Financial Accounting: Information for Decisions

edition Financial Accounting: Information for Decisions John J. Wild University of Wisconsin at Madison McGraw-Hill I Brwin Boston Burr Ridge, IL D...
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edition

Financial Accounting: Information for Decisions

John J. Wild University of Wisconsin at Madison

McGraw-Hill I Brwin Boston Burr Ridge, IL Dubuque, IA Madison, Wl New York San Francisco St. Louis Bangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

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Contents Introducing Accounting in Business 2

Analyzing and Recording Transactions 46

Importance of Accounting 4 Users of Accounting Information 5 Opportunities in Accounting 6 Fundamentals of Accounting 8 Ethics—A Key Concept 8 Generally Accepted Accounting Principles 8 Sarbanes-Oxley (SOX) 11 Transaction Analysis and the Accounting Equation 12 Accounting Equation 12 Transaction Analysis 13 Summary of Transactions 17 Financial Statements 17 Income Statement 18 Statement of Retained Earnings 18 Balance Sheet 18 Statement of Cash Flows 18 Decision Analysis—Return on Assets 20

Analyzing and Recording Process 48 Source Documents 49 The Account and Its Analysis 49 Analyzing and Processing Transactions 52 Ledger and Chart of Accounts 52 Debits and Credits 53 Double-Entry Accounting 53 Journalizing and Posting Transactions 54 Analyzing Transactions—An Illustration 57 Accounting Equation Analysis 61 Trial Balance 63 Preparing a Trial Balance 63 Using a Trial Balance to Prepare Financial Statements 64 Decision Analysis—Debt Ratio 66

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Contents

Adjusting Accounts and Preparing Financial Statements 90 Timing and Reporting 92 The Accounting Period 92 Accrual Basis versus Cash Basis 93 Recognizing Revenues and Expenses 93 Adjusting Accounts 94 Framework for Adjustments 94 Prepaid (Deferred) Expenses 95 Unearned (Deferred) Revenues 98 Accrued Expenses 99 Accrued Revenues 101 Links to Financial Statements 102 Adjusted Trial Balance 103 Preparing Financial Statements 104 Closing Process 104 Temporary and Permanent Accounts 104 Recording Closing Entries 106 Post-Closing Trial Balance 109 Accounting Cycle Summary 109 Classified Balance Sheet 110 Classification Structure 110 Classification Categories 111 Decision Analysis—Profit Margin and Current Ratio 11.3 Appendix 3A

Alternative Accounting for Prepayments 118

'Appendix 3B

Work Sheet as a Tool 119

Appendix 3C

Reversing Entries 122

4

Reporting and Analyzing Merchandising Operations 150 Merchandising Activities 152 Reporting Income for a Merchandiser 152 Reporting Inventory for a Merchandiser 153 Operating Cycle for a Merchandiser 153 Inventory Systems 153 Accounting for Merchandise Purchases 154 Trade Discounts 154 Purchase Discounts 155 Purchase Returns and Allowances 156 Transportation Costs and Ownership Transfer 157 Accounting for Merchandise Sales 158 Sales of Merchandise 159 Sales Discounts 159 Sales Returns and Allowances 160 Completing the Accounting Cycle 161 Adjusting Entries for Merchandisers 162 Preparing Financial Statements 162 Closing Entries for Merchandisers 162 Summary of Merchandising Entries 162 Financial Statement Formats 164 Multiple-Step Income Statement 165 Single-Step Income Statement 166 Classified Balance Sheet 166 Decision Analysis—Acid-Test and Gross Margin Ratios 167 Appendix 4A

Periodic (and Perpetual) Inventory System 172

Appendix 4B

Worksheet—Perpetual System 176

Contents

Reporting and Analyzing Inventories 196 Inventory Basics 198 Determining Inventory Items 198 Determining Inventory Costs 199 Internal Controls and Taking a Physical Count 199 Inventory Costing under a Perpetual System 200 Inventory Cost Flow Assumptions 200 Inventory Costing Illustration 201 Specific Identification 201 First-In, First-Out 203 Last-In, First-Out 203 Weighted Average 204 Financial Statement Effects of Costing Methods 205 Consistency in Using Costing Methods 206 Valuing Inventory at LCM and the Effects of Inventory Errors '207 Lower of Cost of Market 207 Financial Statement Effects of Inventory Errors 208 Decision Analysis—Inventory Turnover and Days' Sales in Inventory 210 Appendix 5A

Inventory Costing under a Periodic System 215

Appendix 5B

Inventory Estimation Methods 219

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Reporting and Analyzing Cash and Internal Controls 238 Internal Control 240 Purpose of Internal Control 240 Principles of Internal Control 241 Technology and Internal Control 242 Limitations of Internal Control 243 Control of Cash 244 Cash, Cash Equivalents, and Liquidity 245 Control of Cash Receipts 245 Control of Cash Disbursements 247 Banking Activities as Controls 251 Basic Bank Services 251 Bank Statement 253 Bank Reconciliation 254 Decision Analysis—Days' Sales Uncollected 257 Appendix 6A

Documents in a Voucher System 260

Appendix 6B

Control of Purchase Discounts 263

Reporting and Analyzing Receivables 280 Accounts Receivable 282 Recognizing Accounts Receivable 282 Valuing Accounts Receivable 285 Estimating Bad Debts Expense 289 Notes Receivable 292 Computing Maturity and Interest 292 Recognizing Notes Receivable 293 Valuing and Settling Notes 294 Disposing of Receivables 295 Selling Receivables 295 Pledging Receivables 295 Decision Analysis—Accounts Receivable Turnover 296

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Contents

8

Reporting and Analyzing Long-Term Assets 312

Reporting and Analyzing Current Liabilities 354

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SECTION 1—PLANT ASSETS 314 Cost Determination 315 Land 315 Land Improvements 316 Buildings 316 Machinery and Equipment 316 Lump-Sum Purchase 316 Depreciation 317 Factors in Computing Depreciation 317 Depreciation Methods 318 Partial-Year Depreciation 322 Change in Estimates for Depreciation 323 Reporting Depreciation 323 Additional Expenditures 324 Ordinary Repairs 325 Betterments and Extraordinary Repairs 325 Disposals of Plant Assets 325 Discarding Plant Assets 326 Selling Plant Assets 326 SECTION 2—NATURAL RESOURCES 328 Cost Determination and Depletion 328 Plant Assets Used in Extracting Resources 329 SECTION 3—INTANGIBLE ASSETS 329 Cost Determination and Amortization 329 Types of Intangibles 330 Decision Analysis—Total Asset Turnover 332 Appendix 8A Exchanging Plant Assets 335

Characteristics of Liabilities 356 Defining Liabilities 356 Classifying Liabilities 356 Uncertainty in Liabilities 357 Known (Determinable) Liabilities 358 Accounts Payable 358 Sales Taxes Payable 358 Unearned Revenues 359 Short-Term Notes Payable 359 Payroll Liabilities 361 Multi-Period Known Liabilities 364 Estimated Liabilities 365 Health and Pension Benefits 365 Vacation Benefits 366 Bonus Plans 366 Warranty Liabilities 366 Multi-Period Estimated Liabilities 367 Contingent Liabilities 367 Accounting for Contingent Liabilities 368 Reasonably Possible Contingent Liabilities 368 Decision Analysis—Times Interest Earned Ratio 369 Appendix 9A

Payroll Reports, Records, and Procedures 372

Appendix 9B

Income Taxes 378

Contents

I 0 Reporting and Analyzing Long-Term Liabilities 398. Basics of Bonds 400 Bond Financing 400 Bond Trading 401 Bond-Issuing Procedures 402 Bond Issuances 402 Issuing Bonds at Par 402 Bond Discount or Premium 403 Issuing Bonds at a Discount 403 Issuing Bonds at a Premium 406 Bond Pricing 408 Bond Retirement 409 Bond Retirement at Maturity 409 Bond Retirement before Maturity 409 Bond Retirement by Conversion 410 Long-Term Notes Payable 410 Installment Notes 410 Mortgage Notes and Bonds 412 Decision Analysis—Debt Features and the Debt-to-Equity Ratio 413 Appendix 10A

Present Values of Bonds and Notes 417

Appendix 10B

Effective Interest Amortization 419

Appendix 10C

Issuing Bonds between Interest Dates ^421

Appendix 10D

Leases and Pensions 423

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Reporting and Analyzing Equity 440 Corporate Form of Organization 442 Characteristics of Corporations 442 Corporate Organization and Management 443 Stockholders of Corporations 444 Basics of Capital Stock 445 Common Stock 446 Issuing Par Value Stock 446 Issuing No-Par Value Stock 447 Issuing Stated Value Stock 447 Issuing Stock for Noncash Assets 448 Dividends 449 Cash Dividends 449 Stock Dividends 450 Stock Splits 452 Preferred Stock 452 Issuance of Preferred Stock 453 , Dividend Preference of Preferred Stock 453 Convertible Preferred Stock 455 Callable Preferred Stock 455 Reasons for Issuing Preferred Stock 455 Treasury Stock 456 Purchasing Treasury Stock 456 Reissuing Treasury Stock 457 Retiring Stock 458 Reporting of Equity 458 Statement of Retained Earnings 458 Statement of Stockholders' Equity 459 Reporting Stock Options 459 Decision Analysis—Earnings per Share, Price-Earnings Ratio, Dividend Yield, and Book Value per Share 460

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S 2 Reporting and Analyzing Cash Flows 484 Basics of Cash Flow Reporting 486 Purpose of the Statement of Cash Flows 486 Importance of Cash Flows 486 Measurement of Cash Flows 487 Classification of Cash Flows 487 Noncash Investing and Financing 489 Format of the Statement of Cash Flows 489 Preparing the Statement of Cash Flows 490 Cash Flows from Operating 492 Indirect and Direct Methods of Reporting 492 Application of the Indirect Method of Reporting 493 Summary of Adjustments for Indirect Method 498 Cash Flows from Investing 499 Three-Stage Process of Analysis 499 Analysis of Noncurrent Assets 499 Analysis of Other Assets 500 Cash Flows from Financing 501 Three-Stage Process of Analysis 501 Analysis of Noncurrent Liabilities 501 Analysis of Equity 502 Proving Cash Balances 503 Decision Analysis—Cash Flow Analysis 503 Appendix 12A 'Appendix 12B

Spreadsheet Preparation of the Statement of Cash Flows 507 Direct Method of Reporting Operating Cash Flows 510

1 3 Analyzing and Interpreting Financial Statements 536 Basics of Analysis 538 Purpose of Analysis 538 Building Blocks of Analysis 539 Information for Analysis 539 Standards for Comparisons 540 Tools of Analysis 540 Horizontal Analysis 540 Comparative Statements 540 Trend Analysis 543 Vertical Analysis 545 Common-Size Statements 545 Common-Size Graphics 547 Ratio Analysis 549 Liquidity and Efficiency 549 Solvency 553 Profitability 554 Market Prospects 556 c Summary of Ratios 556 Decision Analysis—Analysis Reporting 558 Appendix 13A Sustainable Income 561 Appendix A

Financial Statement Information A-l Best Buy A-2 Circuit City A-19 Apple A-24

Appendix B Time Value of Money B-l Appendix C Investments and International Operations C Appendix D* Reporting and Analyzing Partnerships Appendix E* Reporting and Preparing Special Journals Glossary G-l Credits CR-1 Index IND-1 Chart of Accounts CA

* Appendixes D & E are available on the book's Website, mhhe.com/wild4e, and as print copy from a McGraw-Hill representative.