Micado Corporation was formed on January 1, 2025. At December 31, 2025, Miko Liu, the president and sole stockholder, decided to prepare a balance sheet, which appeared as follows. Micado Corporation Balance Sheet December 31, 2025

Assets

Cash Accounts receivable Inventory Boat

Liabilities and Stockholders’ Equity $20,000 50,000 36,000 24,000

Accounts payable Notes payable Boat loan Stockholders’ equity

$30,000 15,000 22,000 63,000

Miko willingly admits that she is not an accountant by training. She is concerned that her balance sheet might not be correct. She has provided you with the following additional information. 1. The boat actually belongs to Miko, not to Micado Corporation. However, because she thinks she might take customers out on the boat occasionally, she decided to list it as an asset of the company. To be consistent, she also listed as a liability of the corporation her personal loan that she took out at the bank to buy the boat. 2. The inventory was originally purchased for $25,000, but due to a surge in demand Miko now thinks she could sell it for $36,000. She thought it would be best to record it at $36,000. 3. Included in the accounts receivable balance is $10,000 that Miko loaned to her brother 5 years ago. Miko included this in the receivables of Micado Corporation so she wouldn’t forget that her brother owes her money.

Instructions a.  Comment on the proper accounting treatment of the three items above.

b.  Tot. assets

$85,000

Provide a corrected balance sheet for Micado Corporation. (Hint: To get the balance sheet to balance, b.  adjust stockholders’ equity.)

Continuing Case

The Cookie Creations case starts in Chapter 1 and continues in every chapter. Complete case details and instructions are available in Wiley Course Resources.

leungchopan/ leungchopan/ Shutterstock.com Shutterstock.com

Cookie Creations CC1  Natalie Koebel spent much of her childhood learning the art of cookie-making from her grandmother. They spent many happy hours mastering every type of cookie imaginable and later devised new recipes that were both healthy and delicious. Now at the start of her second year in college, Natalie is investigating possibilities for starting her own business as part of the entrepreneurship program in which she is enrolled. A long-time friend insists that Natalie has to include cookies in her business plan. After a series of brainstorming sessions, Natalie settles on the idea of operating a cookie-making school. She will start on a part-time basis and offer her services in people’s homes. Now that she has started thinking about it, the possibilities seem endless. During the fall, she will concentrate on holiday cookies. She will offer group sessions (which will probably be more entertainment than education) and individual lessons. Natalie also decides to include children in her target market. The first difficult decision is coming up with the perfect name for her business. She settles on “Cookie Creations,” and then moves on to more important issues.

Instructions a. What form of business organization—proprietorship, partnership, or corporation—do you recommend that Natalie use for her business? Discuss the benefits and weaknesses of each form that Natalie might consider. b.  Will Natalie need accounting information? If yes, what information will she need and why? How often will she need this information? c. Identify specific asset, liability, revenue, and expense accounts that Cookie Creations will likely use to record its business transactions.

Download Complete eBook By email at [email protected] Expand Your Critical Thinking  1-47 d.  Should Natalie open a separate bank account for the business? Why or why not? e. Natalie expects she will have to use her car to drive to people’s homes and to pick up supplies, but she also needs to use her car for personal reasons. She recalls from her first-year accounting course something about keeping business and personal assets separate. She wonders what she should do for accounting purposes. What do you recommend?

Expand Your Critical Thinking Financial Reporting Problem: Apple Inc. CT1.1  The financial statements of Apple Inc. are presented in Appendix A.

Instructions Refer to Apple’s financial statements and answer the following questions. a.  What were Apple’s total assets at September 26, 2020? At September 28, 2019? b.  How much cash (and cash equivalents) did Apple have on September 26, 2020? c.  What amount of accounts payable did Apple report on September 26, 2020? On September 28, 2019? d. What were Apple’s net sales in the year ending September 26, 2020? In the year ending September 28, 2019? In the year ending September 29, 2018? e.  What is the amount of the change in Apple’s net income from 2019 to 2020?

Comparative Analysis Problem: Columbia Sportswear Company vs. Under Armour, Inc. CT1.2  Columbia Sportswear Company’s financial statements are presented in Appendix B. Financial statements of Under Armour, Inc. are presented in Appendix C.

Instructions a.  Based on the information in these financial statements, determine the following for each company.

1.  Total liabilities at December 31, 2020.



2.  Net property, plant, and equipment at December 31, 2020.



3.  Net cash provided or (used) in investing activities for 2020.



4.  Net income for 2020.

b.  What conclusions concerning the two companies can you draw from these data?

Comparative Analysis Problem: Amazon.com, Inc. vs. Walmart Inc. CT1.3  Amazon.com, Inc.’s financial statements are presented in Appendix D. Financial statements of Walmart Inc. are presented in Appendix E.

Instructions a. Based on the information contained in these financial statements, determine the following for each company.

1. Total assets at December 31, 2020, for Amazon and for Walmart at January 31, 2021.



2. Receivables (net) at December 31, 2020, for Amazon and for Walmart at January 31, 2021.



3.  Net sales (product only) for the year ended in 2020 (2021 for Walmart).



4.  Net income for year ended in 2020 (2021 for Walmart).

b.  What conclusions concerning these two companies can be drawn from these data?

Interpreting Financial Statements CT1.4  Xerox was not having a particularly pleasant year. The company’s stock price had already fallen in the previous year from $60 per share to $30. Just when it seemed things couldn’t get worse, Xerox’s stock fell to $4 per share. The following data were taken from the statement of cash flows of Xerox. (All dollars are in millions.)

Download Complete eBook By email at [email protected] 1-48  C H A PTE R 1   Introduction to Financial Statements Cash used in operating activities Cash used in investing activities Financing activities   Dividends paid $ (587)   Net cash received from issuing debt 3,498

$ (663) (644)

   Cash provided by financing activities

2,911

Instructions Analyze the information and then answer the following questions. a.  If you were a creditor of Xerox, what reaction might you have to the above information? b.  If you were an investor in Xerox, what reaction might you have to the above information? c. If you were evaluating the company as either a creditor or a stockholder, what other information would you be interested in seeing? d. Xerox decided to pay a cash dividend. This dividend was approximately equal to the amount paid in the previous year. Discuss the issues that were probably considered in making this decision.

Real-World Focus CT1.5  You can easily search the Internet to find summary information about companies. This information includes basic descriptions of the company’s location, activities, industry, financial health, and financial performance.

Instructions Go to the Yahoo! Finance website, type in a company name, and then use the links (such as Financials) to locate the information necessary to answer the following questions. a.  What is the company’s net income? Over what period was this measured? b.  What is the company’s total sales? Over what period was this measured? c.  What is the company’s industry? d.  What are the names of four companies in this industry? e. Choose one of the competitors. What is this competitor’s name? What is its total sales? What is its net income? CT1.6  The Wall Street Journal published an article by Michael Rapoport entitled “Coming Soon: What Auditors Really Think About Company Numbers.” It provides a discussion about changes to be made to the auditor’s report.

Instructions Read the article and then answer the following questions. a.  What did the old auditor’s report primarily focus on? b. What does the new report provide beyond the old report? What are some examples of items that might be discussed? c. How do the requirements of the new report compare to the requirements of auditor reports in other countries? d.  What criteria must be met in other for an item to be disclosed in the new report?

Decision-Making Across the Organization CT1.7  Sylvia Ayala recently accepted a job in the production department at Johnson & Johnson. Before she starts work, she decides to review the company’s annual report to better understand its operations. The content and organization of corporate annual reports have become fairly standardized. Excluding the public relations part of the report (pictures, products, etc.), the following are the traditional financial portions of the annual report. • Financial Highlights • Letter to the Stockholders • Management’s Discussion and Analysis • Financial Statements • Notes to the Financial Statements • Management’s Responsibility for Financial Reporting • Management’s Report on Internal Control over Financial Reporting

Download Complete eBook By email at [email protected] Expand Your Critical Thinking  1-49 • Report of Independent Registered Public Accounting Firm • Selected Financial Data The official SEC filing of the annual report is called a Form 10-K, which often omits the public relations pieces found in most standard annual reports.

Instructions Search the Internet to find Johnson & Johnson’s 10-K report dated for the year ended January 3, 2021, to answer the following questions. a. What CPA firm performed the audit of Johnson & Johnson’s financial statements? b. What was the amount of Johnson & Johnson’s basic earnings per share for the year ended January 3, 2021? c. What are the company’s net sales in foreign countries during the year ended January 3, 2021? d. What were net sales during the year ended December 30, 2018? e. How many shares of common stock have been authorized? f. How much cash was spent on capital expenditures during the year ended January 3, 2021? g. Over what life does the company depreciate its buildings? h. What was the value of inventory on December 29, 2019?

Communication Activity CT1.8  Marci Ling is the bookkeeper for Samco Company, Inc. Marci has been trying to get the com­ pany’s balance sheet to balance. She finally got it to balance, but she still isn’t sure that it is correct. Samco Company, Inc. Balance Sheet For the Month Ended December 31, 2025 Assets Equipment Cash Supplies Accounts payable

Liabilities and Stockholders’ Equity $18,000 Common stock 9,000 Accounts receivable 1,000 Dividends (4,000) Notes payable Retained earnings $24,000

$12,000 (6,000) (2,000) 10,000 10,000

Total assets Total liabilities and   stockholders’ equity $24,000

Instructions Explain to Marci Ling in a memo (a) the purpose of a balance sheet, and (b) why this balance sheet is incorrect and what she should do to correct it.

Ethics Cases CT1.9  Rules governing the investment practices of individual certified public accountants prohibit them from investing in the stock of a company that their firm audits. The Securities and Exchange Commission (SEC) became concerned that some accountants were violating this rule. In response to an SEC investigation, PricewaterhouseCoopers (PwC) fired 10 people and spent $25 million educating employees about the investment rules and installing an investment tracking system.

Instructions Answer the following questions. a. Why do you think rules exist that restrict auditors from investing in companies that are audited by their firms? b.  Some accountants argue that they should be allowed to invest in a company’s stock as long as they themselves aren’t involved in working on the company’s audit or consulting. What do you think of this idea? c. Today, a very high percentage of publicly traded companies are audited by only four very large public accounting firms. These firms also do a high percentage of the consulting work that is done for publicly traded companies. How does this fact complicate the decision regarding whether CPAs should be allowed to invest in companies audited by their firm?

Download Complete eBook By email at [email protected] 1-50  C H A PTE R 1   Introduction to Financial Statements d. Suppose you were a CPA and you had invested in IBM when IBM was not one of your firm’s clients. Two years later, after IBM’s stock price had fallen considerably, your firm won the IBM audit contract. You will be involved in working with the IBM audit. You know that your firm’s rules require that you sell your shares immediately. If you do sell immediately, you will sustain a large loss. Do you think this is fair? What would you do? e. Why do you think PwC took such extreme steps in response to the SEC investigation? CT1.10  Ethical behavior is fundamental to communications between investors and companies. However, it is difficult for company founders to control their enthusiasm in discussions related to their company, such that sometimes new companies overstate their potential for future success, either intentionally or unintentionally, in order to generate investor interest. For example, Nikola Corporation, a pioneer in electric semi-trucks, was investigated by U.S. securities regulators because critics claimed that the company’s chairperson made false claims about the company’s progress in his efforts to make Nikola “the Tesla of semi-trucks.” Shortly after its stock began trading publicly, the company was estimated to be worth $30 billion, even though it had yet to produce its first electric truck. Similarly, Tesla’s founder and CEO, Elon Musk, has been investigated by the Securities and Exchange Commission a number of times regarding the accuracy of his communications, including Tweets.

Instructions In groups, discuss the following topics. a. Should companies be held accountable for the fairness of their communications, or instead should it be the responsibility of investors to determine whether company statements are true and fair? b. Suppose that you founded a new company. What steps would you take to ensure that your communications were accurate, while still generating enthusiasm with investors? c. Search the Internet to find information about the allegations and any results of regulatory investigations regarding the accuracy of Elon Musk’s communications about Tesla. Provide a brief summary of your findings. d.  What are the potential costs to society of inaccurate company communications to investors?

All About You CT1.11  Some people are tempted to make their finances look worse to get financial aid. Companies sometimes also manage their financial numbers in order to accomplish certain goals. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. In managing earnings, companies’ actions vary from being within the range of ethical activity, to being both unethical and illegal attempts to mislead investors and creditors.

Instructions Provide responses for each of the following questions. a. Discuss whether you think each of the following actions (adapted from the FinAid website) to increase the chances of receiving financial aid is ethical.

1. Spend down the student’s assets and income first, before spending parents’ assets and income.



2. Accelerate necessary expenses to reduce available cash. For example, if you need a new car, buy it before applying for financial aid.



3. State that a truly financially dependent child is independent.



4. Have a parent take an unpaid leave of absence for long enough to get below the “threshold” level of income.

b.  What are some reasons why a company might want to overstate its earnings? c.  What are some reasons why a company might want to understate its earnings? d. Under what circumstances might an otherwise ethical person decide to illegally overstate or understate earnings?

FASB Codification Activity CT1.12  The FASB has developed the Financial Accounting Standards Board Accounting Standards Codification (or more simply “the Codification”). The FASB’s primary goal in developing the Codification is to provide in one place all the authoritative literature related to a particular topic. To provide easy access to the Codification, the FASB also developed the Financial Accounting Standards Board Codification Research System (CRS). CRS is an online, real-time database that provides easy access to the

Download Complete eBook By email at [email protected] Expand Your Critical Thinking  1-51 Codification. The Codification and the related CRS provide a topically organized structure, subdivided into topic, subtopics, sections, and paragraphs, using a numerical index system. You may find this system useful in your present and future studies, and so we have provided an opportunity to use this online system as part of the Expand Your Critical Thinking section.

Instructions Academic access to the FASB Codification is available through university subscriptions, obtained from the American Accounting Association. This subscription covers an unlimited number of students within a single institution. Once this access has been obtained by your school, you should log in and familiarize yourself with the resources that are accessible at the FASB Codification site.

Considering People, Planet, and Profit CT1.13  Although Clif Bar & Company is not a public company, it does share its financial information with its employees as part of its open-book management approach. Further, although it does not publicly share its financial information, it does provide a different form of an annual report to external users. In this report, the company provides information regarding its sustainability efforts.

Instructions Go to the “Who We Are” page at the Clif Bar website and then identify the company’s five aspirations.

Answers to Insight and Accounting Across the Organization Questions Owning a Piece of the Bar  Q: What are the benefits to the company and to the employees of making the financial statements available to all employees?  A: If employees can read and use financial reports, a company will benefit in the following ways. The marketing department will make better decisions about products to offer and prices to charge. The finance department will make better decisions about debt and equity financing and how much to distribute in dividends. The production department will make better decisions about when to buy new equipment and how much inventory to produce. The human resources department will be better able to determine whether employees can be given raises. Finally, all employees will be better informed about the basis on which they are evaluated, which will increase employee morale. Using Data Science to Create Art  Q: How can “big data” improve decision-making?  A: Companies analyze the large amounts of data now available to improve cost estimation for future projects as well as identify bottlenecks and opportunities to increase the efficiency of production processes. I Felt the Pressure—Would You?  Q: Why did these employees lie, and what do you believe should be their penalty for these lies?  A: They felt pressured by their supervisors to make the company’s financial statements look better than warranted. They should be prosecuted for fraudulent activities under the Sarbanes-Oxley Act, as they knowingly misstated financial statement data. Beyond Financial Statements  Q: Why might a company’s stockholders be interested in its environmental and social performance?  A: Many companies now recognize that being a socially responsible organization is not only the right thing to do, but it also is good for business. Many investment professionals understand, for example, that environmental, social, and proper corporate governance of companies affects the performance of their investment portfolios. For example, British Petroleum’s oil spill disaster is a classic example of the problems that can occur for a company and its stockholders. BP’s stock price was slashed, its dividend reduced, its executives replaced, and its reputation badly damaged. It is interesting that socially responsible investment funds are now gaining momentum in the marketplace such that companies now recognize this segment as an important investment group. Spinning the Career Wheel  Q: How might accounting help you?  A: You will need to understand financial reports in any enterprise with which you are associated. Whether you become a manager, a doctor, a lawyer, a social worker, a teacher, an engineer, an architect, or an entrepreneur, a working knowledge of accounting is relevant.

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