About the Authors xxi Acknowledgments xxiii Introduction xxv PART I COMMONLY USED GENERALLY ACCEPTED ACCOUNTING PRINCIPLES CHAPTER 1 Financial Statement Reporting: The Income Statement 3 Income Statement Format 4 Comprehensive Income 4 Extraordinary Items 5 Nonrecurring Items 6 Discontinued Operations 6 Revenue Recognition 8 Realization 9 At the Completion of Production 9 Requirements 9 During Production 9 Cash Basis 12 Recognition of Franchise Fee Revenue by the Franchisor 15 Other Revenue Considerations 18 Multiple Deliverables 18 Software Revenue Recognition 19 Research and Development Costs 20 Advertising Costs 23 Restructuring Charges 23 Other Expense Considerations 23 Earnings per Share 23 Diluted Earnings per Share 26 Antidilutive Securities 29 CHAPTER 2 Financial Statement Reporting: The Balance Sheet 33 Assets 33 Accounts Receivable 34 Inventory 36 Fixed Assets 41 Depreciation 42 Capitalized Interest 44 Nonmonetary Transactions 45 Impairment or Disposal of Long-Lived Assets 46 Involuntary Conversion 48 Asset Retirement Obligations 49 Disclosure 49 Intangibles 49 Financial Assets 54 Insurance 54 Liabilities 57 Bonds Payable 57 Extinguishment of Debt 62 Estimated Liabilities 65 Accounting for Compensated Absences 67 Accounting for Special Termination Benefits to Employees 68 Refinancing of Short-Term Debt to Long-Term Debt 68 Callable Obligations by the Creditor 69 Disclosure of Long-Term Purchase Obligations 70 Exit or Disposal Activities 70 Fair Value Measurements 71 Fair Value Option for Financial Assets and Financial Liabilities 73 Electing the Fair Value Option 74 Events 74 Instrument Application 74 Balance Sheet 75 Statement of Cash Flows 75 Disclosures 75 Eligible Items at Effective Date 76 Available-for-Sale and Held-to-Maturity Securities 77 Stockholders Equity 77 Preferred Stock 78 Stock Retirement 79 Appropriation of Retained Earnings (Reserve) 80 Treasury Stock 80 Cost Method 81 Par Value Method 81 Quasi-Reorganization 82 Dividends 84 Stock Split 86 Stock Options 86 Debt Issued with Stock Warrants 87 Fractional Share Warrants 88 Disclosure 89 CHAPTER 3 Financial Statement Reporting: Statement of Cash Flows and Other Disclosures 91 Statement of Cash Flows 91 Interim Reporting 103 Personal Financial Statements 107 Incorporation of a Business 110 Partnerships 110 Bonus Method 111 Goodwill Method 112 CHAPTER 4 Accounting and Disclosures 113 Hierarchy of GAAP 113 FASB Accounting Standards Codification 113 Accounting Changes 114 Change in Accounting Principle 115 Change in Accounting Estimate 118 Change in Reporting Entity 119 Correction of an Error 120 Prior-Period Adjustments 121 Disclosure of Accounting Policies 122 Development-Stage Companies 123 Troubled Debt Restructuring 124 Debtor 125 Creditor 126 Segmental Reporting 127 Imputing Interest on Notes 133 Accounting for Futures Contracts 135 Oil- and Gas-Producing Companies 138 CHAPTER 5 Key Financial Accounting Areas 139 Consolidations 139 Noncontrolling Interests in Consolidated Financial Statements 142 Business Combinations 143 Investments in Securities 148 Stock Investments 148 Market Value Adjusted 148 Equity Method 152 Leases 156 Lessee 157 Lessor 160 Sales-Leaseback Arrangement 167 Subleases and Similar Transactions 167 Leveraged Leases 168 Pension Plans 170 Defined Contribution Pension Plan 171 Defined Benefit Pension Plan 172 Trustee Reporting for a Defined Benefit Pension Plan 182 Balance Sheet 182 Other Postretirement Benefits 183 Income Tax Accounting 184 Temporary Differences 184 Permanent Differences 185 Financial Statement Presentation 185 Intraperiod Tax Allocation 185 Loss Carrybacks and Carryforwards 185 Deferred Tax Liability versus Deferred Tax Asset 186 Tax Rates 187 Indefinite Reversal 188 Foreign Currency Translation and Transactions 189 Translation Process 192 Balance Sheet 193 Income Statement 193 Translation Adjustments 193 Foreign Currency Transactions 194 Forward Exchange Contracts 197 Hedging 198 Derivative Products 198 Insurance Contracts 200 U.S. GAAP versus IFRS 200 Cash and Cash Equivalents 202 Receivables 202 Inventories 202 Investments 203 Equity-Method Investments 203 Property, Plant, and Equipment 203 Revaluations Involving Depreciable Assets 205 Intangible Assets and Goodwill 206 Contingent Liabilities 207 Defined Benefit Plans 207 Income Tax Deferrals 208 Lease Accounting 209 Equity 209 Revenue Recognition 210 Sale of Goods 210 Bill-and-Hold Transactions 211 Multiple-Element Arrangements 211 Long-Term Construction Contracts 212 Customer Loyalty Programs 212 Discontinued Operations 213 Share-Based Payment 213 Impairment 213 Intangible Impairment 214 Property, Plant, and Equipment Impairment 214 Earnings per Share 214 Subsequent Events 215 PART II ANALYZING FINANCIAL STATEMENTS CHAPTER 6 Financial Statement Analysis 219 Introduction 219 Industry Comparison 220 Trend Analysis 221 Horizontal and Vertical Analysis 221 Balance Sheet Analysis 222 Assets 222 Cash 223 Accounts Receivable 223 Inventory 224 Investments 226 Fixed Assets 227 Intangibles 229 Deferred Charges 230 Unrecorded Assets 231 Liabilities 232 Evaluation of Liquidity 234 Appraising Corporate Solvency 236 Income Statement Analysis 239 Cash Flow from Operations 239 Discretionary Costs 240 Accounting Policies 242 Degree of Certainty in Accounting Estimates 243 Residual Income 244 Taxable Income 245 Foreign Operations 245 Discontinued Operations 245 Stability of Earnings 246 Operating Leverage 247 Profitability Measures 248 Growth Rate 248 Market Value Measures 248 Bankruptcy Prediction 249 Liquidation Value 251 PART III MANAGERIAL ACCOUNTING APPLICATIONS CHAPTER 7 Appraising Segmental Performance 255 The What and Why of Responsibility Accounting 255 Cost Center 256 Profit Center 256 Investment Center 256 Cost Center Performance and Standard Costs 258 Materials Variances 259 Labor Variances 261 Variable Overhead Variances 261 Fixed Overhead Variances 264 Mix and Yield Variances 267 Flexible Budgets and Performance Reports 276 Profit Centers and Segmented Reporting 278 Profit Variance Analysis 281 Types of Standards in Profit Variance Analysis 281 Single-Product Firms 282 Multiproduct Firms 282 Managerial Planning and Decision Making 287 Sales Mix Analysis 288 Performance Reports 288 How to Measure the Performance of Investment Centers 288 Rate of Return on Investment 289 Residual Income 291 Residual Income and Economic Value Added 291 Investment Decisions under ROI and RI 292 More on Economic Value Added 293 EVA and Value Creation 295 Corporate Balanced Scorecard 295 How to Price Goods and Services Transferred 296 Alternative Transfer Pricing Schemes 297 Budgeting and Financial Planning 299 Computer-Based Budgeting 302 Case 1 302 Case 2 302 Budgeting Software 305 Budget Maestro 305 Microsoft Business Solutions for Analytics Forecaster 305 Host Budget 306 SAP BusinessObjects Budgeting and Consolidation 307 Latest Generation of Budgeting and Planning Software 307 CHAPTER 8 Analysis of Projects, Proposals, and Special Situations 309 Cost Volume Profit and Breakeven Analysis 309 Contribution Margin 310 Target Income Volume and Margin of Safety 313 Sales Mix Analysis 318 Short-Term, Nonroutine Decisions 320 Theory of Constraints 327 Life-Cycle Costs and Target Costing 327 Activity-Based Costing 331 Cost of Measurement 334 Indirect Measures and the Degree of Correlation 334 Just-in-Time and Total Quality Management 334 Taguchi Method of Quality Control 338 Backflush Costing 339 Environmental Costs and Ecoefficiency 342 Time Value Fundamentals 346 Capital Budgeting 350 Payback Period 352 Accounting (Simple) Rate of Return 353 Net Present Value 354 Internal Rate of Return (or Time-Adjusted Rate of Return) 355 Profitability Index (or Excess Present Value Index) 358 Limited Funds for Capital Spending 360 Effects of Income Tax Factors on Capital Budgeting Decisions 361 MACRS Rule 363 CHAPTER 9 Quantitative Applications and Modeling in Accounting 369 Statistical Analysis and Evaluation 369 Mean 369 Standard Deviation 372 Regression Analysis 374 Method of Least Squares 374 Use of a Spreadsheet Program for Regression 376 Trend Analysis 378 Regression Statistics 380 Quantitative Methods for Accounting 386 Decision Making 387 Decision Making under Certainty 387 Decision Making under Uncertainty 388 Decision Matrix 390 Expected Value of Perfect Information 391 Decision Tree 392 Linear Programming and Shadow Prices 394 Shadow Prices (Opportunity Costs) 397 Goal Programming and Multiple Goals 398 Learning Curve 402 Inventory Planning and Control 404 Economic Order Quantity 405 Reorder Point 408 Safety Stock and Reorder Point 410 Program Evaluation and Review Technique 411 Project Budgeting and Control Using Earned Value Analysis 416 Forecasting Project Parameters Using Earned Value Methodology 420 Schedule Variance (SV) 420 Cost Variance (CV) 420 Schedule Performance Index (SPI) 420 Cost Performance Index (CPI) 420 Estimate at Completion (EAC) 421 PART IV AUDITING, COMPILING, AND REVIEWING FINANCIAL STATEMENTS CHAPTER 10 Auditing Procedures 425 Risk Assessment Procedures 425 The Entity and Its Environment 426 Internal Control 426 Substantive Procedures 442 Audit Reports 451 Unqualified Opinion 453 Qualified Opinion 455 Disclaimer of Opinion 459 Adverse Opinion 460 CHAPTER 11 Compilation, Review, and Other Reporting Services 463 Compilation of Financial Statements 463 Review of Financial Statements 470 Accountant s Consideration of Obtaining an Updating Representation Letter from Management 480 Documentation in a Review Engagement 481 Reports on Reviewed Financial Statements 481 Departures from the Applicable Financial Reporting Framework 484 Supplementary Information 484 Emphasis of a Matter 485 Restricting the Use of an Accountant s Compilation or Review Report 485 Consideration of an Entity s Ability to Continue as a Going Concern 486 Subsequent Events 486 Subsequent Discovery of Facts Existing at the Date of the Report 487 Change in Engagement from Audit or Review to Compilation 487 Reporting on Prescribed Forms 488 Communication between Successor and Predecessor Accountants 490 Compilation of Specified Elements, Accounts, or Items of a Financial Statement 490 Compilation of Pro Forma Financial Information 494 Communicating to Management and Others in a Compilation or Review Engagement 498 Reports on Prospective Financial Statements 499 Modification and Other Issues 506 Range of Values 506 Departure from AICPA Presentation Guidelines 506 Significant Assumption Does Not Provide Reasonable Basis 506 Scope Limitation 507 Emphasis of a Matter 507 Division of Responsibility 507 Agreed-Upon Procedures 507 Attest Engagements 511 Examination Engagements 512 Review Engagements 514 Engagements to Apply Agreed-Upon Procedures 517 Examination of an Entity s Internal Control over Financial Reporting That Is Integrated with an Audit of Its Financial Statements (SSAE 15) 518 Integration with the Financial Statement Audit 534 Reporting on Controls at a Service Organization 546 Compliance Attestation 555 Management s Discussion and Analysis 557 Personal Financial Statements Included in Written Personal Financial Plans 557 Reporting on Comparative Statements 559 Same Level of Service 562 Higher Level of Service 563 Guideline 563 Lower Level of Service 563 Special Reports 564 Specific Elements, Accounts, or Items in a Basic Set of Financial Statements 567 Compliance with Contracts or Regulations Relating to Audited Financial Statements 569 Financial Information Included in Prescribed Forms 571 CHAPTER 12 Auditing Standards 573 SAS 1 Codification of Auditing Standards and Procedures 573 SAS 2 Reports on Audited Financial Statements 574 SAS 3 The Effects of EDP on the Auditor s Study and Evaluation of Internal Control 575 SAS 4 Quality Control Considerations for a Firm of Independent Auditors 575 SAS 5 The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles in the Independent Auditor s Report 575 SAS 6 Related Party Transactions 575 SAS 7 Communication between Predecessor and Successor Auditor 575 SAS 8 Other Information in Documents Containing Audited Financial Statements 575 SAS 9 The Effect of an Internal Audit Function on the Scope of the Independent Auditor s Examination 575 SAS 10 Limited Review of Interim Financial Information 575 SAS 11 Using the Work of a Specialist 575 SAS 12 Inquiry of a Client s Lawyer Concerning Litigation, Claims, and Assessments 576 SAS 13 Reports on a Limited Review of Interim Financial Information 578 SAS 14 Special Reports 578 SAS 15 Reports on Comparative Financial Statements 578 SAS 16 The Independent Auditor s Responsibility for the Detection of Errors or Irregularities 578 SAS 17 Illegal Acts by Clients 578 SAS 18 Unaudited Replacement Cost Information 578 SAS 19 Client Representations 578 SAS 20 Required Communication of Material Weaknesses in Internal Accounting Control 579 SAS 21 Segment Information 579 SAS 22 Planning and Supervision 579 SAS 23 Analytical Review Procedures 579 SAS 24 Review of Interim Financial Information 579 SAS 25 The Relationship of Generally Accepted Auditing Standards to Quality Control Standards 579 SAS 26 Association with Financial Statements 580 SAS 27 Supplementary Information Required by the Financial Accounting Standards Board 580 SAS 28 Supplementary Information on the Effects of Changing Prices 580 SAS 29 Reporting on Information Accompanying the Basic Financial Statements in Auditor-Submitted Documents 580 SAS 30 Reporting on Internal Accounting Control 581 SAS 31 Evidential Matter 581 SAS 32 Adequacy of Disclosure in Financial Statements 581 SAS 33 Supplementary Oil and Gas Reserve Information 581 SAS 34 The Auditor s Considerations When a Question Arises about an Entity s Continued Existence 581 SAS 35 Special Reports: Applying Agreed-Upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement 581 SAS 36 Review of Interim Financial Information 581 SAS 37 Filings under Federal Securities Statutes 582 SAS 38 Letters for Underwriters 582 SAS 39 Audit Sampling 582 SAS 40 Supplementary Mineral Reserve Information 583 SAS 41 Working Papers 583 SAS 42 Reporting on Condensed Financial Statements and Selected Financial Data 583 Condensed Financial Statements 583 Selected Financial Data 584 SAS 43 Omnibus Statement on Auditing Standards 585 SAS 44 Special-Purpose Reports on Internal Accounting Control at Service Organizations 585 SAS 45 Omnibus Statement on Auditing Standards 1983 585 Related Parties 585 SAS 46 Consideration of Omitted Procedures after the Report Date 586 SAS 47 Audit Risk and Materiality in Conducting an Audit 586 SAS 48 The Effects of Computer Processing on the Audit of Financial Statements 586 SAS 49 Letters for Underwriters 587 SAS 50 Reports on the Application of Accounting Principles 587 SAS 51 Reporting on Financial Statements Prepared for Use in Other Countries 589 SAS 52 Omnibus Statement on Auditing Standards 1987 590 SAS 53 The Auditor s Responsibility to Detect and Report Errors and Irregularities 590 SAS 54 Illegal Acts by Clients 590 SAS 55 Consideration of Internal Control in a Financial Statement Audit 591 SAS 56 Analytical Procedures 591 SAS 57 Auditing Accounting Estimates 591 SAS 58 Reports on Audited Financial Statements 592 SAS 59 The Auditor s Consideration of an Entity s Ability to Continue as a Going Concern 592 SAS 60 Communication of Internal Control Related Matters Noted in an Audit 594 SAS 61 Communication with Audit Committees 594 SAS 62 Special Reports 594 SAS 63 Compliance Auditing Applicable to Governmental Entities and Other Recipients of Governmental Financial Assistance 594 SAS 64 Omnibus Statement on Auditing Standards 594 SAS 65 The Auditor s Consideration of the Internal Audit Function in an Audit of Financial Statements 594 SAS 66 Communication of Matters about Interim Financial Information Filed or to Be Filed with Specified Regulatory Agencies 595 SAS 67 The Confirmation Process 595 SAS 68 Compliance Auditing Applicable to Governmental Entities and Other Recipients of Governmental Financial Assistance 597 SAS 69 The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles in the Independent Auditor s Report 597 SAS 70 Service Organizations 597 SAS 71 Interim Financial Information 598 SAS 72 Letters for Underwriters and Certain Other Requesting Parties 598 SAS 73 Using the Work of a Specialist 599 SAS 74 Compliance Auditing Considerations in Audits of Governmental Entities and Recipients of Governmental Financial Assistance 600 SAS 75 Engagements to Apply Agreed-Upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement 600 SAS 76 Amendments to Statement on Auditing Standards No. 72, Letters for Underwriters and Certain Other Requesting Parties 600 SAS 77 Amendments to Statements on Auditing Standards No. 22, Planning and Supervision; No. 59, The Auditor s Consideration of an Entity s Ability to Continue as a Going Concern; and No. 62, Special Reports 600 SAS 78 Consideration of Internal Control in a Financial Statement Audit: An Amendment to SAS 55 600 SAS 79 Amendment to Statement on Auditing Standards No. 58, Reports on Audited Financial Statements 600 SAS 80 Amendment to Statement on Auditing Standards No. 31, Evidential Matter 601 SAS 81 Auditing Investments 601 SAS 82 Consideration of Fraud in a Financial Statement Audit 601 SAS 83 Establishing an Understanding with the Client 601 SAS 84 Communications between Predecessor and Successor Accountants 602 SAS 85 Management Representations 603 SAS 86 Amendment to Statement on Auditing Standards No. 72, Letters for Underwriters and Certain Other Requesting Parties 607 SAS 87 Restricting the Use of an Auditor s Report 607 SAS 88 Service Organizations and Reporting on Consistency 608 SAS 89 Audit Adjustments 608 SAS 90 Audit Committee Communications 608 SAS 91 Federal GAAP Hierarchy 608 SAS 92 Auditing Derivative Instruments, Hedging Activities, and Investments in Securities 609 Existence or Occurrence 610 Completeness 610 Rights and Obligations 611 Valuation 611 Impairment Losses 612 SAS 93 Omnibus Statement on Auditing Standards 2000 614 SAS 94 The Effect of Information Technology on the Auditor s Consideration of Internal Control in a Financial Statement Audit 614 SAS 95 Generally Accepted Auditing Standards 614 SAS 96 Audit Documentation 614 SAS 97 Amendment to Statement on Auditing Standards No. 50, Reports on the Application of Accounting Principles 614 SAS 98 Omnibus Statement on Auditing Standards 2002 614 SAS 99 Consideration of Fraud in a Financial Statement Audit 615 SAS 100 Interim Financial Information 623 SAS 101 Auditing Fair Value Measurements and Disclosures 623 SAS 102 Defining Professional Requirements in Statements on Auditing Standards 625 SAS 103 Audit Documentation 625 SAS 104 Amendment to SAS 1, Codification of Auditing Standards and Procedures ( Due Professional Care in the Performance of Work ) 629 SAS 105 Amendment to SAS 95 Generally Accepted Auditing Standards 629 SAS 106 Audit Evidence 630 SAS 107 Audit Risk and Materiality in Conducting an Audit 632 SAS 108 Planning and Supervision 634 SAS 109 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement 636 SAS 110 Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained 637 SAS 111 Amendment to Statement on Auditing Standards No. 39, Audit Sampling 640 SAS 112 Communication of Internal Control Related Matters Identified in an Audit 641 SAS 113 Omnibus 2006 641 SAS 114 The Auditor s Communication with Those Charged with Governance 641 SAS 115 Communicating Internal Control Related Matters Identified in an Audit 642 SAS 116 Interim Financial Information 647 SAS 117 Compliance Audits 648 SAS 118 Other Information in Documents Containing Audited Financial Statements 648 SAS 119 Supplementary Information in Relation to the Financial Statements as a Whole 650 SAS 120 Required Supplementary Information 654 SAS 121 Revised Applicability of Statement on Auditing Standards No. 100, Interim Financial Information 655 AS 1 References in Auditor s Reports to the Standards of the Public Company Accounting Oversight Board 656 AS 2 An Audit of Internal Control over Financial Reporting Performed in Conjunction with an Audit of Financial Statements 656 AS 3 Audit Documentation 656 AS 4 Reporting on Whether a Previously Reported Material Weakness Continues to Exist 657 AS 5 An Audit of Internal Control over Financial Reporting That Is Integrated with an Audit of Financial Statements 662 Definitions 664 AS 6 Evaluating Consistency of Financial Statements 670 AS 7 Engagement Quality Review 671 AS 8 Audit Risk 672 AS 9 Audit Planning 673 AS 10 Supervision of the Audit Engagement 674 AS 11 Consideration of Materiality in Planning and Performing an Audit 675 AS 12 Identifying and Assessing Risks of Material Misstatements 677 AS 13 The Auditor s Responses to the Risks of Material Misstatement 680 AS 14 Evaluating Audit Results 681 AS 15 Audit Evidence 682 CHAPTER 13 Sarbanes-Oxley Act of 2002 685 Auditor Independence 685 Partner Rotation 686 Public Company Accounting Oversight Board 686 PART V TAXATION CHAPTER 14 Tax Research 691 Sources of Tax Law 691 The Court System 692 PART VI OTHER PROFESSIONAL STANDARDS CHAPTER 15 Consulting Services 697 CHAPTER 16 Quality Control 699 CHAPTER 17 Code of Professional Conduct 703 Rule 101 Independence 703 Rule 102 Integrity and Objectivity 705 Rule 201 General Standards 705 Rule 202 Compliance with Standards 705 Rule 203 Accounting Principles 706 Rule 301 Confidential Client Information 706 Rule 302 Contingent Fees 706 Rule 501 Acts Discreditable 707 Rule 502 Advertising and Other Forms of Solicitations 707 Rule 503 Commissions and Referral Fees 707 Rule 505 Form of Organization and Name 707 Index 709
