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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 Accounting 42 The Accounting Information System 86 Income Statement and Related Information 158 Balance Sheet and Statement of Cash Flows 212 Accounting and the Time Value of Money 308 Cash and Receivables 364 Valuation of Inventories: A Cost-Basis Approach 434 Inventories: Additional Valuation Issues 492 Acquisition and Disposition of Property, Plant, and Equipment 554 Depreciation, Impairments, and Depletion 604 Intangible Assets 664 Current Liabilities and Contingencies 720 Long-Term Liabilities 782 Stockholdersâ€™ Equity 842 Dilutive Securities and Earnings per Share 904 Investments 974 Revenue Recognition 1064 Accounting for Income Taxes 1142 Accounting for Pensions and Postretirement Benefits 1208 Accounting for Leases 1288 Accounting Changes and Error Analysis 1366 Statement of Cash Flows 1434 Full Disclosure in Financial Reporting 1512

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Contents Chapter 1

Financial Accounting and Accounting Standards

2

Thinking Outside the Box 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) 8 American Institute of Certified Public Accountants (AICPA) 9 Financial Accounting Standards Board (FASB) 10 Changing Role of the AICPA 13 Generally Accepted Accounting Principles 13 FASB Codification 14 What Do the Numbers Mean? You Have to Step Back 16 Issues in Financial Reporting 16 GAAP in a Political Environment 16 What Do the Numbers Mean? Fair Consequences? 17 The Expectations Gap 18 Financial Reporting Challenges 19 International Accounting Standards 20 Ethics in the Environment of Financial Accounting 20 Conclusion 21 FASB Codification 23 IFRS Insights 32

Chapter 2

Conceptual Framework for Financial Accounting

42

What Is It? Conceptual Framework 44 Need for a Conceptual Framework 44 What Do the Numbers Mean? What’s Your Principle? 45 Development of a Conceptual Framework 45 Overview of the Conceptual Framework 46 First Level: Basic Objective 47 Second Level: Fundamental Concepts 47 Qualitative Characteristics of Accounting Information 47

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What Do the Numbers Mean? Living in a Material World 50 What Do the Numbers Mean? Show Me the Earnings! 53 Basic Elements 54 Third Level: Recognition and Measurement Concepts 55 Basic Assumptions 56 What Do the Numbers Mean? Whose Company Is It? 56 Basic Principles of Accounting 58 Constraints 63 What Do the Numbers Mean? You May Need a Map 63 Summary of the Structure 65 FASB Codification 67 IFRS Insights 81

Chapter 3

The Accounting Information System 86 Needed: A Reliable Information System Accounting Information System 88 Basic Terminology 88 Debits and Credits 89 The Accounting Equation 90 Financial Statements and Ownership Structure 92 The Accounting Cycle 93 Identifying and Recording Transactions and Other Events 93 Journalizing 95 Posting 96 Trial Balance 100 Adjusting Entries 100 What Do the Numbers Mean? Am I Covered? 110 Adjusted Trial Balance 111 Preparing Financial Statements 111 What Do the Numbers Mean? 24/7 Accounting 113 Closing 113 Post-Closing Trial Balance 116 Reversing Entries 116 The Accounting Cycle Summarized 116 What Do the Numbers Mean? Statements, Please 117 Financial Statements for a Merchandising Company 117 Income Statement 117 Statement of Retained Earnings 117

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Balance Sheet 118 Closing Entries 119 APPENDIX 3A Cash-Basis Accounting versus Accrual-Basis Accounting 121 Conversion from Cash Basis to Accrual Basis 123 Service Revenue Computation 124 Operating Expense Computation 124 Theoretical Weaknesses of the Cash Basis 126 APPENDIX 3B Using Reversing Entries 126 Illustration of Reversing Entries—Accruals 126 Illustration of Reversing Entries—Deferrals 127 Summary of Reversing Entries 128 APPENDIX 3C Using a Worksheet: The Accounting Cycle Revisited 129 Worksheet Columns 129 Trial Balance Columns 129 Adjustments Columns 129 Adjustments Entered on the Worksheet 130 Adjusted Trial Balance 131 Income Statement and Balance Sheet Columns 131 Preparing Financial Statements from a Worksheet 131 IFRS Insights 153

Chapter 4

Income Statement and Related Information 158 Watch Out for Pro Forma 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 Single-Step Income Statements 163 Multiple-Step Income Statements 164 Condensed Income Statements 167 Reporting Irregular Items 168 What Do the Numbers Mean? Are One-Time Charges Bugging You? 169 Discontinued Operations 169 Extraordinary Items 170 What Do the Numbers Mean? Extraordinary Times 172 Unusual Gains and Losses 172 Changes in Accounting Principle 174 Changes in Estimates 174 Corrections of Errors 175 Summary of Irregular Items 176 Special Reporting Issues 177 Intraperiod Tax Allocation 177 Earnings per Share 178

Retained Earnings Statement 180 What Do the Numbers Mean? Different Income Concepts 181 Comprehensive Income 181 FASB Codification 186 IFRS Insights 204

Chapter 5

Balance Sheet and Statement of Cash Flows 212 Hey, It Doesn’t Balance! SECTION 1 Balance Sheet 214 Usefulness of the Balance Sheet 214 What Do the Numbers Mean? Grounded 214 Limitations of the Balance Sheet 215 Classification in the Balance Sheet 215 Current Assets 217 Noncurrent Assets 220 Liabilities 222 What Do the Numbers Mean? “Show Me the Assets!” 223 Owners’ Equity 225 Balance Sheet Format 225 What Do the Numbers Mean? Warning Signals 227 SECTION 2 Statement of Cash Flows 227 Purpose of the Statement of Cash Flows 227 What Do the Numbers Mean? Watch That Cash Flow 228 Content and Format of the Statement of Cash Flows 228 Overview of the Preparation of the Statement of Cash Flows 230 Sources of Information 230 Preparing the Statement of Cash Flows 230 Significant Noncash Activities 232 Usefulness of the Statement of Cash Flows 233 Financial Liquidity 233 Financial Flexibility 234 Free Cash Flow 234 What Do the Numbers Mean? “There Ought to Be a Law” 235 SECTION 3 Additional Information 236 Supplemental Disclosures 236 Contingencies 236 Accounting Policies 236 Contractual Situations 237 What Do the Numbers Mean? What About Your Commitments? 237 Fair Values 238 Techniques of Disclosure 239 Parenthetical Explanations 239 Notes 239 Cross-Reference and Contra Items 241 Supporting Schedules 241 Terminology 242

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APPENDIX 5A Ratio Analysis—A Reference 244 Using Ratios to Analyze Performance 244 APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company 246 FASB Codification 278 IFRS Insights 301

Chapter 6

Accounting and the Time Value of Money 308 The Magic of Interest Basic Time Value Concepts 310 Applications of Time Value Concepts 310 The Nature of Interest 311 Simple Interest 312 Compound Interest 312 What Do the Numbers Mean? A Pretty Good Start 313 Fundamental Variables 316 Single-Sum Problems 316 Future Value of a Single Sum 317 Present Value of a Single Sum 318 Solving for Other Unknowns in Single-Sum Problems 320 Annuities 321 Future Value of an Ordinary Annuity 322 Future Value of an Annuity Due 324 Examples of Future Value of Annuity Problems 325 Present Value of an Ordinary Annuity 327 What Do the Numbers Mean? Up in Smoke 329 Present Value of an Annuity Due 329 Examples of Present Value of Annuity Problems 330 More Complex Situations 332 Deferred Annuities 332 Valuation of Long-Term Bonds 334 Effective-Interest Method of Amortization of Bond Discount or Premium 335 Present Value Measurement 336 What Do the Numbers Mean? How Low Can They Go? 337 Choosing an Appropriate Interest Rate 337 Example of Expected Cash Flow 337 FASB Codification 340

Chapter 7

Cash and Receivables No-Tell Nortel Cash 366 What Is Cash? 366 Reporting Cash 366

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Summary of Cash-Related Items 368 What Do the Numbers Mean? Deep Pockets 369 Accounts Receivable 369 Recognition of Accounts Receivable 370 Valuation of Accounts Receivable 372 What Do the Numbers Mean? “Too Generous”? 378 Notes Receivable 378 Recognition of Notes Receivable 378 Valuation of Notes Receivable 382 What Do the Numbers Mean? Economic Consequences and Write-Offs 383 Special Issues 383 Fair Value Option 384 Disposition of Accounts and Notes Receivable 384 What Do the Numbers Mean? Return to Lender 389 Presentation and Analysis 391 APPENDIX 7A Cash Controls 395 Using Bank Accounts 395 The Imprest Petty Cash System 396 Physical Protection of Cash Balances 397 Reconciliation of Bank Balances 397 APPENDIX 7B Impairments of Receivables 400 Impairment Measurement and Reporting 401 Impairment Loss Example 401 What Do the Numbers Mean? Lost in Translation 402 Recording Impairment Losses 402 FASB Codification 403 IFRS Insights 428

Chapter 8

Valuation of Inventories: A Cost-Basis Approach 434 Inventories in the Crystal Ball Inventory Issues 436 Classification 436 Inventory Cost Flow 437 Inventory Control 439 What Do the Numbers Mean? Staying Lean 440 Basic Issues in Inventory Valuation 440 Physical Goods Included in Inventory 441 Goods in Transit 441 Consigned Goods 441 Special Sales Agreements 442 What Do the Numbers Mean? No Parking! 443 Effect of Inventory Errors 443 Costs Included in Inventory 446 Product Costs 446

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Period Costs 446 Treatment of Purchase Discounts 447 What Do the Numbers Mean? You May Need a Map 447 Which Cost Flow Assumption to Adopt? 448 Specific Identification 448 Average Cost 449 First-In, First-Out (FIFO) 450 Last-In, First-Out (LIFO) 451 Special Issues Related to LIFO 452 LIFO Reserve 452 What Do the Numbers Mean? Comparing Apples to Apples 453 LIFO Liquidation 454 Dollar-Value LIFO 455 What Do the Numbers Mean? Quite a Difference 460 Comparison of LIFO Approaches 460 Major Advantages of LIFO 461 Major Disadvantages of LIFO 462 Basis for Selection of Inventory Method 463 What Do the Numbers Mean? Repeal LIFO! 465 Inventory Valuation Methods—Summary Analysis 465 FASB Codification 468

Chapter 9

Inventories: Additional Valuation Issues 492 What Do Inventory Changes Tell Us? Lower-of-Cost-or-Market 494 Ceiling and Floor 495 How Lower-of-Cost-or-Market Works 496 Methods of Applying Lower-of-Cost-orMarket 497 Recording “Market” Instead of Cost 498 Use of an Allowance 499 Use of an Allowance—Multiple Periods 500 What Do the Numbers Mean? “Put It in Reverse” 500 Evaluation of the Lower-of-Cost-or-Market Rule 501 Valuation Bases 501 Valuation at Net Realizable Value 501 Valuation Using Relative Sales Value 502 Purchase Commitments—A Special Problem 503 The Gross Profit Method of Estimating Inventory 505 Computation of Gross Profit Percentage 506 Evaluation of Gross Profit Method 507 What Do the Numbers Mean? The Squeeze 508 Retail Inventory Method 508 Retail-Method Concepts 509

Retail Inventory Method with Markups and Markdowns—Conventional Method 510 Special Items Relating to Retail Method 513 Evaluation of Retail Inventory Method 513 Presentation and Analysis 514 Presentation of Inventories 514 Analysis of Inventories 515 APPENDIX 9A LIFO Retail Methods 518 Stable Prices—LIFO Retail Method 518 Fluctuating Prices—Dollar-Value LIFO Retail Method 519 Subsequent Adjustments Under Dollar-Value LIFO Retail 520 Changing from Conventional Retail to LIFO 521 FASB Codification 523 IFRS Insights 545

Chapter 10

Acquisition and Disposition of Property, Plant, and Equipment 554 Where Have All the Assets Gone? Property, Plant, and Equipment 556 Acquisition of Property, Plant, and Equipment 556 Cost of Land 557 Cost of Buildings 557 Cost of Equipment 558 Self-Constructed Assets 558 Interest Costs During Construction 559 What Do the Numbers Mean? What’s in Your Interest? 564 Observations 565 Valuation of Property, Plant, and Equipment 565 Cash Discounts 565 Deferred-Payment Contracts 565 Lump-Sum Purchases 566 Issuance of Stock 567 Exchanges of Nonmonetary Assets 568 What Do the Numbers Mean? About Those Swaps 573 Accounting for Contributions 573 Other Asset Valuation Methods 574 Costs Subsequent to Acquisition 574 What Do the Numbers Mean? Disconnected 575 Additions 576 Improvements and Replacements 576 Rearrangement and Reinstallation 577 Repairs 577 Summary of Costs Subsequent to Acquisition 578

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Disposition of Property, Plant, and Equipment 578 Sale of Plant Assets 578 Involuntary Conversion 579 Miscellaneous Problems 579 FASB Codification 581

Chapter 11

Depreciation, Impairments, and Depletion 604 Here Come the Write-Offs 604 Depreciation—A Method of Cost Allocation 606 Factors Involved in the Depreciation Process 606 What Do the Numbers Mean? Alphabet Dupe 608 Methods of Depreciation 608 Special Depreciation Methods 611 What Do the Numbers Mean? Decelerating Depreciation 613 Special Depreciation Issues 614 What Do the Numbers Mean? Depreciation Choices 617 Impairments 617 Recognizing Impairments 617 Measuring Impairments 618 Restoration of Impairment Loss 619 Impairment of Assets to Be Disposed of 619 Depletion 620 Establishing a Depletion Base 621 Write-Off of Resource Cost 622 Estimating Recoverable Reserves 623 Liquidating Dividends 623 Continuing Controversy 623 What Do the Numbers Mean? Rah-Rah Surprise 625 Presentation and Analysis 625 Presentation of Property, Plant, Equipment, and Natural Resources 625 Analysis of Property, Plant, and Equipment 627 APPENDIX 11A Income Tax Depreciation 630 Modified Accelerated Cost Recovery System 630 Tax Lives (Recovery Periods) 630 Tax Depreciation Methods 631 Example of MACRS System 632 Optional Straight-Line Method 633 Tax versus Book Depreciation 633 FASB Codification 633 IFRS Insights 653

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Chapter 12

Intangible Assets

664

Are We There Yet? Intangible Asset Issues 666 Characteristics 666 Valuation 666 Amortization of Intangibles 667 What Do the Numbers Mean? Definitely Indefinite 668 Types of Intangible Assets 669 Marketing-Related Intangible Assets 669 Customer-Related Intangible Assets 670 Artistic-Related Intangible Assets 670 Contract-Related Intangible Assets 671 Technology-Related Intangible Assets 671 What Do the Numbers Mean? Patent Battles 672 What Do the Numbers Mean? The Value of a Secret Formula 673 Goodwill 674 Impairment of Intangible Assets 677 Impairment of Limited-Life Intangibles 677 Impairment of Indefinite-Life Intangibles Other Than Goodwill 678 Impairment of Goodwill 678 Impairment Summary 679 What Do the Numbers Mean? Impairment Risk 680 Research and Development Costs 680 Identifying R&D Activities 681 Accounting for R&D Activities 682 Costs Similar to R&D Costs 682 What Do the Numbers Mean? Branded 685 Conceptual Questions 685 Presentation of Intangibles and Related Items 686 Presentation of Intangible Assets 686 Presentation of Research and Development Costs 686 APPENDIX 12A Accounting for Computer Software Costs 690 Diversity in Practice 690 The Profession’s Position 691 Accounting for Capitalized Software Costs 691 Reporting Software Costs 692 Setting Standards for Software Accounting 692 FASB Codification 694 IFRS Insights 712

Chapter 13

Current Liabilities and Contingencies 720 Now You See It, Now You Don’t SECTION 1 Current Liabilities 722 What Is a Liability? 722

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What Is a Current Liability? 722 Accounts Payable 723 Notes Payable 723 Current Maturities of Long-Term Debt 725 Short-Term Obligations Expected to Be Refinanced 725 What Do the Numbers Mean? What About That Short-Term Debt? 727 Dividends Payable 727 Customer Advances and Deposits 727 Unearned Revenues 728 What Do the Numbers Mean? Microsoft’s Liabilities—Good or Bad? 729 Sales Taxes Payable 729 Income Taxes Payable 730 Employee-Related Liabilities 730 Compensated Absences 732 SECTION 2 Contingencies 735 Gain Contingencies 735 Loss Contingencies 736 Likelihood of Loss 736 Litigation, Claims, and Assessments 738 Guarantee and Warranty Costs 739 Premiums and Coupons 741 What Do the Numbers Mean? Frequent Flyers 742 Environmental Liabilities 742 What Do the Numbers Mean? More Disclosure, Please 745 Self-Insurance 745 SECTION 3 Presentation and Analysis 746 Presentation of Current Liabilities 746 Presentation of Contingencies 748 Analysis of Current Liabilities 749 Current Ratio 749 Acid-Test Ratio 750 FASB Codification 752 IFRS Insights 773

Chapter 14

Long-Term Liabilities

782

Bonds versus Notes? SECTION 1 Bonds Payable 784 Issuing Bonds 784 Types and Ratings of Bonds 784 What Do the Numbers Mean? All About Bonds 785 Valuation of Bonds Payable—Discount and Premium 786 What Do the Numbers Mean? How’s My Rating? 788 Bonds Issued at Par on Interest Date 788 Bonds Issued at Discount or Premium on Interest Date 789 Bonds Issued Between Interest Dates 790

Effective-Interest Method 791 Bonds Issued at a Discount 791 Bonds Issued at a Premium 792 Accruing Interest 793 Classification of Discount and Premium 794 Costs of Issuing Bonds 794 Extinguishment of Debt 795 What Do the Numbers Mean? Your Debt Is Killing My Equity 796 SECTION 2 Long-Term Notes Payable 797 Notes Issued at Face Value 797 Notes Not Issued at Face Value 798 Zero-Interest-Bearing Notes 798 Interest-Bearing Notes 799 Special Notes Payable Situations 800 Notes Issued for Property, Goods, or Services 800 Choice of Interest Rate 801 Mortgage Notes Payable 802 Fair Value Option 803 Fair Value Measurement 803 Fair Value Controversy 803 SECTION 3 Reporting and Analyzing Long-Term Debt 804 Off-Balance-Sheet Financing 804 Different Forms 804 Rationale 805 What Do the Numbers Mean? Obligated 806 Presentation and Analysis of Long-Term Debt 806 Presentation of Long-Term Debt 806 Analysis of Long-Term Debt 808 APPENDIX 14A Troubled-Debt Restructurings 810 Settlement of Debt 811 Transfer of Assets 811 Granting of Equity Interest 812 Modification of Terms 812 Example 1—No Gain for Debtor 813 Example 2—Gain for Debtor 815 Concluding Remarks 816 FASB Codification 817 IFRS Insights 835

Chapter 15

Stockholders’ Equity

842

It’s a Global Market The Corporate Form of Organization 844 State Corporate Law 844 Capital Stock or Share System 844 Variety of Ownership Interests 845 What Do the Numbers Mean? A Class (B) Act 846 Corporate Capital 846 Issuance of Stock 847 What Do the Numbers Mean? The Case of the Disappearing Receivable 851

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Reacquisition of Shares 851 What Do the Numbers Mean? Signals to Buy? 852 What Do the Numbers Mean? Not So Good Anymore 855 Preferred Stock 856 Features of Preferred Stock 856 Accounting for and Reporting Preferred Stock 857 Dividend Policy 858 Financial Condition and Dividend Distributions 859 Types of Dividends 859 Stock Split 864 What Do the Numbers Mean? Splitsville 865 What Do the Numbers Mean? Dividends Up, Dividends Down 867 Disclosure of Restrictions on Retained Earnings 867 Presentation and Analysis of Stockholders’ Equity 868 Presentation 868 Analysis 870 APPENDIX 15A Dividend Preferences and Book Value per Share 873 Dividend Preferences 873 Book Value per Share 874 FASB Codification 876 IFRS Insights 895

What Do the Numbers Mean? A Little Honesty Goes a Long Way 921 SECTION 2 Computing Earnings per Share 921 Earnings per Share—Simple Capital Structure 922 Preferred Stock Dividends 922 Weighted-Average Number of Shares Outstanding 923 Comprehensive Example 925 Earnings per Share—Complex Capital Structure 926 Diluted EPS—Convertible Securities 927 Diluted EPS—Options and Warrants 929 Contingent Issue Agreement 930 Antidilution Revisited 931 EPS Presentation and Disclosure 932 What Do the Numbers Mean? Pro Forma EPS Confusion 933 Summary of EPS Computation 934 APPENDIX 16A Accounting for Stock-Appreciation Rights 936 SARS—Share-Based Equity Awards 936 SARS—Share-Based Liability Awards 936 Stock-Appreciation Rights Example 937 APPENDIX 16B Comprehensive Earnings per Share Example 939 Diluted Earnings per Share 940 FASB Codification 944 IFRS Insights 965

Chapter 16

Chapter 17

Dilutive Securities and Earnings per Share 904

Investments

Kicking the Habit SECTION 1 Dilutive Securities and Compensation Plans 906 Debt and Equity 906 Accounting for Convertible Debt 906 At Time of Issuance 907 At Time of Conversion 907 Induced Conversions 907 Retirement of Convertible Debt 908 Convertible Preferred Stock 908 What Do the Numbers Mean? How Low Can You Go? 909 Stock Warrants 909 Stock Warrants Issued with Other Securities 910 Rights to Subscribe to Additional Shares 913 Stock Compensation Plans 913 Accounting for Stock Compensation 915 Stock-Option Plans 915 Restricted Stock 917 Employee Stock-Purchase Plans 918 Disclosure of Compensation Plans 919 Debate over Stock-Option Accounting 919

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What to Do? Investment Accounting Approaches 976 SECTION 1 Investments in Debt Securities 976 Held-to-Maturity Securities 977 Available-for-Sale Securities 979 Example: Single Security 980 Example: Portfolio of Securities 981 Sale of Available-for-Sale Securities 981 Financial Statement Presentation 982 What Do the Numbers Mean? What Is Fair Value? 983 Trading Securities 983 SECTION 2 Investments in Equity Securities 984 Holdings of Less Than 20% 985 Available-for-Sale Securities 986 Trading Securities 988 Holdings Between 20% and 50% 988 Equity Method 988 What Do the Numbers Mean? Who’s in Control Here? 990 Holdings of More Than 50% 991

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SECTION 3 Other Reporting Issues 991 Fair Value Option 991 Available-for-Sale Securities 992 Equity Method of Accounting 992 Impairment of Value 992 Reclassification Adjustments 993 Comprehensive Example 995 Transfers Between Categories 997 Fair Value Controversy 998 Measurement Based on Intent 998 Gains Trading 998 Liabilities Not Fairly Valued 998 Fair Values—Final Comment 998 Summary of Reporting Treatment of Securities 998 What Do the Numbers Mean? More Disclosure, Please 999 APPENDIX 17A Accounting for Derivative Instruments 1001 Defining Derivatives 1001 Who Uses Derivatives, and Why? 1002 Producers and Consumers 1002 Speculators and Arbitrageurs 1002 Basic Principles in Accounting for Derivatives 1003 Example of Derivative Financial Instrument— Speculation 1004 Differences between Traditional and Derivative Financial Instruments 1006 What Do the Numbers Mean? Risky Business 1007 Derivatives Used for Hedging 1008 Fair Value Hedge 1008 Cash Flow Hedge 1010 Other Reporting Issues 1012 Embedded Derivatives 1012 Qualifying Hedge Criteria 1013 Summary of Derivatives Accounting 1014 Comprehensive Hedge Accounting Example 1015 Fair Value Hedge 1015 Financial Statement Presentation of an Interest Rate Swap 1017 Controversy and Concluding Remarks 1018 APPENDIX 17B Variable-Interest Entities 1020 What About GAAP? 1020 Consolidation of Variable-Interest Entities 1021 Some Examples 1022 What Is Happening in Practice? 1022 APPENDIX 17C Fair Value Measurements and Disclosures 1023 Disclosure of Fair Value Information: Financial Instruments—No Fair Value Option 1023 Disclosure of Fair Value Information: Financial Instruments—Fair Value Option 1025 Disclosure of Fair Values: Impaired Assets or Liabilities 1025 FASB Codification 1026 IFRS Insights 1048

Chapter 18

Revenue Recognition

1164

It’s Back Current Environment 1066 Guidelines for Revenue Recognition 1067 Departures from the Sale Basis 1068 What Do the Numbers Mean? Liability or Revenue? 1069 Revenue Recognition at Point of Sale (Delivery) 1069 Sales with Discounts 1070 Sales with Right of Return 1071 Sales with Buybacks 1073 Bill and Hold Sales 1074 Principal-Agent Relationships 1074 What Do the Numbers Mean? Grossed Out 1075 Trade Loading and Channel Stuffing 1077 What Do the Numbers Mean? No Take-Backs 1077 Multiple-Deliverable Arrangements 1078 Summary of Revenue Recognition Methods 1080 Revenue Recognition Before Delivery 1081 Percentage-of-Completion Method 1082 Completed-Contract Method 1087 Long-Term Contract Losses 1088 Disclosures in Financial Statements 1091 What Do the Numbers Mean? Less Conservative 1091 Completion-of-Production Basis 1092 Revenue Recognition after Delivery 1092 Installment-Sales Method 1092 Cost-Recovery Method 1101 Deposit Method 1102 Summary of Product Revenue Recognition Bases 1103 Concluding Remarks 1103 APPENDIX 18A Revenue Recognition for Franchises 1105 Initial Franchise Fees 1106 Example of Entries for Initial Franchise Fee 1106 Continuing Franchise Fees 1107 Bargain Purchases 1107 Options to Purchase 1108 Franchisor’s Cost 1108 Disclosures of Franchisors 1108 FASB Codification 1109 IFRS Insights 1134

Chapter 19

Accounting for Income Taxes

1142

How Much Is Enough? Fundamentals of Accounting for Income Taxes 1144 Future Taxable Amounts and Deferred Taxes 1145

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What Do the Numbers Mean? “Real Liabilities” 1148 Future Deductible Amounts and Deferred Taxes 1149 What Do the Numbers Mean? “Real Assets” 1151 Income Statement Presentation 1152 Specific Differences 1153 Tax Rate Considerations 1156 What Do the Numbers Mean? Global Tax Rates 1157 Accounting for Net Operating Losses 1158 Loss Carryback 1158 Loss Carryforward 1158 Loss Carryback Example 1159 Loss Carryforward Example 1159 What Do the Numbers Mean? NOLs: Good News or Bad? 1163 Financial Statement Presentation 1164 Balance Sheet 1164 Income Statement 1165 Uncertain Tax Positions 1168 What Do the Numbers Mean? Sheltered 1169 Review of the Asset-Liability Method 1169 APPENDIX 19A Comprehensive Example of Interperiod Tax Allocation 1173 First Year—2011 1173 Taxable Income and Income Taxes Payable—2011 1174 Computing Deferred Income Taxes— End of 2011 1174 Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes—2011 1175 Financial Statement Presentation—2011 1176 Second Year—2012 1177 Taxable Income and Income Taxes Payable—2012 1178 Computing Deferred Income Taxes—End of 2012 1178 Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes—2012 1179 Financial Statement Presentation—2012 1179 FASB Codification 1180 IFRS Insights 1199

Chapter 20

Accounting for Pensions and Postretirement Benefits 1208 Where Have All the Pensions Gone? Nature of Pension Plans 1210 Defined Contribution Plan 1211 Defined Benefit Plan 1211 What Do the Numbers Mean? Which Plan Is Right for You? 1212 The Role of Actuaries in Pension Accounting 1213

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Accounting for Pensions 1213 Alternative Measures of the Liability 1213 Recognition of the Net Funded Status of the Pension Plan 1215 Components of Pension Expense 1215 Using a Pension Worksheet 1218 2012 Entries and Worksheet 1218 Amortization of Prior Service Cost (PSC) 1220 2013 Entries and Worksheet 1221 Gain or Loss 1223 What Do the Numbers Mean? Pension Costs Ups and Downs 1224 2014 Entries and Worksheet 1227 What Do the Numbers Mean? Roller Coaster 1229 Reporting Pension Plans in Financial Statements 1229 Within the Financial Statements 1230 Within the Notes to the Financial Statements 1232 Example of Pension Note Disclosure 1233 2015 Entries and Worksheet—A Comprehensive Example 1235 Special Issues 1236 What Do the Numbers Mean? Bailing Out 1239 Concluding Observations 1239 APPENDIX 20A Accounting for Postretirement Benefits 1241 Accounting Guidance 1241 Differences Between Pension Benefits and Healthcare Benefits 1242 What Do the Numbers Mean? OPEBs— How Big Are They? 1243 Postretirement Benefits Accounting Provisions 1243 Obligations Under Postretirement Benefits 1244 Postretirement Expense 1245 Illustrative Accounting Entries 1245 2012 Entries and Worksheet 1246 Recognition of Gains and Losses 1247 2013 Entries and Worksheet 1247 Amortization of Net Gain or Loss in 2014 1249 Disclosures in Notes to the Financial Statements 1249 Actuarial Assumptions and Conceptual Issues 1249 What Do the Numbers Mean? GASB Who? 1251 FASB Codification 1252 IFRS Insights 1274

Chapter 21

Accounting for Leases

1288

More Companies Ask, “Why Buy?” The Leasing Environment 1290 Who Are the Players? 1290 Advantages of Leasing 1292

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What Do the Numbers Mean? Off–Balance-Sheet Financing 1293 Conceptual Nature of a Lease 1293 Accounting by the Lessee 1294 Capitalization Criteria 1294 Asset and Liability Accounted for Differently 1298 Capital Lease Method (Lessee) 1298 Operating Method (Lessee) 1301 What Do the Numbers Mean? Restatements on the Menu 1301 Comparison of Capital Lease with Operating Lease 1302 What Do the Numbers Mean? Are You Liable? 1303 Accounting by the Lessor 1304 Economics of Leasing 1305 Classification of Leases by the Lessor 1305 Direct-Financing Method (Lessor) 1307 Operating Method (Lessor) 1309 Special Accounting Problems 1310 Residual Values 1310 Sales-Type Leases (Lessor) 1316 What Do the Numbers Mean? Xerox Takes On the SEC 1319 Bargain-Purchase Option (Lessee) 1319 Initial Direct Costs (Lessor) 1320 Current versus Noncurrent 1320 Disclosing Lease Data 1321 Lease Accounting—Unresolved Problems 1323 APPENDIX 21A Examples of Lease Arrangements 1327 Example 1: Harmon, Inc. 1328 Example 2: Arden’s Oven Co. 1329 Example 3: Mendota Truck Co. 1329 Example 4: Appleland Computer 1330 APPENDIX 21B Sale-Leasebacks 1331 Determining Asset Use 1331 Lessee 1332 Lessor 1332 Sale-Leaseback Example 1332 FASB Codification 1334 IFRS Insights 1355

Chapter 22

Accounting Changes and Error Analysis 1366 In the Dark SECTION 1 Accounting Changes 1368 Changes in Accounting Principle 1368 What Do the Numbers Mean? Quite a Change 1370 Retrospective Accounting Change Approach 1370

What Do the Numbers Mean? Change Management 1372 Impracticability 1379 Changes in Accounting Estimate 1381 Prospective Reporting 1381 Disclosures 1382 Change in Reporting Entity 1383 Correction of Errors 1383 Example of Error Correction 1385 Summary of Accounting Changes and Correction of Errors 1387 What Do the Numbers Mean? Can I Get My Money Back? 1388 Motivations for Change of Accounting Method 1389 SECTION 2 Error Analysis 1390 Balance Sheet Errors 1390 Income Statement Errors 1391 Balance Sheet and Income Statement Errors 1391 Counterbalancing Errors 1391 Noncounterbalancing Errors 1393 Comprehensive Example: Numerous Errors 1394 What Do the Numbers Mean? Guard the Financial Statements! 1396 Preparation of Financial Statements with Error Corrections 1397 APPENDIX 22A Changing from or to the Equity Method 1401 Change from the Equity Method 1401 Dividends in Excess of Earnings 1401 Change to the Equity Method 1402 FASB Codification 1404 IFRS Insights 1428

Chapter 23

Statement of Cash Flows

1434

Show Me the Money SECTION 1 Preparation of the Statement of Cash Flows 1436 Usefulness of the Statement of Cash Flows 1436 Classification of Cash Flows 1437 What Do the Numbers Mean? How’s My Cash Flow? 1438 Format of the Statement of Cash Flows 1439 Steps in Preparation 1439 First Example—2011 1440 Step 1: Determine the Change in Cash 1441 Step 2: Determine Net Cash Flow from Operating Activities 1441 What Do the Numbers Mean? Pumping Up Cash 1443 Step 3: Determine Net Cash Flows from Investing and Financing Activities 1443 Statement of Cash Flows—2011 1444

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Second Example—2012 1445 Step 1: Determine the Change in Cash 1445 Step 2: Determine Net Cash Flow from Operating Activities—Indirect Method 1445 Step 3: Determine Net Cash Flows from Investing and Financing Activities 1446 Statement of Cash Flows—2012 1447 Third Example—2013 1447 Step 1: Determine the Change in Cash 1448 Step 2: Determine Net Cash Flow from Operating Activities—Indirect Method 1449 Step 3: Determine Net Cash Flows from Investing and Financing Activities 1450 Statement of Cash Flows—2013 1450 Sources of Information for the Statement of Cash Flows 1451 Net Cash Flow from Operating Activities— Indirect versus Direct Method 1452 Indirect Method 1452 Direct Method—An Example 1452 Direct versus Indirect Controversy 1457 What Do the Numbers Mean? Not What It Seems 1458 SECTION 2 Special Problems in Statement Preparation 1459 Adjustments to Net Income 1459 Depreciation and Amortization 1459 Postretirement Benefit Costs 1459 Change in Deferred Income Taxes 1459 Equity Method of Accounting 1459 Losses and Gains 1460 Stock Options 1461 Extraordinary Items 1461 Accounts Receivable (Net) 1462 Indirect Method 1463 Direct Method 1463 Other Working Capital Changes 1464 Net Losses 1465 Significant Noncash Transactions 1465 What Do the Numbers Mean? Cash Flow Tool 1467 SECTION 3 Use of a Worksheet 1467 Preparation of the Worksheet 1469 Analysis of Transactions 1471 Change in Retained Earnings 1471 Accounts Receivable (Net) 1471 Inventory 1472 Prepaid Expense 1472 Investment in Stock 1472 Land 1472 Equipment and Accumulated Depreciation 1473 Building Depreciation and Amortization of Trademarks 1473 Other Noncash Charges or Credits 1473 Common Stock and Related Accounts 1474 Final Reconciling Entry 1474

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Preparation of Final Statement 1476 FASB Codification 1478 IFRS Insights 1505

Chapter 24

Full Disclosure in Financial Reporting 1512 High-Quality Financial Reporting—Always in Fashion Full Disclosure Principle 1514 Increase in Reporting Requirements 1515 Differential Disclosure 1515 What Do the Numbers Mean? “The Heart of the Matter” 1516 Notes to the Financial Statements 1516 Accounting Policies 1516 Common Notes 1517 What Do the Numbers Mean? Footnote Secrets 1519 Disclosure Issues 1519 Disclosure of Special Transactions or Events 1519 Post-Balance-Sheet Events (Subsequent Events) 1521 Reporting for Diversified (Conglomerate) Companies 1522 Interim Reports 1528 What Do the Numbers Mean? “I Want It Faster” 1533 Auditor’s and Management’s Reports 1533 Auditor’s Report 1533 Management’s Reports 1536 Current Reporting Issues 1538 Reporting on Financial Forecasts and Projections 1538 Internet Financial Reporting 1541 What Do the Numbers Mean? New Formats, New Disclosure 1542 Fraudulent Financial Reporting 1542 What Do the Numbers Mean? Disclosure Overload 1544 Criteria for Making Accounting and Reporting Choices 1545 APPENDIX 24A Basic Financial Statement Analysis 1547 Perspective on Financial Statement Analysis 1547 Ratio Analysis 1548 Limitations of Ratio Analysis 1549 Comparative Analysis 1551 Percentage (Common-Size) Analysis 1552 FASB Codification 1554 IFRS Insights 1573 Index I-1

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