edition

FinancialAccounting:Informationfor Decisions

John J. WildUniversity of Wisconsin at Madison

McGraw-HillI Brwin

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

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Contents

Introducing Accounting inBusiness 2

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 RecordingTransactions 46

Analyzing and Recording Process 48

Source Documents 49

The Account and Its Analysis 49

Analyzing and Processing Transactions 52Ledger 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 63Preparing a Trial Balance 63

Using a Trial Balance to Prepare Financial

Statements 64

Decision Analysis—Debt Ratio 66

xxvii

xxviii Contents

Adjusting Accounts andPreparing FinancialStatements 90

Timing and Reporting 92The 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 104Closing Process 104

Temporary and Permanent Accounts 104

Recording Closing Entries 106

Post-Closing Trial Balance 109

Accounting Cycle Summary 109

Classified Balance Sheet 110Classification Structure 110

Classification Categories 111

Decision Analysis—Profit Margin andCurrent Ratio 11.3

Appendix 3A Alternative Accounting forPrepayments 118

'Appendix 3B Work Sheet as a Tool 119

Appendix 3C Reversing Entries 122

4 Reporting and AnalyzingMerchandising 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 158Sales 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 166Decision Analysis—Acid-Test and GrossMargin Ratios 167

Appendix 4A Periodic (and Perpetual) InventorySystem 172

Appendix 4B Worksheet—Perpetual System 176

Contents xxix

Reporting and AnalyzingInventories 196

Inventory Basics 198Determining 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 206Valuing Inventory at LCM and the Effects ofInventory Errors '207

Lower of Cost of Market 207

Financial Statement Effects of Inventory Errors 208Decision Analysis—Inventory Turnover and Days'Sales in Inventory 210

Appendix 5A Inventory Costing under a PeriodicSystem 215

Appendix 5B Inventory Estimation Methods 219

6 Reporting and Analyzing Cash andInternal Controls 238

Internal Control 240Purpose 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 251Basic 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 AnalyzingReceivables 280

Accounts Receivable 282

Recognizing Accounts Receivable 282

Valuing Accounts Receivable 285

Estimating Bad Debts Expense 289

Notes Receivable 292Computing Maturity and Interest 292

Recognizing Notes Receivable 293

Valuing and Settling Notes 294

Disposing of Receivables 295Selling Receivables 295

Pledging Receivables 295

Decision Analysis—Accounts ReceivableTurnover 296

X X X Contents

8 Reporting and AnalyzingLong-Term Assets 312

- SECTION 1—PLANT ASSETS 314Cost Determination 315

Land 315

Land Improvements 316

Buildings 316

Machinery and Equipment 316

Lump-Sum Purchase 316

Depreciation 317Factors 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 325Discarding Plant Assets 326

Selling Plant Assets 326

SECTION 2—NATURAL RESOURCES 328Cost 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

Reporting and AnalyzingCurrent Liabilities 354

Characteristics of Liabilities 356

Defining Liabilities 356

Classifying Liabilities 356

Uncertainty in Liabilities 357

Known (Determinable) Liabilities 358Accounts Payable 358

Sales Taxes Payable 358

Unearned Revenues 359

Short-Term Notes Payable 359

Payroll Liabilities 361

Multi-Period Known Liabilities 364

Estimated Liabilities 365Health and Pension Benefits 365

Vacation Benefits 366

Bonus Plans 366

Warranty Liabilities 366

Multi-Period Estimated Liabilities 367

Contingent Liabilities 367Accounting for Contingent Liabilities 368

Reasonably Possible Contingent Liabilities 368

Decision Analysis—Times Interest Earned Ratio 369

Appendix 9A Payroll Reports, Records, andProcedures 372

Appendix 9B Income Taxes 378

Contents xxxi

I 0 Reporting and AnalyzingLong-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 409Bond Retirement at Maturity 409

Bond Retirement before Maturity 409

Bond Retirement by Conversion 410

Long-Term Notes Payable 410Installment Notes 410

Mortgage Notes and Bonds 412Decision Analysis—Debt Features and theDebt-to-Equity Ratio 413

Appendix 10A Present Values of Bonds andNotes 417

Appendix 10B Effective Interest Amortization 419

Appendix 10C Issuing Bonds between InterestDates ̂ 421

Appendix 10D Leases and Pensions 423

! I Reporting and AnalyzingEquity 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 449Cash 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 459Decision Analysis—Earnings per Share,Price-Earnings Ratio, Dividend Yield, andBook Value per Share 460

xxxil Contents

S 2 Reporting and Analyzing CashFlows 484

Basics of Cash Flow Reporting 486Purpose of the Statement of Cash Flows 486Importance of Cash Flows 486Measurement of Cash Flows 487Classification of Cash Flows 487Noncash Investing and Financing 489Format of the Statement of Cash Flows 489Preparing the Statement of Cash Flows 490

Cash Flows from Operating 492

Indirect and Direct Methods of Reporting 492Application of the Indirect Method ofReporting 493Summary of Adjustments for Indirect Method 498

Cash Flows from Investing 499Three-Stage Process of Analysis 499Analysis of Noncurrent Assets 499Analysis of Other Assets 500

Cash Flows from Financing 501

Three-Stage Process of Analysis 501Analysis of Noncurrent Liabilities 501Analysis of Equity 502Proving Cash Balances 503

Decision Analysis—Cash Flow Analysis 503

Appendix 12A Spreadsheet Preparation of theStatement of Cash Flows 507

'Appendix 12B Direct Method of ReportingOperating Cash Flows 510

1 3 Analyzing and InterpretingFinancial Statements 536

Basics of Analysis 538Purpose 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 545Common-Size Statements 545

Common-Size Graphics 547

Ratio Analysis 549Liquidity 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 InternationalOperations C

Appendix D* Reporting and AnalyzingPartnerships

Appendix E* Reporting and Preparing SpecialJournals

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.