Financial
Accounting
Ninth Edition
Belverd E. Needles, Jr., Ph.D., C.P.A., C.M.A.
DePaul University
Marian Powers, Ph.D.
Northwestern University
Houghton Mifflin Company
Boston
New York
To Annabelle and Abigail Needles
In memory of Mr. and Mrs. Belverd E. Needles, Sr., and
Mr. and Mrs. Benjamin E. Needles
To Mr. and Mrs. Thomas R. Powers
Publisher: George Hoffman
Senior Sponsoring Editor: Ann West
Senior Development Editor: Chere Bemelmans
Editorial Assistants: James R. Dimock, Alison McGonagle
Project Editor: Margaret M. Kearney
Editorial Assistant: Brett Pasinella
Art and Design Manager: Gary Crespo
Senior Photo Editor: Jennifer Meyer Dare
Composition Buyer: Chuck Dutton
Senior Manufacturing Buyer: Renee Ostrowski
Marketing Manager: Mike Schenk
Marketing Associate: Kathleen Mellon
Cover engine image © Svenja-Foto/zefa/Corbis
Cover county fair image (The Erie County Fair, Hamburg, Eric County, New York)
© Panoramic Images/James Schwabel
CVS Annual Report reprinted courtesy of CVS.
Portions of Southwest Airlines Annual Report courtesy of Southwest Airlines Co.
COMPANY LOGO CREDITS: page 7, By permission of CVS; page 107, BOEING trademark
used with permission; page 158, By permission of Yahoo!; page 228, Courtesy of Dell Inc.;
page 283, By permission of Costco Wholesale; page 418, Amazon, Amazon.com, and the
Amazon.com logo are registered trademarks of Amazon.com, Inc. or its affiliates; page 615,
Motorola, Inc.; page 660, By permission of Marriott International, Inc.; page 756, eBay and
the eBay logo are trademarks of eBay Inc.
PHOTO CREDITS: page 3, Getty Images; page 9, AP/Wide World Photos; page 17, © Jim
West/The Image Works; page 21, By permission of CVS; page 21, © Frank Trapper/Corbis;
page 105, AFP/Getty Images; page 110, © Reuters/Corbis; page 126, Getty Images; (continued
on page 850)
Copyright © 2007 by Houghton Mifflin Company. All rights reserved.
No part of this work may be reproduced or transmitted in any form or by any means,
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storage or retrieval system without the prior written permission of Houghton Mifflin
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inquiries to College Permissions, Houghton Mifflin Company, 222 Berkeley Street, Boston,
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Printed in the U.S.A.
Library of Congress Control Number: 2005935736
Student Text
ISBN 13: 978-0-618-62676-2
ISBN 10: 0-618-62676-X
Instructor’s Examination Copy
ISBN 13: 978-0-618-72187-0
ISBN 10: 0-618-72187-8
123456789-VH-10 09 08 07 06
Brief Contents
SUPPLEMENT TO CHAPTER
SUPPLEMENT TO CHAPTER
SUPPLEMENT TO CHAPTER
1
Uses of Accounting Information and the Financial Statements 2
1
How to Read an Annual Report 55
2
Analyzing Business Transactions 104
3
Measuring Business Income 156
3
Closing Entries and the Work Sheet 209
4
Financial Reporting and Analysis 224
4
The Annual Report Project 277
5
The Operating Cycle and Merchandising Operations 280
6
Inventories 332
7
Cash and Receivables 374
8
Current Liabilities and the Time Value of Money 416
9
Long-Term Assets 462
10
Long-Term Liabilities 512
11
Contributed Capital 566
12
The Corporate Income Statement and the
Statement of Stockholders’ Equity 610
13
The Statement of Cash Flows 656
14
Financial Performance Measurement 704
15
Investments 754
APPENDIX
A
Accounting for Unincorporated Businesses 798
APPENDIX
B
Future Value and Present Value Tables 808
iii
This page intentionally left blank
Contents
Preface
xiii
User’s Guide to Financial Accounting
Check Figures
xxvii
About the Authors
CHAPTER
xix
1
xxix
í DECISION POINT: A USER’S FOCUS CVS CORPORATION
Accounting as an Information System
3
í FOCUS ON BUSINESS PRACTICE: What Does CVS Have to
Say About Itself?
6
í FOCUS ON BUSINESS PRACTICE: Cash Bonuses Depend
6
on Accounting Numbers!
Financial and Management Accounting
Processing Accounting Information 7
8
Financial Position and the Accounting
Equation 19
20
Financial Statements
8
Decision Makers: The Users of Accounting
Information 10
Management 10
í FOCUS ON BUSINESS PRACTICE: What Do CFOs Do?
Users with a Direct Financial Interest 12
Users with an Indirect Financial Interest 12
Governmental and Not-for-Profit Organizations 13
Accounting Measurement
13
Business Transactions 14
Money Measure 14
Separate Entity 15
11
23
Income Statement 23
Statement of Retained Earnings 23
The Balance Sheet 24
Statement of Cash Flows 24
Relationships Among the Financial Statements
Generally Accepted Accounting Principles
25
27
GAAP and the Independent CPA’s Report 28
Organizations That Influence GAAP 29
Professional Ethics 30
í A LOOK BACK AT CVS CORPORATION
CHAPTER REVIEW
31
33
CHAPTER ASSIGNMENTS
The Corporate Form of Business
16
Formation of a Corporation 17
Organization of a Corporation 17
Corporate Governance 19
Assets 20
Liabilities 20
Stockholders’ Equity
7
í FOCUS ON BUSINESS PRACTICE: How Did Accounting
Ethical Financial Reporting
í FOCUS ON BUSINESS PRACTICE: Are Most
Corporations Big or Small Businesses?
4
Business Goals, Activities, and Performance Measures 5
Develop?
2
Uses of Accounting Information and the Financial Statements
39
15
Characteristics of Corporations, Sole Proprietorships,
and Partnerships 16
SUPPLEMENT TO CHAPTER
1
55
How to Read an Annual Report
The Components of an Annual Report
Letter to the Stockholders 55
Financial Highlights 56
Description of the Company 56
Management’s Discussion and Analysis
55
Notes to the Financial Statements 61
Reports of Management’s Responsibilities 62
Reports of Certified Public Accountants 63
CVS Corporation 2004 Annual Report
56
65
Financial Statements of Southwest Airlines Co.
95
Financial Statements 56
v
vi
|
Contents
CHAPTER
2
í DECISION POINT: A USER’S FOCUS SINGAPORE AIRLINES
AND THE BOEING CO.
Measurement Issues
105
106
Recognition 106
í FOCUS ON BUSINESS PRACTICE: Accounting Policies:
Where Do You Find Them? 106
í FOCUS ON BUSINESS PRACTICE: Is It Always Cost?
108
Valuation 108
í FOCUS ON BUSINESS PRACTICE: No Dollar Amount: How
Can That Be?
108
Double-Entry System
123
Preparation and Use of a Trial Balance
123
í FOCUS ON BUSINESS PRACTICE: Are All Trial Balances
110
Created Equal?
Accounts 111
The T Account 111
The T Account Illustrated 111
Rules of Double-Entry Accounting 112
Normal Balance 113
Stockholders’ Equity Accounts 113
Business Transaction Analysis
124
Finding Trial Balance Errors 124
í FOCUS ON BUSINESS PRACTICE: Should Earnings Be
125
Aligned with Cash Flows?
Cash Flows and the Timing of Transactions
Recording and Posting Transactions
115
Owners’ Investment in the Business 116
Economic Event That Is Not a Business Transaction 116
Prepayment of Expenses in Cash 116
Purchase of an Asset on Credit 117
Purchase of an Asset Partly in Cash and
Partly on Credit 117
3
Payment of a Liability 118
Revenue in Cash 118
Revenue on Credit 119
Revenue Received in Advance 119
Collection on Account 119
Expense Paid in Cash 120
Expense to Be Paid Later 120
Dividends 121
Summary of Transactions 121
The Trial Balance
Classification 109
Ethics and Measurement Issues 109
CHAPTER
104
Analyzing Business Transactions
127
Chart of Accounts 127
General Journal 128
General Ledger 130
Some Notes on Presentation 132
í A LOOK BACK AT SINGAPORE AIRLINES AND THE
BOEING COMPANY
CHAPTER REVIEW
133
135
CHAPTER ASSIGNMENTS
139
156
Measuring Business Income
í DECISION POINT: A USER’S FOCUS YAHOO! INC.
157
Profitability Measurement: Issues and Ethics
Net Income 158
Income Measurement Assumptions
Ethics and the Matching Rule
158
158
í FOCUS ON BUSINESS PRACTICE: Fiscal Years Vary
159
160
Accrual Accounting
162
Recognizing Revenues
Recognizing Expenses
Adjusting the Accounts
Adjustments and Ethics
162
161
í FOCUS ON BUSINESS PRACTICE: Ecommerce: What’s Its
Impact?
174
174
Using the Adjusted Trial Balance to Prepare
Financial Statements 175
The Accounting Cycle
177
Closing Entries 177
The Post-Closing Trial Balance 179
162
162
í FOCUS ON BUSINESS PRACTICE: Entering Adjustments
163
The Adjustment Process
Type 3 Adjustment: Allocating Recorded, Unearned
Revenues (Deferred Revenues) 171
Type 4 Adjustment: Recognizing Unrecorded, Earned
Revenues (Accrued Revenues) 172
A Note About Journal Entries
í FOCUS ON BUSINESS PRACTICE: Are Misstatements of
Earnings Always Overstatements?
125
180
with the Touch of a Button
164
Type 1 Adjustment: Allocating Recorded Costs
(Deferred Expenses) 165
Type 2 Adjustment: Recognizing Unrecorded Expenses
(Accrued Expenses) 169
Cash Flows from Accrual-Based Information
í A LOOK BACK AT YAHOO! INC.
CHAPTER REVIEW
184
CHAPTER ASSIGNMENTS
191
183
181
Contents
SUPPLEMENT TO CHAPTER
3
Preparing Closing Entries
209
4
The Accounts After Closing
212
The Work Sheet: An Accountant’s Tool
Preparing the Work Sheet 213
Using the Work Sheet 216
SUPPLEMENT ASSIGNMENTS
217
212
í DECISION POINT: A USER’S FOCUS DELL COMPUTER
225
224
226
Objectives of Financial Reporting 226
Qualitative Characteristics of Accounting Information 226
Management’s Certification of the Financial
Statements 228
Accounting Conventions
í FOCUS ON BUSINESS PRACTICE: There’s More Than One
Way to Balance a Balance Sheet
Foundations of Financial Reporting
229
234
Liabilities 237
Stockholders’ Equity 237
Owner’s Equity and Partners’ Equity237
Dell’s Balance Sheets 239
Forms of the Income Statement
240
Comparability and Consistency 229
Materiality 230
Multistep Income Statement 240
Dell’s Income Statements 245
Single-Step Income Statement 245
í FOCUS ON BUSINESS PRACTICE: Are Yahoo! and Google
Using Classified Financial Statements
Comparable? Can an Internet Company Be
Conservative? 230
í FOCUS ON BUSINESS PRACTICE: How Much Is Material?
It’s Not Only a Matter of Numbers
231
Evaluation of Liquidity 247
Evaluation of Profitability 248
í FOCUS ON BUSINESS PRACTICE: Who Is Right: The
í FOCUS ON BUSINESS PRACTICE: To What Level of
Profitability Should a Company Aspire?
í FOCUS ON BUSINESS PRACTICE: When Is “Full Disclosure”
Too Much? It’s a Matter of Cost and Benefits
Classified Balance Sheet
247
Credit-Worthiness Analyst or the Profitability
Analyst? 249
Conservatism 231
Full Disclosure 231
Cost-Benefit 232
Assets
213
Financial Reporting and Analysis
CORPORATION
vii
209
Closing Entries and the Work Sheet
Step 1: Closing the Credit Balances 209
Step 2: Closing the Debit Balances 209
Step 3: Closing the Income Summary Account
Balance 212
Step 4: Closing the Dividends Account Balance
CHAPTER
|
232
233
252
í A LOOK BACK AT DELL COMPUTER CORPORATION
CHAPTER REVIEW
254
257
CHAPTER ASSIGNMENTS
261
234
SUPPLEMENT TO CHAPTER
CHAPTER
5
4
277
The Annual Report Project
280
The Operating Cycle and Merchandising Operations
í DECISION POINT: A USER’S FOCUS COSTCO WHOLESALE
CORPORATION
281
Managing Merchandising Businesses
Financial Fraud to Detect When Its Effects
Are Not Material? 287
282
Terms of Sale
Operating Cycle 282
Choice of Inventory System 283
í FOCUS ON BUSINESS PRACTICE: How Have Bar Codes
Influenced the Choice of Inventory Systems?
í FOCUS ON BUSINESS PRACTICE: How Hard Is
284
Foreign Business Transactions 285
The Need for Internal Controls 285
Management’s Responsibility for Internal Control 287
288
Sales and Purchases Discounts 288
Transportation Costs 289
Terms of Debit and Credit Card Sales 290
í FOCUS ON BUSINESS PRACTICE: How Are Buying Habits
Changing?
290
Perpetual Inventory System
Purchases of Merchandise
291
291
viii
|
Contents
í FOCUS ON BUSINESS PRACTICE: Are Purchase
Allowances Revenues?
Sales of Merchandise
Components of Internal Control 301
Control Activities 301
Limitations on Internal Control 303
292
293
í FOCUS ON BUSINESS PRACTICE: How Are Web Sales
Doing?
294
Periodic Inventory System
295
Internal Control and Management Goals 304
Purchases of Merchandise 297
Sales of Merchandise 298
í FOCUS ON BUSINESS PRACTICE: How Do Computers
Promote Internal Control?
í FOCUS ON BUSINESS PRACTICE: Are Sales Returns Worth
Accounting For?
Internal Control over Merchandising
Transactions 303
299
305
Control of Cash Sales Receipts 305
Control of Purchases and Cash Disbursements
Internal Control: Components, Activities, and
Limitations 300
í A LOOK BACK AT COSTCO WHOLESALE
í FOCUS ON BUSINESS PRACTICE: Which Frauds Are Most
CHAPTER REVIEW
Common?
CHAPTER
6
301
CORPORATION
306
311
312
CHAPTER ASSIGNMENTS
316
332
Inventories
í DECISION POINT: A USER’S FOCUS CISCO
SYSTEMS, INC.
Last-In, First-Out (LIFO) Method 346
333
Managing Inventories
í FOCUS ON BUSINESS PRACTICE: What’s a “Category
Killer”?
334
Inventory Decisions 334
Evaluating the Level of Inventory
Impact of Inventory Decisions
335
í FOCUS ON BUSINESS PRACTICE: A Whirlwind Inventory
335
Turnover-How Does Dell Do It?
Effects on the Financial Statements 348
Effects on Income Taxes 349
Inventory Costing Method Affect Its Operating
Decisions? 350
í FOCUS ON BUSINESS PRACTICE: What Do You Do to Cure
338
Inventory Cost and Valuation
347
í FOCUS ON BUSINESS PRACTICE: Does a Company’s
Effects of Inventory Misstatements on Income
Measurement 337
a Bottleneck Headache?
346
Effects on Cash Flows 350
Inventory Cost Under the Perpetual Inventory
System 351
340
Goods Flow and Cost Flows 341
Lower-of-Cost-or-Market (LCM) Rule 342
Disclosure of Inventory Methods 342
í FOCUS ON BUSINESS PRACTICE: More Companies
Inventory Cost Under the Periodic Inventory
System 344
Retail Method 353
Gross Profit Method 354
Specific Identification Method 344
Average-Cost Method 345
First-In, First-Out (FIFO) Method 345
í A LOOK BACK AT CISCO SYSTEMS, INC.
CHAPTER
7
Enjoy LIFO!
Valuing Inventory by Estimation
CHAPTER REVIEW
353
355
357
CHAPTER ASSIGNMENTS
361
374
Cash and Receivables
í DECISION POINT: A USER’S FOCUS NIKE, INC.
375
Management Issues Related to Cash and
Receivables 376
Cash Needs
352
376
í FOCUS ON BUSINESS PRACTICE: How Do Good
Companies Deal with Bad Times?
376
Accounts Receivables and Credit Policies 377
Evaluating the Level of Accounts Receivable 379
í FOCUS ON BUSINESS PRACTICE: How Do Powerful Buyers
Cause Problems for Small Suppliers?
379
Financing Receivables 380
Ethics and Estimates in Accounting for Receivables 382
Cash Equivalents and Cash Control
Cash Equivalents 384
Cash Control Methods 384
Bank Reconciliations 385
384
|
Contents
Uncollectible Accounts
388
The Allowance Method 388
Disclosure of Uncollectible Accounts 389
Estimating Uncollectible Accounts Expense
389
í FOCUS ON BUSINESS PRACTICE: Why Are Estimates
390
Difficult to Make?
Duration of a Note 397
Interest and Interest Rate 398
Maturity Value 398
Accrued Interest 398
Dishonored Note 399
í A LOOK BACK AT NIKE, INC.
Writing Off Uncollectible Accounts 394
CHAPTER REVIEW
Notes Receivable
CHAPTER ASSIGNMENTS
396
ix
400
401
403
Maturity Date 396
CHAPTER
8
416
Current Liabilities and the Time Value of Money
í DECISION POINT: A USER’S FOCUS
AMAZON.COM, INC.
í FOCUS ON BUSINESS PRACTICE: What Is the Cost of
417
431
Frequent Flyer Miles?
Management Issues Related to Current
Liabilities 418
Contingent Liabilities and Commitments
Managing Liquidity and Cash Flows 418
Evaluating Accounts Payable 418
Future Value 435
Present Value 437
The Time Value of Money
í FOCUS ON BUSINESS PRACTICE: Debt Problems Can
Plague Even Well-Known Companies
419
Reporting Liabilities 420
Common Types of Current Liabilities
422
Definitely Determinable Liabilities 422
í FOCUS ON BUSINESS PRACTICE: Small Businesses Offer
Benefits, Too
425
Estimated Liabilities
í FOCUS ON BUSINESS PRACTICE: Those Little Coupons
CHAPTER
9
Applications of the Time Value of Money
440
Valuing an Asset 440
Deferred Payment 441
Investment of Idle Cash 442
Accumulation of a Fund for Loan Repayment 442
Other Applications 443
CHAPTER REVIEW
444
445
CHAPTER ASSIGNMENTS
430
Can Add Up
434
í A LOOK BACK AT AMAZON.COM, INC.
429
433
448
462
Long-Term Assets
í DECISION POINT: A USER’S FOCUS APPLE
COMPUTER, INC.
463
Management Issues Related to Long-Term
Assets 464
Acquiring Long-Term Assets 466
Financing Long-Term Assets 467
Applying the Matching Rule 468
Acquisition Cost of Property, Plant, and
Equipment 469
Disposal of Depreciable Assets
481
Discarded Plant Assets 481
Plant Assets Sold for Cash 482
Exchanges of Plant Assets 483
Natural Resources
483
Depletion 484
Depreciation of Related Plant Assets 485
Development and Exploration Costs in the Oil and
Gas Industry 485
General Approach to Acquisition Costs 470
Specific Applications 471
í FOCUS ON BUSINESS PRACTICE: How Do You Measure
Depreciation
Intangible Assets
474
í FOCUS ON BUSINESS PRACTICE: How Long Is the Useful
Life of an Airplane?
í FOCUS ON BUSINESS PRACTICE: Accelerated Methods
478
Special Issues in Depreciation
479
485
486
í FOCUS ON BUSINESS PRACTICE: Who’s Number One in
Brands?
475
Factors in Computing Depreciation 475
Methods of Computing Depreciation 475
Save Money!
What’s Underground? With a Good Guess
488
í FOCUS ON BUSINESS PRACTICE: What Is the Useful Life
of a Customer List?
489
Research and Development Costs 489
Computer Software Costs 490
Goodwill 490
x
|
Contents
í FOCUS ON BUSINESS PRACTICE: Wake Up, Goodwill Is
490
Growing!
10
Long-Term Liabilities
512
Bonds Issued at a Premium 528
Bond Issue Costs 528
513
CORPORATION
Management Issues Related to Issuing Long-Term
Debt 514
Deciding to Issue Long-Term Debt 514
Evaluating Long-Term Debt 515
í FOCUS ON BUSINESS PRACTICE: How Does Debt Affect a
Company’s Ability to Borrow?
Types of Long-Term Debt
The Nature of Bonds
516
522
523
Bond Issue: Prices and Interest Rates
Characteristics of Bonds 524
í FOCUS ON BUSINESS: Speed Up the
Calculations!
537
540
Calling Bonds 540
Covering Bonds 541
541
Sale of Bonds Between Interest Dates 541
Year-End Accrual of Bond Interest Expense 543
526
Bonds Issued at Face Value 526
Bonds Issued at a Discount 527
í A LOOK BACK AT McDONALD’S CORPORATION
í FOCUS ON BUSINESS PRACTICE: 100-Year Bonds Are Not
11
Amortization of Bond Discounts and
Premiums 531
Other Bonds Payable Issues
525
Accounting for the Issuance of Bonds
527
for Everyone
529
Case 1: Market Rate Above Face Rate 529
Case 2: Market Rate Below Face Rate 530
Retirement of Bonds
523
í FOCUS ON BUSINESS: Some Companies Are Saying
“Yes-Yes” to “No-Nos”
Using Present Value to Value a Bond
Amortizing a Bond Discount 531
Amortizing a Bond Premium 535
517
í FOCUS ON BUSINESS PRACTICE: Check Out Those Bond
CHAPTER
497
491
í DECISION POINT: A USER’S FOCUS McDONALD’S
Prices!
493
CHAPTER ASSIGNMENTS
í A LOOK BACK AT APPLE COMPUTER, INC.
CHAPTER
CHAPTER REVIEW
CHAPTER REVIEW
546
CHAPTER ASSIGNMENTS
550
566
Contributed Capital
í DECISION POINT: A USER’S FOCUS GOOGLE, INC.
567
Management Issues Related to Contributed
Capital 568
The Corporate Form of Business 568
Equity Financing 570
Dividend Policies 572
Using Return on Equity to Measure Performance 574
Stock Options as Compensation 575
í FOCUS ON BUSINESS PRACTICE: How Did Accounting for
Stock Options Become Political?
576
Components of Stockholders’ Equity
Preferred Stock
577
580
Preference as to Dividends 580
Preference as to Assets 581
í FOCUS ON BUSINESS PRACTICE: How Does a Stock
Become a Debt?
582
Convertible Preferred Stock 582
Callable Preferred Stock 583
Issuance of Common Stock
584
Par Value Stock 584
No-Par Stock 585
Issuance of Stock for Noncash Assets 586
Accounting for Treasury Stock
587
Purchase of Treasury Stock 587
í FOCUS ON BUSINESS PRACTICE: When Are Share
Buybacks a Bad Idea?
576
í FOCUS ON BUSINESS PRACTICE: Are You a First-Class or
Second-Class Stockholder?
544
588
Sale of Treasury Stock 588
Retirement of Treasury Stock 590
í A LOOK BACK AT GOOGLE, INC.
CHAPTER REVIEW
592
CHAPTER ASSIGNMENTS
596
591
Contents
CHAPTER
12
xi
The Corporate Income Statement and the Statement of Stockholders’ Equity 610
í DECISION POINT: A USER’S FOCUS MOTOROLA, INC.
611
Earnings per Share
623
Performance Measurement: Quality of Earnings
Issues 612
Basic Earnings per Share 623
Diluted Earnings Per Share 625
í FOCUS ON BUSINESS PRACTICE: Why Do Investors Study
Comprehensive Income and the Statement of
Stockholders’ Equity 626
612
Quality of Earnings?
The Effect of Accounting Estimates and Methods
613
í FOCUS ON BUSINESS PRACTICE: Were Preussag’s
Year-End Results Really “Remarkable”?
Gains and Losses 615
Write-downs and Restructurings
615
Forma” Earnings?
616
Nonoperating Items 616
Quality of Earnings and Cash Flows
Comprehensive Income 626
The Statement of Stockholders’ Equity 626
Retained Earnings 628
Stock Dividends and Stock Splits
615
í FOCUS ON BUSINESS PRACTICE: Can You Believe “Pro-
Income Taxes
|
í FOCUS ON BUSINESS PRACTICE: Do Stock Splits Help
Increase a Company’s Market Price?
616
Book Value
618
CHAPTER REVIEW
635
636
CHAPTER ASSIGNMENTS
622
632
634
í A LOOK BACK AT MOTOROLA, INC.
Deferred Income Taxes 619
Net of Taxes 620
Nonoperating Items
629
Stock Dividends 629
Stock Splits 631
640
Discontinued Operations 622
Extraordinary Items 622
CHAPTER
13
656
The Statement of Cash Flows
Changes in Current Assets 670
Changes in Current Liabilities 670
í DECISION POINT: A USER’S FOCUS MARRIOTT
657
INTERNATIONAL, INC.
Overview of the Statement of Cash Flows
658
í FOCUS ON BUSINESS PRACTICE: What Is EBITA, and Is It
Any Good?
Purposes of the Statement of Cash Flows 658
Uses of the Statement of Cash Flows 658
Classification of Cash Flows 659
Noncash Investing and Financing Transactions 660
Format of the Statement of Cash Flows 660
Schedule of Cash Flows from Operating Activities 671
Investing Activities
Financing Activities
662
í FOCUS ON BUSINESS PRACTICE: How Much Cash Does a
663
Company Need?
Cash-Generating Efficiency 663
Free Cash Flow 664
í FOCUS ON BUSINESS PRACTICE: Cash Flows Tell All
í FOCUS ON BUSINESS PRACTICE: What Do You Mean,
“Free Cash Flow”?
665
Operating Activities
Depreciation 668
Gains and Losses 669
666
676
Bonds Payable 677
Common Stock 677
Ethical Considerations and the Statement of Cash
Flows 662
Analyzing Cash Flows
673
Investments 673
Plant Assets 674
í FOCUS ON BUSINESS PRACTICE: How Universal Is the
Statement of Cash Flows?
671
678
Retained Earnings 678
Treasury Stock 679
664
í A LOOK BACK AT MARRIOTT INTERNATIONAL, INC.
CHAPTER REVIEW
682
CHAPTER ASSIGNMENTS
686
681
xii
|
Contents
CHAPTER
14
Trend Analysis 717
Vertical Analysis 718
Ratio Analysis 721
í DECISION POINT: A USER’S FOCUS STARBUCKS
CORPORATION
705
Foundations of Financial Performance
Measurement 706
Comprehensive Illustration of Ratio Analysis
Financial Performance Measurement: Management’s
Objectives 706
Financial Performance Measurement: Creditors’ and
Investors’ Objectives 706
Standards of Comparison 707
í FOCUS ON BUSINESS PRACTICE: Take the Numbers with
a Grain of Salt
708
Sources of Information 710
Executive Compensation 711
714
755
Evaluating Profitability 724
Evaluating Long-term Solvency 725
Evaluating the Adequacy of Cash Flows 726
Evaluating Market Strength 728
CHAPTER REVIEW
International Joint Ventures
Investments in Debt Securities
Short-Term Investments in Equity Securities
760
Trading Securities 760
í FOCUS ON BUSINESS PRACTICE: How Can Even a Big
761
í A LOOK BACK AT eBAY, INC.
763
Appendix A Accounting for Unincorporated Businesses
Appendix B Future Value and Present Value Tables
833
Company Name Index
837
808
798
778
780
CHAPTER ASSIGNMENTS
815
776
Held-to-Maturity Securities 777
Long-Term Investments in Bonds 777
CHAPTER REVIEW
Available-for-Sale Securities 763
Long-Term Investments in Equity Securities
768
Consolidated Balance Sheet 769
Consolidated Income Statement 774
Restatement of Foreign Subsidiary Financial
Statements 775
758
Answers to Stop, Review, and Apply Questions
767
Consolidated Financial Statements
í FOCUS ON BUSINESS PRACTICE: What Are Special-
839
737
í FOCUS ON BUSINESS PRACTICE: Accounting for
Recognition 756
Valuation 756
Classification 756
Disclosure 758
Ethics of Investing 758
Company Make an Accounting Mistake?
730
731
Noninfluential and Noncontrolling Investment 763
Influential but Noncontrolling Investment 766
The Management Issues Related to
Investments 756
Subject Index
724
One Way to Measure Performance
754
í DECISION POINT: A USER’S FOCUS eBAY, INC.
Endnotes
722
Investments
Purpose Entities?
721
í FOCUS ON BUSINESS PRACTICE: There’s More Than
CHAPTER ASSIGNMENTS
Horizontal Analysis 714
15
Evaluating Liquidity
í A LOOK BACK AT STARBUCKS CORPORATION
Tools and Techniques of Financial Analysis
CHAPTER
704
Financial Performance Measurement
783
Preface
This revision of Financial Accounting is the most significant in the book’s long
history. The substantial changes we have made are geared to meeting the
needs of today’s students, who not only face a business world increasingly
complicated by ethical issues, globalization, and technology, but who also
have more demands on their time. To help them meet these challenges, we
have placed a heavy emphasis on developing their decision-making and
critical-thinking skills and on providing information that is easy to understand
and process.
We invite you to read the User’s Guide that follows this preface to get a
sense of how this book was written to help students master financial accounting. Here, we elaborate on exactly what we set out to achieve in this ninth
edition.
Streamlined Coverage and Redesign of Text
While maintaining a solid foundation in double-entry accounting, we have
reduced complexity by eliminating 30 percent of in-text journal entries and all
nonessential procedural coverage and by condensing learning objectives.
Through extensive editing, we have reduced excessive detail, shortened headings, simplified explanations, and increased readability.
We have also made the text more accessible to students by using small,
diverse companies to illustrate concepts and techniques and well-known public companies to relate the concepts and techniques to the real world.
To make the text as readable, visually appealing, and pedagogically useful
as possible, we have broken it into “user friendly” blocks by using more bulleted and numbered lists and by interspersing the text with new art, photographs, end-of-section review material, and Focus on Business boxes.
Ī We have included more line art to clarify concepts, which will appeal to
students who are visual learners.
Ī We have added photographs to increase visual interest and accompanied them with captions that underscore the points made in the text.
Ī We have introduced a new feature called “Stop•Review•Apply” that
presents review questions at the end of each main section; the answers
to the questions follow the appendixes. Many of these features also
present short exercises together with their solutions.
Ī As in previous editions, learning objectives are clearly presented
throughout the text and in the end-of-chapter assignments.
Ī To reduce distractions, we have used the margins of the text only for key
ratio and cash flow icons, which highlight discussions of profitability and
liquidity; accounting equations; and Study Notes that alert students to
common misunderstandings of concepts and techniques.
Use of Accounting Information in Successful Decision Making
We have increased our emphasis on how businesses use accounting information in making decisions, and we have provided a framework for developing
decision-making skills.
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Ī To emphasize how important financial statements are in decision making, the first page of each chapter now includes a graphic model of the
income statement, balance sheet, and statement of cash flows and a
brief description of how these statements relate to the chapter’s topic.
Ī Each chapter opening also includes a new Decision Point that shows how
a well-known company—one that students will immediately recognize—
uses financial information to make decisions. The Decision Point poses
questions that challenge students to think about the relationship
between financial information and the decisions management makes.
The company discussed in the Decision Point is highlighted throughout
the chapter and is revisited in “A Look Back At,” a new feature that shows
how the questions posed in the Decision Point can now be answered.
Ī We have emphasized how ratios are used in evaluating a company’s
profitability and liquidity and, as noted, we have highlighted those discussions with key ratio and cash flow icons.
Ī To relate accounting concepts to real-world decision making, we have
referred to more than 200 actual companies and have used some of
those companies’ recent financial statements as illustrations.
Ī The assignment material in every chapter includes a case that compares
CVS with Southwest Airlines or Walgreens and that refers to both companies’ financial statements. Among other things, the comparison cases
require students to compute ratios, make assumptions, report on the
effect of seasonal sales, and describe each company’s inventory management system. CVS’s complete annual report and Southwest Airlines’
financial statements and Note 1 to the statements appear in the Supplement to Chapter 1.
Ī Using annual reports as the focus of term projects in the financial
accounting course has become increasingly popular. In the Supplement
to Chapter 4, we provide an annual report project that we have used in
our own classes for several years.
Ī We have used the latest available data in updating tables, figures, and
exhibits and have incorporated the most recent FASB pronouncements
into the text. We have illustrated current practices in financial reporting
by referring to data from the AICPA’s Accounting Trends and Techniques and
have integrated international topics wherever appropriate.
Ethical Financial Reporting
We believe students need to know more about what constitutes ethical financial reporting and good corporate governance, and we have revised the text to
address this need.
Ī The preview at the start of each chapter points out ethical and governance issues related to the chapter topic. We discuss these issues in the
first section of each chapter.
Ī We cover the provisions of the Sarbanes-Oxley Act of 2002 and stress its
importance in Chapter 1 and at appropriate points throughout the text.
Ī In the end-of-chapter material, we continue to provide short cases,
based on real companies, that require students to address an ethical
dilemma directly related to the chapter content.
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Reorganized Assignment Material
This text has always provided a rich assortment of assignments that address
instructors’ needs. While keeping the range and depth of assignments from
previous editions, we have tried to simplify their organization for easier use.
Ī The end-of-chapter assignments are organized into two main sections:
Building Your Basic Knowledge and Skills—which consists of Short Exercises, Exercises, Problems, and Alternate Problems—and Enhancing
Your Knowledge, Skills, and Critical Thinking—which consists of cases.
The cases are grouped under headings that allow instructors to focus on
the skills most important to them and their students (e.g., Conceptual
Understanding Cases, Interpreting Financial Reports, Decision Analysis
Using Excel, Ethical Dilemma Case). Each chapter also has an Annual
Report Case that focuses on CVS’s annual report and, as noted earlier, a
Comparison Case.
Ī The first two exercises in each chapter present questions useful in generating class discussion about the decision-making aspects of the chapter topics.
Ī Almost every problem includes at least one “User Insight” question,
which challenges students to think about the numbers and how they are
used in decision making.
Ī Problems have been carefully scrutinized to reduce the number of transactions involved and the time it takes to work the problems.
New Instructional Technologies for Today’s Business Environment
New technologies are a driving force behind business growth and accounting
education today. We have developed for the ninth edition an integrated text
and technology program dedicated to helping instructors take advantage of
the opportunities created by new instructional technologies. Whether an
instructor takes a more user or more procedural approach to teaching, wants to
incorporate new instructional strategies, wants to develop students’ core skills
and competencies, or desires to integrate technology into the classroom, the
ninth edition of Financial Accounting provides a total solution. (See the inside
back cover of the textbook for a complete listing of supplements.)
Course Management Systems
We know that homework and practice are an integral part of financial accounting
courses, and grading homework and tests can present a challenge to instructors.
The Eduspace® online learning tool pairs the widely recognized resources of
Blackboard with quality, text-specific content from Houghton Mifflin. Autograded homework exercises, algorithmic practice exercises, SMARTHINKING
online tutoring, MP3 files of chapter summaries, and other resources come
ready to use. Premium Blackboard course cartridges and WebCT ePacks are also
available.
HMClassPrep with HMTesting
Available on the HMClassPrep CD, HMTesting—now powered by Diploma®—
contains the computerized version of the Test Bank. HMTesting provides
instructors with all the tools they need to create, customize, and deliver multiple types of tests. Instructors can add their own questions or edit existing algorithmic questions all within Diploma’s powerful electronic platform. Instructors
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can select, edit, and add questions, or generate randomly selected questions
to produce a test master for easy duplication. HMTesting also contains test
questions with algorithms. Online Testing and Gradebook functions allow
instructors to administer tests via their local area network or the Internet, set
up classes, record grades from tests or assignments, analyze grades, and compile class and individual statistics. HMTesting can be used on both PCs and
Mac computers.
The Test Bank is also available in print. The printed Test Bank provides the
same questions found in HMTesting—more than 3,000 true-false, multiple
choice, short essay, and critical-thinking questions, as well as exercises and
problems, all of which test students’ ability to recall, comprehend, apply, and
analyze information. Two achievement tests are provided for each chapter.
HMClassPrep also includes the complete Course Manual, the Electronic
Solutions (fully functioning Excel spreadsheets for all exercises, problems, and
cases in the text; also available in print); completely revised PowerPoint slides
with audio, video, and original content; Video Cases; check figures for end-ofchapter problems; and web links to the Needles Accounting Online Teaching/
Online Study Centers.
Instructor and Student Websites
The Online Teaching and Online Study Centers provide instructors and students with text-specific resources that reinforce key concepts in the Financial
Accounting program. For instructors, the Online Teaching Center includes password-protected course materials, such as completely revised PowerPoint
slides with audio, video, and original content; Classroom Response System
content; sample syllabi; accounting news updates; and Electronic Solutions,
which are fully functioning Excel spreadsheets for all exercises, problems, and
cases in the text. The Online Study Center links students to ACE practice
tests, Flashcards and Crossword Puzzles to reinforce vocabulary, websites for
companies featured in the text, chapter summaries in MP3 format, Annual
Report Activities, and other resources.
See the User’s Guide on p. xix for a complete listing of all the student supplements available.
The Bottom Line
Although we have done more in this revision than in any previous one to make
accounting concepts accessible to students, there is one thing we have not
changed: we still teach students that financial statements tell a company’s
story. For investors and creditors, they reveal a company’s financial health,
prosperity, and future. For management, they are a means of guiding a company’s progress and profitability. Our goal is to improve students’ understanding of the “story” revealed in a company’s financial statements, and never has
that goal been as critical as in current times, with business events underscoring
this fact: accounting really matters.
To read financial statements and follow the “story,” students have to learn
how to think. Financial Accounting teaches students to think about what they are
reading, how they might make a financial decision, and what roles they might
play as future users of financial statements. Students also have to learn how to
analyze and interpret the numbers in the financial statements—where did the
numbers come from? What is the meaning behind the numbers? What do the
numbers say about a company’s financial health? Today, financial accounting
students need to learn more than how to prepare financial statements; they
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xvii
also must learn how to find meaningful information in them. Financial Accounting,
Ninth Edition, focuses on teaching students to do just that.
Acknowledgments
A successful textbook is a collaborative effort. We are grateful to the many professors, other professional colleagues, and students who have taught and studied from our book, and we thank all of them for their constructive comments. In
the space available, we cannot possibly mention everyone who has been helpful, but we do want to recognize those who made special contributions to our
efforts in preparing the ninth edition of Financial Accounting.
We wish to express our deep appreciation to colleagues at DePaul University, who have been extremely supportive and encouraging.
The thoughtful and meticulous work of Edward H. Julius (California
Lutheran University) is reflected not only in the Study Guide, but also in our
Test Bank and Eduspace course as well. We would also like to thank Jeri Condit
for creating the PowerPoint slides, Sue Garr and Linda Burkell for HMAccounting Tutor, and Cathy Larson for her accuracy review of the text and solutions.
Sarah Evans deserves special recognition for her thoroughness and clarity in
editing and laying out the ninth edition.
Also very important to the quality of this book is the supportive collaboration of our senior sponsoring editor, Ann West; senior development editor,
Chere Bemelmans; editorial assistants, Jim Dimock and Alison McGonagle; and
project editor, Margaret Kearney—to whom we give special thanks.
Others who have had a major impact on this book through their reviews,
suggestions, and participation in surveys, interviews, and focus groups are
listed below. We cannot begin to say how grateful we are for the feedback from
the many instructors who have generously shared their responses and teaching
experiences with us.
Glenn Owen Alan, Hancock College
Gregory D. Barnes, Clarion University
Mohamed E. Bayou, University of Michigan—Dearborn
LuAnn Bean, University of Arkansas
Charles M. Betts, Delaware Technical and Community College
Eric Blazer, Millersville University
Michael C. Blue, Bloomsburg University
Cindy E. Bolt, The Citadel
Gary R. Bower, Community College of Rhode Island
Beth Brooks Patel, University of California—Berkeley
Chuck Bunn, Wake Technical College
Mike Campbell, Montana State University—Billings
Lee Cannell, El Paso Community College
Nancy Cassidy, Texas A&M University
James Cieslak, Cuyahoga Community College
Michael Cornick, University of North Carolina, Charlotte
John D. Cunha, University of California—Berkeley
Mark W. Dawson, Duquesne University
Patricia A. Doherty, Boston University
Cathy Duffy, Carthage College
Lizabeth England, American Language Academy
Van Feller, Wilbur Wright Community College
David Fetyko, Kent State University
Micah Frankel, California State University, Hayward
Sue Garr, Wayne State University
John Gillett, Bradley University
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Roxanne Gooch, Cameron University
Rita Grant, Gand Valley State University
Christine Uber Grosse, The American Graduate School of International Management
Dennis A. Gutting, Orange County Community College
John Hancock, University of California—Davis Graduate School of Management
George Heyman, Oakton Community College
Ann Hicks, Northpark University
Marianne James, California State University, Los Angeles
Edward H. Juilus, California Lutheran University
Howard A. Kanter, DePaul University
Stacy Kovar, Kansas State University
Cathy X. Larson, Middlesex Community College
Elliott S. Levy, Bentley College
Dawn W. Massey, Fairfield University
Kevin McClure, ESL Language Center
George McGowan
Gail A. Mestas
Melanie Middlemist, North Colorado State University
Jenine Moscove
Michael F. Monahan
Mark Myring, Ball State University
Maureen O’Brien, Illinois State University
Janet Papiernik, Indiana University
Betty Pilchard, Heartland Community College
LaVonda Ramey, Schoolcraft College
Roberta Rettner, American Ways
James B. Rosa, Queensborough Community College
Yehia Salama, University of Illinois—Chicago
Marguerite Savage, Elgin Community College
Donald Shannon, DePaul Univeristy
S. Murray Simons, Northeastern University
Marion Taube, University of Pittsburgh
Kathleen Villani, Queensborough Community College
John Weber, DeVry Institute
Kay Westerfield, University of Oregon
Bill Wootton, Eastern Illinois
W.T. Wrege, Ball State University
Carol Yacht
Glenn Allen Young, Tulsa Junior College
Marilyn J. Young, Tulsa Junior College
Mary Zenner, College of Lake County
B.N. and M.P.
User’s Guide to
Financial Accounting
We have designed Financial Accounting with you—the student—in
mind. Becoming familiar with this textbook will help you succeed in
this course: you will study more effectively and improve your grades
on tests and assignments. The following User’s Guide will introduce
you to your Financial Accounting textbook.
Preview the Chapter
Use these features to preview the chapter. First, become familiar with
the Learning Objectives (they appear throughout the chapter), and
then read how a leading business uses accounting information.
Review Making a Statement; this feature tells you which financial
statements are important in this chapter.
1 The Chapter Preview focuses on management and ethical
issues. As you read this section, consider the following: Why are
the concepts in this chapter important to managers? What are
the ethical issues?
1
2 The Learning Objectives (LOs) help guide you toward mastery
of the material.These brief statements summarize what you should
know after reading the chapter.You will see many references to
LOs throughout each chapter.
3 Making a Statement reinforces the connection between the
financial statements and the chapter’s topics. It indicates which
financial statements are important in each chapter.
2
3
4
4 Use the Decision Point feature to see how real companies depend
on accounting information in decision making. Look for references
to the Decision Point company throughout the chapter. Many
of the companies profiled are among the most successful
in the world.
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User’s Guide
Reinforce What You Read
As you read each chapter, use the features described below to reinforce the concepts. Look for the LO before every each main section,
and note boldface words: they are terms and definitions you should
know. Use the Stop, Review, and Apply questions at the end of each
main section to assess your understanding of the material.
5
5 Learning Objectives introduce the key points of each section and
are integrated throughout the text.
6 Boldface terms call out important concepts and their definitions.
These words also appear in a glossary at the end of the chapter.
6
7
7 Study Notes highlight important information and provide useful tips
on ways to avoid common mistakes.
8
8 Photographs with detailed captions reinforce concepts in the textbook and show how accounting is used in the business world.
9
9 Stop, Review, and Apply features at the end of every section help
you review important concepts in the section.These questions can
also be used for discussion in class.
10 Accounting equations next to important journal entries
reinforce the impact of the transaction on the financial
statements.
10
User’s Guide
|
Reinforce Concepts Visually
These features visually reinforce the concepts in your textbook. Line
art helps explain concepts, exhibits show financial statements and
other information, and tables include material to support topics covered in the chapter. Also look for icons throughout the text; they are
visual guides to key features.
11 An abundance of line art illustrates the relationships between
concepts and processes.
11
12
12 Exhibits throughout the text show financial information.
13 The cash flow icon highlights discussion of cash as a measure
of liquidity. Measurement of cash flows serves as an indicator
of a company’s success; hence the emphasis on cash flows in
this book.
13
12
14
14 Tables present factual information referred to in the text.
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User’s Guide
Learn Why Accounting Is Relevant
These features demonstrate how and why accounting is relevant.
Focus on Business Practice boxes introduce you to real companies
and real issues. The Supplement to Chapter 1 helps you learn how to
read—and understand—real financial statements and interpret what
management says about them.
15 Focus on Business Practice boxes highlight the relevance of
accounting to business today.
15
16 The textbook refers to over 200 public, private, and not-for-profit
companies.The Needles Online Study Center website (http://
college.hmco.com/pic/needlesfa9e) provides a direct link to the
websites of these companies.The book also has a company name
index.
16
17 Graphs and tables illustrate how actual business practices relate to
chapter topics. Data for these illustrations come from Accounting
Trends & Techniques and from Dun & Bradstreet, key sources of
business information.
17
18 Ratios are used to measure a company’s performance.
The key ratio icon appears in the margin to highlight
discussions of important ratios.
18
19
19 The complete annual report for CVS and the financial statements
of Southwest Airlines are in the supplement to Chapter 1. CVS’s
financial statements with annotations also appear in the
Supplement to Chapter 1.
User’s Guide
Summarize and Review
The end-of-chapter features provide summary, review, and assignments for practice. A Look Back At relates the chapter’s concepts to
the company you read about in the Decision Point at the beginning
of the chapter. Review sections include a Review of Learning Objectives and a Review of Concepts and Terminology.
20 A Look Back At shows how the concepts learned in the chapter can
be used to evaluate a company’s performance.
20
21 The Chapter Review restates each learning objective
and its main ideas.
21
22 Each chapter includes a glossary of the key concepts and terms
defined in the chapter.The LO next to each term indicates the section in which it is discussed.
Want more study aids and review exercises? The Study Guide for
this book provides a thorough review of each learning objective, a
detailed outline, true/false and multiple-choice questions, and
exercises. Answers are included. Ask for it at your bookstore.
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Review and Practice
Continue your review of the chapter with the Review Problem, which
reflects computations or analyses covered in the chapter. For practice at different levels of difficulty, Chapter Assignments—from Short
Exercises to Cases—let you develop skills learned in the chapter. All
assignments are identified by Learning Objective so you can easily
review the concepts presented in the text.
23 Not sure if you understand the techniques and calculations? Want to find
out if you’re ready for a test? The Review
Problem models main computations or
analyses presented in the chapter and
end-of-chapter assignments.The answer,
usually shown in Excel, is provided for
immediate feedback.
23
24 Short exercises provide additional practice. Learning
Objectives appear in the margin next to all assignments
so you can refer to the text for help.
24
25 Single-topic exercises stress the application of the
chapter’s concepts.
25