Financial Accounting

JAN R. WILLIAMS University of Tennessee

SUSAN F. HAKA Michigan State University

MARK S. BETTNER Bucknell University

JOSEPH V. CARCELLO University of Tennessee


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Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2015 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2012, 2010, and 2008. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

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Library of Congress Cataloging-in-Publication Data

Williams, Jan R. Financial accounting / Jan R. Williams, University of Tennessee, Susan F. Haka, Michigan State University, Mark S. Bettner, Bucknell University, Joseph V. Carcello, University of Tennessee. —16th edition. pages cm Revised edition of: Financial accounting / Jan R. Williams . . . [et al.]. 15th ed. ISBN 978-0-07-786238-1 (alk. paper)—ISBN 0-07-786238-4 (alk. paper) 1. Accounting. I. Title. HF5636.W7254 2015 657—dc23 2013041567

The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.

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To Ben and Meg Wishart and Asher, Lainey, and Lucy Hunt, who have taught me the joys of being a grandfather.

— Jan R. Williams

For Cliff, Abi, and my mother, Fran.

— Susan F. Haka

To my parents, Fred and Marjorie.

— Mark S. Bettner

To Terri, Stephen, Karen, and Sarah, whose sacrifices enabled me to participate in writing this book. Thank you—I love you!

— Joseph V. Carcello

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Meet the Authors

Jan R. Williams is Dean and Professor Emeritus of the College of Business Administration at the University of Tennessee— Knoxville, where he has been a faculty member since 1977. He received a BS degree from George Peabody College, an MBA from Baylor University, and a PhD from the University of Arkansas. He previously served on the faculties at the Univer- sity of Georgia and Texas Tech University. A CPA in Tennessee and Arkansas, Dr. Williams is also the coauthor of three books and has published over 70 articles on issues of corporate financial reporting and accounting education.

He served as president of the American Accounting Association in 1999–2000 and has been actively involved in Beta Alpha Psi, the Tennessee Society of CPAs, the American Institute of CPAs, and AACSB International—the Association to Advance Collegiate Schools of Business—the accrediting organization for business schools and accounting programs worldwide. He served as chair of the Board of Directors of AACSB International in 2011 through 2012. He retired from the University of Tennessee in 2013, and remains active in several business and accounting profes- sional organizations.

Susan F. Haka is the Senior Associate Dean for Academic Affairs and Research in the Broad College of Business and the EY Professor of Accounting in the Department of Accounting and Information Systems at Michigan State University. Dr. Haka received her PhD from the University of Kansas and a master’s degree in accounting from the University of Illinois. She served as president of the American Accounting Association in 2008–2009 and has pre- viously served as president of the Management Accounting Section. Dr. Haka is active in editorial processes and has been editor of Behavioral Research

in Accounting and an associate editor of Journal of Management Accounting Research, Accounting Horizons, The International Journal of Accounting, and Contemporary Accounting Research. Dr. Haka has been honored by Michigan State University with several teaching and research awards, including both the university-wide Teacher- Scholar and Distinguished Faculty awards. In 2012, Dr. Haka was honored with the Outstanding Accounting Educator Award from the American Accounting Association.

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Mark S. Bettner is the Christian R. Lindback Chair of Accounting & Financial Management at Bucknell University. Dr. Bettner received his PhD in business administration from Texas Tech University and his MS in accounting from Virginia Tech University. In addition to his work on Financial Accounting and Financial & Managerial Accounting, he has written many ancillary materi- als, published in scholarly journals, and presented at academic and practitio- ner conferences. Professor Bettner is also on the editorial advisory boards of several academic journals, including the International Journal of Accounting and Business Society and the International Journal of Business and Accounting, and has served as a reviewer for several journals, including Advances in Public Interest Accounting, Essays in Economics and Business History, Critical Perspectives on Accounting, and International Journal on Critical Accounting. Professor Bettner also offers professional development courses for the Pennsylvania Bankers Association.

Joseph V. Carcello is the EY and Business Alumni Professor in the Department of Accounting and Information Management at the University of Tennessee. He also is the cofounder and executive director for UT’s Corporate Governance Center. Dr. Carcello received his PhD from Georgia State Univer- sity, his MAcc from the University of Georgia, and his BS from the State Uni- versity of New York College at Plattsburgh. Dr. Carcello is currently the author or coauthor of three books, more than 60 journal articles, and five monographs. Dr. Carcello serves on the Public Company Accounting Oversight Board’s (PCAOB) Investor Advisory Group, and he previously served three terms on the PCAOB’s Standing Advisory Group. He has testified before committees and working groups of the U.S. Department of the Treasury on the future of the auditing profes- sion and on the JOBS Act. Dr. Carcello has also testified before a subcommittee of the U.S. House of Representatives Financial Services Committee on accounting and auditing regulation. He served as a member of the COSO task force that developed guidance on applying COSO’s internal control framework for smaller public com- panies. Dr. Carcello is active in the academic community—he serves as an editor of Contemporary Accounting Research, and serves on the editorial boards of The Accounting Review, Auditing: A Journal of Practice & Theory, Accounting Horizons, and Contemporary Issues in Auditing. Dr. Carcello has taught professional develop- ment programs for two of the Big Four accounting firms and for state CPA societies; conducted funded research for another Big Four firm, the AICPA, and the Center for Audit Quality; and served as an expert for the U.S. Securities and Exchange Commis- sion and for private attorneys.

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As our eyes are drawn upward to the skyline of great cities, it’s important

to remember that these impressive constructions are able to reach such

heights only because their foundations are strong. In much the same way,

being successful in the business world begins with fundamental courses like

financial accounting. It is only when students have a firm grasp of concepts

like the accounting cycle that they have a base on which to stand, a strong

foundation on which to grow.

In this edition, as before, the Williams team has revised the text with a keen

eye toward the principle of helping students establish the foundation they will

need for future success in business. However, through new coverage of Inter-

national Financial Reporting Standards and a revised globalization chapter, the

Williams book also introduces students to larger themes and evolving con-

cerns. This dual emphasis allows students to keep their eyes trained upward

even as they become solidly grounded in accounting fundamentals.




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The Williams book continues to rest on a bedrock of four key components:

Balanced Coverage. The 16th edition of Williams provides the most balanced coverage of financial topics on the market. By giving equal weight to financial topics, the authors emphasize the need for a strong foundation in accounting.

Clear Accounting Cycle Presentation. In the first five chapters of Financial Accounting, the authors present the Accounting Cycle in a clear, graphically interesting four-step process. Central to this presentation is the dedication of three successive chapters to three key components of the cycle: recording entries (Chapter 3), adjusting entries (Chapter 4), and closing entries (Chapter 5). The Williams team places easy-to-read margin notes explaining each equation used in particular journal entries.

Student Motivation. The Williams team has put together a market-leading student package that will not only motivate your stu- dents, but help you see greater retention rates in your accounting courses. Vital pieces of technology supplement the core curriculum covered in the book: McGraw-Hill Connect Accounting uses end-of- chapter material pulled directly from the textbook to create static and algorithmic questions that can be used for homework and prac- tice tests; and the Online Learning Center provides supplemental tools for both students and instructors.

Problem-Solving Skills. Financial Accounting challenges your students to think about real-world situations and put themselves in the role of the decision maker through Case in Point, Your Turn, and Ethics, Fraud, & Corporate Governance boxes. Students refer- ence the Home Depot Financial Statements—included in the text as an appendix—to further hone problem-solving skills by evaluat- ing real world financial data. The authors show a keen attention to detail when creating high-quality end-of-chapter material, such as the Critical Thinking Cases and Problems, ensuring that all home- work is tied directly back to chapter learning objectives.


es By he

ng Cycle Presentation In the first five

“This is a well balanced text- book that encompasses many

issues, yet provides them in a pre- cise, readable, and orderly fashion

to students. The extent of the real- world examples makes this edition

clearly a superior choice.”

Hossein Noorian, Wentworth Institute

Cl ccha CCyc tthis tthr aadj WWi equ

“Excellent book! Explains diffi- cult subjects in easy-to-understand


Naser Kamleh, Wallace Community College

cular journal entries.

a – g

m – c – l

g Skills. Financial Accounting challenges your g

“This textbook is current and very interactive. It brings in excellent “real-world” applications for the students to use in applying the

concepts. It has excellent student and instruc-

tor resources. Some of the resources would be especially

valuable for instructors teaching online.”

Karen Mozingo, Pitt Community College

Pr sstu tthe aand eenc aas ing det the

“The text is excellent. I wish the texts had been this well written

when I was a student!”

Mark Anderson, Bob Jones University


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Recording Balance Sheet Transactions: An Illustration 93

its balance sheet. The revenue and expense transactions that took place on January 31 will be addressed later in the chapter.

Each transaction from January 20 through January 27 is analyzed first in terms of increases in assets, liabilities, and owners’ equity. Second, we follow the debit and credit rules for enter- ing these increases and decreases in specific accounts. Asset ledger accounts are shown on the left side of the analysis; liability and owners’ equity ledger accounts are shown on the right side. For convenience in the following transactions, both the debit and credit figures for the transaction under discussion are shown in red. Figures relating to earlier transactions appear in black.

Jan. 20 Michael McBryan and family invested $80,000 cash in exchange for capital stock.

Jan. 20 Cash . . . . . . . . . . . . . . . . . . . . . 80,000

Capital Stock . . . . . . . . . . . . . . . . . . . 80,000


ANALYSIS The asset Cash is increased by $80,000, and owners’ equity (Capital Stock) is increased by the same amount.

Increases in assets are recorded by debits; debit Cash $80,000.

Increases in owners’ equity are recorded by credits; credit Capital Stock $80,000.




Capital Stock

1/20 80,000


1/20 80,000


Increases in assets are recorded by debits; debit Land $52,000.

Decreases in assets are recorded by credits; credit Cash $52,000.




1/21 52,000


1/20 80,000 1/21 52,000

The asset Land is increased $52,000, and the asset Cash is decreased $52,000.



Jan. 21 Land. . . . . . . . . . . . . . . . . . . . . . 52,000 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . 52,000

Jan. 21 Representing Overnight, McBryan negotiated with both the City of Santa Teresa and Metropolitan Transit Authority (MTA) to purchase an abandoned bus garage. (The city owned the land, but the MTA owned the building.) On January 21, Overnight Auto Service purchased the land from the city for $52,000 cash.

Owners invest cash in the business

Owners’ Assets 5 Liabilities 1 Equity

1$80,000 1$80,000

Purchase of an asset for cash

Owners’ Assets 5 Liabilities 1 Equity

1$52,000 2$52,000

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Financial Accounting was the FIRST text to illustrate Balance Sheet and Income Statement transactions using the four-step process described below. This hallmark coverage has been further revised and refined in the 16th edition.

The Williams team breaks down the Accounting Cycle into three full chapters to help students absorb and understand this material: recording entries (Chapter 3), adjusting entries (Chapter 4), and closing entries (Chapter 5). Transactions are demonstrated visually to help students conquer recording transactions by showing the four steps in the process:

How Does Williams Help Students

Analysis—shows which accounts are recorded with an increase/ decrease.

Debit/Credit Rules—helps students to remember whether the account should be debited/ credited.

Journal Entry—shows the result of the two previous steps.

Ledger T-Accounts—shows students what was recorded and where.

The Williams team puts the Accounting Equation (A 5 L 1 OE) in the margin by transaction illustrations to show students the big picture!

AA ar


D st


JoJ o


L st



Step-by-Step Process for the Accounting Cycle

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Brief Exercises Listed below in random order are the eight s teps comprising a complete accounting cycle:

Prepare a trial balance. Journalize and post the closing entries. Prepare financial statements. Post transaction data to the ledger. Prepare an adjusted trial balance. Make end-of-period adjustments. Journalize transactions. Prepare an after-closing trial balance.

a. List these steps in the sequence in which they would normally be performed. (A detailed under- standing of these eight steps is not required until Chapters 4 and 5.)

b. Describe ways in which the information produced through the accounting cycle is used by a company’s management and employees.

Record the following selected transactions in general journal form for Q uantum Clinic, Inc. Include a brief explanation of the transaction as part of each journal entry.

LO3-1, LO3-2, LO3-5, LO3-9, LO3-10 BRIEF EXERCISE 3.1 The Accounting Cycle

LO3-3 through LO3-5 BRIEF EXERCISE 3.2 Recording Transactions in a Journal

Oct. 1 The clinic issued 5,000 additional shares of capital stock to Doctor Soges at $60 per share

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Smithfield Hotel recently purchased new exercise equipment for its exercise room. The following information refers to the purchase and installation of this equipment: 1. The list price of the equipment was $42,000; however, Smithfield qualified for a “special dis-

count” of $5,000. It paid $10,000 cash, and issued a three-month, 12 percent note payable for the remaining balance. The note, plus accrued interest charges of $750, was paid promptly at the maturity date.

2. In addition to the amounts described in 1, Smithfield paid sales taxes of $2,100 at the date of purchase.

3. Freight charges for delivery of the equipment totaled $600. 4. Installation and training costs related to the equipment amounted to $900.

LO9-1 through LO9-3 PROBLEM 9.1B Determining the Cost of Plant Assets and Depreciation

Problem Set B

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A COMPREHENSIVE ACCOUNTING CYCLE PROBLEM On December 1, 2015, John and Patty Driver formed a corporation called Susquehanna Equipment Rentals. The new corporation was able to begin operations immediately by pur- chasing the assets and taking over the location of Rent-It, an equipment rental company that was going out of business. The newly formed company uses the following accounts:

Susquehanna Equipment Rentals

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Self-Test Questions The answers to these questions appear on page 339.

1. In general terms, financial assets appear in the balance sheet at:

a. Face value. b. Current value. c. Cost. d. Estimated future sales value.

2 Which of the following practices contributes to efficient

shows a balance of $12,890 at the same date. The only reconcil- ing items are the following: • Deposit in transit, $890. • Bank service charge, $24. • NSF check from customer Greg Denton in the amount of

$426. • Error in recording check no. 389 for rent: check was written

in the amount of $1,320, but was recorded improperly in the

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Discussion Questions 1. In broad general terms, what is the purpose of accounting? 2. Why is a knowledge of accounting terms and concepts use-

ful to persons other than professional accountants? 3. In general terms, what are revenues and expenses? How

are they related in the determination of an enterprise’s net income or net loss?

4. Why is the statement of financial position, or balance sheet, a logical place to begin a discussion of financial statements?

5. What is the basic accounting equation? Briefly define the three primary elements in the equation.

9. What is meant by the terms positive cash flows and negative cash flows? How do they relate to revenues and expenses?

10. What are the three categories commonly found in a state- ment of cash flows, and what is included in each category?

11. What is meant by the statement that the financial statements articulate?

12. What is meant by the term adequate disclosure, and how do accountants fulfill this requirement in the preparation of financial statements?

13. What is meant by the term window dressing when referring t fi i l t t t ?


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Accounts Payable . . . . . . . . . $14,000 Land . . . . . . . . . . . . . . . . . . . . . . $68,000

Accounts Receivable . . . . . . . 800 Machinery & Equipment . . . . . . . 65,000

Buildings. . . . . . . . . . . . . . . . . 52,000 Notes Payable (due in

Cash . . . . . . . . . . . . . . . . . . . . 9,200 30 days) . . . . . . . . . . . . . . . . . 29,000

Capital Stock . . . . . . . . . . . . . 100,000 Salaries Payable . . . . . . . . . . . . . 3,000

Retained Earnings . . . . . . . . . ? Supplies . . . . . . . . . . . . . . . . . . . 400

Demonstration Problem Account balances for Crystal Auto Wash at September 30, 2015, are shown below. The figure for retained earnings is not given, but it can be determined when all the available information is assembled in the form of a balance sheet.

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In each of the situations described below, indicate the accounting principles or concepts, if any, that have been violated and explain briefly the nature of the violation. If you believe the practice is in accord with generally accepted accounting principles, state this as your position and defend it.

a. A small business in which credit sales fluctuate greatly from year to year uses the direct write- off method both for income tax purposes and in its financial statements.

b. Computer Systems often sells merchandise in exchange for interest-bearing notes receivable, maturing in 6, 12, or 24 months. The company records these sales transactions by debiting Notes Receivable for the maturity value of the notes, crediting Sales for the sales price of the merchandise, and crediting Interest Revenue for the balance of the maturity value of the note. The cost of goods sold also is recorded.

LO7-1, LO7-6, LO7-7 CASE 7.1 Accounting Principles

Critical Thinking Cases

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Affections manufactures candy and sells only to retailers. It is not a publicly owned company and its financial statements are not audited. But the company frequently must borrow money. Its creditors insist that the company provide them with unaudited financial statements at the end of each quarter.

In October, management met to discuss the fiscal year ending next December 31. Due to a sluggish economy, Affections was having difficulty collecting its accounts receivable, and its cash position was unusually low. Management knew that if the December 31 balance sheet did not look good, the company would have difficulty borrowing the money it would need to boost production for Valentine’s Day.

Thus the purpose of the meeting was to explore ways in which Affections might improve its December 31 balance sheet. Some of the ideas discussed are as follows:

LO7-1 through LO7-6, LO7-8

CASE 7.3 “Improving” the Balance Sheet

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To answer the following questions use the financial statements for Home Depot, Inc. , in Appendix A at the end of the textbook: a. Compute the company’s current ratio and quick ratio for the most recent year reported. Do these

ratios provide support that Home Depot is able to repay its current liabilities as they come due? Explain.

b. Compute the company’s debt ratio. Does Home Depot appear to have excessive debt? Explain. c. Examine the company’s statement of cash flows. Does Home Depot ’s cash flow from operat-

ing activities appear adequate to cover its current liabilities as they come due? Explain.

EXERCISE 10.15 Examining Home Depot ’s Capital Structure

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