06481i

C O N T E N TS ◗ PART

ONE

FI NANCIAL R E PORTI NG AN D TH E A C C O U N T I N G CYC L E 1 1

ACCOUNTING INFORMATION: USERS AND USES . . . . . . . . . . . . . 3 What’s the Purpose of Accounting? . . . . . . . . . . . . . . . . . . . . . . . . . . 5 The Relationship of Accounting to Business . . . . . . . . . . . . . . . . . . 7 Who Uses Accounting Information . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Lenders . . . . . Investors . . . . Management . Other Users of

........ ........ ........ Financial

........... ........... ........... Information .

. . . .

10 11 11 11

Within What Kind of Environment Does Accounting Operate? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 The Significance and Development of Accounting Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Financial Accounting Standards Board . . . . . Other Organizations . . . . . . . . . . . . . . . . . . . . . . . International Business. . . . . . . . . . . . . . . . . . . . . . Ethics in Accounting . . . . . . . . . . . . . . . . . . . . . . . Technology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . .

13 14 14 15 17 17

So, Why Should I Study Accounting? . . . . . . . . . . . . . . . . . . . . . . . . 20 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 2

FINANCIAL STATEMENTS: AN OVERVIEW . . . . . . . . . . . . . . . . . . 28 The Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 The Balance Sheet . . . . . . . . . . . . . . . . . . . . The Income Statement . . . . . . . . . . . . . . . . . The Statement of Cash Flows . . . . . . . . . . . . How the Financial Statements Tie Together.

. . . .

31 38 43 45

Notes to the Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Summary of Significant Accounting Policies . . . . . . . . . . . . . . . . . 46 Additional Information about Summary Totals . . . . . . . . . . . . . . 46

xx

Contents

Disclosure of Information Not Recognized . . . . . . . . . . . . . . . . . . 46 Supplementary Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 The External Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Fundamental Concepts and Assumptions. . . . . . . . . . . . . . . . . . . . . . 49 The The The The The

Separate Entity Concept . . . . . . . . . . . . . . Assumption of Armâ&#x20AC;&#x2122;s-Length Transactions. Cost Principle . . . . . . . . . . . . . . . . . . . . . . Monetary Measurement Concept. . . . . . . . Going Concern Assumption . . . . . . . . . . .

. . . . .

49 49 50 50 50

End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 3

THE MECHANICS OF ACCOUNTING . . . . . . . . . . . . . . . . . . . . . . . 75 How Can We Collect All This Information? . . . . . . . . . . . . . . . . . . . . 76 How Do Transactions Affect the Accounting Equation? . . . . . . . . . . . 79 The Accounting Equation . . . . . . . . . . . . . . . . . . . . . . . . Using Accounts to Categorize Transactions . . . . . . . . . . . Expanding the Accounting Equation to Include Revenues, Expenses, and Dividends . . . . . . . . . . . . . . . . . Why Should I Understand the Mechanics of Accounting?

. . . . . . . 79 . . . . . . . 80 . . . . . . . 84 . . . . . . . 84

How Do We Record the Effects of Transactions? . . . . . . . . . . . . . . . . 86 Acquiring Cash, Either from Owners or by Acquiring Other Assets. . . . . . . . . . . . . . . . Selling Goods or Providing Services. . . . . . Collecting Cash and Paying Obligations . . A Note on Journal Entries . . . . . . . . . . . . .

Borrowing ......... ......... ......... .........

. . . . .

87 88 91 93 95

Posting Journal Entries and Preparing a Trial Balance . . . . . . . . . . . . . 97 Determining Account Balances . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 Illustration of the First Three Steps in the Accounting Cycle . . . . . . . 99 Where Do Computers Fit In All This? . . . . . . . . . . . . . . . . . . . . . . . 104 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 4

COMPLETING THE ACCOUNTING CYCLE. . . . . . . . . . . . . . . . . . 129 Accrual Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 Periodic Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 Accrual- versus Cash-Basis Accounting . . . . . . . . . . . . . . . . . . . . 132

Contents

Adjusting Entries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 Unrecorded Receivables . Unrecorded Liabilities . . Prepaid Expenses . . . . . . Unearned Revenues . . . .

. . . .

136 136 138 140

Preparing Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 Financial Statement Preparation. . . . . . . . . . . . . . . . . . . . . . . . . 143 The Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145 The Audit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146 Closing the Books . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 Real and Nominal Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 Closing Entries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 Preparing a Post-Closing Trial Balance . . . . . . . . . . . . . . . . . . . . 149 A Summary of the Accounting Cycle. . . . . . . . . . . . . . . . . . . . . . . . 151 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152 5

ENSURING THE INTEGRITY OF FINANCIAL INFORMATION . . . 185 The Types of Problems That Can Occur . . . . . . . . . . . . . . . . . . . . . 187 Types of Errors in the Reporting Process . . . . . . . . . . . . . . . . . . . 188 Disagreements in Judgment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 Fraudulent Financial Reporting . . . . . . . . . . . . . . . . . . . . . . . . . 189 Safeguards Designed to Minimize Problems . . . . . . . . . . . . . . . . . . . 190 The Control Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192 Control Activities (Procedures) . . . . . . . . . . . . . . . . . . . . . . . . . . 192 Reasons for Earnings Management . . . . . . . . . . . . . . . . . . . . . . . . . 195 Meet Internal Targets. . . . . . . . . . . . . . . Meet External Expectations . . . . . . . . . . Income Smoothing. . . . . . . . . . . . . . . . . Window Dressing for an IPO or a Loan The Earnings Management Continuum . Is Earnings Management Ethical? . . . . . Personal Ethics . . . . . . . . . . . . . . . . . . .

. . . . . . .

196 196 196 197 197 199 200

The Sarbanes-Oxley Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 Public Company Accounting Oversight Board . . . . . . . . . . . . . . . 201 Constraints on Auditors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 Constraints on Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202

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The Role of Auditors in the Accounting Process . . . . . . . . . . . . . . . 202 Internal Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . External Auditors. . . . . . . . . . . . . . . . . . . . . . . . . . What Do Auditors Do?. . . . . . . . . . . . . . . . . . . . . . Are Outside (Independent) Auditors Independent?

. . . .

202 203 204 206

The Securities and Exchange Commission . . . . . . . . . . . . . . . . . . . . 207 The Effect of the 1934 Act on Independent Accountants . . . . . . . 208 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Comprehensive Problem 1–5 . . . . . . . . . . . . . . . . . . . . . . . . . 220

◗ PART

TWO

O P E R AT I N G A C T I V I T I E S 2 2 3 6

SELLING A PRODUCT OR A SERVICE . . . . . . . . . . . . . . . . . . . . . 224 Major Activities of a Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228 Recognizing Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230 When Should Revenue Be Recognized? . . . . . . . . . . . . . . . . . . . . 231 Application of the Revenue Recognition Criteria . . . . . . . . . . . . . 232 Cash Collection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234 Sales Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234 Sales Returns and Allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . 235 Control of Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 Accounting for Credit Customers Who Don’t Pay . . . . . . . . . . . . . . 237 Direct Write-Off Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238 The Allowance Method. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239 Real-World Illustration of Accounting for Bad Debts . . . . . . . . . . 243 Assessing How Well Companies Manage Their Receivables. . . . . . . . 244 Recording Warranty and Service Costs Associated with a Sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245 EXPANDED

material Reconciling the Bank Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

Contents

Foreign Currency Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250 Foreign Currency Transaction Example. . . . . . . . . . . . . . . . . . . . 250 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253 7

INVENTORY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282 Inventory and Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . 285 What is Inventory?. . . . . . . . . . . . . . . . . . . . What Costs Are Included in Inventory Cost? Who Owns the Inventory? . . . . . . . . . . . . . . Ending Inventory and Cost of Goods Sold . .

. . . .

286 287 287 288

Accounting for Inventory Purchases and Sales . . . . . . . . . . . . . . . . . 289 Overview of Perpetual and Periodic Systems . . . . . . . . . . . . . . . . 289 Perpetual and Periodic Journal Entries . . . . . . . . . . . . . . . . . . . . 290 Counting Inventory and Calculating Cost of Goods Sold . . . . . . . . . . 295 Taking a Physical Count of Inventory . . . . . . . . . . . . . . . . . . . . . 295 The Income Effect of an Error in Ending Inventory . . . . . . . . . . 296 Inventory Cost Flow Assumptions. . . . . . . . . . . . . . . . . . . . . . . . . . 297 Specific Identification Inventory Cost Flow . . . . . FIFO Cost Flow Assumption . . . . . . . . . . . . . . . . . LIFO Cost Flow Assumption . . . . . . . . . . . . . . . . . Average Cost Flow Assumption . . . . . . . . . . . . . . A Comparison of All Inventory Costing Methods .

. . . . .

298 300 300 301 301

Assessing How Well Companies Manage Their Inventories . . . . . . . . 303 Evaluating the Level of Inventory . . . . . . . . . . . . . . . . . . . . . . . . 303 Impact of the Inventory Cost Flow Assumption . . . . . . . . . . . . . . 304 Number of Daysâ&#x20AC;&#x2122; Purchases in Accounts Payable . . . . . . . . . . . . 304

EXPANDED

material Inventory Errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306 Complications of the Perpetual Method with LIFO and Average Cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309

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Reporting Inventory at Amounts below Cost . . . . . . . . . . . . . . . . . . 311 Inventory Valued at Net Realizable Value. . . . . . . . . . . . . . . . . . 311 Inventory Valued at Lower of Cost or Market . . . . . . . . . . . . . . . 311 Method of Estimating Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . 313 The Gross Margin Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315 8

COMPLETING THE OPERATING CYCLE . . . . . . . . . . . . . . . . . . . 341 Employee Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344 Payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compensated Absences . . . . . . . . . . . . . . . . . Bonuses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock Options. . . . . . . . . . . . . . . . . . . . . . . . . Postemployment Benefits . . . . . . . . . . . . . . . . Pensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . Postretirement Benefits Other Than Pensions

. . . . . . .

345 346 347 347 348 348 350

Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351 Sales Taxes. . . . . . . . . . Property Taxes . . . . . . . Income Taxes. . . . . . . . Deferred Tax Example .

. . . .

351 351 352 353

Contingencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355 Environmental Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 356 Capitalize versus Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 358 Research and Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359 Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359 Summarizing Operations on an Income Statement . . . . . . . . . . . . . . 360 Other Revenues and Expenses . . . . . . Extraordinary Items . . . . . . . . . . . . . Earnings per Share . . . . . . . . . . . . . . Differing Income Statement Formats .

. . . .

360 360 362 363

End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 364 Comprehensive Problem 6â&#x20AC;&#x201C;8 . . . . . . . . . . . . . . . . . . . . . . . . . 384

Contents

â&#x2014;&#x2014; PART

THREE

I NVE STI N G AN D F I NAN C I N G A C T I V I T I E S 3 87 9

INVESTMENTS IN PROPERTY, PLANT, AND EQUIPMENT AND IN INTANGIBLE ASSETS . . . . . . . . . . . . . . . . . 388 Nature of Long-Term Operating Assets . . . . . . . . . . . . . . . . . . . . . . 391 Deciding Whether to Acquire a Long-Term Operating Asset . . . . . . . 392 Accounting for Acquisition of Property, Plant, and Equipment . . . . . . 393 Assets Acquired by Purchase . . . . . . . Assets Acquired by Leasing . . . . . . . . Assets Acquired by Self-Construction . Acquisition of Several Assets at Once.

. . . .

394 394 397 397

Calculating and Recording Depreciation Expense. . . . . . . . . . . . . . . 399 Straight-Line Method of Depreciation. . . . . . . . . . . . Units-of-Production Method of Depreciation . . . . . . A Comparison of Depreciation Methods . . . . . . . . . Partial-Year Depreciation Calculations . . . . . . . . . . Units-of-Production Method with Natural Resources

. . . . .

400 402 403 403 404

Repairing and Improving Property, Plant, and Equipment. . . . . . . . . 405 Recording Impairments of Asset Value . . . . . . . . . . . . . . . . . . . . . . 407 Recording Decreases in the Value of Property, Plant, and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 407 Recording Increases in the Value of Property, Plant, and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 408 Disposal of Property, Plant, and Equipment. . . . . . . . . . . . . . . . . . . 409 Discarding Property, Plant, and Equipment . . . . . . . . . . . . . . . . 409 Selling Property, Plant, and Equipment . . . . . . . . . . . . . . . . . . . . 410 Exchanging Property, Plant, and Equipment . . . . . . . . . . . . . . . . 410 Accounting for Intangible Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . 411 Amortization of Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . . 414 Impairment of Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . . . 415

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Measuring Property, Plant, and Equipment Efficiency . . . . . . . . . . . . 416 Evaluating the Level of Property, Plant, and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416 Industry Differences in Fixed Asset Turnover . . . . . . . . . . . . . . . 416 EXPANDED

material Accelerated Depreciation Methods . . . . . . . . . . . . . . . . . . . . . . . . . 417 Declining-Balance Method of Depreciation . . . . . . . . . . . . . . . . . 418 Sum-of-the-Yearsâ&#x20AC;&#x2122;-Digits Method of Depreciation . . . . . . . . . . . . . 419 A Comparison of Depreciation Methods . . . . . . . . . . . . . . . . . . . 420 Changes in Depreciation Estimates and Methods . . . . . . . . . . . . . . . 422 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 423 10 LONG-TERM DEBT FINANCING. . . . . . . . . . . . . . . . . . . . . . . . . . 453 Measuring Long-Term Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 455 Present Value and Future Value Concepts . . . . . . . . . . . . . . . . . . 455 Computing the Present Value of an Annuity . . . . . . . . . . . . . . . . 459 Accounting for Long-Term Liabilities. . . . . . . . . . . . . . . . . . . . . . . . 461 Interest-Bearing Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 462 Mortgages Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 463 Accounting for Lease Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . 465 Operating Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467 The Nature of Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468 Types of Bonds. . . . . . . . . . . . . . . . . . Characteristics of Bonds . . . . . . . . . . Determining a Bondâ&#x20AC;&#x2122;s Issuance Price Accounting for Bonds Payable Issued Bond Retirements before Maturity. . .

.. .. .. at ..

.......... .......... .......... Face Value . ..........

. . . . .

468 469 469 473 475

Using Debt-Related Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . 476 Debt Ratio and Debt-to-Equity Ratio . . . . . . . . . . . . . . . . . . . . . . 476 Times Interest Earned Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477

Contents

EXPANDED

material Bonds Issued at a Discount or at a Premium . . . . . . . . . . . . . . . . . . 478 Accounting for Bonds Issued at a Discount . . . . . . . . . . . . . . . . . 478 Accounting for Bonds Issued at a Premium . . . . . . . . . . . . . . . . 480 Effective-Interest Amortization. . . . . . . . . . . . . . . . . . . . . . . . . . . 481 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 11 EQUITY FINANCING. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513 Raising Equity Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 516 Difference between a Loan and an Investment . . . . . . . . . . . . . . 516 Proprietorships and Partnerships. . . . . . . . . . . . . . . . . . . . . . . . . 517 Corporations and Corporate Stock . . . . . . . . . . . . . . . . . . . . . . . . . 518 Characteristics of a Corporation Starting a Corporation . . . . . . . Common Stock . . . . . . . . . . . . . Preferred Stock . . . . . . . . . . . . .

. . . .

518 519 520 520

Accounting for Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 521 Issuance of Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 521 Accounting for Stock Repurchases . . . . . . . . . . . . . . . . . . . . . . . . 523 Balance Sheet Presentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525 Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 526 Cash Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 526 Dividend Payout Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 530 Other Equity Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 531 Equity Items That Bypass the Income Statement . . . . . . . . . . . . . 531 Statement of Stockholdersâ&#x20AC;&#x2122; Equity . . . . . . . . . . . . . . . . . . . . . . . . 533 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 534 12 INVESTMENTS IN DEBT AND EQUITY SECURITIES . . . . . . . . . . 559 Why Companies Invest in Other Companies . . . . . . . . . . . . . . . . . . 561 Classifying a Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 564 Held-to-Maturity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 565 Equity Method Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 565

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Trading and Available-for-Sale Securities. . . . . . . . . . . . . . . . . . . 566 Why the Different Classifications? . . . . . . . . . . . . . . . . . . . . . . . . 566 Accounting for Trading and Available-for-Sale Securities . . . . . . . . . . 568 Accounting for the Purchase of Securities . . . . . . . . . . . . . . . . . . 568 Accounting for the Return Earned on an Investment . . . . . . . . . 569 Accounting for the Sale of Securities . . . . . . . . . . . . . . . . . . . . . . 570 Accounting for Changes in the Value of Securities . . . . . . . . . . . . . . 571 Changes in the Value of Trading Securities . . . . . . . . . . . . . . . . . 571 Changes in the Value of Available-for-Sale Securities. . . . . . . . . . 571 Subsequent Changes in Value . . . . . . . . . . . . . . . . . . . . . . . . . . . 572 EXPANDED

material Accounting for Held-to-Maturity Securities . . . . . . . . . . . . . . . . . . . . 574 Accounting for the Initial Purchase . . . . . . . . . . . . . . Accounting for Bonds Purchased between Interest Dates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounting for the Amortization of Bond Discounts and Premiums. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounting for the Sale or Maturity of Bond Investments . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . 574 . . . . . . . . . 575 . . . . . . . . . 576 . . . . . . . . . 579

Accounting for Equity Investments Using the Equity Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 580 Illustrating the Equity Method . . . . . . . . . . . . . . . . . . . . . . . . . . . 581 Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . 582 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 585 Comprehensive Problem 9–12 . . . . . . . . . . . . . . . . . . . . . . . . 609

◗ PART FOUR

OT H E R D I M E N S I O N S O F F I N A N C I A L R E PORTI NG 611 13 THE STATEMENT OF CASH FLOWS. . . . . . . . . . . . . . . . . . . . . . . 613 What’s the Purpose of a Statement of Cash Flows?. . . . . . . . . . . . . . 615

Contents

What Information Is Reported in the Statement of Cash Flows? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 616 Major Classifications of Cash Flows. . . . . . . . . . . . . . . . . . . . . . . 616 Noncash Investing and Financing Activities . . . . . . . . . . . . . . . . 619 Cash Flow Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 619 Preparing a Statement of Cash Flowsâ&#x20AC;&#x201D;A Simple Example. . . . . . . . . 620 Analyzing the Other Primary Financial Statements to Prepare a Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . 623 A Six-Step Process for Preparing a Statement of Cash Flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625 An Illustration of the Six-Step Process . . . . . . . . . . . . . . . . . . . . . 626 Using Information from the Statement of Cash Flows to Make Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 635 End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 637 14 INTRODUCTION TO FINANCIAL STATEMENT ANALYSIS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 667 The Need for Financial Statement Analysis . . . . . . . . . . . . . . . . . . . 669 Widely Used Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 671 Debt Ratio . . . . . . . . Current Ratio . . . . . Return on Sales . . . . Asset Turnover. . . . . Return on Equity. . . Price-Earnings Ratio

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671 671 672 672 673 673

Common-Size Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . 676 DuPont Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 679 Profitability Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 680 Efficiency Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 680 Leverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 681 More Efficiency Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 682 Accounts Receivable Efficiency. . . . . . . . . . . . . . . . . . . . . . . . . . . 683 Inventory Efficiency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 683 Property, Plant, and Equipment Efficiency . . . . . . . . . . . . . . . . . 684

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More Leverage Ratios. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 685 Debt-to-Equity Ratio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 685 Times Interest Earned Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . 686 Cash Flow Ratios. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 686 Usefulness of Cash Flow Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . 687 Cash Flow to Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687 Cash Flow Adequacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 688 Potential Pitfalls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 689 Financial Statements Donâ&#x20AC;&#x2122;t Contain All Information Lack of Comparability . . . . . . . . . . . . . . . . . . . . . . . . Search for the Smoking Gun . . . . . . . . . . . . . . . . . . . Anchoring, Adjustment, and Timeliness. . . . . . . . . . .

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689 690 690 690

End-of-Chapter Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691

APPE N DICES A WAL-MART 2006 ANNUAL REPORT. . . . . . . . . . . . . . . . . . . . . . . . A-1 B GLOSSARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B-1 C CHECK FIGURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C-1

INDEXES SUBJECT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SI-1 REAL WORLD COMPANY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CI-1

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