H o r n g r e n ’ s Financial & Managerial accounting F o u r t h e d i t i o n Tracie Nobles Texas State University–San Marcos Brenda Mattison Tri-County Technical College Ella Mae Matsumura University of Wisconsin–Madison Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Editor-in-Chief: Donna Battista Permissions Project Manager: Jill Dougan Acquisitions Editor: Lacey Vitetta Manufacturing Buyer: Carol Melville Director of Editorial Services: Ashley Santora Senior Art Director: Anthony Gemmellaro VP/Director of Development: Steve Deitmer Interior Design:Anthony Gemmellaro/Studio Montage Development Editor: Linda Harrison, Harrison Cover Design: Anthony Gemmellaro Ridge Services Cover Photo: Sascha Burkard/Shutterstock.com; Editorial Project Manager: Nicole Sam Le Do/Shutterstock.com Editorial Assistants: Jane Avery and Lauren Editorial Media Project Manager: James Bateman Zanedis Production Media Project Manager: John Cassar Director of Marketing: Maggie Moylan Leen Full-Service Project Management and Marketing Manager: Alison Haskins Composition: Integra Marketing Assistant: Kimberly Lovato Printer/Binder: Courier Kendallville Managing Editor, Production: Jeff Holcomb Cover Printer: Lehigh Phoenix Color/Hagerstown Senior Production Project Manager: Roberta Sherman Typeface: 11/13, Adobe Garamond Pro Regular Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within text or on pages P-1 and P-2. 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To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Permissions Department, One Lake Street, Upper Saddle River, New Jersey 07458, or you may fax your request to 201-236-3290. Many of the designations by manufacturers and sellers to distinguish their products are claimed as trademarks. Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps. Library of Congress Cataloging-in-Publication Data on file. 10 9 8 7 6 5 4 3 2 ISBN-13: 978-0-13-325124-1 ISBN-10: 0-13-325124-1 In memory of Charles T. Horngren 1926–2011 Whose vast contributions to the teaching and learning of accounting impacted and will continue to impact generations of accounting students and professionals. About the Authors Tracie L. Nobles, CPA, received her bachelor’s and master’s degrees in accounting from Texas A&M University. She is currently a Senior Lecturer at Texas State University, San Marco, TX. Previously she served as an Associate Professor of Accounting at Austin Community College and has served as department chair of the Accounting, Business, Computer Information Systems, and Marketing/ Management department at Aims Community College, Greeley, CO. Professor Nobles has public accounting experience with Deloitte Tax LLP and Sample & Bailey, CPAs. Professor Nobles is a recipient of the Texas Society of CPAs Outstanding Accounting Educator Award, NISOD Teaching Excellence Award and the Aims Community College Excellence in Teaching Award. She is a member of the Teachers of Accounting at Two Year Colleges, the American Accounting Association, the American Institute of Certified Public Accountants, and the Texas State Society of Certified Public Accountants. She is currently serving on the Board of Directors as secretary/webmaster of Teachers of Accounting at Two Year Colleges, as chair of the American Institute of Certified Public Accountants Pre-certification Executive Education committee, and as program chair for the Teaching, Learning and Curriculum section of the American Accounting Association. In addition, Professor Nobles served on the Commission on Accounting Higher Education: Pathways to a Profession. Tracie has spoken on such topics as using technology in the classroom, motivating non-business majors to learn accounting, and incor- porating active learning in the classroom at numerous conferences. In her spare time she enjoys spending time with her friends and family, and camping, fishing, and quilting. Brenda L. Mattison has a bachelor’s degree in education and a master’s degree in accounting, both from Clemson University. She is currently an Accounting Instructor at Tri-County Technical College in Pendleton, South Carolina. Brenda previously served as Accounting Program Coordinator at TCTC and has prior experience teaching accounting at Robeson Community College, Lumberton, North Carolina; University of South Carolina–– Upstate, Spartanburg, South Carolina; and Rasmussen Business College, Eagan, Minnesota. She also has accounting work experience in retail and manufacturing businesses. Brenda is a member of Teachers of Accounting at Two Year Colleges and the American Accounting Association. She is currently serving on the board of directors as Vice President of Registration of Teachers of Accounting at Two Year Colleges. Brenda engages in the scholarship of teaching and learning (SOTL). While serving as Faculty Fellow at Tri-County Technical College, her research project was Using Applied Linguistics in Teaching Accounting, the Language of Business. Brenda has presented her research findings. Other presentations include using active learning and manipulatives, such as building blocks and poker chips, in teaching accounting concepts. In her spare time, Brenda enjoys reading and spending time with her family, espe- cially touring the United States in their motorhome. She is also an active volunteer in the community, serving her church, local Girl Scouts, and other organizations. Ella Mae Matsumura is a professor in the Department of Accounting and Information Systems in the School of Business at the University of Wisconsin– Madison, and is affiliated with the university’s Center for Quick Response Manufacturing. She received an A.B. in mathematics from the University of California, Berkeley, and M.Sc. and Ph.D. degrees from the University of British Columbia. Matsumura has won two teaching excellence awards at the University of Wisconsin–Madison and was elected as a lifetime fellow of the university’s Teaching Academy, formed to promote effective teaching. She is a member of the university team awarded an IBM Total Quality Management Partnership grant to develop curriculum for total quality management education. Professor Matsumura was a co-winner of the 2010 Notable Contributions to Management Accounting Literature Award. She has served in numerous leader- ship positions in the American Accounting Association (AAA). She was coeditor of Accounting Horizons and has chaired and served on numerous AAA committees. She has been secretary–treasurer and president of the AAA’s Management Accounting Section. Her past and current research articles focus on decision making, performance evaluation, compensation, supply chain relationships, and sustainability. She coauthored a monograph on customer profitability analysis in credit unions. iv Brief Contents Chapter 1 Accounting and the Business Environment 2 Chapter 2 Recording Business Transactions 66 Chapter 3 The Adjusting Process 136 Chapter 4 Completing the Accounting Cycle 210 Chapter 5 Merchandising Operations 280 Chapter 6 Merchandise Inventory 366 Chapter 7 Internal Control and Cash 432 Chapter 8 Receivables 488 Chapter 9 Plant Assets, Natural Resources, and Intangibles 548 Chapter 10 Investments 604 Chapter 11 Current Liabilities and Payroll 640 Chapter 12 Long-Term Liabilities 686 Chapter 13 Stockholders’ Equity 744 Chapter 14 The Statement of Cash Flows 808 Chapter 15 Financial Statement Analysis 884 Chapter 16 Introduction to Managerial Accounting 954 Chapter 17 Job Order Costing 1006 Chapter 18 Process Costing 1068 Chapter 19 Cost Management Systems: Activity-Based, Just-In-Time, and Quality Management Systems 1144 Chapter 20 Cost-Volume-Profit Analysis 1210 Chapter 21 Variable Costing 1268 Chapter 22 Master Budgets 1314 Chapter 23 Flexible Budgets and Standard Cost Systems 1400 Chapter 24 Responsibility Accounting and Performance Evaluation 1470 Chapter 25 Short-Term Business Decisions 1522 Chapter 26 Capital Investment Decisions 1584 AppENdIx A—2011 Green Mountain Coffee Roasters, Inc. Annual Report A-1 AppENdIx B—Present Value Tables B-1 AppENdIx C—Accounting Information Systems C-2 GlossAry G-1 INdEx I-1 pHoTo CrEdITs P-1 v Contents 1 What Is the Trial Balance? 91 Chapter Preparing Financial Statements From the Trial Balance 91 Correcting Trial Balance Errors 92 Accounting and the Business Environment 2 How Do You Use the Debt Ratio to Evaluate Business Why Is Accounting Important? 4 Performance? 93 Decision Makers: The Users of Accounting Information 4 ■ review 96 The Accounting Profession 5 What Are the Organizations and Rules That Govern ■ Assess Your Progress 104 Accounting? 7 ■ Critical thinking 132 Governing Organizations 7 Generally Accepted Accounting Principles 7 3 The Economic Entity Assumption 8 Chapter The Cost Principle 10 The Adjusting process 136 The Going Concern Assumption 11 The Monetary Unit Assumption 11 What Is the Difference Between Cash Basis Accounting International Financial Reporting Standards 11 and Accrual Basis Accounting? 138 Ethics in Accounting and Business 11 What Concepts and Principles Apply to Accrual Basis What Is the Accounting Equation? 13 Accounting? 140 Assets 13 The Time Period Concept 140 Liabilities 13 The Revenue Recognition Principle 140 Equity 13 The Matching Principle 141 How Do You Analyze a Transaction? 15 What Are Adjusting Entries and How Do We Record Them? 142 Transaction Analysis for Smart Touch Learning 15 Prepaid Expenses 143 How Do You Prepare Financial Statements? 21 Unearned Revenues 149 Income Statement 21 Accrued Expenses 150 Statement of Retained Earnings 22 Accrued Revenues 154 Balance Sheet 23 What Is the Purpose of the Adjusted Trial Balance and Statement of Cash Flows 24 How Do We Prepare It? 158 How Do You Use Financial Statements to Evaluate What Is the Impact of Adjusting Entries on the Financial Business Performance? 26 Statements? 160 Green Mountain Coffee Roasters, Inc. 26 How Could a Worksheet Help in Preparing Adjusting Return on Assets (ROA) 26 Entries and the Adjusted Trial Balance? 161 ■ review 29 AppENdIx 3A: Alternative Treatment of Recording Prepaid ■ Assess Your Progress 36 Expenses and Unearned Revenues 164 ■ Critical thinking 58 What Is an Alternative Treatment of Recording Prepaid 2 Expenses and Unearned Revenues? 164 Chapter Prepaid Expenses 164 Unearned Revenues 165 recording Business Transactions 66 ■ review 167 What Is an Account? 68 ■ Assess Your Progress 176 Assets 68 ■ Critical thinking 202 Liabilities 69 Equity 70 Chart of Accounts 70 4 Ledger 71 Chapter What Is Double-Entry Accounting? 72 Completing the Accounting Cycle 210 The T-Account 72 How Do We Prepare Financial Statements? 212 Increases and Decreases in the Accounts 72 Relationships Among the Financial Statements 213 Expanding the Rules of Debit and Credit 73 The Normal Balance of an Account 73 How Could a Worksheet Help in Preparing Financial Determining the Balance of a T-Account 74 Statements? 217 How Do You Record Transactions? 75 Section 5—Income Statement 217 Section 6—Balance Sheet 217 Source Documents—The Origin of the Section 7—Determine Net Income or Net Loss 217 Transactions 75 Journalizing and Posting Transactions 76 What Is the Closing Process, and How Do We Close The Ledger Accounts After Posting 87 the Accounts? 219 The Four-Column Account: An Alternative to the Closing Temporary Accounts—Net Income 221 T-Account 89 Closing Temporary Accounts—Net Loss 223 vi How Do We Prepare a Post-Closing Trial Balance? 225 ■ review 316 What Is the Accounting Cycle? 227 ■ Assess Your Progress 328 How Do We Use the Current Ratio to Evaluate Business ■ Critical thinking 357 Performance? 228 Comprehensive Problem for Chapters 1–5 361 AppENdIx 4A: Reversing Entries: An Optional Step 230 6 Chapter What Are Reversing Entries? 230 Accounting for Accrued Expenses 230 Merchandise Inventory 366 Accounting Without a Reversing Entry 231 What Are the Accounting Principles and Controls Accounting With a Reversing Entry 232 That Relate to Merchandise Inventory? 368 ■ review 234 Accounting Principles 368 ■ Assess Your Progress 244 Control Over Merchandise Inventory 369 ■ Critical thinking 272 How Are Merchandise Inventory Costs Determined Comprehensive Problem 1 for Chapters 1–4 275 Under a Perpetual Inventory System? 370 Comprehensive Problem 2 for Chapters 1–4 277 Specific Identification Method 372 First-In, First-Out (FIFO) Method 373 5 Last-In, First-Out (LIFO) Method 374 Chapter Weighted-Average Method 377 How Are Financial Statements Affected by Using Different Merchandising operations 280 Inventory Costing Methods? 379 What Are Merchandising Operations? 282 Income Statement 380 The Operating Cycle of a Merchandising Business 282 Balance Sheet 380 Merchandise Inventory Systems: Perpetual and Periodic Inventory How Is Merchandise Inventory Valued When Using Systems 284 the Lower-of-Cost-or-Market Rule? 383 How Are Purchases of Merchandise Inventory Recorded Computing the Lower-of-Cost-or-Market 383 in a Perpetual Inventory System? 285 Recording the Adjusting Journal Entry to Adjust Merchandise Purchase of Merchandise Inventory 286 Inventory 383 Purchase Discounts 287 What Are the Effects of Merchandise Inventory Errors Purchase Returns and Allowances 288 on the Financial Statements? 385 Transportation Costs 290 Cost of Inventory Purchased 291 How Do We Use Inventory Turnover and Days’ Sales in Inventory to Evaluate Business Performance? 388 How Are Sales of Merchandise Inventory Recorded in a Perpetual Inventory System? 292 Inventory Turnover 388 Days’ Sales in Inventory 388 Sale of Merchandise Inventory 292 Sales Discounts 294 AppENdIx 6A: Merchandise Inventory Costs Under Sales Returns and Allowances 295 a Periodic Inventory System 389 Transportation Costs—Freight Out 296 How Are Merchandise Inventory Costs Determined Under Net Sales Revenue and Gross Profit 297 a Periodic Inventory System? 389 What Are the Adjusting and Closing Entries First-In, First-Out (FIFO) Method 391 for a Merchandiser? 298 Last-In, First-Out (LIFO) Method 391 Adjusting Merchandise Inventory Based on a Physical Count 298 Weighted-Average Method 391 Closing the Accounts of a Merchandiser 299 Worksheet for a Merchandising Business—Perpetual Inventory AppENdIx 6B: Estimating Ending Merchandise Inventory 393 System 299 How Can the Cost of Ending Merchandise Inventory How Are a Merchandiser’s Financial Statements Be Estimated? 393 Prepared? 302 Gross Profit Method 393 Income Statement 302 The Retail Method 394 Statement of Retained Earnings and the Balance Sheet 304 ■ review 396 How Do We Use the Gross Profit Percentage to Evaluate ■ Assess Your Progress 405 Business Performance? 304 ■ Critical thinking 425 AppENdIx 5A: Accounting for Merchandise Inventory 7 in a Periodic Inventory System 306 Chapter How Are Merchandise Inventory Transactions Recorded Internal Control and Cash 432 in a Periodic Inventory System? 306 Purchases of Merchandise Inventory 306 What Is Internal Control and How Can It Be Used to Protect Sale of Merchandise Inventory 308 a Company’s Assets? 434 Adjusting and Closing Entries 308 Internal Control and the Sarbanes-Oxley Act 434 Preparing Financial Statements 311 The Components of Internal Control 435 Contents vii Internal Control Procedures 436 How Do We Use the Acid-Test Ratio, Accounts Receivable The Limitations of Internal Control—Costs and Benefits 439 Turnover Ratio, and Days’ Sales in Receivables to What Are the Internal Control Procedures With Respect Evaluate Business Performance? 512 to Cast Receipts? 440 Acid-Test (or Quick) Ratio 513 Cash Receipts Over the Counter 440 Accounts Receivable Turnover Ratio 514 Cash Receipts by Mail 440 Days’ Sales in Receivables 514 What Are the Internal Control Procedures With Respect ■ review 516 to Cash Payments? 441 ■ Assess Your Progress 523 Controls Over Payment by Check 441 ■ Critical thinking 543 How Can a Petty Cash Fund Be Used for Internal Control Purposes? 444 9 Setting Up the Petty Cash Fund 444 Chapter Replenishing the Petty Cash Fund 445 Changing the Amount of the Petty Cash Fund 447 plant Assets, Natural resources, and Intangibles 548 How Can the Bank Account Be Used as a Control How Does a Business Measure the Cost of a Plant Asset? 550 Device? 448 Land and Land Improvements 551 Signature Card 448 Buildings 552 Deposit Ticket 448 Machinery and Equipment 552 Check 448 Furniture and Fixtures 553 Bank Statement 449 Lump-Sum Purchase 553 Electronic Funds Transfer 450 Capital and Revenue Expenditures 554 Bank Reconciliation 450 What Is Depreciation and How Is It Computed? 556 Examining a Bank Reconciliation 453 Factors in Computing Depreciation 556 Journalizing Transactions From the Bank Reconciliation 454 Depreciation Methods 557 How Can the Cash Ratio Be Used to Evaluate Business Partial-Year Depreciation 563 Performance? 455 Changing Estimates of a Depreciable Asset 563 ■ review 457 Reporting Plant Assets 564 ■ Assess Your Progress 466 How Are Disposals of Plant Assets Recorded? 565 Discarding Plant Assets 565 ■ Critical thinking 484 Selling Plant Assets 567 8 How Are Natural Resources Accounted For? 572 Chapter How Are Intangible Assets Accounted For? 573 receivables 488 Accounting for Intangibles 573 Specific Intangibles 573 What Are Common Types of Receivables and How Are Credit Reporting of Intangible Assets 576 Sales Recorded? 490 How Do We Use the Asset Turnover Ratio to Evaluate Types of Receivables 490 Business Performance? 577 Exercising Internal Control Over Receivables 491 Recording Sales on Credit 491 AppENdIx 9A: Exchanging Plant Assets 578 Recording Credit Card and Debit Card Sales 492 How Are Exchanges of Plant Assets Accounted For? 578 Factoring and Pledging Receivables 494 Exchange of Plant Assets—Gain Situation 578 How Are Uncollectibles Accounted for When Using the Direct Exchange of Plant Assets—Loss Situation 579 Write-Off Method? 495 ■ review 581 Recording and Writing Off Uncollectible Accounts—Direct ■ Assess Your Progress 587 Write-Off Method 495 Recovery of Accounts Previously Written Off—Direct Write-Off ■ Critical thinking 600 Method 496 Limitations of the Direct Write-Off Method 496 10 How Are Uncollectibles Accounted for When Using the Chapter Allowance Method? 497 Investments 604 Recording Bad Debts Expense—Allowance Method 497 Writing Off Uncollectible Accounts—Allowance Method 498 Why Do Companies Invest? 606 Recovery of Accounts Previously Written Off—Allowance Method 499 Debt Securities Versus Equity Securities 606 Estimating and Recording Bad Debts Expense—Allowance Method 500 Reasons to Invest 606 Comparison of Accounting for Uncollectibles 505 Classification and Reporting of Investments 607 How Are Notes Receivable Accounted For? 507 How Are Investments in Debt Securities Accounted Indentifying Maturity Date 508 For? 609 Computing Interest on a Note 509 Purchase of Debt Securities 609 Accruing Interest Revenue and Recording Honored Notes Receivable 509 Interest Revenue 609 Recording Dishonored Notes Receivable 512 Disposition at Maturity 609 viii Contents How Are Investments in Equity Securities Accounted For? 610 Present Value 694 Equity Securities With Less Than 20% Ownership (Cost Method) 610 Bond Interest Rates 695 Equity Securities With 20% or More, But Less Than 50%, Bond Financing Versus Issuing Stock 696 Ownership (Equity Method) 611 How Are Bonds Payable Accounted for Using the Straight-Line Equity Securities With 50% or More Ownership (Consolidations) 614 Amortization Method? 697 How Are Debt and Equity Securities Reported? 615 Issuing Bonds Payable at Face Value 697 Trading Investments 615 Issuing Bonds Payable at a Discount 698 Available-for-Sale Investments 616 Issuing Bonds Payable at a Premium 700 Held-to-Maturity Investments 618 How Is the Retirement of Bonds Payable Accounted For? 703 How Do We Use the Rate of Return on Total Assets Retirement of Bonds at Maturity 703 to Evaluate Business Performance? 619 Retirement of Bonds Before Maturity 703 ■ review 621 How Are Liabilities Reported on the Balance Sheet? 705 ■ Assess Your Progress 627 How Do We Use the Debt to Equity Ratio to Evaluate ■ Critical thinking 636 Business Performance? 707 AppENdIx 12A: The Time Value of Money 708 11 What Is the Time Value of Money, and How Is the Present Chapter Value of a Future Amount Calculated? 708 Current liabilities and payroll 640 Time Value of Money Concepts 708 How Are Current Liabilities of Known Amounts Present Value of a Lump Sum 711 Present Value of an Annuity 711 Accounted For? 642 Present Value of Bonds Payable 712 Accounts Payable 642 Sales Tax Payable 643 AppENdIx 12B: Effective-Interest Method of Unearned Revenues 643 Amortization 714 Short-Term Notes Payable 644 How Are Bonds Payable Accounted for Using the Effective- Current Portion of Long-Term Notes Payable 645 Interest Amortization Method? 714 How Do Companies Account for and Record Payroll? 646 Effective-Interest Amortization for a Bond Discount 714 Gross Pay and Net (Take-Home) Pay 647 Effective-Interest Amortization of a Bond Premium 715 Employee Payroll Withholding Deductions 647 ■ review 718 Payroll Register 650 Journalizing Employee Payroll 651 ■ Assess Your Progress 724 Employer Payroll Taxes 651 ■ Critical thinking 738 Internal Control Over Payroll 653 How Are Current Liabilities That Must Be Estimated 13 Accounted For? 654 Chapter Bonus Plans 654 stockholders’ Equity 744 Vacation, Health, and Pension Benefits 655 Warranties 655 What Is a Corporation? 746 Characteristics of Corporations 746 How Are Contingent Liabilities Accounted For? 657 Stockholders’ Equity Basics 747 Remote Contingent Liability 658 Reasonably Possible Contingent Liability 658 How Is the Issuance of Stock Accounted For? 750 Probable Contingent Liability 658 Issuing Common Stock at Par Value 750 Issuing Common Stock at Premium 751 How Do We Use the Times-Interest-Earned Ratio to Evaluate Issuing Common Stock at a Discount 752 Business Performance? 660 Issuing No-Par Common Stock 752 ■ review 662 Issuing Stated Value Common Stock 753 ■ Assess Your Progress 669 Issuing Common Stock for Assets Other Than Cash 753 ■ Critical thinking 682 Issuing Preferred Stock 754 How Are Dividends and Stock Splits Accounted 12 For? 755 Chapter Cash Dividends 755 Stock Dividends 758 long-Term liabilities 686 Stock Splits 762 How Are Long-Term Notes Payable and Mortgages Payable Cash Dividends, Stock Dividends, and Stock Splits Accounted For? 688 Compared 763 Long-Term Notes Payable 688 How Is Treasury Stock Accounted For? 764 Mortgages Payable 689 Treasury Stock Basics 764 What Are Bonds? 692 Purchase of Treasury Stock 764 Types of Bonds 693 Sale of Treasury Stock 765 Bond Prices 693 Retirement of Stock 768 Contents ix