Regents Professor Emeritus of Accounting

Accounting Principles: A Business Perspective

First Global Text Edition, Volume 1 Financial Accounting

Roger H. Hermanson,PhD, CPA Regents Professor Emeritus of Accounting

Ernst & Young-J. W. Holloway Memorial Professor Emeritus

Georgia State University

James Don Edwards PhD, D.H.C, CPA J.M. Tull Professor Emeritus of Accounting

Terry College of Business

University of Georgia

Michael W. Maher PhD, CPA Graduate School of Management

University of California at Davis

Special cont ributors to managerial chapters:

Kathleen M. Donelan-Knox

Department of Accountancy

University of Notre Dame

Funding for the First Global Text Edition was provided by the Endeavor Corporation, Houston, Texas, USA

The Global Text Project is funded by the Jacobs Foundation, Zurich, Switzerland

This book is licensed under a Creative Commons Attribution 3.0 License

 

 

Acknowledgments for the Global Text First Edition:

Revision Editor: Donald J. McCubbrey, PhD

Clinical Professor, Daniels College of Business

University of Denver

Life member, American Institute of Certified Public Accountants

Revision Assistants

Emily Anderson

Kyle Block

Assistant Editor

Jackie Sharman

Associate Editor

Marisa Drexel

Conversion Specialist

Varun Sharma

 

 

This book is licensed under a Creative Commons Attribution 3.0 License

Table of Contents Accounting principles:A business perspective…………………………………………………………………………………….8

The accounting environment………………………………………………………………………………………………………….. 18

Accounting defined……………………………………………………………………………………………………………………….. 19

Financial accounting versus managerial accounting………………………………………………………………………….23

Development of financial accounting standards………………………………………………………………………………..25

Ethical behavior of accountants……………………………………………………………………………………………………… 26

1. Accounting and its use in business decisions……………………………………………………………..30 Forms of business organizations…………………………………………………………………………………………………….. 31

Types of activities performed by business organizations……………………………………………………………………32

Financial statements of business organizations………………………………………………………………………………..33

The financial accounting process…………………………………………………………………………………………………….37

Analyzing and using the financial results—the equity ratio………………………………………………………………..46

2. Recording business transactions……………………………………………………………………………….65 The account and rules of debit and credit…………………………………………………………………………………………66

The accounting cycle……………………………………………………………………………………………………………………… 72

The journal…………………………………………………………………………………………………………………………………… 73

The ledger…………………………………………………………………………………………………………………………………….. 76

The accounting process in operation……………………………………………………………………………………………….. 76

3. Adjustments for financial reporting…………………………………………………………………………116 Cash versus accrual basis accounting……………………………………………………………………………………………… 117

Classes and types of adjusting entries……………………………………………………………………………………………. 120

Adjustments for deferred items…………………………………………………………………………………………………….. 122

Adjustments for accrued items……………………………………………………………………………………………………… 129

4. Completing the accounting cycle……………………………………………………………………………..150 The accounting cycle summarized…………………………………………………………………………………………………. 151

The work sheet…………………………………………………………………………………………………………………………….. 151

Preparing financial statements from the work sheet…………………………………………………………………………157

Journalizing adjusting entries………………………………………………………………………………………………………. 158

The closing process……………………………………………………………………………………………………………………… 159

Accounting systems: From manual to computerized………………………………………………………………………..164

A classified balance sheet……………………………………………………………………………………………………………… 169

Analyzing and using the financial results — the current ratio……………………………………………………………175

5. Accounting theory………………………………………………………………………………………………….198 Traditional accounting theory………………………………………………………………………………………………………. 199

Other basic concepts……………………………………………………………………………………………………………………. 201

The measurement process in accounting………………………………………………………………………………………..202

The major principles…………………………………………………………………………………………………………………… 203

Modifying conventions (or constraints)…………………………………………………………………………………………209

The financial accounting standards board’s conceptual framework project………………………………………..212

Objectives of financial reporting…………………………………………………………………………………………………….212

Qualitative characteristics……………………………………………………………………………………………………………. 214

Recognition and measurement in financial statements…………………………………………………………………….218

6. Merchandising transactions……………………………………………………………………………………236 Introduction to inventories and the classified income statement………………………………………………………236

Two income statements compared— Service company and merchandising company………………………….237

Sales revenues…………………………………………………………………………………………………………………………….. 238

Cost of goods sold……………………………………………………………………………………………………………………….. 244

Classified income statement…………………………………………………………………………………………………………. 252

Analyzing and using the financial results—Gross margin percentage………………………………………………..256

7. Measuring and reporting inventories……………………………………………………………………….279

Accounting Principles: A Business Perspective 4 A Global Text

 

 

Inventories and cost of goods sold…………………………………………………………………………………………………280

Determining inventory cost………………………………………………………………………………………………………….. 282

Departures from cost basis of inventory measurement…………………………………………………………………….303

Analyzing and using financial results—inventory turnover ratio……………………………………………………….308

8. Control of cash………………………………………………………………………………………………………332 Internal control…………………………………………………………………………………………………………………………… 333

Controlling cash………………………………………………………………………………………………………………………….. 340

The bank checking account………………………………………………………………………………………………………….. 343

Bank reconciliation……………………………………………………………………………………………………………………… 347

Petty cash funds………………………………………………………………………………………………………………………….. 352

Analyzing and using the financial results—The quick ratio……………………………………………………………….355

9. Receivables and payables………………………………………………………………………………………..371 Accounts receivable…………………………………………………………………………………………………………………….. 372

Current liabilities………………………………………………………………………………………………………………………… 381

Notes receivable and notes payable……………………………………………………………………………………………….387

Short-term financing through notes payable…………………………………………………………………………………..391

Analyzing and using the financial results—Accounts receivable turnover and number of days’ sales in

accounts receivable………………………………………………………………………………………………………………………….. 394

10. Property, plant, and equipment…………………………………………………………………………….410 Nature of plant assets…………………………………………………………………………………………………………………… 411

Initial recording of plant assets…………………………………………………………………………………………………….. 412

Depreciation of plant assets………………………………………………………………………………………………………….. 416

Subsequent expenditures (capital and revenue) on assets………………………………………………………………..428

Subsidiary records used to control plant assets……………………………………………………………………………….431

Analyzing and using the financial results—Rate of return on operating assets……………………………………433

11. Plant asset disposals, natural resources, and intangible assets………………………………….449 Disposal of plant assets……………………………………………………………………………………………………………….. 450

Intangible assets………………………………………………………………………………………………………………………….. 461

Analyzing and using the financial results—Total assets turnover………………………………………………………468

12. Stockholders’ equity: Classes of capital stock………………………………………………………….486 The corporation………………………………………………………………………………………………………………………….. 487

Documents, books, and records relating to capital stock…………………………………………………………………..491

Par value and no-par capital stock…………………………………………………………………………………………………492

Other values commonly associated with capital stock……………………………………………………………………..493

Capital stock authorized and outstanding………………………………………………………………………………………493

Classes of capital stock………………………………………………………………………………………………………………… 494

Types of preferred stock………………………………………………………………………………………………………………. 495

Balance sheet presentation of stock……………………………………………………………………………………………….497

Stock issuances for cash………………………………………………………………………………………………………………. 498

Capital stock issued for property or services…………………………………………………………………………………..500

Balance sheet presentation of paid-in capital in excess of par (or stated) value—Common or preferred. 500

Analyzing and using the financial results—Return on average common stockholders’ equity………………503

13. Corporations: Paid-in capital, retained earnings, dividends, and treasury stock…………521 Paid-in (or contributed) capital…………………………………………………………………………………………………….. 522

Retained earnings……………………………………………………………………………………………………………………….. 523

Paid-in capital and retained earnings on the balance sheet………………………………………………………………523

Retained earnings appropriations…………………………………………………………………………………………………. 530

Statement of retained earnings…………………………………………………………………………………………………….. 532

Statement of stockholders’ equity…………………………………………………………………………………………………. 532

Treasury stock…………………………………………………………………………………………………………………………….. 533

Net income inclusions and exclusions……………………………………………………………………………………………536

Analyzing and using the financial results—Earnings per share and price-earnings ratio……………………..540

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14. Stock investments………………………………………………………………………………………………..559 Cost and equity methods……………………………………………………………………………………………………………… 560

Consolidated balance sheet at time of acquisition……………………………………………………………………………568

Accounting for income, losses, and dividends of a subsidiary……………………………………………………………572

Consolidated financial statements at a date after acquisition……………………………………………………………572

Uses and limitations of consolidated statements……………………………………………………………………………..576

Analyzing and using the financial results—Dividend yield on common stock and payout ratios……………577

15. Long-term financing: Bonds………………………………………………………………………………….593 Bonds payable…………………………………………………………………………………………………………………………….. 594

Bond prices and interest rates………………………………………………………………………………………………………600

Analyzing and using the financial results—Times interest earned ratio………………………………………………611

16. Analysis using the statement of cash flows……………………………………………………………..630 Purposes of the statement of cash flows………………………………………………………………………………………….631

Uses of the statement of cash flows………………………………………………………………………………………………..631

Information in the statement of cash flows…………………………………………………………………………………….632

Cash flows from operating activities………………………………………………………………………………………………634

Steps in preparing statement of cash flows……………………………………………………………………………………..636

Analysis of the statement of cash flows…………………………………………………………………………………………..641

Analyzing and using the financial results—Cash flow per share of common stock, cash flow margin, and cash

flow liquidity ratios………………………………………………………………………………………………………………………….. 647

Appendix: Use of a working paper to prepare a statement of cash flows…………………………………………….649

17. Analysis and interpretation of financial statements…………………………………………………675 Objectives of financial statement analysis………………………………………………………………………………………676

Sources of information………………………………………………………………………………………………………………… 678

Horizontal analysis and vertical analysis: An illustration…………………………………………………………………679

Trend percentages………………………………………………………………………………………………………………………. 682

Ratio analysis……………………………………………………………………………………………………………………………… 683

18. Managerial accounting concepts/job costing………………………………………………………….728 Compare managerial accounting with financial accounting………………………………………………………………729

Merchandiser and manufacturer accounting: Differences in cost concepts………………………………………..730

Financial reporting by manufacturing companies……………………………………………………………………………733

The general cost accumulation model…………………………………………………………………………………………….736

Job costing…………………………………………………………………………………………………………………………………. 738

Predetermined overhead rates……………………………………………………………………………………………………… 743

19. Process: Cost systems……………………………………………………………………………………………765 Nature of a process cost system…………………………………………………………………………………………………….. 765

Process costing illustration…………………………………………………………………………………………………………… 766

Process costing in service organizations………………………………………………………………………………………….775

Spoilage……………………………………………………………………………………………………………………………………… 775

20. Using accounting for quality and cost management………………………………………………..795 Importance of good accounting information…………………………………………………………………………………..795

Quality and customer satisfaction measures…………………………………………………………………………………..802

Just-in-time method…………………………………………………………………………………………………………………… 805

Activity-based costing and management………………………………………………………………………………………..808

Methods used for activity-based costing………………………………………………………………………………………….811

Impact of new production environment on cost drivers……………………………………………………………………815

Activity-based costing in marketing……………………………………………………………………………………………….816

Strategic use of activity-based management……………………………………………………………………………………816

Behavioral and implementation issues……………………………………………………………………………………………817

Opportunities to improve activity-based costing in practice……………………………………………………………..817

21. Cost-volume-profit analysis…………………………………………………………………………………..831

Accounting Principles: A Business Perspective 6 A Global Text

 

 

Cost behavior patterns………………………………………………………………………………………………………………… 832

Methods for analyzing costs…………………………………………………………………………………………………………. 835

Cost-volume-profit (CVP) analysis…………………………………………………………………………………………………837

Finding the break-even point………………………………………………………………………………………………………..838

Cost-volume-profit analysis illustrated…………………………………………………………………………………………..841

Assumptions made in cost-volume-profit analysis………………………………………………………………………….843

Using computer spreadsheets for CVP analysis………………………………………………………………………………844

Effect of automation on cost-volume-profit analysis……………………………………………………………………….845

22. Short-term decision making: Differential analysis………………………………………………….859 Contribution margin income statements………………………………………………………………………………………..859

Differential analysis…………………………………………………………………………………………………………………….. 861

Applications of differential analysis……………………………………………………………………………………………….863

Applying differential analysis to quality…………………………………………………………………………………………867

23. Budgeting for planning and control……………………………………………………………………….881 The budget—For planning and control…………………………………………………………………………………………..882

The master budget illustrated……………………………………………………………………………………………………….887

Budgeting in merchandising companies…………………………………………………………………………………………899

Budgeting in service companies……………………………………………………………………………………………………900

Additional concepts related to budgeting……………………………………………………………………………………….900

24. Control through standard costs……………………………………………………………………………..916 Uses of standard costs………………………………………………………………………………………………………………….. 916

Advantages and disadvantages of using standard costs……………………………………………………………………918

Computing variances…………………………………………………………………………………………………………………… 920

Goods completed and sold…………………………………………………………………………………………………………… 930

Investigating variances from standard…………………………………………………………………………………………..930

Disposing of variances from standard…………………………………………………………………………………………….931

Nonfinancial performance measures……………………………………………………………………………………………..932

Activity-based costing, standards, and variances…………………………………………………………………………….933

25. Responsibility accounting: Segmental analysis……………………………………………………….945 Responsibility accounting……………………………………………………………………………………………………………. 945

Responsibility reports………………………………………………………………………………………………………………….. 947

Responsibility centers…………………………………………………………………………………………………………………. 949

Transfer prices……………………………………………………………………………………………………………………………. 952

Use of segmental analysis…………………………………………………………………………………………………………….. 952

Concepts used in segmental analysis……………………………………………………………………………………………..953

Investment center analysis…………………………………………………………………………………………………………… 956

Economic value added and residual income…………………………………………………………………………………..960

Segmental reporting in external financial statements………………………………………………………………………961

26. Capital budgeting:Long-range planning…………………………………………………………………978 Capital budgeting defined……………………………………………………………………………………………………………. 978

Profitability index……………………………………………………………………………………………………………………….. 987

Investments in working capital…………………………………………………………………………………………………….. 990

The …