PRINCIPLESOF A C C O U N T I N G

FOURTH EDITION Volume I 'A* Version Chapters 1-14

1 Belverd E. Needles, Jr. Ị PhlX, CP.A., C.M.A.

Arthur Andersen & Co. AJumni Distin cmished Professor oi Accoi DePaul University

Henry R. Anderson Ph.D., CP.A., CM.A. Professor of Accounting Director, School of Accounting University of Central Florida

James c, Caldwell Ph.D.. C P A Partner, Change Management Service Andersen Consulting Dallas/Fort Worth

GIFT FROM FEED THE CHILDREN

NOT FOR RESALE

Houghton Mifflin Company Boston

Dallas Geneva, Illinois Palo Alto PrinCQtoft* NÉ#4i

CONTENTS

Note: The topic of income tax is integrated throughout the book- It i t covered at those points where it is relevant to the discussion.

PART ONE The Basic Accounting Model

1 A c c o u n t i n g Ễl ấn Information System

Accounting Defined Accounting Information and Decision Making Decision Makers: The Users of Accounting Information

Management 6/ Users with Dừect Financial Interest 8/ Users with an ỉndứect Financial Interest 8

Financial and Management Accounting Generally Accepted Accounting Principles 10/ Organizations That Influence Current Practice 10

Accounting Measurement What Is to Be Measured? 12/ Business Transactions as the Object of Measurement 13 Money Measure 13/ The Concept of Separate Entity 13

Forms of Business Organization Sole Proprietorships 15/ Partnerships 15 Corporations 15

Financial Position and the Accounting Equation Assets 16/ Liabilities 16 Owner's Equity 17 Some Illustrative Transactions 18

Accounting Communication Through Financial Statements

The Income Statement 24' The Statement of Owner's Equity 24 The Balance Sheet 26/ The Statement of Cash Flows 26 Relationships Among the Four Statements 26

Professional Ethics and the Accounting Profession Management Accounting 28/ Public Accounting 29/ Government and Other Not-for-

Profit Accounting 32' Accounting Education 32 Chapter Review Chapter Assignments

Interpreting Accounting Information Merrill Lynch & Co. 44

Financial Decision Case Murphy Lawn Services Company 48

2 4

12

14

16

22

27

33 39

XI

xu Contents

59

2 The Double-Entry System S 1

Measurement Issues ^ The Recognition Issue 51/ The Valuation Issue 52/ The Classification Issue 53

53 Accounts

Types of Commonly Used Accounts 55/ Titles of Accounts 58

The Double-Entry System: The Basic Method of Accounting

The T Account 59/ The T Account Illustrated 60/ Analysis of Transactions 60/ Transaction Analysis Illustrated 62/ Summary of Transactions 67

Recording Transactions 68 The Journal 68/ The General Journal 68/ The Ledger Account Form 70/ Relationship Between the Journal and the Ledger 71

The Trial Balance 73 Some Notes on Presentation Techniques Chapter Review 75 Chapter Assignments 82

Interpreting Accounting Information First Chicago Corporation 88

Financial Decision Case Ruiz Repair Service Company 92

The following computer-assisted practice sets may be started after Chapter 2:

Parks Computer Company Matthew Sports Company Cooks Solar Energy Systems, Second Edition Sounds Abound

3 Business Income and Adjusting Entries 98

The Measurement of Business Income 98 Net Income 99/ The Accounting Period Issue 100/ The Continuity Issue 101/ The Matching Issue 102/ Accrual Accounting 102

The Adjustment Process 103 Apportioning Recorded Expenses Between Two or More Accounting Periods (Deferrals) 105/ Apportioning Recorded Revenues Between Two or More Accounting Periods (Deferrals) 109/ Unrecorded or Accrued Revenues 110/ Unrecorded or Accrued Expenses 111/ Using the Adjusted Trial Balance to Prepare Financial Statements 112

The Importance of Adjustments in Accounting 113 Correcting Errors 115

Con t

A Note About Journa! Entries Chapter Review Chapter Assignments

Walt Disney Produd|Ịp^ỆỊP Financial I >ei ^^h^ỆSÊ

Lockyer Systems Company 135

116 116 125

4 Completing the Accounting Cycle Overview of the Accounting System The Work Sheet: A Tool of Accountants Steps in Preparing the Work Sheet Uses of the Work Sheet

Preparing the Financial Statements 151/ Recording the Adjusting Entries 153/ Recording the Closing Entries 153

Required Closing Entries Closing the Credit Balances from Income Statement Accounts to the Income Summary 155 Closing the Debit Balances from Income Statement Accounts to the Income Summary 156/ Closing the Income Summary Account to the Capital Account 157/ Closing the Withdrawals Account to the Capital Account 158/ The Accounts After Closing 159

The Post-Closing Trial Balance Reversing Entries: Optional First Step of the Next Accounting Period Chapter Review Chapter Assignments

Interpreting Accounting Information City of Chicago 172

Financial Decision Case Donna's Quik-Type 178

Comprehensive Problem: Joan Mil ler Advertising Agency

142

142 143 144 151

155

159

159 164 167

CPA

PART T W O Extensions of the Basic Accounting Model

4

5 Accounting for Merchandising Operations

Income Statement for a Merchandising Concern Revenue from Sales

Gross Sales 188/ Trade Discounts 189/ Sales Returns and Allowances 189/ Sales Discounts 189

Cost of Goods Sold „ u—«» repurchases 192/ Control o purchases Discounts Using t ^ ^ ^ H i l l H

186

186 188

191

Merchandise Inventory 196/ Inventory Losses 198

Operating Expenses Handling Merchandise Inventory at the End of the Accounting Period Work Sheet for a Merchandising Concern

The Adjusting Entry Method 202/ The Closing Entry Method 204

Income Statement Illustrated Chapter Review Chapter Assignments

Interpreting Accounting Information Sears vs. K mart 222

Financial Decision Case Jefferson Jeans Company 227

6 Accounting Systems and Special-Purpose Journals

Accounting Systems Installation Principles of Systems Design

Cost-Benefit Principle 234/ Control Principle 235/ Compatibility Principle 235/ Flexibility Principle 235

Data Processing: Three Perspectives Computer Data Processing

Elements of a Computer System 237/ Mainframe Accounting Systems 239/ Microcomputer Accounting Systems 239

Manual Data Processing: Journals and Procedures Sales Journal 242/ Purchases Journal 247/ Cash Receipts Journal 249/ Cash Payments Journal 253/ General Journal 255/ Flexibility of Special-Purpose Journals 256

Chapter Review Chapter Assignments

Interpreting Accounting Information B. Dalton and Waldenbooks 267

Financial Decision Case Buy-Rite Foods Company 272

The following practice set may be used after Chapter 6:

Micro-Tec Practice Set, Third Edition Comprehensive Problem: Fenwick Fashions

Internal Control and Merchandising Transactions

Contents XV

Internal Control structure: Basic Elements and Procedures .SflSI!

Internal Control Defined 280/ Limitations of Internal Control 281 -..

Internal Control Over Merchandising Transactions 282 Control of Cash Sa le*pfc%i* 2IH/ Control oi Purchases and Cash Disbursements 285

Banking Transactions 290 Bank Account 290/ Deposits 291/ Bank Statement 291/ Preparing a Bank Reconciliation 292

Petty Cash Procedures 296 Establishing the Petty Cash Fund 297/ Making Disbursements from the Petty Cash Fund 297/ Reimbursing the Petty Cash Fund 297

The Voucher System 298 Vouchers 299/ Voucher Checks 299/ Voucher Register 299/ Check Register 301/ Operation of a Voucher System 301

Chapter Review 305 Chapter Assignments 312

Interpreting Accounting Information J. Walter Thompson 316

Financial Decision Case Gabhart's 321

8 Accounting Concepts and Classified Financial Statements 327

Objectives of Financial Information 327 Qualitative Characteristics of Accounting Information 329 Conventions to Aid Interpretation of Financial Information

Comparability and Consistency 331/ Materiality 332/ Conservatism 332/ Full Disclosure 333/ Cost-Benefit 333

Financial Accounting Concepts and Ethical Reporting 334

Summary of Financial Accounting Concepts 334/ Ethics and Financial Reporting 336

Classified Balance Sheet Assets 337/ Liabilities 341/ Owner's Equity 341

Forms of the Income Statements Other Financial Statements Using Classified Financial Statements

Evaluation of Liquidity 346/ Evaluation of Profitability 347

337

342 345 346

XV í Contents

The Annual Report of a Major Corporation Letter to the Stockholders 350/ Financial Highlights (Figure 8-4) 351/ Statements of Consolidated Earnings (Figure 8-5) 351/ Consolidated Balance Sheets (Figure 8-6) 353/ The Statement of Consolidated Stockholders' Equity 355/ The Statement of Consolidated Cash Flows (Figure 8-7) 355/ Notes to Consolidated Financial Statements 357/ Report of Management's Responsibilities 359/ Management's Discussion and Analysis 359/ Report of Certified Public Accountants (Figure 8-8) 360

Chapter Review Chapter Assignments

Interpreting Accounting Information Toys " R " U s , Inc. 373

Financial Decision Case Josephina Tapestries Company 377

350

361 368

P A R T T H R E E Measuring and Reporting Assets and Current Liabili t ies

9 Short-Term L i q u i d Assets

Accounting for Cash and Short-Term Investments Accounting for Accounts Receivable

Credit Policies and Uncollectible Accounts 387/ Matching Losses on Uncollectible Accounts with Sales 388/ Estimating Uncollectible Accounts Expense 389/ Writing Off an Uncollectible Account 394/ Other Issues Related to Receivables 395

Accounting for Notes Receivable Computations for Promissory Notes 398/ Illustrative Accounting Entries 402

Chapter Review Chapter Assignments

Interpreting Accounting Information Winton Sharrer Co. 415

Financial Decision Case Golina Christmas Tree Company 419

384

384 387

397

405 411

10 Inventories

Inventories and Income Determination Review of Gross Margin and Cost of Goods Sold Computations 425/ Effects of Errors in Inventory Measurement 425

Inventory Measurement Merchandise in Transit 429/ Merchandise on Hand Not Included in Inventory 429

424

424

428

Contents

Pricing the Inventory at Cost Cost Defined 429/ Methods of Pricing Inventory at Cost 430/ Comparison and Effects of the Alternative Methods of Pricing Inventory 433

Application of the Perpetual Inventory System Handling the Perpetual Inventory System in the Accounting Recor<^4§SV Maintaining the Detailed Perp^pi inventory Records 438/ Need for Physical Inventories Under the Perpetual Inventory System 439

Valuing the Inventory at the Lower of Cost or Market (LCM)

Methods of Applying LCM 440 Valuing Inventory by Estimation

Retail Method of Inventory Estimation 441/ Gross Profit Method of Inventory Estimation 442

Chapter Review Chapter Assignments

Interpreting Accounting Information General Motors 453

Financial Decision Case RTS Company 456

11 Current Liabilities and Payroll Accounting Nature and Measurement of Liabilities

Recognition of Liabilities 460/ Valuation of Liabilities 461/ Classification of Liabilities 461/ Disclosure of Liabilities 461

Common Categories of Current Liabilities Definitely Determinable Liabilities 462/ Estimated Liabilities 466

Contingent Liabilities Introduction to Payroll Accounting

Liabilities for Employee Compensation 471/ Liabilities for Employee Payroll Withholdings 472

Computation of an Employee's Take-Home Pay: An Illustration

Liabilities for Employer Payroll Taxes 476/ Payment of Payroll and Payroll Taxes 477

Chapter Review Chapter Assignments

Interpreting Accounting Information Texaco, Inc. 486

Financial Decision Case Highland Television Repair 489

The following practice set may be used after Chapter 11:

College Words and Sounds Store, Third Edition

• • * XVI l i Contents

12 Long-Term Assets: Acquisition and Depreciation 9̂3

Long-Term Assets life of Long-Term Assets 494/ Types of Long-Term Assets 494/ Issues of Accounting for Long-Term Assets 495

Acquisition Cost of Property, Plant, and Equipment ffp

Land 496/ Land Improvements 497/ Buildings 497/ Equipment 497/ Group Purchases 497

Accounting for Depreciation 498 Factors That Affect the Computation of Depreciation 499

Methods of Computing Depreciation 500 Straight-Line Method 500/ Production Method 500/ Accelerated Methods 501/ Comparing the Four Methods 503

Special Problems of Depreciating Plant Assets 504 Depreciation for Partial Years 505/ Revision of Depreciation Rates 506/ Accounting for Assets of Low Unit Cost 507/ Group Depreciation 508/ Cost Recovery for Federal Tax Purposes 508

Control of Plant Assets 511 Chapter Review 513 Chapter Assignments 518

Interpreting Accounting Information Inland Steel 521

Financial Decision Case Hyde Computer Company 526

13 Long-Term Assets: Other Issues and Types 530

Capital Expenditures and Revenue Expenditures 530 Disposal of Depreciable Assets 532

Assumptions for the Comprehensive Illustration 532/ Depreciation for Partial Year Prior to Disposal 533/ Recording Discarded Plant Assets 533/ Recording Plant Assets Sold for Cash 534/ Recording Exchanges of Plant Assets 534

Contents xix

Accounting for Natural Resources Depletion 53Ểt^epreciatiàtt jôf Closely Related Plant Assets 539/ Development and Exploration Costs in the Oil and Gas Industry 539

Accounting for Intangible Assets Research and Development Costs 541/ Goodwill 543/ Computer Software Costs 545

Chapter Review Chapter Assignments

Interpreting Accounting Information Ocean Drilling and Exploration Company (ODECO) 555

Financial Decision Case Conway Enterprises 559

538

540

545 552

PART FOUR Accounting for Partnerships and Corporations

14 Accounting for Partnerships Partnership Characteristics

Voluntary Association 566/ Partnership Agreement 566/ Limited Life 567/ Mutual Agency 567/ Unlimited Liability 567/ Co-ownership of Partnership Property 568/ Participation in Partnership Income 568/ Summary of the Advantages and Disadvantages of Partnerships 568

Accounting for Partners' Equity Distribution of Partnership Income and Losses

Stated Ratio 570/ Capital Investment Ratio 571/ Salaries, Interest, and Stated Ratio 573

Dissolution of a Partnership Admission of a New Partner 576/ Withdrawal of a Partner 580/ Death of a Partner 582

Liquidation of a Partnership Gain on Sale of Assets 584/ Loss on Sale of Assets 585

Chapter Review Chapter Assignments

Interpreting Accounting Information Burlington Clinic 597

Financial Decision Case Perfect Fitness Center 601

566

566

568 570

576

583

588 594

XX Contents

Appendix A The Time Value of Money

Simple Interest and Compound Interest Future ^^ỆPệỊẶ^ÍỈ^ Invested Sum at Compound Interest A-2/ Future Value of an Ordinary Annuity A-3

Present Value Present Value of a Single Sum Due in the Future A-5/ Present Value of an Ordinary Annuity A-6

Time Periods Applications of Present Value to Accounting

Imputing Interest on Noninterest-Bearing Notes A-8/ Valuing an Asset A-9/ Other Accounting Applications A-10

Exercises

Appendix B Future Value and Present Value Tables

Appendix c Overview of Income Taxes for Individuals

Some Basic Concepts Related to Federal Income Taxes

Taxable Income and Accounting Income C-2/ Tax Planning and Tax Evasion C-2/ Cash Basis and Accrual Basis C-2/ Classifications of Taxpayers C-3

Income Tax for Individuals Gross Income C-4/ Deductions from Gross Income C-4/ Deductions from Adjusted Gross Income C-4/ Computing Tax Liability C-5/ Capital Gains and Losses C-5/ Credit Against the Tax Liability C-7/ Withholding and Estimated Tax C-7

Discussion Questions and Writing Assignments Exercise C-l

Appendix D Overview of Governmental and Not-for-Profit Accounting

Governmental, Not-for-Profit, and Business Accounting

Financial Reporting Objectives of Governmental Units D-1/ Modified Accrual Accounting D-3/ Financial Reporting System D-5

Contents xxi

Not-for-Profit Organizations Colleges and universities D-6/ Hospitals D-7/ Voluntary Health and Welfare Organizations D-7

Summary D_9 Discussion Questions and Writing Assignments D-10 Exercises D-10 Problem D-ll

Appendix E The Just-in-Time Philosophy E-l Computer-Integrated Manufacturing Systems E-l The Just-in-Time Philosophy Defined E-2 Traditional Versus JIT Factory Layout E-3

The Traditional Manufacturing Environment E-3/ The JIT Production Environment E-6/ JIT: Capital Intensive Versus Labor Intensive Manufacturing E-8

Elements Supporting the JIT Philosophy E-9 Maintain Minimum Inventory Levels E-9/ Develop Pull-Through Production Planning and Scheduling Procedures E-10/ Purchase Materials and Produce Products as Needed in Smaller Lot Sizes E-10/ Perform Simple, Inexpensive Machine Setups E-10/ Develop a Multiskilled Work Force E-10/ Create a Flexible Manufacturing System E-10/ Maintain High Levels of Product Quality E-11/ Enforce a System of Effective Preventive Facility Maintenance E-11/ Encourage Continuous Work Environment Improvement E - l l

Product Costing in a JIT Environment E-12 JIT's Influence on Product Costing E-12/ New Cost Drivers E-14/ Standard Costs E-15/ Direct Versus Indirect Costs E-15/ The IBM Approach E-16

The Raw-in-Process Inventory Account JIT and Process Costing E " 1 8

Illustrative Problem: JIT/Process Costing E-18/ Solution E-19

Discussion Questions and Writing Assignments Exercises Problems

E-22 E-24

Glossary G " *

Index l-l