Warren Reeve Duchac. Professor Emeritus of Accounting University of Georgia, Athens

Full text


Warren Reeve Duchac



Carl S. Warren

Professor Emeritus of Accounting University of Georgia, Athens

James M. Reeve

Professor Emeritus of Accounting University of Tennessee, Knoxville

Jonathan E. Duchac

Professor of Accounting Wake Forest University


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Printed in the United States of America 1 2 3 4 5 6 7 11 10 09 08 Accounting, 23e

Warren Reeve Duchac



The Author Team

Carl S. Warren

Dr. Carl S. Warren is Professor Emeritus of Accounting at the University of Georgia, Athens. Dr. Warren has taught classes at the University of Georgia, University of Iowa, Michigan State University, and University of Chicago. Professor Warren focused his teaching efforts on principles of accounting and auditing. He received his Ph.D. from Michigan State University and his B.B.A. and M.A. from the University of Iowa. During his career, Dr. Warren published numerous articles in professional journals, including The Accounting Review, Journal of Accounting Research, Journal of Accountancy, The CPA Journal, and Auditing: A Journal of Practice & Theory. Dr. Warren has served on numerous committees of the American Accounting Association, the American Institute of Certified Public Accountants, and the Institute of Internal Auditors. He has also consulted with numerous companies and public accounting firms. Warren’s outside interests include playing handball, golfing, skiing, backpacking, and fly-fishing.

James M. Reeve

Dr. James M. Reeve is Professor Emeritus of Accounting and Information Management at the University of Tennessee. Professor Reeve taught on the accounting faculty for 25 years, after graduating with his Ph.D. from Oklahoma State University. His teaching effort focused on undergraduate accounting principles and graduate education in the Master of Accountancy and Senior Executive MBA programs. Beyond this, Professor Reeve is also very active in the Supply Chain Certification program, which is a major executive education and research effort of the College. His research interests are varied and include work in managerial accounting, supply chain management, lean manufac- turing, and information management. He has published over 40 articles in academic and professional journals, including the Journal of Cost Management, Journal of Management Accounting Research, Accounting Review, Management Accounting Quarterly, Supply Chain Management Review, and Accounting Horizons. He has consulted or provided training around the world for a wide variety of organizations, including Boeing, Procter and Gamble, Norfolk Southern, Hershey Foods, Coca-Cola, and Sony. When not writing books, Professor Reeve plays golf and is involved in faith-based activities.

Jonathan Duchac

Dr. Jonathan Duchac is the Merrill Lynch and Co. Professor of Accounting and Director of the Program in Enterprise Risk Management at Wake Forest University. He earned his Ph.D. in accounting from the University of Georgia and currently teaches introductory and advanced courses in financial accounting. Dr. Duchac has received a number of awards during his career, including the Wake Forest University Outstanding Graduate Professor Award, the T.B. Rose award for Instructional Innovation, and the University of Georgia Outstanding Teaching Assistant Award. In addition to his teaching responsibilities, Dr.

Duchac has served as Accounting Advisor to Merrill Lynch Equity Research, where he worked with research analysts in reviewing and evaluating the financial reporting prac- tices of public companies. He has testified before the U.S. House of Representatives, the Financial Accounting Standards Board, and the Securities and Exchange Commission; and has worked with a number of major public companies on financial reporting and account- ing policy issues. In addition to his professional interests, Dr. Duchac is the Treasurer of The Special Children’s School of Winston-Salem; a private, nonprofit developmental day school serving children with special needs. Dr. Duchac is an avid long-distance runner, mountain biker, and snow skier. His recent events include the Grandfather Mountain Marathon, the Black Mountain Marathon, the Shut-In Ridge Trail run, and NO MAAM (Nocturnal Overnight Mountain Bike Assault on Mount Mitchell).



Leading by Example

For nearly 80 years, Accounting has been used effectively to teach generations of busi- nessmen and women. The text has been used by millions of business students. For many, this book provides the only exposure to accounting principles that they will ever receive. As the most successful business textbook of all time, it continues to introduce students to accounting through a variety of time-tested ways.

The previous edition, 22e, started a new journey into learning more about the changing needs of accounting students through a variety of new and innovative research and development methods. Our Blue Sky Workshops brought accounting fac- ulty from all over the country into our book development process in a very direct and creative way. Many of the features and themes present in this text are a result of the col- laboration and countless conversations we’ve had with accounting instructors over the last several years. 23e continues to build on this philosophy and strives to be reflective of the suggestions and feedback we receive from instructors and students on an ongo- ing basis. We’re very happy with the results, and think you’ll be pleased with the improvements we’ve made to the text.

The original author of Accounting, James McKinsey, could not have imagined the success and influence this text has enjoyed or that his original vision would continue to lead the market into the twenty-first century. As the current authors, we appreciate the responsibility of protecting and enhancing this vision, while continuing to refine it to meet the changing needs of students and instructors. Always in touch with a tradition of excellence but never satisfied with yesterday’s success, this edition enthusiastically embraces a changing environment and continues to proudly lead the way. We sincerely thank our many colleagues who have helped to make it happen.

“The teaching of accounting is no longer designed to train professional accountants only. With the growing complexity of business and the constantly increasing difficulty of the problems of management, it has become essential that everyone who aspires to a position of responsibility should have a knowledge of the fundamental principles of accounting.”

— James O. McKinsey, Author, first edition, 1929



Leading by Example

Textbooks continue to play an invaluable role in the teaching and learning environment. Continuing our focus from previous editions, we reached out to accounting teachers in an effort to improve the textbook presenta- tion. New for this edition, we have extended our discussions to reach out to students directly in order to learn what they value in a textbook. Here’s a preview of some of the improvements we’ve made to this edition based on student input:

Guiding Principles System

Students can easily locate the information they need to master course concepts with the new “Guiding Principles System (GPS).” At the beginning of every chapter, this inno- vative system plots a course through the chapter content by displaying the chapter objectives, major topics, and related Example Exercises. The GPS reference to the chap- ter “At a Glance” summary completes this proven system.


Describe the characteristics of an account and a chart of accounts.

Using Accounts to Record Transactions

Describe and illustrate journalizing transactions using the double- entry accounting system.

Double-Entry Accounting System Balance Sheet Accounts Income Statement Accounts Owner Withdrawals Normal Balances

EE(page 54)2-1 Journalizing

EE(page 58)2-2

Describe and illustrate the journalizing and posting of transactions to accounts.

Posting Journal Entries to Accounts

EE(page 63)2-3

EE(page 66)2-4

EE(page 66)2-5

Prepare an unadjusted trial balance and explain how it can be used to discover errors.

Trial Balance


EE(page 71)2-7

After studying this chapter, you should be able to:


At a Glance Menu Turn to pg 72

2 3 4

Chart of Accounts

Errors Affecting the Trial Balance

Errors Not Affecting the Trial Balance

2-6(page 70)

Written for Today’s Students

Designed for today’s students, the 23rd edition has been extensively revised using an innovative, high-impact writing style that emphasizes topics in a concise and clearly written manner. Direct sentences, concise paragraphs, numbered lists, and step-by-step calculations provide students with an easy-to-follow structure for learning accounting.

This is achieved without sacrificing content or rigor.




Leading by Example


Statement of Owner’s Equity For the Year Ended December 31, 2011




$75,400 18,000 Chris Clark, capital, January 1, 2011

Net income for the year Less withdrawals Increase in owner’s equity

Chris Clark, capital, December 31, 2011

Journal Page 25

Date Description


Ref. Debit Credit


Jan. 3 1,800

1,800 Cash


To record cash sales.

Exhibit 4 Statement of Owner’s Equity for Merchandising Business

Mornin’ Joe Financial Statements

Beginning after “Accounting for Merchandising Businesses” and continuing through Chapter 15, “Investments and Fair Value Accounting,” each chapter contains an excerpt from the full financial statements for Mornin’ Joe, a coffee company. The addition of this new example shows students the big picture of accounting by providing a consistent ref- erence point for users who want to see an entire set of financial statements and the way each chapter topic fits within them. The financial statements were crafted by the authors to be consistent with the presentation in each chapter.

Revised Coverage of Investments

A new chapter on investments and fair value accounting has been written to consoli- date coverage of both dept and equity investments. The chapter also contains a con- ceptual discussion of fair value accounting and its increasing role in defining today’s modern accounting methods.

Modern User-Friendly Design

Based on students’ testimonials of what they find most useful, this streamlined presenta- tion includes a wealth of helpful resources without the clutter. To update the look of the material, some exhibits use computerized spreadsheets to better reflect the changing envi- ronment of business. Visual learners will appreciate the generous number of exhibits and illustrations used to convey concepts and procedures.






Leading by Example

Chapter Updates and Enhancements

The following includes some of the specific content changes that can be found in Accounting, 23e.

Chapter 1: Introduction to Accounting and Business

• Starbucks replaces DaimlerChrysler in opening lead-in example.

• Discussion of “types of business organizations” has been moved to later in the chapter.

Proprietorships, partnerships, corporations, and limited liability companies (LLC) are now dis- cussed with the business entity concept.

• “General-purpose financial statements” has been added as a new key term.

• New Exhibit 3 provides guidelines for ethical conduct.

• Discussion on career opportunities for accountants has been updated.

• Improved formatting of transaction discussion for NetSolutions for greater clarity.

• International Accounting Standards Board (IASB) and International Financial Reporting Standards are now mentioned in the discussion of generally accepted accounting principles.

• New Financial Analysis and Interpretation (FAI) box has been added that introduces the ratio for liabilities to owner’s equity.

Chapter 2: Analyzing Transactions

• New chapter opener features Apple.

• New section on the double-entry accounting system (Objective 2) provides improved coverage of the rules of debit and credit for balance sheet, income statement, and owner drawing account. This discussion includes normal balances of accounts. In addition, Exhibit 3 was revised so that it better summarizes the rules of debits and credits for students to refer to when working end-of-chapter homework.

• Discussion of recording transactions in accounts has been streamlined by including the discussion of the rules of debits and credits earlier in the chapter. Also, a new more simplified format for the journal and accounts is used.

• Each illustrated transaction now includes the following sections: “Transaction, Analysis, and Journal Entry.” In addition, new line art design improves the presentation of journal entries and accounts.

• Discussion of discovery and correction of errors has been revised and is now integrated into the dis- cussion of the unadjusted trial balance.

• New FAI feature has been added that discusses horizontal analysis of financial statements.

Chapter 3: The Adjusting Process

• Discussion of the adjusting process has been revised to list the reasons for updating some accounts in the ledger under accrual accounting.

• A new Exhibit 6 on Summary of Adjustments has been developed to include the reason for each adjustment, the adjusting entry, example adjusting entries from NetSolutions, and the financial statement impact if adjusting is omitted.

• New FAI feature has been added that discusses vertical analysis of financial statements.

Chapter 4: Completing the Accounting Cycle

• New spreadsheet format provides row and column labels that are more consistent with Microsoft Excel to reflect what students will see in practice.

• Integrated all accounts necessary to complete the spreadsheet directly into the spreadsheet rather than adding them at the bottom of the spreadsheet. As reviewer feedback notes, this is consistent with using Microsoft Excel where new rows (accounts) can be directly inserted into the spreadsheet at their appropriate place.

• New acetate for preparing the work sheet (spreadsheet) has been added that separates the individ- ual adjustments from the adjusted trial balance totals.

• Added stepwise approach to preparing the work sheet (spreadsheet).



• Added “closing the books” as a key term. Added (permanent) descriptor to real accounts key term.

• New FAI feature covers working capital and the current ratio.

Chapter 5: Accounting Systems

• Added stepwise approach to journalizing and posting transactions to special journal and subsidiary ledgers.

• Updated QuickBooks illustration to QuickBooks 2008 and tied better (using steps) into the chapter illustrations of a manual accounting system.

• New FAI feature covers horizontal and vertical analyses as they relate to how accounting systems can provide analysis of business segments.

Chapter 6: Accounting for Merchandising Businesses

• New chapter opener features Dollar Tree, Inc.

• For added clarity, “transportation” terminology has been changed to “freight.” For example, instead of transportation costs, we use freight costs or simply freight.

• For added clarity, this edition provides a fuller definition of debit (credit) memorandums. For effi- ciency, they are usually referenced as just debit memo or credit memo.

• In Appendix 2 (The Periodic Inventory System), “Transportation In” was switched to “Freight In”

for consistency with the chapter presentation.

Chapter 7: Inventories

• Begin financial reporting illustrations using Mornin’ Joe to reinforce the importance of financial statements to a business and as a framework to learn accounting.

• Significantly revised section on “Effect of Inventory Errors on the Financial Statements.” Added new Exhibits 9, 10, and 11. The section begins with a list of reasons that inventory errors can occur. Further illustrations get into the effects on the income statement and balance sheet. Exhibit 9 depicts the inventory error and whether the effect is understated or overstated in terms of COMS, gross profit, and net income. Exhibit 10 shows the effects of inventory errors on two years of income statements.

Exhibit 11 shows the ending error and whether it is overstated or understated as it relates to mer- chandise inventory, current assets, total assets, and owner’s equity (capital).

• Moved the “Estimating Inventory Cost” section from the chapter to an appendix at the end of the chapter. This section describes and illustrates “retail” and the “gross profit” methods of estimating inventory. The end-of-chapter materials still include exercises and one problem (A and B) for this appendix.

Chapter 8: Sarbanes-Oxley, Internal Control,

and Cash

• New illustration and journal entry for “Cash Short and Over” provides a visual presentation to rein- force this concept.

• For added clarity, “Depositor” terminology has change to “Company” in the bank reconciliations.

• Added check numbers to Exhibit 5, illustration of a bank statement. This is done based on user feed- back and reflects that most banks do not return checks but simply list the cleared checks (by check number) on the bank statement.

• Added stepwise illustration of how to prepare the bank statement (see Exhibit 7).

• Used Mornin’ Joe as the financial statement reporting illustration to reinforce the importance of financial statements to a business and as a framework to learn accounting.

Chapter 9: Receivables

• New chapter opener features Oakley, Inc.

• Illustrations for allowance methods revised to use the same data to facilitate comparisons of the percent of sales and aging of receivables methods.

Leading by Example



• New Exhibit 2 comparing percent of sales and aging of receivables methods.

• New illustration of promissory note (Exhibit 4) provides a visual reference to reinforce this concept.

• Used Mornin’ Joe as the financial statement reporting illustration to reinforce the importance of financial statements to a business and as a framework to learn accounting.

Chapter 10: Fixed Assets and Intangible Assets

• New Exhibit 7, Comparing Depreciation Methods, compares depreciation methods using chapter illustration.

• Exchanging of similar fixed assets moved to end of chapter appendix (Appendix 2). Related end-of- chapter materials are still included.

• Used Mornin’ Joe as the financial statement reporting illustration to reinforce the importance of financial statements to a business and as a framework to learn accounting.

Chapter 11: Current Liabilities and Payroll

• Updated federal withholding table and revised chapter illustrations.

• Revised “Contingent Liabilities” section including Exhibit 10.

• Used Mornin’ Joe as the financial statement reporting illustration to reinforce the importance of finan- cial statements to a business and as a framework to learn accounting.

Chapter 12: Accounting for Partnerships and Limited

Liability Companies

• New chapter opener features AgentBlaze, LLC.

• Revised Exhibit 1 to be consistent with chapter discussion using parallel terminology.

• New illustration of a partner not paying capital deficiency in liquidation visually reinforces this concept.

Chapter 13: Corporations: Organization, Stock

Transactions, and Dividends

• New chapter opener features Hasbro, Inc.

• Added discussion of cumulative preferred stock with dividends in arrears.

• Used Mornin’ Joe as the financial statement reporting illustration to reinforce the importance of financial statements to a business and as a framework to learn accounting.

Chapter 14: Long-Term Liabilities: Bonds and Notes

This chapter was based on Chapter 15 in 22e. Objectives for this chapter are:

• Objective 1: Compute the potential impact of long-term borrowing on earnings per share.

• Objective 2: Describe the characteristics and terminology of bonds payable.

• Objective 3: Journalize entries for bonds payable.

• Objective 4: Describe and illustrate the accounting for installment notes.

• Objective 5: Describe and illustrate the reporting of long-term liabilities including bonds and notes payable.

• A new objective has been added that includes discussion of installment notes.

• Discussion of pricing of bonds using present values moved to Appendix 1 at the end of the chapter.

Related end-of-chapter is still included.

• “Effective Interest Rate Method of Amortization” is now Appendix 2 at the end of the chapter.

Related end-of-chapter is still included.

Leading by Example



Chapter 15: Investments and Fair Value


A new chapter on “Investments and Fair Value Accounting” has been written for this edition, consolidating all investments-related topics into one chapter based on market feedback. The objectives for this chapter are:

• Objective 1: Describe why companies invest in debt and equity securities.

• Objective 2: Describe and illustrate the accounting for debt investments.

• Objective 3: Describe and illustrate the accounting for equity investments.

• Objective 4: Describe and illustrate valuing and reporting investments in the financial statements.

• Objective 5: Describe fair value accounting and its implications for the future.

• Chapter opener features News Corporation.

• Appendix 1 covers accounting for held-to-maturity investments.

• Appendix 2 covers the topic of comprehensive income.

Chapter 16: Statement of Cash Flows

• Revised beginning section discussing the statement of cash flows (SCF) and illustrating the format for the SCF under the direct and indirect methods.

• Revised beginning discussion of direct method to emphasize conversion of accrual income state- ment to cash flows from operations (on an item-by-item basis). New graphic for conversion of inter- est expense to cash payments for interest provides visual reinforcement for this topic.

• Used stepwise format for preparing the statement of cash flows under indirect and direct methods.

• Used stepwise format for preparing the work sheet for the indirect method in the end-of-chapter appendix.

Chapter 17: Financial Statement Analysis

• New chapter opener features Nike, Inc.

• Real world financial statement analysis problem features data from the Nike, Inc. 2007 10K, which can be found in Appendix E in the back of the text.

• Each ratio is highlighted in a boxed screen for easier review.

• Appendix on “Unusual Items on the Income Statement” was added.

Chapter 18: Managerial Accounting Concepts

and Principles

• Added a new section at the beginning of the chapter on the uses of managerial accounting, which references subsequent chapters where the uses are described and illustrated.

• Added an illustration of comparing merchandising and manufacturing income statements.


22e Chapter Topic 23e Chapter

Chapter 14 Deferred Taxes Appendix D (back of text)

Chapter 14 Reporting Unusual Items on the Income Statement Chapter 17 (FSA Appendix)

Chapter 14 Earnings Per Common Share Chapters 14, 17

Chapter 14 Comprehensive Income Chapter 15 (Appendix 2)

Chapter 14 Accounting for Investments in Stocks Chapter 15

Chapter 15 Characteristics of Bonds Payable Chapter 14

Chapter 15 Payment and Redemption of Bonds Payable Chapter 14

Chapter 15 Investments in Bonds Chapter 15

Chapter 15 Appendix: Effective Interest Rate Method of Amortization Chapter 14

NOTE: Chapter 14 from the prior edition no longer exists. The material from Chapter 14 of 22e has been redis- tributed as follows:

Leading by Example



• Added format for the cost of goods manufactured statement.

• Added stepwise preparation of the cost of goods manufactured.

Chapter 19: Job Order Costing

• Added format for the entries used to dispose of overapplied or underapplied factory overhead.

• Changed order of entries so that entries for sales and cost of goods sold are shown separately from the finished goods entry for completed units.

Chapter 20: Process Cost Systems

• Revised Exhibit 2 and accompanying narrative so that Exhibit 2 ties into Exhibit 8, which illustrates entries for Frozen Delights.

• Revised illustration of cost of production report so that units are classified into groups consisting of beginning work in process units (Group 1), started and completed units (Group 2), and ending work in process units (Group 3). This aids students in computing unit costs and assigning costs to groups using first-in, first-out inventory cost flow. Accompanying exhibits and art also classify units by these groups.

• Revised and expanded the section on using the cost of production report for decision making to include an example from Frozen Delights.

Chapter 21: Cost Behavior and Cost-Volume-Profit


• Supplemented the mixed cost discussion by adding an equation for determining fixed costs.

• Added contribution margin equation to cost-volume-profit discussion.

• Added unit contribution margin equation to cost-volume-profit discussion.

• Added “change in income from operations” equation based on unit contribution margin to cost- volume-profit discussion.

• Incorporated a discussion of computing break-even in sales dollars using contribution margin ratio.

• Added a stepwise approach to discussion of preparing cost-volume-profit and profit-volume charts.

• Added equation for computing the percent change in income from operations using “operating leverage.”

• Expanded discussion of margin of safety so that margin of safety may be expressed in sales dollars, units, or percent of current sales.

• Revised appendix on variable costing to include format for variable costing income statement.

Chapter 22: Budgeting

• Made minor changes to chapter objectives.

• Added stepwise approach to preparing a flexible budget.

• Modified the definition of the master budget.

• Added new classifications of budget components of the master budget as operating, investing, and financing budget components.

• Added format for determining “total units to be produced.”

• Added format for determining “direct materials to be purchased.”

Chapter 23: Performance Evaluation Using Variances

from Standard Costs

• Added a 2nd level heading for Objective 1, “Criticisms of Standard Costs.”

• Added several new headings for Objective 2, “Budget Performance Report” and “Manufacturing Cost Variances.”

Leading by Example



• Revised discussion of “Manufacturing Cost Variances” to better tie into subsequent discussion of standard cost variances.

• Utilized a new equation format for computing standard cost variances. Using these equations, a pos- itive amount indicates an unfavorable variance while a negative amount indicates a favorable vari- ance. Later in the chapter, positive variance amounts are recorded as debits and negative variance amounts are recorded as credits.

• Revised the factory overhead variance discussion to include equations for computing total, variable, and fixed factory overhead rates. These rates are then used to explain and illustrate the computation of the controllable factory overhead variance and the volume factory overhead variance.

• Revised the factory overhead variance discussion to use equations for computing the controllable and volume variances.

• Revised the discussion of how the total factory overhead cost variance is related to overapplied or underapplied overhead balance. Further explanation is provided to show how the overapplied or underapplied overhead balance can be separated into the controllable and volume variances.

• Added new key terms for budgeted variable factory overhead, favorable cost variance, unfavorable cost variance, and standards.

Chapter 24: Performance Evaluation for Decentralized


• Modified the chapter objectives slightly.

• Added equations for computing service department charge rates.

• Presented equations for allocating service department charges to decentralized operations (divisions).

• Added example format for determining residual income.

• Added equations for computing increases and decreases in divisional income using different negotiated transfer prices.

Chapter 25: Differential Analysis and Product Pricing

• Added section on managerial decision making. Objective 1 now includes a new flowchart depicting the steps that define the decision-making process.

• Added equations (e.g., markup percentages, desired profit) to “Setting Normal Product Selling Prices” Section.

• Adopted a stepwise approach to setting normal prices for each cost-plus (total, product, variable) concept.

• Added Exhibit 11 to summarize cost-plus approaches to setting normal prices.

• Added equation to determine “contribution margin per bottleneck constraint.”

• Presented equations for assessing product pricing and cost decisions related to bottlenecks.

• Added equation for determining “activity rate” in Activity-Based Costing appendix.

Chapter 26: Capital Investment Analysis

• Replaced XM Satellite Radio with Carnival Corporation as the opener vignette.

• Revised the learning objectives so that the nonpresent value (average rate of return and cash pay- back) methods have a separate learning objective from the present value (net present value and internal rate of return) methods.

• Added an equation for determining the “average investment” for use in the average rate of return method.

• Added an equation for determining the “cash payback period.”

• Added a graphic for determining the present value of $1 along with additional explanations of pres- ent values.

• Added format for using the net present value method that is consistent with that shown in the solutions manual.

• Added an equation for determining the present value index.

Leading by Example



Leading by Example

Accounting, 23e, is unparalleled in pedagogical innovation. Our constant dialogue with accounting faculty continues to affect how we refine and improve the text to meet the needs of today’s students. Our goal is to provide a logical framework and pedagogical system that caters to how students of today study and learn.

Clear Objectives and Key Learning Outcomes

To help guide students, the authors provide clear chapter objectives and important learning outcomes. All aspects of the chapter materials relate back to these key points and outcomes, which keeps students focused on the most important topics and concepts in order to succeed in the course.

Example Exercises

Example Exercises were developed to reinforce concepts and procedures in a bold, new way. Like a teacher in the classroom, students follow the authors’ example to see how to complete accounting applications as they are presented in the text. This feature also provides a list of Practice Exercises that parallel the Example Exercises so students get the practice they need. In addition, the Practice Exercises also include references to the chapter Example Exercises so that students can easily cross-reference when completing homework.

Describe the nature of a business, the role of accounting, and ethics in business.


During the current year, merchandise is sold for $795,000. The cost of the merchandise sold is $477,000.

a. What is the amount of the gross profit?

b. Compute the gross profit percentage (gross profit divided by sales).

c. Will the income statement necessarily report a net income? Explain.

EX 6-1

Determining gross profit

obj. 1

Example Exercise 2-2 Journal Entry for Asset Purchase

Prepare a journal entry for the purchase of a truck on June 3 for $42,500, paying $8,500 cash and the remainder on account.

Follow My Example 2-2

June 3 Truck . . . . 42,500 Cash . . . . 8,500 Accounts Payable . . . . 34,000 For Practice: PE 2-2A, PE 2-2B

Follow along as


the authors work through the Example Exercise.

See the example of the application being presented.

Try these corresponding end-of-chapter exercises for practice!



The accrual basis of accounting requires that revenues are reported in the period in which they are earned and expenses matched with the revenues they generate. The updating of ac- counts at the end of the accounting period is called the adjusting process. Each adjusting en- try affects an income statement and balance sheet account. The four types of accounts re- quiring adjusting entries are prepaid expenses, unearned revenues, accrued revenues, and ac- crued expenses.

• Explain why accrual accounting requires adjusting entries.

• List accounts that do and do NOT require adjusting entries at the end of the accounting period.

• Give an example of a prepaid expense, unearned revenue, accrued revenue, and accrued expense.

3-1 3-1A, 3-1B

3-2 3-2A, 3-2B


Describe the nature of the adjusting process.

Key Points Key Learning Outcomes Example Practice

Exercises Exercises

Provides a conceptual review of each objective.

Creates a checklist of skills to help review for a test.

Directs the student to this helpful feature!

Leading by Example

“At a Glance” Chapter Summary

The “At a Glance” summary grid ties everything together and helps students stay on track. First, the Key Points recap the chapter content for each chapter objective. Second, the related Key Learning Outcomes list all of the expected student performance capa- bilities that come from completing each objective. In case students need further practice on a specific outcome, the last two columns reference related Example Exercises and their corresponding Practice Exercises. In addition, the “At a Glance” grid guides strug- gling students from the assignable Practice Exercises to the resources in the chapter that will help them complete their homework. Through this intuitive grid, all of the chapter pedagogy links together in one cleanly integrated summary.

Real-World Chapter


Building on the strengths of past editions, these openers continue to relate the accounting and business concepts in the chapter to students’ lives. These openers employ examples of real companies and provide invaluable insight into real practice.

Several of the openers created especially for this edition focus on interesting companies such as Apple; Dollar Tree; Hasbro; and News Corporation (Fox), the parent compa- ny of the hit television shows American Idol and The Simpsons.


A P P L E , I N C.™


Analyzing Transactions

Everyday it seems like we get an incredible amount of incoming e-mail messages; you get them from your friends, relatives, subscribed e-mail lists, and even spam- mers! But how do you organize all of these messages? You might create folders to sort messages by sender, topic, or project. Perhaps you use keyword search utilities. You might even use filters/rules to automatically delete spam or send messages from your best friend to a special folder.

In any case, you are organizing information so that it is sim- ple to retrieve and allows you to understand, respond, or refer to the messages.

In the same way that you organize your e-mail, compa- nies develop an organized method for processing, recording, and summarizing financial transactions. For example, Apple, Inc., has a huge volume of financial transactions, resulting from sales of its innovative computers, digital media (like iPod music and video players), and iPhone mobile phones.

When Apple sells an iPhone online or at The Apple Store, a customer has the option of paying with credit card, a debit

or check card, an Apple gift card, a financing arrangement, or cash (using a cashier’s check, a money order, or a wire transfer). In order to analyze only the information related to Apple’s cash transactions, the company must record or sum- marize all these similar sales using a single category or “cash”

account. This is comparable to how you summarize cash in the check register of your checkbook. Similarly, Apple will record credit card payments for iPhones and sales from fi- nancing arrangements in different accounts (records).

While Chapter 1 uses the accounting equation (Assets = Liabilities + Owner’s Equity) to analyze and record financial transactions, this chapter presents more practical and efficient recording methods that most companies use. In addition, this chapter discusses possible ac- counting errors that may occur, along with methods to detect and correct them.

© AP Photo/Paul Sakuma


xv Financial Analysis and Interpretation

Comparing each item in a current statement with a total amount within that same statement is useful in an- alyzing relationships within a financial statement. Vertical analysis is the term used to describe such comparisons.

In vertical analysis of a balance sheet, each asset item is stated as a percent of the total assets. Each lia- bility and owner’s equity item is stated as a percent of the total liabilities and owner’s equity. In vertical analysis of an income statement, each item is stated as a percent of revenues or fees earned.

Vertical analysis may be prepared for several periods to analyze changes in relationships over time. Vertical analysis of two years of income statements for J. Holmes, Attorney- at-Law, is shown below.

J. Holmes, Attorney-at-Law Income Statements

For the Years Ended December 31, 2010 and 2009

2010 2009

Amount Percent Amount Percent Fees earned $187,500__________ 100.0% $150,000 100.0%______ __________ ______

Operating expenses:

Wages expense $ 60,000 32.0% $ 45,000 30.0%*

Rent expense 15,000 8.0% 12,000 8.0%

Utilities expense 12,500 6.7% 9,000 6.0%

Supplies expense 2,700 1.4% 3,000 2.0%


expense __________2,300 ______1.2% __________ ______1,800 1.2%

Total operating

expenses $ 92,500__________ ______49.3% $ 70,800__________ ______47.2%

Net income $ 95,000____________________ ____________50.7% $ 79,200__________ ________________ ______52.8%

*$45,000 ÷ $150,000

The preceding vertical analysis indicates both favor- able and unfavorable trends affecting the income state- ment of J. Holmes, Attorney-at-Law. The increase in wages expense of 2% (32% 30%) is an unfavorable trend, as is the increase in utilities expense of 0.7% (6.7% 6.0%).

A favorable trend is the decrease in supplies expense of 0.6% (2.0% 1.4%). Rent expense and miscellaneous expense as a percent of fees earned were constant. The net result of these trends was that net income decreased as a percent of fees earned from 52.8% to 50.7%.

The analysis of the various percentages shown for J.

Holmes, Attorney-at-Law, can be enhanced by compar- isons with industry averages. Such averages are published by trade associations and financial information services.

Any major differences between industry averages should be investigated.

Financial Analysis and Interpretation

The “Financial Analysis and Interpretation” section at the end of each accounting chapter introduces relevant key ratios used throughout the textbook. Students connect with the business environment as they learn how stakeholders interpret financial reports. This section covers basic analysis tools that students will use again in Chapter 17, “Financial Statement Analysis.” Furthermore, students get to test their pro- ficiency with these tools through special activities and exercises at the end of each chap- ter. To ensure a consistent presentation, a unique icon is used for both the section and related end-of-chapter materials.

Business Connection and Comprehensive

Real-World Notes

Students get a close-up look at how accounting operates in the marketplace through a variety of items in the margins and in the “Business Connection” boxed features. In addi- tion, a variety of end-of- chapter exercises and problems employ real- world data to give stu- dents a feel for the materi- al that accountants see daily. No matter where they are found, elements that use material from real companies are indicated with a unique icon for a consistent presentation.

THE ACCOUNTING EQUATION The accounting equation serves as the basic foundation for the accounting systems of all companies. From the small- est business, such as the local convenience store, to the

largest business, such as Ford Motor Company, compa- nies use the accounting equation. Some examples taken from recent financial reports of well-known companies are shown below.

Company Assets* Liabilities Owner’s Equity

The Coca-Cola Company $ 29,963 $13,043 $16,920

Circuit City Stores, Inc. 4,007 2,216 1,791

Dell Inc. 25,635 21,196 4,439

eBay Inc. 13,494 2,589 10,905

Google 18,473 1,433 17,040

McDonald’s 29,024 13,566 15,458

Microsoft Corporation 63,171 32,074 31,097

Southwest Airlines Co. 13,460 7,011 6,449

Wal-Mart 151,193 89,620 61,573

*Amounts are shown in millions of dollars.

Leading by Example



Leading by Example

Integrity, Objectivity, and Ethics in Business

In each chapter, these cases help students develop their ethical compass. Often coupled with related end-of-chapter activities, these cases can be discussed in class or students can consider the cases as they read the chapter. Both the section and related end-of- chapter materials are indicated with a unique icon for a consistent presentation.

Continuing Case Study

Students follow a fictitious company, NetSolutions, throughout Chapters 1–6, which demonstrates a variety of transactions. The continuity of using the same company facili- tates student learning especially for Chapters 1–4, which cover the accounting cycle. Also, using the same company allows students to follow the transition of the company from a service business in Chapters 1–4 to a merchandising business in Chapters 5 and 6.


Within each chapter, these synopses draw special attention to important points and help clarify difficult concepts.

Self-Examination Questions

Five multiple-choice questions, with answers at the end of the chapter, help students review and retain chapter concepts.

Illustrative Problem and Solution

A solved problem models one or more of the chapter’s assignment problems so that stu- dents can apply the modeled procedures to end-of-chapter materials.

Market Leading End-of-Chapter Material

Students need to practice accounting so that they can understand and use it. To give students the greatest possible advantage in the real world, Accounting, 23e, goes beyond presenting theory and procedure with comprehensive, time-tested, end-of-chapter material.


The financial accounting and reporting failures of Enron, WorldCom, Tyco, Xerox, and others shocked the invest- ing public. The disclosure that some of the nation’s lar- gest and best-known corporations had overstated profits and misled investors raised the question: Where were the CPAs?

In response, Congress passed the Investor Protection, Auditor Reform, and Transparency Act of 2002, called the

Sarbanes-Oxley Act. The Act establishes a Public Company Accounting Oversight Board to regulate the portion of the accounting profession that has public companies as clients.

In addition, the Act prohibits auditors (CPAs) from provid- ing certain types of nonaudit services, such as investment banking or legal services, to their clients, prohibits em- ployment of auditors by clients for one year after they last audited the client, and increases penalties for the reporting of misleading financial statements.



Online Solutions

South-Western, a division of Cengage Learning, offers a vast array of online solutions to suit your course needs. Choose the product that best meets your classroom needs and course goals. Please check with your Cengage representative for more details or for ordering information.


Founded in 2000 by economist and Stanford professor Paul Romer, Aplia is an educa- tional technology company dedicated to improving learning by increasing student effort and engagement. Currently, our products support college-level courses and have been used by more than 650,000 students at over 750 institutions.

For students, Aplia offers a way to stay on top of coursework with regularly sched- uled homework assignments. Interactive tools and content further increase engagement and understanding.

For professors, Aplia offers high-quality, auto-graded assignments, which ensure that students put forth effort on a regular basis throughout the term. These assignments have been developed for a range of textbooks and are easily customized for individual

teaching schedules.

Every day, we develop our products by responding to the needs and concerns of the students and professors who use Aplia in their classrooms. As you explore the features and benefits Aplia has to offer, we hope to hear from you as well.

Welcome to Aplia.

CengageNOW Express

CengageNOW Express

for Warren/Reeve/Duchac Accounting, 23e,

is an online homework solution that delivers better student outcomes—NOW! CengageNOW Express focuses on the textbook homework that is central to success in accounting with streamlined course start-up, straightforward assignment creation, automatic grading and tracking student progress, and instant feedback for students.

• Streamlined Course Start-Up: All Brief Exercises, Exercises, Problems, and Comprehensive Problems are available immediately for students to practice.

• Straightforward Assignment Creation: Select required exercises and problems, and CengageNOW Express automatically applies faculty approved, Accounting Homework Options.

• Automatic grading and tracking student progress: CengageNOW Express grades and captures students’ scores to easily monitor their progress. Export the grade book to Excel for easy data management.

• Instant feedback for students: Students stay on track with instructor-written hints and immediate feedback with every assignment. Links to the e-book, animated exer- cise demonstrations, and Excel spreadsheets from specific assignments are ideal for student review.




CengageNOW for Warren/Reeve/Duchac Accounting, 23e,

is a powerful and fully integrated online teaching and learning system that provides you with flexi- bility and control. This complete digital solution offers a comprehensive set of digital tools to power your course. CengageNOW offers the following:

• Homework, including algorithmic variations

• Integrated E-book

• Personalized Study Plans, which include a variety of multimedia assets (from exercise demonstrations to video to iPod content) for students as they master the chapter materials

• Assessment options which include the full test bank, including algorithmic variations

• Reporting capability based on AACSB, AICPA, and IMA competencies and standards

• Course Management tools, including grade book

• WebCT and Blackboard Integration



Available packaged with Warren/Reeve/Duchac Accounting, 23e, or for

individual student purchase

Jumpstart your course with customizable, rich, text- specific content within your Course Management System.

• Jumpstart—Simply load a WebTutor cartridge into your Course Management System.

• Customizable—Easily blend, add, edit, reorganize, or delete content.

• Content—Rich, text-specific content, media assets, quizzing, test bank, weblinks, dis- cussion topics, interactive games and exercises, and more.

Visit academic.cengage.com for more information.

Online Solutions



For the Instructor

When it comes to supporting instructors, South-Western is unsurpassed.

Accounting, 23e, continues the tradition with powerful print and digital ancillaries aimed at facilitating greater course successes.

Instructor’s Manual

This manual contains a number of resources designed to aid instructors as they prepare lectures, assign homework, and teach in the classroom. For each chapter, the instructor is given a brief synopsis and a list of objectives. Then each objective is explored, including information on Key Terms, Ideas for Class Discussion, Lecture Aids, Demonstration Problems, Group Learning Activities, Exercises and Problems for Reinforcement, and Internet Activities. Also, Suggested Approaches are included that incor- porate many of the teaching initiatives being stressed in higher education today, including active learning, collaborative learning, critical thinking, and writing across the curriculum.

Solutions Manual

The Solutions Manual contains answers to all exercises, problems, and activities that appear in the text. As always, the solutions are author-written and verified multiple times for numerical accuracy and consistency with the core text.

Solutions transparencies are also available.

Test Bank

For each chapter, the Test Bank includes True/False questions, Multiple- Choice questions, and Problems, each marked with a difficulty level, chapter objective association, and a tie-in to standard course outcomes. Along with the normal update and upgrade of the 2,800 test bank questions, variations of the new Example Exercises have been added to this bank for further quizzing and better integration with the text- book. In addition, the bank provides a grid for each chapter that compiles the correla- tion of each question to the individual chapter’s objectives, as well as a ranking of dif- ficulty based on a clearly described categorization. Through this helpful grid, making a test that is comprehensive and well-balanced is a snap!



Pro Testing Software

This intuitive software allows you to easily cus- tomize exams, practice tests, and tutorials and deliver them over a network, on the Internet, or in printed form. In addition, ExamView comes with searching capabilities that make sorting the wealth of questions from the printed test bank easy. The software and files are found on the IRCD.


® Each presentation, which is included on the IRCD and on the product support site, enhances lectures and simplifies class preparation. Each chapter contains objectives followed by a thorough outline of the chapter that easily provide an entire lecture model. Also, exhibits from the chapter, such as the new Example Exercises, have been recreated as colorful PowerPoint slides to create a powerful, customizable tool.

Instructor Excel



These templates provide the solutions for the prob- lems and exercises that have Enhanced Excel®templates for students. Through these files, instructors can see the solutions in the same format as the students. All problems with accompanying templates are marked in the book with an icon and are listed in the information grid in the solutions manual. These templates are available for download on academic.cengage.com/accounting/warren or on the IRCD.

Instructor’s Resource CD-ROM

This convenient resource includes the PowerPoint® Presentations, Instructor’s Manual, Solutions Manual, Test Bank, ExamView®, An Instructor’s Guide to Online Resources, and Excel Application Solutions. Lively demon- strations of support technology are also included. All the basic material an instructor would need is available in one place on this IRCD.



For the Student

Students come to accounting with a variety of learning needs. Accounting, 23e, offers a broad range of supplements in both printed form and easy-to- use technology. We continue to refine our entire supplement package around the comments instructors have provided about their courses and teaching needs.

Study Guide

This author-written guide provides students Quiz and Test Hints, Matching questions, Fill-in-the-Blank questions (Parts A & B), Multiple-Choice ques- tions, True/False questions, Exercises, and Problems for each chapter. Designed to assist students in comprehending the concepts and principles in the text, solutions for all of these items are available in the guide for quick reference.

Working Papers for Exercises and Problems

The traditional working papers include problem-specific forms for preparing solutions for Exercises, A & B Problems, the Continuing Problem, and the Comprehensive Problems from the textbook. These forms, with preprinted headings, provide a structure for the problems, which helps students get started and saves them time. Additional blank forms are included.

Blank Working Papers

These Working Papers are available for completing exer- cises and problems either from the text or prepared by the instructor. They have no preprinted headings. A guide at the front of the Working Papers tells students which form they will need for each problem.

Enhanced Excel



These templates are provided for selected long or complicated end-of-chapter exercises and problems and provide assistance to the student as they set up and work the problem. Certain cells are coded to display a red asterisk when an incorrect answer is entered, which helps students stay on track.

Selected problems that can be solved using these templates are designated by an icon.

Klooster & Allen General Ledger Software

Prepared by Dale Klooster and Warren Allen, this best-selling, educational, general ledger package introduces students to the world of computerized accounting through a more intuitive, user-friendly system than the commercial software they’ll use in the future. In addition, students have access to general ledger files with information based on problems from the textbook and prac- tice sets. The program is enhanced with a problem checker that enables students to determine if their entries are correct and emulates commercial general ledger packages more closely than other educational packages. Problems that can be used with Klooster/Allen are highlighted by an icon. A free Network Version is available to schools whose students purchase Klooster/Allen GL.

Product Support Web Site

academic.cengage.com/accounting/warren. This site provides students with a wealth of introductory accounting resources, including quizzing and supplement downloads and access to the Enhanced Excel®Templates.





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