S U M M A R Y O F S E L E C T E D F I N A N C I A L R A T I O SRATIO NAME FORMULA

Liquidity Analysis

Working capital Current Assets � Current Liabilities

Current ratio

Acid-test ratio (quick ratio)

Cash flow from operations to current liabilities ratio

Accounts receivable turnover ratio

Number of days’ sales in receivables

Inventory turnover ratio

Number of days’ sales in inventory

Cash-to-cash operating cycle Number of Days’ Sales in Inventory �Number of Days’ Sales in Receivables

Solvency Analysis

Debt-to-equity ratio

Times interest earned ratio

Debt service coverage ratio

Cash flow from operations to capital expenditures ratio

Profitability Analysis

Gross profit ratio

Profit margin ratio

Return on assets ratio

Return on sales ratio

Asset turnover ratio

Return on common stockholders’ equity ratio

Earnings per share

Price/earnings ratio

Dividend payout ratio

Dividend yield ratio

Cash flow adequacyCash Flow from Operating Activities � Capital Expenditures�������

Average Amount of Debt Maturing over Next Five Years

Common Dividends per Share����

Market Price per Share

Common Dividends per Share����

Earnings per Share

Current Market Price���

Earnings per Share

Net Income�Preferred Dividends�������Weighted Average Number of Common Shares Outstanding

Net Income�Preferred Dividends����Average Common Stockholders’ Equity

Net Sales���Average Total Assets

Net Income � Interest Expense, Net of Tax�����

Net Sales

Net Income � Interest Expense, Net of Tax�����

Average Total Assets

Net Income��

Net Sales

Gross Profit��

Net Sales

Cash Flow from Operations�Total Dividends Paid������

Cash Paid for Acquisitions

Cash Flow from Operations before Interest and Tax Payments�������

Interest and Principal Payments

Net Income � Interest Expense � Income Tax Expense������

Interest Expense

Total Liabilities���Total Stockholders’ Equity

Number of Days in the Period����

Inventory Turnover

Cost of Goods Sold��Average Inventory

Number of Days in the Period����Accounts Receivable Turnover

Net Credit Sales����Average Accounts Receivable

Net Cash Provided by Operating Activities�����

Average Current Liabilities

Cash � Marketable Securities � Current Receivables������

Current Liabilities

Current Assets��Current Liabilities

PAGE REFERENCE*

67, 667

68, 79, 668

668

669

344, 669

670

254, 255, 671

671

671

672

673

673

674

233, 666

81, 666

676

676

401, 676

677

679

679

536, 680

680

619, 620–621

*boldface � Ratio Decision Model

Gary A. PorterSenior Lecturer

University of Minnesota

•

Curtis L. NortonArizona State University

Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States

IFRS UPDATE

2009 IFRS UPDATE—FINANCIALACCOUNTING: IMPACT ONDECISION-MAKERS 6EGary A. Porter, Curtis L. Norton

Vice President of Editorial: Jack W. Calhoun

Editor-in-Chief: Rob Dewey

Sr. Acquisitions Editor: Mathew Filimonov

Sr. Developmental Editor: Craig Avery

Marketing Manager: Steven E. Joos

Marketing Coordinator: Heather McAuliffe

Content Project Manager: Corey Geissler

Technology Project Manager: Robin Browning

Sr. Frontlist Buyer, Manufacturing:Doug Wilke

Production Service: LEAP PublishingServices, Inc.

Compositor: Macmillan PublishingSolutions

Sr. Art Director: Stacy Shirley

Internal Designer: Chris A. MillerDesign

Cover Designer: Beckmeyer Design

Cover Image: Michael Grimm/DigitalVision/Getty Images

Photography Manager: John Hill

Photo Researcher: Sam Marshall

© 2010 South-Western, Cengage Learning

ALL RIGHTS RESERVED. No part of this work covered by the copyrighthereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including photocopying, recording,taping, Web distribution, information storage and retrieval systems, orin any other manner—except as may be permitted by the license termsherein.

Library of Congress Control Number:

ISBN-13: 978-0-324-82781-1

ISBN-10: 0-324-82781-4

South-Western Cengage Learning5191 Natorp BoulevardMason, OH 45040USA

Cengage Learning products are represented in Canada by Nelson Education, Ltd.

For your course and learning solutions, visit www.cengage.com

Purchase any of our products at your local college store or at ourpreferred online store www.ichapters.com

For product information and technology assistance, contact us at Cengage Learning Customer & Sales Support, 1-800-354-9706

For permission to use material from this text or product,submit all requests online at www.cengage.com/permissions

Further permissions questions can be emailed topermissionrequest@cengage.com

Printed in the United States of America1 2 3 4 5 6 7 12 11 10 09 08

www.cengage.com/permissionswww.cengage.comwww.ichapters.com

To those who really “count”:Melissa

Kathy, Amy, Andrew

This page intentionally left blank

v

S t a r t T h e m O f f R i g h t w i t h P o r t e r / N o r t o n !

OUR GOAL has been consistent from day one: A student finishing afinancial accounting course needs to understand how to read andcomprehend a simple annual report. Even more, that student needsto be able to discern what information is needed to make sound businessdecisions. This is why, from the very first edition, we have pursued a carefulbalance between a preparer perspective and a user focus. From our experi-ence, students need to understand both how transactions are recorded andstatements are prepared, and also how accounting information is used andwhy it is important to decision-making.

What is new for the sixth edition is our increased emphasis on study materialswritten and focused on how students actually learn and prefer to study.Extensive feedback from both students and educators reveals the need to keepstudents motivated by offering a number of opportunities to review and testtheir knowledge. Frequent reinforcement and instant feedback builds confi-dence and success.

From our balanced perspective to our focus on how students actually learn,we invite you to discover why Porter/Norton will Start Your Students OffRight!

“If I need help and thereis no professor around,the instant feedbackfrom the textbook is likeyour own personal tutor.”

—Tia Pinkelton, NorthernKentucky University

P R E F A C E

vi Preface

For the sixth edition, we stayed true to our goals by focusing our innovation on how wesupport students’ learning styles:

A Book Should Motivate and Focus Students. The sixth edition continues oureffort to adopt a more streamlined approach that emphasizes key points. Extensivefocus groups and surveys on student learning behavior reveal that a majority of stu-dents prefer to have their book broken up into readily mastered segments. That’s whywe offer frequent in-text opportunities for review and feedback in the form of our inno-vative new Portable On-Demand (POD) Reviews.

REVISION GOALS

89.2% of students wantimmediate feedback

“Introductory accounting students are often overwhelmed and need assistancein understanding major topics of importance. POD Reviews help students under-stand what is most vital in the chapter information.”

—Dori Danko, Grand Valley State University

“POD Reviews will help students with test preparation. Quizzing at regular inter-vals should lead to better exam performance.”

—Christopher Denstel, Louisiana State University

“Instant feedback helps me understand where I went wrong before finishing itand having to start over.”

—Karalyn Schierberg, Northern Kentucky University

P O D R E V I E W 1.2

Q U E S T I O N S

1 . Kellogg’s is organized as which of the follow-ing business entities?

a. sole proprietorshipb. partnershipc. corporationd. none of the above

2 . One of the advantages of the corporate formof organization is

a. the ease of transfer of ownership.b. the limited liability of the stockholder.c. the ability to raise large amounts of capital in

a relatively brief period of time.d. all of the above are advantages of the corpo-

rate form of organization.

• Some entities are organized to earn a profit while others are organized to serve various segments ofsociety.

• The three forms of business entities are sole proprietorships, partnerships, and corporations.

LO2 Distinguish among the forms of organization.

Preface vii

B R I E F E X E R C I S E S

Brief Exercise 4-1 Measurement in Financial Statements

What are two possible attributes to be measured when an item is to be included in financialstatements? What unit of money is used to measure items in the United States?

Brief Exercise 4-2 Accrual Basis of AccountingFor the following situations, indicate the date on which revenue would be recognized, assumingthe accrual basis of accounting.

a. On June 10, a customer orders a product over the phone. The product is shipped tothe customer on June 14, and the customer pays the amount owed on July 10.

b. On March 15, a law firm agrees to draft a legal document for a client. The document iscompleted and delivered to the client on April 5, and the client pays the amount owed onMay 2.

c. A homeowner signs a contract on August 6 to have a company install a central airconditioning system. The work is completed on August 30, and the homeowner paysthe amount owed on September 25.

Brief Exercise 4-3 Revenue RecognitionExplain whether a company must have an inflow of an asset to be able to recognize revenue. Alsogive two examples of situations in which revenue is earned continuously over a period of time.

LO1

LO2

LO3

93% of instructorsconsider completinghomework to be eithervery or critically impor-tant to student successin accounting

47% of students con-sider completing home-work to be either very orcritically important tosuccess in accounting

Students Succeed When They Know Why Accounting Is Important. Usingreal-world, relevant flagship companies like Nike, Apple, Starbucks, and Coca-Colahelps show why accounting is important to a business. Experience has shown thatknowing the why helps students succeed.

Getting an ‘A’ in Accounting Is Still About Homework. Experience shows thatstudent success is still largely a measure of doing homework. That is why this bookcontains a range of problems and exercises—including A & B problems, review prob-lems, warm-up exercises, and more—that are designed to motivate and build skills ina systematic, step-by-step manner. The addition of Brief Exercises enhances this impor-tant success tool.

Solutions to brief exercises appear in the solutions manual.

The adjusting entry for the month of March is as follows:

Mar. 31 Interest Expense 150Interest Payable 150

To record interest for one month on a 9%, $20,000 loan.

Balance Sheet Income Statement

ASSETS � LIABILITIES � STOCKHOLDERS’ EQUITY � REVENUES � EXPENSES

Interest Payable 150 Interest Expense (150)

Balance Sheet Income Statement

ASSETS � LIABILITIES � STOCKHOLDERS’ EQUITY � REVENUES � EXPENSES

Interest Payable 150 Interest Expense (150)

The same adjusting entry is made at the end of April.

Apr. 30 Interest Expense 150Interest Payable 150

To record interest for one month on a 9%, $20,000 loan.

viii Preface

START THEM OFF RIGHT!NEW! Portable On-Demand (POD) Reviews provide opportunities to review andtest students’ knowledge after each learning outcome. The POD Reviews, consisting oflearning outcome, key points for the section just read, and two or three short multiple-choice questions, give instant feedback to students to help them master key concepts.Found after each chapter outcome, the POD Reviews combine a conceptual overviewwith a quick quiz to engage students in the content.

KEY FEATURES IN THIS EDITION

P O D R E V I E W 3.1

Q U E S T I O N S

1 . Which of the following events is not an exter-nal event?

a. a sale to a customerb. a purchase of inventory from a supplierc. payment to the newspaper for advertisingd. recognition of the use of equipment by the

recording of depreciation

2 . Which of the following is necessary to recog-nize an event as a transaction?

a. It must be subject to measurement.b. It must be an external event.c. It must be an internal event.d. It must be an event that recurs regularly.

• Both of these different types of events affect an entity and are usually recorded in the accounting systemas a transaction.

• External events are interactions between an entity and its environment.

• Internal events are interactions entirely within an entity.

LO1 Explain the difference between an external and internal event.

Answers to POD Reviews appear at the end of the chapter.

Enhanced Journal Entry Model. Students need to understand how transactionsaffect the financial statements. The sixth edition, like previous editions, supplementsnearly all journal entries with the accounting equation. The sixth edition enhances thisfeature to include a transaction-effects equation that reflects how each transactionaffects the income statement and balance sheet. This more conceptual approach helpsstudents see both the preparation of journal entries and debits and credits and theimpact of decisions on the balance sheet and income statement.

“The POD Reviews arean excellent idea. Placingthem after every learn-ing objective createsimmediate feedback andaffirmation of theirunderstanding.”

—Benjamin W. Bean,Utah Valley State College

Preface ix

Balance Sheet Income Statement

ASSETS � LIABILITIES � STOCKHOLDERS’ EQUITY � REVENUES � EXPENSES

Cash (20,450) Interest Payable (300) Interest Expense (150)Notes Payable (20,000)

The entry on Granger’s books on May 30 when it repays the principal and interest isas follows:

May 30 Interest Payable 300Interest Expense 150Notes Payable 20,000

Cash 20,450To record payment of a 9%, 90-day, $20,000 loan with interest.

Learning Outcomes Approach. The use of Learning Outcomes throughout the bookand supplements, rather than Learning Objectives, reflects a fundamental shift in ourphilosophy about how instructors should be able to access and use quizzing and test-ing for pre-testing, post-testing, and assessment.

MAKE SOUND BUSINESS DECISIONSFinancial Decision Framework. Chapter 1 introduces a framework for financialdecision making as a process that illustrates how to use financial information to makebusiness and investment decisions.

1. Formulate the Question

2. Gather Information

3. Read the Financials

4. Analyze the Financials

5. Make the Decision

6. Assess the Decision

Using this model, students learn not only what accounting is and who uses financialinformation, but also how that information is the basis for decision making.

Enhanced Ratio Decision Model. Each time a ratio is introduced, the RatioDecision Model walks students step-by-step through developing and using a financialratio from financial statement excerpts that highlight ratio terms. To encourage criticalthinking, the model depicts the financial statement line items that actually make up theratio to help students understand where the numbers come from. Most importantly, themodel highlights the interrelationship of the statements and the numbers and empha-sizes the importance of comparing the results with both prior performance and indus-try competitors.

x Preface

1. Formulate the QuestionManagers, investors, and creditors are all interested in a company’s liquidity. They must be able toanswer the following question:

Is the company liquid enough to pay its obligations as they come due?

2. Gather the Information from the Financial StatementsThe current ratio measures liquidity. To calculate the ratio, it is essential to know a company’s currentassets and liabilities. Current assets are the most liquid of all assets. Current liabilities are the debtsthat will be paid the soonest.

• Current assets: From the balance sheet• Current liabilities: From the balance sheet

3. Calculate the Ratio

Use the following Ratio Decision Model to evaluate the current ratio for General Mills or any other public company.

U S I N G T H E R A T I O D E C I S I O N M O D E L : A N A L Y Z I N G T H E C U R R E N T R A T I O

4. Compare the Ratio with OthersRatios are of no use in a vacuum. It is necessary to compare them with prior years and withcompetitors.

General Mills Kellogg’s

May 28, 2006 May 29, 2005 December 30, 2006 December 31, 2005

0.52 to 1 0.73 to 1 0.60 to 1 0.69 to 1

5. Interpret the ResultsIn general, the higher the current ratio, the more liquid the company. However, earlier in the chapteryou learned that rules of thumb do not always apply. It is necessary to take into account the nature ofa company’s business when evaluating ratios and other measures of performance. Also, ratios shouldbe compared with those of prior years and with the same ratios of competitors. However, it should benoted that in making comparisons, the year-end is different for General Mills (end of May) and Kellogg’s(end of December). Both companies operate with a relatively low current ratio compared to companiesin other industries.

Current Ratio �Current Assets��Current Liabilities

General MillsPartial Balance Sheet

May 28,2006

AssetsTotal current assets $3,176

Liabilities and Stockholders’ EquityTotal current liabilities $6,138

Current Ratio � � 0.52 to 1$3,176�$6,138

Ethical Decision Model. In the wake of accounting and business scandals of the lastfew years, the sixth edition provides a step-by-step ethical analysis and decision toolthat students can rely on to help them base their business decisions on ethical and socialprinciples throughout their careers.

ENGAGE RELEVANT FINANCIAL INFORMATIONNEW Flagship Companies provide relevance and promote critical thinking. Excerptsfrom both the Kellogg’s and General Mills annual reports are included to provide rele-vance to the role of accounting in business. Also, the inclusion of two reports from com-panies in the same field allow for comparisons that encourage critical thinking.

REVISED Concentration on Fewer Real-World Financial Statements.Examples are generated from the chapter-opening company to reinforce concepts withclear, easy-to-follow examples. A focus on fewer companies and examples minimizesdistracting and complicated alternative financial formats and numbers. Students canconcentrate on learning one business or one industry and one set of financial statementsthat apply to the company example within the chapter.

Coverage of the PCAOB, Sarbanes-Oxley, Auditing Standards for InternalControl, and International Accounting Issues. In response to the accounting andreporting scandals that have occurred in the last few years, the sixth edition introducesthe role of Sarbanes-Oxley and the PCAOB in Chapter 1. Chapter 6 devotes an entire

New in the sixth edition,the Ratio Decision Modelincludes two years ofratios for both the focuscompany and one of itscompetitors to allowbetter comparisons.

section to Sarbanes-Oxley in the context of internal control. Students are exposed toSection 404 of SOX and the new management report on internal control required by thismonumental legislation.

The text has provided coverage of international accounting issues where appropri-ate, and the book’s Web site (www.academic.cengage.com/accounting/porter) will beused to update adopters as further developments occur relating to the use of interna-tional accounting standards.

CHAPTER-BY-CHAPTER CHANGESChapter 1: Accounting as a Form of Communication• Integrated the “Getting Started in Business” module with Chapter 1 to provide a

seamless introduction to the role of accounting in a business. • Added Kellogg’s as the new focus company for Chapter 1. Chosen for its straight-

forward financial statements and high brand recognition, Kellogg’s provides anideal opportunity to introduce students to the relevance of financial accounting. Aportion of Kellogg’s 10-K is reproduced in the appendix, allowing for a comparisoncase with General Mills, Chapter 2’s focus company.

• Included the statement of cash flows in Exhibit 1-10 showing the relationshipsamong the financial statements.

• Moved “The Accounting Profession” from Chapter 1 to Appendix A at the end of thebook. Based on reviewer feedback, this change allows students to better focus onessential material.

• Added a brief section on the role of auditors in determining whether accountingstandards are being followed ahead of the discussion of ethics and the introductionof an ethical decision model.

• Added a fuller discussion of the harmonization of accounting standards, as this con-vergence of U.S. and international accounting standards and practices is an issue thatfuture business students will likely face.

• Within the section on ethics, added a Hot Topics feature illustrating why Kellogg’swas named one of the most ethical companies for 2007.

• In addition to the new Brief Exercises, the following end-of-chapter material is newor updated: New: DC1-3; Updated: E1-13, P1-8, P1-8A, P1-9A, DC1-1, DC1-2.

Chapter 2: Financial Statements and the Annual Report• Added General Mills as the focus company for Chapter 2. General Mills is a well-

known industry competitor to Chapter 1’s Kellogg’s and is used as a comparisoncompany in the Ratio Decision Model on the current ratio and profit margin in thischapter. Like Kellogg’s, General Mills’s financial statements are very straightfor-ward.

• Changed the chapter company examples to focus on a hypothetical retail businessfrom the service company used in the fifth edition. Based on reviewer feedback, thischapter employs Dixon Sporting Goods to introduce the financial statements.Instructors indicated that they prefer to cover inventories and cost of goods soldearly in the book.

• Reinstated coverage of the operating cycle in connection with a return to a focus onproduct companies rather than service companies. This key coverage was suggestedby reviewers’ desire for early treatment of inventories and cost of goods sold.

• Included General Mills’s complete balance sheet to give students a full picture of thisstatement. (In the fifth edition, the balance sheet for the chapter focus company wasa condensed version.)

• Added a Hot Topics feature on Kraft Foods’ search for a buyer for its Post® cereals:Would the buyer General Mills or Kellogg’s?

• In addition to the new Brief Exercises, the following end-of-chapter material is newor updated: New: DC2-1; Updated: P2-10, P2-10A, DC2-2.

Preface xi

www.academic.cengage.com/accounting/porter

Chapter 3: Processing Accounting Information• Added Southwest Airlines as the focus company for Chapter 3. The operation of an

airline is easy for students to understand, and they can easily relate to how an airlinegenerates revenue and the types of expenses it incurs.

• Introduced a new transaction format at the end of the chapter, which is used inthe remainder of the text. The new format includes both the journal entry and atransaction-effects equation showing the effect of the entry on the financial statements.

• Replaced the term owner’s equity with stockholders’ equity to reflect the public-corpo-ration focus of the book, starting in the transaction analysis equation and carriedthrough elsewhere in the chapter.

• Added a Hot Topics feature on Southwest Airlines teaming up with PayPal to makebuying its tickets online safer. This allows instructors to link online purchases withrevenues on Southwest’s income statement featured in the chapter.

• In addition to the new Brief Exercises, the following end-of-chapter material is newor updated: New: DC3-1; Updated: DC3-2, DC3-3.

Chapter 4: Income Measurement and Accrual Accounting• Added Nordstrom, Inc. as the focus company for Chapter 4. Students buy products

from retailers such as Nordstrom and can easily understand the nature of their busi-ness. For example, a new section was added to illustrate how Nordstrom recognizesrevenue and reports liabilities arising from the use of gift cards.

• Began using the new transaction-effects equation as an element with all journalentries to provide a conceptual basis for recording transactions.

• Added a Hot Topics feature on Nordstrom’s announced return of $1.5 billion tostockholders. Generation of excess cash comes in the context of the chapter opener’sdiscussion of accruals, deferrals, and accounts receivable for the company, intro-duced in this chapter.

• Added explanation of the receivables that arise from two different forms of creditNordstrom extends to customers. One is from the company’s own private label cardand the other from its co-branded VISA® credit card.

• In addition to the new Brief Exercises, the following end-of-chapter material is newor updated: New: DC4-1; Updated: E4-23, DC4-2, DC4-3.

Chapter 5: Inventories and Cost of Goods Sold• Added Gap Inc. as the focus company for Chapter 5. Gap’s brands are highly rec-

ognized, particularly with college students.• Moved the operating cycle coverage to Chapter 2 for better and earlier integration of

a business that sells a product.• Added a Hot Topics feature on Gap Inc.’s closing of its Forth & Towne stores and the

accounting implications shown in the 2007 financial statements.• In addition to the new Brief Exercises, the following end-of-chapter material is new

or updated: New: DC5-1, DC5-3; Updated: E5-16, P5-2, P5-6, P5-9, P5-15, P5-16, P5-2A, P5-6A, P5-9A, P5-15A, DC5-2.

Chapter 6: Cash and Internal Control• Added Sears Holdings Corp. as the focus company for Chapter 6. Focusing on cash

and cash equivalents is graphically illustrated in the opener using the first line ofSears’ balance sheet.

• Added a Hot Topics feature on the merger of Sears and K-Mart that focuses on cashflows and the management of excess cash as a key to the success of the combinedcompanies.

• Revised the Sarbanes-Oxley coverage around Sears’ management report on its inter-nal controls and on its auditors’ report on internal control.

• In addition to the new Brief Exercises, the following end-of-chapter material is new:DC6-1.

xii Preface

Chapter 7: Receivables and Investments• Updated the Apple chapter opener with the most current information available and

replaced the financial statements for Apple, Inc. as the focus company for Chapter 7.Apple has high name recognition among students, and the company has been in thespotlight recently with the introduction of its new iPhone.

• Chapter 7 has undergone significant revision and reorganization:• Receivables is placed at the start of the chapter, prior to investments. This order is

more logical, as companies often invest excess cash from the collection of theirreceivables. Thus, investments follow receivables.

• Coverage of investments has been consolidated into the body of the chapter withthe elimination of the appendix in the fifth edition. In doing so, the coverage hasbeen streamlined considerably, with the elimination of any discussion of the dis-tinction between trading securities and available-for-sale securities.

• Added a Hot Topics feature covering Apple’s record-setting third-quarter 2007revenues.

• In addition to the new Brief Exercises, the following end-of-chapter material is newor updated: New: DC7-3; Updated: E7-3, P7-3, P7-3A, DC7-1, DC7-2.

Chapter 8: Operating Assets: Property, Plant, and Equipment, and Intangibles• Updated the Nike chapter opener with the most current information available and

replaced the financial statements for Nike as the focus company for Chapter 8. • Eliminated coverage of natural resources as a result of reviewer comments.• Added a Hot Topics feature on Nike’s introduction of it ZOOM footwear, depend-

ing on Nike’s brand identity as a valuable intangible asset.• In addition to the new Brief Exercises, the following end-of-chapter material is new

or updated: New: DC8-1, DC8-2; Updated: P8-11, P8-11A.

Chapter 9: Current Liabilities, Contingencies, and the Time Value of Money• Added Starbucks as the focus company for Chapter 9. • Included new information on Starbucks and its competitors to allow for clean industry-

specific comparisons. Also new is supporting end-of-chapter material to engagestudents.

• Deleted material on the use of the calculator for time value of money. This allows theinstructor to focus on the two preferred methods: use of time value tables and the useof Excel®. Both of these methods appear at the end of the chapter.

• Updated Exhibit 9-1 on current and quick ratios to focus only on Starbucks and itsindustry competitors, based on reviewer comments.

• Added a Hot Topics feature that focuses on a possible contingent liability: lawsuitstargeting Starbucks’ use of milk having artificial growth hormone.

• Deleted the appendix on payroll accounting as a result of reviewer feedback.• In addition to the new Brief Exercises, the following end-of-chapter material is new:

P9-2, P9-3, P9-2A, P9-3A, DC9-1, DC9-2, DC9-3, DC9-4.

Chapter 10: Long-Term Liabilities• Updated the Coca-Cola chapter opener with the most current information available and

replaced the financial statements as the focus company for Chapter 10. Focuses onCoke’s long-term growth plans needing long-term investments to support that growth.

• Deleted material on the use of the calculator to calculate present value of bonds. Thischange was made for consistency with the elimination of calculators for time valuein Chapter 9.

• Deleted the appendix on pensions, as reviewers indicated that it was beyond thescope of the introductory financial accounting course.

• Added a separate Learning Outcome (and related Brief Exercise) to support thechapter’s ratio coverage.

Preface xiii

• Added a Hot Topics feature comparing Coca-Cola and PepsiCo for product intro-ductions and how much these companies depend on long-term financing.

• In addition to the new Brief Exercises, the following end-of-chapter material is newor updated: New: DC10-1, DC10-2; Updated: P10-10, P10-10A, DC10-3.

Chapter 11: Stockholders’ Equity• Added Southwest Airlines as the focus company for Chapter 11. Southwest’s perfor-

mance is key to building shareholder value, shown by its stockholders’ equity section.• All exhibits that include actual company information were replaced with new com-

panies for continued relevance.• Shortened and made more concise the section on preferred stock for easier review by

students.• Added a Hot Topics feature on Southwest’s 124th consecutive dividend in the face

of a number of future challenges found in its 2006 annual report. • In addition to the new Brief Exercises, the following end-of-chapter material is new

or updated: New: DC11-1, DC11-2; Updated: P11-7, 11-7A.

Chapter 12: The Statement of Cash Flows• Updated the chapter opener with the most current information available and

replaced the financial statements from Best Buy as the focus company for Chapter 12.Best Buy increased its cash and cash equivalents by 60% in 2006, and an updatedcash flows analysis is continued in the chapter.

• Updated Exhibit 12-1 comparing cash flows of various companies to include BestBuy competitor Circuit City.

• Added a Hot Topics feature on Best Buy’s 2007 statement of cash flows that reportedexpenditure of $733 million on additions to property and equipment.

• In addition to the new Brief Exercises, the following end-of-chapter material is new:DC12-1, DC12-2, DC12-3.

Chapter 13: Financial Statement Analysis• Updated the chapter opener with the most current information available and

replaced the financial statements from Wm. Wrigley Jr. Co. as the focus company forChapter 13.

• Added a Hot Topics feature on how Wrigley’s financed its purchase of a Russianpremium chocolate maker.

• In addition to the new Brief Exercises, the following end-of-chapter material is newor updated: New: DC13-3; Updated: E13-3, E13-4, E13-5, E13-6, DC13-1, DC13-2,DC13-4.

Appendix A: The Accounting Profession• Based on reviewer feedback, this topic was moved from Chapter 1.

Appendix B: Excerpts from Kellogg’s Form 10-K for 2006• New for this edition is Kellogg’s, the focus company used in Chapter 1.

Appendix C: Excerpts from General Mills’s Form 10-K for 2006• New for this edition is General Mills, the focus company used in Chapter 2.

xiv Preface

Preface xv

CengageNOW™ for Porter/Norton, Financial Accounting: The Impact on Decision Makersis an online teaching and learning resource that gives you more control in less timeand delivers better outcomes—NOW. CengageNOW offers all of your teaching andlearning resources in one place to help teach an accounting course. CengageNOW sat-isfies students who prefer to use digital resources to study. CengageNOW includes:

• Homework• Interactive Course Assignments• Personalized Study Plans• Integrated eBook• Assessment Options• Course Management Tools, including Grade Book

Flexible Assignment Options. With CengageNOW’s flexible homework and grade-book options, you can automatically grade all end-of-chapter assignments, weighgrades, choose points or percentages, and set the number of attempts and due dates perproblem to best suit your overall course plan. Furthermore, all end-of-chapter exercisesand problems are included, and select activities can be algorithmically modified tocreate unlimited versions for testing and practice.

Measure Course Outcomes. CengageNOW can not only help improve student per-formance, but also provides information you can use. Students can master key conceptsand prepare for exams with CengageNOW’s Personalized Study—a diagnostic pro-gram plus study plan—preloaded with an Integrated eBook and other text-specificmaterial. In addition, CengageNOW identifies and reports content and results as itrelates to accounting course outcomes (AACSB, AICPA, and ACBSP) through quizzing,assessment options, homework exercises, problems, and tutorials.

SUPPLEMENTS

Instructors, contact your Cengage sales representative about the CengageNOWversion that’s right for you.

HELPING STUDENTS SUCCEEDExcel® Templates. Many problems in each chapter may be solved on a Microsoft Excelspreadsheet to increase student awareness of basic software applications. Those selectedassignments that may be solved using the Excel spreadsheets are identified by icons inthe text. Downloadable from the Student Resources page of the product Web site.

Web Resources. Many helpful Web resources, including quizzes, topical discussions,POD Review audio downloads, and more, are available for students to access. Theseitems help reinforce and shed light on text topics. We invite you to discover more bylogging into the text Web site.

HELPING INSTRUCTORS SHINEBeyond the extraordinary advantages of using CengageNOW™, an unsurpassed pack-age of supplementary resources helps you plan, manage, and teach your course.Additionally, special resources are available to help assess the progress of your students.

Instructor’s Resource CD-ROM (ISBN 0-324-65843-5). This all-in-one resourcecontains all of the key instructor ancillaries. The Instructor’s Manual, by CatherineLumbattis (Southern Illinois University), contains detailed lecture outlines, lecture topics,and suggestions for classroom activities. The Solutions Manual, by the text authors,consists of solutions to all the end-of-chapter material keyed to learning outcomes and

“POD Reviews keep stu-dents alert and breakthe chapter up into man-ageable learning objec-tives. Great idea!”

—Paul Copley, JamesMadison University

xvi Preface

REVIEWERSThroughout the course of our writing, we are indebted to those individuals who pro-vided valuable guidance to our ongoing efforts. These include:

Sheryl J. Alley, Ball State University Monica Banyi, Oregon State UniversityBenjamin W. Bean, Utah Valley State CollegePaul Copley, James Madison UniversityMarcia Croteau, University of Maryland, Baltimore County Dori Danko, Grand Valley State UniversityChristopher E. Denstel, Louisiana State UniversityRobert Derstine, Villanova UniversityCathy Duffy, Carthage CollegeCarolyn Galantine, Pepperdine UniversityAbo Habib, Minnesota State University, MankatoShelley Kane, Wake Technical Community CollegeHoward Keller, Indiana University, Indianapolis Yaw M. Mensah, Rutgers University Charles J. Russo, Bloomsburg University of PennsylvaniaGary Schader, Keane UniversityAlbert Schepanski, University of Iowa Richard Schroeder, University of North Carolina, CharlotteL. Murphy Smith, Texas A&M University Pamela S. Stuerke, University of Missouri, St. LouisBill Talbot, Montgomery CollegeManjuri Talukdar, Northern Illinois UniversityChristian Wurst, Temple University

ACKNOWLEDGMENTS

using the new transaction-effects equation notation for journal entries. The Test Bank,by Andrew Morgret (University of Memphis), contains a comprehensive set of testitems to meet every assessment need from brief exercises to problems and decisioncases. The Test Bank in ExamView® is an easy-to-use test-creation program making itsimple to customize tests to your specific class needs as you edit or create questions andstore customized exams. An ideal tool for online testing on its own, ExamView is alsoincluded within CengageNOW. Instructor PowerPoint slides are also included on theInstructor’s Resource CD-ROM as well as downloadable from the instructor resourcepage of the text’s Web site (www.academic.cengage.com/accounting/porter), whichcontains the solutions manual, instructor’s manual, PowerPoint® and presentation slides,giving instructors the ultimate tool for customizing lectures and presentations.

Instructor’s PowerPoint® Slides. Located on the Instructor’s Resource CD-ROMand on the text’s Web site, these colorful slides, by Catherine Lumbattis (SouthernIllinois University), reinforce chapter content and provide a rich tool for in-class lec-tures and out-of-class reviewing.

Assessment Tools. The testing materials accompanying the sixth edition wererevised to accommodate your need to accurately assess student performance outcomesand measure progress towards achieving departmental and college objectives.

www.academic.cengage.com/accounting/porter

We also wish to thank participants in a financial accounting survey whose findingshelped guide us in our revision.

Throughout the first five editions, many other individuals have contributed helpfulsuggestions that have resulted in many positive changes. Although they are not citedhere, we remain grateful for their assistance.

We also wish to thank several individuals whose help with supplements and verifi-cation have aided us in the revision: Philip Babin (University of Memphis), Chris Jonick(Gainesville State College), Leslie Kauffman (LEAP Publishing), Cathy Lumbattis(Southern Illinois University, Carbondale), Andy Morgret (University of Memphis),Janice Stoudemire (Midlands Technical College), Sara Wilson (Cats Publishing), JeffWong (University of Nevada, Reno), and Gail Wright (Bryant College). We are gratefulto Malvine Litten and her staff at LEAP Publishing for their invaluable productionassistance. Finally, we are grateful to the editorial and marketing staff at Cengage, pri-marily Matt Filimonov, Craig Avery, Steve Joos, Robin Browning, and Kim Kusnerakfor their extensive help with the sixth edition.

Gary A. PorterCurtis L. Norton

November 2007

Preface xvii

Gary A. Porter earned Ph.D. and M.B.A. degrees from the University of Colorado andhis B.S.B.A. from Drake University. Recently retired as Professor of Accounting, Dr.Porter served as Department Chair and taught at numerous universities. He is cur-rently a Senior Lecturer at the University of Minnesota. Dr. Porter has published in theJournal of Accounting Education, Journal of Accounting, Auditing & Finance, and Journal ofAccountancy, among others, and has conducted numerous workshops on the subjects ofintroductory accounting education and corporate financial reporting.

Dr. Porter’s professional activities include experience as a staff accountant withDeloitte & Touche in Denver, a participant in KPMG Peat Marwick Foundation’sFaculty Development program, and a leader in numerous bank training programs. Hehas won an Excellence in Teaching Award from the University of Colorado andOutstanding Professor Awards from both San Diego State University and theUniversity of Montana. He served on the Illinois CPA Society’s Innovations inAccounting Education Grants Committee, the steering committee of the Midwestregion of the American Accounting Association, and the board of directors of theChicago chapter of Financial Executives International.

Curtis L. Norton is a Professor Emeritus at Northern Illinois University in DeKalb,Illinois, where he has taught since 1976. He currently is teaching in NIU’s highlyacclaimed CPA Review program. He is also a Visiting Professor at Arizona StateUniversity at the West Campus. He earned his Ph.D. from Arizona State University, hisM.B.A. from the University of South Dakota, and his B.S. from Jamestown College,North Dakota. His extensive list of publications include articles in Accounting Horizons,The Journal of Accounting Education, Journal of Accountancy, Journal of CorporateAccounting, Journal of the American Taxation Association, Real Estate Review, TheAccounting Review, CPA Journal, and many others. In 1988–1989, Dr. Norton receivedthe University Excellence in Teaching Award, the highest university-wide teachingrecognition at NIU. He is also a consultant and has conducted training programs forgovernmental authorities, bank, utilities, and other entities.

Dr. Norton is a member of the American Accounting Association and a member andofficer of Financial Executives International.

M E E T T H E A U T H O R S

xviii

xix

CHAPTER 1 Accounting as a Form of Communication 2

CHAPTER 2 Financial Statements and the Annual Report 52

CHAPTER 3 Processing Accounting Information 104

CHAPTER 4 Income Measurement and Accrual Accounting 150

CHAPTER 5 Inventories and Cost of Goods Sold 218

CHAPTER 6 Cash and Internal Control 294

CHAPTER 7 Receivables and Investments 334

CHAPTER 8 Operating Assets: Property, Plant, and Equipment, and Intangibles 376

CHAPTER 9 Current Liabilities, Contingencies, and the Time Value of Money 424

CHAPTER 10 Long-Term Liabilities 478

CHAPTER 11 Stockholders’ Equity 524

CHAPTER 12 The Statement of Cash Flows 582

CHAPTER 13 Financial Statement Analysis 654

A P P E N D I X A : T H E A C C O U N T I N G P R O F E S S I O N A - 1

A P P E N D I X B : E X C E R P T S F R O M K E L L O G G ’ S F O R M 1 0 - K F O R 2 0 0 6 B - 1

A P P E N D I X C : E X C E R P T S F R O M G E N E R A L M I L L S ’ S F O R M 1 0 - K F O R 2 0 0 6 C - 1

G L O S S A R Y G - 1

C O M P R E H E N S I V E I N D E X I - 1

B R I E F C O N T E N T S

CHAPTER 1 Accounting as a Form of Communication 2Kellogg Company: Making Business Decisions 3What Is Business? 4Forms of Organization 6

Business Entities 6Nonbusiness Entities 7Organizations and Social Responsibility 8

The Nature of Business Activity 8Financing Activities 8Investing Activities 9Operating Activities 9

What Is Accounting and What Information Do Users ofAccounting Reports Need? 11

Users of Accounting Information and Their Needs 11Internal Users 11External Users 11Using Financial Accounting Information 12

Using the Ratio Decision Model: Financial Decision Framework 14Financial Statements: How Accountants Communicate 14

The Accounting Equation 14The Balance Sheet 15The Income Statement 16The Statement of Retained Earnings 17The Statement of Cash Flows 18Relationships Among the Financial Statements 18Looking at Financial Statements for a Real Company: Kellogg’s 19Kellogg’s Balance Sheet 20Kellogg’s Income Statement 21

The Conceptual Framework: Foundation for Financial Statements 22

Conceptual Framework for Accounting 22Economic Entity Concept 22Cost Principle 22Going Concern 23Time Period Assumption 23Generally Accepted Accounting Principles 23Accounting as a Social Science 23

Setting Accounting Standards 24Who Determines the Rules of the Game? 24The Audit of Financial Statements 25

Introduction to Ethics in Accounting 26Why Should Accountants Be Concerned with Ethics? 26

Hot Topics: Kellogg’s—One of the World’s Most Ethical Companies 29Accountants and Ethical Judgments 29The Changing Face of the Accounting Profession 29

Each chapter contains some or all of the following end-of-chapter material:

• Ratio Review • Accounts Highlighted • Key Terms Quiz • Alternate Terms • Warmup Exercises & Solutions • Review Problem & Solution • Appendix ReviewProblem & Solution • Questions • Brief Exercises • Exercises • MulticonceptExercises • Problems • Multiconcept Problems • Alternate Problems • Alternate Multiconcept Problems • Decision Cases • Solutions to Key Terms Quiz • Answers to POD Review

© Ge

tty

Imag

es

xx

C O N T E N T S

Contents xxi

CHAPTER 2 Financial Statements and the Annual Report 52General Mills: Making Business Decisions 53Objectives of Financial Reporting 54

The Primary Objective of Financial Reporting 55Secondary Objectives of Financial Reporting 55

What Makes Accounting Information Useful? Qualitative Characteristics 57

Understandability 57Relevance 57Reliability 57Comparability and Consistency 58Materiality 59Conservatism 59An International Perspective on Qualitative Characteristics 60

The Classified Balance Sheet 61What are the Parts of the Balance Sheet? Understanding theOperating Cycle 61Current Assets 62Noncurrent Assets 63Current Liabilities 64Long-Term Liabilities 64Stockholders’ Equity 65

Using a Classified Balance Sheet: Introduction to Ratios 67Working Capital 67Current Ratio 68

The Income Statement 69What Appears on the Income Statement? 69Format of the Income Statement 70

Using an Income Statement 72The Statement of Retained Earnings 73The Statement of Cash Flows 74Looking at Financial Statements for a Real Company: General Mills, Inc. 77

General Mills’s Balance Sheet 77General Mills’s Income Statement 77

Using the Ratio Decision Model: Analyzing the Current Ratio 79Using the Ratio Decision Model: Analyzing the Profit Margin 80Hot Topics: Who Will Reign Supreme over the Breakfast Table? 81

Other Elements of an Annual Report 82

CHAPTER 3 Processing Accounting Information 104Southwest Airlines: Making Business Decisions 105Economic Events: The Basis for Recording Transactions 106

External and Internal Events 106The Role of Source Documents in Recording Transactions 107Analyzing the Effects of Transactions on the Accounting Equation 108

Balance Sheet and Income Statement for Glengarry Health Club 111

What Is an Account? 113Chart of Accounts 114The General Ledger 114The Double-Entry System 115The T Account 115

Debits and Credits 116Debits and Credits for Revenues, Expenses, and Dividends 116Summary of the Rules for Increasing and Decreasing Accounts 117

© Ja

mes

F.

Quin

n/M

CT/L

ando

v©

AP P

hoto

/Mar

k Le

nnih

an

Normal Account Balances 117Debits Aren’t Bad, and Credits Aren’t Good 118Debits and Credits Applied to Transactions 118Transactions for Glengarry Health Club 118

The Journal: The Firm’s Chronological Record of Transactions 121Hot Topics: Southwest Airlines and PayPal Team Up 124The Trial Balance 124

A Final Note: Processing Account Information 125

CHAPTER 4 Income Measurement and Accrual Accounting 150Nordstrom, Inc.: Making Business Decisions 151Recognition and Measurement in Financial Statements 152

Recognition 152Measurement 153Summary of Recognition and Measurement in Financial Statements 154

The Accrual Basis of Accounting 155Comparing the Cash and Accrual Bases of Accounting 155What the Income Statement and the Statement of Cash Flows Reveal 157Accrual Accounting and Time Periods 158

The Revenue Recognition Principle 159Expense Recognition and the Matching Principle 160Accrual Accounting and Adjusting Entries 162

Types of Adjusting Entries 162Hot Topics: What to Do with an Extra $1.5 Billion? 166

Accruals and Deferrals 170Summary of Adjusting Entries 171Comprehensive Example of Adjusting Entries 171Using a Trial Balance to Prepare Adjusting Entries 172Adjusting Entries at the End of January 172Ethical Considerations for a Company on the Accrual Basis 176

The Accounting Cycle 177The Use of a Work Sheet 177

The Closing Process 178Interim Financial Statements 180

APPENDIX—Accounting Tools: Work Sheets 181

Integrative Problem 216

CHAPTER 5 Inventories and Cost of Goods Sold 218Gap Inc.: Making Business Decisions 219The Nature of Inventory 220

Three Types of Inventory Cost and Three Forms of Inventory 221Net Sales of Merchandise 223

Sales Returns and Allowances 224Credit Terms and Sales Discounts 224

Hot Topics: Some Work and Some Don’t 225The Cost of Goods Sold 225

The Cost of Goods Sold Model 225Inventory Systems: Perpetual and Periodic 227Beginning and Ending Inventories in a Periodic System 228The Cost of Goods Purchased 229

The Gross Profit Ratio 233Using the Ratio Decision Model: Analyzing the Gross Profit Ratio 233

xxii Contents

© Am

y Et

ra/P

hoto

Edit

. Al

l rig

hts

rese

rved

.©

AP P

hoto

/Pau

l Sak

uma

Contents xxiii

Inventory Valuation and the Measurement of Income 235Inventory Costs: What Should Be Included? 235

Inventory Costing Methods with a Periodic System 236Specific Identification Method 237Weighted Average Cost Method 238First-in, First-out Method (FIFO) 239Last-in, First-out Method (LIFO) 239

Selecting an Inventory Costing Method 241Costing Methods and Cash Flow 241LIFO Liquidation 242The LIFO Conformity Rule 242The LIFO Reserve: Estimating LIFO’s Effect on Income and on Taxes Paid for Winnebago Industries 243Costing Methods and Inventory Profits 243Changing Inventory Methods 244Inventory Valuation in Other Countries 244

Inventory Errors 245Valuing Inventory at Lower of Cost or Market 248

Why Replacement Cost Is Used as a Measure of Market 249Conservatism Is the Basis for the Lower-of-Cost-or-Market Rule 250Application of the LCM Rule 250

Methods for Estimating Inventory Value 251Gross Profit Method 252Retail Inventory Method 253

Analyzing the Management of Inventory 254Using the Ratio Decision Model: Analyzing the Management of Inventory 255How Inventories Affect the Cash Flows Statement 257APPENDIX—Accounting Tools: Inventory Costing Methods with theUse of a Perpetual Inventory System 259

CHAPTER 6 Cash and Internal Control 294Sears Holdings Corporation: Making Business Decisions 295What Constitutes Cash? 296

Cash Equivalents and the Statement of Cash Flows 296Hot Topics: A $53 Billion Start-Up 297Control Over Cash 299

Cash Management 299Reading a Bank Statement 299The Bank Reconciliation 300The Bank Reconciliation and the Need for Adjustments to the Records 302Establishing a Petty Cash Fund 304An Example of a Petty Cash Fund 305

An Introduction to Internal Control 307The Sarbanes-Oxley Act of 2002 307The Control Environment 310The Accounting System 310

Internal Control Procedures 311Limitations on Internal Control 313

Computerized Business Documents and Internal Control 314Control Over Cash Receipts 314The Role of Computerized Business Documents in Controlling Cash Disbursements 315

© Ju

stin

Sul

livan

/Get

ty I

mag

es

CHAPTER 7 Receivables and Investments 334Apple Inc.: Making Business Decisions 335Accounts Receivable 336

The Use of a Subsidiary Ledger 336The Valuation of Accounts Receivable 337Two Methods to Account for Bad Debts 338Write-Offs of Uncollectible Accounts with the Allowance Method 339Two Approaches to the Allowance Method of Accounting for Bad Debts 340

The Accounts Receivable Turnover Ratio 343Using the Ratio Decision Model: Analyzing the Accounts ReceivableRate of Collection 344Hot Topics: A Record-Setting Quarter 346Notes Receivable 346

Important Terms Connected with Promissory Notes 347Accelerating the Inflow of Cash from Sales 348

Credit Card Sales 349Discounting Notes Receivable 350

Accounting for Investments 351Investments in Highly Liquid Financial Instruments 351Investments in Stocks and Bonds 353Valuation and Reporting for Investments on the FinancialStatements 356

How Liquid Assets Affect the Statement of Cash Flows 357

CHAPTER 8 Operating Assets: Property, Plant, and Equipment, and Intangibles 376Nike: Making Business Decisions 377Operating Assets: Property, Plant, and Equipment 378

Balance Sheet Presentation 378Acquisition of Property, Plant, and Equipment 379Use and Depreciation of Property, Plant, and Equipment 382Capital versus Revenue Expenditures 389Environmental Aspects of Operating Assets 391Disposal of Property, Plant, and Equipment 391

Operating Assets: Intangible Assets 393Hot Topics: The Nike Brand: Intangible? Yes. Valuable? Absolutely! 394

Balance Sheet Presentation 394Acquisition Cost of Intangible Assets 395Amortization of Intangibles 396

How Long-Term Assets Affect the Statement of Cash Flows 399Analyzing Long-Term Assets for Average Life and Asset Turnover 401Using the Ratio Decision Model: Analyzing Average Life and Asset Turnover 402

CHAPTER 9 Current Liabilities, Contingencies, and the Time Value of Money 424Starbucks Corporation: Making Business Decisions 425Current Liabilities 426

Accounts Payable 427Notes Payable 427

xxiv Contents

© Ju

stin

Sul

livan

/Get

ty I

mag

es©

PRNe

wsF

oto/

NIKE

© Bo

b Pa

rdue

/Ala

my

Contents xxv

Current Maturities of Long-Term Debt 429Taxes Payable 430Other Accrued Liabilities 431Reading the Statement of Cash Flows for Changes in Current Liabilities 432

Contingent Liabilities 434Contingent Liabilities That Are Recorded 434Contingent Liabilities That Are Disclosed 436

Hot Topics: Starbuck’s Liability for Products 436Contingent Liabilities versus Contingent Assets 437

Time Value of Money Concepts 438Simple Interest 439Compound Interest 440Interest Compounding 440Future Value of a Single Amount 441Present Value of a Single Amount 442Future Value of an Annuity 443Present Value of an Annuity 445Solving for Unknowns 446

APPENDIX—Accounting Tools: Using Excel® for Problems Involving Interest Calculations 452

CHAPTER 10 Long-Term Liabilities 478Coca-Cola: Making Business Decisions 479Balance Sheet Presentation 480Hot Topics: Coca-Cola versus Pepsi 481Bonds Payable 482

Characteristics of Bonds 482Issuance of Bonds 484Factors Affecting Bond Price 484Premium or Discount on Bonds 486Bond Amortization 489Redemption of Bonds 493

Liability for Leases 495Leases 495

Analyzing Debt to Assess a Firm’s Ability to Pay Its Liabilities 499Using the Ratio Decision Model: Analyzing the Debt-to-Equity and Times Interest Earned Ratios 500How Long-Term Liabilities Affect the Statement of Cash Flows 502APPENDIX—Accounting Tools: Other Liabilities 504

CHAPTER 11 Stockholders’ Equity 524Southwest Airlines: Making Business Decisions 525An Overview of Stockholders’ Equity 526

Equity as a Source of Financing 526Stockholders’ Equity on the Balance Sheet 527How Income and Dividends Affect Retained Earnings 528Identifying the Components of the Stockholders’ Equity Section of theBalance Sheet 528

What Is Preferred Stock? 530Issuance of Stock 532

Stock Issued for Cash 532Stock Issued for Noncash Consideration 532

What Is Treasury Stock? 533Retirement of Stock 536

© Ch

rist

ian

Vero

n/Re

uter

s/La

ndov

© AP

Pho

to/M

ark

Lenn

ihan

Hot Topics: Southwest Airlines’ Creation of Stockholders’ Value 536Dividends: Distribution of Income to Shareholders 536

Cash Dividends 536Cash Dividends for Preferred and Common Stock 537Stock Dividends 538Stock Splits 541

Statement of Stockholders’ Equity 543What Is Comprehensive Income? 543

What Analyzing Stockholders’ Equity Reveals About a Firm’s Value 545

Book Value per Share 545Using the Ratio Decision Model: Analyzing Book Value per Share 546

Calculating Book Value When Preferred Stock Is Present 547Market Value per Share 548

How Changes in Stockholders’ Equity Affect the Statement of Cash Flows 549APPENDIX—Accounting Tools: Unincorporated Businesses 551

Integrative Problem 580

CHAPTER 12 The Statement of Cash Flows 582Best Buy: Making Business Decisions 583Cash Flows and Accrual Accounting 585

Purpose of the Statement of Cash Flows 586An Example 586Reporting Requirements for a Statement of Cash Flows 588

The Definition of Cash: Cash and Cash Equivalents 588Classification of Cash Flows 590Hot Topics: Spending Money to Make Money 592Two Methods of Reporting Cash Flow From Operating Activities 594

Noncash Investing and Financing Activities 596How the Statement of Cash Flows Is Put Together 598

The Accounting Equation and the Statement of Cash Flows 598A Master T-Account Approach to Preparing the Statement of Cash Flows: Direct Method 599Compare Net Income with Net Cash Flow From Operating Activities 607

A Master T-Account Approach to Preparing the Statement of Cash Flows: Indirect Method 614

Comparison of the Indirect and Direct Methods 617The Use of Cash Flow Information 618

Creditors and Cash Flow Adequacy 619Using the Ratio Decision Model: Analyzing Cash Flow Adequacy 620

Stockholders and Cash Flow per Share 621APPENDIX—Accounting Tools: A Work-Sheet Approach to theStatement of Cash Flows 622

CHAPTER 13 Financial Statement Analysis 654Wm. Wrigley Jr. Company: Making Business Decisions 655Precautions in Statement Analysis 656

Watch for Alternative Accounting Principles 656Take Care When Making Comparisons 657Understand the Possible Effects of Inflation 657

Analysis of Comparative and Common-Size Statements 658Horizontal Analysis 658Vertical Analysis 664

xxvi Contents

© AP

Pho

to/T

he V

indi

cato

r. J

ean

Niec

e©

Gary

Gar

dine

r/Bl

oom

berg

Contents xxvii

Liquidity Analysis and the Management of Working Capital 667Working Capital 667Current Ratio 668Acid-Test Ratio 668Cash Flow from Operations to Current Liabilities 669Accounts Receivable Analysis 669Inventory Analysis 671Cash Operating Cycle 671

Solvency Analysis 672Debt-to-Equity Ratio 672Times Interest Earned 673Debt Service Coverage 673Cash Flow from Operations to Capital Expenditures Ratio 674

Profitability Analysis 675Rate of Return on Assets 675Components of Return on Assets 676Return on Common Stockholders’ Equity 677Return on Assets, Return on Equity, and Leverage 678Earnings per Share 678Price/Earnings Ratio 679Dividend Ratios 680Summary of Selected Financial Ratios 680

APPENDIX—Accounting Tools: Reporting and Analyzing Other Income Statement Items 682

Hot Topics: Wrigley Sweetens Its Business in Another Part of the World 684 Integrative Problem 717

A P P E N D I X A : T H E A C C O U N T I N G P R O F E S S I O N A - 1

A P P E N D I X B : E X C E R P T S F R O M K E L L O G G ’ S F O R M 1 0 - K F O R 2 0 0 6 B - 1

A P P E N D I X C : E X C E R P T S F R O M G E N E R A L M I L L S ’ S F O R M 1 0 - K F O R 2 0 0 6 C - 1

G L O S S A R Y G - 1

C O M P R E H E N S I V E I N D E X I - 1

1

L e a r n i n g O u t c o m e sAfter studying this chapter, you should be able to:

LO1 Explain what business is about.LO2 Distinguish among the forms of

organization.LO3 Describe the various types of

business activities.LO4 Define accounting and identify

the primary users of accountinginformation and their needs.

LO5 Explain the purpose of each ofthe financial statements and therelationships among them andprepare a set of simplestatements.

LO6 Identify and explain the primaryassumptions made in preparingfinancial statements.

LO7 Identify the various groupsinvolved in setting accountingstandards and the role ofauditors in determining whetherthe standards are followed.

LO8 Explain the critical role thatethics play in providing usefulfinancial information.

A Look at This ChapterBusiness is the foundationupon which accounting rests.After a brief introduction tobusiness, we begin the studyof accounting by consideringwhat accounting is and whouses the information it pro-vides. We will see thataccounting is an importantform of communication andthat financial statements arethe medium that accountants

use to communicate withthose who have some interestin the financial affairs of acompany.

A Look at UpcomingChaptersChapter 1 introduces account-ing and financial statements.Chapter 2 looks in more detailat the composition of thestatements and the concep-tual framework that supports

the work of an accountant.Chapter 3 steps back fromfinancial statements andexamines how companiesprocess economic events as a basis for preparing thestatements. Chapter 4 com-pletes the introduction to theaccounting model by consider-ing the importance of accrualaccounting in this communica-tion process.

Accountingas a Form ofCommunication

CH

AP

TE

R

S t u d y L i n k s . . .

3

Kellogg CompanyM A K I N G B U S I N E S S D E C I S I O N S

Pick your favorite company. Maybe it is Abercrombie& Fitch because you buy all of your clothes there. Ormaybe it is Google because you use its searchengine nearly every day. Or is it Coca-Cola because youlike its commercials? At any rate, have you ever consideredhow the company got started? Consider Kellogg Company.The Battle Creek, Michigan–based cereal company got itsstart over one hundred years ago when two brothers bysheer chance discovered toasted flakes. W. K. Kellogg andhis brother, Dr. John Harvey Kellogg, were cooking wheatfor a type of granola, left for a while, and came back tofind that the wheat had become stale. They put the wheatthrough the rollers anyway, and what came out was a thinflake. From this came the formation of the Battle CreekToasted Corn Flake Company, the forerunner of KelloggCompany.

From this modest start, Kellogg Company has grown tothe point that it employs 25,000 people around theglobe, manufactures its products in 17 countries, andmarkets those products in more than 180 countries. Thecompany’s brand names are among the most recognizablein the world, including such heavyweights as Kellogg’s®,Keebler®, Rice Krispies®, and Special K®.

As you will see throughout your study of business, allcompanies must make decisions and all decisions inher-ently involve risks. When the Kellogg brothers made thedecision to form their company in 1906, they risked someof their own money to start a business that eventuallyrevolutionized the way people eat breakfast. Over thecourse of one hundred years, Kellogg Company has facedany number of other critical decisions. One of the mostfar-reaching of these decisions was made in 2001 when itfinalized the acquisition of Keebler Foods Company. Atone time in its history, cereal was Kellogg Company’s onlybusiness. The company’s product mix changed dramati-cally in 2001 when it acquired Keebler, a leading producerof cookies and crackers, for over $4 billion.

How does management of a company, its stockholders,and others interested in the financial well-being of acompany know if the company is making good businessdecisions? Was Keebler “worth” the $4 billion thatKellogg Company paid for it? Although questions such asthese have no clear-cut answers, the numbers produced

by an accounting system go a long way in assessing acompany’s financial performance. Consider the FinancialHighlights shown here as they appeared in KelloggCompany’s 2006 annual report. The first chart shows thatsales have increased for six consecutive years, not coin-cidentally the length of time since the company acquiredKeebler. Net sales in 2006 reached nearly $11 billion.Operating profit, a measure that gives an indication asto how well a company is controlling the costs necessaryto generate sales, has also risen steadily over thisperiod, as shown in the second chart.

Of course, it isn’t just companies that use financialinformation in making decisions. For example, when youwere deciding whether to enroll at your present school,you needed information about the tuition and othercosts at the different schools you were considering.When a stockbroker decides whether to recommend to aclient the purchase of stock in a company, the brokerneeds information about the company’s profits andneeds to know whether it pays dividends. When tryingto decide whether to loan money to a company, a bankermust consider the company’s current debts.

This book explores how accounting can help everyonemake informed decisions. Before turning to the role of

(continued)

© Getty Images

What Is Business?

4 Chapter 1 Accounting as a Form of Communication

accounting in decision making, we need to explore busi-ness in more detail. Then we turn to the measures thataccountants use to assess a company’s performance:

• What is business? (See pp. 4–5.)

• What forms of organization carry on business activi-ties? (See pp. 6–8.)

• In what types of business activities do those organi-zations engage? (See pp. 8–10.)

• What is revenue? How is it measured? (See pp. 16–17.)

• What is net income? How is it measured? (See pp.16–17.)

• How do revenue and net income relate to a company’sassets? (See pp. 15–17.)

• Where do the various items appear on a company’sfinancial statements? (See pp. 15–18.)

Just as Kellogg’s got its start over one hundred years ago in Battle Creek, Michigan,your study of accounting has to start somewhere. All disciplines have a foundation onwhich they rest. For accounting, that foundation is business.

Broadly defined, business consists of all activities necessary to provide the membersof an economic system with goods and services. Certain business activities focus on theproviding of goods or products, such as ice cream, automobiles, and computers. Someof these companies, such as Kellogg’s, produce or manufacture the products. Othercompanies are involved in the distribution of the goods, either as wholesalers (who sellto retail outlets) or retailers (who sell to consumers). Other business activities, by theirnature, are service-oriented. Corporate giants such as Citicorp, Walt Disney, TimeWarner, and United Airlines remind us of the prominence of service activities in theworld today. The relatively recent phenomenon of various “service providers,” such ashealth-care organizations and Internet companies, is a testimony to the growing impor-tance of the service sector in the U.S. economy.

To appreciate the kinds of business enterprises in our economy, consider the varioustypes of companies that have a stake in the delivery of a box of cereal to the grocery store.

LO1 Explain whatbusiness is about.

BusinessAll of the activities necessaryto provide the members of aneconomic system with goodsand services.

Net Sales (millions $)

02

8,304

03

8,812

04

9,614

06

10,907

05

10,177

Operating Profit (millions $)

02 03 04 05 06

1,508 1,5441,681

1,7661,750

Net sales increasedagain in 2006, the sixthconsecutive year of growth.

Operating profit increaseddespite cost inflation,significant investment infuture growth, and the effectof expensing stock options.

Financial Highlights

Source: Kellogg Company’s web site and its 2006 annual report.

First, Kellogg’s must contract with various suppliers of the raw materials, such as grainsthat are needed to produce cereal. For example, assume that Kellogg’s buys grains fromWholesome Wheat. As a manufacturer or producer, Kellogg’s takes the grain and othervarious raw materials and transforms them into a finished product. At this stage, a dis-tributor or wholesaler gets involved. For example, assume that Kellogg’s sells cereal toDuffy’s Distributors. Duffy’s Distributors, in turn, sells the products to many differentretailers, such as Albertson’s and Safeway. Although maybe less obvious, any numberof service companies are also involved in the process. For example, ABC Transport haulsthe grains to Kellogg’s for production, and others move the cereal along to Duffy’sDistributors. Still others get the cereal to supermarkets and other retail outlets. Exhibit 1-1summarizes the process.

What Is Business? 5

P O D R E V I E W 1.1

Q U E S T I O N S

1 . A department store is an example of a

a. wholesaler.b. manufacturer.c. retailer.d. supplier.

2 . An airline is an example of a

a. service provider.b. retailer.c. supplier.d. producer.

• Business consists of all activities necessary to provide members of an economic system with goods andservices. Suppliers, manufacturers, wholesalers, and retailers are examples of product companies.

LO1 Explain what business is about.

Distributor/Wholesaler:

Duffy’s Distributors

Retailers:Albertsons’

Manufacturers/Producers:

Kellogg’s

Service Companies:ABC Transport

ProductCompanies

ServiceCompanies

Supplier:Wholesome

Wheat

Wheat

CerealCereal

EXHIBIT 1-1 Types of Businesses

Forms of Organization

6 Chapter 1 Accounting as a Form of Communication

There are many different types of organizations in our society. One convenient way tocategorize the myriad types is to distinguish between those that are organized to earnmoney and those that exist for some other purpose. Although the lines can becomeblurred, business entities such as Kellogg’s generally are organized to earn a profit,whereas nonbusiness entities generally exist to serve various segments of society. Bothtypes are summarized in Exhibit 1-2.

BUSINESS ENTITIESBusiness entities are organized to earn a profit. Legally, a profit-oriented company isone of three types: a sole proprietorship, a partnership, or a corporation.

Sole Proprietorships This form of organization is characterized by a single owner.Many small businesses are organized as sole proprietorships. Very often the busi-ness is owned and operated by the same person. Because of the close relationshipbetween the owner and the business, the affairs of the two must be kept separate.This is one example in accounting of the economic entity concept, which requiresthat a single, identifiable unit of organization be accounted for in all situations. Forexample, assume that Bernie Berg owns a neighborhood grocery store. In paying themonthly bills, such as utilities and supplies, Bernie must separate his personal costsfrom the costs associated with the grocery business. In turn, financial statementsprepared for the business must not intermingle Bernie’s personal affairs with thecompany affairs.

Unlike the distinction made for accounting purposes between an individual’s per-sonal and business affairs, the Internal Revenue Service (IRS) does not recognize theseparate existence of a proprietorship from its owner. That is, a sole proprietorship isnot a taxable entity; any profits earned by the business are taxed on the return of theindividual.

Partnerships A partnership is a business owned by two or more individuals. Manysmall businesses begin as partnerships. When two or more partners start out, they needsome sort of agreement as to how much each will contribute to the business and howthey will divide any profits. In many small partnerships, the agreement is often just anoral understanding between the partners. In large businesses, the partnership agree-ment is formalized in a written document.

Although a partnership may involve just two owners, some have thousands of part-ners. Public accounting firms, law firms, and other types of service companies are often

Federal Governmentand Its Agencies

SoleProprietorships

Partnerships Corporations

Business Entities

GovernmentEntities

Nonbusiness Entities

PrivateOrganizations

State and LocalGovernments and

Their Agencies

Hospitals, Universities,Cooperatives,

Philanthropic Organizations

EXHIBIT 1-2 Forms of Organization

Business entityAn organization operated toearn a profit.

Sole proprietorshipA form of organization with asingle owner.

LO2 Distinguishamong the forms of organization.

Economic entity conceptThe assumption that a single,identifiable unit must beaccounted for in all situations.

PartnershipA business owned by two ormore individuals; the organiza-tion form often used byaccounting firms and lawfirms.

organized as partnerships. Like a sole proprietorship, a partnership is not a taxableentity. The individual partners pay taxes on their proportionate shares of the profits ofthe business.

Corporations Although sole proprietorships and partnerships dominate in sheernumber, corporations control an overwhelming majority of the private resources in this country. A corporation is an entity organized under the laws of a particularstate. Each of the 50 states is empowered to regulate the creation and operation ofbusinesses organized as corporations in it. Even though Kellogg’s is headquarteredin Michigan, for legal reasons, it is incorporated under the laws of the state ofDelaware.

To start a corporation, one must file articles of incorporation with the state. If the arti-cles are approved by the state, a corporate charter is issued, and the corporation canbegin to issue stock. A share of stock is a certificate that acts as evidence of ownershipin a corporation. Although not always the case, stocks of many corporations are tradedon organized stock exchanges, such as the New York and American Stock Exchanges.Kellogg Company stock is traded on the New York Stock Exchange.

Advantages of Incorporation What are the advantages of running a business as acorporation?

• One of the primary advantages of the corporate form of organization is the abilityto raise large amounts of money in a relatively brief period of time. This is whatprompted Kellogg Company to eventually “go public.” To raise money, the companysold a specific type of security: stock. As stated earlier, a share of stock is simply acertificate that evidences ownership in a corporation. Sometimes corporations issueanother type of security called a bond. A bond is similar in that it is a certificate orpiece of paper issued to someone. However, it is different from a share of stock inthat a bond represents a promise by the company to repay a certain amount ofmoney at a future date. In other words, if you were to buy a bond from a company,you would be lending it money. Interest on the bond is usually paid semiannually.You will learn more about stocks and bonds later.

• The ease of transfer of ownership in a corporation is another advantage of thisform of organization. If you hold shares of stock in a corporation whose stock isactively traded and you decide that you want out, you simply call your brokerand put in an order to sell. Another distinct advantage is the limited liability ofthe stockholder. Generally speaking, a stockholder is liable only for the amountcontributed to the business. That is, if a company goes out of business, the mostthe stockholder stands to lose is the amount invested. On the other hand, bothproprietors and general partners usually can be held personally liable for thedebts of the business.

NONBUSINESS ENTITIESMost nonbusiness entities are organized for a purpose other than to earn a profit. Theyexist to serve the needs of various segments of society. For example, a hospital is orga-nized to provide health care to its patients. A municipal government is operated for thebenefit of its citizens. A local school district exists to meet the educational needs of theyouth in the community.

All of these entities are distinguished by the lack of an identifiable owner. The lackof an identifiable owner and of the profit motive changes to some extent the type ofaccounting used by nonbusiness entities. This type, called fund accounting, is discussedin advanced accounting courses. Regardless of the lack of a profit motive in nonbusi-ness entities, there is still a demand for the information provided by an accountingsystem. For example, a local government needs detailed cost breakdowns in order tolevy taxes. A hospital may want to borrow money and will need financial statements topresent to the prospective lender.

Forms of Organization 7

CorporationA form of entity organizedunder the laws of a particularstate; ownership evidenced byshares of stock.

Share of stockA certificate that acts asevidence of ownership in acorporation.

BondA certificate that represents acorporation’s promise to repaya certain amount of moneyand interest in the future.

Nonbusiness entityAn organization operated forsome purpose other than toearn a profit.

The Nature of Business Activity

8 Chapter 1 Accounting as a Form of Communication

P O D R E V I E W 1.2

Q U E S T I O N S

1 . Kellogg’s is organized as which of the follow-ing business entities?

a. sole proprietorshipb. partnershipc. corporationd. none of the above

2 . One of the advantages of the corporate formof organization is

a. the ease of transfer of ownership.b. the limited liability of the stockholder.c. the ability to raise large amounts of capital in

a relatively brief period of time.d. all of the above are advantages of the corpo-

rate form of organization.

• Some entities are organized to earn a profit while others are organized to serve various segments ofsociety.

• The three forms of business entities are sole proprietorships, partnerships, and corporations.

LO2 Distinguish among the forms of organization.

Because corporations dominate business activity in the United States, this book willfocus on this form of organization. Corporations engage in a multitude of differenttypes of activities. It is possible to categorize all of them into one of three types,however: financing, investing, and operating.

FINANCING ACTIVITIESAll businesses must start with financing. Simply put, money is needed to start a busi-ness. W. K. Kellogg needed money in 1906 to start his new company. The companyfound itself in need of additional financing later and thus eventually made the decisionto sell stock to the public. Most companies not only sell stock to raise money but alsoborrow from various sources to finance their operations.

Accounting has its own unique terminology. In fact, accounting is often referred toas the language of business. The discussion of financing activities brings up two impor-tant accounting terms: liabilities and capital stock. A liability is an obligation of a busi-ness; it can take many different forms. When a company borrows money at a bank, theliability is called a note payable. When a company sells bonds, the obligation is termedbonds payable. Amounts owed to the government for taxes are called taxes payable.Assume that Kellogg’s buys corn to be used to produce Corn Flakes®. Assume that thesupplier gives Kellogg’s 30 days to pay the amount owed. During this 30-day period,Kellogg’s has an obligation called accounts payable.

Capital stock is the term used by accountants to indicate the dollar amount of stocksold to the public. Capital stock differs from liabilities in one very important respect.

LiabilityAn obligation of a business.

LO3 Describe the var-ious types of businessactivities.

ORGANIZATIONS AND SOCIAL RESPONSIBILITYAlthough nonbusiness entities are organized specifically to serve members of society,U.S. business entities also have become more sensitive to their broader social responsi-bilities. Because they touch the lives of so many members of society, most large corpo-rations recognize the societal aspects of their overall mission and have establishedprograms to meet their social responsibilities. Some companies focus their efforts onlocal charities, while others donate to national or international causes. All of the com-panies showcased in the chapter openers of this book have programs in place to meettheir corporate giving objectives.

Capital stockIndicates the owners’ contri-butions to a corporation.

Those who buy stock in a corporation are not lending money to the business, as arethose who buy bonds in the company or make a loan in some other form to the com-pany. Someone who buys stock in a company is called a stockholder, and that personis providing a permanent form of financing to the business. In other words, there is nota due date at which time the stockholder will be repaid. Normally, the only way for astockholder to get back his or her original investment from buying stock is to sell it tosomeone else. Someone who buys bonds in a company or in some other way makes aloan to it is called a creditor. A creditor does not provide a permanent form of financ-ing to the business. That is, the creditor expects repayment of the amount loaned and,in many instances, payment of interest for the use of the money.

INVESTING ACTIVITIESThere is a natural progression in a business from financing activities to investingactivities. That is, once funds are generated from creditors and stockholders, money isavailable to invest.

An asset is a future economic benefit to a business. For example, cash is an asset toa company. To Kellogg’s, its buildings and the equipment that it uses to make cereal areassets. At any time, Kellogg’s has on hand raw materials and products in various stagesof production. These materials and products are called inventories and are another valu-able asset of the company.

An asset represents the right to receive some sort of benefit in the future. The pointis that not all assets are tangible in nature, as are inventories and buildings and equip-ment. For example, assume that Kellogg’s sells cereal to one of its customers and allowsthe company to pay at the end of 30 days. At the time of the sale, Kellogg’s doesn’thave cash yet, but it has another valuable asset. The right to collect the amount duefrom the customer in 30 days is an asset called an account receivable. As a second exam-ple, assume that a company acquires from an inventor a patent that will allow the com-pany the exclusive right to manufacture a certain product. The right to the futureeconomic benefits from the patent is an asset. In summary, an asset is a valuableresource to the company that controls it.

At this point, you should notice the inherent tie between assets and liabilities. Howdoes a company satisfy its liabilities, that is, its obligations? Although there are someexceptions, most liabilities are settled by transferring assets. The asset most often usedto settle a liability is cash.

OPERATING ACTIVITIESOnce funds are obtained from financing activities and investments are made in pro-ductive assets, a business is ready to begin operations. Every business is organizedwith a purpose in mind. The purpose of some businesses is to sell a product. For example,Kellogg’s was organized to produce and sell cereal. Other companies provide services.Service-oriented businesses are becoming an increasingly important sector of the U.S.economy. Some of the largest corporations in this country, such as banks and airlines,sell services rather than products.

Accountants have a name for the sale of products and services. Revenue is the inflowof assets resulting from the sale of products and services. When a company makes acash sale, the asset it receives is cash. When a sale is made on credit, the asset receivedis an account receivable. Revenue represents the dollar amount of sales of products andservices for a specific period of time.

We have thus far identified one important operating activity: the sale of products andservices. However, costs must be incurred to operate a business. Kellogg’s must pay itsemployees salaries and wages. Suppliers must be paid for purchases of inventory, andthe utility company has to be paid for heat and electricity. The government must bepaid the taxes owed it. All of these are examples of important operating activities of abusiness. Accountants use a specific name for the costs incurred in operating a business.An expense is the outflow of assets resulting from the sale of goods and services.

Exhibit 1-3 summarizes the three types of activities conducted by a business. The dis-cussion and the exhibit present a simplification of business activity; but actual businesses

The Nature of Business Activity 9

AssetA future economic benefit.

RevenueAn inflow of assets resultingfrom the sale of goods andservices.

CreditorSomeone to whom a companyor person has a debt.Alternate term: Lender.

StockholderOne of the owners of acorporation. Alternateterm: Shareholder.

ExpenseAn outflow of assets resultingfrom the sale of goods andservices.

are in a constant state of motion with many different financing, investing, and operatingactivities going on at any one time. Still, the model as portrayed in Exhibit 1-3 should behelpful as you begin the study of accounting. To summarize, a company obtains moneyfrom various types of financing activities, uses the money raised to invest in productiveassets, and then provides goods and services to its customers.

10 Chapter 1 Accounting as a Form of Communication

Kellogg’s startedwith owner investments.

Some profits areused to pay

creditors

while other profits are reinvested inproductive assets—such as more equipment.

Money raised throu