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Financial Accounting
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11th edition
Financial
Accounting
W. Steve Albrecht
PhD, CPA, CIA, CFE
Brigham Young University
•••
Earl K. Stice
PhD
Brigham Young University
•••
James D. Stice
PhD
Brigham Young University
This page intentionally left blank
About the Authors iii
11th edition
Financial
Accounting
Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States
W. Steve Albrecht
PhD, CPA, CIA, CFE
Brigham Young University
•••
Earl K. Stice
PhD
Brigham Young University
•••
James D. Stice
PhD
Brigham Young University
© 2011, 2008 South-Western, Cengage Learning
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ISBN-13: 978-0-538-74695-3
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Financial Accounting, Eleventh Edition
W. Steve Albrecht, Earl K. Stice, and James D. Stice
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1 2 3 4 5 6 7 13 12 11 10 09
About the Authors v
PART ONE
Financial Reporting and the Accounting Cycle 1
1 ACCOUNTING INFORMATION: USERS AND USES 2
2 FINANCIAL STATEMENTS: AN OVERVIEW 24
3 THE ACCOUNTING CYCLE: THE MECHANICS OF ACCOUNTING 70
4 COMPLETING THE ACCOUNTING CYCLE 123
5 INTERNAL CONTROLS: ENSURING THE INTEGRITY OF FINANCIAL INFORMATION 179
PART TWO
Operating Activities 213
6 RECEIVABLES: SELLING A PRODUCT OR SERVICE 214
7 INVENTORY AND THE COST OF SALES 269
8 COMPLETING THE OPERATING CYCLE 330
PART THREE
Investing and Financing Activities 375
9 INVESTMENTS: PROPERTY, PLANT, AND EQUIPMENT AND INTANGIBLE ASSETS 376
10 FINANCING: LONG-TERM LIABILITIES 446
11 FINANCING: EQUITY 505
12 INVESTMENTS: DEBT AND EQUITY SECURITIES 552
B RIEF CONTENTS
Brief Contents v
(Continued)
vi Brief Contents About the Authors
PART FOUR
Other Dimensions of Financial Reporting 609
13 STATEMENT OF CASH FLOWS 610
14 ANALYZING FINANCIAL STATEMENTS 663
Appendix A: Wal-Mart 2009 Annual Report A-1
Appendix B: Present Value Tables B-1
Appendix C: Check Figures C-1
Glossary G-1
Subject Index SI-1
Real Company Index CI-1
About the Authors vii
C ONTENTS
PART ONE
Financial Reporting and the Accounting Cycle 1
CHAPTER 1 ACCOUNTING INFORMATION: USERS AND USES 2
What’s the Purpose of Accounting?__________________________________________ 4
Th e Relationship of Accounting to Business _______________________________ 6
Who Uses Accounting Information? _________________________________________ 7
Lenders ___________________________________________________________ 9
Investors __________________________________________________________ 9
Management ______________________________________________________ 10
Other Users of Financial Information ___________________________________ 10
Within What Kind of Environment Does Accounting Operate? __________________ 11
Th e Signifi cance and Development of Accounting Standards _________________ 12
Th e Financial Accounting Standards Board _______________________________ 12
Other Organizations ________________________________________________ 12
International Business _______________________________________________ 13
Ethics in Accounting ________________________________________________ 14
Technology _______________________________________________________ 15
So, Why Should I Study Accounting? _______________________________________ 16
End-of-Chapter Materials________________________________________________ 18
CHAPTER 2 FINANCIAL STATEMENTS: AN OVERVIEW 24
Th e Financial Statements ________________________________________________ 25
Th e Balance Sheet _____________________________________________________ 26
Accounting Equation _______________________________________________ 28
Th e Income Statement __________________________________________________ 32
Th e Statement of Cash Flows _____________________________________________ 37
How the Financial Statements Tie Together ______________________________ 40
Notes to the Financial Statements _________________________________________ 41
Summary of Signifi cant Accounting Policies ______________________________ 41
Additional Information about Summary Totals ____________________________ 42
Disclosure of Information Not Recognized _______________________________ 42
Supplementary Information __________________________________________ 42
Contents vii
viii viii Contents About the Authors
Th e External Audit _____________________________________________________ 44
Fundamental Concepts and Assumptions ____________________________________ 46
Th e Separate Entity Concept __________________________________________ 46
Th e Assumption of Arm’s-Length Transactions ____________________________ 47
Th e Cost Principle _________________________________________________ 47
Th e Monetary Measurement Concept ___________________________________ 47
Th e Going Concern Assumption _______________________________________ 47
End-of-Chapter Materials________________________________________________ 48
CHAPTER 3 THE ACCOUNTING CYCLE: THE MECANICS OF
ACCOUNTING 70
How Can We Collect All Th is Information? __________________________________ 71
How Do Transactions Aff ect the Accounting Equation? _________________________ 73
Th e Accounting Equation ____________________________________________ 73
Using Accounts to Categorize Transactions _______________________________ 75
Expanding the Accounting Equation to Include Revenues,
Expenses, and Dividends _____________________________________________ 77
How Do We Record the Eff ects of Transactions? ______________________________ 79
Acquiring Cash, Either from Owners or by Borrowing ______________________ 80
Acquiring Other Assets ______________________________________________ 82
Selling Goods or Providing Services ____________________________________ 85
Collecting Cash and Paying Obligations _________________________________ 87
A Note on Journal Entries ____________________________________________ 89
Posting Journal Entries and Preparing a Trial Balance ___________________________ 92
Determining Account Balances ________________________________________ 93
Illustration of the First Th ree Steps in the Accounting Cycle __________________ 94
Where Do Computers Fit In All Th is? ______________________________________ 99
End-of-Chapter Materials_______________________________________________ 101
CHAPTER 4 COMPLETING THE ACCOUNTING CYCLE 123
Accrual Accounting ___________________________________________________ 124
Periodic Reporting ________________________________________________ 125
Accrual- versus Cash-Basis Accounting _________________________________ 126
Adjusting Entries _____________________________________________________ 129
Unrecorded Receivables ____________________________________________ 130
Unrecorded Liabilities ______________________________________________ 131
Prepaid Expenses __________________________________________________ 132
Unearned Revenues ________________________________________________ 134
About the Authors ix
Preparing Financial Statements ___________________________________________ 138
Financial Statement Preparation ______________________________________ 138
Th e Notes _______________________________________________________ 140
Th e Audit _______________________________________________________ 141
Closing the Books ____________________________________________________ 144
Real and Nominal Accounts _________________________________________ 144
Closing Entries ___________________________________________________ 144
Preparing a Post-Closing Trial Balance _________________________________ 146
A Summary of the Accounting Cycle ______________________________________ 148
End-of-Chapter Materials_______________________________________________ 149
CHAPTER 5 INTERNAL CONTROLS: ENSURING THE INTEGRITY
OF FINANCIAL INFORMATION 179
Th e Types of Problems Th at Can Occur ____________________________________ 180
Types of Errors in the Reporting Process ________________________________ 181
Disagreements in Judgment _________________________________________ 182
Fraudulent Financial Reporting _______________________________________ 183
Safeguards Designed to Minimize Problems _________________________________ 184
Th e Control Environment ___________________________________________ 186
Control Activities (Procedures) _______________________________________ 186
Reasons for Earnings Management ________________________________________ 188
Meet Internal Targets ______________________________________________ 188
Meet External Expectations __________________________________________ 189
Income Smoothing ________________________________________________ 189
Window Dressing for an IPO or a Loan ________________________________ 190
Th e Earnings Management Continuum ________________________________ 190
Is Earnings Management Ethical? _____________________________________ 191
Personal Ethics ___________________________________________________ 192
Th e Sarbanes-Oxley Act ________________________________________________ 193
Public Company Accounting Oversight Board ___________________________ 193
Constraints on Auditors ____________________________________________ 194
Constraints on Management _________________________________________ 194
Th e Role of Auditors in the Accounting Process ______________________________ 195
Internal Auditors __________________________________________________ 195
External Auditors _________________________________________________ 195
What Do Auditors Do? _____________________________________________ 196
Are External (Independent) Auditors Independent? _______________________ 197
Th e Securities and Exchange Commission __________________________________ 198
Th e Eff ect of the 1934 Act on Independent Accountants ___________________ 199
End-of-Chapter Materials_______________________________________________ 200
Comprehensive Problem Chapters 1–5 ___________________________________ 210
Contents ix
x About the Authors
PART TWO
Operating Activities 213
CHAPTER 6 RECEIVABLES: SELLING A PRODUCT OR SERVICE 214
Major Activities of a Business ____________________________________________ 216
Recognizing Revenue __________________________________________________ 218
When Should Revenue Be Recognized? _________________________________ 218
Application of the Revenue Recognition Criteria _________________________ 219
Cash Collection ______________________________________________________ 222
Sales Discounts ___________________________________________________ 222
Sales Returns and Allowances ________________________________________ 223
Control of Cash __________________________________________________ 224
Accounting for Credit Customers Who Don’t Pay ____________________________ 225
Th e Allowance Method _____________________________________________ 226
Real-World Illustration of Accounting for Bad Debts ______________________ 229
Assessing How Well Companies Manage Th eir Receivables _____________________ 231
Recording Warranty and Service Costs Associated with a Sale ___________________ 233
Reconciling the Bank Account ___________________________________________ 235
Foreign Currency Transactions ___________________________________________ 239
Foreign Currency Transaction Example _________________________________ 240
End-of-Chapter Materials_______________________________________________ 242
CHAPTER 7 INVENTORY AND THE COST OF SALES 269
Inventory and Cost of Goods Sold ________________________________________ 271
What is Inventory? ________________________________________________ 272
What Costs Are Included in Inventory Cost? ____________________________ 272
Who Owns the Inventory? __________________________________________ 272
Ending Inventory and Cost of Goods Sold ______________________________ 273
Accounting for Inventory Purchases and Sales _______________________________ 274
Overview of Perpetual and Periodic Systems _____________________________ 274
Perpetual and Periodic Journal Entries _________________________________ 275
Counting Inventory and Calculating Cost of Goods Sold ______________________ 280
Taking a Physical Count of Inventory __________________________________ 280
Th e Income Eff ect of an Error in Ending Inventory _______________________ 282
x Contents
About the Authors xi
Inventory Cost Flow Assumptions ________________________________________ 283
Specifi c Identifi cation Inventory Cost Flow ______________________________ 284
FIFO Cost Flow Assumption ________________________________________ 285
LIFO Cost Flow Assumption ________________________________________ 286
Average Cost Flow Assumption _______________________________________ 286
A Comparison of All Inventory Costing Methods _________________________ 287
Assessing How Well Companies Manage Th eir Inventories _____________________ 290
Evaluating the Level of Inventory _____________________________________ 290
Number of Days’ Purchases in Accounts Payable __________________________ 291
Inventory Errors ______________________________________________________ 294
Complications of the Perpetual Method with LIFO and Average Cost _____________ 297
Reporting Inventory at Amounts Below Cost ________________________________ 298
Inventory Valued at Net Realizable Value _______________________________ 299
Inventory Valued at Lower of Cost or Market ____________________________ 299
Method of Estimating Inventories ________________________________________ 302
Th e Gross Margin Method __________________________________________ 302
End-of-Chapter Materials_______________________________________________ 304
CHAPTER 8 COMPLETING THE OPERATING CYCLE 330
Employee Compensation _______________________________________________ 332
Payroll __________________________________________________________ 332
Compensated Absences _____________________________________________ 334
Bonuses _________________________________________________________ 335
Stock Options ____________________________________________________ 335
Postemployment Benefi ts ___________________________________________ 336
Pensions ________________________________________________________ 336
Postretirement Benefi ts Other Th an Pensions ____________________________ 338
Taxes ______________________________________________________________ 339
Sales Taxes _______________________________________________________ 340
Property Taxes ____________________________________________________ 340
Income Taxes ____________________________________________________ 341
Deferred Tax Example ______________________________________________ 341
Contingencies _______________________________________________________ 344
Environmental Liabilities ___________________________________________ 345
Capitalize versus Expense _______________________________________________ 347
Research and Development __________________________________________ 348
Advertising ______________________________________________________ 349
Contents xi
xii xii Contents About the Authors
Summarizing Operations on an Income Statement ____________________________ 350
Other Revenues and Expenses ________________________________________ 350
Extraordinary Items _______________________________________________ 350
Earnings per Share ________________________________________________ 352
Diff ering Income Statement Formats __________________________________ 352
End-of-Chapter Materials_______________________________________________ 353
Comprehensive Problem Chapters 6–8 ___________________________________ 373
PART THREE
Investing and Financing Activities 375
CHAPTER 9 INVESTMENTS: PROPERTY, PLANT, AND
EQUIPMENT AND INTANGIBLE ASSETS 376
Nature of Long-Term Operating Assets ____________________________________ 378
Deciding Whether to Acquire a Long-Term Operating Asset ____________________ 379
Accounting for Acquisition of Property, Plant, and Equipment __________________ 381
Assets Acquired by Purchase _________________________________________ 381
Assets Acquired by Leasing __________________________________________ 382
Assets Acquired by Self-Construction __________________________________ 384
Acquisition of Several Assets at Once __________________________________ 385
Calculating and Recording Depreciation Expense ____________________________ 387
Straight-Line Method of Depreciation _________________________________ 387
Units-of-Production Method of Depreciation ____________________________ 389
A Comparison of Depreciation Methods ________________________________ 390
Partial-Year Depreciation Calculations _________________________________ 391
Units-of-Production Method with Natural Resources ______________________ 391
Repairing and Improving Property, Plant, and Equipment ______________________ 393
Recording Impairments of Asset Value _____________________________________ 396
Recording Decreases in the Value of Property, Plant, and Equipment __________ 396
Recording Increases in the Value of Property, Plant, and Equipment ___________ 398
Disposal of Property, Plant, and Equipment _________________________________ 399
Discarding Property, Plant, and Equipment _____________________________ 399
Selling Property, Plant, and Equipment _________________________________ 400
Exchanging Property, Plant, and Equipment _____________________________ 401
Accounting for Intangible Assets _________________________________________ 402
Amortization of Intangible Assets _____________________________________ 405
Impairment of Intangible Assets ______________________________________ 406
Measuring Property, Plant, and Equipment Effi ciency _________________________ 407
Evaluating the Level of Property, Plant, and Equipment ____________________ 407
Industry Diff erences in Fixed Asset Turnover ____________________________ 407
About the Authors Contents xiii xi
Accelerated Depreciation Methods ________________________________________ 409
Declining-Balance Method of Depreciation _____________________________ 409
Sum-of-the-Years’-Digits Method of Depreciation_________________________ 411
A Comparison of Depreciation Methods ________________________________ 412
Changes in Depreciation Estimates and Methods _____________________________ 414
End-of-Chapter Materials_______________________________________________ 416
CHAPTER 10 FINANCING: LONG-TERM LIABILITIES 446
Measuring Long-Term Liabilities _________________________________________ 447
Present Value and Future Value Concepts _______________________________ 448
Computing the Present Value of an Annuity _____________________________ 452
Using Excel Spreadsheets for Time Value of Money Calculations _____________ 453
Accounting for Long-Term Liabilities ______________________________________ 456
Interest-Bearing Notes _____________________________________________ 457
Mortgages Payable_________________________________________________ 458
Accounting for Lease Obligations _________________________________________ 460
Operating Leases __________________________________________________ 462
Th e Nature of Bonds __________________________________________________ 463
Types of Bonds ___________________________________________________ 464
Characteristics of Bonds ____________________________________________ 464
Determining a Bond’s Issuance Price ___________________________________ 465
Accounting for Bonds Payable Issued at Face Value ________________________ 469
Bond Retirements before Maturity ____________________________________ 470
Using Debt-Related Financial Ratios ______________________________________ 472
Debt Ratio and Debt-to-Equity Ratio __________________________________ 472
Interest Earned Ratio ______________________________________________ 473
Bonds Issued at a Discount or at a Premium ________________________________ 474
Accounting for Bonds Issued at a Discount ______________________________ 474
Accounting for Bonds Issued at a Premium ______________________________ 476
Eff ective-Interest Amortization _______________________________________ 477
End-of-Chapter Materials_______________________________________________ 480
CHAPTER 11 FINANCING: EQUITY 505
Raising Equity Financing _______________________________________________ 507
Diff erence between a Loan and an Investment ___________________________ 508
Proprietorships and Partnerships ______________________________________ 508
xiv About the Authors
Corporations and Corporate Stock ________________________________________ 509
Starting a Corporation _____________________________________________ 510
Common Stock ___________________________________________________ 511
Preferred Stock ___________________________________________________ 511
Accounting for Stock __________________________________________________ 512
Issuance of Stock __________________________________________________ 512
Accounting for Stock Repurchases ____________________________________ 514
Balance Sheet Presentation __________________________________________ 516
Retained Earnings ____________________________________________________ 517
Cash Dividends ___________________________________________________ 518
Dividend Payout Ratio _____________________________________________ 521
Other Equity Items ___________________________________________________ 523
Equity Items that Bypass the Income Statement __________________________ 523
Statement of Stockholders’ Equity _____________________________________ 524
End-of-Chapter Materials_______________________________________________ 526
CHAPTER 12 INVESTMENTS: DEBT AND EQUITY SECURITIES 552
Why Companies Invest in Other Companies ________________________________ 554
Classifying a Security __________________________________________________ 556
Held-to-Maturity Securities _________________________________________ 556
Equity Method Securities ___________________________________________ 557
Trading and Available-for-Sale Securities ________________________________ 558
Why the Diff erent Classifi cations? ____________________________________ 558
Accounting for Trading and Available-for-Sale Securities _______________________ 560
Accounting for the Purchase of Securities _______________________________ 560
Accounting for the Return Earned on an Investment ______________________ 561
Accounting for the Sale of Securities ___________________________________ 562
Accounting for Changes in the Value of Securities ____________________________ 563
Changes in the Value of Trading Securities ______________________________ 564
Changes in the Value of Available-for-Sale Securities _______________________ 564
Subsequent Changes in Value ________________________________________ 565
Accounting for Held-to-Maturity Securities _________________________________ 568
Accounting for the Initial Purchase ____________________________________ 568
Accounting for Bonds Purchased between Interest Dates ___________________ 569
Accounting for the Amortization of Bond Discounts and Premiums ___________ 570
Accounting for the Sale or Maturity of Bond Investments ___________________ 572
Accounting for Equity Investments Using the Equity Method ___________________ 575
Illustrating the Equity Method _______________________________________ 576
Consolidated Financial Statements ________________________________________ 578
End-of-Chapter Materials_______________________________________________ 581
Comprehensive Problem Chapters 9–12 __________________________________ 606
xiv Contents