Lecture Notes for Financial Accounting, 5th Edition

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1Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.The Importance of Building a FrameworkThe learning sciences promote an instructional framework to help students build a mental imageof a discipline. As students are presented with each advancing topic, they are able to sort thematerial within this framework, and this makes learning not only easier, but more engaging.Financial Accountingby Spiceland, Thomas, and Herrmann understands the importance ofhelping students to build a framework.We establish a framework for financial accountingbyemphasizingthree simple components:(1)Measurementof business activities,(2)Communicationof those measurements, and(3)Decision makingby investors and others using the information communicated.For each topic in the book, we encourage students to ask themselves, “How is the activitymeasured,andhowis itcommunicated?”Studentswillseetopic-by-topichowbusinesstransactions are recorded and then how those measurementsare communicated in financialstatements. The intent is for students tobe remindedthroughout the bookthat measurement andcommunication are linked processes used to tell a company’s financial story.In addition,students willbe more engaged andbetter understand thismeasurement-communicationprocessbyseeingtheimportantdecisions that people makeusing financial accounting information.Theinstructor’smanualforeachchapterbeginswithAuthors’Perspectivesontheorganization of the chapter’s topics, important insights, key illustrations, teaching tips, and somecommonmistakestowarnstudents about—all withthe purpose of helpingyou build aframework of financial accounting for your students.Here’s a quick overview ofthe many features that have been developed to help your studentsbuildaframework.Amore detailed discussionis providedin each chapter’s instructor’s manual.Chapter StructureChapter 1–Establish a Framework.The first page of Chapter 1 dispels the misconceptionthat financial accounting is another math class. Financial accounting is presented as “thelanguage companies use to tell their financial story.”This story is told by measuring businessactivities and then communicating those measurements to decision makers. Illustrations1-1and 1-2, along with theirdiscussion,develop thisframeworkto help students get started onthe right track.Chapters 2 and 3–Develop theAccounting Cycle.In Chapters 2 and 3, the chapter titles,illustrations, and text discussionemphasizethe measurement role of financial accounting“during the period” versus “end of the period.”This emphasis helps students to understandtheclear distinction betweenrecording transactions during the year versus completingactivities at the end of the year (adjusting entries, financial statements, and closing entries).Chapter 3 offers a wide variety of full accounting cycle assignments that directly link themeasurement of activities with their communication in financial statements.Chapters 4-10–Continue the Accounting Cycle.Chapters 4-10 areorganizedin balancesheet order, allowing systematic coverage of topics.In these chapters,additional accountingcycleproblemsareavailableusingmoreadvancedtopicstofurtherreinforcethemeasurement-communication-decision makingframeworkof financial accounting. You canassign accounting cycle problems that focus specifically on receivables, inventory, long-termassets, current liabilities, long-term liabilities, or equities.

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2Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Chapter11–Statement of Cash Flows.Thestatement of cash flows is presented as anextension of the information communicated in the balance sheet and income statement.Students are shownthelinks between these financial statements.Chapter 12–Financial Statement Analysis.Chapter 12 provides comparative analysis ofUnderArmourandNike.Weshowhowdecisionmakersusefinancialaccountinginformationtobuildratiosforcomparingcompanies’businessstrategies,operationalefficiency, profitability, and risk.Under Armour and Nike were chosen because they are real-world companies that areinteresting andfamiliarto most students.Insidethe FrameworkMeasurement and Communicationarepresented as thetwo primary functions of financialaccounting.Inside the back cover, studentscan viewaone-pageillustrationthatsummarizesthecompletemeasurement role of financial accounting and its communication role throughlinkedfinancial statements.Each topic in the book can be placed within thisgeneralframework.Students can getdeeperinside the framework by viewing theChapter Highlightsat theend of eachchapter. Theseflowchart-styleillustrationsdemonstratehoweachchapter’sprimarymeasurementandcommunicationtopicsfitwithinthegeneralframeworkoffinancial accounting.Also inside the back cover is aChart ofAccountsthat provides students with a completelist of accounts that they’lluse to record transactions and prepare financial statements. Theseare the only accounts usedin the chapters, assignments, test bank, and all other supplements.Decision Makingmakes up the third component of the framework.One of the best ways wecan motivate students to learn and enjoy accounting is to see that it has real-world relevanceto decision makers.Each chapterbegins with areal-world exampleinan openingFeatureStoryto motivate the chapter’s topic.Then throughout the chapter,Decision PointsandDecision Maker’s Perspectivesare added to help give more meaning and insight into howfinancial accounting information isused bydecision makers. Finally, anAnalysissectionisprovided at the end of each chapter. In these sections,the ratios of two real companies relatedto that chapter’s themeare calculated and discussed. Studentscansee howdecision makersuse these ratios to understand companies’different business strategies, profitability, and risk.Assignment MaterialsTo give instructors the most flexibility as they develop their students’ understanding, theassignment material is arranged byadvancing levelof knowledge required—Brief Exercises,Exercises(A & B set), andProblems(A & B set). These assignments are available in Connectin both static and algorithmic formats.Additional assignment materialfurtherreinforcesthe framework of financial accountinginunique ways,andthese additionalassignments can beassigned andauto-graded in Connect.General Ledger Assignmentsareaccountingsoftware-like assignmentsthatallow studentstoentertransactionsinthegeneraljournalandseehowthosemeasurementsflowautomaticallythrough the general ledger and trial balance to build the financial statements.Many of these assignments also include anAnalysisrequirement, asking students to analyzethe information communicated in the financial statements.

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3Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Great Adventures Continuing Caseisacontinuing case that can be assignedinChapters1-12, and it’s available in theGeneral Ledger format.Students will build a comprehensive setof financial statements witheach successive chapter. They will see how to apply theframework of financial accounting as a company evolves and grows.Real-World Financial Analysis Casesaskstudentsto analyze the financial statements ofBuckle and American Eagle. These cases can be assigned separately for each company orcomparing the two companies.EthicsCasesand Earnings Management Casesallow studentstoseea more completepictureof financial accounting by seeing howmanagerscanmanipulate the estimates andassumptions inherent in financial reporting to alter reported amounts andpotentiallyaffectthe decisions of financial statement users.Video InstructionIn today’s world, many students use visual learning tools, and many instructors teach in hybridand online formats. For this reason, we continue to expand our video offerings. Each of thevideos below can be assigned or simply made available to students in Connect.Concept Overview Videosincludeconcisely writtenscriptstakendirectly from the text.These videosaredeveloped foreach Learning Objective. In addition, knowledge checkquestions aligned to each video can be assigned to students. Some instructors find theseuseful as pre-class assignments or for use in their online classes.Let’s ReviewVideosare in-chapter demonstrationproblemsthat provide an additionalexample of a key topic.These videos walk students through each step of the solution.Interactive IllustrationVideoshelp students in cases where the material in an illustration isparticularly helpful if seen in an animated way. This animation helps to direct students’attention to a certain part of the illustration while the related instruction is taking place.Guided ExampleVideosare provided with Exercises and appear as hints to the student.These videos show students how to solve a similar (but different) exercise. After seeing thevideo, students can then apply the concepts explained to their assigned Exercise.Applying ExcelVideosshow students how to solve a practice problem using Excel.Students can either go directly to the video or first try to solve the problemon their ownforadditional practice. Many instructors like to assign Excel-based problems in accounting butdon’t have the time to teach Excel basics. These videos are meant to help students learn howto apply Excel basics to accounting problems.An Invitation from the AuthorsFinally, we (the authors) extend an invitation for you to contact us directly with any questions,comments, or requests for additional materials. We appreciate the dialogue we have had withmany instructors over the years that have helped us to build a comprehensive set of materials thatcan be used to help you and your students.Sincerely,David Spiceland (dspice@memphis.edu)Wayne Thomas (wthomas@ou.edu)

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Chapter 01-A Framework for Financial Accounting1-1Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Chapter 1A Framework for Financial AccountingINSTRUCTOR’SMANUALAuthors’ PerspectivesPARTA:Accounting as a Measurement/Communication ProcessLO1-1Describe the two primary functions of financial accounting.LO1-2Understand the business activities that financial accounting measures.LO1-3Determine how financial accounting information is communicated through financialstatements.LO1-4Describethe role that financial accounting plays in the decision-making process.Eliminate the Misconception–It’s important on Day 1 to changeanymisconception studentshave about financial accounting. Moststudentsthink this is going to be another math class.Chapter1begins by explaining that this is not the case. Financial accounting is described as“thelanguage companies use to tell their financial story.”The concept of storytelling has broadappealacrossall business students.Companiestell theirfinancialstoriesusingfinancialstatements and related disclosures.Illustration 1-2(with video)presents a simple framework students can use tovisualizefinancial accounting. This illustration looksmore like a business class than amath class.We cansimplify the course by explaining to students that theywillneed tolearn twofunctions of accountingover the semester: (1) how tomeasurebusiness activities and (2)how tocommunicatethose measurements. To better understandwhy accountantsmeasureand communicate the way they do,students willalsoseehow financial accountinghelpsinvestors, creditors, and others inmakingdecisions.StartSimple–The financial accounting course can be intimidating to many students, most ofwhomhaveneverhad an accounting course. We can simplify the measurement-communication-decisionmakingnature of financial accounting with the following illustrations:Illustration 1-4 providesacomplete list ofthemeasurementcategoriesstudents will needto know.Studentswillseemanyaccount titlesthroughout the semester,and this mayseem overwhelming to them at first. However, we can explain thatall of theseaccountsfall into six easy-to-learn categories (Note: hold off onintroducinggains and losses untillater chapters). Seeing only these six measurement categoriesmakes the measurementfunctionseemmore attainable.Illustration 1-9(with video)provides thefull setof financial statements students willneed to know. Moredetailed financial statementsare shownpreviously in Illustration 1-5through 1-8.Seeing the fullsetof financial statementsin a single illustration helpsstudentsrealizethatlearningthecommunicationroleoffinancialaccountingis

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Chapter 01-A Framework for Financial Accounting1-2Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.manageable.Illustration 1-10wascreated bythe Pathways Commission of the American AccountingAssociation.Accounting serves an important role in a prosperous society by measuringeconomic activity and communicating useful information to help investors and creditorsmake good decisions.We can confidently tell our students that financial accountingmatters and has relevance to the well-being of our society.PART B:Financial Accounting InformationLO1-5Explain the term generally accepted accounting principles (GAAP) and describe therole of GAAP in financial accounting.Accountingis a Dynamic Social Science–Many students are surprised to learn that the formalrules of financial accounting are established by a private-sector body, the Financial AccountingStandards Board.Someare also surprised to find out that separate rules have been establishedoutside of the United States by the International Accounting Standards Board. The differences instandardsbetween the two boardsreflect the fact that accounting is asocial science, unlike theformal sciences (mathematics, physics, chemistry, etc.).The rules of the formal sciences do notdiffer across countries (for example, in all countries, 2 + 2 = 4, and water is made up of twoatomsof hydrogen and oneatomof oxygen). However, the rules offinancialaccounting do notexist on their own; they are developed by the society for which they exist. Differences in beliefsand economic conditions across countriescan lead to differences inaccountingstandards andpractices, as well as changes over time in the same country.Many students will find the dynamicnature of a social science like accounting far more exciting than mathematics.IntriguingRole oftheAuditor–The description of financial accountingas“the languagecompanies use to tell their financial story” was introduced in Part A. In Part B, students areintroducedbriefly tothe role of an independent auditorinproviding verification that companiesare tellingtheir story accurately.Studentsarehighly interested in cases of financial statementfraud, and instructorscan explain that topics covered throughout the book willdemonstratehowfraudoccurs. There are two types ofauto-gradableassignmentsat the end ofeachchapterthatcan be assigned related tofinancial statement fraud:1.Ethics Cases.InPart Bof the text, students will seea simple four-step framework forthinking about ethical decisions related to financial reporting.InEthicscases at the end ofthe chapter, students will work through this framework usinga topicrelated to thatparticularchapter.Allof these casesare assignable andauto-graded in Connect.2.Earnings Management Cases.Studentsneed tounderstand how certain assumptions anddiscretion available in financial accountingprovide an opportunity formanagers tomanipulatereported amounts. The solutionsto the cases involve students understandingthe financial statementeffectsof earnings management.Allof these casesare assignableandauto-graded in Connect.

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Chapter 01-A Framework for Financial Accounting1-3Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.PART C: Careers in AccountingLO1-6Identify career opportunities in accounting.Can I get a job?–This is a question on all students’ minds.Accounting tends to be one of thefirst business courses that students take. Many of them don’t yet know what their major will be,what they’ll like, and if they can get a job. We can capture the best students in accounting byemphasizingithasreal-worldrelevance,strongjobdemand,andmanydifferentcareeropportunities.Part Cprovidesadiscussion of careers in accounting.Thisdiscussioncan be usedtobothinformandmotivatestudents.Thissectionemphasizesthebroadrangeofjobopportunities available to those earning a degree in accounting, perhaps dispelling the traditionalview of accountants. It also discusses the strong demand for accounting majors.Illustration 1-14 provides a convenientlistof some of the typical career opportunitiesinthe different areas of accounting.Instructors canpoint out that accounting has been oneof the top majors for decades, and as businesses continue to grow in their use ofinformation, accountants will surely be needed in the decades to come.APPENDIXLO1-7Explain the nature of the conceptual framework used to develop generally acceptedaccounting principles.The conceptual framework is discussed in the appendix.Instructorscan cover the conceptualframework in this chapter and then refer back to it as topics in subsequent chapters are covered.Alternatively, instructorsmay wish to cover the conceptual framework in conjunction withanother chapter, such as Chapter 12, Financial Statement Analysis, to help in providing asummary overview of the course.Self-StudyMaterials■ Let’s Review—Measuring business activities (p. 8).■ Let’s Review—Communicating through financial statements (p. 17).■ Chapter Highlights (p. 31).■ Key Points by Learning Objective (p. 32).■ Glossary of Key Terms (p. 33).■ Self-Study Questions with answers available (p. 34).■ Applying Excel videos to demonstrate key topics (p. 35).■ Videos for Let’s Review and certain illustrations.

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Chapter 01-A Framework for Financial Accounting1-4Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Key Points by Learning ObjectiveThroughout the chapter,Key Pointsprovide quick synopses of the criticalpieces of informationstudents should be understanding. These Key Points are summarized byLearning Objectiveatthe end of the chapter, providing students with a convenient study guide.LO1-1 Describe the two primary functions of financial accounting.The functions of financial accounting are to measure business activities of a company and tocommunicate information about those activities to investors and creditors and other outside usersfor decision-making purposes.LO1-2Understand thebusiness activitiesthat financial accounting measures.The measurement role of accounting is to create a record of the activities of a company. To makethis possible, a company must maintain an accurate record of its assets, liabilities, stockholders’equity, revenues, expenses, and dividends.LO1-3Determinehow financial accounting information iscommunicated through financialstatements.The income statement compares revenues and expenses for the current period to assess thecompany’s ability to earn a profit from running its operations.The statement of stockholders’ equity reports information related to changes in common stockand retained earnings each period. The change in retained earnings equals net income lessdividends for the period.The balance sheet demonstrates that the company’s resources (assets) equal creditors’ claims(liabilities) plus owners’ claims (stockholders’ equity) to those resources on a particular date.The statement of cash flows reports cash transactions from operating, investing, and financingactivities for the period.All transactions that affect revenues or expenses reported in the income statement ultimatelyaffect the balance sheet through the balance in retained earnings.LO1-4 Describe the role that financial accountingplays in thedecision-making process.Financial accounting serves an important role by providing information useful in investment andlending decisions.No single piece of company information better explains companies’ stock price performancethan does financial accounting net income. A company’s debt level is an important indicator ofmanagement’s ability to respond to business situations and the possibility of bankruptcy.

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Chapter 01-A Framework for Financial Accounting1-5Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.LO1-5 Explain the term generally accepted accountingprinciples (GAAP) and describe therole of GAAPin financial accounting.The rules of financial accounting are called generally accepted accounting principles (GAAP).The Financial Accounting Standards Board (FASB) is an independent, private body that hasprimary responsibility for the establishment of GAAP in the United States.The primary objective of financial accounting is to provide useful information to investors andcreditors in making decisions.LO1-6 Identify career opportunities in accounting.Because of the high demand for accounting graduates, the wide range of job opportunities, andincreasing salaries, this is a great time to obtain a degree in accounting.AppendixLO1-7 Explain the nature of the conceptual frameworkused to develop generally acceptedaccountingprinciples.The conceptual framework provides an underlying foundation for the development of accountingstandards and interpretation of accounting information.To be useful for decision-making, accounting information should have relevance and faithfulrepresentation.

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Chapter 01-A Framework for Financial Accounting1-6Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.AAssssiiggnnmmeenntt CChhaarrttssQuestionsLearningObjective(s)TopicTime(Min.)1LO1-1Define accounting52LO1-1Identify decision makers53LO1-1Define financial accounting54LO1-1Determine the functions of accounting55LO1-2Classify business activities56LO1-2Determine financing activities57LO1-2Determine investing activities58LO1-2Determine operating activities59LO1-2Distinguish legal forms of business510LO1-2Define account types511LO1-2Name advantages and disadvantages of the legalforms of business512LO1-3Describe basic financial statements513LO1-3Understand financial reporting periods514LO1-3Identify revenues and expenses515LO1-3Understand the accounting equation516LO1-3Identify assets and liabilities517LO1-3Understand the link between the income statementand balance sheet518LO1-3Identify cash flows519LO1-3Explain other forms of financial accountinginformation520LO1-4Explain the role of accounting in society521LO1-5Define GAAP522LO1-5Describe the role of the FASB523LO1-5Compare U.S. GAAP and IFRS524LO1-5Understand the historical role of the securities acts525LO1-5Describe the role of the auditor526LO1-5List the three objectives of financial reporting527LO1-6Understand the benefits of an accounting degree528LO1-7Discuss relevance and faithful representation529LO1-7Identify the components of relevance and faithfulrepresentation530LO1-7Describe cost effectiveness531LO1-7Define the four basic assumption underlying GAAP5

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Chapter 01-A Framework for Financial Accounting1-7Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.BriefExercisesLearningObjective(s)TopicTime(Min.)BE1-1LO1-1Define accounting5BE1-2LO1-2Identify the different types of business activities5BE1-3LO1-2Identify the different forms of businessorganizations5BE1-4LO1-2Recognize the different account classifications5BE1-5LO1-2Assign account classifications5BE1-6LO1-2Assign account classifications5BE1-7LO1-3Describe each financial statement5BE1-8LO1-3Determine thelocationof itemsin financialstatements5BE1-9LO1-5Identify different groups engaged in providing high-quality financial reporting5BE1-10LO1-5Identify the objectives of financial accounting5BE1-11LO1-6Identify careers for accounting majors5BE1-12LO1-7Identify the components/aspectsof relevance5BE1-13LO1-7Identify the components/aspectsof faithfulrepresentation5ExercisesLearningObjective(s)TopicTime(Min.)E1-1LO1-2Identify the different types of business activities5E1-2LO1-2Identify account classifications and businessactivities5E1-3LO1-2Identify account classifications and businessactivities5E1-4LO1-2Calculate net income and stockholders’ equity10E1-5LO1-2Calculate net loss and stockholders’ equity10E1-6LO1-3Prepare an income statement5E1-7LO1-3Prepare a statement of stockholders’ equity10E1-8LO1-3Prepare a balance sheet5E1-9LO1-3Prepare a statement of cash flows10E1-10LO1-3Link the income statement to the statement ofstockholders’ equity15E1-11LO1-3Link the statement of stockholders’ equity to thebalance sheet15E1-12LO1-3Link the balance sheet to the statement of cashflows15E1-13LO1-3Computemissing amounts from financial statements10E1-14LO1-3Calculate the balance of retained earnings5E1-15LO1-3Calculate amounts related to the balance of retainedearnings10

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Chapter 01-A Framework for Financial Accounting1-8Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.E1-16LO1-3Use the accounting equation to calculate amountsrelated to the balance sheet10E1-17LO1-3Calculate missing amounts related to the statementof cash flows10E1-18LO1-5Understand the role of the auditorE1-19LO1-7Identify the purpose of qualitative characteristics10E1-20LO1-7Identify business assumptions underlying GAAP5ProblemsLearningObjective(s)TopicTime(Min.)P1-1ALO1-2Classify business activities10P1-2ALO1-2Assign account classifications10P1-3ALO1-3Prepare financial statements20P1-4ALO1-3Understand the format of financial statements andthe linksamong them25P1-5ALO1-3Prepare financial statements20P1-6ALO1-7Identify underlying assumptions of GAAP15P1-7ALO1-7Understand the components of the FASB’sconceptual framework10P1-1BLO1-2Classifybusiness activities10P1-2BLO1-2Assign account classifications10P1-3BLO1-3Prepare financial statements20P1-4BLO1-3Understand the format of financial statements andthe link among them25P1-5BLO1-3Prepare financial statements20P1-6BLO1-7Identify underlying assumptions of GAAP15P1-7BLO1-7Understand the components of the FASB’sconceptual framework10AdditionalPerspectivesTopicTime(Min.)AP1-1Continuing Problem: Great Adventures20AP1-2Financial Analysis: American Eagle Outfitters, Inc.15AP1-3Financial Analysis: The Buckle, Inc.15AP1-4Comparative Analysis: American Eagle Outfitters, Inc. vs. The Buckle,Inc.20AP1-5Ethics20AP1-6Internet Research30AP1-7Written Communication25

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Chapter 01-A Framework for Financial Accounting1-9Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Alternate Let’s ReviewOn December 31, Wortham Services reports the following year-end amounts.Assets:Cash$11,000Revenues:Service$85,000Accounts receivable19,000Buildings32,000Expenses:Advertising12,000Liabilities:Salaries payable5,000Insurance18,000Notes payable20,000Salaries44,000Additional information:a. The balance of retained earnings at the beginning of the year is $6,000.b. The company pays dividends of $5,000 on December 31.c. Common stock is $20,000 at the beginning of the year, and $5,000 of additional shares areissued during the year.Required:Preparethe (1) income statement, (2) statement of stockholders’ equity, and (3) balance sheet.Solution:1. Income statement:2. Statement of stockholders’ equity:Wortham ServicesIncome StatementYear ended Dec. 31Wortham ServicesStatement of Stockholders’ EquityYear ended Dec. 31Service revenue$85,000CommonStockRetainedEarningsLess:Beginning$20,000$ 6,000Advertis. expense(12,000)New issuances5,000Insuranceexpense(18,000)Net income11,000Salaries expense(44,000)Less: Dividends(5,000)Net Income$ 11,000Ending$25,000$12,0003. Balance sheet:Wortham ServicesBalance SheetDecember 31AssetsLiabilitiesCash$11,000Salariespayable$ 5,000Accountsreceivable19,000Notes payable20,000Buildings32,000Stockholders’ EquityCommonstock25,000Retainedearnings12,000Total assets$62,000Total liabilities and equity$62,000

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Chapter 01-A Framework for Financial Accounting1-10Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.CommonMistakesCommon Mistakesmade by students are highlighted in each of the chapters. With greaterawareness of the potential pitfalls, studentscan avoid making the same mistakes and gain adeeper understanding of the chapter material.CommonMistakeDividends represent the payment of cash but are not considered an expense in runningthebusiness. Students sometimes mistakenly include the amount of dividendsas an expense in theincome statement, rather than as a distribution of net incomein the statement of stockholders’equity.

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Chapter 01-A Framework for Financial Accounting1-11Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Decision Pointsand Decision Maker’s PerspectivesDecision PointsandDecision Maker’s Perspectivesare providedthroughout each chapter to giveinsight into how measurement and communication of financial accounting information helpdecision makers.Decision PointsQuestionAccounting InformationAnalysisHow can I tell ifacompany isprofitable?Income statementIf revenues exceedexpenses, acompanyhas net income andisprofitable.QuestionAccounting InformationAnalysisWas the change instockholders’ equitythe result of externalor internal sources?Statementof stockholders’equityWhen a company sells common stock,equity increases due to externalsources. When a company has profitsduring the year in excess of dividendspaid, equity increases due to internalsources.QuestionAccounting InformationAnalysisWhat are creditors’claims and owners’claims to thecompany’s resources?Balance sheetThe amount of total liabilities equalscreditors’ claims to the company’sresources. The extent to which totalassets exceed total liabilitiesrepresents owners’ claims.Decision Maker’s PerspectiveThe statement of cash flows can be an important source of information to investors andcreditors. For example investors use the relationship between net income (revenues minusexpenses) and operating cash flows (cash flows from revenue and expense activities) to fore-cast a company’s future profitability. Creditors compare operating cash flows and investingcash flows to assess a company’s ability to repay debt. Financing activities provide informa-tion to investors and creditors about the mix of externalfinancing of the company.

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Chapter 01-A Framework for Financial Accounting1-12Copyright© 2019McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Ethical DilemmaYou have been the manager of a local restaurantfor the past five years. Because of increasedcompetition, you notice you’re getting fewer customers.Despite all your attempts to attract newcustomers and cut costs, the restaurant’sprofitabilitycontinues to decline. The restaurant ownertells you that if this year’s profit is lower than lastyear’s, you’ll lose your job.When preparing financial statements at theend of the year, you notice that this year’s profitislower. You know that by purposely understatingcertain expenses, you can falsely reporthigherprofits to the owner for this year. That will allowyou to keep your job for at least onemore year and look for a new job in themeantime.What should you do? What if you really believe the lower profitability iscaused by factorsoutside your control? Would this make the false reportingacceptable?Key IssuesReporting higher profit makes the restaurant’s operations seem more profitable, signalingbetter managerial performance.Self-preservation (keeping your job) vs. honesty (accurate reporting)Managing expectations—justifying why performance is truly decliningOption 1:Do not understate expensesThe actions we take depict the type of person we are,not whom we hope to be. You maybelieve other causes besides your performance drove the decline in performance, but thatshould not be an excuse to lie and manipulate your boss.A strong likelihood exists that the understatement of expenses will eventually be detected(by auditors, owner, employees, etc.).If caught, the ability to maintain employment with this restaurant or anywhere else will bea challenge.The best defense of your job is to prepare the financial statements accurately and presenta thorough analysis to the restaurant ownerregarding what you see asthe true cause ofthe decline in performance. A proactive approach with possible solutions to the problemwould be well received by a competent owner.Option 2:Understate expensesAs the decline in performance is notyourfault, you may decide that falsifying thefinancial statements will allowyoutime to either explain to the owner why performancehas declined or to look for another job.It does not seem fair to be punished for things outside your control. You shouldn’t have tolose your job just because the restaurant is not doing as well as it used to.

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