Financial and
Managerial

Accounting
NINTH EDITION

Belverd E. Needles, Jr., Ph.D., C.P.A., C.M.A.
DePaul University

Marian Powers, Ph.D.
Northwestern University

Susan V. Crosson, M.S. Accounting, C.P.A
Santa Fe College


Financial and Managerial Accounting,
Ninth Edition
Belverd Needles, Marian Powers,
Susan Crosson
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1 2 3 4 5 6 7 14 13 12 11 10


BRIEF CONTENTS

SUPPLEMENT TO CHAPTER

SUPPLEMENT TO CHAPTER

SUPPLEMENT TO CHAPTER

1

Uses of Accounting Information and the Financial Statements

1

How to Read an Annual Report

2

Analyzing Business Transactions

3

Measuring Business Income

3

Closing Entries and the Work Sheet


4

Financial Reporting and Analysis

4

The Annual Report Project

5

The Operating Cycle and Merchandising Operations

6

Inventories

7

Cash and Receivables

8

Current Liabilities and Fair Value Accounting

9

Long-Term Assets

2


50
90

142
194

208

258
260

310

392

434

10 Long-Term Liabilities
11 Contributed Capital
12 Investments

352

480

532

578


13 The Corporate Income Statement and the Statement
of Stockholders’ Equity

620

14 The Statement of Cash Flows

666

15 The Changing Business Environment: A Manager’s Perspective
16 Cost Concepts and Cost Allocation

760

17 Costing Systems: Job Order Costing
18 Costing Systems: Process Costing

718

806

844

19 Value-Based Systems: ABM and Lean

882

iii



iv

Brief Contents

20 Cost Behavior Analysis

922

21 The Budgeting Process

964

22 Performance Management and Evaluation
23 Standard Costing and Variance Analysis
24 Short-Run Decision Analysis

1108

25 Capital Investment Analysis

1148

1016

1060

26 Pricing Decisions, Including Target Costing and Transfer
Pricing

1186


27 Quality Management and Measurement
28 Financial Analysis of Performance
APPENDIX

A

Accounting for Investments

APPENDIX

B

Present Value Tables

1334

1320

1270

1232


CONTENTS
Preface xix
About the Authors xxxiii

CHAPTER 1


Uses of Accounting Information and the Financial Statements
DECISION POINT Ǡ A USER’S FOCUS CVS CAREMARK

3

Accounting as an Information System 4
Business Goals and Activities 4
Financial and Management Accounting 7
Processing Accounting Information 7
Ethical Financial Reporting 8

Decision Makers: The Users of Accounting
Information 10

Corporate Governance 18

Financial Position and the Accounting
Equation 19
Assets 19
Liabilities 19
Stockholders’ Equity 20

Financial Statements 21

Management 10
Users with a Direct Financial Interest 11
Users with an Indirect Financial Interest 12
Governmental and Not-for-Profit Organizations 12

Income Statement 21

Statement of Retained Earnings 22
The Balance Sheet 22
Statement of Cash Flows 23
Relationships Among the Financial Statements 24

Accounting Measurement 13

Generally Accepted Accounting Principles 26

Business Transactions 13
Money Measure 14
Separate Entity 14

GAAP and the Independent CPA’s Report 27
Organizations That Issue Accounting Standards 27
Other Organizations That Influence GAAP 28
Professional Conduct 29

The Corporate Form of Business 15
Characteristics of Corporations, Sole Proprietorships,
and Partnerships 15
Formation of a Corporation 17
Organization of a Corporation 17

SUPPLEMENT TO CHAPTER 1

A LOOK BACK AT Ǡ CVS CAREMARK

STOP & REVIEW


30

33

CHAPTER ASSIGNMENTS

35

How to Read an Annual Report

The Components of an Annual Report 50
Letter to the Stockholders 51
Financial Highlights 51
Description of the Company 51
Management’s Discussion and Analysis 51

CHAPTER 2

2

Financial Statements 52
Notes to the Financial Statements 57
Reports of Management’s Responsibilities 58
Reports of Certified Public Accountants 58

Analyzing Business Transactions
DECISION POINT Ǡ A USER’S FOCUS THE BOEING
COMPANY

91


Measurement Issues 92
Recognition 92
Valuation 94

50

90
Classification 95
Ethics and Measurement Issues 95

Double-Entry System 96
Accounts 97
The T Account 97

v


vi

Contents

CHAPTER 3

The T Account Illustrated 97
Rules of Double-Entry Accounting 98
Normal Balance 99
Stockholders’ Equity Accounts 99

Expense Paid in Cash 106

Expense to Be Paid Later 106
Dividends 106
Summary of Transactions 107

Business Transaction Analysis 101

The Trial Balance 109

Owner’s Investment in the Business 101
Economic Event That Is Not a Business
Transaction 101
Prepayment of Expenses in Cash 102
Purchase of an Asset on Credit 102
Purchase of an Asset Partly in Cash and Partly
on Credit 103
Payment of a Liability 103
Revenue in Cash 104
Revenue on Credit 104
Revenue Received in Advance 104
Collection on Account 105

Preparation and Use of a Trial Balance 109
Finding Trial Balance Errors 110

Cash Flows and the Timing of
Transactions 111
Recording and Posting Transactions 114
Chart of Accounts 114
General Journal 114
General Ledger 116

Some Notes on Presentation 118
A LOOK BACK AT Ǡ THE BOEING COMPANY

STOP & REVIEW

119

123

CHAPTER ASSIGNMENTS

125

Measuring Business Income
DECISION POINT Ǡ A USER’S FOCUS NETFLIX, INC.

142
143

Profitability Measurement Issues
and Ethics 144
Net Income 144
Income Measurement Assumptions 144
Ethics and the Matching Rule 146

Accrual Accounting 148
Recognizing Revenues
Recognizing Expenses
Adjusting the Accounts
Adjustments and Ethics


148

Using the Adjusted Trial Balance to Prepare
Financial Statements 160
The Accounting Cycle 163
Closing Entries 163
The Post-Closing Trial Balance 165

148
149
149

The Adjustment Process 150
Type 1 Adjustment: Allocating Recorded Costs
(Deferred Expenses) 151
Type 2 Adjustment: Recognizing Unrecorded
Expenses (Accrued Expenses) 154

SUPPLEMENT TO CHAPTER 3

Type 3 Adjustment: Allocating Recorded, Unearned
Revenues (Deferred Revenues) 157
Type 4 Adjustment: Recognizing Unrecorded,
Earned Revenues (Accrued Revenues) 158
A Note About Journal Entries 160

Cash Flows from Accrual-Based
Information 167
A LOOK BACK AT Ǡ NETFLIX, INC.


STOP & REVIEW

169

174

CHAPTER ASSIGNMENTS

176

Closing Entries and the Work Sheet

Preparing Closing Entries

194

Step 1: Closing the Credit Balances 194
Step 2: Closing the Debit Balances 194
Step 3: Closing the Income Summary Account
Balance 196
Step 4: Closing the Dividends Account Balance 196
The Accounts After Closing 196

The Work Sheet: An Accountant’s Tool
Preparing the Work Sheet 199
Using the Work Sheet 202

Supplement Assignments 203


194
198


vii

Contents

CHAPTER 4

Financial Reporting and Analysis
DECISION POINT Ǡ A USER’S FOCUS DELL COMPUTER
CORPORATION

209

Foundations of Financial Reporting 210
Objective of Financial Reporting 210
Qualitative Characteristics of Accounting
Information 210
Accounting Conventions 212
Ethical Financial Reporting 212

Accounting Conventions for Preparing
Financial Statements 213
Consistency 213
Full Disclosure (Transparency) 214
Materiality 215
Conservatism 215
Cost-Benefit 216


Classified Balance Sheet 217

208
Assets 217
Liabilities 220
Stockholders’ Equity 220
Owner’s Equity and Partners’ Equity 221
Dell’s Balance Sheets 221

Forms of the Income Statement 223
Multistep Income Statement 223
Dell’s Income Statements 227
Single-Step Income Statement 227

Using Classified Financial Statements 229
Evaluation of Liquidity 229
Evaluation of Profitability 230
A LOOK BACK AT Ǡ DELL COMPUTER
CORPORATION

STOP & REVIEW

237
240

CHAPTER ASSIGNMENTS

242


The Annual Report Project

258

The Operating Cycle and Merchandising Operations

260

SUPPLEMENT TO CHAPTER 4
Instructions 258

CHAPTER 5

DECISION POINT Ǡ A USER’S FOCUS COSTCO WHOLESALE
CORPORATION

261

Managing Merchandising Businesses 262
Operating Cycle 262
Choice of Inventory System 263
Foreign Business Transactions 264
The Need for Internal Controls 265
Management’s Responsibility for Internal
Control 267

Terms of Sale 268
Sales and Purchases Discounts 268
Transportation Costs 269
Terms of Debit and Credit Card Sales 269


Perpetual Inventory System 270
Purchases of Merchandise 270
Sales of Merchandise 272

Periodic Inventory System 274

Purchases of Merchandise 275
Sales of Merchandise 276

Internal Control: Components, Activities,
and Limitations 279
Components of Internal Control 279
Control Activities 279
Limitations on Internal Control 280

Internal Control over Merchandising
Transactions 281
Internal Control and Management Goals 282
Control of Cash Receipts 283
Control of Purchases and Cash Disbursements 284
A LOOK BACK AT Ǡ COSTCO WHOLESALE
CORPORATION

STOP & REVIEW

289
292

CHAPTER ASSIGNMENTS


294


viii

Contents

CHAPTER 6

Inventories

310

DECISION POINT Ǡ A USER’S FOCUS TOYOTA MOTOR
CORPORATION

311

Managing Inventories 312
Inventory Decisions 312
Evaluating the Level of Inventory 313
Effects of Inventory Misstatements on Income
Measurement 315

Inventory Cost and Valuation 318
Goods Flows and Cost Flows 319
Lower-of-Cost-or-Market (LCM) Rule 320
Disclosure of Inventory Methods 320


Impact of Inventory Decisions 325
Effects on the Financial Statements 326
Effects on Income Taxes 326
Effects on Cash Flows 327

Inventory Cost Under the Perpetual
Inventory System 328
Valuing Inventory by Estimation 330
Retail Method 330
Gross Profit Method 331

Inventory Cost Under the Periodic
Inventory System 321

A LOOK BACK AT Ǡ TOYOTA MOTOR
CORPORATION

Specific Identification Method 322
Average-Cost Method 322
First-In, First-Out (FIFO) Method 322

CHAPTER 7

Last-In, First-Out (LIFO) Method 323
Summary of Inventory Costing Methods 324

STOP & REVIEW

333
337


CHAPTER ASSIGNMENTS

339

Cash and Receivables
DECISION POINT Ǡ A USER’S FOCUS NIKE, INC.

352
353

Management Issues Related to Cash and
Receivables 354
Cash Management 354
Accounts Receivable and Credit Policies 355
Evaluating the Level of Accounts Receivable 356
Financing Receivables 358
Ethics and Estimates in Accounting for
Receivables 359

Cash Equivalents and Cash Control 361
Cash Equivalents 361
Fair Value of Cash and Cash Equivalents 361
Cash Control Methods 361

Disclosure of Uncollectible Accounts 366
Estimating Uncollectible Accounts Expense 366
Writing Off Uncollectible Accounts 370

Notes Receivable 372

Maturity Date 373
Duration of a Note 374
Interest and Interest Rate 374
Maturity Value 375
Accrued Interest 375
Dishonored Note 375
A LOOK BACK AT Ǡ NIKE, INC.

STOP & REVIEW

376

378

CHAPTER ASSIGNMENTS

380

Uncollectible Accounts 365
The Allowance Method 365

CHAPTER 8

Current Liabilities and Fair Value Accounting
DECISION POINT Ǡ A USER’S FOCUS MICROSOFT

Management Issues Related to Current
Liabilities 394
Managing Liquidity and Cash Flows 394
Evaluating Accounts Payable 394

Reporting Liabilities 396

393

392

Common Types of Current
Liabilities 398
Definitely Determinable Liabilities 398
Estimated Liabilities 404

Contingent Liabilities and Commitments 408


ix

Contents
Valuation Approaches to Fair Value
Accounting 409

Deferred Payment 414
Other Applications 415

Interest and the Time Value of Money 409
Calculating Present Value 410

A LOOK BACK AT Ǡ MICROSOFT

Applications Using Present Value 414


CHAPTER ASSIGNMENTS

STOP & REVIEW

416

419
421

Valuing an Asset 414

CHAPTER 9

Long-Term Assets
DECISION POINT Ǡ A USER’S FOCUS APPLE
COMPUTER, INC.

435

Management Issues Related to
Long-Term Assets 436

434
Plant Assets Sold for Cash 453
Exchanges of Plant Assets 454

Natural Resources 455

Acquiring Long-Term Assets 438
Financing Long-Term Assets 439

Applying the Matching Rule 440

Depletion 455
Depreciation of Related Plant Assets 456
Development and Exploration Costs in the Oil and
Gas Industry 456

Acquisition Cost of Property, Plant,
and Equipment 441

Intangible Assets 458

General Approach to Acquisition Costs 442
Specific Applications 442

Depreciation 445
Factors in Computing Depreciation 446
Methods of Computing Depreciation 446
Special Issues in Depreciation 450

Research and Development Costs 461
Computer Software Costs 461
Goodwill 461
A LOOK BACK AT Ǡ APPLE COMPUTER, INC.

STOP & REVIEW

463

465


CHAPTER ASSIGNMENTS

467

Disposal of Depreciable Assets 452
Discarded Plant Assets 453

CHAPTER 10

Long-Term Liabilities
DECISION POINT Ǡ USER’S FOCUS M C DONALD’S
CORPORATION

481

Management Issues Related to Issuing
Long-Term Debt 482
Deciding to Issue Long-Term Debt 482
Evaluating Long-Term Debt 483
Types of Long-Term Debt 484
Cash Flow Information 490

The Nature of Bonds 490
Bond Issue: Prices and Interest Rates 491
Characteristics of Bonds 492

Accounting for the Issuance of Bonds 493
Bonds Issued at Face Value 494
Bonds Issued at a Discount 494

Bonds Issued at a Premium 495
Bond Issue Costs 496

480
Using Present Value to Value a Bond 497
Case 1: Market Rate Above Face Rate 497
Case 2: Market Rate Below Face Rate 497

Amortization of Bond Discounts
and Premiums 499
Amortizing a Bond Discount 499
Amortizing a Bond Premium 502

Retirement of Bonds 507
Calling Bonds 507
Converting Bonds 508

Other Bonds Payable Issues 509
Sale of Bonds Between Interest Dates 509
Year-End Accrual of Bond Interest Expense 510
A LOOK BACK AT Ǡ M C DONALD’S CORPORATION

STOP & REVIEW

515

CHAPTER ASSIGNMENTS

518


512


x

Contents

CHAPTER 11

Contributed Capital

532

DECISION POINT Ǡ A USER’S FOCUS GOOGLE, INC.

533

Management Issues Related to Contributed
Capital 534
The Corporate Form of Business 534
Equity Financing 536
Dividend Policies 538
Using Return on Equity to Measure
Performance 540
Stock Options as Compensation 541
Cash Flow Information 542

Issuance of Common Stock 549
Par Value Stock 550
No-Par Stock 551

Issuance of Stock for Noncash Assets 551

Accounting for Treasury Stock 553

Components of Stockholders’ Equity 543
Preferred Stock 546
Preference as to Dividends 546
Preference as to Assets 547

CHAPTER 12

Convertible Preferred Stock 547
Callable Preferred Stock 548

Purchase of Treasury Stock 553
Sale of Treasury Stock 554
Retirement of Treasury Stock 556
A LOOK BACK AT Ǡ GOOGLE, INC.

STOP & REVIEW

557

561

CHAPTER ASSIGNMENTS

563

Investments

DECISION POINT Ǡ A USER’S FOCUS EBAY, INC.

578
579

Management Issues Related to
Investments 580
Recognition 580
Valuation 580
Classification 580
Disclosure 582
Ethics of Investing 583

Consolidated Financial Statements 593
Consolidated Balance Sheet 593
Consolidated Income Statement 598
Restatement of Foreign Subsidiary Financial
Statements 599

Investments in Debt Securities 600
Held-to-Maturity Securities 600
Long-Term Investments in Bonds 601

Short-Term Investments in Equity
Securities 584

A LOOK BACK AT Ǡ EBAY, INC.

Trading Securities 584
Available-for-Sale Securities 587


CHAPTER ASSIGNMENTS

STOP & REVIEW

602

605
607

Long-Term Investments in Equity
Securities 588
Noninfluential and Noncontrolling Investment 588
Influential but Noncontrolling Investment 590

CHAPTER 13

The Corporate Income Statement and the Statement
of Stockholders’ Equity
DECISION POINT Ǡ A USER’S FOCUS MOTOROLA,
INC.

621

Performance Measurement: Quality of
Earnings Issues 622
The Effect of Accounting Estimates and
Methods 623
Gains and Losses 625


Write-downs and Restructurings 625
Nonoperating Items 626
Quality of Earnings and Cash Flows 627

Income Taxes 629
Deferred Income Taxes 630
Net of Taxes 631

620


xi

Contents

CHAPTER 14

Earnings per Share 632

Stock Dividends and Stock Splits 638

Basic Earnings per Share 633
Diluted Earnings per Share 634

Stock Dividends 638
Stock Splits 641

Comprehensive Income and the Statement
of Stockholders’ Equity 635


Book Value 643

Comprehensive Income 635
The Statement of Stockholders’ Equity 636
Retained Earnings 637

STOP & REVIEW

A LOOK BACK AT Ǡ MOTOROLA, INC.

CHAPTER ASSIGNMENTS

650

The Statement of Cash Flows
DECISION POINT Ǡ A USER’S FOCUS AMAZON.COM,
INC.

667

Overview of the Statement of Cash
Flows 668
Purposes of the Statement of Cash Flows 668
Uses of the Statement of Cash Flows 668
Classification of Cash Flows 668
Required Disclosure of Noncash Investing and
Financing Transactions 670
Format of the Statement of Cash Flows 670
Ethical Considerations and the Statement of
Cash Flows 672


Analyzing Cash Flows 673
Can a Company Have Too Much Cash? 673
Cash-Generating Efficiency 673
Asking the Right Questions About the Statement
of Cash Flows 675
Free Cash Flow 676

666
Operating Activities 678
Depreciation 680
Gains and Losses 681
Changes in Current Assets 681
Changes in Current Liabilities 682
Schedule of Cash Flows from Operating
Activities 683

Investing Activities 684
Investments 685
Plant Assets 685

Financing Activities 688
Bonds Payable 688
Common Stock 688
Retained Earnings 689
Treasury Stock 690
A LOOK BACK AT Ǡ AMAZON.COM, INC.

STOP & REVIEW


692

697

CHAPTER ASSIGNMENTS

CHAPTER 15

645

648

699

The Changing Business Environment: A Manager’s Perspective 718
DECISION POINT Ǡ A MANAGER’S FOCUS WAL-MART
STORES, INC.

719

Achieving Continuous Improvement 733

The Role of Management Accounting 720

Performance Measures: A Key to Achieving
Organizational Objectives 735

Management Accounting and Financial Accounting:
A Comparison 720
Management Accounting and the Management

Process 721

Using Performance Measures in the Management
Process 735
The Balanced Scorecard 736
Benchmarking 738

Value Chain Analysis 727
Primary Processes and Support Services 728
Advantages of Value Chain Analysis 729
Managers and Value Chain Analysis 729

Continuous Improvement 731
Management Tools for Continuous
Improvement 732

Standards of Ethical Conduct 738
A LOOK BACK AT Ǡ WAL-MART STORES, INC.

STOP & REVIEW

743

CHAPTER ASSIGNMENTS

745

741



xii

Contents

CHAPTER 16

Cost Concepts and Cost Allocation
DECISION POINT Ǡ A MANAGER’S FOCUS THE HERSHEY
COMPANY

761

Cost Information 762
Managers’ Use of Cost Information 762
Cost Information and Organizations 762
Cost Classifications and Their Uses 762
Cost Traceability 763
Cost Behavior 764
Value-Adding Versus Nonvalue-Adding
Costs 764
Cost Classifications for Financial Reporting 764

Financial Statements and the Reporting
of Costs 766
Income Statement and Accounting for
Inventories 766
Statement of Cost of Goods Manufactured 767
Cost of Goods Sold and a Manufacturer’s Income
Statement 769


CHAPTER 17

Inventory Accounts in Manufacturing
Organizations 770
Document Flows and Cost Flows Through the
Inventory Accounts 770
The Manufacturing Cost Flow 772

Elements of Product Costs 774
Prime Costs and Conversion Costs 775
Computing Product Unit Cost 775
Product Cost Measurement Methods 776
Computing Service Unit Cost 778

Cost Allocation 779
Allocating the Costs of Overhead 779
Allocating Overhead: The Traditional Approach 781
Allocating Overhead: The ABC Approach 783
A LOOK BACK AT Ǡ THE HERSHEY COMPANY

STOP & REVIEW

785

787

CHAPTER ASSIGNMENTS

790


Costing Systems: Job Order Costing
DECISION POINT Ǡ A MANAGER’S FOCUS COLD STONE
CREAMERY, INC.

807

Product Unit Cost Information and the
Management Process 808
Planning 808
Performing 808
Evaluating 808
Communicating 808

Product Costing Systems 809
Job Order Costing in a Manufacturing
Company 811
Materials 812
Labor 814

CHAPTER 18

760

806

Overhead 814
Completed Units 815
Sold Units 815
Reconciliation of Overhead Costs 816


A Job Order Cost Card and the Computation
of Unit Cost 817
A Manufacturer’s Job Order Cost Card and the
Computation of Unit Cost 817
Job Order Costing in a Service Organization 818
A LOOK BACK AT Ǡ COLD STONE CREAMERY, INC.

STOP & REVIEW

823

CHAPTER ASSIGNMENTS

825

Costing Systems: Process Costing
DECISION POINT Ǡ A MANAGER’S FOCUS DEAN
FOODS

845

The Process Costing System 846
Patterns of Product Flows and Cost Flow
Methods 847
Cost Flows Through the Work in Process Inventory
Accounts 848

821

844

Computing Equivalent Production 849
Equivalent Production for Direct
Materials 850
Equivalent Production for Conversion
Costs 851
Summary of Equivalent Production 851


xiii

Contents
Preparing a Process Cost Report Using the
FIFO Costing Method 852
Accounting for Units 852
Accounting for Costs 855
Assigning Costs 855
Process Costing for Two or More Production
Departments 857

Accounting for Costs 861
Assigning Costs 861
A LOOK BACK AT Ǡ DEAN FOODS

STOP & REVIEW

864

867

CHAPTER ASSIGNMENTS


869

Preparing a Process Cost Report Using the
Average Costing Method 859
Accounting for Units 859

CHAPTER 19

Value-Based Systems: ABM and Lean
DECISION POINT Ǡ A MANAGER’S FOCUS LA-Z-BOY,
INC.

883

Value-Based Systems and
Management 884
Value Chains and Supply Chains 885
Process Value Analysis 886
Value-Adding and Non-Value-Adding Activities 887
Value-Based Systems 887
Activity-Based Management 887
Managing Lean Operations 888

CHAPTER 20

882

The New Operating Environment and Lean
Operations 892

Just-in-Time (JIT) 892
Continuous Improvement of the Work
Environment 894
Accounting for Product Costs in a JIT Operating
Environment 894

Backflush Costing 896
Comparison of ABM and Lean 900
A LOOK BACK AT Ǡ LA-Z-BOY, INC.

Activity-Based Costing 888

STOP & REVIEW

The Cost Hierarchy and the Bill of Activities 889

CHAPTER ASSIGNMENTS

901

904
906

Cost Behavior Analysis
DECISION POINT Ǡ A MANAGER’S FOCUS FLICKR

922
923

Cost Behavior and Management 924

The Behavior of Costs 924

Mixed Costs and the Contribution Margin
Income Statement 930
The Engineering Method 930
The Scatter Diagram Method 930
The High-Low Method 931
Statistical Methods 933
Contribution Margin Income Statements 933

Cost-Volume-Profit Analysis 934

Breakeven Analysis 936
Using an Equation to Determine the Breakeven
Point 937
The Breakeven Point for Multiple Products 938

Using C-V-P Analysis to Plan Future Sales,
Costs, and Profits 941
Applying C-V-P to Target Profits 941
A LOOK BACK AT Ǡ FLICKR

STOP & REVIEW

944

947

CHAPTER ASSIGNMENTS


949


xiv

Contents

CHAPTER 21

The Budgeting Process
DECISION POINT Ǡ A MANAGER’S FOCUS FRAMERICA
CORPORATION

965

The Budgeting Process 966
Advantages of Budgeting 966
Budgeting and Goals 967
Budgeting Basics 967

The Master Budget 969
Preparation of a Master Budget 969
Budget Procedures 972

Operating Budgets 973
The Sales Budget 973
The Production Budget 974
The Direct Materials Purchases Budget 975

CHAPTER 22


The Direct Labor Budget 977
The Overhead Budget 977
The Selling and Administrative Expense
Budget 978
The Cost of Goods Manufactured Budget 979

Financial Budgets 981
The Budgeted Income Statement 981
The Capital Expenditures Budget 982
The Cash Budget 982
The Budgeted Balance Sheet 985
A LOOK BACK AT Ǡ FRAMERICA CORPORATION

STOP & REVIEW

RESORTS

1017

Performance Measurement 1018
What to Measure, How to Measure 1018
Other Measurement Issues 1018
Organizational Goals and the Balanced
Scorecard 1019
The Balanced Scorecard and Management 1019

Responsibility Accounting 1021
Types of Responsibility Centers 1022
Organizational Structure and Performance

Management 1024

Performance Evaluation of Cost Centers and
Profit Centers 1026
Evaluating Cost Center Performance Using Flexible
Budgeting 1026
Evaluating Profit Center Performance Using
Variable Costing 1027

CHAPTER ASSIGNMENTS

992

1016

Performance Evaluation of Investment
Centers 1029
Return on Investment 1029
Residual Income 1031
Economic Value Added 1032
The Importance of Multiple Performance
Measures 1034

Performance Incentives and Goals 1035
Linking Goals, Performance Objectives, Measures,
and Performance Targets 1035
Performance-Based Pay 1036
The Coordination of Goals 1036
A LOOK BACK AT Ǡ VAIL RESORTS


STOP & REVIEW

CORPORATION

1061

Standard Costing 1062
Standard Costs and Managers 1062
Computing Standard Costs 1063
Standard Direct Materials Cost 1063
Standard Direct Labor Cost 1063

1039

1042

CHAPTER ASSIGNMENTS

1044

Standard Costing and Variance Analysis
DECISION POINT Ǡ A MANAGER’S FOCUS iROBOT

987

990

Performance Management and Evaluation
DECISION POINT Ǡ A MANAGER’S FOCUS VAIL


CHAPTER 23

964

1060

Standard Overhead Cost 1064
Total Standard Unit Cost 1065

Variance Analysis 1066
The Role of Flexible Budgets in Variance
Analysis 1066
Using Variance Analysis to Control Costs 1068


xv

Contents
Computing and Analyzing Direct Materials
Variances 1071
Computing Direct Materials Variances 1071
Analyzing and Correcting Direct Materials
Variances 1073

Computing and Analyzing Direct Labor
Variances 1074
Computing Direct Labor Variances 1074
Analyzing and Correcting Direct Labor
Variances 1076


Using a Flexible Budget to Analyze Overhead
Variances 1077
Computing Overhead Variances 1078
Analyzing and Correcting Overhead Variances 1083

Using Cost Variances to Evaluate Managers’
Performance 1085
A LOOK BACK AT Ǡ iROBOT CORPORATION

STOP & REVIEW

1087

1092

CHAPTER ASSIGNMENTS

1094

Computing and Analyzing Overhead
Variances 1077

CHAPTER 24

Short-Run Decision Analysis
DECISION POINT Ǡ A MANAGER’S FOCUS BANK OF
AMERICA

1109


Short-Run Decision Analysis and the
Management Process 1110
Incremental Analysis for Short-Run Decisions 1110

Incremental Analysis for Outsourcing
Decisions 1113
Incremental Analysis for Special Order
Decisions 1115

CHAPTER 25

1108
Incremental Analysis for Segment
Profitability Decisions 1118
Incremental Analysis for Sales Mix
Decisions 1120
Incremental Analysis for Sell or ProcessFurther Decisions 1123
A LOOK BACK AT Ǡ BANK OF AMERICA

STOP & REVIEW

1126

1129

CHAPTER ASSIGNMENTS

1131

Capital Investment Analysis

DECISION POINT Ǡ A MANAGER’S FOCUS AIR PRODUCTS
AND CHEMICALS INC.

1149

The Capital Investment Process 1150
Capital Investment Analysis 1150
Capital Investment Analysis in the Management
Process 1151
The Minimum Rate of Return on Investment 1153
Cost of Capital 1153
Other Measures for Determining Minimum Rate of
Return 1154
Ranking Capital Investment Proposals 1154

Measures Used in Capital Investment
Analysis 1155
Expected Benefits from a Capital Investment 1155
Equal Versus Unequal Cash Flows 1156
Carrying Value of Assets 1156
Depreciation Expense and Income Taxes 1156
Disposal or Residual Values 1157

1148
The Time Value of Money 1158
Interest 1158
Present Value 1159
Present Value of a Single Sum Due in the
Future 1160
Present Value of an Ordinary Annuity 1160


The Net Present Value Method 1162
Advantages of the Net Present Value Method 1162
The Net Present Value Method Illustrated 1162

Other Methods of Capital Investment
Analysis 1165
The Payback Period Method 1165
The Accounting Rate-of-Return Method 1166
A LOOK BACK AT Ǡ AIR PRODUCTS
AND CHEMICALS INC.

STOP & REVIEW

1168

1170

CHAPTER ASSIGNMENTS

1172


xvi

Contents

CHAPTER 26

Pricing Decisions, Including Target Costing

and Transfer Pricing
DECISION POINT Ǡ A MANAGER’S FOCUS LAB 126

1187

The Pricing Decision and the Manager 1188
Pricing Policies 1188
Pricing Policy Objectives 1188
Pricing and the Management Process 1189
External and Internal Pricing Factors 1189

Economic Pricing Concepts 1191
Total Revenue and Total Cost Curves 1191
Marginal Revenue and Marginal Cost Curves 1193
Auction-Based Pricing 1193

Cost-Based Pricing Methods 1194
Gross Margin Pricing 1195
Return on Assets Pricing 1196
Summary of Cost-Based Pricing Methods 1197
Pricing Services 1198
Factors Affecting Cost-Based Pricing Methods 1199

CHAPTER 27

Pricing Based on Target Costing 1201
Differences Between Cost-Based Pricing and Target
Costing 1201
Target Costing Analysis in an Activity-Based
Management Environment 1203


Pricing for Internal Providers of Goods
and Services 1205
Transfer Pricing 1205
Developing a Transfer Price 1206
Other Transfer Price Issues 1207
Using Transfer Prices to Measure
Performance 1207
A LOOK BACK AT Ǡ LAB 126

STOP & REVIEW

1209

1212

CHAPTER ASSIGNMENTS

1214

Quality Management and Measurement
DECISION POINT Ǡ A MANAGER’S FOCUS AMAZON
.COM

1233

The Role of Management Information
Systems in Quality Management 1234
Enterprise Resource Planning Systems 1234
Managers’ Use of MIS 1234


Financial and Nonfinancial Measures
of Quality 1236
Financial Measures of Quality 1236
Nonfinancial Measures of Quality 1237
Measuring Service Quality 1241

CHAPTER 28

1186

1232

Measuring Quality: An Illustration 1242
Evaluating the Costs of Quality 1242
Evaluating Nonfinancial Measures of Quality 1245

The Evolving Concept of Quality 1246
Recognition of Quality 1248
A LOOK BACK AT Ǡ AMAZON.COM

STOP & REVIEW

1250

1252

CHAPTER ASSIGNMENTS

1254


Financial Analysis of Performance
DECISION POINT Ǡ A MANAGER’S FOCUS STARBUCKS
CORPORATION

1271

Foundations of Financial Performance
Measurement 1272
Financial Performance Measurement: Management’s
Objectives 1272
Financial Performance Measurement: Creditors’ and
Investors’ Objectives 1272
Standards of Comparison 1273

1270
Sources of Information 1275
Executive Compensation 1277

Tools and Techniques of Financial
Analysis 1279
Horizontal Analysis 1279
Trend Analysis 1282
Vertical Analysis 1283
Ratio Analysis 1285


xvii

Contents


APPENDIX A

Comprehensive Illustration of Ratio
Analysis 1287

Evaluating the Adequacy of Cash Flows 1291
Evaluating Market Strength 1293

Evaluating Liquidity 1287

A LOOK BACK AT Ǡ STARBUCKS CORPORATION

Evaluating Profitability 1289
Evaluating Long-Term Solvency 1290

STOP & REVIEW

CHAPTER ASSIGNMENTS

Accounting for Investments

1294

1299
1301

1320

Management Issues Related to Investments 1320

Trading Securities 1322
Available-for-Sale Securities 1325
Long-Term Investments in Equity Securities 1325
Investments in Debt Securities 1329
Long-Term Investments in Bonds 1330
STOP & REVIEW

APPENDIX B

1331

Present Value Tables
Endnotes 1338
Company Index 1344
Subject Index 1346

1334


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PREFACE
Accounting
in Motion!

This revision of Financial and Managerial Accounting is based on an understanding of the nature, culture, and motivations of today’s undergraduate students and
on extensive feedback from many instructors who use our book. These substantial
changes meet the needs of these 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 assist them to meet these challenges,
the authors carefully show them how the effects of business transactions, which
are the result of business decisions, are recorded in a way that will be reflected on
the financial statements. Instructors will find that building on the text’s historically strong pedagogy, the authors have strengthened transaction analysis and its
link to the accounting cycle.

Updated Content,
Organization
and Pedagogy

Strengthened Transaction Analysis
Maintaining a solid foundation in double-entry accounting, we increased the
number of in-text journal entries and have used T accounts linked to these
journal-entry illustrations throughout the financial accounting chapters. In
Chapter 2, “Analyzing Business Transactions,” for example, we clarified the relationship of transaction analysis to the accounting cycle. In Chapter 5, “The Operating Cycle and Merchandising Accounting,” we include transaction illustrations
for all transactions mentioned in the chapter. At the same time, we reduced excessive detail, shortened headings, simplified explanations, and increased readability
in an effort to reduce the length of each chapter.

Application of Double Entry:
Assets
C ASH
Dr.
July 1 40,000
10 2,800
19 1,400
22 5,000

ϭ Liabilities ϩ

Cr.

July 3 3,200
6 13,320
9 2,600
26 4,800

Owner’s Equity
WAGES E XPENSE
Dr.
July 26 4,800

Cr.

Entry in Journal Form:
July 26 Wages Expense
Cash

Dr.
4,800

Cr.
4,800

xix


xx

Preface

Strong Pedagogical System

Financial and Managerial Accounting originated the pedagogical system of
Integrated Learning Objectives. The system supports both learning and teaching by providing flexibility in support of the instructor’s teaching of first-year
accounting. The chapter review and all assignments identify the applicable learning objective(s) for easy reference.
Each learning objective refers to a specific content area, usually either conceptual content or procedural techniques, in short and easily understandable segments. Each segment is followed by a “Stop and Apply” section that illustrates
and solves a short exercise related to the learning objective.

STOP

& APPLY

Match the letter of each item below with the numbers of the related items:
a. An inventory cost
b. An assumption used in the valuation of
inventory
c. Full disclosure convention
d. Conservatism convention
e. Consistency convention
f. Not an inventory cost or assumed flow
____ 1. Cost of consigned goods
____ 2. A note to the financial statements
explaining inventory policies

____
____
____

____
____
____


3. Application of the LCM rule
4. Goods flow
5. Transportation charge for merchandise shipped FOB shipping
point
6. Cost flow
7. Choosing a method and sticking
with it
8. Transportation charge for merchandise shipped FOB destination

SOLUTION

1. f; 2. c; 3. d; 4. b; 5. a; 6. f; 7. e; 8. f

To make the text more visually appealing and readable, it is divided into
student-friendly sections with brief bulleted lists, new art, photographs, and endof-section review material.

Cash Flows
and the Timing
of Transactions
LO5 Show how the timing
of transactions affects cash
flows and liquidity.

To avoid financial distress, a company must be able to pay its bills on time. Because
the timing of cash flows is critical to maintaining adequate liquidity to pay bills,
managers and other users of financial information must understand the difference
between transactions that generate immediate cash and those that do not. Consider the transactions of Miller Design Studio shown in Figure 2-3. Most of them
involve either an inflow or outflow of cash.
As you can see in Figure 2-3, Miller’s Cash account has more transactions
than any of its other accounts. Look at the transactions of July 10, 15, and 22:

Ǡ July 10: Miller received a cash payment of $2,800.
Ǡ July 15: The firm billed a customer $9,600 for a service it had already performed.
Ǡ July 22: The firm received a partial payment of $5,000 from the customer,
but it had not received the remaining $4,600 by the end of the month.
Because Miller incurred expenses in providing this service, it must pay careful
attention to its cash flows and liquidity.
One way Miller can manage its expenditures is to rely on its creditors to give
it time to pay. Compare the transactions of July 3, 5, and 9 in Figure 2-3.


Preface

Study Note
After Step 1 has been completed,
the Income Summary account
reflects the account balance of
the Design Revenue account
before it was closed.

Enhanced RealWorld Examples
Demonstrate
Accounting
in Motion

xxi

Further, to reduce distractions, the margins of the text include only Study
Notes, which alert students to common misunderstandings of concepts and techniques; key ratio and cash flow icons, which highlight discussions of profitability
and liquidity; and accounting equations. Icons and equations appear in the financial chapters (Chapters 1–14).


IFRS, Fair Value, and Other Updates
International Financial Reporting Standards and fair value have been integrated
throughout the book where accounting standards have changed and also in the
Business Focus features where applicable. All current events, statistics, and tables
have been updated with the latest data.

FOCUS ON BUSINESS PRACTICE
IFRS: The Arrival of International Financial Reporting Standards in the United States
Over the next few years, international financial
reporting standards (IFRS) will become much more
important in the United States and globally. The
International Accounting Standards Board (IASB)
has been working with the Financial Accounting
Standards Board (FASB) and similar boards in other
nations to achieve identical or nearly identical standards worldwide. IFRS are now required in many
parts of the world, including Europe. The Securities-

and Exchange Commission (SEC) recently voted to
allow foreign registrants in the United States. This
is a major development because in the past, the
SEC required foreign registrants to explain how the
standards used in their statements differed from
U.S. standards. This change affects approximately 10
percent of all public U.S. companies. In addition, the
SEC may in the near future allow U.S. companies to
use IFRS. 11

Use of Diverse Companies
Each chapter begins with a Decision Point, a real-world scenario about a
company that challenges students to see the connection between accounting

information and management decisions.

DECISION POINT Ǡ A USER’S FOCUS

Ǡ

An order for airplanes is
obviously an important
economic event for both the
buyer and the seller. Is there a
difference between an economic
event and a business transaction
that should be recorded in the
accounting records?

Ǡ

Should Boeing record the order
in its accounting records?

Ǡ

How important are liquidity and
cash flows to Boeing?

THE BOEING COMPANY
In April 2006, the Chinese government announced that it had ordered
80 Boeing commercial jet liners, thus fulfilling a commitment it
had made to purchase 150 airplanes from Boeing. Valued at about
$4.6 billion, the order for the 80 airplanes was one of many events

that brought about Boeing’s resurgence in the stock market. After
Boeing received this order, as well as orders from other customers,
its stock began trading at an all-time high.
Typically, it takes Boeing almost two years to manufacture an
airplane. In this case, the aircraft delivery cycle was expected to peak
in 2009.1


xxii

Preface

These company examples come full circle at the end of the chapter by linking
directly to the A Look Back At diverse company examples illustrate accounting
concepts and encourage students to apply what they have learned.

A LOOK BACK AT

Ǡ

THE BOEING COMPANY
The Decision Point at the beginning of the chapter described the order for 80 airplanes
that the Chinese government placed with Boeing. It posed the following questions:
• An order for airplanes is obviously an important economic event to both the buyer
and the seller. Is there a difference between an economic event and a business
transaction that should be recorded in the accounting records?
• Should Boeing record the order in its accounting records?
• How important are liquidity and cash flows to Boeing?
Despite its importance, the order did not constitute a business transaction, and neither the buyer nor the seller should have recognized it in its accounting records. At the
time the Chinese government placed the order, Boeing had not yet built the airplanes.

Until it delivers them and title to them shifts to the Chinese government, Boeing cannot
record any revenue.

Use of Well-Known Public Companies
This textbook also offers examples from highly recognizable public companies,
such as CVS Caremark, Southwest Airlines, Dell Computer, and Netflix, to relate
basic accounting concepts and techniques to the real world. Chapter 4, “Financial Reporting and Analysis,” helps students interpret financial information.
The latest available data is used in exhibits to incorporate the most recent FASB
pronouncements. The authors illustrate current practices in financial reporting by
referring to data from Accounting Trends and Techniques (AICPA) and integrate
international topics wherever appropriate.

Consolidated means that data from all
companies owned by CVS are combined.

CVS Caremark Corporation
Consolidated Statements of Operations

CVS’s fiscal year ends on the Saturday
closest to December 31.

Fiscal Year Ended
Dec. 31, 2008
(52 weeks)

Dec. 29, 2007
(52 weeks)

Dec. 30, 2006
(53 weeks)


$87,471.9
69,181.5

$76,329.5
60,221.8

$43,821.4
32,079.2

Gross profit

18,290.4

16,107.7

11,742.2

Total operating expenses

12,244.2

11,314.4

9,300.6

Operating profit1
Interest expense, net2

6,046.2

509.5

4,793.3
434.6

2,441.6
215.8

Earnings before income tax provision
Loss from discontinued operations,
net of income tax benefit of $82.4
Income tax provision

5,536.7
(132)

4,358.7
—

2,225.8
—

2,192.6

1,721.7

856.9

Net earnings3
Preference dividends, net of income tax benefit4


3,212.1
14.1

2,637.0
14.2

1,368.9
13.9

Net earnings available to common shareholders

$ 3,198.0

$ 2,622.8

$ 1,355.0

$

$

$

(In millions, except per share amounts)
Net revenues
Cost of revenues

BASIC EARNINGS PER COMMON SHARE:5


Net earnings
Weighted average common shares outstanding

2.23
1,433.5

1.97
1,328.2

1.65
820.6

DILUTED EARNINGS PER COMMON SHARE:

Net earnings
Weighted average common shares outstanding

$

2.18
1,469.1

$

1.92
1,371.8

$

1.60

853.2


Preface

xxiii

Revised and Expanded Assignments
Assignments have been carefully scrutinized for direct relevancy to the learning
objectives in the chapters. Names and numbers for all Short Exercises, Exercises,
and Problems have been changed except those used on videos. We have reversed
the alternate and main problems from the previous edition. Most importantly,
alternative problems have been expanded so that there are ample problems for
any course.
All of the cases have been updated as appropriate and the number of cases in
each chapter has been reduced in response to user preferences. The variety of cases
in each chapter depends on their relevance to the chapter topics, but throughout
the text there are cases involving conceptual understanding, ethical dilemmas,
interpreting financial reports, group activities, business communication, and the
Internet. Annual report cases based on CVS Caremark and Southwest Airlines
can be found at the end of the chapter.

Specific Chapter Changes
The following chapter-specific changes have been made in this edition of
Financial and Managerial Accounting:
Chapter 1 Uses of Accounting Information and the Financial Statements
• Discussion of performance measures revised using CVS and General Motors
as examples of how these measures relate to profitability and liquidity
• Discussion of the statement of cash flows revised to relate the statement to
business activities and goals

• Updated and enhanced coverage of the roles of the Financial Accounting
Standards Board (FASB) and the International Accounting Standards Board
(IASB)
• New Focus on Business Practice box on SEC’s decision to let foreign companies registered in the United States use international financial reporting
standards (IFRS)
• New study note on the role of the Public Company Accounting Oversight
Board (PCAOB)
Chapter 2 Analyzing Business Transactions
• Section on valuation in Learning Objective (LO) 1 revised to address fair
value and IFRS
• New Focus on Business Practice box on fair value accounting in an international marketplace
• New example of recognition violation focusing on Computer Associates
• LO3 revised to emphasize and clarify the role of T accounts, journal form,
and their relationship to the general ledger
• Cash flow discussion in LO5 edited for clearer delineation of the sequence of
transactions
Chapter 3 Measuring Business Income
• New company (Netflix) used as example in the Decision Point
• Discussion of the matching rule and cash basis of accounting in LO1 revised
for greater clarity
• New example of earnings management focusing on Dell Computer
• New Focus on Business Practice box describing the FASB’s rules for revenue
recognition and the one broad IFRS that the IASB uses
• Inclusion of journal entries, along with T accounts and explanatory comments, in the discussion of the adjustment process in LO3


xxiv

Preface


Chapter 4 Financial Reporting and Analysis
• First section in LO1 revised to reflect the FASB’s emphasis on the needs of
capital providers and other users of financial reports
• Coverage of qualitative characteristics simplified and shortened
• Topics in LO2 reorganized to reflect changes in LO1
• New Focus on Business Practice box on convergence of U.S. GAAP and IFRS
and their effect on accounting conventions
• New Focus on Business Practice box on the IASB’s proposed changes in the
format of financial statements
• New Focus on Business Practice box on how the convergence of U.S. GAAP
and IFRS has made financial analysis more difficult
• New Focus on Business Practice box on the use of ratios in measuring performance and determining executives’ compensation
Chapter 5 The Operating Cycle and Merchandising Operations
• Discussion of the operating cycle in LO1 revised for greater clarity
• New Focus on Business Practice box on the effectiveness of the SarbanesOxley Act in preventing fraud
• Journal entries used to illustrate accounting for merchandising transactions
under both the perpetual and periodic inventory systems (LO3 and LO4)
• Clearer differentiation in LO4 between the cost of goods available for sale
and the cost of goods sold
• New Focus on Business Practice box on methods of preventing shoplifting
• Material in LO6 reformatted to clarify discussion of documents used in an
internal control plan for purchases and cash disbursements
Chapter 6 Inventories
• New company (Toyota) used as example in the Decision Point
• Discussion in LO1 of disclosure of inventory methods shortened for greater
clarity
• New Focus on Business Practice box on the lower-of-cost-or-market rule
• New Focus on Business Practice box on the use of LIFO inside and outside
the United States
• New Focus on Business Practice box on how IFRS and U.S. standards define

fair value
Chapter 7 Cash and Receivables
• New coverage of subprime loans, including a new Focus on Business Practice
box in LO1
• Concept of fair value introduced at various points throughout the chapter
• Revised Focus on Business Practice box on estimating cash collections
Chapter 8 Current Liabilities and Fair Value Accounting
• New company (Microsoft) used as example in the Decision Point
• Chapter revised to include coverage of fair value accounting
• Discussions and assignments related to future value deleted to emphasize
present value and fair value, which are more directly related to this course
Chapter 9 Long-Term Assets
• Tables added in LO1 and LO3 to enhance and clarify discussions of acquisition of long-term assets and methods of computing depreciation
• Revised Focus on Business Practice box on accelerated methods of accounting
for depreciation