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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
INTERMEDIATE ACCOUNTING 16E
D E D I C A T E D T O
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BRV ISBN-13 978-1-118-74297-6
The inside back cover will contain printing identification and country of origin if omitted from this page. In addition, if the ISBN on the back cover differs from the ISBN on this page, the one on the back cover is correct.
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10 9 8 7 6 5 4 3 2 1
1 Financial Accounting and Accounting Standards 2
2 Conceptual Framework for Financial Reporting 36
3 The Accounting Information System 78 4 Income Statement and Related Information 152 5 Balance Sheet and Statement of Cash
Flows 200 6 Accounting and the Time Value of Money 266 7 Cash and Receivables 324 8 Valuation of Inventories: A Cost-Basis
Approach 386 9 Inventories: Additional Valuation Issues 442 10 Acquisition and Disposition of Property, Plant,
and Equipment 502 11 Depreciation, Impairments, and Depletion 552 12 Intangible Assets 610 13 Current Liabilities and Contingencies 658 14 Long-Term Liabilities 718 15 Stockholders’ Equity 774 16 Dilutive Securities and Earnings per Share 834 17 Investments 898 18 Revenue Recognition 978 19 Accounting for Income Taxes 1052 20 Accounting for Pensions and Postretirement
Benefits 1116 21 Accounting for Leases 1194 22 Accounting Changes and Error Analysis 1266 23 Statement of Cash Flows 1330 24 Full Disclosure in Financial Reporting 1402
APPENDICES A Private Company Accounting A-1 B Specimen Financial Statements: The Procter &
Gamble Company B-1 C Specimen Financial Statements: The Coca-Cola
Company C-1 D Specimen Financial Statements: PepsiCo, Inc. D-1 E Specimen Financial Statements: Marks and
Spencer plc E-1
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 GAAP and IFRS One of the most important innovations shaping our capital markets was the idea of 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 would make it easier for interna- tional investors to compare the financial results of companies from different countries. Fortunately, GAAP and international accounting standards have converged to result in a number of common standards between 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 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 under- stand what GAAP is and how it is applied in practice. With this Sixteenth Edition, we strive to con- tinue to provide the material needed to understand this subject area. The textbook is comprehen- sive 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.
We are excited about Intermediate Accounting, Sixteenth 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 Jerry J. Weygandt Terry D. Warfield Somonauk, Illinois Madison, Wisconsin Madison, Wisconsin
“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 p repares you for advanced study, profes- sional 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.”
From the Authors
Author Commitment Don Kieso 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 Secretary-Treasurer 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 Weygandt 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 j ournals. 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 Warfield TERRY D. WARFIELD, PhD, is the PwC 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, and he currently serves as a trustee of the Financial Accounting Foundation. 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.
The Sixteenth 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.
WileyPLUS with ORION Over 3,500 questions, including new medium-level, computational, and accounting-cycle- based questions, are available for practice and review. is an adaptive study and practice tool that helps students build proficiency in course topics.
WileyPLUS Videos Over 150 videos are available in WileyPLUS. The videos walk students through relevant home- work problems and solutions and review important concepts.
Review and Practice and Solutions New practice opportunities with solutions are integrated throughout the textbook and WileyPLUS course. Each textbook chapter now provides students with a Review and Practice section that includes learning objective summaries, a key term listing, and a practice problem with solution.
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 signifi cantly revised several chapters.
CHAPTER 4 Income Statement and Related Information
• Revised discussion and presentation of unusual and infrequent gains and losses, as well as discontinued operations, per recent accounting standards.
• Deleted discussion of extraordinary items to reflect the most recent accounting standards.
CHAPTER 9 Inventories: Additional Valuation Issues
• New discussion and end-of-chapter material on lower-of-cost-or-net realizable value and lower-of-cost-or-market to reflect the most recent accounting standards.
CHAPTER 17 Investments
• Discussion and update of material in response to the recent standard on classification and measurement.
CHAPTER 18 Revenue Recognition
• New discussion based on the recent FASB ruling on the revenue recognition principle. Legacy GAAP discussion is available online.
See the next two pages for a complete list of content revisions by chapter.
Content Changes by Chapter Chapter 1: Financial Accounting and Accounting
Standards • Updated discussion on diminishing role of AICPA in
standard-setting process. • Added discussion on potential abuse of historical cost
valuation within Evolving Issue box on fair value. • New discussion on whether convergence of GAAP
and IFRS will really occur. • New Concepts of Analysis case on financial crisis of
2008. • Significantly updated IFRS Insights section to include
most recent information on convergence efforts.
Chapter 2: Conceptual Framework for Financial Reporting
• New discussion on how the IASB is now moving for- ward on its own conceptual framework instead of a continuation of a joint FASB/IASB project.
• New WDNM boxes on (1) how the use of unconven- tional financial terms in statements can mislead inves- tors and (2) the use of pro forma measures.
Chapter 3: The Accounting Information System • Completely revised and updated opening story on
economic crime and importance of effective inter- nal controls of a company’s accounting information system.
Chapter 4: Income Statement and Related Information • New opening story on how Groupon’s adjusted
EBITDA reflects trend of companies employing pro forma reporting and concerns with that practice.
• Completely revised Discontinued Operations section per recent FASB standard.
• Completely revised Unusual and Infrequent Gains and Losses section per recent FASB standard.
• Deleted Extraordinary Items section per recent FASB standard.
Chapter 5: Balance Sheet and Statement of Cash Flows • New discussion of IBM’s financial flexibility within
WDNM box on importance of cash flow information for investors.
• Moved P&G’s financial statements to Appendix B at end of textbook; the complete annual report is available online.
Chapter 6: Accounting and the Time Value of Money • Changed interest rates on many of the in-chapter
examples to reflect more realistic data.
Chapter 7: Cash and Receivables • New opening story on companies moving their prof-
its to overseas operations to avoid taxes. Previous
opening story, on sources of companies’ earnings, now updated and placed as a WDNM box.
• New WDNM box, on where companies park their cash. • Thoroughly updated discussion of recognition and
valuation of accounts receivable, per latest FASB stan- dard, including deleting percentage-of-sales approach.
• Updated discussion of securitizations, now placed as a WDNM box.
• Appendix 7B, Impairments of Receivables, now Collectibility Assessment Based on Expected Cash Flows, per recent FASB standard. Impairment Evaluation Process in IFRS Insights section also delet- ed accordingly.
Chapter 8: Valuation of Inventories: A Cost-Basis Approach
• Updated discussion on ownership of goods and costs to include in inventory, per recent FASB standard.
• Inventory errors discussion moved to end of chapter, for improved flow of discussion.
Chapter 9: Inventories: Additional Valuation Issues • Updated discussion of lower-of-cost-and-net realizable
value and lower-of-cost-or-market, per recent FASB pronouncement. New EOC Exercises and Problems related to this discussion.
• New table highlighting disadvantages of the gross profit method.
• New WDNM box on price fixing, and how new tech- nology on changing store prices can reduce the cost of implementing the retail inventory method.
Chapter 10: Acquisition and Disposition of Property, Plant, and Equipment
• Updated opening story on importance of and capital expenditures related to property, plant, and equipment for many companies.
Chapter 11: Depreciation, Impairments, and Depletion • Generally updated for new design, content, and recent
Chapter 12: Intangible Assets • New WDNM boxes on (1) including internally gener-
ated intangible assets in the financial statements and (2) global R&D incentives.
• New footnotes on recent guidance for private companies in the accounting for goodwill.
• Moved up Presentation of Intangible Assets section within chapter for improved flow of topics.
Chapter 13: Current Liabilities and Contingencies • Moved discussion of current maturities of long-term
debt and short-term obligations expected to be
refinanced to end of Current Liabilities section for improved flow of discussion.
• New illustrations highlighting the entries required to record unearned revenues, payroll deductions, and bonus agreements.
• New footnote on refinancing criteria, to inform about FASB’s latest deliberations regarding them in light of the Board’s simplification initiative.
• Rewritten discussion of warranties, per latest FASB standard.
• New WDNM box, on how companies’ extension of payment terms affects their current ratios and there- fore analysis of them.
Chapter 14: Long-Term Liabilities • Updated WDNM box on bond ratings for most recent
trends and information. • New footnote explaining why the effective-interest
rate will be higher on bonds issued at a discount rate based on the reduced carrying value.
• Deleted Costs of Issuing Bonds section per latest FASB standard.
Chapter 15: Stockholders’ Equity • Moved up discussion of preferred stock for improved
flow of discussion. • New illustrations on common stock issuance, cash
dividends, property dividends, liquidating dividends, and stock dividends to highlight journal entry proce- dures.
• Updated WDNM boxes for the most recent corporate information and trends on stock buybacks, classes of stock, stock splits, and dividends.
Chapter 16: Dilutive Securities and Earnings per Share • Revised WDNM box on convertible bonds, to include
most recent information and trends. • New WDNM box on FASB’s proposal of fair value
method for accounting for stock options.
Chapter 17: Investments • Discussion reflects proposed 2016 FASB pronounce-
ment on accounting for investments. • New WDNM boxes on (1) recent trend of many large
banks shifting debt investment portfolios into the held- to-maturity category as protection against market volatility, and (2) issue of how mutual funds assign a current value to private technology companies.
• Rewrote Impairment section, as well as Fair Value Hedge section in Appendix 17A, to reflect proposed FASB pronouncement.
• Deleted Appendix 17B on variable-interest entities.
Chapter 18: Revenue Recognition • New section with extended example of the five-step
revenue recognition model, to give students a good understanding/overview before more advanced issues are discussed.
• Right of Return section completely rewritten as Sales Returns and Allowances, with more explanations and examples, per new FASB standard.
• EOC material includes many new Brief Exercises, Exercises, and Problems, to reflect new FASB stand- ard and terminology.
Chapter 19: Accounting for Income Taxes • New section on financial statement effects of future
taxable amounts and deferred taxes. • Rewrote balance sheet classification section, to reflect
recent FASB pronouncement. • Completely revised Financial Statement Presentation
section, including new material on note disclosure.
Chapter 20: Accounting for Pensions and Postretirement Benefits
• Generally updated for new design, content, and recent developments.
Chapter 21: Accounting for Leases • Updated Evolving Issue boxes, to coincide with
expected new FASB leasing rules. • New WDNM box on how GM realized losses due to
inaccurate estimates of residual value profits.
Chapter 22: Accounting Changes and Error Analysis • New WDNM box on whether changes for accounting
estimates are motivated by attempt to provide more useful information or to make financial results look better.
• Motivations for Change of Accounting Method section now a WDNM box.
Chapter 23: Statement of Cash Flows • Extraordinary Items section now Unusual and
Infrequent Items, to conform to new FASB treatment. • Expanded footnote on reporting of significant noncash
transactions, as they can significantly affect analysts’ assessments of capital expenditures and free cash flow.
• New marginal T-accounts in Use of a Worksheet section, to help demonstrate adjustments made to the accounts.
• New WDNM box, on COROA (cash operating return on assets), a new measure of profitability.
Chapter 24: Full Disclosure in Financial Reporting • Updated Evolving Issue box on issue of financial
disclosure, to include recent developments on the FASB’s Disclosure Framework project.
• Deleted discussion of extraordinary items, to conform to new FASB treatment.
New Appendices A-E • Appendix A: Private Company Accounting (private
company alternatives for intangible assets and goodwill)
• Appendix B: Financial statements for The Procter & Gamble Company
• Appendix C: Financial statements for The Coca-Cola Company
• Appendix D: Financial statements for PepsiCo, Inc. • Appendix E: Financial statements for Marks and
This edition continues to provide numerous 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.
PREVIEW OF CHAPTER 12 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.
INTANGIBLE ASSET ISSUES
• Characteristics • Valuation • Amortization
TYPES OF INTANGIBLES
• Marketing-related • Customer-related • Artistic-related • Contract-related • Technology-related • Goodwill
IMPAIRMENT AND PRESENTATION OF INTANGIBLES
• Limited-life intangibles • Indefinite-life intangibles
other than goodwill • Goodwill • Presentation
RESEARCH AND DEVELOPMENT COSTS
• Identifying R&D • Accounting for R&D • Similar costs • Presentation
This chapter also includes numerous conceptual and international discussions that are integral to the topics presented here.
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WHAT DO THE NUMBERS MEAN? The “What do the numbers mean?” boxes further students’ understanding of key concepts with practical, real-world examples.
WHAT DO THE NUMBERS MEAN? KEEP YOUR HANDS OFF MY INTANGIBLE!
Source: “Converse Sues to Protect Its Chuck Taylor All Stars,” The New York Times (October 14, 2014).
Companies go to great extremes to protect their valuable intangible assets. Consider how the creators of the highly suc- cessful game Trivial Pursuit protected their creation. First, they copyrighted the 6,000 questions that are at the heart of the game. Then they shielded the Trivial Pursuit name by applying for a registered trademark. As a third mode of protection, they obtained a design patent on the playing board’s design as a unique graphic creation.
Another more recent example is the case of Converse and its efforts to protect its classic Chuck Taylor trademark. Converse (owned by Nike) accused 31 companies (including
Wal-Mart Stores, Inc., Kmart, and Skechers) of trademark infringement for co-opting its widely recognizable Chuck Taylor® sneakers. While Converse is suing for monetary dam- ages, its main goal is to get these imposters off store shelves. The company went as far as fi ling a separate complaint with the International Trade Commission to stop any shoes consid- ered to be counterfeit from entering the country. That Converse (Nike) is going to these ends to protect its trademark is under- standable given that Nike reinvigorated the brand by expanding the franchise, introducing more colors and styles, and helping to push All Stars® into overseas markets.
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UNDERLYING CONCEPTS The Underlying Concepts highlight and explain major conceptual topics in the chapter.
INTERNATIONAL PERSPECTIVE International Perspectives provide students with specific examples of how global companies (and countries) implement key accounting regulations. They also provide examples of how and where IFRS differs from GAAP.
The controversy sur- rounding the accounting for R&D expenditures refl ects a debate about whether such expendi- tures meet the defi nition of an asset. If so, then an “expense all R&D costs” policy results in overstated expenses and understated assets.
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IFRS requires the capitalization of certain development expendi- tures. This confl icts with GAAP.
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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.
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 benefi ting future peri- ods is conceptually incorrect.
Proponents of immediate expensing contend that from an income statement standpoint, long-run application of this stan- dard 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 expens- ing or capitalization and subsequent amortization.
Others criticize this practice. They believe that the balance sheet should report an intangible asset related to expenditures that have future benefi t. To preclude capitalization of all R&D expenditures removes from the balance sheet what may be a company’s most valuable asset.
Indeed, research fi ndings indicate that capitalizing R&D costs may be helpful to investors. For example, one study showed a signifi cant relationship between R&D outlays and subsequent benefi ts in the form of increased productivity, earnings, and share- holder value for R&D-intensive companies. Another study found that there was a signifi cant decline in earnings’ usefulness for companies that were forced to switch from capitalizing to expens- ing R&D costs, and that the decline appears to persist over time.
The current accounting for R&D and other internally gener- ated intangible assets represents one of the many trade-offs made among relevance, faithful representation, and cost- benefi t considerations. The FASB and IASB have completed some lim- ited-scope projects on the accounting for intangible assets, and the Boards have contemplated a joint project on the accounting for identifi able intangible assets (i.e., excluding goodwill). Such a project would address concerns that the current accounting requirements lead to inconsistent treatments for some types of intangible assets depending on how they arise.
Sources for research studies: Baruch Lev and Theodore Sougiannis, “The Capitalization, Amortization, and Value-Relevance of R&D,” Journal of Accounting and Economics (February 1996); and Martha L. Loudder and Bruce K. Behn, “Alternative Income Determination Rules and Earnings Useful- ness: The Case of R&D Costs,” Contemporary Accounting Research (Fall 1995).
EVOLVING ISSUE RECOGNITION OF R&D AND INTERNALLY GENERATED INTANGIBLES
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Key Learning Features
BRIDGE TO THE PROFESSION NEW to this edition, this section now includes FASB Codification References, Codification Exercises, and a Codification Research Case, all designed to refer students to the relevant FASB literature for key concepts in the text and provide assessment of their understanding.
REVIEW AND PRACTICE NEW Review and Practice section includes Key Terms Review, Learning Objectives Review, and a Practice Problem with Solution. In addition, multiple-choice questions with solutions, review exercises with solutions, and a full glossary of all key terms are available online.
LEARNING OBJECTIVES REVIEW 1 Describe the characteristics, valuation, and amortization of intangible assets. Intangible assets have two main
characteristics: (1) they lack physical existence, and (2) they are not financial instruments. In most cases, intangible assets provide services over a period of years and so are normally classified as long-term assets.
Intangibles are recorded at cost. Cost includes all acquisition costs and expenditures needed to make the intangible asset ready for its intended use. If intangibles are acquired in exchange for stock or other assets, the cost of the intangible is the fair value of the consideration given or the fair value of the intangible received, whichever is more clearly evident. When a company makes a “basket purchase” of several intangibles or a combination of intangibles and tangibles, it should allocate the cost on the basis of fair values.
Intangibles have either a limited useful life or an indefinite useful life. Companies amortize limited-life intangibles. They do not amortize indefinite-life intangibles. Limited-life intangibles should be amortized by systematic charges to expense over their useful life. The useful life should reflect the period over which these assets will contribute to cash flows. The amount
REVIEW AND PRACTICE KEY TERMS REVIEW
amortization, 613 bargain purchase, 622 business combination,
612(n) copyright, 616 development activities, 628 fair value test, 623
franchise, 617 goodwill, 619 impairment, 622 indefinite-life
intangibles, 613 intangible assets, 612 license (permit), 617
limited (finite)-life intangibles, 613
master valuation approach, 621
organizational costs, 631 patent, 617 recoverability test, 623
research activities, 628 research and development
(R&D) costs, 628 start-up costs, 631 trademark, trade name, 615
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Sky Co., organized in 2017, provided you with the following information.
1. Purchased a license for $20,000 on July 1, 2017. The license gives Sky exclusive rights to sell its services in the tri-state region and will expire on July 1, 2025.
2. Purchased a patent on January 2, 2018, 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, 2018, were $45,000. The process has an
indefinite life. 4. On April 1, 2018, Sky purchased a small circuit board manufacturer for $350,000. Goodwill recorded in the transaction
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USING YOUR JUDGMENT The Using Your Judgment section provides students with real-world homework problems covering topics such as financial reporting and financial statement analysis.
USING YOUR JUDGMENT
Financial Reporting Problem The Procter & Gamble Company (P&G) The financial statements of P&G are presented in Appendix B. The company’s complete annual report, including the notes to the financial statements, is available online.
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 2014 financial statements and accompanying notes? (b) How much research and development (R&D) cost was expensed by P&G in 2013 and 2014? What percentage of sales rev-
enue and net income did P&G spend on R&D in 2013 and 2014?
Comparative Analysis Case The Coca-Cola Company and PepsiCo, Inc. The financial statements of Coca-Cola and PepsiCo are presented in Appendices C and D, respectively. The companies’ complete annual reports, including the notes to the financial statements, are available online.
Instructions Use the companies’ financial information to answer the following questions.
(a) (1) What amounts for intangible assets were reported in their respective balance sheets by Coca-Cola and PepsiCo at year-end 2014?
(2) What percentage of total assets is each of these reported amounts at year-end 2014? (3) What was the change in the amount of intangibles from 2013 to 2014 for Coca-Cola and PepsiCo?
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BRIDGE TO THE PROFESSION
FASB Codifi cation References  FASB ASC 350-10-05. [Predecessor literature: “Goodwill and Other Intangible Assets,” Statement of Financial Accounting
Standards No. 142 (Norwalk, Conn.: FASB, 2001).]  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.]  FASB ASC 805-10. [Predecessor literature: “Business Combinations,” Statement of Financial Accounting Standards No. 141R
(Norwalk, Conn.: FASB, 2007).]  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.]  FASB ASC 805-10-20. [Predecessor literature: “Business Combinations,” Statement of Financial Accounting Standards No.
141R (Norwalk, Conn.: FASB, 2007).]  FASB ASC 805-10-30. [Predecessor literature: “Business Combinations,” Statement of Financial Accounting Standards No.
141R (Norwalk, Conn.: FASB, 2007).]  FASB ASC 805-20-15. [Predecessor literature: None]
 FASB ASC 350 20 15 [Predecessor literature: None]
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IFRS INSIGHTS IFRS Insights offer students a detailed discussion and assessment material of international accounting standards at the end of each chapter.
IFRS Insights There are some significant differences between IFRS and GAAP in the accounting for both intan- gible 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”).
RELEVANT FACTS Following are the key similarities and differences between GAAP and IFRS related to intangible assets.
Similarities • Like GAAP, under IFRS intangible assets (1) lack physical substance and (2) are not fi nancial
instruments. In addition, under IFRS an intangible asset is identifi able. To be identifi able, an intangible asset must either be separable from the company (can be sold or transferred) or it arises from a contractual or legal right from which economic benefi ts will fl ow to the company.
LEARNING OBJECTIVE 6 Compare the accounting for intangible assets under GAAP and IFRS.
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1 Financial Accounting and Accounting Standards 2
WE CAN DO BETTER 2
FINANCIAL REPORTING ENVIRONMENT 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) 9
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES 13
What Do the Numbers Mean? You Have to Step Back 13
FASB Codification 13
MAJOR CHALLENGES IN FINANCIAL REPORTING 15
GAAP in a Political Environment 15 Evolving Issue Fair Value, Fair Consequences? 16 The Expectations Gap 16 Financial Reporting Issues 17 International Accounting Standards 18 What Do the Numbers Mean? Can You
Do That? 20 Ethics in the Environment of Financial
Accounting 20 Conclusion 20
IFRS INSIGHTS 29
2 Conceptual Framework for Financial Reporting 36
WHAT IS IT? 36
CONCEPTUAL FRAMEWORK 38
Need for a Conceptual Framework 38 What Do the Numbers Mean? What’s Your
Principle? 39 Development of a Conceptual Framework 39 Overview of the Conceptual Framework 40
FIRST LEVEL: BASIC OBJECTIVE 40
SECOND LEVEL: FUNDAMENTAL CONCEPTS 41
Qualitative Characteristics of Accounting Information 41
What Do the Numbers Mean? Living in a Material World 44
What Do the Numbers Mean? Show Me the Earnings! 46 Basic Elements 48
THIRD LEVEL: RECOGNITION AND MEASUREMENT CONCEPTS 49
Basic Assumptions 50 What Do the Numbers Mean? Whose
Company Is It? 50 Basic Principles of Accounting 52 Cost Constraint 57 Summary of the Structure 58 What Do the Numbers Mean? Don’t
Count These Please 59
FASB CODIFICATION 73
IFRS INSIGHTS 74
3 The Accounting Information System 78
NEEDED: A RELIABLE INFORMATION SYSTEM 78
ACCOUNTING INFORMATION SYSTEM 80
Basic Terminology 80 Debits and Credits 81 The Accounting Equation 82 Financial Statements and Ownership
Structure 84 The Accounting Cycle 85
RECORD AND SUMMARIZE BASIC TRANSACTIONS 87
Journalizing 87 Posting 88 Trial Balance 92
ADJUSTING ENTRIES 92
Types of Adjusting Entries 93 Adjusting Entries for Deferrals 93 Adjusting Entries for Accruals 98 What Do the Numbers Mean?
Am I Covered? 103 Adjusted Trial Balance 104
PREPARING FINANCIAL STATEMENTS 104
What Do the Numbers Mean? 24/7 Accounting 106
Closing 106 Post-Closing Trial Balance 109 Reversing Entries—An Optional Step 109 The Accounting Cycle Summarized 110 What Do the Numbers Mean? Hey, It’s Complicated 110
Table of Contents
FINANCIAL STATEMENTS FOR A MERCHANDISING COMPANY 110
Income Statement 110 Statement of Retained Earnings 111 Balance Sheet 111 What Do the Numbers Mean? Statements,
Please 113 Closing Entries 113
APPENDIX 3A: CASH-BASIS ACCOUNTING VERSUS ACCRUAL-BASIS ACCOUNTING 113
CONVERSION FROM CASH BASIS TO ACCRUAL BASIS 115
Service Revenue Computation 116 Operating Expense Computation 117
THEORETICAL WEAKNESSES OF THE CASH BASIS 118
APPENDIX 3B: USING REVERSING ENTRIES 119
ILLUSTRATION OF REVERSING ENTRIES— ACCRUALS 119
ILLUSTRATION OF REVERSING ENTRIES—DEFERRALS 120
SUMMARY OF REVERSING ENTRIES 121
APPENDIX 3C: USING A WORKSHEET: THE ACCOUNTING CYCLE REVISITED 121
WORKSHEET COLUMNS 121
Trial Balance Columns 121 Adjustments Columns 121
ADJUSTMENTS ENTERED ON THE WORKSHEET 123
Adjusted Trial Balance 123 Income Statement and Balance Sheet Columns 123
PREPARING FINANCIAL STATEMENTS FROM A WORKSHEET 124
IFRS INSIGHTS 147
4 Income Statement and Related Information 152
FINANCIAL STATEMENTS ARE CHANGING 152
INCOME STATEMENT 154
Usefulness of the Income Statement 154 Limitations of the Income Statement 154 Quality of Earnings 155 What Do the Numbers Mean? Four: The
Loneliest Number 156
FORMAT OF THE INCOME STATEMENT 156
Elements of the Income Statement 156 Intermediate Components of the
Income Statement 157 What Do the Numbers Mean? Top Line or
Bottom Line? 160 Condensed Income Statements 160 Single-Step Income Statements 161
REPORTING VARIOUS INCOME ITEMS 162
Unusual and Infrequent Gains and Losses 162 Discontinued Operations 164 Noncontrolling Interest 167 Earnings per Share 167 Summary of Various Income Items 169 What Do the Numbers Mean? Different Income
OTHER REPORTING ISSUES 170
Accounting Changes and Errors 170 Retained Earnings Statement 172 Comprehensive Income 173 Evolving Issue Income Reporting 176
FASB CODIFICATION 194
IFRS INSIGHTS 195
5 Balance Sheet and Statement of Cash Flows 200
HEY, IT DOESN’T BALANCE! 200
BALANCE SHEET 202
Usefulness of the Balance Sheet 202 Limitations of the Balance Sheet 202 What Do the Numbers Mean? Grounded 203 Classification in the Balance Sheet 203 What Do the Numbers Mean? “Show Me the
Assets!” 210 What Do the Numbers Mean? Warning Signals 214 Balance Sheet Format 214
STATEMENT OF CASH FLOWS 216
What Do the Numbers Mean? Watch That Cash Flow 216
Purpose of the Statement of Cash Flows 217 Content and Format of the Statement
of Cash Flows 217 Preparation of the Statement of Cash Flows 218 Usefulness of the Statement of Cash Flows 221 What Do the Numbers Mean? “There Ought to Be a
ADDITIONAL INFORMATION 224
Supplemental Disclosures 224 What Do the Numbers Mean? What About Your
Commitments? 226 Techniques of Disclosure 227 Evolving Issue Balance Sheet Reporting:
Gross or Net? 230
APPENDIX 5A: RATIO ANALYSIS—A REFERENCE 231
USING RATIOS TO ANALYZE PERFORMANCE 231
FASB CODIFICATION 257
IFRS INSIGHTS 258
6 Accounting and the Time Value of Money 266
HOW DO I MEASURE THAT? 266
BASIC TIME VALUE CONCEPTS 268
Applications of Time Value Concepts 268 The Nature of Interest 269 Simple Interest 270 Compound Interest 270 What Do the Numbers Mean? A Pretty Good Start 271 Fundamental Variables 274
SINGLE-SUM PROBLEMS 274
Future Value of a Single Sum 275 Present Value of a Single Sum 276 Solving for Other Unknowns in Single-Sum Problems 278
ANNUITIES (FUTURE VALUE) 279
Future Value of an Ordinary Annuity 280 Future Value of an Annuity Due 282 What Do the Numbers Mean? Don’t Wait to Make That
Contribution! 284 Examples of Future Value of Annuity Problems 284
ANNUITIES (PRESENT VALUE) 286
Present Value of an Ordinary Annuity 286 What Do the Numbers Mean? Up in Smoke 288 Present Value of an Annuity Due 288 Examples of Present Value of Annuity Problems 289
OTHER TIME VALUE OF MONEY ISSUES 291
Deferred Annuities 291 Valuation of Long-Term Bonds 293 Effective-Interest Method of Amortization of Bond
Discount or Premium 294 Present Value Measurement 295 What Do the Numbers Mean? How Low Can They Go? 297
FASB CODIFICATION 312
7 Cash and Receivables 324 LUCK OF THE IRISH 324
Reporting Cash 326 Summary of Cash-Related Items 328 What Do the Numbers Mean? Where Did I Park
My Cash? 329
Recognition of Accounts Receivable 330 Valuation of Accounts Receivable 334
NOTES RECEIVABLE 338
Recognition of Notes Receivable 338 Valuation of Notes Receivable 342 What Do the Numbers Mean? Please Release Me? 343
SPECIAL ISSUES 343
Fair Value Option 344 Disposition of Accounts and Notes Receivable 344 What Do the Numbers Mean? Securitizations—
Good or Bad? 349 Presentation and Analysis 350 What Do the Numbers Mean? I’m Still Waiting 352
APPENDIX 7A: CASH CONTROLS 352
USING BANK ACCOUNTS 353
THE IMPREST PETTY CASH SYSTEM 353
PHYSICAL PROTECTION OF CASH BALANCES 355
RECONCILIATION OF BANK BALANCES 355
APPENDIX 7B: COLLECTABILITY ASSESSMENT BASED ON EXPECTED CASH FLOWS 358
MEASUREMENT OF COLLECTIBILITY 358
Example 358 Recording Bad Debts 359
FASB CODIFICATION 382
IFRS INSIGHTS 383
8 Valuation of Inventories: A Cost-Basis Approach 386
TO SWITCH OR NOT TO SWITCH 386
INVENTORY ISSUES 388
Classification 388 Inventory Cost Flow 389 Inventory Control 391 What Do the Numbers Mean? Staying Lean 392 Determining Cost of Goods Sold 392
GOODS AND COSTS INCLUDED IN INVENTORY 393
Goods Included in Inventory 393 What Do the Numbers Mean? No Parking! 395 Costs Included in Inventory 395 What Do the Numbers Mean? You May
Need a Map 397
WHICH COST FLOW ASSUMPTION TO ADOPT? 398
Specific Identification 398 Average-Cost 399 First-In, First-Out (FIFO) 400 Last-In, First-Out (LIFO) 401
SPECIAL ISSUES RELATED TO LIFO 402
LIFO Reserve 402 What Do the Numbers Mean? Comparing
Apples to Apples 403 LIFO Liquidation 403 Dollar-Value LIFO 405 What Do the Numbers Mean? Quite a Difference 410
Comparison of LIFO Approaches 410 Major Advantages of LIFO 411 Major Disadvantages of LIFO 412 Basis for Selection of Inventory Method 413 Evolving Issue Repeal LIFO! 415
EFFECT OF INVENTORY ERRORS 416
Ending Inventory Misstated 416 Purchases and Inventory Misstated 417
FASB CODIFICATION 441
9 Inventories: Additional Valuation Issues 442
NOT WHAT IT SEEMS TO BE 442
LOWER-OF-COST-OR-NET REALIZABLE VALUE 444
Definition of Net Realizable Value 444 Illustration of LCNRV 444 Methods of Applying LCNRV 445 Recording NRV Instead of Cost 446 Use of an Allowance 447 Use of an Allowance—Multiple Periods 447
How Lower-of-Cost-or-Market Works 449 Methods of Applying Lower-of-Cost-or-Market 450 What Do the Numbers Mean? “Put It in Reverse” 451 Evaluation of the LCNRV and Lower-of-Cost-or-Market
OTHER VALUATION APPROACHES 452
Valuation at Net Realizable Value 452 Valuation Using Relative Sales Value 453 Purchase Commitments—A Special Problem 453
THE GROSS PROFIT METHOD OF ESTIMATING INVENTORY 455
Computation of Gross Profit Percentage 456 Evaluation of Gross Profit Method 458 What Do the Numbers Mean? The Squeeze 458
RETAIL INVENTORY METHOD 458
Retail-Method Concepts 459 Retail Inventory Method with Markups and Markdowns—
Conventional Method 460 What Do the Numbers Mean? Price Fixing 463 Special Items Relating to Retail Method 463 Evaluation of Retail Inventory Method 464
PRESENTATION AND ANALYSIS 464
Presentation of Inventories 464 Analysis of Inventories 465
APPENDIX 9A: LIFO RETAIL METHODS 466
STABLE PRICES—LIFO RETAIL METHOD 466
FLUCTUATING PRICES—DOLLAR-VALUE LIFO RETAIL METHOD 467
SUBSEQUENT ADJUSTMENTS UNDER DOLLAR-VALUE LIFO RETAIL 469
CHANGING FROM CONVENTIONAL RETAIL TO LIFO 470
FASB CODIFICATION 493
IFRS INSIGHTS 494
10 Acquisition and Disposition of Property, Plant, and Equipment 502
WATCH YOUR SPENDING 502
PROPERTY, PLANT, AND EQUIPMENT 504
Acquisition of Property, Plant, and Equipment 504 Self-Constructed Assets 506 Interest Costs During Construction 507 What Do the Numbers Mean? What’s in Your
Interest? 512 Observations 513
VALUATION OF PROPERTY, PLANT, AND EQUIPMENT 513
Cash Discounts 513 Deferred-Payment Contracts 513 Lump-Sum Purchases 514 Issuance of Stock 515 Exchanges of Nonmonetary Assets 516 What Do the Numbers Mean? About Those Swaps 521 Accounting for Contributions 521 Other Asset Valuation Methods 522
COSTS SUBSEQUENT TO ACQUISITION 522
What Do the Numbers Mean? Disconnected 523 Additions 524 Improvements and Replacements 524 Rearrangement and Reinstallation 525 Repairs 525 Summary of Costs Subsequent to Acquisition 526
DISPOSITION OF PROPERTY, PLANT, AND EQUIPMENT 526
Sale of Plant Assets 526 Involuntary Conversion 527 Miscellaneous Problems 527
FASB CODIFICATION 550
11 Depreciation, Impairments, and Depletion 552
HERE COME THE WRITE-OFFS 552
DEPRECIATION—A METHOD OF COST ALLOCATION 554
Factors Involved in the Depreciation Process 554 What Do the Numbers Mean? Alphabet Dupe 556 Methods of Depreciation 556
SPECIAL DEPRECIATION METHODS AND OTHER ISSUES 559
Special Depreciation Methods 559 What Do the Numbers Mean? Decelerating
Depreciation 561 Other Depreciation Issues 562 What Do the Numbers Mean? Depreciation Choices 565
Recognizing Impairments 565 Measuring Impairments 566 Restoration of Impairment Loss 567 Impairment of Assets to Be Disposed Of 567
Establishing a Depletion Base 569 Write-Off of Resource Cost 570 Estimating Recoverable Reserves 571 What Do the Numbers Mean? Reserve Surprise 571 Liquidating Dividends 571 Continuing Controversy 572 Evolving Issue Full-Cost or Successful-Efforts? 573
PRESENTATION AND ANALYSIS 573
Presentation of Property, Plant, Equipment, and Natural Resources 573
Analysis of Property, Plant, and Equipment 575
APPENDIX 11A: INCOME TAX DEPRECIATION 576
MODIFIED ACCELERATED COST RECOVERY SYSTEM 577
Tax Lives (Recovery Periods) 577 Tax Depreciation Methods 577 Example of MACRS 578
OPTIONAL STRAIGHT-LINE METHOD 579
TAX VERSUS BOOK DEPRECIATION 579
FASB CODIFICATION 600
IFRS INSIGHTS 601
12 Intangible Assets 610 IS THIS SUSTAINABLE? 610
INTANGIBLE ASSET ISSUES 612
Characteristics 612 Valuation 612 Amortization of Intangibles 613 What Do the Numbers Mean? Are All Brands the
TYPES OF INTANGIBLE ASSETS 614
Marketing-Related Intangible Assets 615 What Do the Numbers Mean? Keep Your Hands
Off My Intangible! 615 Customer-Related Intangible Assets 616 Artistic-Related Intangible Assets 616 Contract-Related Intangible Assets 617 Technology-Related Intangible Assets 617 What Do the Numbers Mean? Patent Battles 618
What Do the Numbers Mean? The Value of a Secret Formula 619
IMPAIRMENT AND PRESENTATION OF INTANGIBLE ASSETS 622
Impairment of Limited-Life Intangibles 623 Impairment of Indefinite-Life Intangibles Other Than
Goodwill 623 Impairment of Goodwill 624 Impairment Summary 625 What Do the Numbers Mean? Impairment Risk 625 Presentation of Intangible Assets 626
RESEARCH AND DEVELOPMENT COSTS 628
Identifying R&D Activities 628 Accounting for R&D Activities 629 What Do the Numbers Mean? Global R&D
Incentives 629 Costs Similar to R&D Costs 631 What Do the Numbers Mean? Branded 632 Presentation of Research and Development Costs 633 Evolving Issue Recognition of R&D and Internally
Generated Intangibles 634
FASB CODIFICATION 650
IFRS INSIGHTS 652
13 Current Liabilities and Contingencies 658
NOW YOU SEE IT, NOW YOU DON’T 658
CURRENT LIABILITIES 660
Accounts Payable 661 Notes Payable 661 Dividends Payable 663 Customer Advances and Deposits 663 Unearned Revenues 663 What Do the Numbers Mean? Microsoft’s Liabilities—
Good or Bad? 664 Sales Taxes Payable 665 Income Taxes Payable 665 Employee-Related Liabilities 666 Current Maturities of Long-Term Debt 671 Short-Term Obligations Expected to Be Refinanced 671 What Do the Numbers Mean? What About That Short-
Term Debt? 673
Gain Contingencies 673 Loss Contingencies 674 What Do the Numbers Mean? Frequent Flyers 680 Evolving Issue Greenhouse Gases: Let’s Be Standard-
Setters 682 What Do the Numbers Mean? More Disclosure,
PRESENTATION AND ANALYSIS 684
Presentation of Current Liabilities 684 Presentation of Contingencies 686 Analysis of Current Liabilities 687 What Do the Numbers Mean? I’ll Pay You Later 688
FASB CODIFICATION 708
IFRS INSIGHTS 710
14 Long-Term Liabilities 718 GOING LONG 718
BONDS PAYABLE 720
Issuing Bonds 720 Types of Bonds 720 What Do the Numbers Mean? All About Bonds 721 Valuation and Accounting for Bonds Payable 722 What Do the Numbers Mean? How’s My Rating? 723 Extinguishment of Debt 730 What Do the Numbers Mean? Your Debt Is Killing My
LONG-TERM NOTES PAYABLE 731
Notes Issued at Face Value 732 Notes Not Issued at Face Value 732 Special Notes Payable Situations 734 Mortgage Notes Payable 737 Fair Value Option 737 What Do the Numbers Mean? Fair Value
Fun House 738
REPORTING AND ANALYZING LIABILITIES 739
Off-Balance-Sheet Financing 739 What Do the Numbers Mean? Obligated 741 Presentation and Analysis of Long-Term Debt 741
APPENDIX 14A: TROUBLED-DEBT RESTRUCTURING 743
SETTLEMENT OF DEBT 744
Transfer of Assets 744 Granting of Equity Interest 745
MODIFICATION OF TERMS 745
Example 1—No Gain for Debtor 746 Example 2—Gain for Debtor 748
CONCLUDING REMARKS 749
FASB CODIFICATION 767
IFRS INSIGHTS 768
15 Stockholders’ Equity 774 IT’S A GLOBAL MARKET 774
CORPORATE CAPITAL 776
Corporate Form 776 What Do the Numbers Mean? 1209 North Orange
Components of Stockholders’ Equity 778 Issuance of Stock 779 What Do the Numbers Mean? The Case of the
Disappearing Receivable 783 Preferred Stock 783 What Do the Numbers Mean?
A Class (B) Act 785
REACQUISITION OF SHARES 786
What Do the Numbers Mean? Buybacks—Good or Bad? 787
Purchase of Treasury Stock 788 Sale of Treasury Stock 789 Retiring Treasury Stock 790
DIVIDEND POLICY 791
Financial Condition and Dividend Distributions 791 Types of Dividends 792 Stock Dividends and Stock Splits 795 What Do the Numbers Mean? Splitsville 798 What Do the Numbers Mean? Dividends Up, Dividends
PRESENTATION AND ANALYSIS OF STOCKHOLDERS’ EQUITY 800
Presentation 800 Analysis 802
APPENDIX 15A: DIVIDEND PREFERENCES AND BOOK VALUE PER SHARE 804
DIVIDEND PREFERENCES 804
BOOK VALUE PER SHARE 805
FASB CODIFICATION 826
IFRS INSIGHTS 827
16 Dilutive Securities and Earnings per Share 834
KICKING THE HABIT 834
DILUTIVE SECURITIES 836
Debt and Equity 836 Accounting for Convertible Debt 836 Convertible Preferred Stock 838 What Do the Numbers Mean? How Low Can
You Go? 839
STOCK WARRANTS 839
Stock Warrants Issued with Other Securities 840 Rights to Subscribe to Additional Shares 842 Evolving Issue Is That All Debt? 842
STOCK COMPENSATION PLANS 843
Measurement—Stock Compensation 844 What Do the Numbers Mean? What’s the Debate
About? 845 Recognition—Stock Compensation 846 Restricted Stock 847
Employee Stock-Purchase Plans 849 Disclosure of Compensation Plans 849
BASIC EARNINGS PER SHARE 851
Earnings per Share—Simple Capital Structure 851 Comprehensive Example 854
DILUTED EARNINGS PER SHARE 855
Diluted EPS—Convertible Securities 856 Diluted EPS—Options and Warrants 858 Contingent Issue Agreement 859 Antidilution Revisited 859 EPS Presentation and Disclosure 860 What Do the Numbers Mean? Pro Forma EPS
Confusion 861 Summary of EPS Computation 862
APPENDIX 16A: ACCOUNTING FOR STOCK-APPRECIATION RIGHTS 863
SARS—SHARE-BASED EQUITY AWARDS 864
SARS—SHARE-BASED LIABILITY AWARDS 864
STOCK-APPRECIATION RIGHTS EXAMPLE 865
APPENDIX 16B: COMPREHENSIVE EARNINGS PER SHARE EXAMPLE 866
DILUTED EARNINGS PER SHARE 867
FASB CODIFICATION 889
IFRS INSIGHTS 890
17 Investments 898 WHAT TO DO? 898
INVESTMENTS IN DEBT SECURITIES 900
Debt Investment Classifications 900 Held-to-Maturity Securities 901 Available-for-Sale Securities 903 Trading Securities 907 What Do the Numbers Mean? To Have
and To Hold 908
INVESTMENTS IN EQUITY SECURITIES 908
Holdings of Less Than 20% 909 What Do the Numbers Mean? More Disclosure,
Please 912 Holdings Between 20% and 50% 912 Holdings of More Than 50% 914 What Do the Numbers Mean? Who’s in Control
OTHER FINANCIAL REPORTING ISSUES 915
Fair Value Option 915 Evolving Issue Fair Value Controversy 916 Impairment of Value 916 Reclassification Adjustments 918 Transfers Related to Debt Securities 921 Summary of Reporting Treatment of Securities 922
What Do The Numbers Mean? So You Think It Is Easy! 923
APPENDIX 17A: ACCOUNTING FOR DERIVATIVE INSTRUMENTS 923
DEFINING DERIVATIVES 924
WHO USES DERIVATIVES, AND WHY? 924
Producers and Consumers 924 Speculators and Arbitrageurs 925
BASIC PRINCIPLES IN ACCOUNTING FOR DERIVATIVES 926
Example of Derivative Financial Instrument— Speculation 926
Differences Between Traditional and Derivative Financial Instruments 929
DERIVATIVES USED FOR HEDGING 929
What Do the Numbers Mean? Risky Business 930 Fair Value Hedge 930 Cash Flow Hedge 932
OTHER REPORTING ISSUES 934
Embedded Derivatives 934 Qualifying Hedge Criteria 935 Summary of Derivatives Accounting 936
COMPREHENSIVE HEDGE ACCOUNTING EXAMPLE 937
Fair Value Hedge 937 Financial Statement Presentation of an Interest Rate
CONTROVERSY AND CONCLUDING REMARKS 940
APPENDIX 17B: FAIR VALUE DISCLOSURES 941
DISCLOSURE OF FAIR VALUE INFORMATION: FINANCIAL INSTRUMENTS 941
DISCLOSURE OF FAIR VALUES: IMPAIRED ASSETS OR LIABILITIES 944
FASB CODIFICATION 965
IFRS INSIGHTS 966
18 Revenue Recognition 978 IT’S BACK 978
FUNDAMENTALS OF REVENUE RECOGNITION 980
Background 980 New Revenue Recognition Standard 980 Overview of the Five-Step Process—Boeing
Example 981 Extended Example of the Five-Step Process:
THE FIVE-STEP PROCESS REVISITED 986
Identifying the Contract with Customers—Step 1 986 Identifying Separate Performance Obligations—
Step 2 987
Determining the Transaction Price—Step 3 988 Allocating the Transaction Price to Separate Performance
Obligations—Step 4 992 Recognizing Revenue When (or as) Each Performance
Obligation Is Satisfied—Step 5 994 Summary 995
ACCOUNTING FOR REVENUE RECOGNITION ISSUES 996
Sales Returns and Allowances 996 Repurchase Agreements 999 Bill-and-Hold Arrangements 1001 Principal-Agent Relationships 1001 Consignments 1002 What Do the Numbers Mean? Grossed Out 1004 Warranties 1004 Nonrefundable Upfront Fees 1006 Summary 1006
PRESENTATION AND DISCLOSURE 1007
Presentation 1007 Disclosure 1011 Evolving Issue Revenue: “It’s Like An
APPENDIX 18A: LONG-TERM CONSTRUCTION CONTRACTS 1013
REVENUE RECOGNITION OVER TIME 1013
Percentage-of-Completion Method 1014 Completed-Contract Method 1019 Long-Term Contract Losses 1020
APPENDIX 18B: REVENUE RECOGNITION FOR FRANCHISES 1023
FRANCHISE ACCOUNTING 1024
RECOGNITION OF FRANCHISE RIGHTS REVENUE OVER TIME 1026
FASB CODIFICATION 1050
19 Accounting for Income Taxes 1052
HEY–LET’S PAY MORE INCOME TAXES! 1052
FUNDAMENTALS OF ACCOUNTING FOR INCOME TAXES 1054
Future Taxable Amounts and Deferred Taxes 1055 What Do the Numbers Mean?
“Real Liabilities” 1059 Future Deductible Amounts and
Deferred Taxes 1059 What Do the Numbers Mean? “Real Assets” 1062 Deferred Tax Asset—Valuation Allowance 1063
ADDITIONAL CONSIDERATIONS 1064
Income Statement Presentation 1064
Specific Differences 1064 Tax Rate Considerations 1067 What Do the Numbers Mean? Global Tax Rates 1068
ACCOUNTING FOR NET OPERATING LOSSES 1069
Loss Carryback 1069 Loss Carryforward 1070 Loss Carryback Example 1070 Loss Carryforward Example 1071 What Do the Numbers Mean? NOLs:
Good News or Bad? 1075
FINANCIAL STATEMENT PRESENTATION 1076
Balance Sheet 1076 Note Disclosure 1076 What Do the Numbers Mean? Imagination at Work 1077 Income Statement 1078 Evolving Issue Uncertain Tax Positions 1081 The Asset-Liability Method 1081
APPENDIX 19A: COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATION 1083
FIRST YEAR—2016 1083
Taxable Income and Income Taxes Payable—2016 1084
Computing Deferred Income Taxes— End of 2016 1085
Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes—2016 1086
Financial Statement Presentation—2016 1086
SECOND YEAR—2017 1087
Taxable Income and Income Taxes Payable—2017 1088
Computing Deferred Income Taxes—End of 2017 1088 Deferred Tax Expense (Benefit) and the Journal Entry to
Record Income Taxes—2017 1089 Financial Statement Presentation—2017 1089
FASB CODIFICATION 1109
IFRS INSIGHTS 1110
20 Accounting for Pensions and Postretirement Benefits 1116
WHERE HAVE ALL THE PENSIONS GONE? 1116
FUNDAMENTALS OF PENSION PLAN ACCOUNTING 1118
Defined Contribution Plan 1119 Defined Benefit Plan 1119 What Do the Numbers Mean? Which Plan
Is Right for You? 1120 The Role of Actuaries in Pension Accounting 1121 Measures of the Liability 1121 What Do the Numbers Mean? Roller Coaster 1123 Components of Pension Expense 1123
USING A PENSION WORKSHEET 1126
2017 Entries and Worksheet 1127 Funded Status 1128
PRIOR SERVICE COST (PSC) 1128
Amortization 1128 2018 Entries and Worksheet 1130
GAINS AND LOSSES 1131
Smoothing Unexpected Gains and Losses on Plan Assets 1131
What Do the Numbers Mean? Pension Costs Ups and Downs 1132
Smoothing Unexpected Gains and Losses on the Pension Liability 1132
Corridor Amortization 1133 Evolving Issue Bye Bye Corridor 1136 2019 Entries and Worksheet 1136
REPORTING PENSION PLANS IN FINANCIAL STATEMENTS 1138
Within the Financial Statements 1138 Within the Notes to the Financial Statements 1140 Example of Pension Note Disclosure 1142 2020 Entries and Worksheet—A Comprehensive
Example 1143 Special Issues 1144 What Do the Numbers Mean? Who Guarantees the
Guarantor? 1146 Concluding Observations 1148
APPENDIX 20A: ACCOUNTING FOR POSTRETIREMENT BENEFITS 1148
ACCOUNTING GUIDANCE 1148
DIFFERENCES BETWEEN PENSION BENEFITS AND HEALTHCARE BENEFITS 1149
What Do the Numbers Mean? OPEBs—How Big Are They? 1150
POSTRETIREMENT BENEFITS ACCOUNTING PROVISIONS 1150
Obligations Under Postretirement Benefits 1150 Postretirement Expense 1151
ILLUSTRATIVE ACCOUNTING ENTRIES 1152
2017 Entries and Worksheet 1152 Recognition of Gains and Losses 1153 2018 Entries and Worksheet 1154 Amortization of Net Gain or Loss in 2019 1155
DISCLOSURES IN NOTES TO THE FINANCIAL STATEMENTS 1155
ACTUARIAL ASSUMPTIONS AND CONCEPTUAL ISSUES 1157
What Do the Numbers Mean? Want Some Bad News? 1157
FASB CODIFICATION 1179
IFRS INSIGHTS 1180
21 Accounting for Leases 1194 MORE COMPANIES ASK, “WHY BUY?” 1194
THE LEASING ENVIRONMENT 1196
Who Are the Players? 1196 Advantages of Leasing 1198 What Do the Numbers Mean? Off-Balance-Sheet
Financing 1199 Conceptual Nature of a Lease 1199
ACCOUNTING BY THE LESSEE 1200
Capitalization Criteria 1201 Asset and Liability Accounted for Differently 1204 Capital Lease Method (Lessee) 1204 Operating Method (Lessee) 1207 What Do the Numbers Mean? Restatements on the
Menu 1207 Comparison of Capital Lease with Operating Lease 1208 Evolving Issue Are You Liable? 1209
ACCOUNTING BY THE LESSOR 1210
Economics of Leasing 1210 Classification of Leases by the Lessor 1211 Direct-Financing Method (Lessor) 1212 Operating Method (Lessor) 1215
SPECIAL LEASE ACCOUNTING PROBLEMS 1215
Residual Values 1216 What Do the Numbers Mean? Residual Value
Regret 1222 Sales-Type Leases (Lessor) 1222 What Do the Numbers Mean? Xerox
Takes on the SEC 1224 Bargain-Purchase Option (Lessee) 1225 Initial Direct Costs (Lessor) 1225 Current versus Noncurrent 1226 Disclosing Lease Data 1227 Unresolved Lease Accounting Problems 1228 Evolving Issue Lease Accounting—If It Quacks
Like a Duck 1230
APPENDIX 21A: SALE-LEASEBACKS 1231
DETERMINING ASSET USE 1231
Lessee 1232 Lessor 1232
SALE-LEASEBACK EXAMPLE 1232
FASB CODIFICATION 1254
IFRS INSIGHTS 1256
22 Accounting Changes and Error Analysis 1266
IN THE DARK 1266
ACCOUNTING CHANGES 1268
Background 1268 Changes in Accounting Principle 1268 What Do the Numbers Mean? Quite a Change 1270 What Do the Numbers Mean? Change Management 1272 Impracticability 1280
OTHER ACCOUNTING CHANGES 1281
Changes in Accounting Estimates 1281 What Do the Numbers Mean? A Change for the
Better? 1283 Changes in Reporting Entity 1283
ACCOUNTING ERRORS 1284
What Do the Numbers Mean? Can I Get My Money Back? 1286
Example of Error Correction 1286 Summary of Accounting Changes and
Correction of Errors 1288 What Do the Numbers Mean? What’s Your
ERROR ANALYSIS 1290
Balance Sheet Errors 1291 Income Statement Errors 1291 Balance Sheet and Income Statement Errors 1291 Comprehensive Example: Numerous Errors 1294 What Do the Numbers Mean? Guard the Financial
Statements! 1296 Preparation of Financial Statements with Error
APPENDIX 22A: CHANGING FROM OR TO THE EQUITY METHOD 1299
CHANGE FROM THE EQUITY METHOD 1299
Dividends in Excess of Earnings 1299
CHANGE TO THE EQUITY METHOD 1300
FASB CODIFICATION 1325
IFRS INSIGHTS 1326
23 Statement of Cash Flows 1330 SHOW ME THE MONEY! 1330
STATEMENT OF CASH FLOWS 1332
Usefulness of the Statement of Cash Flows 1332 Classification of Cash Flows 1333 What Do the Numbers Mean? How’s My
Cash Flow? 1334 Format of the Statement of Cash Flows 1335
PREPARING THE STATEMENT OF CASH FLOWS 1335
Illustrations—Tax Consultants Inc. 1336 What Do the Numbers Mean? Earnings and Cash Flow
Management? 1338 Sources of Information for the Statement of
Cash Flows 1346
Net Cash Flow from Operating Activities—Direct Method 1346
Evolving Issue Direct versus Indirect 1352
SPECIAL PROBLEMS IN STATEMENT PREPARATION 1353
Adjustments to Net Income 1353 Accounts Receivable (Net) 1356 What Do the Numbers Mean? Not What It Seems 1358 Other Working Capital Changes 1358 Net Losses 1359 Significant Noncash Transactions 1360 What Do the Numbers Mean? Better Than ROA? 1361
USE OF A WORKSHEET 1361
Preparation of the Worksheet 1362 Analysis of Transactions 1363 Preparation of Final Statement 1369
FASB CODIFICATION 1395
IFRS INSIGHTS 1396
24 Full Disclosure in Financial Reporting 1402
HIGH-QUALITY FINANCIAL REPORTING—ALWAYS IN FASHION 1402
FULL DISCLOSURE PRINCIPLE 1404
Increase in Reporting Requirements 1405 Differential Disclosure 1405 Evolving Issue Disclosure—Quantity and Quality 1406 Notes to the Financial Statements 1407 What Do the Numbers Mean? Footnote Secrets 1409
DISCLOSURE ISSUES 1409
Disclosure of Special Transactions or Events 1409 Post-Balance-Sheet Events (Subsequent Events) 1411 Reporting for Diversified (Conglomerate)
Companies 1413 Interim Reports 1417 Evolving Issue It’s Faster but Is It Better? 1423
AUDITOR’S AND MANAGEMENT’S REPORTS 1423
Auditor’s Report 1423 What Do the Numbers Mean? Heart of the Matter 1426 Management’s Reports 1427
CURRENT REPORTING ISSUES 1428
Reporting on Financial Forecasts and Projections 1428 What Do the Numbers Mean? Global Forecasts 1430 Internet Financial Reporting 1431 Fraudulent Financial Reporting 1432 What Do the Numbers Mean? Disclosure Overload 1434 Criteria for Making Accounting and Reporting
APPENDIX 24A: BASIC FINANCIAL STATEMENT ANALYSIS 1435
PERSPECTIVE ON FINANCIAL STATEMENT ANALYSIS 1436
RATIO ANALYSIS 1437
Limitations of Ratio Analysis 1437
COMPARATIVE ANALYSIS 1439
PERCENTAGE (COMMON-SIZE) ANALYSIS 1440
FASB CODIFICATION 1460
IFRS INSIGHTS 1461
APPENDIX A Private Company Accounting A-1
THE PRIVATE COMPANY COUNCIL (PCC) A-1
Background on the PCC A-1 Private Company Decision-Making Framework A-1 PCC Accomplishments A-2
PRIVATE COMPANY ALTERNATIVES FOR INTANGIBLE ASSETS AND GOODWILL A-2
Accounting for Identifiable Intangible Assets A-2 Accounting for Goodwill A-4
APPENDIX B Specimen Financial Statements: The Procter & Gamble Company B-1
APPENDIX C Specimen Financial Statements: The Coca-Cola Company C-1
APPENDIX D Specimen Financial Statements: PepsiCo, Inc. D-1
APPENDIX E Specimen Financial Statements: Marks and Spencer plc E-1
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.
Melissa Aldredge Northwestern State University Elsie Ameen Sam Houston State University Sean Andre York College of Pennsylvania Jack Armitage University of Nebraska—Omaha Avinash Arya William Paterson University Jane Baldwin Baylor University
Kristin Bauer Financial Accounting Standards Board
Robert Bloom John Carroll University George Boland Queen’s University Eric Bostwick University of West Florida Naat Briscoe Northwestern State University D. Jeffrey Brothers University of Denver Stephen Brown University of Maryland Deanna Burgess Florida Gulf Coast University Andy Call Arizona State University Chuck Campbell University of British Columbia Suzanne Cansler University of Connecticut Karen Castro-González University of Puerto Rico Kam Chan Pace University Paul Cheney Vanderbilt University Xiaoyan Cheng University of Nebraska—Omaha Dhiman Chowdhury Dhaka University
Ming Lu Chun Santa Monica College Hyeesoo Chung California State University—Long Beach Lamine Conteh Saint Leo University Kelvie Crabb University of Kansas Ken Dalton University of Nevada—Las Vegas Robert Davis Canisius College Julie Dawson Carthage College Passard Dean Saint Leo University Alex Debbink Ernst & Young Andrew DeJoseph Nassau Community College Kristine Del Vecchio University of South Florida Shawna Denny Lipscomb University Mike Dugan Georgia Regents University Susetta Emery York College of Pennsylvania Cole Engel Fort Hays State University David Farber University of Texas at El Paso Barbara Farrell Pace University Linda Flaming Monmouth University Paul Foote California State University—Fullerton James Fuehrmeyer University of Notre Dame Kristen Fuhremann University of Wisconsin—Madison Pam Graybeal University of Central Florida
Tony Greig University of Wisconsin—Madison Elaine Guenthner Northern Kentucky University Amy Haas Kingsborough Community College Lizhong Hao California State University—Fresno John Hassell Kelley School of Business—Indianapolis Pamela Hillman Gateway Technical College Ken House Belmont University Pei-Hui Hsu California State University—East Bay Allen Hunt Western Kentucky University Kim Hurt Central Community College Dave Hurtt Baylor University Anthony Hurwitz UCLA Extension Christine Irujo Westfi eld State University Emil Jirik Gustavus Adolphus College Joseph Johnson University of Central Florida
Burch Kealey University of Nebraska—Omaha Marsha Keune University of Dayton Kate Konetzke PricewaterhouseCoopers Lisa Koonce University of Texas Lee Krueger UCLA Extension David Krug Johnson County Community College Jeffrey Kunz Carroll University
Prior Edition Reviewers We greatly appreciate the over 300 reviewers who have assisted with the prior editions of Intermediate Accounting. These instructors have been invaluable in the development and continued improvement of our textbook.
Melissa Larson Brigham Young University Cynthia Lovick Austin Community College Daphne Main Loyola University New Orleans Leslie Mandel Fairleigh Dickinson University Anthony Masino East Tennessee State University Katie Maxwell University of Arizona Gerald Miller College of New Jersey Sally Mitzel Sheridan College Michael Motes University of Maryland University College
John Naegle University of Kansas R.D. Nair University of Wisconsin—Madison Sia Nassiripour William Paterson University Randy Nicholls Red Deer College Curt Norton Arizona State University Derek Oler Texas Tech University Steve Orpurt Arizona State University Alison Parker Camosun College Glenn Pate Palm Beach State College Denise Patterson California State University—Fresno Milo Peck Fairfi eld University Charles Pendola St Joseph’s University (NYC) Alee Phillips University of Kansas Catherine Plante University of New Hampshire Martha Pointer East Tennessee State University Theresa Presley Kansas State University Mark Riley Northern Illinois University Tracey Riley Suffolk University Francisco Roman George Mason University Eric Rothenburg Kingsborough Community College Martin Rudnick William Paterson University Mike Ruff Bentley College August Saibeni Los Rios Community College
Arpita Shroff Texas A&M University—Corpus Christi Tom Skogland Deloitte
Douglas Smith University of Montevallo Larry Stephens Austin Community College Ronald Stoltzfus Eastern Mennonite University Dan Teed Troy University
Walter Teets Gonzaga University
Tom Tierney University of Wisconsin—Madison John Valenzuela California State University—Long Beach Troy Vornholt Oglethorpe University Kat Walden Southern New Hampshire University Patricia Walters Texas Christian University Larry Walther Utah State University Suzanne Wright Pennsylvania State University Jialin Yin University of Wisconsin—Madison Brian York PricewaterhouseCoopers
Steve Zeff Rice University Mary Zenner College of Lake County Haiwen Zhang Ohio State University Special thanks to Kurt Pany, Arizona State University, for his input on auditor disclo- sure issues, and to Stephen A. Zeff, Rice University, for his comments on international accounting.
In addition, we thank the following colleagues who contributed to several of the unique features of this edition.
Codification Cases Katie Adler Deloitte LLP, Chicago Jack Cathey University of North Carolina—Charlotte 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 Ernst & Young, Milwaukee Jeremy Kunicki Walgreens Courtney Meier Deloitte LLP, Milwaukee Andrew Prewitt KPMG, Chicago Jeff Seymour KPMG, Minneapolis Matt Sullivan Northwestern Mutual Matt Tutaj Deloitte LLP, Chicago Jen Vaughn PricewaterhouseCoopers, Chicago Erin Viel PricewaterhouseCoopers, Milwaukee
Ancillary Authors, Contributors, Proofers, and Accuracy Checkers Ellen Bartely St. Joseph’s University (NYC) LuAnn Bean Florida Institute of Technology Jack Borke University of Wisconsin—Platteville Melodi Bunting Edgewood College Bea Chiang The College of New Jersey Susetta Emery York College of Pennsylvania Jim Emig Villanova University Larry Falcetto Emporia State University Kim Hurt Central Community College Derek Jackson St. Mary’s University of Minnesota Mark Kohlbeck Florida Atlantic University Cynthia Lovick Austin Community College Kirk Lynch Sandhills Community College Anthony Masino East Tennessee University Jill Misuraca University of Tampa Barb Muller Arizona State University Alison Parker Camosun College Yvonne Phang Borough of Manhattan Community College Laura Prosser Blackhills State University Mark Riley Northern Illinois University
Alice Sineath University of Maryland University College Lynn Stallworth Appalachian State University Sheila Viel University of Wisconsin—Milwaukee Dick Wasson Southwestern College Suzanne Wright Pennsylvania State University Lori Zaher Bucks County Community College
Advisory Board We gratefully acknowledge the following members of the Intermediate Accounting Advisory Board for their advice and assis- tance with this edition. Barbara Durham University of Central Florida Pamela Graybeal University of Central Florida Jeffery Hales Georgia Institute of Technology Melissa Larson Brigham Young University—Provo
Ming Lu Santa Monica College Linda Matuszewski Northern Illinois University Kevin Rich Marquette University Angela Spencer Oklahoma State University—Stillwater
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 com- mitment given us by the development, marketing, production, and editorial staffs of John Wiley & Sons, including the following: George Hoffman, Michael McDonald, Emily McGee, Rebecca Costantini, Valerie Vargas, Allie Morris, Greg Chaput, Harry Nolan, and Maureen Eide. Thanks, too, to Jackie Henry and the staff at Aptara®, Inc. for their work on the textbook, and the staff at SPI Global for their work on the solutions manual.
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 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.
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 Jerry J. Weygandt Terry D. Warfield Somonauk, Illinois Madison, Wisconsin Madison, Wisconsin
WE CAN DO BETTER A recent report says it best: “Accounting information is central to the functioning of international capital mar- kets 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. As shown in the chart on the right, the results indicate that the 2008 financial crisis took a bite out of investor confidence. While investor confidence in U.S. markets has stabi- lized, it has not returned to pre-crisis levels. So the question is, how can we improve? Here are some possibilities on how we can enhance the existing system of financial reporting.
1. Today, equity securities are broadly held, with approxi- mately half of American households investing in stocks. This presents a challenge—investors have expressed con- cerns that one-size-fi ts-all fi nancial reports do not meet the needs of the spectrum of investors who rely on those reports. While many individual investors are more interested in summarized, plain-English reports, mar- ket analysts and other investment professionals may desire information at a far more detailed level than is currently provided. Technology may help customize the information that the different types of investors desire.
2. Companies also express concerns with the complexity of the fi nancial reporting system. Companies assert that when preparing fi nancial reports, it is diffi cult to ensure compliance with the voluminous and com- plex requirements contained in U.S. GAAP and SEC reporting rules. This is a particularly heavy burden on smaller, non-public companies, which may have fewer resources to comply with the wide range of rules.
3. We also need to consider the broader array of information that investors need to make informed decisions. As some have noted, the percentage of a company’s market value that can be attributed to accounting book value has declined signifi cantly from the days of a bricks-and-mortar economy. Thus, we may want to
1 1 Understand the financial reporting
2 Identify the major policy-setting bodies and their role in the standard-setting process.
3 Explain the meaning of generally accepted accounting principles (GAAP) and the role of the Codification for GAAP.
4 Describe major challenges in the financial reporting environment.
Financial Accounting and Accounting Standards LEARNING OBJECTIVES After studying this chapter, you should be able to:
2007 2008 2009 2010 2011 2012 2013 2014 2015
Confidence in Capital Markets
consider a more comprehensive business reporting model, including both fi nancial and nonfi nan- cial key performance indicators.
4. Finally, we must also consider how to deliver all of this information in a timelier manner. In a world where messages can be sent across the world in a blink of an eye, it is ironic that the analysis of fi nancial information is still subject to many manual processes, resulting in delays, increased costs, and errors.
Thus, improving financial reporting involves more than simply trimming or reworking the existing accounting literature. In some cases, major change is already underway. For example:
• The FASB and IASB are working on a convergence project, which will contribute to less-complex, more- understandable standards in the important areas of revenue recognition, leasing, and financial instruments.
• Standard-setters are exploring expanded reporting of key performance indicators, including reports on sustain- ability and a disclosure framework project to improve the effectiveness of disclosures to clearly communicate the information that is most important to users of financial statements. This project, combined with the intro- duction of a private-company reporting framework, could go a long way to address one-size-fits-all challenges.
• The SEC now requires the delivery of financial reports using eXtensible Business Reporting Language (XBRL). Reporting through XBRL allows timelier reporting via the Internet and allows statement users to transform accounting reports to meet their specific needs.
Each of these projects will hopefully support improvements in the quality of financial reporting and increase confidence in U.S. capital markets.
Sources: Adapted from The Pathways Commission, “Charting a National Strategy for the Next Generation of Accountants” (AAA, AICPA, July 2012); Conrad W. Hewitt, “Opening Remarks Before the Initial Meeting of the SEC Advisory Committee on Improvements to Financial Reporting,” U.S. Securities and Exchange Commission, Washington, D.C. (August 2, 2007); and Center for Audit Quality, Main Street Investor Survey (September 2015). See www.fasb.org for updates on FASB/IASB conver- gence, disclosure, and private company decision-making projects.
PREVIEW OF CHAPTER 1 As our opening story indicates, the U.S. system of financial reporting has long been the most robust and transparent in the world. However, to ensure that it continues to provide the most relevant and reliable financial information to users, a number of financial reporting issues must be resolved. These issues include such matters as evalu- ating global standards, increasing fair value reporting, and meeting multiple user needs. This chap- ter explains the environment of financial reporting and the many factors affecting it, as follows.
FINANCIAL ACCOUNTING AND ACCOUNTING STANDARDS
This chapter also includes numerous conceptual and international discussions that are integral to the topics presented here.
FINANCIAL REPORTING ENVIRONMENT
• Accounting and capital allocation
• Objective of financial reporting
• Need to develop standards
PARTIES INVOLVED IN STANDARD-SETTING
• Securities and Exchange Commission
• American Institute of CPAs
• Financial Accounting Standards Board
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
• FASB Codification
MAJOR CHALLENGES IN FINANCIAL REPORTING
• Political environment • Expectations gap • Financial reporting issues • International accounting
standards • Ethics
REVIEW AND PRACTICE Go to the REVIEW AND PRACTICE section at the end of the chapter for a targeted summary review and practice problem with solution. Multiple-choice questions with annotated solutions as well as additional exercises and practice problem with solutions are also available online.
4 Chapter 1 Financial Accounting and Accounting Standards
FINANCIAL REPORTING ENVIRONMENT The essential characteristics of accounting are (1) the identification, measurement, and communication of financial information about (2) economic entities to (3) interested parties. Financial accounting is the process that culminates in the preparation of finan- cial reports on the enterprise for use by both internal and external parties. Users of these financial reports include investors, creditors, managers, unions, and government agen- cies. In contrast, managerial accounting is the process of identifying, measuring, ana- lyzing, and communicating financial information needed by management to plan, con- trol, and evaluate a company’s operations.