Principles of

Accounting
Tenth Edition

Openmirrors.com
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 Community College, Florida

Houghton Mifflin Company

Boston

New York


To Jennifer, Jeffrey, Annabelle, and Abigail
To my family—Bruce, Brent, and Courtney Crosson—and
in loving memory of my parents Helen and Bryce Van Valkenburgh

Executive Publisher: George Hoffman
Senior Sponsoring Editor: Ann West
Senior Marketing Manager: Mike Schenk
Marketing Coordinator: Erin Lane

Senior Development Editor: Chere Bemelmans
Editorial Assistant: Diane Akerman
Project Editor: Margaret M. Kearney
Art and Design Manager: Gary Crespo
Cover Design Manager: Anne S. Katzeff
Senior Photo Editor: Jennifer Meyer Dare
Composition Buyer: Chuck Dutton
Cover photo © Don Smetzer/Stone/Getty Images
CVS Annual Report reprinted with permission of CVS
Portions of Southwest Airlines Annual Report courtesy of Southwest Airlines
COMPANY LOGO CREDITS: p. 7, Reprinted with permission of CVS; p. 53, Logo provided
by The Boeing Company, Copyright 2006, All Rights Reserved; p. 104, ©2006 Yahoo! Inc.
Yahoo! and the Yahoo! logo are the trademarks of Yahoo! Inc.; p. 152, Reprinted with
permission of Best Buy; p. 293, Reprinted with permission of Costco Wholesale;
(Continued on p. 1312)
PHOTO CREDITS: p. 3, Getty Images; p. 9, AP Images; p. 17, © Jim West/The Image Works;
p. 26, © Frank Trapper/Corbis; p. 51, Boeing Image Licensing; p. 56, © Reuters/Corbis; p. 72,
Getty Images; p. 103, © Yahoo! Inc. Yahoo! and the Yahoo! logo are the trademarks of
Yahoo! Inc.; p. 111, AP Images; p. 118, © Norbert von der Groeben/The Image Works;
(Continued on page 1312)

Copyright © 2008 by Houghton Mifflin Company. All rights reserved.
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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: 2006936632

Instructor’s examination copy
ISBN-10: 0-618-83349-8
ISBN-13: 978-0-618-83349-8
For orders, use student text ISBNs
ISBN-10: 0-618-73661-1
ISBN-13: 978-0-618-73661-4
1 2 3 4 5 6 7 8 9-VH-11 10 09 08 07


Brief Contents

SUPPLEMENT TO CHAPTER

1

Uses of Accounting Information and the Financial Statements 2

2

Analyzing Business Transactions 50

3

Measuring Business Income 102

4

Completing the Accounting Cycle 148

5


Financial Reporting and Analysis 184

5

How to Read an Annual Report 235

6

The Operating Cycle and Merchandising Operations 290

7

Inventories 326

8

Cash and Receivables 368

9

Current Liabilities and the Time Value of Money 410

10

Internal Control 456

11

Long-Term Assets 490


12

Contributed Capital 540

13

Long-Term Liabilities 584

14

The Corporate Income Statement and the Statement of Stockholders’
Equity 638

15

The Statement of Cash Flows 684

16

Investments 732

17

Financial Performance Measurement 776

18

The Changing Business Environment: A Manager’s Perspective 826


19

Cost Concepts and Cost Allocation 876

20

Costing Systems: Job Order and Process Costing 934

21

Activity-Based Systems: ABM and JIT 986

22

Cost Behavior Analysis 1034

23

The Budgeting Process 1080

iii


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iv

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Brief Contents


24

Performance Management and Evaluation 1136

25

Standard Costing and Variance Analysis 1182

26

Analysis for Decision Making 1232

APPENDIX

A

Future Value and Present Value Tables 1284


Contents
Preface

xv

User’s Guide

xxi

Check Figures


xxix

About the Authors

CHAPTER 1

xxxii

Uses of Accounting Information and the Financial Statements

í DECISION POINT: A USER’S FOCUS CVS CORPORATION

Accounting as an Information System 4
Business Goals, Activities, and Performance Measures
5

Financial and Management Accounting 7
Processing Accounting Information 7
Ethical Financial Reporting 8

Decision Makers: The Users of Accounting
Information 10
Management 10
Users with a Direct Financial Interest 12
Users with an Indirect Financial Interest 12
Governmental and Not-for-Profit Organizations 13
Accounting Measurement
Business Transactions 14
Money Measure 14

Separate Entity 15

13

The Forms of Business Organization
CHAPTER 2

Financial Position and the Accounting Equation
Assets 18
Liabilities 18
Owner’s Equity 18

Generally Accepted Accounting Principles
GAAP and the Independent CPA’s Report 25
Organizations That Influence GAAP 26
Professional Ethics 27
Corporate Governance 27
CHAPTER REVIEW

15

Measurement Issues 52
Recognition 52
Valuation 54
Classification 55
Ethics and Measurement Issues 55

24

28


30

CHAPTER ASSIGNMENTS

35

Analyzing Business Transactions
51

17

Financial Statements 20
Income Statement 20
Statement of Owner’s Equity 20
The Balance Sheet 21
Statement of Cash Flows 21
Relationships Among the Financial Statements 22

í A LOOK BACK AT CVS CORPORATION

í DECISION POINT: A USER’S FOCUS THE BOEING

COMPANY

3

2

50

Economic Event That Is Not a Business Transaction 62
Prepayment of Expenses in Cash 62
Purchase of an Asset on Credit 62
Purchase of an Asset Partly in Cash and Partly on Credit
63

Double-Entry System 56
Accounts 57
The T Account 57
The T Account Illustrated 58
Rules of Double-Entry Accounting 58
Normal Balance 59
Owner’s Equity Accounts 59

Payment of a Liability 63
Revenue in Cash 64
Revenue on Credit 64
Revenue Collected in Advance 65
Collection on Account 65
Expense Paid in Cash 66
Expense to Be Paid Later 66
Withdrawals 67
Summary of Transactions 67

Business Transaction Analysis 61
Owners’ Investment to Form the Business 61

The Trial Balance 69
Preparation and Use of a Trial Balance 69


v


vi

|

Contents

Finding Trial Balance Errors 70

Cash Flows and the Timing of Transactions
Recording and Posting Transactions
Chart of Accounts 75
General Journal 75
CHAPTER 3

71

í A LOOK BACK AT THE BOEING COMPANY

73

CHAPTER REVIEW

80

CHAPTER ASSIGNMENTS

84


102

103

Profitability Measurement: Issues and Ethics
Net Income 104
Income Measurement Assumptions 104
Ethics and the Matching Rule 106
Accrual Accounting
Recognizing Revenues
Recognizing Expenses
Adjusting the Accounts
Adjustments and Ethics

104

108
108

Type 2 Adjustment: Recognizing Unrecorded, Incurred
Expenses (Accrued Expenses) 115
Type 3 Adjustment: Allocating Recorded, Unearned
Revenues (Deferred Revenues) 116
Type 4 Adjustment: Recognizing Unrecorded, Earned
Revenues (Accrued Revenues) 117
A Note About Journal Entries 119

Using the Adjusted Trial Balance to Prepare
Financial Statements 121


108
108

Cash Flows from Accrual-Based Information

109

í A LOOK BACK AT YAHOO! INC.

The Adjustment Process 110
Type 1 Adjustment: Allocating Recorded Costs (Deferred
Expenses) 111

4

79

Measuring Business Income

í DECISION POINT: A USER’S FOCUS YAHOO! INC.

CHAPTER

General Ledger 76
Some Notes on Presentation 78

CHAPTER REVIEW

126


CHAPTER ASSIGNMENTS

132

Completing the Accounting Cycle

í DECISION POINT: A USER’S FOCUS BEST BUY ENTERPRISE

SERVICES, INC.

149

From Transactions to Financial Statements
The Accounting Cycle 150
Closing Entries 150

150

Preparing Closing Entries 152
Step 1: Closing the Credit Balances 154
Step 2: Closing the Debit Balances 155
Step 3: Closing the Income Summary Account Balance
155

123

124

148

The Accounts After Posting 156
The Post-Closing Trial Balance 156

Reversing Entries: An Optional First Step
The Work Sheet: An Accountant’s Tool
Preparing the Work Sheet 160
Using the Work Sheet 164

158

160

í A LOOK BACK AT BEST BUY ENTERPRISE SERVICES, INC.

165
CHAPTER REVIEW

166

CHAPTER ASSIGNMENTS

168

Step 4: Closing the Withdrawals Account Balance 155

CHAPTER 5

Financial Reporting and Analysis

í DECISION POINT: A USER’S FOCUS DELL COMPUTER


CORPORATION

185

Foundations of Financial Reporting 186
Objectives of Financial Reporting 186
Qualitative Characteristics of Accounting Information
187

Management’s Certification of the Financial Statements
188

Accounting Conventions 189
Comparability and Consistency 189
Materiality 190
Conservatism 191
Full Disclosure 191

184
Cost-Benefit 192

Classified Balance Sheet 194
Assets 194
Liabilities 197
Owner’s Equity 197
Dell’s Balance Sheets 198
Forms of the Income Statement 201
Multistep Income Statement 201
Dell’s Income Statements 205

Single-Step Income Statement 205
Using Classified Financial Statements
Evaluation of Liquidity 206

206


Contents

CHAPTER REVIEW

Evaluation of Profitability 208
í A LOOK BACK AT DELL COMPUTER CORPORATION

SUPPLEMENT TO CHAPTER

5

214

CHAPTER 6

CORPORATION

291

Managing Merchandising Businesses
Operating Cycle 292
Choice of Inventory System 293
Foreign Business Transactions 295


292

Notes to the Financial Statements 242
Reports of Management’s Responsibilities 242
Reports of Certified Public Accountants 243

Annual Report of CVS Corporation

245

Financial Statements of Southwest Airlines Co.
281

290

Perpetual Inventory System 299
Purchases of Merchandise 299
Sales of Merchandise 300

308
CHAPTER REVIEW

309

CHAPTER ASSIGNMENTS

312

Inventories


326

327

Managing Inventories 328
Inventory Decisions 328
Evaluating the Level of Inventory 329
Effects of Inventory Misstatements on Income
Measurement 331

First-In, First-Out (FIFO) Method 339
Last-In, First-Out (LIFO) 340

Impact of Inventory Decisions 341
Effects on the Financial Statements 342
Effects on Income Taxes 343
Effects on Cash Flows 344
Inventory Cost Under the Perpetual Inventory
System 345

Inventory Cost and Valuation 334
Goods Flows and Cost Flows 335
Lower-of-Cost-or-Market (LCM) Rule 336
Disclosure of Inventory Methods 336

Valuing Inventory by Estimation
Retail Method 347
Gross Profit Method 348


Inventory Cost Under the Periodic Inventory
System 338
Specific Identification Method 338
Average-Cost Method 339

8

235

í A LOOK BACK AT COSTCO WHOLESALE CORPORATION

í DECISION POINT: A USER’S FOCUS CISCO SYSTEMS, INC.

CHAPTER

220

Periodic Inventory System 303
Purchases of Merchandise 305
Sales of Merchandise 306

Terms of Sale 296
Sales and Purchases Discounts 296
Transportation Costs 297
Terms of Debit and Credit Card Sales 298
CHAPTER 7

CHAPTER ASSIGNMENTS

The Operating Cycle and Merchandising Operations


í DECISION POINT: A USER’S FOCUS COSTCO WHOLESALE

í A LOOK BACK AT CISCO SYSTEMS, INC.

CHAPTER REVIEW

347

349

351

CHAPTER ASSIGNMENTS

355

Cash and Receivables

í DECISION POINT: A USER’S FOCUS NIKE, INC.

vii

216

How to Read an Annual Report

The Components of an Annual Report 235
Letter to the Stockholders 235
Financial Highlights 236

Description of the Company 236
Management’s Discussion and Analysis 236
Financial Statements 236

|

368
369

Management Issues Related to Cash and
Receivables 370
Cash Needs 370
Accounts Receivable and Credit Policies 371
Evaluating the Level of Accounts Receivable 373

Financing Receivables 374
Ethics and Estimates in Accounting for Receivables 376

Cash Equivalents and Cash Control
Cash Equivalents 378
Cash Control Methods 378
Bank Reconciliations 379

378


viii

|


Contents

Uncollectible Accounts 382
The Allowance Method 382
Disclosure of Uncollectible Accounts 383
Estimating Uncollectible Accounts Expense 383
Writing Off Uncollectible Accounts 388

Interest and Interest Rate 392
Maturity Value 392
Accrued Interest 392
Dishonored Note 393

Notes Receivable 390
Maturity Date 390
Duration of a Note 391

CHAPTER REVIEW

CHAPTER 9

í A LOOK BACK AT NIKE, INC.

394

395

CHAPTER ASSIGNMENTS

397


Current Liabilities and the Time Value of Money

í DECISION POINT: A USER’S FOCUS AMAZON.COM, INC.

411

Management Issues Related to Current Liabilities
412

Managing Liquidity and Cash Flows 412
Evaluating Accounts Payable 412
Reporting Liabilities 414

Common Types of Current Liabilities
Definitely Determinable Liabilities 416
Estimated Liabilities 423

416

Contingent Liabilities and Commitments
The Time Value of Money

410

Future Value 429
Present Value 431

Applications of the Time Value of Money 434
Valuing an Asset 434

Deferred Payment 435
Investment of Idle Cash 436
Accumulation of a Fund for Loan Repayment 436
Other Applications 437
í A LOOK BACK AT AMAZON.COM, INC.

CHAPTER REVIEW
427

438

439

CHAPTER ASSIGNMENTS

442

428

CHAPTER 10 Internal Control
í DECISION POINT: A USER’S FOCUS HOME DEPOT, INC.

457

456
Internal Control over Merchandising Transactions
463

Management Issues Related to Internal Control
458


The Need for Internal Controls 458
Management’s Responsibility for Internal Control 459
Independent Accountant’s Audit of Internal Control 460

Internal Control: Components, Activities, and
Limitations 461
Components of Internal Control 461
Control Activities 461
Limitations of Internal Control 463

Control of Cash 464
Control of Cash Receipts 465
Control of Purchases and Cash Disbursements 466

Petty Cash Funds 471
Establishing the Petty Cash Fund 471
Making Disbursements from the Petty Cash Fund 471
Reimbursing the Petty Cash Fund 472
í A LOOK BACK AT HOME DEPOT, INC.

CHAPTER REVIEW

473

474

CHAPTER ASSIGNMENTS

476


CHAPTER 11 Long-Term Assets
í DECISION POINT: A USER’S FOCUS APPLE COMPUTER,

INC.

491

490
Acquisition Cost of Property, Plant, and Equipment
497

492

General Approach to Acquisition Costs 498
Specific Applications 499

Acquiring Long-Term Assets 494
Financing Long-Term Assets 495
Applying the Matching Rule 496

Depreciation 502
Factors in Computing Depreciation 503
Methods of Computing Depreciation 503

Management Issues Related to Long-Term Assets


Contents


509

Intangible Assets 514
Research and Development Costs 517
Computer Software Costs 518
Goodwill 518

Natural Resources 511
Depletion 512
Depreciation of Related Plant Assets 513

í A LOOK BACK AT APPLE COMPUTER, INC.

CHAPTER REVIEW

519

521

CHAPTER ASSIGNMENTS

525

CHAPTER 12 Contributed Capital

540

í DECISION POINT: A USER’S FOCUS GOOGLE, INC.

541


Management Issues Related to Contributed
Capital 542
The Corporate Organization 542
Advantages and Disadvantages of Incorporation 543
Equity Financing 544
Dividend Policies 546
Using Return on Equity to Measure Performance 548
Stock Options as Compensation 549
Components of Stockholders’ Equity

550

Convertible Preferred Stock 556
Callable Preferred Stock 557

Issuance of Common Stock 558
Par Value Stock 558
No-Par Stock 559
Issuance of Stock for Noncash Assets 560
Accounting for Treasury Stock 561
Purchase of Treasury Stock 561
Sale of Treasury Stock 562
Retirement of Treasury Stock 564
í A LOOK BACK AT GOOGLE, INC.

Preferred Stock 554
Preference as to Dividends 554
Preference as to Assets 555


CHAPTER REVIEW

565

566

CHAPTER ASSIGNMENTS

570

CHAPTER 13 Long-Term Liabilities

584

í DECISION POINT: A USER’S FOCUS MCDONALD’S

CORPORATION

585

Management Issues Related to Issuing Long-Term
Debt 586
Deciding to Issue Long-Term Debt 586
Evaluating Long-Term Debt 587
Types of Long-Term Debt 589
The Nature of Bonds 594
Bond Issue: Prices and Interest Rates 595
Characteristics of Bonds 596
Accounting for the Issuance of Bonds
Bonds Issued at Face Value 598

Bonds Issued at a Discount 599
Bonds Issued at a Premium 600
Bond Issue Costs 600
Using Present Value to Value a Bond

598

Case 1: Market Rate Above Face Rate 601
Case 2: Market Rate Below Face Rate 602

Amortization of Bond Discounts and Premiums
603

Amortizing a Bond Discount 603
Amortizing a Bond Premium 607

Retirement of Bonds 612
Calling Bonds 612
Converting Bonds 613
Other Bonds Payable Issues 613
Sale of Bonds Between Interest Dates 613
Year-End Accrual of Bond Interest Expense 615
í A LOOK BACK AT MCDONALD’S CORPORATION

CHAPTER REVIEW

616

618


CHAPTER ASSIGNMENTS

622

601

CHAPTER 14 The Corporate Income Statement and the Statement of Stockholders’ Equity
í DECISION POINT: A USER’S FOCUS MOTOROLA, INC.

639

ix

Development and Exploration Costs in the Oil and Gas
Industry 513

Special Issues in Depreciation 507

Disposal of Depreciable Assets
Discarded Plant Assets 509
Plant Assets Sold for Cash 510
Exchanges of Plant Assets 511

|

638

Performance Measurement: Quality of Earnings
Issues 640



x

|

Contents

The Effect of Accounting Estimates and Methods 641
Gains and Losses 643
Write-downs and Restructurings 643
Nonoperating Items 644
Quality of Earnings and Cash Flows 644

Income Taxes 646
Deferred Income Taxes 647
Net of Taxes 648

Diluted Earnings Per Share 653

Comprehensive Income and the Statement of
Stockholders’ Equity 654
Comprehensive Income 654
The Statement of Stockholders’ Equity 654
Retained Earnings 656
Stock Dividends and Stock Splits
Stock Dividends 657
Stock Splits 659

Nonoperating Items 650
Discontinued Operations 650

Extraordinary Items 650

Book Value

662

í A LOOK BACK AT MOTOROLA, INC.

CHAPTER REVIEW

Earnings per Share 651
Basic Earnings per Share 651

657

663

664

CHAPTER ASSIGNMENTS

668

CHAPTER 15 The Statement of Cash Flows

684

í DECISION POINT: A USER’S FOCUS MARRIOTT

INTERNATIONAL, INC.


685

Overview of the Statement of Cash Flows 686
Purposes of the Statement of Cash Flows 686
Uses of the Statement of Cash Flows 686
Classification of Cash Flows 687
Noncash Investing and Financing Transactions 688
Format of the Statement of Cash Flows 688
Ethical Considerations and the Statement of Cash Flows
690

Analyzing Cash Flows 691
Cash-Generating Efficiency 691
Free Cash Flow 692
Operating Activities
Depreciation 696

Gains and Losses 697
Changes in Current Assets 698
Changes in Current Liabilities 698
Schedule of Cash Flows from Operating Activities 699

Investing Activities
Investments 701
Plant Assets 702

701

Financing Activities 704

Bonds Payable 705
Common Stock 705
Retained Earnings 706
Treasury Stock 707
í A LOOK BACK AT MARRIOTT INTERNATIONAL, INC.

694

CHAPTER REVIEW

CHAPTER ASSIGNMENTS

714

CHAPTER 16 Investments
í DECISION POINT: A USER’S FOCUS eBAY, INC.

709

710

732
733

Management Issues Related to Investments
Recognition 734
Valuation 734
Classification 734
Disclosure 736
Ethics of Investing 736

Short-Term Investments in Equity Securities
Trading Securities 738
Available-for-Sale Securities 741

734

Consolidated Financial Statements 746
Consolidated Balance Sheet 747
Consolidated Income Statement 752
Restatement of Foreign Subsidiary Financial Statements
753

738

Long-Term Investments in Equity Securities 741
Noninfluential and Noncontrolling Investment 741
Influential but Noncontrolling Investment 744

Investments in Debt Securities 754
Held-to-Maturity Securities 755
Long-Term Investments in Bonds 755
í A LOOK BACK AT EBAY, INC.

CHAPTER REVIEW

756

758

CHAPTER ASSIGNMENTS


761


Contents

CHAPTER 17 Financial Performance Measurement
í DECISION POINT: A USER’S FOCUS STARBUCKS

CORPORATION

777

Foundations of Financial Performance
Measurement 778
Financial Performance Measurement: Management’s
Objectives 778
Financial Performance Measurement: Creditors’ and
Investors’ Objectives 778
Standards of Comparison 779
Sources of Information 782
Executive Compensation 783
Tools and Techniques of Financial Analysis
Horizontal Analysis 786

786

STORES, INC.

827


The Role of Management Accounting 828
Management Accounting and Financial Accounting: A
Comparison 828
Management Accounting and the Management Process
829

Trend Analysis 789
Vertical Analysis 790
Ratio Analysis 793

Comprehensive Illustration of Ratio Analysis
Evaluating Liquidity 794
Evaluating Profitability 796
Evaluating Long-term Solvency 797
Evaluating the Adequacy of Cash Flows 798
Evaluating Market Strength 800
í A LOOK BACK AT STARBUCKS CORPORATION

CHAPTER REVIEW

CHAPTER ASSIGNMENTS

802

809

826

Achieving Continuous Improvement 843


Performance Measures: A Key to Achieving
Organizational Objectives 844
Using Performance Measures in the Management
Process 844
The Balanced Scorecard 845
Benchmarking 847
Analysis of Nonfinancial Data in a Retail
Organization 847

Continuous Improvement 840
Management Tools for Continuous Improvement 841

CHAPTER REVIEW

Standards of Ethical Conduct

849

í A LOOK BACK AT WAL-MART STORES, INC.

851

853

CHAPTER ASSIGNMENTS

857

CHAPTER 19 Cost Concepts and Cost Allocation

AIRLINES

877

Cost Information 878
Managers’ Use of Cost Information 878
Cost Information and Organizations 880
Cost Classifications and Their Uses 880
Cost Traceability 881
Cost Behavior 882
Value-Adding Versus Nonvalue-Adding Costs 883
Cost Classifications for Financial Reporting 883
Financial Statements and the Reporting of Costs
884

Cost Reporting and Accounting for Inventories
884

Statement of Cost of Goods Manufactured 886

793

803

Value Chain Analysis 836
Primary Processes and Support Services 836
Advantages of Value Chain Analysis 838
Managers and Value Chain Analysis 838

í DECISION POINT: A MANAGER’S FOCUS SOUTHWEST


xi

776

CHAPTER 18 The Changing Business Environment: A Manager’s Perspective
í DECISION POINT: A MANAGER’S FOCUS WAL-MART

|

876
Cost of Goods Sold and a Manufacturer’s Income
Statement 888

Inventory Accounts in Manufacturing
Organizations 889
Document Flows and Cost Flows Through the Inventory
Accounts 889
The Manufacturing Cost Flow 891
Elements of Product Costs 894
Prime Costs and Conversion Costs 895
Computing Product Unit Cost 895
Computing Service Unit Cost 898
Cost Allocation 899
Allocating the Costs of Overhead 900
The Importance of Good Estimates 902
Allocating Overhead:The Traditional Approach

903



xii

|

Contents

Allocating Overhead: The ABC Approach
Planning Overhead Rates 906
Applying the Overhead Rates 908

905

í A LOOK BACK AT SOUTHWEST AIRLINES

CHAPTER REVIEW

909

910

CHAPTER ASSIGNMENTS

914

CHAPTER 20 Costing Systems: Job Order and Process Costing
í DECISION POINT: A MANAGER’S FOCUS COLD STONE

CREAMERY, INC.


935

Product Cost Information and the Management
Process 936
Planning 936
Performing 936
Evaluating 937
Communicating 937
Job Order Versus Process Costing

938

The Job Order Costing System 940
Cost Flow in a Job Order Costing System for a
Manufacturing Company 940
The Job Order Cost Card and Computation of Product
Unit Costs 947
Job Order Costing in a Service Organization 948
The Process Costing System 951
Patterns of Product Flows and Cost Flows 952
Cost Flows Through the Work in Process Inventory
Accounts 954

934

Computing Equivalent Production 955
Equivalent Production for Direct Materials 956
Equivalent Production for Conversion Costs 957
Summary of Equivalent Production 957
Preparing a Process Cost Report Using the FIFO

Costing Method 958
Accounting for Units 958
Accounting for Costs 960
Assigning Costs 961
Process Costing for Two or More Production
Departments 962
Using Information About Product Cost to Evaluate
Performance 963
í A LOOK BACK AT COLD STONE CREAMERY, INC.

CHAPTER REVIEW

CHAPTER ASSIGNMENTS

969

CHAPTER 21 Activity-Based Systems: ABM and JIT
í DECISION POINT: A MANAGER’S FOCUS LA-Z-BOY, INC.

987

Activity-Based Systems and Management
Activity-Based Systems 988
Using Activity-Based Cost Information 989

988

Activity-Based Management 991
Value Chains and Supply Chains 991
ABM in a Service Organization 993


986
Minimum Inventory Levels 1003
Pull-Through Production 1004
Quick Setup and Flexible Work Cells 1004
A Multiskilled Work Force 1004
High Levels of Product Quality 1005
Effective Preventive Maintenance 1005
Continuous Improvement of the Work Environment
1005

Value-Adding and Nonvalue-Adding Activities
and Process Value Analysis 994
Value-Adding and Nonvalue-Adding Activities in a
Service Organization 995
Process Value Analysis 996

Accounting for Product Costs in the New
Operating Environment 1006
Classifying Costs 1006
Assigning Costs 1006

Activity-Based Costing 997
The Cost Hierarchy and the Bill of Activities 998
Activity-Based Costing for Selling and Administrative
Activities 1001

Comparison of ABM and JIT

The New Operating Environment and JIT

Operations 1002

964

965

Backflush Costing

1007
1011

í A LOOK BACK AT LA-Z-BOY, INC.

CHAPTER REVIEW

1013

CHAPTER ASSIGNMENTS

1018

1012


Contents

CHAPTER 22 Cost Behavior Analysis
í DECISION POINT: A MANAGER’S FOCUS KRAFT FOODS

1035


Cost Behavior and Management 1036
Planning 1036
Performing 1037
Evaluating and Communicating 1037
The Behavior of Costs
Variable Costs 1038
Fixed Costs 1042
Mixed Costs 1043

1038

Cost-Volume-Profit Analysis

Breakeven Analysis 1049
Using Contribution Margin to Determine the Breakeven
Point 1051
The Breakeven Point for Multiple Products 1052
Using C-V-P Analysis to Plan Future Sales, Costs,
and Profits 1054
Applying C-V-P to a Manufacturing Business 1054
Applying C-V-P Analysis to a Service Business 1058
CHAPTER REVIEW

1060

1061

CHAPTER ASSIGNMENTS


1064

CHAPTER 23 The Budgeting Process
í DECISION POINT: A MANAGER’S FOCUS JOHNSON &

JOHNSON

1081

The Budgeting Process 1082
Budgeting and Goals 1083
The Importance of Participation 1084
Budget Implementation 1085
Managers and the Budgeting Process 1085
The Master Budget

1087

Operating Budgets 1091
The Sales Budget 1091
The Production Budget 1092
The Direct Materials Purchases Budget 1093

1080
The Direct Labor Budget 1095
The Overhead Budget 1096
The Selling and Administrative Expense Budget 1096
The Cost of Goods Manufactured Budget 1097

Financial Budgets 1099

The Budgeting Income Statement 1099
The Capital Expenditures Budget 1099
The Cash Budget 1100
The Budgeted Balance Sheet 1104
í A LOOK BACK AT JOHNSON & JOHNSON

CHAPTER REVIEW

1137

Organizational Goals and the Balanced Scorecard
1138

The Balanced Scorecard and Management 1138

Performance Measurement 1142
What to Measure, How to Measure 1142
Other Measurement Issues 1142
Responsibility Accounting 1143
Types of Responsibility Centers 1143
Organizational Structure and Performance Management
1146

Performance Evaluation of Cost Centers and Profit
Centers 1148
Evaluating Cost Center Performance Using Flexible
Budgeting 1148
Evaluating Profit Center Performance Using Variable
Costing 1149


1106

1108

CHAPTER ASSIGNMENTS

1112

CHAPTER 24 Performance Management and Evaluation
í DECISION POINT: A MANAGER’S FOCUS VAIL RESORTS

xiii

1034

í A LOOK BACK AT KRAFT FOODS

1047

|

1136

Performance Evaluation of Investment Centers
1151

Return on Investment 1151
Residual Income 1153
Economic Value Added 1154
The Importance of Multiple Performance Measures

1156

Performance Incentives and Goals 1157
Linking Goals, Performance Objectives, Measures, and
Performance Targets 1157
Performance-Based Pay 1158
The Coordination of Goals 1158
í A LOOK BACK AT VAIL RESORTS

CHAPTER REVIEW

1161

CHAPTER ASSIGNMENTS

1166

1159


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Contents

CHAPTER 25 Standard Costing and Variance Analysis

1182


Analyzing and Correcting Direct Materials Variances

í DECISION POINT: A MANAGER’S FOCUS COACH, INC.

1196

1183

Standard Costing 1184
Standard Costs and Managers 1184
The Relevance of Standard Costing in Today’s Business
Environment 1186

Computing and Analyzing Direct Labor Variances

Computing Standard Costs 1186
Standard Direct Materials Cost 1187
Standard Direct Labor Cost 1187
Standard Overhead Cost 1188
Total Standard Unit Cost 1188

Computing and Analyzing Overhead Variances

1198

Computing Direct Labor Variances 1198
Analyzing and Correcting Direct Labor Variances 1199
1201

Using a Flexible Budget to Analyze Overhead Variances

1201

Variance Analysis 1190
The Role of Flexible Budgets in Variance Analysis 1190
Using Variance Analysis to Control Costs 1192
Computing and Analyzing Direct Materials
Variances 1194
Computing Direct Materials Variances 1194

Computing Overhead Variances 1202
Analyzing and Correcting Overhead Variances 1207

Using Cost Variances to Evaluate Managers’
Performance 1207
í A LOOK BACK AT COACH, INC.

CHAPTER REVIEW

1210

1211

CHAPTER ASSIGNMENTS

1217

CHAPTER 26 Analysis for Decision Making

1232
Capital Investment Analysis 1249

Measures Used in Capital Investment Analysis 1250

í DECISION POINT: A MANAGER’S FOCUS BANK OF

1233

AMERICA

Short-Run Decision Analysis
Planning 1234
Performing 1235
Evaluating 1236
Communicating 1236

1234

Incremental Analysis for Short-Run Decisions
Irrelevant Costs and Revenues 1237
Opportunity Costs 1238

The Time Value of Money 1252
Interest 1252
Present Value 1253
Present Value of a Single Sum Due in the Future 1254
Present Value of an Ordinary Annuity 1255
1237

Application of Incremental Analysis to Short-Run
Decisions 1239
Incremental Analysis for Outsourcing Decisions 1239

Incremental Analysis for Special Order Decisions 1241
Incremental Analysis for Segment Profitability Decisions
1243

Other Methods of Capital Investment Analysis
1259

The Payback Period Method 1259
The Accounting Rate-of-Return Method 1260
í A LOOK BACK AT BANK OF AMERICA

Incremental Analysis for Sales Mix Decisions 1245
Incremental Analysis for Sell or Process-Further
Decisions 1247

Capital Investment Decisions

1290

Company Name Index
Subject Index

1298

1296

CHAPTER REVIEW

1263


CHAPTER ASSIGNMENTS

1249

Appendix A: Future Value and Present Value Tables
Endnotes

Analyzing Capital Investment Proposals: The Net
Present Value Method 1256
Advantages of the Net Present Value Method 1256
The Net Present Value Method Illustrated 1256

1284

1268

1262


Preface
This revision of Principles of Accounting is the most significant in the book’s long
history. The substantial changes we have made meet 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 place 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 accounting. Here,
we elaborate on exactly what we set out to achieve in this tenth edition.


Streamlined Coverage and Redesign of the Text
While maintaining a solid foundation in double-entry accounting, we reduced
complexity by eliminating approximately 30 percent of in-text journal entries
and all nonessential procedural coverage and by condensing learning objectives. We also reduced excessive detail, shortened headings, simplified explanations, and increased readability. In addition, we 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 more readable, visually appealing, and pedagogically
useful, we broke it into “user friendly” portions with bulleted and numbered
lists and new art, photographs, end-of-section review material, and Focus on
Business boxes.
Ī New line art clarifies concepts and appeals to students who are visual
learners.
Ī Photographs, with captions that underscore concepts in the text,
increase visual interest.
Ī A new feature called “Stop, Review, and Apply” presents review questions; the answers to the questions are available on the student website
(Online Study Center). Many of these new sections also include short
exercises and solutions.
Ī 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 1-17).

Emphasis on Accounting Information and Successful Decision Making
Throughout the text, we increased our emphasis on how businesses use
accounting information to make decisions, thus providing a uniform framework
for developing decision-making skills.
Ī Each chapter opening includes a new Decision Point that shows how a
well-known company—one that students will immediately recognize—

xv



xvi

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Preface

uses accounting information to make decisions. The Decision Point
poses questions that challenge students to think about the relationship
between this information and the decisions management makes. The
company discussed in the Decision Point is highlighted in the chapter
and is revisited in “A Look Back At,” a feature that shows how the questions introduced in the Decision Point can now be answered.
Ī To relate accounting information to real-world decision making, we refer
to more than 200 actual companies and use some of those companies’
recent financial statements as illustrations.
Ī We use the latest available data in tables, figures, and exhibits and
incorporate the most recent FASB pronouncements in the text. We illustrate current practices in financial reporting by referring to data from
Accounting Trends and Techniques (AICPA) and integrate international topics
wherever appropriate.

Financial Accounting Coverage: Using Financial Statements for Decision Making
In the financial chapters, our emphasis is on teaching students how to tell a
company’s “story” through its financial statements.
Ī To emphasize how important financial statements are in decision making, the first page of each financial chapter 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 We emphasize how ratios are used in evaluating a company’s profitability and liquidity and highlight those discussions with key ratio and cash
flow icons.
Ī The assignment material in every financial chapter includes a case that compares CVS with Southwest Airlines or Walgreens and 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 5.

Management Accounting Coverage: Applying Accounting Concepts
to Real Businesses
Today, management’s use of information goes far beyond computing the cost of
products and services. In the managerial chapters (Chapters 18-26), we explore
the full range of innovative managerial systems in a value-centered economy in
which managers must make critical decisions about product quality, customer
service, and long-term relationships.
Ī Rather than focusing on the technical details of cost accounting, we
emphasize the management process critical to operating a successful
business. A figure entitled “The Management Process: To-Dos for Managers,” which appears in the first section of each chapter, highlights managerial activities important at each stage of the management process.
Ī We emphasize the approaches learned from the most progressive companies, such as how to manage supply chains, analyze value chains,


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Preface

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xvii

operate in a just-in-time environment, utilize activity-based management, apply the theory of constraints, and improve quality.
Ī We discuss the latest in management models and technology and
emphasize that performance measurement and evaluation are essential
to a manager’s success in today’s competitive environment.
Ī Service businesses, in which many students will ultimately work, receive
expanded emphasis in the text discussion and the chapter assignments.


Ethical Financial Reporting
We believe students need to know more about what constitutes ethical financial reporting and good corporate governance. We revised the text to address
this need.
Ī The previews at the start of many chapters point out ethical and governance issues related to the chapter topic that are discussed in the 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.

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 simplified 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.
Ī The first exercises in many chapters present questions useful in generating
class discussion about the decision-making aspects of the chapter topics.
Ī Problems have been carefully scrutinized to reduce the number of transactions involved and the time it takes to work them. Many of the problems have a requirement labeled “User Insight” or “Manager Insight.”
These requirements challenge students to think about the numbers and
how they are used in business decision making.
Ī Cases are grouped by skill: Conceptual Understanding; Interpreting
Financial or Management Reports; Decision Analysis Using Excel; Ethical
Dilemma; Internet; Group Activity; and Business Communication. Each
financial chapter also has an Annual Report Case that focuses on CVS’s
annual report and, as noted earlier, a Comparison Case.

New Instructional Technologies for Today’s Business Environment
New technologies are today a driving force behind business growth and

accounting education. For this tenth edition of Principles of Accounting, we developed an integrated text and technology program to help instructors take
advantage of the opportunities created by new instructional technologies.


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Preface

Whether an instructor takes a user or 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, this
edition provides a total solution. (See the inside back cover of the book for a
complete listing of supplements.)

Course Management
We know that homework and practice are integral parts of 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 comprising end-of-chapter short exercises, exercises, and
problems; algorithmic practice exercises; SMARTHINKING online tutoring;
multimedia ebook with links to tutorials; demonstration videos; and other textsupporting content come ready to use. Premium Blackboard course cartridges
and WebCT ePacks are also available.
Included in Eduspace and new to this edition of Principles of Accounting is HM
Assess, an online diagnostic assessment and study tool. Working in HM Assess,
students take Chapter Assessments and receive Individual Study Paths, with
links to tutorials, video, algorithmic practice questions, and online text content. Reporting and tracking are also available.
HMTesting
HMTesting—now powered by Diploma®—contains the computerized version

of the Test Bank. HMTesting provides instructors with the tools they need to
create, customize, and deliver multiple types of tests. Instructors can select,
edit, and add questions—some with algorithms—or generate randomly selected
questions to produce a test master for easy duplication. All test questions are
now tagged with AACSB learning outcomes, learning objectives, and key concepts. 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 Macintosh computers.
The Test Bank is also available in print. The printed Test Bank provides the
same questions found in HMTesting—more than 4,000 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.
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 Principles of
Accounting program. For instructors, the Online Teaching Center includes password-protected course materials, such as completely revised PowerPoint
slides with video and original content; Classroom Response System content;
sample syllabi; the Accounting Instructor’s Report, which explores a wide range of
contemporary teaching issues; and Electronic Solutions, which are fully functioning Excel spreadsheets for all exercises, problems, and cases in the text.
For students, the Online Study Center offers open access to helpful supplementary materials, such as ACE practice tests, answers to Stop, Review, and
Apply questions, weblinks to companies discussed in the text, chapter outlines
and summaries, glossaries (chapter-based and complete), and much more. In
addition, all new texts are packaged with a passkey providing access to a set of
“Your Guide to an ‘A’” premium resources, which focus on helping students succeed in their course. “Your Guide to an ‘A’” material includes additional (ACE+)


Preface

|


xix

self-test quizzes, Flashcards, crossword puzzles, Study Guide content, Demonstration Videos, HMAccounting Tutor, and audio chapter reviews (MP3 chapter
summaries and quizzes). Both the student and instructor websites can be
accessed at college.hmco.com/info/needles. See the User’s Guide and endpapers of the text 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 how to use financial statements and the
accounting systems that provide the data needed to make business decisions
and that tell a company’s story. For investors and creditors, financial information reveals a company’s financial health, prosperity, and future. For management, both financial information and nonfinancial information 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 and nonfinancial data, and never has that goal been as critical as in current times, with
business events underscoring this fact: accounting really matters.
To follow the “story,” students have to learn how to think. Principles of
Accounting teaches students to think about what they are reading, how they
might make financial decisions, and what roles they might play as future users
of accounting information. Students also have to learn how to analyze and
interpret data—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, accounting students need to learn more than how to prepare
financial statements; they also must learn how to analyze meaningful information in them and in the supporting data. Principles of Accounting, Tenth 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 tenth edition of Principles of 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 in our Test
Bank and Eduspace course as well. Eric Blazer (Millersville University) wrote
the managerial chapters of the study guide, and Judy R. Colwell (Northern
Oklahoma College) wrote the managerial chapters of the test bank. We also
thank Jeri Condit for creating the PowerPoint slides, Linda Burkell for HMAccounting Tutor and GLS, and Cathy Larson for her accuracy review of the text
and solutions. Sarah Evans deserves special recognition for her thoroughness
and clarity in editing portions of the text and laying out the tenth 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 assistant, Diane Akerman; 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


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Preface

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.
Daneen Adams, Santa Fe Community College
Gregory D. Barnes, Clarion University
Mohamed E. Bayou, The University of Michigan—Dearborn
Charles M. Betts, Delaware Technical and Community College
Michael C. Blue, Bloomsburg University
Gary R. Bower, Community College of Rhode Island
Lee Cannell, El Paso Community College
Gerald Carnes, Edinboro College
John D. Cunha, University of California—Berkeley
Julie Dailey, Central Virginia Community College

Mark W. Dawson, Duquesne University
Patricia A. Doherty, Boston University
Lizabeth England, American Language Academy
David Fetyko, Kent State University
Albert Fisher, Community College of Southern Nevada
Robert Flemming, Northern Michigan University
Sue Garr, Wayne State University
Roxanne Gooch, Cameron 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
Yvonne Hatami, Borough of Manhattan Community College
Robert Holtfreter, Centra, Washington University
Harry Hooper, Santa Fe Community College

Mark Henry, Victoria College
Margaret Hoskins, Henderson State Univ.
Marianne James, California State University, Los Angeles
Sharon Johnson, Kansas City Kansas Community College
Edward H. Julius, California Lutheran University
Howard A. Kanter, DePaul University
Ann Kelley, Providence College
Debbie Luna, El Paso Community College
Kevin McClure, ESL Language Center
George McGowan
Gail A. Mestas
Jenine Moscove
Beth Brooks Patel, University of California—Berkeley

LaVonda Ramey, Schoolcraft College
Roberta Rettner, American Ways
Gayle Richardson, Bakersfield College
James B. Rosa, Queensborough Community College
Donald Shannon, DePaul Univeristy
S. Murray Simons, Northeastern University
Marion Taube, University of Pittsburgh
Kathleen Villani, Queensborough Community College
Vicki Vorell, Cuyahoga Community College
John Weber, DeVry Institute
Brenda Werts, Park University
Kay Westerfield, University of Oregon
Andy Williams, Edmunds Community College

Finally, we want to thank the facilitators for the last five years of COAE (Conference on Accounting
Education):
2006 COAE Facilitators
Salvador Aceves, University of San Francisco
Rita Grant, Grand Valley State University
Emmanuel Onifade, Morehouse College
Janet Papiernik, Indiana University—Purdue University
Andy Williams, Edmonds Community College
2005 COAE Facilitators
Peter Aghimien, Indiana University, South Bend
Charles Bunn, Wake Technical College
James Dougher, DeVry University
Frank Lordi, Widener University
Elizabeeth Murphy, DePaul University
Karen Novey, Robert Morris College
Wendy Tietz, Kent State University

2004 COAE Facilitators
Star Brown, Western Piedmont Community College
Rosie Bukics, Lafayette College
Stanley Chu, Borough of Manhattan Community College
Michael Cottrill, Northeastern University
Mark Mitschow, SUNY—Genesee
Elizabeth Murphy, DePaul University

Richard Fern, Eastern Kentucky University
Terry Grant, Mississippi College
Yvonne Hatami, Borough of Manhattan Community College
Rodger Holland, Columbus State University
2002 COAE Facilitators
Sharon Bell, University of North Carolina—Pembroke
Mark Henry, Victoria College
Harry Hooper, Santa Fe Community College
Richard Irvine, Pensacola Junior College
Nancy Kelly, Middlesex Community College
Paul Mihalek, University of Hartford
Paul Weitzel, Eastern Shore Community College
2001 COAE Facilitators
Salvador Aceves, University of San Francisco
Betty Habershon, Prince George's Community College
Jim Mazza, Heald College
Roselyn Morris, Southwest Texas State University
Ginger Parker, Creighton University
David Rogers, Mesa State College
Jeanne Yamamura, University of Nevada—Reno
—B.N., M.P., and S.C.


2003 COAE Facilitators
Charlene Abendroth, California State University
Daneen Adams, Santa Fe Community College

Openmirrors.com


User’s Guide to
Principles of Accounting
We have designed Principles of 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 Principles of 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 in Chapters 1–17; this feature tells you
which financial statements are important in the chapter.
1 Each Chapter Preview focuses on management issues; many also
present 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 (Chapters 1–17) 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 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.
7 Study Notes highlight important information and provide useful tips
on ways to avoid common mistakes.

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CHAPTER 2

6

7

Analyzing Business Transactions

8
Senior WorldCom executives violated
standards of good financial reporting
and GAAP when they deliberately
understated expenses to disguise
poor performance. Consequences
were devastating for employees,
investors, and the public trust. Left to
right: Melvin Dick of Arthur Andersen,
Bernard Ebbers and Scott Sullivan of
WorldCom, and Jack Grabman of

Salomon Smith Barney are sworn in
on July 8, 2002, at a congressional
hearing of charges against WorldCom.

‘ By a simple violation of the guidelines for classification, WorldCom (now
MCI) perpetrated the largest financial fraud in history, which resulted in the
largest bankruptcy in history. Over a period of several years, the company
recorded expenditures that should have been classified as expenses as
assets; this had the effect of understating the company’s expenses and overstating its income by more than $10 billion.

9

S

T

O

P

•

R

E

V

I


E

W

•

A

P

P

L

Y

1-1. What three issues underlie most major accounting decisions?
1-2. A customer asks the owner of a store to save an item for him and says
he will pick it up and pay for it next week. The owner agrees to hold it.
Should this transaction be recorded as a sale? Explain your answer.
1-3. Why do accountants rely on original cost for valuation purposes?
1-4. Why is classification of a transaction as an expense or an asset a critical
issue in accounting?
1-5. How are recognition, valuation, and classification related to the ethics
of financial reporting?
Suggested answers to all Stop, Review, and Apply questions are available at
/>
8 Photographs with detailed captions reinforce concepts in the textbook and show how accounting is used in the business world.
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.

Uncollectible Accounts

Double-Entry System
LO2

T

Explain the double-entry system and the usefulness of T accounts in
analyzing business transactions.

he double-entry system, the backbone of accounting, evolved during
the Renaissance. The first systematic description of double-entry bookkeeping appeared in 1494, two years after Columbus discovered America,

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383

receivable amounted to $100,000. On December 31, 20x8, management
reviewed the collectible status of the accounts receivable. Approximately
$6,000 of the $100,000 of accounts receivable were estimated to be uncollectible. The following adjusting entry would be made on December 31 of
that year:

10


A
ϭ L ϩ OE
Ϫ6,000
Ϫ6,000

20x8
Dec. 31 Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
To record the estimated uncollectible
accounts expense for the year

6,000
6,000


User’s Guide

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xxiii

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.
18

|


CHAPTER 1

Uses of Accounting Information and the Financial Statements

11

11 An abundance of line art illustrates the relationships between
concepts and processes.

■ FIGURE 5
The Accounting Equation

Owner’s
Equity

Liabilities

Assets

A = L + OE

Standard Costing

|

1185

■ FIGURE 1
The Management Process: To-Do’s for Managers


12

12 Each managerial chapter (Chapters 18–26) includes a graphic:
To-Do’s for Managers.These figures highlight managerial activities
important to each stage of the management process.

To-Do’s for Managers
• Plan
– Determine standard costs and prepare budgets
– Establish cost-based goals for products or services
• Perform
– Apply cost standards as work is performed in cost centers
– Collect actual cost data
• Evaluate
– Use flexible budgets to evaluate managers’ performance
– Calculate variances between standard and actual costs
for direct materials, direct labor, variable overhead,
and fixed overhead
– Determine their causes and take corrective action
• Communicate
– Prepare cost center performance reports using standard
costing
– Prepare comparative analyses of flexible budget to actual
results for materials, labor and overhead

Financial Statements

13


EXHIBIT 2 Ǡ

|

21

Statement of Owner’s Equity for Ramirez Agency

13 Exhibits throughout the text show financial information.

Ramirez Agency
Statement of Owner’s Equity
For the Month Ended December 31, 20xx
R. Ramirez, Capital, December 1, 20xx
Investment by R. Ramirez
Net income for the month
Subtotal
Less withdrawals
R. Ramirez, Capital, December 31, 20xx

$
0
100,000
4,200
$104,200
1,200
$103,000

from this amount are $1,200 of withdrawals that the owner made during the
month, leaving an ending balance of $103,000 of capital in the business.


14

Statement of Cash Flows
Whereas the income statement focuses on a company’s profitability, the
statement of cash flows focuses on its liquidity (see Exhibit 4). Cash flows are
the inflows and outflows of cash into and out of a business. Net cash flows are
the difference between the inflows and outflows. The statement of cash flows
shows the cash produced by business operations during an accounting period

15

14 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.

15 Tables present factual information referred to in the text.


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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 5 helps you learn how to

read—and understand—real financial statements and interpret what
management says about them.
16 Focus on Business Practice boxes highlight the relevance of
accounting to business today.

16

17 The textbook refers to over 200 public, private, and not-for-profit
companies.The Needles Online Study Center website (http://
college.hmco.com/info/needles) provides a direct link to the websites of these companies.The book also has a company name index.

17

18

18 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.
19 Ratios are used to measure a company’s performance.
The key ratio icon appears in the margin to highlight
discussions of important ratios.
19

Current Ratio The current ratio is closely related to working capital. Many
bankers and other creditors believe it is a good indicator of a company’s ability
to pay its debts on time. The current ratio is the ratio of current assets to current liabilities. For Ling Auto Supply Company, it is computed like this:
Current Ratio ϭ

Current Assets

$248,712
ϭ
ϭ 2.9
Current Liabilities
$85,366

Thus, Ling Auto Supply has $2.90 of current assets for each $1.00 of current liabilities. Is that good or bad? The answer requires a comparison of this year’s
current ratio with ratios for earlier years and with similar measures for companies in the same industry.
ll
h
f
d

20 The complete annual report for CVS and the financial statements
of Southwest Airlines are in the Supplement to Chapter 5. CVS’s
financial statements with annotations also appear in the
Supplement to Chapter 5.

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