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Accounting Workbook

FOR

DUMmIES

by John A. Tracy, CPA

Accounting Workbook For Dummies? Published by Wiley Publishing, Inc. 111 River St. Hoboken, NJ 07030-5774

Copyright ? 2006 by Wiley Publishing, Inc., Indianapolis, Indiana

Published by Wiley Publishing, Inc., Indianapolis, Indiana

Published simultaneously in Canada

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Library of Congress Control Number is available from the publisher.

ISBN-13: 978-0-471-79145-4

ISBN-10: 0-471-79145-8

Manufactured in the United States of America

10 9 8 7 6 5 4 3 2 1

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About the Author

John A. Tracy (Boulder, Colorado) is Professor of Accounting, Emeritus, at the University of Colorado in Boulder. Before his 35-year tenure at Boulder, he was on the business faculty for 4 years at the University of California in Berkeley. He has served as staff accountant at Ernst & Young and is the author of several books on accounting and finance, including Accounting For Dummies, The Fast Forward MBA in Finance, How To Read a Financial Report, and How to Manage Profit and Cash Flow with his son Tage Tracy. Dr. Tracy received his BSC degree from Creighton University 50 years ago this year, and earned his MBA and PhD degrees from the University of Wisconsin. He is a CPA (inactive) in Colorado.

Dedication

In memory of Gordon B. Laing, the original editor of my How to Read a Financial Report -- a gentleman and editor of the first rank.

Author's Acknowledgments

I'm deeply grateful to everyone at Wiley Publishing, Inc. who helped produce this book. Their professionalism, courtesy, and good humor were much appreciated. My editors, Tim Gallan and Elizabeth Rea, were exceptional. It was a pleasure working with them. I owe them a debt I cannot repay. So a simple but heartfelt "thank you" will have to do.

This book would not have been possible but for the success of my Accounting For Dummies (Wiley, 3rd Edition, 2005). I owe Wiley Publishing, Inc. and the several editors on the three editions of the book an enormous debt of gratitude, which I am most willing to acknowledge. Thanks to all of you! I hope I have done you proud with Accounting Workbook For Dummies.

Publisher's Acknowledgments

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Some of the people who helped bring this book to market include the following:

Acquisitions, Editorial, and Media Development Senior Project Editor: Tim Gallan Acquisitions Editor: Stacy Kennedy Senior Copy Editor: Elizabeth Rea Editorial Program Coordinator: Hanna K. Scott Technical Editor: Jill Gilbert Welytok Editorial Manager: Christine Meloy Beck Editorial Assistants: David Lutton, Nadine Bell,

Erin Calligan Cartoons: Rich Tennant ()

Composition Services

Project Coordinator: Michael Kruzil

Layout and Graphics: Lauren Goddard, Denny Hager, Stephanie D. Jumper, Barry Offringa, Lynsey Osborn, Heather Ryan

Proofreaders: Jessica Kramer

Indexer: Estalita Slivoskey

Publishing and Editorial for Consumer Dummies Diane Graves Steele, Vice President and Publisher, Consumer Dummies Joyce Pepple, Acquisitions Director, Consumer Dummies Kristin A. Cocks, Product Development Director, Consumer Dummies Michael Spring, Vice President and Publisher, Travel Kelly Regan, Editorial Director, Travel

Publishing for Technology Dummies Andy Cummings, Vice President and Publisher, Dummies Technology/General User

Composition Services Gerry Fahey, Vice President of Production Services Debbie Stailey, Director of Composition Services

Contents at a Glance

Introduction.................................................................................1

Part I: Business Accounting Basics................................................5

Chapter 1: Elements of Business Accounting ...........................................................................................7 Chapter 2: Financial Effects of Transactions ..........................................................................................27 Chapter 3: Getting Started in the Bookkeeping Cycle ...........................................................................47 Chapter 4: The Bookkeeping Cycle: Adjusting and Closing Entries ....................................................75

Part II: Preparing Financial Statements .......................................97

Chapter 5: The Effects and Reporting of Profit ......................................................................................99 Chapter 6: Reporting Financial Condition in the Balance Sheet ........................................................119 Chapter 7: Coupling the Income Statement and Balance Sheet .........................................................143 Chapter 8: Reporting Cash Flows and Changes in Owners' Equity ...................................................159 Chapter 9: Choosing Accounting Methods ...........................................................................................177

Part III: Managerial, Manufacturing, and Capital Accounting .....201

Chapter 10: Analyzing Profit Behavior ..................................................................................................203 Chapter 11: Manufacturing Cost Accounting........................................................................................229 Chapter 12: Figuring Out Interest and Return on Investment ............................................................259

Part IV: The Part of Tens...........................................................287

Chapter 13: Ten Things You Should Know About Business Financial Statements ..........................289 Chapter 14: A Ten-Point Checklist for Management Accountants .....................................................295

Index.......................................................................................301

Table of Contents

Introduction .................................................................................1

About This Book.........................................................................................................................1 Foolish Assumptions .................................................................................................................2 How This Book Is Organized.....................................................................................................2

Part I: Business Accounting Basics ................................................................................3 Part II: Preparing Financial Statements .........................................................................3 Part III: Managerial, Manufacturing, and Capital Accounting .....................................3 Part IV: The Part of Tens .................................................................................................3 Icons Used In This Book............................................................................................................3 Where to Go from Here..............................................................................................................4

Part I: Business Accounting Basics ................................................5

Chapter 1: Elements of Business Accounting ...................................................................7

Keeping the Accounting Equation in Balance ........................................................................7 Distinguishing Between Cash- and Accrual-Basis Accounting ...........................................10 Summarizing Profit Activities in the Income (Profit & Loss) Statement...........................13 Assembling a Balance Sheet ...................................................................................................15 Partitioning the Statement of Cash Flows.............................................................................17 Tracing How Dishonest Accounting Distorts Financial Statements ..................................19 Answers to Problems on Elements of Business Accounting ..............................................21

Chapter 2: Financial Effects of Transactions...................................................................27

Classifying Business Transactions.........................................................................................27 Seeing Both Sides of Business Transactions ........................................................................30 Concentrating on Sales............................................................................................................33 Concentrating on Expenses ....................................................................................................36 Determining the Composite Effect of Profit..........................................................................38 Answers to Problems on Financial Effects of Transactions ...............................................42

Chapter 3: Getting Started in the Bookkeeping Cycle ...................................................47

Constructing the Chart of Accounts......................................................................................48 Distinguishing Real and Nominal Accounts..........................................................................50 Knowing Your Debits from Your Credits ...............................................................................53 Making Original Journal Entries .............................................................................................56 Recording Revenue and Income.............................................................................................58 Recording Expenses and Losses ............................................................................................61 Recording Set-Up and Follow-Up Transactions for Revenue and Expenses.....................64 Recording Investing and Financing Transactions................................................................66 Answers to Problems on the Bookkeeping Cycle ................................................................68

Chapter 4: The Bookkeeping Cycle: Adjusting and Closing Entries ...........................75

Getting Accurate with Adjusting Entries...............................................................................75 Breaking Down the End-of-Year Adjusting Entries...............................................................78

Recording depreciation expense..................................................................................78 Recording amortization expense .................................................................................81 Recording other adjusting entries ...............................................................................82 Closing the Books on the Year................................................................................................85 Instituting Internal Controls ...................................................................................................88 Answers to Problems on the Bookkeeping Cycle ................................................................90

viii Accounting Workbook For Dummies

Part II: Preparing Financial Statements........................................97

Chapter 5: The Effects and Reporting of Profit ................................................................99

Understanding the Nature of Profit .......................................................................................99 Choosing the Income Statement Format.............................................................................102 Deciding on Disclosure in the Income Statement ..............................................................103 Examining How Sales and Expenses Change Assets and Liabilities................................105 Summing Up the Manifold Effects of Profit.........................................................................109 Answers to Problems on the Effects and Reporting of Profit...........................................113

Chapter 6: Reporting Financial Condition in the Balance Sheet ...............................119

Getting Started on the Balance Sheet..................................................................................119 Building a Balance Sheet .......................................................................................................122 Fleshing Out the Balance Sheet............................................................................................125 Clarifying the Values of Assets in Balance Sheets..............................................................130 Using the Balance Sheet in Business Valuation..................................................................133 Answers to Problems on Reporting Financial Condition in the Balance Sheet .............135

Chapter 7: Coupling the Income Statement and Balance Sheet................................143

Rejoining the Income Statement and Balance Sheet .........................................................143 Filling in Key Pieces of the Balance Sheet from the Income Statement ..........................146 Putting Fixed Assets in the Picture......................................................................................151 Completing the Balance Sheet with Debt and Equity........................................................152 Answers to Problems on Coupling the Income Statement and Balance Sheet ..............155

Chapter 8: Reporting Cash Flows and Changes in Owners' Equity ...........................159

Figuring Profit from the Balance Sheet................................................................................159 Reporting the Statement of Changes in Stockholders' Equity .........................................162 Determining Cash Effect from Making Profit ......................................................................164 Presenting the Statement of Cash Flows.............................................................................166

Reporting Cash Flows ..................................................................................................167 Connecting Balance Sheet Changes with Cash Flows..............................................168 Answers for Problems on Reporting Cash Flows and Changes in Owners' Equity .......172

Chapter 9: Choosing Accounting Methods ....................................................................177

Getting Off to a Good Start....................................................................................................177 Determining Whether Products Are Unique or Fungible ..................................................181 Contrasting Cost of Goods Sold Expense Methods (for Fungible Products) .................181

Averaging things out ....................................................................................................183 Going with the flow: The FIFO method ......................................................................185 Going against the flow: The LIFO method .................................................................186 Appreciating Depreciation Methods....................................................................................188 Timing Bad Debts Expense ...................................................................................................190 Answers to Problems on Choosing Accounting Methods ................................................194

Part III: Managerial, Manufacturing, and Capital Accounting ......201

Chapter 10: Analyzing Profit Behavior............................................................................203

Mapping Profit for Managers ................................................................................................203 Analyzing Operating Profit....................................................................................................206

Analysis method #1: Contribution margin minus fixed costs.................................206 Analysis method #2: Excess over breakeven............................................................207 Analysis method #3: Minimizing fixed costs per unit..............................................207

ix Table of Contents

Analyzing Return on Capital .................................................................................................210 Improving Profit Performance..............................................................................................213

Selling more units.........................................................................................................213 Improving margin per unit ..........................................................................................215 Making Trade-Offs Among Profit Factors............................................................................218 Answers to Problems on Analyzing Profit Behavior..........................................................220

Chapter 11: Manufacturing Cost Accounting ................................................................229

Minding Manufacturing Costs ..............................................................................................229 Product costs................................................................................................................230 Period costs ..................................................................................................................231 Separating period and product costs ........................................................................231

Taking a Short Tour of Manufacturing Entries ...................................................................233 Calculating Product Cost: Basic Methods and Problems .................................................237

Connecting fixed manufacturing overhead costs and production capacity.........237 Boosting profit by boosting production....................................................................239 Calculating Product Cost in Unusual Situations ................................................................242 Answers to Problems on Manufacturing Cost Accounting...............................................248

Chapter 12: Figuring Out Interest and Return on Investment......................................259

Getting Down the Basics of Interest ....................................................................................259 Keeping it simple with simple interest ......................................................................260 Distinguishing nominal and effective interest rates ................................................262 Discounting loans.........................................................................................................264

Lifting the Veil on Compound Interest.................................................................................266 Borrowing and Investing in Installments ............................................................................268

Paying off a loan ...........................................................................................................268 Investing in a retirement account ..............................................................................270 Measuring Return on Investment (ROI) ..............................................................................272 Example 1: Steady income flow; liquidation value equals entry cost ...................272 Example 2: Substantial cash flows each year ...........................................................274 Example 3: Zero cash flow until final year ................................................................275 Example 4: Irregular cash flows, both positive and negative .................................276 Example 5: Market value?driven investments..........................................................277 Answers to Problems on Interest and Return on Investment ..........................................279

Part IV: The Part of Tens ...........................................................287

Chapter 13: Ten Things You Should Know About Business Financial Statements............................................................................289

Rules and Standards Matter .................................................................................................289 Exactitude Would Be Nice, but Estimates Are Key ............................................................290 Financial Statements Fit Together Hand in Glove..............................................................290 Accrual Basis Is Used to Record Profit, Assets, and Liabilities........................................291 Cash Flow Differs from Accrual Basis Profit .......................................................................291 Profit and Balance Sheet Values Can Be and Often Are Manipulated..............................292 Financial Statements May Be Revised Later to Correct Errors and Fraud .....................292 Some Asset Values Are Current, but Others May Be Old..................................................293 Financial Statements Leave Interpretation to Readers .....................................................293 Financial Statements Tell the Story of a Business, Not Its Individual Shareowners .....294

Chapter 14: A Ten-Point Checklist for Management Accountants............................295

Designing Internal Accounting Reports ..............................................................................296 Helping Managers Understand Their Accounting Reports...............................................296

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