Accounting Book Contents

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Text and Cases Thirteenth Edition

Robert N. An thon yRoss G. Walker Professor EmeritusGradu ate School of Business Adm inistrationHarvard University

David F. HawkinsLovett-Learned Professor of BusinessAdministrationGradu ate School of Business Adm inistrationHarvard University

Kenneth A. MerchantDeloitte & Touche LLP C hair of AccountancyLeventhal Scho ol of Accoun tingUniversity of Southern California

McGraw-HillIrwin


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ContentsPARTIFINANCIAL ACCOUN TING 1Chapter 1The Nature and Purpose of Accounting 2The Need for Information 2

Operating Information 3Financial Accounting Information 4Management Accounting Information 4Tax Accounting Information 5Definition of Accounting 6

The Profession of Accounting 6Our Approach to Accounting 7Preconceptions about Accounting 7

Plan of the Book 8The Financial Accounting Framework' 8

Accounting as a Language 9Different Formats 9Nature o f Principles 9Criteria 10Source of Accounting Principles 11Principles Vs. Rules 12

Financial Statements 13The Balance Sheet 14The Income Statement 16"Package " of Financial Reports 17Financial Statement Objectives 17Sarbanes-Oxley A ct 19Income Tax Reporting 19

Summary 19Problems 20Cases 22

Case 11: Ribbons an'Bows, Inc. 22Case 1-2: Kim F uller 23Case 1-3: Baron C oburg 24

Chapter 2Basic Accounting Concepts:The Balance Sheet 26Basic Concepts 26

The Money Measurement Concept 27The Entity Concept 28The Going-Concern Concept 28The Cost Concept 29The Dual-Aspect Concept 32

The Balance Sheet 33An Overall View 34Account Categories 35Assets 36Liabilities 38Owners 'Equity 39

Ratios 42Current Ratio 42

Balance Sheet Changes 42Original Capital Contribution 42Bank Loan 43Purchase of M erchandise 43Sale of Merchandise 43

Concluding Comment 44Summary 44Problems 44Cases 47

Case 2-1: Maynard Company (A) 47Case 2-2: Music Mart, Inc. 48Case 2-3: Lone Pine Cafe (A) 48

Chapter 3Basic Accounting Concepts: The IncomeStatement 50The Nature of Income 50Basic Concepts 51

The Accounting Period Concept 51The Conservatism Concept 54The Realization Concept 56The Matching Concept 57

Recognition of Expenses 58Terminology 58Criteria for Expense R ecognition 58Expenses and Expenditures 59Dividends 61Summary of Expense Measurement 62

Gains and Losses 63The Consistency Concept 63The Materiality Concept 63

The Income Statement 64Revenues 66Cost of Sales 66Gross Margin 67Expenses 67Net Income 67


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Statement of Retained Earnings 67Relation between Balance Sheet and Income

Statement 68Income Statement Percentages 68

Other Concepts of Income 68" - -Accrual versus Cash-BasisAccounting 68Income Tax A ccounting 69Economic Income 70Pro Forma Earnings 70


Case 3-1: Maynard Company (B) 73Case 3-2: Lone Pine Cafe (B) 74Case 3-3: Dispensers of C alifornia, Inc. 74Case 3-4: Pinetree Motel 75Case 3-5: National Association of Accou ntants 77

Chapter 4Accounting R ecords and Systems 80Recordkeeping Fundamentals 80

The Account 81Permanent Accounts and Temporary Accounts 81The Ledger 82The Chart of Accounts 82Debit an d Credit 82

The Accounting Process 84Transaction Analysis 85Example: Campus Pizzeria, Inc. 85Balancing Accounts 88The Trial Balance 89

The Adjusting and Closing Process 90Adjusting Entries 90Closing Entries 93Statement Preparation 95The Journal 96

Accounting Systems 97Internal Accounting Controls 97

Computer-Based Accounting Systems 98What a Computer-Based System Does 98Modules 99Problems with Computer Systems 99


Case 4-1: PC Depot 102Case 4-2: Save-Mart 104Case 4-3: Copies Express 104Case 4-4: Waltham Oil and Lube Center, Inc. 106

Chapter 5Revenue and M onetary Assets 108Timing of Revenue Recognition 108

Basic Recognition Criteria 108SEC Response 110Delivery Method 112Percentage-of-Completion Method 113Production Method 114Installment Method 114

Amount of Revenue Recognized 116Bad Debts 116Sales Discounts 119Credit Card Sales 119Sales Returns and Allowances 120Revenue Adjustment versus Expense 120Warranty Costs 121Interest Revenue 122

Monetary Assets 124Difference in Reporting Monetary and

Nonmonetary Assets 124Cash 125Receivables 125Marketable Securities 125

Analysis of Monetary Assets 126Curren t Ratio 126Acid-Test Ratio 127Days'Cash 127Days'Receivables 128


Case 5-1: Stern C orporation (A) 132Case 5-2: Grennell Farm 132Case 5-3: Joan Holtz (A) 135Case 5-4: Wareham SCSystems, Inc. 137

Chapter 6Cost of Sales and In ventories 141Types of Companies 141

Supplies 142Merchandising Companies 142

Acquisition Cost 142The Basic Measurement P roblem 143Periodic Inventory Method 144Perpetual Inventory Method 145Comparison of Periodic and P erpetual

Methods 146Retail Method 147


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Companies 148Inventory Accounts 148Materials Used 149Cost of Goods M anufactured 150Cost of G oods Sold 151Product Costing Systems 152Product Costs and Period Costs 152

Companies 153Costing Methods 153

Specific Identification Me thod 154Average Cost Method 154First-Jn, First-Out Method 155Last-In, First-Out Metho d 155Comparison of Methods 156

er of Cost or Market 159of Inventory 160

Inventory Turnover 160Gross Margin Percentage 161

Case 61: B rowning ManufacturingCompany 164

Case 6-2: Lewis Corporation 167Case 6-3: M organ Manufacturing 168Case 6-4: Joan Holtz (B) 170

andortization 172of Long-Lived Assets 172

Types of Long-Lived Assets 173and Equipment: Acquisition 174

Distinction between Asset and Expense 174Items Included in Cost 175Acquisitions Recorded at Other Than Cost 176Basket Purchases 176

and Equipment: Depreciation 177Judgments Required 177Service Life 178Depreciation Methods 178Choice of a D epreciation Method 181

for Depreciation 181Change in Depreciation R ates 182Partial-Year Depreciation 183Disclosure 183

and Equipment: Disposal 183Exchanges and Trade-Ins 185Group Depreciation 185

of Depreciation 186

Income Tax Considerations 187Depreciation Allowances 187Investment Tax Credit 188

Natural Resources 189Depletion 189Accretion and Apprec iation 190

Intangible Assets 190Limited Useful Life 190Indefinite U seful Life 191Goodwill 191Patents and Copyrights 192Leasehold Improvements 192Deferred Charges 192Research and Development Costs 192Analysis of N onmonetary Assets 193


Case 7-1: Stern Corporation (B) 196Case 7-2: Joan Holtz (C) 197Case 7-3: Stafford Press 199Case 7-4: Silic: Choosing Cost or Fair Value

on Adoption of IFRS 200Case 7-5: Accounting Fraud at WorldCom 208

Chapter 8Sources of Capital: Debt 220Nature of Liabilities 220

Executory C ontracts 220Contingencies 221Liabilities as a Source of Funds 222

Debt Capital 223Term Loans 223Bonds 223

Accounting for Bonds 224Recording a Bond Issue 224Balance Sheet Presentation 226Bond Interest Expense 22 7Retirement of Bonds 228Refunding a Bond Issue 229

Leased Assets 229Capital Leases 230Sale and Leaseback 231

Other Liabilities 231Curren t Liabilities 231Deferred Taxes 231 '

Analysis of Capital Structure 231Debt Ratios 231Times Interest Earned 233Bond Ratings 233


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Summary 233Appendix: Present Value 234Problems 241Cases 243

Case 8-1: Norman C orporation (A)"" 24 3Case 8-2: Paul Murray 245Case 8-3: Joan Holtz (D) 245Case 8-4: Leasing Computers at Persistent Learning 24 7Case 8-5: Kim Park 252

Chapter 9Sources of Capital: Owners' Equity 256Forms of Business Organization 256

Sole Proprietorship 256Partnership 257Corporation 257Accounting for Proprietor's and Partners'Equity 258Proprietorship Equity 258Partnership Equity 258 )

Ownership in a Corporation 259Preferred Stock 259Common Stock 260Treasury Stock 261Retained Earnings 261Reserves 262Dividends 262Warrants and Stock Options 264 /Employee Stock Ownership Plans 264Balance Sheet Presentation 265

Earnings per Share 265The Line between Debt and Equity 267

Zero-Coupon Bonds 268Debt with Warrants 268Redeemable Preferred Stock 269

Equity in Nonprofit Organizations 269Summary 270Problems 270Cases 273

Case 9-1: Xytech, Inc. 273Case 9-2: Innovative Engineering Company 274Case 9-3: UPC Inc. 275Case 9-4: Maxim Integrated Products, Inc. 278

Chapter 10Other Items That Affect Ne t In com e andOwners' Equity 283Total and Other Nonowner Changes in Owners'

Equity 283

Nonoperating Items 285Extraordinary Items 285Pro Forma Earnings 286Discontinued Operations 287Change in Accounting Principles 287Errors 288

Personnel Costs 288Pensions 289Other Postretireme nt Benefits 292Compensated Absences 292

Income Taxes 292Book-to-Tax Differences 292Deferred Income Taxes 295Deferred Tax Measurement 295Accounting Entries 297

Foreign Currency Accounting 300Foreign Currency Transactions 300Foreign Currency Translation

Adjustments 301Derivatives 303Pro Forma Earnings 304Net Income 304Summary 305Problems 305Cases 308

Case 10-1: Norman Corporation (B) 308Case 10-2: Silver Appliance Company 309Case 10-3: Freedom Technology Company 311Case 1 0-4: Proxim, Inc. 312

Chapter 11The Statement of Cash Flows 314Purpose of the Cash Flow Statement 314

Sources and Uses of Cash 315The Cash Flow Statement 316

Statement Categories 317Investing Ac tivities 317Financing Ac tivities 319Noncash Transactions 321Cash Flow from Operating Activities 321Indirect Method Calculations 322Summary of the Cash Flow Statement 326

Misconceptions about Depreciation 327Cash Flow Earnings 328

Preparation of the Cash FlowStatement 328Cash Flow Worksheet 329Worksheet Entries 331Statement Preparation 333Summary of Preparation Procedures 334


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Analysis of the Cash Flow Statement 335Ratios 335Cash Flow Projections 336Summary 337P ro bl em s 3 37 " ~ -

Cases 339Case 11-1: Medieval Adventures Company 339Case 11-2: Amerbran Company (A) 340

Chapter 12Acquisitions and ConsolidatedStatements 343Accounting for Investments 343

Fair-Value Method 343Cost Method 344Equity Method 344Consolidated Basis 345Business Combinations 345Purchase versus Pooling 346 :Accounting as a Pooling 346 '_.Accounting as a Acquisition 347Consolidated Statements 348Basis for Consolidation . 34 9Consolidation Procedur e 349Asset Valuation 35 2Minority Interest 352

Summary 353Problems 353Cases 356Case 12-1: Hardin Tool Company 356Case 12-2: Carter Corporation 357Case 12-3: The Politics and Economics of Accounting

for Goodw ill at Cisco Systems 358Case 12-4: Productos Finas 364

Chapter 13Financial Statement Analysis 367Business Objectives 367

Return on Investment 368Sound F inancial Position 36 9Structure of the Analysis 369Overall Measures 369Return on Investment 369Investment Turnover an d Profit Margin 3 74Price/Earnings Ratio 375Profitability Ra tios 376Profit Margin 3 76Common-Size Financial Statements 3 76

Investment Utilization Ratios 377Investment Turnover 377Capital Asset Intensity 3 77Working Capital Measures 377Financial Condition Ratios 379Liquidity and Solvency 3 79Dividend Policy 379Growth Measures 381Making Comparisons 382Difficulties 382Possible Bases for Comparison 384Use of Comparisons 385Summary 386Problems 386Cases 388Case 131: Genmo Corporation 388Case 13-2: Amerbran Company (B) 390Case 13-3: Identify the Industries 391Case 13-4: Supplement to Identify the Industries 391Case 13-5: Springfield National Bank 391Case 13-6: Butler Lumber Company 398

Chapter 14Und erstanding Financial Statements 402Additional Information in Annual Reports 402

Auditors' Opinion 40 2Notes to Financial Statements 405Segment Reporting 406Full Disclosure 406Com parative Statements 407Management's Discussion and Analysis 407Securities and Exchange Commission (SEC)

Reports 407Review of Criteria and Concepts 408Criteria 408Concepts 409Accounting Alternatives 413Regulatory Requirements 413Income Tax Principles 413Latitude in Method s 414Basis of Choice 414Controversies over Principles 415Implications of These Differences 416Inherent Limitations 417Ethical Problems 417Meaning of the Financial Statements 418Income Statement 418Balance Sheet 419Statement of Cash Flows 421


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Case 14-1: Quick Lunch 424Case 14-2: Accounting at M acCloud

Winery 425Case 14-3: PolyMedica Corporation (A) 426Case 14-4: Tokyo AFM 433

PART 2MANAGEMENT ACCOUNTING 437Chapter 15The Nature of ManagementAccounting 438Management Accounting 438Management Accounting Is a Relatively

Young Field 439Management A ccountants 440

Contrast between Management Accounting andFinancial Reporting 441Differences 441Similarities 443

Types of Management Accounting Informationand Their Uses 444Measurement 445Control 446Alternative Choice Decisions 447 '

Databases 447General Observations on Management

Accounting 449Different Numbers for Different

Purposes 450Accounting Numbers Are Approximations 450Working with Incomplete Data 450Accounting Evidence Is Only Partial

Evidence 450People, Not Numbers, Get Things Done 451

Summary 451Problems 452Case 454

Case 15-1: Private Fitness, LLC 454Chapter 16The Behavior of Costs 456

Relation to Unit Costs 459Inherent Conditions 460Linear Assumption 463Estimating the Cost-Volume Relationship 464Measures of Volume 467Profitgraphs 468Break-Even A nalysis 469Target Profit 470Operating Leverage 470Contribution 470Cash versus Accrual Profitgraphs 473Using the Profitgraph 473Several Products 474Other Influences on Costs 476

Summary 477Appendix: Learning Curves 477Problems 479Cases 481

Case 16-1: Hospital Supply, Inc. 481Case 16-2: P restige Telephone Company 483Case 16-3: Bill French 486

Chapter 17Full Costs and Their Uses 490

Relation of Costs to Volume 456Variable and Fixed Costs 456Cost-Volume Diagrams 457

Cost Concepts 490Genera l Definition 490Cost Object 491Full Cost 491Direct and Indirect Costs 491Applicable Accounting Principles 492Elements of Product Cost 493Product Costing Systems 495Account Flowchart 496Nonmanufacturing Costs 499Merchandising Companies 500Service Organizations 501Nonprofit Organizations 501

Uses of Full Cost 502Financial Reporting 502Analyses of Profitability 502What Did It Cost? 502Setting Regulated Prices 503Product Pricing 503Summary 506Problems 506Cases 508Case 17-1: Delaney Motors 508Case 17-2: Lipman Bottle Company 511Case 17-3: Shelter Partnership, Inc. 515


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Chapter 18Additional Aspects of Product CostingSystems 519Job Order Costing and Process Costing" 519

Production Processes 519Averaging 519Basic Types of Systems 520Job Order Costing 520Process C osting 521Choice of a System 523Variations in Practice 524

Measurement of Direct Costs 524'Direct Labor Cost 525Direct Material Cost 526Direct versus Variable Cost 526

Allocation of Indirect Costs 527Distinction between Direct and Indirect Costs 527Nature of Allocation 528Cost Centers 528Calculating Overhead Rates 529 ,'Cost Drivers (Allocation Bases) 533Predetermined Overhead Rates 535Procedu re for Establishing Predetermined

Rates 536Underabsorbed an d Overabsorbed

Overhead 539Activity-Based Costing 539Cross-Subsidies 541Activity-Based Costing Concepts 541


Case 18-1: Huron Automotive Company 553Case 18-2: California Creamery, Inc. 557Case 18-3: Safety Monitoring Devices, Inc. 559Case 18-4: Sippican C orporation (A) 563Case 18-5: Sippican Corporation (B) 566Case 18-6: Midwest Office Products 567

Chapter 19Standard Costs, Variable Costing S ystem s,Quality Costs, and Joint Costs 571Standard Costs 571

Standard Cost Sheet 571Account Flowchart 5 72Variations in the Standard C ost Idea 576Terminology Ambiguities 577Uses of Standard Costs 577

Variable Costing Systems 579Comparison of Absorption and Variable Costing 579Why Use Full Costing? 582

Quality Costs 584Joint Products and By-Products 585

Joint-Product Costing 585By-Product Costing 586

Accuracy of Costs 587Judgment Calls 587Tendencies toward Uniformity 587

Cost.System Design Choices 588Summary 588Appendix A: Standard Costing

Illustration 589Appendix B: Absorption versus Variable

Costing's Impact on Income 595Problems 596Cases 598

Case 19-1: Bennett Body Company 598Case 19-2: Black Meter Company 600Case 19-3: Brisson Company 600Case 19-4: Landau Company 601Case 19-5: Lynch's Chicken Ranch, Inc. 603

Chapter 20Production Cost VarianceAnalyses 606Variances 606Direct Material and Labor Variances 607

Direct Material Variances 607Direct Labor Variances 611

Overhead Variances 612Production Volume Variance 613Spending Variance 614Calculation of Overhead Variances 615

Summary 618Problems 619Cases 621Case 20-1: SunAir Boat Builders, Inc. 621

Case 20-2: Medi-Exam Health Services, Inc. 623Case 20-3: Cotter Company, Inc. 624Case 20-4: Lupton C ompany 625

Chapter 21Other Variance Analyses 628Overview of the Analytical Process 628

The Need for Variance Analysis 628Types of Variances 629


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Marketing Variances 629Expense Variances 629Gross Margin Variances 631

Production Cost Variances 637Correct Volume Measures 637"" ~

Other Variances 638Complete Analysis 639

Marketing Variances 639Production Cost Variances 639Uses of Variances 641


Case 21-1: Campar Industries, Inc. 645Case 21-2: Darius Company 647Case 21-3: Woodside Products, Inc. 647Case 21-4: O lympic Car Wash 649

Chapter 22Control: The Ma nag em ent Con trolEnvironment 650Management Control 650The Environment 651

The Nature of Organizations 651Rules, Guidelines, an d Procedures 653Culture 653External Environment 653Responsibility Centers and ResponsibilityAccounts 654Inputs an d Outputs 654Respon sibility Accounting 655Effectiveness an d Efficiency 657

Types of Responsibility Centers 657Revenue Centers 658Expense Centers 658Profit Centers 659Transfer Prices 660Investment Centers 663Nonmonetary Measures 665


Case 22-1: Behavioral Implications ofAirline Depreciation Accounting PolicyChoices 667

Case 22-2: Shuman Automobiles, Inc. 669Case 22-3: ZumwaldAG 673Case 22-4: Enager Industries, Inc. 675Case 22-5: Piedmont University 679

Chapter 23Control: The Ma nagem ent ControlProcess 682Phases of Management Control 682

Strategic Planning 682Budgeting 683Measurement and Reporting 683Evaluation 684

Accounting Information Used in ManagementControl 684Controllable Costs 684Engineered, Discretionary, and Comm itted C osts 688

Behavioral Aspects of Management Control 690Behavior of Participants 690Motivation 691Incentives 692Goal Congruence 693Cooperation and Conflict 694Other Types of Control 695


Case 23-1: Tru-Fit Parts, Inc. 698Case 23-2: Industrial Electronics, Inc. 701Case 23-3: Las Ferreterias de Mexico,

S.A.deC.V 702Case 23-4: Berkshire Industries PLC 705

Chapter 24Strategic Planning and Budgeting 711Strategic Planning 711

Ongoing Programs 712Proposed New Programs 713Formal Strategic Planning Systems 714

Budgeting 714Uses of the Budget 714The Master B udget 716

The Operating Budget 717Project Budgets 718Flexible (Variable) Budgets 718Management by Objectives 718

Preparing the Operating Budget 720Organ ization for Budge t Prepara tion 720Budget Timetable 721Setting Planning Guidelines 722Preparing the Sales Budget 722Initial Preparation of Other Budget Components 723Negotiation 724


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Coordination and Review 726Final Approval and Distribution 726Revisions 726Variations in Practice 727

The Cash Budget 728 ~~-*:rThe Capital Expenditure Budget 729Project Proposals 729

Authorization 730Follow-Up 730

Beyond Budgeting 730Summary 731Problems 731Cases 733

Case 24-1: Body Glove 733Case 24-2: Waikerie Co-Operative

Producers Ltd. 740Case 24-3: Patagonia, Inc. 749Case 24-4: Borealis 762

C h a p t e r 25 jReporting and Evaluation 773Control Reports 773

Key Success Factors 773Types of Management Reports 774Period of Control Reports 775Contents of Control Reports 775

Use of Control Reports 779Feedback 781Steps in the Control Process 781Reporting and Continuous Improvement 782

Incentive Compensation 783Summary 784Problems 784Cases 787

Case 25-1: Harwood M edical Instruments PLC 787Case 25-2: Armco, Inc.: Midwestern Steel

Division 788Case 25-3: Form osa Plastics Group 799

Chapter 26Short-Run Alternative C hoiceDecisions 807The Differential Concept 807

Cost Constructions for Various Purposes" 807Differential Costs and Revenues 808Contrasts with Full Costs 808

Contribution Analysis 809Types of Cost 811

Alternative Choice Problems 812Steps in the Analysis 813

Differential Costs 814Mechanics of the Calculation 815Other Terminology 817Estimates of Future Costs 818Sunk Costs 818Importance of the Time Span 819Example: Operating an Automobile 820

Types of Alternative Choice Problems 821Problems Involving Costs 821Problems Involving Both Revenues and Costs 822Differential Investment 825Sensitivity Analysis 825The "Just One " Fallacy 826Expected Values 827Decision T ree Analysis 828Some Practical Pointers 828


Case 26-1: Import Distributors, Inc. 832Case 26-2: Forner Carpet Company 833Case 26-3: Precision Worldwide, Inc. 835Case 26-4: Baldwin Bicycle Company 837

Chapter 27Longer-Run Decisions: CapitalBudgeting 840Nature of the Problem 840General Approach 841

Net Present Value 842Return on Investment 842

Estimating the Variables 844Required Rate of Return 844Economic Life 846Cash Inflows 846Investment 850Terminal Value 851Nonmonetary Considerations 851Summary of the Analytical P rocess 853

Other Methods of Analysis 853Internal Rate of Return Method 853Payback Method 855Unadjusted Return on Investment Method 856Multiple Decision Criteria 857

Preference Problems 858Criteria for Preference Problems 858Comparison of P reference Rules 858


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Nonprofit Organizations 859Summary 859Problems 860Cases 862

Case 27-1: Sinclair Company 862Case 27-2: Rock Creek Golf Club 864Case 27-3: Phuket Beach Hotel: Valuing Mutually

Exclusive Capital Projects 865

Chapter 28Management Accounting SystemDesign 868Types of Accounting Information 868

Measurement 868Control 869Alternative Choice Problems 869Relative Importance 869

Cost Categories 870Designing the Management Accounting

System 872Accounting Database 872Level of Detail 872Cost Accounting Systems 873Management Control Systems 873

Cases 874Case 28-1: Puente Hills Toyota 8 74Case 28-2: Axeon N.V. 886

Appendixes 893Index 895

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Accounting Book Contents