accounting assignment

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ACCT 311:1 – FALL 2015 ASSIGNMENT 3 - INTERNATIONAL FINANCIAL REPORTING & ETHICS ISSUES [72 POINTS] The assignment is based on the material covered in chapters 2, 4,5, 7, 9, 11 and 12 of the course text – th Intermediate Accounting (15 Ed.), Kieso, Weygandt and Warfield. You may also find useful resources to address the requirements of Part A of this assignment on the IASB’s website, especially in its conceptual framework document. Part B of this assignment focuses on understanding and applying the AICPA Code of Professional Conduct (Especially Part 2). Information about accessing the Code is available at the course Canvas site https://svsu.instructure.com/courses/4151 . GENERAL GUIDELINES 1. Your responses MUST be presented in memorandum format. (Negative grading of up to 4 points is applicable if the memo format is not properly used.) 2. The memo should be written in clear language from the perspective of a staff accountant writing to her/his manager. 3. The memo should not exceed 10, double line spaced, 12-point font, type written pages (8 1/2” x 11”) in length. 4. Do NOT use note book pages or other sizes of paper. 5. You may use bullets, tables or other appropriate mechanisms to present your responses. 6. You are required to work independently on this assignment. While you may discuss the assignment with your peers, the work submitted for grading must be that of the student whose name and ID number appears on the assignment ONLY. ASSIGNMENT REQUIREMENTS PART A – INTERNATIONAL FINANCIAL ACCOUNTING & REPORTING ISSUES (30 Points) 1 1. Review the details of Pinafore Holding B.V. Group Consolidated Income Statement presented on page 83 in the attached annual report. Then answer questions 1(a) – (c) below. a) Identify ONE difference between the format / structure of the Pinafore Holding B.V. Group, iGAAP-based income statement and the US-GAAP-based income statement of a U.S. company as presented in Chapter 4 of the text book, for example those presented on pages 165 and 172. (1 Points) b) Identify ONE irregular item reported by the Pinafore Holding B.V. Group. (1 Points) 2. Review the IASB’s Conceptual Framework for the Preparation and Presentation of Financial Statements (2010) (available at the following link), then describe the other means that are available for communicating financial reporting information, besides financial statements? (2 Points) 3. Review the iGAAP-based Balance Sheet of Pinafore Holdings B.V. Group presented on page 86 of the attached annual report (available at the following link) identify TWO differences between the structure / format of the iGAAPbased balance sheet of this British firm and that prepared by USGAAP-based firms, as shown in chapter 5 of the course text, for example on pages 213 and 237. (2 Points) 4. Review the information for Liberty International and Kimco Realty presented on pages 645/6 of the course text. Then answer question 4(a) – (d) below. (a) Compute the following ratios for both companies: i. ii. iii. iv. Return on assets [ Net Income / Average Total Assets] (2 Point) Profit margin on sales [Net Income / Total Revenue] (2 Point) Asset turnover [Total Revenue / Average Total Asset] (2 Point) How do the companies compare on these three performance measures? (2 Points) (b) Liberty reports a revaluation surplus (see pages 641 – 643 in the course text) of £1,952. Assume that £1,550 of this amount arose from an increase in the net replacement value of investment properties during the year. Prepare the journal entry to record this (£1,550) increase. (2 Points) (c) Under the UK (and IASB) standards, are Liberty’s assets and equity overstated relative to what they would be under US-GAAP? If so, why? (2 Point) (d) When comparing Liberty to US companies, like Kimco, what adjustments would you need to make in order to have valid comparisons of ratios such as those computed in 4(a) above? (2 Point) 2 5. Review the IFRS Insights section of Chapter 9 on pages 525 – 534 in the course text. Then briefly describe TWO differences between US-GAAP and iGAAP in the methods allowed for inventory valuation. (4 Points) 6. Review the following information related to NEC Enterprises. Then complete question 6(a) and (b) below. NEC Enterprises uses the lower-of-cost-or-net-realizable-value (LCNRV) method, on an individualitem basis, in pricing its inventory items. The inventory at 31, December 2013, consisted of products A, B, and C. Relevant data for these products appear below. Estimated selling price Acquisition cost Replacement cost Cost to complete Selling costs Normal profit margin Item A Item B $120 $90 75 80 78 33 30 10 10 20 10 5 Item C $90 36 32 30 20 5 (a) Using the LCNRV rule under IFRS, determine the proper unit value for statement of financial position (balance sheet) purposes at December 31, 2013, for each of the items above. (3 Points) (b) Using the LCM rule under US GAAP, determine the proper unit value for statement of financial position (balance sheet) purposes at December 31, 2013, for each of the items above. (3 Points) PART B – PROFESSIONAL RESPONSIBILITY & ETHICS ISSUES (42 Points) Unique Design Concepts (UDC) was a private company that manufactured office, school and restaurant furniture in the English-speaking Caribbean. The company began its operations in 1984 and quickly attained a leadership position in the industry as a direct result of its high quality products and its aggressive sales and credit policies. UDC manufactures an indigenous line of furniture as well as a leading international brand of ergonomic chairs – Glove - under license from an Austrian firm. All UDC’s products met or exceeded international standards. The Company’s sales team was engineered for efficiency and growth, and consistently delivered double-digit sales growth through its export activities in the Caribbean and Central America. Export sales accounted for forty-five percent (45%) of overall sales. The company utilized a generous credit policy and offered attractive discounts for prompt payment by customers. Its rapid growth had placed a considerable strain on the administrative resources of UDC. As a result, UDC had recently employed several persons at the middle management level to help relieve this administrative strain. 3 Your friend, Tom De Gazon, a CPA, was one of the persons recently hired by UDC. He was appointed to the newly created position of Supervisor – Revenue Accounting. His contract provided for a probationary period of three months before his appointment was confirmed. As part of his orientation, Tom was given a copy of the company’s chart of accounts, its accounting manual and “read-only” access to the accounting system. While reviewing the general ledger, Tom noticed a debit entry of $500,000 to WIP Inventory two days before the end of the third quarter and an off-setting credit entry to the same account a few weeks later, on November 7th for the same amount. The entries aroused Tom’s interest and he decided to review the journal and supporting documents. The full journal entry follows: Date Account Title & Explanation Dr. Cr. 9-29-14 WIP Inventory $500,000 Administrative Expenses $500,000 To reclassify production costs The entry on November 7th was a reversal of the above entry and Tom found no supporting documents for either entry. While having lunch with the Chief Accountant, Darcelle Mark, Tom asked whether she was aware of the third quarter adjusting entry that reclassified a substantial amount of administrative expenses as inventory. Mark indicated that she was aware of the entry, and explained that it was made based on the company’s experience during the 2013 audit. During their examination of the company’s 2013 records the auditors had discovered that several items were misclassified and required a similar journal entry in order for the firm to receive a clean report. The company complied with the auditors adjustments at that time. Mark also indicated that it was her understanding that UDC also decided to make a similar adjustment for 2014 as the control flaws that led to the 2013 errors had not been corrected. Tom asked Mark about the criteria used for estimating the amount of the adjustment and whether similar adjustments had been made in the first or second quarter of 2014. Mark casually responded that she assumed the CFO (Hayden LaCroix) had used his professional judgment since he had given the directive for the third quarter entry to be made, and that she was not sure whether similar entries were made for the first two quarters of 2014. Mark seemed surprised when Tom told her that the entry was subsequently reversed in November 2014 and suggested that he speak with the CFO about it. Tom casually raised the matter with the CFO following a weekly departmental meeting and was told it was "not a big deal" and he should be concentrating on activities in his core area of responsibility. Tom conducted some additional investigations and discovered that the company would not have met its third quarter income target without the September 29 th adjusting entry. When Tom attempted to share this latest information with the CFO he was reminded that he was still on probation and advised to be more strategic about the issues he pursues. Tom asked for your advice. REQUIREMENTS 1. What facts in this scenario are relevant to Tom De Gazon's ability to comply with the provisions of the AICPA Code of Professional Conduct? (3 Points) 4 2. What questions must Tom De Gazon answer as he determines the appropriateness of the company's accounting related to the reclassification of its administrative expenses as assets and the responses of the CFO to his questions? (5 Points) 3. Identify and briefly describe the specific principles of the AICPA Code of Professional Conduct that might be relevant to Tom De Gazon's resolution of this situation. (6 Points) 4. Explain why you think any TWO of the principles you identified in requirements 3 above are relevant to Tom De Gazon’s resolution of the situation. (4 Points) 5. Identify TWO types of threats to compliance with the AICPA Code of Professional Conduct (e.g., adverse interest, advocacy, familiarity, self-interest, self-review, undue influence) that are present in this scenario. Use information from the case to support your choice. (4 Points) 6. How significant is each type of threat you identified to compliance with the principle(s)? (2 Points) 7. For each type of threat to Tom's compliance with the requirements of the AICPA Code of Professional Conduct that you identified in requirement 5 above, indicate ONE safeguard that might be implemented to reduce the threat to an acceptable level. (2 Points) 8. Identify at least THREE parties / stakeholders that should be involved in the resolution of this situation, and explain why you think each of these parties should be involved in the resolution of this situation. (6 Points) 9. Outline an approach (series of steps) that Tom De Gazon might take to resolve this situation in conformity with the AICPA Code of Professional Conduct. (10 Points) Supporting Materials • iasb conceptual framework.pdf • • annual results pinafore holdings bv group - dec 2013.pdf http://pub.aicpa.org/codeofconduct/Ethics.aspx (链接到外部网站。) (AICPA Code of Professional Conduct) • http://www.ifrs.org/Pages/default.aspx (链接到外部网站。) (IASB Website) 5 Key learning aids to help you master the textbook material and prepare you for a successful career. CHAPTER PREVIEW The Chapter Preview summarizes the major issues discussed in the chapter, and provides students with a visual outline of the key topics. c12IntangibleAssets.indd Page 651 28/12/12 3:00 PM f-392 As our opening story indicates, sustainability strategies are taking on increased importance for companies like Southwest Airlines and Clorox. Reporting challenges for effective sustainability investments are similar to those for intangible assets. In this chapter, we explain the basic conceptual and reporting issues related to intangible assets. The content and organization of the chapter are as follows. PREVIEW OF CHAPTER Intangible Assets ~/Desktop/Nalini%2028.12/ch12 Intangible Asset Issues • Characteristics • Valuation • Amortization UNDERLYING CONCEPTS The Underlying Concepts highlight and explain major conceptual topics in the chapter. WHAT DO THE NUMBERS MEAN? The “What do the numbers mean?” boxes further students’ understanding of key concepts with practical, real-world examples. 12 Types of Intangibles Impairment of Intangibles • Marketing-related • Customer-related • Artistic-related • Contract-related • Technology-related • Goodwill • Limited-life intangibles • Indefinite-life intangibles other than goodwill • Goodwill • Summary Presentation of Intangibles and Related Items Research and Development Costs • Identifying R&D • Accounting for R&D • Similar costs • Intangible assets • R&D costs Underlying Concepts The controversy surrounding the accounting for R&D expenditures reflects a debate about whether such expenditures meet the 1/8/13 def- 10:39 AM f-535 c12IntangibleAssets.indd Page 653 inition of an asset. If so, then an “expense all R&D costs” policy c12IntangibleAssets.indd Page 666 02/01/13 7:52 PM f-391 results in overstated expenses and understated assets. What do the numbers mean? /Users/f-535/Desktop/Praveen/9654969236 /208/WB00806/XXXXXX DEFINITELY INDEFINITE The importance of intangible asset classification as either limited-life or indefinite-life is illustrated in the experience of Outdoor Channel Holdings. Here’s what happened. Outdoor Channel recorded an intangible asset related to the value of an important distributor relationship, purchased from another company. At that time, it classified the relationship as indefinite-life. Thus, in the first two years of the asset’s life, Outdoor Channel recorded no amortization expense on this asset. In the third year, investors were surprised to find that Outdoor Channel changed the classification of the distributor relationship to limited-life, with an expected life of 21.33 years (a fairly definite useful life) and, shortly thereafter, wrote off this intangible completely. Apparently, the company was overly optimistic about the expected future cash flows arising from the distributor relationship. As a result of that optimism, income in the second year was overstated by $9.5 million, or 14 percent, and the impairment recorded in the third year amounted to 7 percent of assets. From indefinite-life to limited-life to worthless in two short years—investors were surely hurt by Outdoor’s aggressive intangible asset classification. Source: Jack Ciesielski, The AAO Weblog, www.accountingobserver.com/blog/ (January 12, 2007). INTERNATIONAL PERSPECTIVE International Perspectives provide students with specific examples of how global companies (and other countries) implement key accounting regulations. They also provide examples of how and where IFRS differs from GAAP. EVOLVING ISSUE The Evolving Issue feature introduces and discusses a current topic in the accounting industry in which the profession may be encountering controversy or nearing resolution. The feature shows how the key standard-setting organizations make decisions to adjust to the changing global business environment. International Perspective IFRS requires the capitalization of appropriate development expenditures. This conflicts with GAAP. c12IntangibleAssets.indd Page 673 1/8/13 9:32 AM f-535 Evolving Issue /Users/f-535/Desktop/Praveen/965496 RECOGNITION OF R&D AND INTERNALLY GENER The requirement that companies expense immediately all R&D costs (as well as start-up costs) incurred internally is a practical solution. It ensures consistency in practice and uniformity among companies. But the practice of immediately writing off expenditures made in the expectation of benefiting future periods is conceptually incorrect. Proponents of immediate expensing contend that from an income statement standpoint, long-run application of this standard frequently makes little difference. They argue that because of the ongoing nature of most companies’ R&D activities, the amount of R&D cost charged to expense each accounting period is about the same, whether there is immediate expensing or capitalization and subsequent amortization. Others criticize this practice. They believe that the balance showed a significant relati subsequent benefits in th earnings, and shareholder v Another study found that earnings usefulness for com from capitalizing to exp decline appears to persist The current accountin generated intangible ass trade-offs made among r and cost-benefit consider completed some limitedfor intangible assets, and joint project on the accou c12IntangibleAssets.indd Page 675 28/12/12 3:00 PM f-392 ~/Desktop/Nalini%2028.12/ch12 c12IntangibleAssets.indd Page 676 28/12/12 3:00 PM f-392 ~/Desktop/Nalini%2028.12/ch12 D E M O N S T R AT I O N P R O B L E M Sky Co., organized in 2014, provided you with the following information. 1. Purchased a license for $20,000 on July 1, 2014. The license gives Sky exclusive rights to sell its services in the tri-state region and will expire on July 1, 2022. 2. Purchased a patent on January 2, 2015, for $40,000. It is estimated to have a 5-year life. 3. Costs incurred to develop an exclusive Internet connection process as of June 1, 2015, were $45,000. The process has an indefinite life. 4. On April 1, 2015, Sky Co. purchased a small circuit board manufacturer for $350,000. Goodwill recorded in the transaction was $90,000. 5. On July 1, 2015, legal fees for successful defense of the patent purchased on January 2, 2015, were $11,400. 6. Research and development costs incurred as of September 1, 2015, were $75,000. DEMONSTRATION PROBLEM Instructions (a) Prepare the journal entries to record all the entries related to the patent during 2015. (b) At December 31, 2015, an impairment test is performed on the license purchased in 2014. It is estimated that the net cash flows to be received from the license will be $13,000, and its fair value is $7,000. Compute the amount of impairment, if any, to be recorded on December 31, 2015. (c) What is the amount to be reported for intangible assets on the balance sheet at December 31, 2014? At December 31, 2015? The Demonstration Problem provides a model for how to solve end-of-chapter material. FASB CODIFICATION FASB CODIFICATION The FASB Codification refers students to the relevant FASB literature for the key concepts presented in each chapter. FASB Codification References [1] FASB ASC 350-10-05. [Predecessor literature: “Goodwill and Other Intangible Assets,” Statement of Financial Accounting Standards No. 142 (Norwalk, Conn.: FASB, 2001).] [2] FASB ASC 350-30-35. [Predecessor literature: “Goodwill and Other Intangible Assets,” Statement of Financial Accounting Standards No. 142 (Norwalk, Conn.: FASB, 2001), par. 11.] [3] FASB ASC 805-10. [Predecessor literature: “Business Combinations,” Statement of Financial Accounting Standards No. 141R (Norwalk, Conn.: FASB, 2007).] c12IntangibleAssets.indd Page 690 28/12/12 3:00 PM f-392 ~/Desktop/Nalini%2028.12/ch12 [4] FASB ASC 350-30-35. [Predecessor literature: “Goodwill and Other Intangible Assets,” Statement of Financial Accounting Standards No. 142 (Norwalk, Conn.: FASB, 2001), par. B55.] [5] FASB ASC 805-10-20. [Predecessor literature: “Business Combinations,” Statement of Financial Accounting Standards No. 141R (Norwalk, Conn.: FASB, 2007).] c12IntangibleAssets.indd Page 688 28/12/12 3:00 PM f-392 USING YOUR JUDGMENT The Using Your Judgment section provides students with real-world homework problems covering topics such as financial reporting, financial statement analysis, and professional research. USING YOUR JUDGMENT FINANCIAL REPORTING Financial Reporting Problem The Procter & Gamble Company (P&G) The financial statements of P&G are presented in Appendix 5B. The company’s complete annual report, including the notes to the financial statements, can be accessed at the book’s companion website, www.wiley.com/college/kieso. Instructions Refer to P&G’s financial statements and the accompanying notes to answer the following questions. (a) Does P&G report any intangible assets, especially goodwill, in its 2011 financial statements and accompanying notes? (b) How much research and development (R&D) cost was expensed by P&G in 2010 and 2011? What percentage of sales revenue and net income did P&G spend on R&D in 2010 and 2011? PROBLEMS SET B In addition to the B Set of Exercises, we now provide an additional set of problems for each chapter, based on the problems in the textbook. The B Set of Problems are available in WileyPLUS and on the book’s companion website, at www.wiley.com/college/kieso. IFRS INSIGHTS IFRS Insights offer students a detailed discussion as well as assessment material of international accounting standards at the end of each chapter. ~/Desktop/Nalini%2028.12/ch12 PROBLEMS SET B See the book’s companion website, at www.wiley.com/college/kieso, for an additional set of problems. c12IntangibleAssets.indd Page 693 28/12/12 3:00 PM f-392 IFRS INSIGHTS There are some significant differences between IFRS and GAAP in the accounting for both intangible assets and impairments. IFRS related to intangible assets is presented in IAS 38 (“Intangible Assets”). IFRS related to impairments is found in IAS 36 (“Impairment of Assets”). ~/Desktop/Nalini%2028.12/ch12 CPA Exam Readiness How Would You Score If You Took the CPA Exam Today? Before you can call yourself a CPA, you’ll have to pass one of the toughest licensure exams in any profession. To help you get a sense of what the exam is like and see where you stand, we’ve created a quick assessment consisting of actual exam questions from Wiley’s industry-leading CPAexcel Review Course software. Find out what it’s like to face off against real exam questions and see how you would fare if you took the real exam today. Visit CPAexcel.com/Kieso to start your quick assessment today. CPA Exam Support Site for Kieso Adopters Intermediate Accounting is a course that is a bridge to the profession. Throughout the course, you will be learning key concepts that you will be tested on if you choose to sit for the CPA exam. To help you understand how the concepts you are learning will be presented in the actual exam environment as well as learn more about the exam, please visit CPAexcel.com/Kieso. Donald E. Kieso PhD, CPA Northern Illinois University DeKalb, Illinois Jerry J. Weygandt PhD, CPA University of Wisconsin—Madison Madison, Wisconsin Terry D. Warfield, PhD University of Wisconsin—Madison Madison, Wisconsin Dedicated to our wives, Donna, Enid, and Mary, for their love, support, and encouragement Vice President & Executive Publisher Associate Publisher Senior Acquisitions Editor Content Editor Senior Development Editor Development Editor Editorial Operations Manager Senior Content Manager Senior Production Editor Associate Director of Marketing Marketing Manager Senior Product Designer Product Designer Senior Designer Designer Production Management Services Creative Director Senior Photo Editor Senior Editorial Assistant Cover Photo Chapter Opener Photo Cover Credit George Hoffman Christopher DeJohn Michael McDonald Brian Kamins Terry Ann Tatro Margaret Thompson Yana Mermel Dorothy Sinclair Valerie Vargas Amy Scholz Jesse Cruz Allie K. Morris Greg Chaput Maureen Eide Kristine Carney Ingrao Associates Harry Nolan Mary Ann Price Jackie MacKenzie JB Broccard/Getty Images, Inc. JB Broccard/Getty Images, Inc. 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This book contains quotations fr om Accounting Research Bulletins, Accounting Principles Boar d Opinions, Accounting Principles Board Statements, Accounting Interpr etations, and Accounting Terminology Bulletins, copyright © 1953, 1956, 1966, 1968, 1969, 1970, 1971, 1972, 1973, 1974, 1975, 1976, 1977, 1978, 1979, 1980, 1981, 1982 by the A merican Institute of Certified Public Accountants, Inc., 1211 A venue of the Americas, New Y ork, NY 10036. This book contains citations fr om various FASB pronouncements. Copyright © by Financial Accounting Standar ds Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856 U.S.A. Reprinted with permission. Copies of complete documents ar e available from Financial Accounting Standar ds Board. Material from the Certificate in Management Accounting Examinations, copyright © 1975, 1976, 1977, 1978, 1979, 1980, 1981, 1982, 1983, 1984, 1985, 1986, 1987, 1988, 1989, 1990, 1991, 1992, and 1993 by the Institute of Certified Management Accountants, 10 Paragon Drive, Montvale, NJ 07645, is adapt ed with permission. Material from the Certified Internal Auditor Examinations, copyright © May 1984, November 1984, May 1986 by The Institute of Inter nal Auditors, 249 Maitland A ve., Altemonte Springs, FL 32701, is adapted with per mission. The financial statements and accompanying notes r eprinted from the 2011 Annual Report of Pr octer & Gamble Company ar e courtesy of P&G, copyright © 2011, all rights r eserved. ISBN-13 978-1-118-98531-1 BRV ISBN-13 978-1-118-93878-2 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 Brief Contents 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Financial Accounting and Accounting Standards 2 Conceptual Framework for Financial Reporting 42 The Accounting Information System 82 Income Statement and Related Information 158 Balance Sheet and Statement of Cash Flows 212 Accounting and the Time Value of Money 286 Cash and Receivables 344 Valuation of Inventories: A Cost-Basis Approach 414 Inventories: Additional Valuation Issues 472 Acquisition and Disposition of Property, Plant, and Equipment 536 Depreciation, Impairments, and Depletion 588 Intangible Assets 648 Current Liabilities and Contingencies 700 Long-Term Liabilities 762 Stockholders’ Equity 820 Dilutive Securities and Earnings per Share 882 Investments 950 Revenue Recognition 1040 Accounting for Income Taxes 1116 Accounting for Pensions and Postretirement Benefits 1182 Accounting for Leases 1268 Accounting Changes and Error Analysis 1342 Statement of Cash Flows 1410 Full Disclosure in Financial Reporting 1486 iii Author Commitment Don Kieso Jerry Weygandt Terry Warfield Donald E. Kieso, PhD, CPA, received his bachelor’s degree from Aurora University and his doctorate in accounting from the University of Illinois. He has served as chairman of the Department of Accountancy and is currently the KPMG Emeritus Professor of Accountancy at Northern Illinois University. He has public accounting experience with Price Waterhouse & Co. (San Francisco and Chicago) and Arthur Andersen & Co. (Chicago) and research experience with the Research Division of the American Institute of Certified Public Accountants (New York). He has done post-doctorate work as a Visiting Scholar at the University of California at Berkeley and is a recipient of NIU’s Teaching Excellence Award and four Golden Apple Teaching Awards. Professor Kieso is the author of other accounting and business books and is a member of the American Accounting Association, the American Institute of Certified Public Accountants, and the Illinois CPA Society. He has served as a member of the Board of Directors of the Illinois CPA Society, then AACSB’s Accounting Accreditation Committees, the State of Illinois Comptroller’s Commission, as Secretary-Treasurer of the Federation of Schools of Accountancy, and as SecretaryTreasurer of the American Accounting Association. Professor Kieso is currently serving on the Board of Trustees and Executive Committee of Aurora University, as a member of the Board of Directors of Kishwaukee Community Hospital, and as Treasurer and Director of Valley West Community Hospital. From 1989 to 1993, he served as a charter member of the National Accounting Education Change Commission. He is the recipient of the Outstanding Accounting Educator Award from the Illinois CPA Society, the FSA’s Joseph A. Silvoso Award of Merit, the NIU Foundation’s Humanitarian Award for Service to Higher Education, a Distinguished Service Award from the Illinois CPA Society, and in 2003 an honorary doctorate from Aurora University. Jerry J. Weygandt, PhD, CPA, is Arthur Andersen Alumni Emeritus Professor of Accounting at the University of Wisconsin—Madison. He holds a Ph.D. in accounting from the University of Illinois. Articles by Professor Weygandt have appeared in the Accounting Review, Journal of Accounting Research, Accounting Horizons, Journal of Accountancy, and other academic and professional journals. These articles have examined such financial reporting issues as accounting for price-level adjustments, pensions, convertible securities, stock option contracts, and interim reports. Professor Weygandt is author of other accounting and financial reporting books and is a member of the American Accounting Association, the American Institute of Certified Public Accountants, and the Wisconsin Society of Certified Public Accountants. He has served on numerous committees of the American Accounting Association and as a member of the editorial board of the Accounting Review; he also has served as President and Secretary-Treasurer of the American Accounting Association. In addition, he has been actively involved with the American Institute of Certified Public Accountants and has been a member of the Accounting Standards Executive Committee (AcSEC) of that organization. He has served on the FASB task force that examined the reporting issues related to accounting for income taxes and served as a trustee of the Financial Accounting Foundation. Professor Weygandt has received the Chancellor’s Award for Excellence in Teaching and the Beta Gamma Sigma Dean’s Teaching Award. He is on the board of directors of M & I Bank of Southern Wisconsin. He is the recipient of the Wisconsin Institute of CPA’s Outstanding Educator’s Award and the Lifetime Achievement Award. In 2001, he received the American Accounting Association’s Outstanding Educator Award. Terry D. Warfield, PhD, is the PricewaterhouseCoopers Professor in Accounting at the University of Wisconsin—Madison. He received a B.S. and M.B.A. from Indiana University and a Ph.D. in accounting from the University of Iowa. Professor Warfield’s area of expertise is financial reporting, and prior to his academic career, he worked for five years in the banking industry. He served as the Academic Accounting Fellow in the Office of the Chief Accountant at the U.S. Securities and Exchange Commission in Washington, D.C. from 1995–1996. Professor Warfield’s primary research interests concern financial accounting standards and disclosure policies. He has published scholarly articles in The Accounting Review, Journal of Accounting and Economics, Research in Accounting Regulation, and Accounting Horizons, and he has served on the editorial boards of The Accounting Review, Accounting Horizons, and Issues in Accounting Education. He has served as president of the Financial Accounting and Reporting Section, the Financial Accounting Standards Committee of the American Accounting Association (Chair 1995–1996), and on the AAA-FASB Research Conference Committee. He also served on the Financial Accounting Standards Advisory Council of the Financial Accounting Standards Board. Professor Warfield has received teaching awards at both the University of Iowa and the University of Wisconsin, and he was named to the Teaching Academy at the University of Wisconsin in 1995. Professor Warfield has developed and published several case studies based on his research for use in accounting classes. These cases have been selected for the AICPA Professor-Practitioner Case Development Program and have been published in Issues in Accounting Education. From the Authors Accounting continues to be one of the most employable, sought-after majors, according to entry-level job site CollegeGrad.com. One reason for this interest is found in the statement by former Secretary of the Treasury and Economic Advisor to the President, Lawrence Summers. He noted that the single-most important innovation shaping our capital markets was the idea of generally accepted accounting principles (GAAP). We agree with Mr. Summers. Relevant and reliable financial information is a necessity for viable capital markets. Without it, our markets would be chaotic, and our standard of living would decrease. This textbook is the market leader in providing the tools needed to understand what GAAP is and how it is applied in practice. Mastery of this material will be invaluable to you in whatever field you select. Through many editions, this textbook has continued to reflect the constant changes taking place in the GAAP environment. This edition continues this tradition, which has become even more significant as the financial reporting environment is exploding with major change. Here are three areas of major importance that are now incorporated extensively into this edition of the textbook. Convergence of U.S. GAAP and IFRS As mentioned above, the most important innovation shaping our capital markets was the idea of U.S. GAAP. It might be said that it would be even better if we had one common set of accounting rules for the whole world, which will make it easier for international investors to compare the financial results of companies from different countries. That is happening quickly as U.S. GAAP and international accounting standards are converging. The convergence process has resulted in a number of common standards between U.S. GAAP and International Financial Reporting Standards (IFRS). And you have the chance to be on the ground floor as we develop for you the similarities and differences in the two systems that ultimately will be one. A Fair Value Movement “If this textbook helps you appreciate the challenges, worth, and limitations of financial reporting, if it encourages you to evaluate critically and understand financial accounting concepts and practice, and if it prepares you for advanced study, professional examinations, and the successful and ethical pursuit of your career in accounting or business in a global economy, then we will have attained our objectives.” The FASB believes that fair value information is more relevant to users than historical cost. As a result, there is more information that is being reported on this basis, and even more will occur in the future. The financial press is full of articles discussing how financial institutions must fair value their assets, which has led to massive losses during the recent credit crisis. In addition, additional insight into the reliability related to fair values is being addressed and disclosed to help investors make important capital allocation decisions. We devote a considerable amount of material that discusses and illustrates fair value concepts in this edition. A New Way of Looking at Generally Accepted Accounting Principles (GAAP) Learning GAAP used to be a daunting task, as it is comprised of many standards that vary in form, completeness, and structure. Fortunately, the profession has developed the Financial Accounting Standards Board Codification (often referred to as the Codification). This Codification provides in one place all the GAAP related to a given topic. This textbook is the first to incorporate this Codification—it will make learning GAAP easier and more interesting! Intermediate Accounting is the market-leading textbook in providing the tools needed to understand what GAAP is and how it is applied in practice. With this Fifteenth Edition, we strive to continue to provide the material needed to understand this subject area. The textbook is comprehensive and up-to-date. We also include proven pedagogical tools, designed to help you learn more effectively and to answer the changing needs of this course. Look inside the front cover for a detailed description of all of the learning tools of the textbook. We are excited about Intermediate Accounting, Fifteenth Edition. We believe it meets an important objective of providing useful information to educators and students interested in learning about both GAAP and IFRS. Suggestions and comments from users of this textbook will be appreciated. Please feel free to e-mail any one of us at AccountingAuthors@yahoo.com. Donald E. Kieso DeKalb, Illinois Jerry J. Weygandt Madison, Wisconsin Terry D. Warfield Madison, Wisconsin v What’s New? The Fifteenth Edition expands our emphasis on student learning and improves upon a teaching and learning package that instructors and students have rated the highest in customer satisfaction. Based on extensive reviews, focus groups, and interactions with other intermediate accounting instructors and students, we have developed a number of new pedagogical features and content changes, designed both to help students learn more effectively and to answer the changing needs of the course. Evolving Issues As we continue to strive to reflect the constant changes in the accounting environment, we have added a new feature to the Fifteenth Edition, Evolving Issues, which highlight and discuss areas in which the profession may be encountering controversy or nearing resolution. Our hope is that these high-interest boxes will increase student engagement, as well as serve as classroom discussion points. For another source of high-interest material, see the What Do the Numbers Mean? boxes, most of which are new to this edition. Demonstration Problems We understand that students often struggle to apply accounting concepts to realistic business situations. As a result, we include a new Demonstration Problem before the end-of-chapter problem material, to serve as a model to help students with their homework assignments. Updated IFRS Insights Content We have updated the end-of-chapter section, IFRS Insights, throughout the textbook. In addition, in the Relevant Facts section, we now present Similarities as well as Differences between GAAP and IFRS to increase student understanding. Major Content Revisions In response to the changing environment, we have significantly revised several chapters. Chapter 2 Conceptual Framework for Financial Reporting • New footnote material on the FASB’s additional guidance related to the use of fair value in financial statements. • Updated discussion plus added an illustration on the five steps of revenue recognition. • Revised Constraints section, as now only cost constraint is included in the conceptual framework. Chapter 4 Income Statement and Related Information • Revised Format of the Income Statement section, adding discussion on the intermediate components of the income statement and presenting the multiple-step before the single-step format to reflect current practice. • Revised Reporting Irregular Items section, to broaden focus on irregular and unusual items. Updated discussion throughout as well as added new material on noncontrolling interest. • Updated Comprehensive Income discussion, to reflect the most recent accounting standards. • New illustration showing and explaining the revised income statement sections. Chapter 18 Revenue Recognition • We anticipate a new FASB ruling on the revenue recognition principle. As a result, please see the book’s companion website, at www.wiley.com/college/kieso, for the latest information as well as the availability of an updated, replacement chapter. Chapter 23 Statement of Cash Flows • Reorganized chapter, to present the indirect method through preparation of the statement of cash flows first, followed by the discussion of the direct method as well as the advantages and disadvantages of both methods. • New Evolving Issue, “Direct versus Indirect Controversy,” on the arguments in favor of each method. See the next two pages for a complete list of content revisions by chapter. vi Content Changes by Chapter Chapter 1 Financial Accounting and Accounting Standards • New opening story, about how the U.S. can improve its financial reporting system to provide reliable accounting information. • Updated Types of Pronouncements section and increased coverage of the EITF. • New WDNM box on how different countries’ cultures impede international convergence efforts. • Updated International Accounting Convergence discussion in IFRS Insights section. • New Evolving Issue, on the use of fair value accounting. Chapter 2 Conceptual Framework for Financial Reporting • Updated WDNM box on earnings with recent information about Facebook’s reporting of its first earnings after going public. • New footnote on the liquidation basis of accounting. • New footnote material on the FASB’s additional guidance related to use of fair value in financial statements. • Updated discussion plus added an illustration on the five steps of revenue recognition. • Revised Constraints section, as now only cost constraint is included in the conceptual framework. Chapter 3 The Accounting Information System • Revised discussion/terminology used to reflect anticipated new wording of revenue recognition principle. • Updated material on economic crime in opening story. • Updated graphics to increase student engagement. • New WDNM box on companies’ need to update their accounting information systems yet unwillingness to interrupt their operations to do so. Chapter 4 Income Statement and Related Information • Revised opening story, to discuss Groupon’s recent pro forma reporting. • Revised Format of the Income Statement section, adding discussion on the intermediate components of the income statement and presenting the multiple-step before singlestep format to reflect current practice. • Revised Reporting Irregular Items section, to broaden focus on irregular and unusual items. Updated discussion throughout as well as added discussion on noncontrolling interest. • Updated Comprehensive Income discussion, to reflect most recent accounting standards. • New Underlying Concepts marginal note, about how the income statement provides information that is central to the objective of financial reporting. • Revised the WDNM box on managing earnings to discuss a recent study that reinforces concerns about earnings management. • New illustration showing and explaining the revised income statement sections. • New WDNM box on the importance of the top line, in addition to the bottom line, in the income statement when analyzing companies. • New Evolving Issue, on income reporting. Chapter 5 Balance Sheet and Statement of Cash Flows • Updated WDNM box on the airline industry, to include recent merger activity. • Replaced several examples of real-company financial statements. • Added noncontrolling interest line item to the balance sheet, to reflect recent FASB pronouncement. • Moved most of P&G’s annual report from Appendix 5B to book’s companion website. • New Evolving Issue, on balance sheet reporting. Chapter 6 Accounting and the Time Value of Money • New opening story, about developing fair value estimates and applying fair value guidance to specific examples. • New WDNM box on how starting a savings account earlier can significantly affect the value of a retirement fund. • Revised WDNM box on Fed’s ability to adjust interest rates by adding discussion on Fed’s more recent use of quantitative easing. Chapter 7 Cash and Receivables • New opening story, about banks’ boosting earnings by releasing loan loss reserves. • New WDNM boxes, on tax incentives for companies to move their cash overseas, and recent trends of companies to delay payment of bills. • New discussion on repurchase agreements (see footnote 14). • New Evolving Issue, on how existing GAAP results in allowances for loan loss that tend to be at their lowest level when they are needed most, the beginning of a downward-trending economic cycle. Chapter 8 Valuation of Inventories: A Cost-Basis Approach • New opening story, about why some companies are switching from LIFO to FIFO. Chapter 9 Inventories: Additional Valuation Issues • New opening story, about why investors need comparable information about inventory when evaluating retailers’ financial statements. Chapter 10 Acquisition and Disposition of Property, Plant, and Equipment • New opening story, about importance of capital expenditures and how they can affect a company’s income. Chapter 11 Depreciation, Impairments, and Depletion • New Evolving Issue, on whether to account for exploration costs in the oil and gas industry using full-cost or successful-efforts. Chapter 12 Intangible Assets • New opening story, on increasing amount of sustainability information provided by companies. • New Underlying Concepts marginal note about surrounding controversy for R&D accounting. • Added more real-world examples to Contract-Related Intangible Assets section. • Completely rewritten WDNM box, discussing the patent battles between e-tailers and cell phone companies. • New discussion (footnotes) on qualitative assessment to determine impairment of indefinite-life intangibles. • Revised WDNM box on impairment risk, to discuss more recent case of Bank of America. • New Evolving Issue, on the recognition of R&D and internally generated intangibles. • Moved Appendix 12A, Accounting for Computer Software Costs, to book’s companion website. Chapter 13 Current Liabilities and Contingencies • New Evolving Issue, on how to account for greenhouse gases. Chapter 14 Long-Term Liabilities • New opening story, about the impact of long-term debt on governments and companies. • New Evolving Issue, on how the FASB believes that using the fair value option for liabilities makes sense, as the valuation of a liability is related to a company’s credit standing. Chapter 15 Stockholders’ Equity • Updated opening story, on the global IPO market. • New WDNM boxes, on Delaware as a tax haven for companies, whether buybacks signal good or bad news about companies, and an analysis of recent company dividend payouts. • Revised WDNM box to include more recent information about companies going public with two or more classes of stock. • New information and illustration on recent company buybacks. Chapter 16 Dilutive Securities and Earnings per Share • Revised opening story, updating information about companies’ use of options and restricted stock. • Updated material to include recent convergence material on accounting for financial instruments with characteristics of both debt and equity. • New Evolving Issue, on accounting for convertible debt. • New illustration on company equity grants. • New footnote on rationale for why companies are moving away from options to restricted stock, and revised footnote about how EPS effects of noncontrolling interest should be presented. • Completely revised WDNM box, about the effect of companies that expense stock options on their stock prices. Chapter 17 Investments • Revised opening story, to include recent FASB position on how banking industry values loans. • New footnotes on FASB’s current exploration for a new impairment model for financial instruments as well as additional disclosures required for items reclassified out of accumulated other comprehensive income. • New Evolving Issues, on fair value controversy as well as proposed new classification and measurement model for financial assets. viii • New material on FASB required disclosures for financial instruments, with special emphasis on Level 3 measurements. Chapter 18 Revenue Recognition • Updated WDNM boxes, to reflect new disclosure requirements for gift-card issuers and to stress importance of companies reporting sales on a net basis. Chapter 19 Accounting for Income Taxes • Updated footnotes on determining the true cost of taxes and deferred tax assets (Sony’s experience in post-quake Japan). • New Evolving Issue, on uncertain tax positions. • New WDNM box, about creative tax accounting at Apple, Google, and GE. Chapter 20 Accounting for Pensions and Postretirement Benefits • Updated opening story on pension plan choices. • Updated statistics on size of pension plan assets globally. • Updated chart on defined benefit/defined contribution plan mix. • New Evolving Issue, on companies’ voluntary choice to abandon corridor amortization. • Updated WDNM box on funded status of pension plans. • New WDNM box on guarantees for the PBGC. • New IFRS Insight section reflecting major amendments to IFRS for pensions (IAS 19). Chapter 21 Accounting for Leases • Updated opening story on aircraft leasing data and added information about Rite-Aid’s off-balance-sheet obligations. • New Evolving Issue, on proposal to address off-balancesheet reporting of leases. Chapter 22 Accounting Changes and Error Analysis • Updated opening story, of recent accounting changes mandated by the FASB and subsequent company restatements. • Revised WDNM box, on need to protect company statements from negative effects of fraud. Chapter 23 Statement of Cash Flows • Reorganized chapter, to present the indirect method through preparation of the statement of cash flows first, followed by the discussion of the direct method as well as advantages and disadvantages of both methods. • New WDNM box, on how cash flow management can affect the quality of accounting information. • Reformatted “Direct versus Indirect Controversy” as new Evolving Issue, to highlight the arguments in favor of each method. • Updated WDNM box to show how banks’ use of investment classifications can affect operating cash flows. Chapter 24 Full Disclosure in Financial Reporting • New discussion in Differential Disclosure section about costs and benefits of a “one size fits all” reporting package. • New Evolving Issues, on ensuring the quantity and quality of financial disclosure, and interim reporting rules. • New footnote on FASB going concern project. • New WDNM box, on the difference between British and U.S. forecasting. Teaching and Learning Supplementary Material For Instructors For Students Active-Teaching Aids Active-Learning Aids Instructors can take advantage of the resources and support available in WileyPLUS and the Wiley Faculty Network, as well as a number of helpful assets (such as the Instructor’s Manual, Test Bank, PowerPoint presentations, and Solutions Manual) at our book’s companion site, www.wiley.com/college/kieso. In addition, instructors will find that we have made a number of additions and enhancements to the Fifteenth Edition instructor and student resources. The book’s companion site for students, www.wiley.com/ college/kieso, is home to a number of helpful learning aids, including a B Set of Exercises, B Set of Problems, Self-Study Tests and Additional Self-Tests, Excel templates, annual reports, and a complete glossary of key terms. Test Bank/Computerized Test Bank. We have made several key enhancements to the Test Bank, both in print and in WileyPLUS. These include: • Newly authored Test Bank questions to cover recent topical additions/expansions (e.g., IFRS, revenue recognition, and fair value). • New Critical Thinking Questions added to Exercises. • Removal of outdated questions. WileyPLUS now includes numerous questions from the Test Bank, offering simple multiple-choice and more complex exercises and problems. Many of these exercises/problems will be algorithmic. Instructor’s Manual, Vols. 1 and 2. Included in each chapter are lecture outlines with teaching tips, chapter reviews, illustrations, and review quizzes. Solutions Manual, Vols. 1 and 2. Each volume contains detailed solutions to all Brief Exercises, Exercises, and Problems in the textbook, as well as suggested answers to the Concepts for Analysis and Using Your Judgment questions and cases. Narrated PowerPoints. Brief chapter-based videos walk the students through the core concepts in each chapter, as outlined in the PowerPoint Slides. B Set of Problems. In addition to the B Set of Exercises, we now provide an additional set of problems for each chapter, based on the problems in the textbook. The B Sets of Exercises and Problems are available in WileyPLUS and at the book’s companion site. Student Videos. Three new types of videos will be available in WileyPLUS: • Mini lecture videos from Terry Warfield on select difficult topics in intermediate accounting. • Exercise solution walkthrough videos where a student can see how an exercise similar to one in the textbook is solved. • Accounting skills videos that demonstrate the basic concepts and skills needed for students to understand how to solve a multitude of intermediate accounting problems. Student Study Guide, Vols. 1 and 2. Each chapter of the Study Guide contains a chapter review, chapter outline, and a glossary of key terms. Demonstration problems, multiple-choice, true/false, matching, and other exercises are included. Available for purchase at the book’s companion site. Problem-Solving Survival Guide, Vols. 1 and 2. This study guide contains exercises and problems that help students develop their intermediate accounting problem-solving skills. Explanations assist in the approach, set-up, and completion of accounting problems. Tips alert students to common pitfalls and misconceptions. Available for purchase at the book’s companion site. Rockford Corporation: An Accounting Practice Set. This practice set helps students review the accounting cycle and the preparation of financial statements. Available for purchase at the book’s companion site. The computerized Rockford practice set is a general ledger software version of the printed practice set, also available in WileyPLUS. Gateway to the Profession (accessed at www.wiley.com/college/kieso) Expanding beyond technical accounting knowledge, the Gateway to the Profession materials emphasize certain skills necessary to become a successful accountant or financial manager. The following materials will help students develop needed professional skills: • Financial Statement Analysis Primer • Database of Real Companies • Writing Handbook • Working in Teams • Ethics in Accounting We also include chapter-level resources that help students process and understand key course concepts: • Interactive Tutorials • Expanded Discussions • Spreadsheet Tools • Additional Internet Links ix WileyPLUS WileyPLUS is a research-based, online environment for effective teaching and learning. The market-leading homework experience in WileyPLUS offers: A Blank Sheet of Paper Effect The WileyPLUS homework experience, which includes type-ahead for account title entry, imitates a blank sheet of paper format so that students use recall memory when doing homework and will do better in class, on exams, and in their professions. A Professional Worksheet Style The professional, worksheet-style problem layouts help students master accounting skills while doing homework that directly applies to the classroom and the real world. The Opportunity to Catch Mistakes Earlier Multi-part problems further help students focus by providing feedback at the part-level. Students can catch their mistakes earlier and access content-specific resources at the point of learning. More Assessment Options All brief exercises, exercises, and problems from the textbook are now available for assignment in WileyPLUS in static or algorithmic format. WileyPLUS includes a full ebook, interactive tutorials, assessment capabilities, and Blackboard integration. www.wileyplus.com FMTOC.indd Page ix 03/10/12 7:31 PM F-402 Quantum® Accelerate Learning and Improve Test Scores! Quantum helps students master the core accounting topics and skills needed to be successful in their accounting course. Personal Step-by-Step Feedback and Immediate Answers to Student Questions Quantum uses powerful artificial intelligence technology to interpret and explain why individual student answers are right or wrong with personal step-by-step feedback. Rather than wait until the next day to ask their instructor, students can now ask questions any time and get the real-time help needed to understand and master the material. ASK QUESTIONS CHECK MY WORK SHOW SOLUTION Target Areas Where Students Need Most Help Students also receive real-time “How Am I Doing?” progress reports showing concept mastery and specific skills requiring more practice. Quantum provides the individualized feedback that is proven to increase test scores at least a full letter grade with less study time. PACKAGED WITH A TEXTBOOK AND WileyPLUS, QUANTUM HELPS STUDENTS MASTER ACCOUNTING WITH LESS STUDY TIME! www.quantumsimulations.com Contents Chapter 1 Financial Accounting and Accounting Standards 2 We Can Do Better Financial Statements and Financial Reporting 4 Accounting and Capital Allocation 4 What Do the Numbers Mean? It’s the Accounting 5 Objective of Financial Reporting 5 What Do the Numbers Mean? Don’t Forget Stewardship 6 The Need to Develop Standards 7 Parties Involved in Standard-Setting 7 Securities and Exchange Commission (SEC) 7 American Institute of Certified Public Accountants (AICPA) 9 Financial Accounting Standards Board (FASB) 10 Generally Accepted Accounting Principles 13 What Do the Numbers Mean? You Have to Step Back 14 FASB Codification 14 Issues in Financial Reporting 16 GAAP in a Political Environment 16 Evolving Issue Fair Value, Fair Consequences? 17 The Expectations Gap 17 Financial Reporting Challenges 18 International Accounting Standards 20 What Do the Numbers Mean? Can You Do That? 21 Ethics in the Environment of Financial Accounting 21 Conclusion 21 FASB Codification 23 IFRS Insights 31 Chapter 2 Conceptual Framework for Financial Reporting 40 What Is It? Conceptual Framework 42 Need for a Conceptual Framework 42 What Do the Numbers Mean? What’s Your Principle? 43 xii Development of a Conceptual Framework 43 Overview of the Conceptual Framework 44 First Level: Basic Objective 45 Second Level: Fundamental Concepts 45 Qualitative Characteristics of Accounting Information 45 What Do the Numbers Mean? Living in a Material World 48 What Do the Numbers Mean? Show Me the Earnings! 50 Basic Elements 52 Third Level: Recognition and Measurement Concepts 53 Basic Assumptions 54 What Do the Numbers Mean? Whose Company Is It? 54 Basic Principles of Accounting 56 What Do the Numbers Mean? You May Need a Map 61 Cost Constraint 61 Summary of the Structure 63 FASB Codification 65 IFRS Insights 78 Chapter 3 The Accounting Information System 82 Needed: A Reliable Information System Accounting Information System 84 Basic Terminology 84 Debits and Credits 85 The Accounting Equation 86 Financial Statements and Ownership Structure 88 The Accounting Cycle 89 Identifying and Recording Transactions and Other Events 89 Journalizing 91 Posting 92 Trial Balance 96 Adjusting Entries 96 What Do the Numbers Mean? Am I Covered? 107 Adjusted Trial Balance 108 Preparing Financial Statements 108 What Do the Numbers Mean? 24/7 Accounting 110 Closing 110 Post-Closing Trial Balance 113 Reversing Entries—An Optional Step 113 The Accounting Cycle Summarized 114 What Do the Numbers Mean? Hey, It’s Complicated 114 Financial Statements for a Merchandising Company 114 Income Statement 114 Statement of Retained Earnings 115 Balance Sheet 115 What Do the Numbers Mean? Statements, Please 117 Closing Entries 117 APPENDIX 3A Cash-Basis Accounting versus Accrual-Basis Accounting 118 Conversion from Cash Basis to Accrual Basis 120 Service Revenue Computation 121 Operating Expense Computation 122 Theoretical Weaknesses of the Cash Basis 123 APPENDIX 3B Using Reversing Entries 124 Illustration of Reversing Entries—Accruals 124 Illustration of Reversing Entries—Deferrals 125 Summary of Reversing Entries 126 APPENDIX 3C Using a Worksheet: The Accounting Cycle Revisited 127 Worksheet Columns 127 Trial Balance Columns 127 Adjustments Columns 127 Adjustments Entered on the Worksheet 127 Adjusted Trial Balance 129 Income Statement and Balance Sheet Columns 129 Preparing Financial Statements from a Worksheet 130 IFRS Insights 153 Chapter 4 Income Statement and Related Information 158 Financial Statements Are Changing Income Statement 160 Usefulness of the Income Statement 160 Limitations of the Income Statement 160 Quality of Earnings 161 What Do the Numbers Mean? Four: The Loneliest Number 162 Format of the Income Statement 162 Elements of the Income Statement 162 Intermediate Components of the Income Statement 164 What Do the Numbers Mean? Top Line or Bottom Line? 166 Condensed Income Statements 166 Single-Step Income Statements 167 Reporting Various Income Items 168 What Do the Numbers Mean? Are One-Time Charges Bugging You? 169 Unusual Gains and Losses 169 Discontinued Operations 170 Extraordinary Items 173 What Do the Numbers Mean? Extraordinary Times 175 Noncontrolling Interest 176 Summary of Various Income Items 176 Earnings per Share 177 What Do the Numbers Mean? Different Income Concepts 179 Other Reporting Issues 179 Accounting Changes and Errors 179 Retained Earnings Statement 181 Comprehensive Income 182 Evolving Issue Income Reporting 185 FASB Codification 188 IFRS Insights 205 Chapter 5 Balance Sheet and Statement of Cash Flows 212 Hey, It Doesn’t Balance! Balance Sheet 214 Usefulness of the Balance Sheet 214 Limitations of the Balance Sheet 215 What Do the Numbers Mean? Grounded 215 Classification in the Balance Sheet 215 What Do the Numbers Mean? “Show Me the Assets!” 223 What Do the Numbers Mean? Warning Signals 226 Balance Sheet Format 226 Statement of Cash Flows 228 What Do the Numbers Mean? Watch That Cash Flow 228 Purpose of the Statement of Cash Flows 228 Content and Format of the Statement of Cash Flows 229 Overview of the Preparation of the Statement of Cash Flows 230 Usefulness of the Statement of Cash Flows 232 What Do the Numbers Mean? “There Ought to Be a Law” 235 Additional Information 236 Supplemental Disclosures 236 What Do the Numbers Mean? What About Your Commitments? 238 Techniques of Disclosure 239 Evolving Issue Balance Sheet Reporting: Gross or Net? 243 APPENDIX 5A Ratio Analysis—A Reference 245 Using Ratios to Analyze Performance 245 xiii APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company 246 FASB Codification 255 IFRS Insights 277 Chapter 6 Accounting and the Time Value of Money 286 How Do I Measure That? Basic Time Value Concepts 288 Applications of Time Value Concepts 288 The Nature of Interest 289 Simple Interest 290 Compound Interest 290 What Do the Numbers Mean? A Pretty Good Start 291 Fundamental Variables 294 Single-Sum Problems 294 Future Value of a Single Sum 295 Present Value of a Single Sum 296 Solving for Other Unknowns in Single-Sum Problems 298 Annuities 299 Future Value of an Ordinary Annuity 300 What Do the Numbers Mean? Don’t Wait to Make That Contribution! 302 Future Value of an Annuity Due 303 Examples of Future Value of Annuity Problems 304 Present Value of an Ordinary Annuity 306 What Do the Numbers Mean? Up in Smoke 308 Present Value of an Annuity Due 308 Examples of Present Value of Annuity Problems 309 More Complex Situations 311 Deferred Annuities 311 Valuation of Long-Term Bonds 313 Effective-Interest Method of Amortization of Bond Discount or Premium 314 Present Value Measurement 315 Choosing an Appropriate Interest Rate 316 What Do the Numbers Mean? How Low Can They Go? 316 Example of Expected Cash Flow 316 FASB Codification 320 Chapter 7 Cash and Receivables 344 Please Release Me? Cash 346 What Is Cash? 346 Reporting Cash 346 Summary of Cash-Related Items 348 What Do the Numbers Mean? Luck of the Irish 349 xiv Accounts Receivable 349 Recognition of Accounts Receivable 351 Valuation of Accounts Receivable 352 What Do the Numbers Mean? I’m Still Waiting 358 Notes Receivable 359 Recognition of Notes Receivable 359 Valuation of Notes Receivable 363 What Do the Numbers Mean? Economic Consequences and Write-Offs 364 Special Issues 364 Fair Value Option 365 Disposition of Accounts and Notes Receivable 365 What Do the Numbers Mean? Return to Lender 371 Presentation and Analysis 372 Evolving Issue A Cure for “Too Little, Too Late”? 374 APPENDIX 7A Cash Controls 376 Using Bank Accounts 376 The Imprest Petty Cash System 377 Physical Protection of Cash Balances 378 Reconciliation of Bank Balances 378 APPENDIX 7B Impairments of Receivables 381 Impairment Measurement and Reporting 382 Impairment Loss Example 382 Recording Impairment Losses 383 What Do the Numbers Mean? Lost in Translation 383 FASB Codification 385 IFRS Insights 408 Chapter 8 Valuation of Inventories: A Cost-Basis Approach 414 To Switch or Not to Switch Inventory Issues 416 Classification 416 Inventory Cost Flow 417 Inventory Control 419 What Do the Numbers Mean? Staying Lean 420 Basic Issues in Inventory Valuation 420 Physical Goods Included in Inventory 421 Goods in Transit 421 Consigned Goods 422 Special Sales Agreements 422 What Do the Numbers Mean? No Parking! 423 Effect of Inventory Errors 423 Costs Included in Inventory 425 Product Costs 426 Period Costs 426 Treatment of Purchase Discounts 426 What Do the Numbers Mean? You May Need a Map 427 Which Cost Flow Assumption to Adopt? 428 Specific Identification 428 Average-Cost 429 First-In, First-Out (FIFO) 430 Last-In, First-Out (LIFO) 431 Special Issues Related to LIFO 432 LIFO Reserve 432 What Do the Numbers Mean? Comparing Apples to Apples 433 LIFO Liquidation 434 Dollar-Value LIFO 435 What Do the Numbers Mean? Quite a Difference 440 Comparison of LIFO Approaches 440 Major Advantages of LIFO 441 Major Disadvantages of LIFO 442 Basis for Selection of Inventory Method 443 Evolving Issue Repeat LIFO! 445 Inventory Valuation Methods—Summary Analysis 445 FASB Codification 449 Chapter 9 Inventories: Additional Valuation Issues 472 Not What It Seems to Be Lower-of-Cost-or-Market 474 Ceiling and Floor 475 How Lower-of-Cost-or-Market Works 476 Methods of Applying Lower-of-Cost-orMarket 477 Recording “Market” Instead of Cost 478 Use of an Allowance 479 Use of an Allowance—Multiple Periods 480 What Do the Numbers Mean? “Put It in Reverse” 480 Evaluation of the Lower-of-Cost-or-Market Rule 481 Valuation Bases 481 Valuation at Net Realizable Value 481 Valuation Using Relative Sales Value 482 Purchase Commitments—A Special Problem 483 The Gross Profit Method of Estimating Inventory 485 Computation of Gross Profit Percentage 486 Evaluation of Gross Profit Method 488 What Do the Numbers Mean? The Squeeze 488 Retail Inventory Method 488 Retail-Method Concepts 489 Retail Inventory Method with Markups and Markdowns—Conventional Method 490 Special Items Relating to Retail Method 493 Evaluation of Retail Inventory Method 493 Presentation and Analysis 494 Presentation of Inventories 494 Analysis of Inventories 495 APPENDIX 9A LIFO Retail Methods 497 Stable Prices—LIFO Retail Method 497 Fluctuating Prices—Dollar-Value LIFO Retail Method 498 Subsequent Adjustments Under Dollar-Value LIFO Retail 500 Changing from Conventional Retail to LIFO 501 FASB Codification 504 IFRS Insights 525 Chapter 10 Acquisition and Disposition of Property, Plant, and Equipment 536 Watch Your Spending Property, Plant, and Equipment 538 Acquisition of Property, Plant, and Equipment 538 Cost of Land 539 Cost of Buildings 539 Cost of Equipment 540 Self-Constructed Assets 540 Interest Costs During Construction 541 What Do the Numbers Mean? What’s in Your Interest? 546 Observations 547 Valuation of Property, Plant, and Equipment 547 Cash Discounts 547 Deferred-Payment Contracts 547 Lump-Sum Purchases 548 Issuance of Stock 549 Exchanges of Nonmonetary Assets 550 What Do the Numbers Mean? About Those Swaps 555 Accounting for Contributions 555 Other Asset Valuation Methods 556 Costs Subsequent to Acquisition 556 What Do the Numbers Mean? Disconnected 557 Additions 558 Improvements and Replacements 558 Rearrangement and Reinstallation 559 Repairs 559 Summary of Costs Subsequent to Acquisition 560 Disposition of Property, Plant, and Equipment 560 Sale of Plant Assets 560 Involuntary Conversion 561 Miscellaneous Problems 561 FASB Codification 564 Chapter 11 Depreciation, Impairments, and Depletion 588 Here Come the Write-Offs xv Depreciation—A Method of Cost Allocation 590 Factors Involved in the Depreciation Process 590 What Do the Numbers Mean? Alphabet Dupe 592 Methods of Depreciation 592 Special Depreciation Methods 595 What Do the Numbers Mean? Decelerating Depreciation 597 Special Depreciation Issues 598 What Do the Numbers Mean? Depreciation Choices 601 Impairments 601 Recognizing Impairments 601 Measuring Impairments 602 Restoration of Impairment Loss 603 Impairment of Assets to Be Disposed Of 603 Depletion 604 Establishing a Depletion Base 605 Write-Off of Resource Cost 606 Estimating Recoverable Reserves 607 What Do the Numbers Mean? Reserve Surprise 607 Liquidating Dividends 607 Continuing Controversy 608 Evolving Issue Full-Cost or Successful-Efforts? 609 Presentation and Analysis 609 Presentation of Property, Plant, Equipment, and Natural Resources 609 Analysis of Property, Plant, and Equipment 611 APPENDIX 11A Income Tax Depreciation 614 Modified Accelerated Cost Recovery System 614 Tax Lives (Recovery Periods) 614 Tax Depreciation Methods 615 Example of MACRS 615 Optional Straight-Line Method 616 Tax versus Book Depreciation 617 FASB Codification 618 IFRS Insights 637 Chapter 12 Intangible Assets 648 Is This Sustainable? Intangible Asset Issues 650 Characteristics 650 Valuation 650 Amortization of Intangibles 651 What Do the Numbers Mean? Definitely Indefinite 653 Types of Intangible Assets 653 Marketing-Related Intangible Assets 653 What Do the Numbers Mean? Keep Your Hands Off My Intangible! 654 xvi Customer-Related Intangible Assets 654 Artistic-Related Intangible Assets 655 Contract-Related Intangible Assets 655 Technology-Related Intangible Assets 656 What Do the Numbers Mean? Patent Battles 657 What Do the Numbers Mean? The Value of a Secret Formula 658 Goodwill 658 Impairment of Intangible Assets 662 Impairment of Limited-Life Intangibles 662 Impairment of Indefinite-Life Intangibles Other Than Goodwill 662 Impairment of Goodwill 663 Impairment Summary 664 What Do the Numbers Mean? Impairment Risk 665 Research and Development Costs 665 Identifying R&D Activities 666 Accounting for R&D Activities 667 Costs Similar to R&D Costs 667 What Do the Numbers Mean? Branded 670 Presentation of Intangibles and Related Items 670 Presentation of Intangible Assets 670 Presentation of Research and Development Costs 672 Evolving Issue Recognition of R&D and Internally Generated Intangibles 673 FASB Codification 676 IFRS Insights 693 Chapter 13 Current Liabilities and Contingencies 700 Now You See It, Now You Don’t Current Liabilities 702 Accounts Payable 703 Notes Payable 703 Current Maturities of Long-Term Debt 705 Short-Term Obligations Expected to Be Refinanced 705 What Do the Numbers Mean? What About That Short-Term Debt? 707 Dividends Payable 707 Customer Advances and Deposits 707 Unearned Revenues 708 What Do the Numbers Mean? Microsoft’s Liabilities—Good or Bad? 708 Sales Taxes Payable 709 Income Taxes Payable 709 Employee-Related Liabilities 710 Contingencies 715 Gain Contingencies 715 Loss Contingencies 716 What Do the Numbers Mean? Frequent Flyers 722 What Do the Numbers Mean? More Disclosure, Please 726 Presentation and Analysis 726 Presentation of Current Liabilities 726 Presentation of Contingencies 728 Analysis of Current Liabilities 729 Evolving Issue Greenhouse Gases: Let’s Be Standard-Setters 730 FASB Codification 733 IFRS Insights 753 Chapter 14 Long-Term Liabilities 762 Going Long Bonds Payable 764 Issuing Bonds 764 Types of Bonds 764 What Do the Numbers Mean? All About Bonds 765 Valuation of Bonds Payable—Discount and Premium 766 What Do the Numbers Mean? How’s My Rating? 768 Bonds Issued at Par on Interest Date 768 Bonds Issued at Discount or Premium on Interest Date 768 Bonds Issued Between Interest Dates 770 Effective-Interest Method 770 Costs of Issuing Bonds 774 Extinguishment of Debt 775 What Do the Numbers Mean? Your Debt Is Killing My Equity 776 Long-Term Notes Payable 776 Notes Issued at Face Value 777 Notes Not Issued at Face Value 777 Special Notes Payable Situations 779 Mortgage Notes Payable 782 Fair Value Option 782 Reporting and Analyzing Liabilities 783 Off-Balance-Sheet Financing 783 What Do the Numbers Mean? Obligated 785 Presentation and Analysis of Long-Term Debt 786 Evolving Issue Fair Value of Liabilities: Pick a Number, Any Number 788 APPENDIX 14A Troubled-Debt Restructurings 790 Settlement of Debt 791 Transfer of Assets 791 Granting of Equity Interest 791 Modification of Terms 792 Example 1—No Gain for Debtor 792 Example 2—Gain for Debtor 795 Concluding Remarks 796 FASB Codification 798 IFRS Insights 815 Chapter 15 Stockholders’ Equity 820 It’s a Global Market The Corporate Form of Organization 822 State Corporate Law 822 What Do the Numbers Mean? 1209 North Orange Street 822 Capital Stock or Share System 823 Variety of Ownership Interests 824 Corporate Capital 824 Issuance of Stock 825 What Do the Numbers Mean? The Case of the Disappearing Receivable 829 Reacquisition of Shares 829 What Do the Numbers Mean? Buybacks—Good or Bad? 830 Preferred Stock 834 Features of Preferred Stock 834 What Do the Numbers Mean? A Class (B) Act 836 Accounting for and Reporting Preferred Stock 836 Dividend Policy 837 Financial Condition and Dividend Distributions 837 Types of Dividends 838 Stock Dividends and Stock Splits 841 What Do the Numbers Mean? Splitsville 844 What Do the Numbers Mean? Dividends Up, Dividends Down 846 Disclosure of Restrictions on Retained Earnings 846 Presentation and Analysis of Stockholders’ Equity 847 Presentation 847 Analysis 849 APPENDIX 15A Dividend Preferences and Book Value per Share 852 Dividend Preferences 852 Book Value per Share 853 FASB Codification 856 IFRS Insights 874 Chapter 16 Dilutive Securities and Earnings per Share 882 Kicking the Habit Dilutive Securities 884 Debt and Equity 884 Accounting for Convertible Debt 884 xvii Convertible Preferred Stock 886 What Do the Numbers Mean? How Low Can You Go? 887 Stock Warrants 887 Evolving Issue Is That All Debt? 890 Accounting for Stock Compensation 893 Stock-Option Plans 893 Restricted Stock 894 Employee Stock-Purchase Plans 896 Disclosure of Compensation Plans 897 Debate over Stock-Option Accounting 897 What Do the Numbers Mean? A Little Honesty Goes a Long Way 899 Computing Earnings per Share 899 Earnings per Share—Simple Capital Structure 900 Earnings per Share—Complex Capital Structure 904 What Do the Numbers Mean? Pro Forma EPS Confusion 911 APPENDIX 16A Accounting for Stock-Appreciation Rights 913 SARS—Share-Based Equity Awards 914 SARS—Share-Based Liability Awards 914 Stock-Appreciation Rights Example 915 APPENDIX 16B Comprehensive Earnings per Share Example 916 Diluted Earnings per Share 918 FASB Codification 923 IFRS Insights 941 Chapter 17 Investments 950 What to Do? Investments in Debt Securities 952 Debt Investment Classifications 952 Held-to-Maturity Securities 953 Available-for-Sale Securities 955 What Do the Numbers Mean? What Is Fair Value? 959 Trading Securities 959 Investments in Equity Securities 960 Holdings of Less Than 20% 961 What Do the Numbers Mean? More Disclosure, Please 964 Holdings Between 20% and 50% 964 Holdings of More Than 50% 966 What Do the Numbers Mean? Who’s in Control Here? 967 Additional Measurement Issues 967 Fair Value Option 967 Evolving Issue Fair Value Controversy 968 Impairment of Value 969 Reclassifications and Transfers 970 Reclassification Adjustments 970 Transfers Between Categories 974 xviii Summary of Reporting Treatment of Securities 975 Evolving Issue Classification and Measurement— The Long Road 975 APPENDIX 17A Accounting for Derivative Instruments 977 Defining Derivatives 977 Who Uses Derivatives, and Why? 978 Producers and Consumers 978 Speculators and Arbitrageurs 979 Basic Principles in Accounting for Derivatives 980 Example of Derivative Financial Instrument— Speculation 980 Differences Between Traditional and Derivative Financial Instruments 983 Derivatives Used for Hedging 983 What Do the Numbers Mean? Risky Business 984 Fair Value Hedge 984 Cash Flow Hedge 987 Other Reporting Issues 989 Embedded Derivatives 989 Qualifying Hedge Criteria 989 Summary of Derivatives Accounting 990 Comprehensive Hedge Accounting Example 991 Fair Value Hedge 992 Financial Statement Presentation of an Interest Rate Swap 994 Controversy and Concluding Remarks 995 APPENDIX 17B Variable-Interest Entities 996 What About GAAP? 997 Consolidation of Variable-Interest Entities 997 Some Examples 998 What Is Happening in Practice? 999 APPENDIX 17C Fair Value Disclosures 999 Disclosure of Fair Value Information: Financial Instruments 1000 Disclosure of Fair Values: Impaired Assets or Liabilities 1003 Conclusion 1003 FASB Codification 1005 IFRS Insights 1026 Chapter 18 Revenue Recognition 1040 It’s Back Overview of Revenue Recognition 1042 Guidelines for Revenue Recognition 1043 Departures from the Sale Basis 1044 What Do the Numbers Mean? Liability or Revenue? 1045 Revenue Recognition at Point of Sale (Delivery) 1045 Sales with Discounts 1046 Sales with Right of Return 1047 Sales with Buybacks 1049 Bill and Hold Sales 1050 Principal-Agent Relationships 1050 What Do the Numbers Mean? Grossed Out 1051 Trade Loading and Channel Stuffing 1053 What Do the Numbers Mean? No Take-Backs 1053 Multiple-Deliverable Arrangements 1054 Summary 1056 Revenue Recognition before Delivery 1057 Percentage-of-Completion Method 1058 Completed-Contract Method 1063 Long-Term Contract Losses 1064 What Do the Numbers Mean? Less Conservative 1067 Disclosures in Financial Statements 1068 Completion-of-Production Basis 1068 Revenue Recognition after Delivery 1068 Installment-Sales Method 1068 Cost-Recovery Method 1077 Deposit Method 1078 Summary and Concluding Remarks 1079 APPENDIX 18A Revenue Recognition for Franchises 1081 Initial Franchise Fees 1082 Example of Entries for Initial Franchise Fee 1082 Continuing Franchise Fees 1083 Bargain Purchases 1083 Options to Purchase 1084 Franchisor’s Cost 1084 Disclosures of Franchisors 1084 FASB Codification 1086 IFRS Insights 1109 What Do the Numbers Mean? NOLs: Good News or Bad? 1138 Financial Statement Presentation 1138 Balance Sheet 1138 What Do the Numbers Mean? Imagination at Work 1140 Income Statement 1141 Evolving Issue Uncertain Tax Positions 1143 Review of the Asset-Liability Method 1144 APPENDIX 19A Comprehensive Example of Interperiod Tax Allocation 1147 First Year—2013 1147 Taxable Income and Income Taxes Payable—2013 1148 Computing Deferred Income Taxes— End of 2013 1148 Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes—2013 1149 Financial Statement Presentation—2013 1150 Second Year—2014 1151 Taxable Income and Income Taxes Payable—2014 1152 Computing Deferred Income Taxes—End of 2014 1152 Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes—2014 1153 Financial Statement Presentation—2014 1153 FASB Codification 1156 IFRS Insights 1175 Chapter 19 Where Have All the Pensions Gone? Nature of Pension Plans 1184 Defined Contribution Plan 1185 Defined Benefit Plan 1185 What Do the Numbers Mean? Which Plan Is Right for You? 1186 The Role of Actuaries in Pension Accounting 1187 Accounting for Pensions 1187 Alternative Measures of the Liability 1187 Recognition of the Net Funded Status of the Pension Plan 1189 Components of Pension Expense 1189 Using a Pension Worksheet 1192 2014 Entries and Worksheet 1192 Amortization of Prior Service Cost (PSC) 1194 2015 Entries and Worksheet 1195 Gain or Loss 1197 What Do the Numbers Mean? Pension Costs Ups and Downs 1198 Corridor Amortization 1199 Evolving Issue Bye Bye Corridor 1202 2016 Entries and Worksheet 1202 What Do the Numbers Mean? Roller Coaster 1204 Accounting for Income Taxes 1116 How Much Is Enough? Fundamentals of Accounting for Income Taxes 1118 Future Taxable Amounts and Deferred Taxes 1119 What Do the Numbers Mean? “Real Liabilities” 1122 Future Deductible Amounts and Deferred Taxes 1123 What Do the Numbers Mean? “Real Assets” 1125 Deferred Tax Asset—Valuation Allowance 1125 Income Statement Presentation 1126 Specific Differences 1127 Tax Rate Considerations 1130 What Do the Numbers Mean? Global Tax Rates 1131 Accounting for Net Operating Losses 1132 Loss Carryback 1132 Loss Carryforward 1132 Loss Carryback Example 1133 Loss Carryforward Example 1134 Chapter 20 Accounting for Pensions and Postretirement Benefits 1182 xix Reporting Pension Plans in Financial Statements 1204 Within the Financial Statements 1205 Within the Notes to the Financial Statements 1207 Example of Pension Note Disclosure 1208 2017 Entries and Worksheet—A Comprehensive Example 1210 Special Issues 1211 What Do the Numbers Mean? Who Guarantees the Guarantor? 1213 Concluding Observations 1215 APPENDIX 20A Accounting for Postretirement Benefits 1217 Accounting Guidance 1217 Differences Between Pension Benefits and Healthcare Benefits 1218 What Do the Numbers Mean? OPEBs—How Big Are They? 1219 Postretirement Benefits Accounting Provisions 1219 Obligations Under Postretirement Benefits 1220 Postretirement Expense 1220 Illustrative Accounting Entries 1221 2014 Entries and Worksheet 1221 Recognition of Gains and Losses 1223 2015 Entries and Worksheet 1223 Amortization of Net Gain or Loss in 2016 1224 Disclosures in Notes to the Financial Statements 1225 Actuarial Assumptions and Conceptual Issues 1225 What Do the Numbers Mean? Want Some Bad News? 1227 FASB Codification 1229 IFRS Insights 1250 Chapter 21 Accounting for Leases 1268 More Companies Ask, “Why Buy?” The Leasing Environment 1270 Who Are the Players? 1270 Advantages of Leasing 1272 What Do the Numbers Mean? Off-Balance-Sheet Financing 1273 Conceptual Nature of a Lease 1273 Accounting by the Lessee 1274 Capitalization Criteria 1275 Asset and Liability Accounted for Differently 1278 Capital Lease Method (Lessee) 1278 Operating Method (Lessee) 1281 What Do the Numbers Mean? Restatements on the Menu 1281 Comparison of Capital Lease with Operating Lease 1282 Evolving Issue Are You Liable? 1283 Accounting by the Lessor 1284 Economics of Leasing 1284 Classification of Leases by the Lessor 1285 xx Direct-Financing Method (Lessor) 1286 Operating Method (Lessor) 1289 Special Lease Accounting Problems 1289 Residual Values 1290 Sales-Type Leases (Lessor) 1296 What Do the Numbers Mean? Xerox Takes on the SEC 1298 Bargain-Purchase Option (Lessee) 1298 Initial Direct Costs (Lessor) 1298 Current versus Noncurrent 1299 Disclosing Lease Data 1300 Unresolved Lease Accounting Problems 1302 Evolving Issue Lease Accounting—If It Quacks Like a Duck 1303 APPENDIX 21A Sale-Leasebacks 1306 Determining Asset Use 1307 Lessee 1307 Lessor 1308 Sale-Leaseback Example 1308 FASB Codification 1313 IFRS Insights 1331 Chapter 22 Accounting Changes and Error Analysis 1342 In the Dark Accounting Changes 1344 Changes in Accounting Principle 1344 What Do the Numbers Mean? Quite a Change 1346 Retrospective Accounting Change Approach 1346 What Do the Numbers Mean? Change Management 1348 Direct and Indirect Effects of Changes 1355 Impracticability 1356 Changes in Accounting Estimates 1357 Prospective Reporting 1357 Disclosures 1358 Changes in Reporting Entity 1359 Accounting Errors 1359 Example of Error Correction 1361 Summary of Accounting Changes and Correction of Errors 1363 What Do the Numbers Mean? Can I Get My Money Back? 1364 Motivations for Change of Accounting Method 1365 Error Analysis 1366 Balance Sheet Errors 1366 Income Statement Errors 1367 Balance Sheet and Income Statement Errors 1367 Comprehensive Example: Numerous Errors 1370 What Do the Numbers Mean? Guard the Financial Statements! 1372 Preparation of Financial Statements with Error Corrections 1373 APPENDIX 22A Changing from or to the Equity Method 1377 Change from the Equity Method 1377 Dividends in Excess of Earnings 1377 Change to the Equity Method 1378 FASB Codification 1381 IFRS Insights 1404 Chapter 23 Statement of Cash Flows 1410 Show Me the Money! Preparation of the Statement of Cash Flows 1412 Usefulness of the Statement of Cash Flows 1412 Classification of Cash Flows 1413 What Do the Numbers Mean? How’s My Cash Flow? 1414 Format of the Statement of Cash Flows 1415 Steps in Preparation 1415 Illustrations—Tax Consultants Inc. 1416 Step 1: Determine the Change in Cash 1417 Step 2: Determine Net Cash Flow from Operating Activities 1417 What Do the Numbers Mean? Earnings and Cash Flow Management? 1419 Step 3: Determine Net Cash Flows from Investing and Financing Activities 1419 Statement of Cash Flows—2013 1419 Illustration—2014 1420 Illustration—2015 1423 Sources of Information for the Statement of Cash Flows 1426 Net Cash Flow from Operating Activities— Direct Method 1428 Evolving Issue Direct versus Indirect 1433 Special Problems in Statement Preparation 1434 Adjustments to Net Income 1434 Accounts Receivable (Net) 1438 What Do the Numbers Mean? Not What It Seems 1439 Other Working Capital Changes 1440 Net Losses 1440 Significant Noncash Transactions 1441 What Do the Numbers Mean? Cash Flow Tool 1442 Use of a Worksheet 1443 Preparation of the Worksheet 1444 Analysis of Transactions 1444 Preparation of Final Statement 1451 FASB Codification 1454 IFRS Insights 1480 Chapter 24 Full Disclosure in Financial Reporting 1486 High-Quality Financial Reporting—Always in Fashion Full Disclosure Principle 1488 Increase in Reporting Requirements 1489 Differential Disclosure 1489 Evolving Issue Disclosure—Quantity and Quality 1490 Notes to the Financial Statements 1491 Accounting Policies 1491 Common Notes 1491 What Do the Numbers Mean? Footnote Secrets 1493 Disclosure Issues 1493 Disclosure of Special Transactions or Events 1493 Post-Balance-Sheet Events (Subsequent Events) 1495 Reporting for Diversified (Conglomerate) Companies 1497 Interim Reports 1501 Evolving Issue It’s Faster but Is It Better? 1507 Auditor’s and Management’s Reports 1508 Auditor’s Report 1508 What Do the Numbers Mean? Heart of the Matter 1511 Management’s Reports 1511 Current Reporting Issues 1513 Reporting on Financial Forecasts and Projections 1513 What Do the Numbers Mean? Global Forecasts 1515 Internet Financial Reporting 1516 What Do the Numbers Mean? New Formats, New Disclosure 1517 Fraudulent Financial Reporting 1517 What Do the Numbers Mean? Disclosure Overload 1519 Criteria for Making Accounting and Reporting Choices 1520 APPENDIX 24A Basic Financial Statement Analysis 1522 Perspective on Financial Statement Analysis 1522 Ratio Analysis 1523 Limitations of Ratio Analysis 1524 Comparative Analysis 1526 Percentage (Common-Size) Analysis 1527 FASB Codification 1530 IFRS Insights 1548 Index I-1 xxi Acknowledgments Intermediate Accounting has benefited greatly from the input of focus group participants, manuscript reviewers, those who have sent comments by letter or e-mail, ancillary authors, and proofers. We greatly appreciate the constructive suggestions and innovative ideas of reviewers and the creativity and accuracy of the ancillary authors and checkers. Prior Edition Reviewers We greatly appreciate the over 250 reviewers who have assisted with the prior editions of Intermediate Accounting. Please visit the book’s companion website, at www.wiley.com/college/kieso, for a full listing of these instructors who have been invaluable in the development and continued improvement of our textbook. Fifteenth Edition Wendy Bailey, Northeastern University; Samuel Bass, Missouri State University; Susan Bennett, Wake Technical Community College; Elise A. Boyas, University of Pittsburgh; Jeff Brothers, Regis University; John Brozovsky, Virginia Polytechnic Institute and State University; Helen Brubeck, San Jose State University; Janie Casello Bouges, University of Massachusetts—Lowell; Tim Cangeleri, St. Joseph’s College; Kimberly D. Charland, Kansas State University; Elizabeth Conner, University of Colorado—Denver; Ming Lu Chun, Santa Monica College; Natalie Churyk, Northern Illinois University; Eugene Comiskey, Georgia Institute of Technology; Tim Coville, St. John’s University; Illia Dichev, Emory University; Bob Eskew, Purdue University; Tony Greig, University of Wisconsin—Madison; Lynne Hendrix, Hope College; Travis Holt, University of Tennessee; Allen Hunt, Southern Illinois University; John Jiang, Michigan State University; Mary Jo Jones, Eastern University; Lisa Koonce, University of Texas—Austin; Barbara Kren, Marquette University; Gaurav Kumar, University of Arkansas— Little Rock; Zining Li, Southern Methodist University; Ellen Lippman, University of Portland; Daphne Main, Loyola University—New Orleans. S.A. Marino, Westchester Community College; Ariel Markelevich, Suffolk University; Linda McDaniel, University of Kentucky; K. Bryan Menk, Virginia State University; Gerald Miller, The College of New Jersey; Kathleen Moffitt, Texas State University—San Marcos; Kanalis Ockree, Washburn University; Felicia Olagbemi, Colorado State University; Mitch Oler, Virginia Polytechnic Institute and State University; Keith Patterson, Brigham Young University—Idaho; Charles Pendola, St. Joseph’s College; Pete Poznanski, Cleveland State University; Jay Price, Utah State University; Terence Reilly, Albright University; Ken Reichelt, Louisiana State University; Ada Rodriguez, Lehman College, CUNY; Jack Rude, Bloomsburg University; Michael Ruff, Bentley University; August Saibeni, Cosumnes River College; Alexander J. Sannella, Rutgers University; Richard Schneible, University of Albany SUNY; Stephen Stubben, University of North Carolina—Chapel Hill; Stefanie Tate, University of Massachusetts—Lowell; Dan Teed, Troy University; Robin Thomas, North Carolina State University; Thomas Tyson, St. John Fisher College; Dan Wangerin, Michigan State University; Donna Whitten, Purdue University North Central; Kenneth Winter, University of Wisconsin—Madison; David Wright, University of Michigan; Jim Zapapas, Regis University; Lin Zheng, Mercer University. Special thanks to Kurt Pany, Arizona State University, for his input on auditor disclosure issues, and to Stephen A. Zeff, Rice University, for his comments on international accounting. xxii In addition, we thank the following colleagues who contributed to several of the unique features of this edition. Gateway to the Profession and Codification Cases Katie Adler, Deloitte LLP, Chicago; Jack Cathey, University of North Carolina—Charlotte; Michelle Ephraim, Worcester Polytechnic Institute; Erik Frederickson, Madison, Wisconsin; Danielle Griffin, KPMG, Chicago; Jason Hart, Deloitte LLP, Milwaukee; Frank Heflin, Florida State University; Mike Katte, SC Johnson, Racine, WI; Kelly Krieg, E & Y, Milwaukee; Jeremy Kunicki, Walgreens; Courtney Meier, Deloitte LLP, Milwaukee; Andrew Prewitt, KPMG, Chicago; Jeff Seymour, KPMG, Minneapolis; Matt Sullivan, Deloitte LLP, Milwaukee; Matt Tutaj, Deloitte LLP, Chicago; Jen Vaughn, PricewaterhouseCoopers, Chicago; Erin Viel, PricewaterhouseCoopers, Milwaukee. Ancillary Authors, Contributors, Proofers, and Accuracy Checkers LuAnn Bean, Florida Institute of Technology; Mary Ann Benson; John C. Borke, University of Wisconsin—Platteville; Jack Cathey, University of North Carolina—Charlotte; Jim Emig, Villanova University; Larry Falcetto, Emporia State University; Coby Harmon, University of California, Santa Barbara; Marilyn F. Hunt, Douglas W. Kieso, Aurora University; Mark Kohlbeck, Florida Atlantic University; Steven Lifland, High Point University; Ming Lu, Santa Monica College; Maureen Mascha, Marquette University; Barbara Muller, Arizona State University; Jill Misuraca, University of Tampa; Yvonne Phang, Borough of Manhattan Community College; John Plouffe, California State Polytechnic University—Pomona; Mark Riley, Northern Illinois University; Lynn Stallworth, Appalachian State University; Diane Tanner, University of North Florida; Sheila Viel, University of Wisconsin—Milwaukee; Dick D. Wasson, Southwestern College; Melanie Yon, San Diego University. Advisory Board We gratefully acknowledge the following members of the Intermediate Accounting Advisory Board for their advice and assistance with this edition. Steve Balsam, Temple University; Jack Cathey, University of North Carolina—Charlotte; Uday Chandra, State University of New York at Albany; Ruben Davila, University of Southern California; Doug deVidal, University of Texas—Austin; Sunita Goel, Siena College; Jeffrey Hales, Georgia Institute of Technology; Celina Jozsi, University of South Florida; Jocelyn Kauffunger, University of Pittsburgh; Adam Koch, University of Virginia; Roger Martin, University of Virginia; Mark Riley, Northern Illinois University; Karen Turner, University of Northern Colorado. Practicing Accountants and Business Executives From the fields of corporate and public accounting, we owe thanks to the following practitioners for their technical advice and for consenting to interviews. Mike Crooch, FASB (retired); Tracy Golden, Deloitte LLP; John Gribble, PricewaterhouseCoopers (retired); Darien Griffin, S.C. Johnson & Son; Michael Lehman, Sun Microsystems, Inc.; Tom Linsmeier, FASB; Michele Lippert, Evoke.com; Sue McGrath, Vision Capital Management; David Miniken, Sweeney Conrad; Robert Sack, University of Virginia; Clare Schulte, Deloitte LLP; Willie Sutton, Mutual Community Savings Bank, Durham, NC; Lynn Turner, former SEC Chief Accountant; Rachel Woods, PricewaterhouseCoopers; Arthur Wyatt, Arthur Andersen & Co., and the University of Illinois—Urbana. Finally, we appreciate the exemplary support and professional commitment given us by the development, marketing, production, and editorial staffs of John Wiley & Sons, including the following: George Hoffman, Susan Elbe, Chris DeJohn, Michael McDonald, Amy Scholz, Jesse Cruz, Valerie Vargas, Brian Kamins, Jackie MacKenzie, Allie Morris, Greg Chaput, Harry Nolan, Maureen Eide, and Kristine Carney. Thanks, too, to Suzanne Ingrao for her production work, to Denise Showers and the staff at Aptara®, Inc. for their work on the textbook, Cyndy Taylor, and to Matt Gauthier and the staff at Integra Publishing Services for their work on the solutions manual. 2011 annual report for our specimen financial statements. We also acknowledge permission from the American Institute of Certified Public Accountants, the Institute of Management Accountants, and the Institute of Internal Auditors to adapt and use material from the Uniform CPA Examinations, the CMA Examinations, and the CIA Examinations, respectively. We also appreciate the cooperation of the American Institute of Certified Public Accountants and the Financial Accounting Standards Board in permitting us to quote from their pronouncements. We thank The Procter & Gamble Company for permitting us to use its Jerry J. Weygandt Madison, Wisconsin Suggestions and comments from users of this book will be appreciated. Please feel free to e-mail any one of us at AccountingAuthors@yahoo.com. Donald E. Kieso Somonauk, Illinois Terry D. Warfield Madison, Wisconsin CHAPTER 1 Financial Accounting and Accounting Standards LEARNING OBJECTIVES After studying this chapter, you should be able to: 1 Identify the major financial statements and other means of financial reporting. 2 Explain how accounting assists in the efficient use of scarce resources. 3 Identify the objective of financial reporting. 6 Explain the meaning of generally accepted accounting principles (GAAP) and the role of the Codification for GAAP. 7 Describe the impact of user groups on the rule-making process. 4 Explain the need for accounting standards. 8 Describe some of the challenges facing financial reporting. 5 Identify the major policy-setting bodies and their role in the standard-setting process. 9 Understand issues related to ethics and financial accounting. We Can Do Better A recent report says it best: “Accounting information is central to the functioning of international capital markets and to managing small businesses, conducting effective government, understanding business processes, and . . . how economic decisions are made. . . . Across the globe, a common characteristic of economies that flourish is the presence of reliable accounting information.” Many in the United States take pride in our system of financial reporting as being the most robust and transparent in the world. But most would also comment that we can do better, particularly in light of the many accounting scandals that have occurred at companies like AIG, WorldCom, and Lehman Brothers, and the financial crisis of 2008. To better understand where we are today, the Center for Audit Quality conducts a yearly survey that measures investor confidence in such categories as U.S. capital markets, audited financial information, and U.S. publicly traded companies. Here are the results: The results indicate that the 2008 financial crisis took 90% a bite out of investor confidence. While investor confidence in U.S. markets, auditors, and public companies 80% has stabilized, the question is how can we improve? Here are some possibilities on how we can enhance the 70% existing system of financial reporting. 1. Today, equity securities are broadly held, with approximately half of American households investing in stocks. This presents a challenge—investors 50% have expressed concerns that one-size-fits-all financial reports do not meet the needs of the 40% spectrum of investors who rely on those reports. While many individual investors are more inter0% 2007 2010 2012 ested in summarized, plain-English reports, marConfidence in capita...
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