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© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
Obviously, this list is not exhaustive. Fur-
thermore, selecting from among these alter-
natives—like making most decisions—
involves many factors besides accounting
considerations.
4. The term “business” refers to the general
process of producing or distributing goods or
providing services. It also may refer to an
entity that has been organized to earn a profit.
5. Accounting is considered the “language of
business” because it provides the means of
accumulating, measuring, and recording the
successes and failures of business opera-
tions. Accounting also provides a mecha-
nism for communicating the financial results
of businesses to the decision makers (e.g.,
investors, creditors, managers, government,
labor unions, etc.).
6. Internal and external users of accounting
information have similar needs in that both
groups are required to make financial deci-
sions. Managers (internal users) are re-
quired to make many day-to-day decisions
in running their organizations; they generally
need more detailed and more timely infor-
mation. The information supplied to manag-
ers can be in any form that fits the specific
questions and circumstances facing the
manager. Investors and creditors, the pri-
mary external users, need summarized data
to assist in making investing and lending de-
cisions. The information supplied to external
users should follow generally accepted ac-
counting principles (GAAP) so that the in-
formation is consistent and comparable and,
therefore, more useful for decision making.
7. Generally accepted accounting principles
(GAAP) are accounting standards recog-
nized by the accounting profession and the
business community. These standards must
be followed when preparing financial state-
ments for external users. Only when con-
cepts and principles prove useful over time
are they incorporated into GAAP.
1

or in part.
2 Chapter 1
Currently, the Financial Accounting Stan-
dards Board (FASB) issues Statements of
Financial Accounting Standards (SFAS) and
Interpretations of SFAS after extensive re-
view and discussion with groups involved in
preparing and using external reports.
The purpose of GAAP is to ensure consis-
tent application of accounting principles in
preparing external financial reports. Thus,
GAAP allows comparability among firms and
provides users of external reports with the
foundation for sound decision making.
8. Financial reports are prepared primarily for
external users, mainly investors and credi-
tors. It is important that the financial reports of
different companies be based on the same
set of generally accepted accounting
principles (GAAP) so that the results are
comparable. Thus, investors can choose
from among several companies the ones in
which they wish to invest, and lenders can
select those entities that they feel are credit-
worthy. If there were no general guidelines
upon which financial reports were based, the
reports of companies would likely be so dif-
ferent that comparisons and meaningful
analysis of company results would be im-
possible.
9. The Securities and Exchange Commission
(SEC) holds legal authority to set accounting
standards. The SEC, however, delegates its
authority to the Financial Accounting Stan-
dards Board (FASB). The SEC can, at any
time, take over the accounting standard-
setting process.
The Internal Revenue Service (IRS) moni-
tors businesses to see if they are in compli-
ance with its rules and regulations, which may
or may not coincide with generally accepted
accounting principles (GAAP).
10. When different countries have different
accounting standards, the ability to compare
financial statements across countries be-
comes extremely difficult. Some countries
prohibit certain accounting procedures, while
other countries allow a wide variety of ac-
counting alternatives. As a potential inves-
tor, these differences make the comparabil-
ity of results increasingly difficult. As the
president of a multinational company, you
would have difficulty comparing your com-
pany’s performance to the performance of
foreign competitors who report using differ-
ent accounting standards.
11. Accountants are responsible to the public
and the companies that they work for to en-
sure that financial statements are in accor-
dance with GAAP and are reported in an
unbiased manner. Thus, accountants must
maintain the reputation of being ethical to
meet their professional responsibilities.
12. No. Although the role of accountants may
change in the future, the need for judgment,
which is provided by accountants, will not
decrease. While technology has aided ac-
countants in the everyday bookkeeping
tasks, computers cannot analyze and inter-
pret financial information as an accountant
can. In the future, accountants could be re-
quired to perform all the financial tasks for a
business. These include tax preparation,
auditing, and financial planning.
13. Accounting is necessary to make wise fi-
nancial decisions. Almost without exception,
everyone will be faced with some type of
decision requiring financial analysis. Ac-
counting provides the needed tools to make
sound decisions. Furthermore, in selecting
investments, working within the business
environment, and budgeting for a house-
hold, accounting concepts can prove very
useful.

or in part.
3
Chapter 1
EXERCISES
Note: Because Chapter 1 is fairly general and is intended to be a brief introduc- tion
to important accounting concepts, these exercises can be used most effec- tively
to initiate class discussion.
E 1–1 (LO1) The Role and Importance of Accounting
Every organization, regardless of its size or purpose, should have a means of
monitoring its activities and measuring how well it is accomplishing its objec- tives.
Accounting provides such a mechanism by helping organizations to determine
the optimal use of resources and to analyze the costs and benefits of decision
alternatives. Accounting helps a retailer make such decisions as which lines of
clothing to carry and what prices to charge. Numerous other examples are possible.
E 1–2 (LO1) Bookkeeping Is Everywhere
Bookkeeping is “the preservation of a systematic, quantitative record of an activ-
ity.” As such, bookkeeping is applied in many settings, not just in maintaining fi-
nancial records. This point is illustrated with the following examples:
a. Your college English class. Even though most English professors claim that
the only numbers they ever look at are on the bottoms of the pages of the
books they read, they must use numbers to record performance on assign-
ments and papers in order to fairly assign final grades.
b. The National Basketball Association. The NBA—and sports in general—is a
record keeper’s delight. Official statisticians record every turnover, every as-
sist, every foul, every three-point attempt, etc. In addition, with teams always
struggling to sign key players and still remain under the “salary cap,” the most
valuable player in the franchise is often the accountant.
c. A hospital emergency room. Most emergency rooms have a status board
where the status of the patient in each room is posted. This ensures that
everyone can easily see where the high-risk patients are so that they can be
given priority treatment. In addition, when you receive your bill from the
emergency room, you realize that someone has been doing a lot of book-
keeping.
d. Jury selection for a major murder trial. Juror pools typically come from lists
of registered voters. That list must be maintained, a random selection must
be made, and the potential jurors must be tracked as they report for jury
duty. The rival lawyer teams also study all potential jurors and rank them as
to how sympathetic each might be to the team’s legal arguments.

4 Chapter 1
or in part.
E 1–2 (LO1) (Concluded)
e. Four college roommates on a weekend skiing trip. Even among friends, bills
must be settled up. Not every bill can be equally split at the time of pay- ment—
convenience store cashiers don’t like four people coming in, each paying for
one-fourth of a tank of gas. So, someone must track who pays for what during
the skiing trip so that a fair settlement can be reached at the end of the trip.
E 1–3 (LO1) Accounting Information and Decision Making
The following items of information are typical of those that would help in deciding
which types of computer to sell and in determining the profitability of Automated
Systems, Inc.:
1. The number of computers and related equipment sold during a period (for
example, a month).
2. The selling prices and costs of the items sold.
3. The number of items purchased for sale during a period and the quantity of
units remaining on hand at the end of the period.
4. The amount of office supplies used during the period and their cost.
5. The amounts paid for employee wages, rent, utilities, advertising, and mis-
cellaneous items.
6. The amount of cash or other items personally invested in the business.
In addition to the above information, which is related to the general business ac-
tivities of Automated Systems, Inc., you also would want to collect specific infor-
mation concerning (1) comparative costs of the Apple and Windows-based per-
sonal computers, (2) expected number of sales of both products, (3) comparative
sales prices of the two computers, and (4) any additional costs that may have to
be paid or savings that may result in switching from one computer line to the other.
Other information, such as the impact of consumer preferences, also would
have to be analyzed. Accounting provides only part of the information needed for
making business decisions, but it is an important part.
E 1–4 (LO1) Allocation of Limited Resources
Accounting information will tell you the financial results of your company. The fol-
lowing steps will help you identify and determine how to efficiently allocate the com-
pany’s limited resources:
x Identify and value the limited resources in your business.
x Evaluate past performance of business activities for successes and fail-
ures.
x Prepare budgets that will express your desires and goals for the company
in quantitative terms.

or in part.
5
Chapter 1
E 1–4 (LO1) (Concluded)
x Set financial goals, both short term and long term.
x Examine current expenses to ascertain where costs can be reduced.
x Analyze current operations to decide which business activities are most
profitable.
x Determine if a different investment would be more profitable.
E 1–5 (LO2) Users of Financial Information
These groups or individuals would be interested in a firm’s financial statements
for the following reasons:
a. Current stockholders have already invested in the firm, and with the financial
statements, they can analyze the firm’s performance and evaluate whether
their investment has been a good one.
b. Creditors are interested in the firm’s performance because they have loaned
money to the firm. They need to review the financial statements to see if the
firm is performing well enough to repay the loan.
c. Management needs to see what areas of the business the firm needs to im-
prove upon. Management can also see if the firm has met operational goals for
the last period.
d. Prospective stockholders need to review the financial statements to deter-
mine whether they want to invest their money in the firm.
e. The tax filings made with the Internal Revenue Service are prepared using a
different set of rules from those used in preparing the financial statements.
However, the IRS may make a comparison between the tax filing and the fi-
nancial statements to detect unusual or extreme differences suggesting the
underpayment of taxes.
f. The SEC ensures that financial statements have been evaluated by inde-
pendent external auditors. The SEC also identifies problem accounting areas
in which the SEC staff may do additional checking.
g. The firm’s major labor union would want to make sure that the employees of
the firm are being treated fairly and that the company is conducting business
in an appropriate manner.

or in part.
6 Chapter 1
E 1–6 (LO2) Structuring Information for Use in Evaluation
With some additional record-keeping procedures, the information from the con-
venience store cash register can be used to generate all sorts of useful data for
managing the store. Some examples are as follows:
x Product category. If each sale were identified by the type of product sold
(e.g., gasoline, food, refrigerated product), then the manager of the store
could know what types of items were selling the best.
x Timing of sale. Each sale could also be identified by time of day and day of
the week. This information could be used to determine whether the store was
open for the optimal number of hours per day and whether extra staff were
needed on certain days at certain times.
x Salesclerk. The store manager could determine whether certain clerks were
influencing sales, either positively or negatively. For example, the de-
meanor of some clerks may discourage customers who purchase gasoline
from entering the store and making additional purchases of food and snacks.
x Specific products. With a more elaborate system, the convenience store
could track each item sold. This information could be used to determine
when inventory restocking purchases need to be made. In addition, the store
manager could use this information to place the best-selling products in
high-visibility locations within the store.
E 1–7 (LO2) Investing in the Stock Market
In any bookstore, you can find numerous books devoted to this very question—
how to identify companies that will have high rates of return. Here are some basic
accounting concepts that will help you analyze a company’s future stock per-
formance.
x Past and present stock performance
x Net earnings
x Cash flows (i.e., positive or negative)
x Total revenues
x Dividends (i.e., increasing, decreasing, nonexistent, etc.)
x Total debt outstanding and respective interest rates
x Total assets
x Price-earnings ratio (average market price of stock divided by net income
per share)
As your understanding of accounting increases, you will realize that there are
hundreds of ways to predict a company’s stock performance, but none of them
are 100% effective. Good luck in your future stock market endeavors.

or in part.
7
Chapter 1
E 1–8 (LO2) Management versus Financial Accounting
Management accounting is concerned primarily with providing information to
managers, those who work inside the organization and who are responsible for
directing and controlling its operations. Internal reports are used in management
accounting to provide management with the necessary information to run the
day-to-day business operations. Since management has control over the ac-
counting system, these internal reports are tailored to meet the specific needs of
management and will vary considerably among businesses.
Financial accounting is concerned with developing and communicating financial
information to external users (i.e., stockholders, creditors, regulatory agencies, and
others outside the organization). These external users need assurance that the
financial information has been prepared using a common set of ground rules. To
provide this assurance to external users, financial accounting provides infor-
mation in the form of external financial reports prepared according to generally
accepted accounting principles.
Although management and financial accounting are two different fields of ac-
counting, the following similarities exist between them:
1. Both rely on the accounting information system to generate information.
2. Both focus on providing information for decision making. The decision mak-
ers who receive this information are different—some being external to the firm
and some being internal—but the need for information to make wise and timely
decisions is the same.
E 1–9 (LO2) The Role of the SEC
The advantage to the accounting profession of being allowed to govern itself is
its ability to select individuals with a knowledge of the field of business and ac-
counting. If the government were determining accounting rules, political appoint-
ees who know little about accounting might be setting the rules. The individuals on
the FASB have spent their entire business lives working in accounting and
business and have developed a keen understanding of how accounting rules af-
fect business practice. Such knowledge and understanding are invaluable in
evaluating the effects of certain accounting rules.
On the other hand, if the SEC chose to establish all accounting rules, it would
have the ability to dictate how rules would be followed. Similar to the IRS, the
SEC could enforce a strict code. A lack of adherence to the SEC’s rules could re-
sult in penalties and jail time. The SEC has recognized that the private sector has
a competitive advantage in understanding accounting and standard setting. For the
time being, it has elected to leave well enough alone.

or in part.
8 Chapter 1
E 1–10 (LO2) Why Two Sets of Books?
GAAP and IRS rules are different because they apply to different types of reports.
GAAP rules apply to financial reports. GAAP ensures that all companies’ report-
ing procedures are the same so they can be easily compared. The purpose of fi-
nancial reporting is to provide users with information to improve their decisions.
IRS rules, however, are used for income tax purposes only. They are completely
different from GAAP because they do not deal with preparing financial reports.
IRS rules are designed to raise revenue for the government. Such rules have a
different objective than GAAP.
E 1–11 (LO2) Career Opportunities in Accounting
Since accounting is the “language of business,” your mother should take comfort
in knowing that you know how to speak another language. With a knowledge of
accounting, you are prepared to seek employment in many different areas within
the business world. Since all aspects of business have some cost or profit ele-
ment, your knowledge of how these costs or profits are accounted for will provide
you with an advantage. In addition to working in for-profit organizations, ac-
countants are in demand in government and not-for-profit agencies as well.
In addition, tell your mom that not all those who graduate with a degree in ac-
counting seek employment as accountants. Many use their degree in accounting
as background for a master’s or PhD degree. Examples of areas of graduate
study include an MBA degree, a law degree, and a master’s degree in accounting.
E 1–12 (LO3) Differences in Accounting across Borders
The financial statements of a company from, for example, the United Kingdom
may not be comparable with the financial statements of a company from the United
States. As an example, many companies in the United States use some form of
LIFO, while that method of accounting is not used very often in the United Kingdom.
A straightforward comparison of the operating results of these two companies
would be ill-advised as it would be like comparing apples and or- anges. For the
comparison to be meaningful, similar accounting methods should be used. In the
United States, many companies provide notes to the financial statements that detail
what the results would be if alternative accounting methods were used.
In addition to the problems caused by the availability of different accounting
methods, different business environments can make it difficult to compare com-
panies. Companies in Russia operate in a completely different business environ-
ment than do companies in the United States. These differences must also be fac-
tored in when evaluating companies across borders.

or in part.
9
Chapter 1
E 1–13 (LO3) Ethics in Accounting
This exercise should provide the basis for discussing several aspects of ethics.
Students likely will have different points of view.
The authors believe that ethics can be “taught,” although probably not in the
same way that we teach history or math. A student’s sense of ethics develops
over time. The way people approach and deal with ethical issues seems to be af-
fected by life experiences, including formal education.
The authors have tried to expose students to some ethical considerations in ac-
counting by incorporating ethical issues in several of the end-of-chapter cases
throughout the textbook. Hopefully, these materials, and the discussion of them,
will increase students’ awareness of the ethical dimensions of accounting.
E 1–14 (LO3) Challenges to the Accounting Profession
The accounting profession faces several challenges. Among them are (1) in-
creased competition for clients, (2) increased number of malpractice lawsuits, (3)
escalating costs of insurance, (4) greater difficulty in recruiting bright young tal-
ent to the profession, (5) the possibility of increased government regulation of
accounting, (6) problems associated with international operations, and (7) ethical
considerations of business decisions. While it is clear that the environment in
which accounting operates is complex and dynamic, and that these challenges
are real, many within the profession still feel that the future is bright.
E 1–15 (LO4) Why Do I Need to Know Accounting?
Your friend will find that he needs accounting sooner than he thinks. He will need
a knowledge of accounting to complete his tax returns. He will be required to
have a complete financial history should he ever elect to expand his business
and need to borrow funds. He will need accounting information to determine if he
is covering his costs and providing to himself a fair return. Your friend will cer-
tainly need a knowledge of revenues and expenses to measure his success. In
addition, he will need a record of his obligations and the amounts owed to him.
Every business manager finds out rather quickly that accounting information is
very valuable.

or in part.
10 Chapter 1
ANALYTICAL ASSIGNMENTS
AA 1–16 To Lend or Not To Lend—That Is the Question
Discussion
Sam needs several pieces of information to determine whether to give Bill the loan. First, he would need
to see a listing of Bill’s assets and liabilities. Examples of these would include a list of all of Bill’s property
and equipment needed to run the ranch, the cash that he has, money other people owe him, the debts he
owes, and any investments that he has made. Second, Sam would want to see evidence of Bill’s income
from the Mountain Meadow Ranch. Bill would need to bring his receipts and tax returns to show evidence
of income. Third, Sam would want to see documentation of the inflows and outflows of Bill’s bank ac- counts
and the monthly payments that Bill has to make. These records would give Sam an idea of where Bill’s
money is coming from, where it is going, and whether he will have enough money in the future to repay the
loan.
Bill should compile the pieces of information listed above and determine if he has been successful in his
business thus far. Bill should see if he is operating at a profit or at a loss. If he is operating at a loss, he
should determine how he plans to turn things around and therefore be able to repay the loan. Bill should
anticipate the questions Sam is sure to ask and be prepared with data to support his answers to those
questions.
AA 1–17 Information Needs to Remain Competitive
Discussion
AMD would want to look at the financial statements of other computer companies, such as Intel, to see what
they are doing differently. An analysis of competitors’ statements may show AMD that certain areas of the
computer industry are more successful than others. AMD would also want to look at its own financial
statements and identify the areas that are most successful, as well as those that are less successful. AMD
may want to consider focusing its energy on the most successful segments.
AMD could also conduct market research to see why computer manufacturers are selecting Intel chips over
AMD chips. From this research, it could determine what improvements should be made.
AA 1–18 We Don’t Have Time for Good Accounting!
Discussion
Your sister is correct in recognizing the importance of continuing to develop the most important part of her
business, which is new products and new people. However, one of those new people should be a trust-
worthy accountant. New, successful businesses often make the mistake of assuming that the initial period
when they are swimming in cash and profits will last forever. It won’t. As the business expands, there will
be a greater need for managing the payroll, systematically paying the bills, preparing forecasts and budg-
ets, and generating performance evaluations. Only by carefully laying the groundwork for a useful ac-
counting system can a successful new business mature into a successful old business.

or in part.
11
Chapter 1
AA 1–19 You Decide: How much education is necessary for an accountant?
Judgment Call
Issues to be discussed with this question are:
1. Certainly, computers and technology have replaced much of the procedural work that accountants used
to do—preparing manual tax returns, making journal entries, posting to ledgers, etc.
2. No matter how much technology develops, there will always be a need for individuals who can design
systems, interpret results, provide financial insight into decision making, perform planning, audit sys-
tems, and do other tasks requiring analytical skills. Today, accountants are an integral part of man-
agement teams. With knowledge of financial data, better management decisions can be made.
3. The skills needed for today’s accountants are expanding rapidly. Instead of being a preparer of infor-
mation, today’s accountants must have good analytical skills, communication skills, technology skills,
and other knowledge and skills. Being an accountant is being a professional, and five years is one of
the lowest levels of education required to enter a professional field.
4. QuickBooks can help, but it will never replace one who understands what QuickBooks can do and
who can make intelligent decisions based on the data.
AA 1–20 Wal-Mart
Real Company Analysis
Wal-Mart’s annual report is divided into four main sections. These are financials, editorial, the chairman’s
letter, and analysis tools. Each of these sections can be accessed online (http://www.walmart.com). About
fifteen pages of the report are devoted to the description of the business. More than half of the report is
devoted to financial information, the report of independent auditors, a listing of directors and offi- cers,
subsidiaries, and shareholder services. Within the financial information, students can find the three primary
financial statements: the income statement, the balance sheet, and the statement of cash flows, as well
as management’s discussion and analysis, and the notes to the financial statements.
Students should be encouraged to review the annual report and perhaps compare it with other annual
reports. They will soon realize that most annual reports follow a similar format.
AA 1–21 General Electric
Real Company Analysis
1. Obviously, General Electric (GE) didn’t acquire this large amount of loans receivable as part of its
consumer electronics or appliance businesses. GE also has a large and well-known financing sub-
sidiary, General Electric Capital Services (GECS). GECS offers many different financial products and
services. Some examples are commercial loans, operating leases, home loans, insurance, and credit
cards.
2. The $113.612 billion excess of GE’s assets over its liabilities represents the amount of funds invested
in GE by its shareholders, as well as past earnings that have been retained in the business. Another
way to think of this difference is that if the assets were used to repay all the liabilities, the remainder
of $113.612 billion would be left for the shareholders.

or in part.
12 Chapter 1
AA 1–22 Should the SEC Choose the FASB or the IASB?
International
The SEC has been charged by Congress to make sure that all investors trading in U.S. securities markets
have access to sufficient financial disclosures to allow them to make informed trades. If the SEC were to
allow U.S. companies to adopt IASB accounting standards, the SEC would be ceding its accounting
standard-setting responsibilities to a group over which they, the SEC, have no direct jurisdiction.
However, it seems only a matter of time before U.S. companies argue that requiring one set of accounting
standards for one group of companies and allowing another set of standards for another set of companies
results in an unlevel playing field.
It seems likely that the SEC will push for a convergence of IASB and FASB accounting standards. Allow-
ing non-U.S. companies access to U.S. capital markets seems a first step in that direction.
AA 1–23 Disagreement with the Boss
Ethics
In instances like the one presented in this case, students should realize that if they knowingly process an
item that is outside corporate guidelines, without the written approval from someone who is authorized, they
are jeopardizing their job. If your boss has the authority to deviate from established guidelines, then written
approval from him or her should be obtained. If your boss is not authorized to go outside guidelines, yet
insists on being reimbursed for the expenditures, you should realize that auditors will eventually audit the
expense reports, and you will be asked to account for the deviations from the norm. Without written approval
from your boss, you will be in trouble.
SOLUTIONS TO “STOP & THINK”
Stop & Think (p. 12): Why is it important for the FASB to remain completely independent?
Independence enables the FASB to make decisions for the good of the entire business community rather
than giving special advantages to select firms or other constituents. Independence also enhances the
FASB’s credibility as a policy-making body.

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