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Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203
Financial and Managerial
Accounting 15e
Carl S. Warren
Professor Emeritus of Accounting
University of Georgia, Athens
Jefferson P. Jones
Associate Professor of Accounting
Auburn University
William B. Tayler
Brigham Young University
Australia • Brazil • Canada • Mexico • Singapore • United Kingdom • United States
Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
This is an electronic version of the print textbook. Due to electronic rights restrictions,
some third party content may be suppressed. Editorial review has deemed that any suppressed
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to remove content from this title at any time if subsequent rights restrictions require it. For
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Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203
Financial and Managerial Accounting, 15e © 2020, 2018 Cengage Learning, Inc. ALL RIGHTS RESERVED.
Carl S. Warren
Unless otherwise noted, all content is © Cengage.
Jefferson P. Jones
WCN: 02-300
William B. Tayler
No part of this work covered by the copyright herein may be reproduced
or distributed in any form or by any means, except as permitted by U.S.
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Print Number: 10 Print Year: 2022
Preface
Roadmap for Success

Warren/Jones/Tayler Financial and Managerial Accounting, 15e, provides a sound pedagogy for
giving students a solid foundation in business and accounting. Warren/Jones/Tayler covers the fun-
damentals AND motivates students to learn by showing how accounting is important to businesses.
Warren/Jones/Tayler is successful because it reaches students with a combination of new and
tried-and-tested pedagogy.
This revision includes a range of new and existing features that help Warren/Jones/Tayler pro-
vide students with the context to see how accounting is valuable to business. These include:
▪▪ New! Certified Management Accountant (CMA®) Examination Questions
▪▪ New! Make a Decision section
▪▪ New! Pathways Challenge
Warren/Jones/Tayler also includes a thorough grounding in the fundamentals that any busi-
ness student will need to be successful. These key features include:
▪▪ Stepwise approach to accounting cycle
▪▪ Presentation style designed around the way students learn
▪▪ At the start of each chapter, a schema, or roadmap, shows students what they are going
to learn and how it is connected to the larger picture. In the early chapters, the schema
illustrates how the steps in the accounting cycle are interrelated. In later financial chapters,
the schema shows how each chapter’s topics are connected to the financial statements.
4 7
Chapter
Chapter
The Accounting Cycle Internal Control and Cash

Chapter 1
Transactions
Statement of Statement of caSh flowS

StockholderS’ equity For the Year Ended December 31, 20Y5
For the Year Ended December 31, 20Y5
Cash flows from (used for)
Common Retained operating activities $XXX
Accounting SyStem Cash flows from (used for)
Stock Earnings Total
Accounting Equation Balances, Jan. 1, 20Y5 $XXX $ XXX $ XXX investing activities XXX
Assets = Liabilities + Equity Issued common stock XXX XXX Cash flows from (used for)
Net income XXX XXX financing activities XXX
Dividends (XXX) (XXX) Net increase (decrease) in cash $XXX
Chapter 2 Balances, Dec. 31, 20Y5 $XXX $ XXX $ XXX Cash balance, January 1, 20Y5 XXX
Account
Cash balance, December 31, 20Y5 $XXX
Debits Credits
RuleS of Debit AnD cReDit Balance Sheet
Balance Sheet Accounts income Statement December 31, 20Y5
For the Year Ended December 31, 20Y5
Assets
Sales $ XXX Current assets:
ASSET S = L IABILIT IE S + STOCKHOLDE RS' E QUIT Y
Cost of goods sold (XXX) Cash $XXX
Asset Accounts Liability Accounts Common Stock + Retained Earnings
Debit for Credit for Debit for Credit for
Gross profit $ XXX Accounts receivable XXX
increases decreases decreases increases Operating expenses: Inventory XXX
decreases increases decreases increases
(+) (–) (–) (+) (–) (+) (–) (+) Wages expense $XXX Total current assets $XXX
Balance Balance Advertising expense XXX Property, plant, and equipment XXX
Balance Balance
Utilities expense XXX Total assets $XXX
Depreciation expense XXX Liabilities
Income Statement … XXX Current liabilities $XXX
Accounts Total operating expenses (XXX) Long-term liabilities XXX
Dividends Revenue Accounts Operating income $ XXX Total liabilities $XXX
Other revenue and expense XXX Stockholders’ Equity
increases decreases decreases increases Net income $ XXX Common stock $XXX
(+) (–) (–) (+) Retained earnings XXX
Balance Balance Total stockholders’ equity XXX
Total liabilities and stockholders’ equity $XXX
Expense Accounts
Debit for Credit for
increases decreases
(+) (–)
Balance
Unadjusted Trial Balance

158 350
To t al Deb it Bala n c es = To t a l Cr ed it Bala n c es
98169_ch04_ptg01_158-231.indd 158 25/09/17 5:27 PM 98169_ch07_ptg01_350-395.indd 350 25/09/17 5:28 PM
iii
iv Preface
▪▪ The schema for the managerial chapters illustrates

how the chapter content lays the foundation
15
with managerial concepts and principles. Then it
Introduction to
Chapter
moves students through developing the informa-
Managerial Accounting
tion and ultimately into evaluating and analyzing
information in order to make decisions.
Principles
Chapter 15 Introduction to Managerial Accounting
Developing Information
COST SYSTEMS COST ALLOCATIONS
Chapter 16 Job Order Costing Chapter 19 Support Departments

Chapter 17 Process Costing Chapter 19 Joint Costs
Chapter 18 Activity-Based Costing
Decision Making
PLANNING AND EVALUATING TOOLS STRATEGIC TOOLS
Chapter 20 Cost-Volume-Profit Analysis Chapter 26 Capital Investment Analysis

Chapter 21 Variable Costing Chapter 27 Lean Manufacturing
Chapter 22 Budgeting Systems Chapter 27 Activity Analysis
Chapter 23 Standard Costing and Variances Chapter 28 The Balanced Scorecard
Chapter 24 Decentralized Operations Chapter 28 Corporate Social Responsibility
Chapter 25 Differential Analysis
748
02663_ch15_ptg01_748-791.indd 748 17/08/18 2:30 PM
Chapter 6 Inventories 301
Finally, controls for safeguarding inventory should include security measures to prevent damage
and customer or employee theft. Some examples of security measures include the following:
Best Buy ▪▪ Storing inventory in areas that are restricted to only authorized employees
▪▪ Locking high-priced inventory in cabinets
A ssume that in September you purchased a Sony HDTV from

Best Buy (BBY). At the same time, you purchased a Denon
surround sound system for $599.99. You liked your surround sound
Businesses such as Best Buy make similar assumptions when
identical merchandise is purchased at different costs. For example,
Best Buy may have purchased thousands of Denon surround sound
▪▪ Using two-way mirrors, cameras, security tags, and guards
so well that in November you purchased an identical Denon sys- systems over the past year at different costs. At the end of a period, Best Buy uses scanners to screen customers as they leave the store for merchandise that has not been pur- Link to
tem on sale for $549.99 for your bedroom TV. Over the holidays, you
moved to a new apartment and in the process of unpacking discov-
some of the Denon systems will still be in inventory, and some will
have been sold. But which costs relate to the sold systems, and
chased. In addition, Best Buy stations greeters at the store’s entrance to keep customers from bringing in bags
that can be used to shoplift merchandise.
Best Buy
ered that one of the Denon surround sound systems was missing. which costs relate to the Denon systems still in inventory? Best
Luckily, your renters or homeowners insurance policy will cover the Buy’s assumption about inventory costs can involve large dollar
theft; but the insurance company needs to know the cost of the amounts and, thus, can have a significant impact on the financial Reporting Inventory
system that was stolen. statements. For example, Best Buy reported $5,051 million of inven- A physical inventory or count of inventory should be taken near year-end to make sure that
The Denon systems were identical. However, to respond to tory and net income of $897 million for a recent year. the quantity of inventory reported in the financial statements is accurate. After the quantity
▪▪ Link to the “opening company” of each chapter

the insurance company, you will need to identify which system was This chapter discusses such issues as how to determine the of inventory on hand is determined, the cost of the inventory is assigned for reporting in the
stolen. Was it the first system, which cost $599.99, or was it the sec- cost of merchandise in inventory and the cost of goods sold. How- financial statements. Most companies assign costs to inventory using one of three inventory
ond system, which cost $549.99? Whichever assumption you make ever, this chapter begins by discussing the importance of control cost flow assumptions. If a physical count is not possible or inventory records are not available,
over inventory.
calls out examples of how the concepts introduced
© Photo credit here
may determine the amount that you receive from the insurance the inventory cost may be estimated as described in the appendix at the end of this chapter.
company.
in the chapter are connected to the openingLinkcom-

Best Buy conducts ongoing physical counts of inventory throughout the year as a basis for monitoring and to
pany. This shows how accounting is usedBest
predicting loss adjustments for theft.
in Buy
the
real world by real companies.
Inventory Cost Flow Assumptions Objective 2
Describe three
An accounting issue arises when identical units of merchandise are acquired at different unit costs inventory cost flow
during a period. In such cases, when an item is sold, it is necessary to determine its cost using a assumptions and how
they impact the income
cost flow assumption and related inventory costing method. Three common cost flow assumptions
statement and balance
and related inventory costing methods are shown in Exhibit 1. sheet.
©richard Levine/aLamy Stock Photo
Exhibit 1 Cost Flow Assumptions
1. Cost flow is in the order 2. Cost flow is in the reverse 3. Cost flow is an average of
in which the costs were order in which the costs the costs.
incurred. were incurred.
Link to Best Buy Pages 301, 303, 314, 315, 316 First-in, First-out Last-in, First-out Weighted Average Cost
(FIFO) (LIFO)
Why It Matters Page 308 Purchased Purchased Sold Purchased
Goods Goods Goods Goods
Analysis for Decision Making Pages 320–321
FIFO LIFO WEI

AVEGRHTED Sold
COSAGE Goods
T
299
Sold
Goods
98169_ch06_rev05_298-349.indd 299 18/08/17 2:25 pm
98169_ch06_rev05_298-349.indd 301 18/08/17 2:29 pm
from a literary, artistic, or to exceed legal life
musical composition
Trademark Exclusive use of a name, None Impairment loss if fair
term, or symbol value less than carrying
value (impaired)
Goodwill Excess of purchase price of None Impairment loss if fair
a business over the fair value less than carrying Preface v
value of its net assets value (impaired)
(assets ] liabilities)
▪▪ New! Pathways Challenge encourages students’ interest in accounting and emphasizes

the critical thinking aspect of accounting. A suggested answer to the Pathways Challenge
is provided at the end of the chapter.
Pathways Challenge
This is Accounting!
Economic Activity
Verizon Communications Inc. (VZ) is the largest wireless service provider in the United States
with over 114 million retail subscribers. To deliver its products and services, Verizon must have access to
spectrum—the radio frequencies that carry sound, data, and video to wireless devices. However, spectrum
is a limited resource that the Federal Communications Commission (FCC) licenses to businesses for a period
of 10 years, subject to renewal. In a recent year, Verizon acquired almost $10 billion in wireless licenses.
Critical Thinking/Judgment Chapter 9 Long-Term Assets: Fixed and Intangible 445

How should Verizon account for its acquisition of wireless licenses?
What is the useful life of a wireless license?
As shown in Exhibit 1, classifying a cost involves
Should Verizon expense (amortize) the cost of its wireless licenses?
the following steps:
▪ Step 1. Is the purchased item long-lived? Suggested answer at end of chapter.
Chapter 9 Long-Term Assets: Fixed and Intangible 493
If yes, the item is recorded as an asset on the balance sheet, either as a fixed asset
Pathways
or an investment. Proceed to Step 2. Challenge
If no, the item is classified and recorded as an expense.
This is Accounting!
▪ Step 2. Is the asset used in normal operations?
Information/Consequences
If yes, the asset is classified and recorded as a fixed asset.
Because a wireless license does not exist physically, Verizon’s (VZ) wireless licenses are intangible assets.
If no, the asset is classified and recorded
All of as ana wireless
the costs of acquiring investment.
license should be recorded as an asset. In a recent year, Verizon report-
ed almost $87 billion of wireless licenses, representing 35% of its total assets.
Items that are classified and recorded as fixed assets include land, buildings, or equip-
Even though the FCC license is granted for a 10-year period, Verizon considers this license to have an indef-
ment. Such assets normally last more than a year
inite useful and
life. This aretheused
is because insubject
license is theto normal operations
renewal at a low of the FCC has
cost and, historically,
renewed Verizon’s licenses.
the business. However, standby equipment for use during peak periods or when other equip-
Verizon does not expense (amortize) the cost of its wireless licenses. Instead, the licenses are reviewed for
ment breaks down is still classified as a fixed asset, even though it is not used very often. In
any impaired value.
contrast, fixed assets that have been abandoned or are no longer used in operations are not
Suggested Answer
classified as fixed assets.
98169_ch09_ptg01_442-493.indd 467 25/09/17 5:38 PM
In a recent financial statement, McDonald’s reported total property, plant, and equipment of over $34 billion, Link to
▪▪ Located
which
inconsists
eachofchapter,
land, buildings,
Why and equipment.
It M McDonald’s
atters shows students how accounting is important
to businesses with which they are familiar. A Concept Clip icon indicates which Why
It Matters features have an accompanying concept clip video in CNOWv2.
CONCEPT CLIP
Why It Matters
CONCEPT CLIP
Fixed Assets the proportion of fixed assets to total assets. Retail has the high-
est percent of fixed assets to total assets, while social media and
F
ixed assets often represent a significant portion of a company’s software are on the lower end of the scale. High-tech service com-
total assets. The table that follows shows the fixed assets as panies often use fewer fixed assets to deliver their services than
a percent of total assets for some select companies across a will companies that use stores, equipment, planes, cell towers,
variety of industries. As can be seen, the type of industry will impact or theme parks.
Percent of Fixed Assets

Company Industry to Total Assets
McDonald’s Corporation (MCD) Food Retail 69%
Target Corporation (TGT) Merchandise Retail 63%
Delta Air Lines, Inc. (DAL) Transportation 48%
Verizon Communications Inc. (VZ) Communications 35%
The Walt Disney Company (DIS) Entertainment 30%
Facebook, Inc. (FB) Social Media 13%
98169_ch09_ptg01_442-493.indd 493 25/09/17 5:39 PM
Microsoft Corporation (MSFT) Software 9%
Fixed assets have important properties that require management ▪ Fixed assets need to be maintained during use. Managers need to
attention: develop maintenance programs to keep the investment in fixed as-
▪ Fixed assets require a long-term commitment. Mistakes in acquir- sets productive.
ing fixed assets can be very costly and difficult to reverse; thus, ▪ Fixed assets often require significant funds to purchase. Managers
managers must take special care in acquiring fixed assets. must acquire funding internally or by other sources to finance the
▪ Fixed assets wear out over time and need to be replaced. Managers purchase of fixed assets.
must monitor fixed assets and know when to replace fixed assets
due to wear and tear or obsolescence.
vi Preface
238 238 Chapter
Chapter
5 Accounting
5 Accounting
for Retail
forBusinesses
Retail Businesses
▪▪ To aid comprehension and to demonstrate the impact of transactions, journal entries
UnderUnder
includethethe
perpetual
the
netperpetual
inventory
effect inventory
of system,
the system,
cash purchases
transactioncashon
purchases
theof accounting
merchandise
of merchandise
are recorded
are recorded
equation. as follows:
as follows:
20Y8 20Y8
A 5 A L 51 L E 1 E Jan. 3Jan. Inventory
3 Inventory 2,510 2,510
12 12 Cash Cash 2,510 2,510
Purchased
Purchased
inventory
inventory
from Bowen
from Bowen
Co. Co.
Purchases
Purchases
of inventory
of inventory
on account
on account
are recorded
are recorded
as follows:
as follows:
A 5 A L 51 LE 1 E Jan. 4Jan. Inventory

4 Inventory 9,250 9,250
1 11 1 Accounts
Accounts
Payable—Thomas
Payable—Thomas
Corporation
Corporation 9,250 9,250
Purchased
Purchased
inventory
inventory
on account.
on account.
The terms
The terms
of purchases
of purchases
on account
on account
are normally
are normally
indicated
indicated invoice
on theon the invoice
or billor
that
billthe
that
seller
the seller
▪sends
▪ The link
sends
the between
buyer.
the buyer. Anthe
An example journal
example
of an of entry
invoice
an and
invoice
sent the
tosent to accounting
NetSolutions
NetSolutions equation
by Alpha
by Alpha is also
Technologies included
Technologies
is shown in in
is shown in
the
Exhibit accompanying
Exhibit
3. 3. CengageNOWv2 course in the accounting cycle chapters, reminding
students of the link—but not requiring them to actively make the link.
Exhibit
Exhibit
3 3
AlphaAlpha
Technologies
Technologies InvoiceInvoice
Invoice
Invoice 1000 Matrix
1000 Matrix
Blvd. Blvd. 106-8 106-8
San Jose,
SanCA
Jose,
95116-1000
CA 95116-1000
Made inMade
U.S.A.in U.S.A.
Sold ToSold To CUSToMER

CUSToMER oRdERoRdER
NetSolutions
NetSolutions oRdERoRdER
No. No. dATE dATE
5101 Washington
5101 Washington
Ave. Ave. 412 412 Jan. 3, 20Y8
Jan. 3, 20Y8
Cincinnati,
Cincinnati,
OH 45227-5101
OH 45227-5101
dATE ShIppEd
dATE ShIppEd how ShIppEd
how ShIppEd
ANd RoUTE
ANd RoUTE TERMSTERMS INvoICE INvoICE
dATE dATE
Jan. 5, 20Y8
Jan. 5, 20Y8 US Express
US Express
Trucking
Trucking
Co. Co. 2/10, n/30
2/10, n/30 Jan. 5, 20Y8
Jan. 5, 20Y8
FRoM FRoM F.o.B. F.o.B.

San Jose
San Jose Cincinnati
Cincinnati
▪▪ To aid learning and problem solving, throughout each chapter Check Up Corners provide
QUANTITy
QUANTITy dESCRIpTIoN
dESCRIpTIoN UNIT pRICE
UNIT pRICE AMoUNT AMoUNT
students
20
with step-by-step
20
guidance
HC9 Printer/Fax/Copiers
on how to solve
HC9 Printer/Fax/Copiers
problems. Problem-solving
150.00 150.00 3,000.00
3,000.00
tips help
462students avoid
Chapter common
9 Long-Term errors.
Assets: Fixed and Intangible
Check Up Corner 9-2 Selling Fixed Assets

The terms The terms for when for when
payments payments
for merchandise
for merchandise are toarebe tomadebe made
are called the credit
are called the credit
terms.terms.
If If
payment
Onpayment
the is
firstrequired
dayis
of required
on delivery,
the year, onCompany
Firefall delivery,
the purchased
terms
the terms
are cash
areor
equipment cash
at anet
costor
cash.
of net Otherwise,
cash.
$340,000. TheOtherwise,
the buyer
equipment the buyer
is allowed
is allowed
an an
was expected to have a useful life of four years, a residual value of $20,000, and is depreciated at a straight-
amount amount
line of oftime,
rate of Firefall
25%. known
time,sold
known
as
thethe credit
as theatcredit
equipment period, period,
in of
the beginning which
theinfourth
which
to year
pay.to The
pay.
when credit
the The credit
period
balance in the period
usually usually
beginsbegins
with with
the datetheofdate
accumulated thedepreciation
of
sale
theassale
shownas shown
account on$240,000.
was theoninvoice.
the invoice.
Journalize the entry to record the sale if the equipment
Ifwaspayment
sold for:
If payment is dueiswithin
due within
a stateda stated
number number
of days of after
days theafterinvoice
the invoice
date, such
date, as
such30 as
days,
30 days,
the the
termsa. terms
$95,000
are net are30net
days.
30 These
days. Theseterms terms
may be maywritten as n/30.
be written as 2n/30.
If payment
2
If payment
is dueisbyduethebyendtheofend
theof the
monthb. month
$105,000
in which in which
the sale thewassalemade,
was made,
the termsthe terms
are written as n/eom.
are written as n/eom.
2 Solution:
The word
2
The
netword
as used
nethere
as used
does
here
notdoes
havenot
thehave
usualthe
meaning
usual meaning
of a number
of a number
after deductions
after deductions
have been
have
subtracted,
been subtracted,
as in net as in net income.
income.
a. Equipment sold for $95,000:
WhyWhy
It It
Matters
Matters Cash terms, terms,
then the
then
Accumulated Depreciation—Equipment
eratingerating
company
the company
95,000
240,000
cycle. For
cycle.
example,
is ableistoable
For example, Apple
use to
Apple
suppliers
(AAPL)
use suppliers
(AAPL)
to finance
to finance
is ableistoable
the op-the op-
collect
to collect
on on
Loss on Sale of Equipment 5,000
sales within
sales within
an average
an average
of approximately
of approximately
30 days.
30 However,
days. However,
Apple Apple
Apple’s
Apple’s
CreditCredit
Terms Terms Equipment
uses anuses
average
an average
340,000
of approximately
of approximately 100 days100todays
paytoitspaysuppliers.
its suppliers.
WW
orkingorking
capitalcapital
efficiency
efficiency
is influenced
is influenced
by theby relationship
the relationship Thus, Apple
Thus, AppleSelling
collects Price
collects
faster – Book Value
faster
than =
itthan
pays,it allowing
pays,Accumulated
allowing
Apple Apple
to use tothe
use the
$95,000 – $100,000 Depreciation at
between
between
the suppliers’
the suppliers’
and customers’
and customers’
credit credit
terms. terms. suppliers’
If the If the suppliers’
moneymoney
as an interest-free
as an interest-free
loan forloan
the for
70-day
the 70-day
(100 days(100–days –
b. Equipment sold for $105,000: the End of Year 3
suppliers’
suppliers’
credit terms
credit are
termslonger
are longer
than the
thancustomers’
the customers’
credit credit30 days)
30difference.
days) difference.
Source: Apple®
Source: Apple® Cash 105,000
Accumulated Depreciation—Equipment 240,000
Equipment 340,000
Gain on Sale of Equipment 5,000 Selling Price – Book Value =
$105,000 – $100,000
Check Up Corner
98169_ch05_rev03_232-297.indd
98169_ch05_rev03_232-297.indd
238 238 16/08/17 16/08/17
5:10 pm 5:10 pm
Note to Financial Statements:
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,465.0
Buildings and improvements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,207.1
Equipment and other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,771.3
Total cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $34,443.4 Preface vii
Source: Adapted from McDonald’s Corporation’s 2016 annual report.
▪▪ Analysis for Decision Making highlights how companies use accounting information to
The
make cost and related accumulated
decisions depletion
and evaluate of mineral
their rights are
business. normally
This shown asstudents
provides part of the with context of why
“Fixed assets” section of the balance sheet. The mineral rights may be shown net of depletion on
accounting
the face is sheet.
of the balance important to companies.
In such cases, a supporting note discloses the accumulated depletion.
Analysis for Decision Making
Fixed Asset Turnover Ratio Objective 7

Describe and illustrate
The fixed asset turnover ratio measures the number of sales dollars earned per dollar of the fixed asset
fixed assets. The higher the ratio, the more efficiently a company is using its fixed assets in turnover ratio to
generating sales. The ratio is computed as follows: assess the efficiency
of a company’s use of
Sales its fixed assets.
Fixed Asset Turnover Ratio =
Average Book Value of Fixed Assets
To illustrate, the following data (in millions) were taken from a recent financial statement
of McDonald’s Corporation (MCD):
Sales $24,621.9
Fixed assets (net):
Beginning of year 21,257.6
End of year 23,117.6
McDonald’s fixed asset turnover ratio for the year is computed as follows (rounded to one
decimal place):
Sales
Fixed Asset Turnover Ratio =
Average Book Value of Fixed Assets
$24,621.9
=
($21,257.6 + $23,117.6) ÷ 2
$24,621.9
= = 1.1
$22,187.6
Is 1.1 efficient? To answer this question, McDonald’s fixed asset turnover ratio can be com-
pared to other quick-service restaurant companies, as shown in Exhibit 14. Yum! Brands (YUM)
operates KFC, Pizza Hut, and Taco Bell quick-service restaurants. The other restaurants are likely
familiar by name.
▪▪ Make a Decision in the end-of-chapter material gives students a chance to analyze real-world
business decisions.
98169_ch09_ptg01_442-493.indd 469 25/09/17 5:20 PM
Make a Decision
Fixed Asset Turnover Ratio
MAD 9-1 Analyze and compare Amazon.com to Netflix Obj. 7

Amazon.com, Inc. (AMZN) is the world’s leading Internet retailer of merchandise and
REAL WORLD
media. Amazon also designs and sells electronic products, such as e-readers. Netflix, Inc.
(NFLX) is one of the world’s leading Internet television networks. Both companies compete
in the digital media and streaming space. However, Netflix is more narrowly focused in the
digital streaming business than is Amazon.
Sales and average book value of fixed assets information (in millions) are provided for
Amazon and Netflix for a recent year as follows:
Amazon.com Netflix
Sales $135,987 $8,830
Average book value of fixed assets 25,476 212
a. Compute the fixed asset turnover ratio for each company. Round to one decimal place.
b. Which company is more efficient in generating sales from fixed assets?
c. Interpret your results.
MAD 9-2 Analyze and compare Alaska Air, Delta Air Lines, and Southwest Airlines Obj. 7
Alaska Air Group (ALK), Delta Air Lines (DAL), and Southwest Airlines (LUV) reported
the following financial information (in millions) in a recent year:
REAL WORLD
Alaska Air Group Delta Air Lines Southwest Airlines

Sales $5,931 $39,639 $20,425
Average book value of fixed assets 5,234 23,707 16,323
a. Determine the fixed asset turnover ratio for each airline. Round to one decimal place.
b. Based on the fixed asset turnover ratio, which airline appears to be the most ef-
ficient in the use of its fixed assets?
c. The most important fixed asset to an airline is the aircraft. Given this, what factors
might influence the efficient use of fixed assets for an airline?
MAD 9-3 Analyze Verizon Obj. 7

Verizon Communications Inc. (VZ) is a major telecommunications company in the
United States. Two recent balance sheets for Verizon disclosed the following information
REAL WORLD
regarding
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May notassets:
be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
viii Preface
▪▪ At the end of each chapter, Let’s Review is a new chapter summary and self-assessment
feature that is designed to help busy students prepare for an exam. It includes a summary
of each learning objective’s key points, key terms, multiple-choice questions, exercises, and
a sample problem that students may use to practice.
▪▪ Sample multiple-choice questions allow students to practice with the type of assessments
they are likely to see on an exam.
▪▪ Short exercises and a longer problem allow students to apply their knowledge.
▪▪ Answers provided at the end of the Let’s Review section let students check their knowl-
edge immediately.
▪ Take It Further in the end-of-chapter activities allows instructors to assign other special
activities related to ethics, communication, and teamwork.
▪ NEW! Certified Management Accountant (CMA®) Examination Questions help students
prepare for the CMA exam so they can earn CMA certification.
CengageNOWv2
CengageNOWv2 is a powerful course management and online homework resource that pro-
vides control and customization to optimize the student learning experience. Included are
many proven resources, such as algorithmic activities, a test bank, course management tools,
reporting and assessment options, and much more.
NEW! Excel Online

Cengage and Microsoft have partnered in CNOWv2 to provide students with a uniform, authen-
tic Excel experience. It provides instant feedback, built-in video tips, and easily accessible
spreadsheet work. These features allow you to spend more time teaching college accounting
applications, and less time troubleshooting Excel.
These new algorithmic activities offer pre-populated data directly in Microsoft Excel Online.
Each student receives his or her own version of the problem to perform the necessary data cal-
culations in Excel Online. Their work is constantly saved in Cengage cloud storage as a part of
homework assignments in CNOWv2. It’s easily retrievable so students can review their answers
without cumbersome file management and numerous downloads/uploads.
Motivation: Set Expectations and Prepare Students

for the Course
CengageNOWv2 helps motivate students and get them ready to learn by reshaping their misconcep-
tions about the introductory accounting course and providing a powerful tool to engage students.
CengageNOWv2 Start-Up Center

Students are often surprised by the amount of time they need to spend outside of class work-
ing through homework assignments in order to succeed. The CengageNOWv2 Start-Up Center
will help students identify what they need to do and where they need to focus in order to
be successful with a variety of new resources.
▪▪ What Is Accounting? Module ensures students understand course expectations and how to
be successful in the introductory accounting course. This module consists of two assign-
able videos: Introduction to Accounting and Success Strategies. The Student Advice Videos
offer advice from real students about what it takes to do well in the course.
▪▪ Math Review Module, designed to help students get up to speed with necessary math
skills, includes math review assignments and Show Me How math review videos to ensure
that students have an understanding of basic math skills.
▪▪ How to Use CengageNOWv2 Module focuses on learning accounting, not on a particular
software system. Quickly familiarize your students with CengageNOWv2 and direct them
to all of its built-in student resources.
Preface ix
Motivation: Prepare Them for Class

With all the outside obligations accounting students have, finding time to read the textbook
before class can be a struggle. Point students to the key concepts they need to know before
they attend class.
▪▪ Video: Tell Me More. Short Tell Me More lecture activities explain the core concepts of the
chapter through an engaging auditory and visual presentation. Available either on a stand-
alone basis or as an assignment, they are ideal for all class formats—flipped model, online,
hybrid, or face-to-face.
Provide Help Right When Students Need It

The best way to learn accounting is through practice, but students often get stuck when
attempting homework assignments on their own.
▪▪ Video: Show Me How. Created for the most frequently assigned end-of-chapter items,
Show Me How problem demonstration videos provide a step-by-step model of a similar
problem. Embedded tips help students avoid common mistakes and pitfalls.
SHOW ME HOW
x Preface
Help Students Go Beyond Memorization to True

Understanding
Students often struggle to understand how concepts relate to one another. For most students, an
introductory accounting course is their first exposure to both business transactions and the account-
ing system. While these concepts are already difficult to master individually, their combination
and interdependency in the introductory accounting course often pose a challenge for students.
▪▪ Mastery Problems. Mastery Problems enable you to assign problems and activities de-
signed to test students’ comprehension and mastery of difficult concepts.
MindTap eReader
The MindTap eReader for Warren/Jones/Tayler’s Financial and Managerial Accounting is
the most robust digital reading experience available. Hallmark features include:
▪▪ Fully optimized for the iPad.
▪▪ Note taking, highlighting, and more.
▪▪ Embedded digital media.
▪▪ The MindTap eReader also features ReadSpeaker®, an online text-to-speech application that
vocalizes, or “speech-enables,” online educational content. This feature is ideally suited
for both instructors and learners who would like to listen to content instead of (or in
addition to) reading it.
Cengage Unlimited
Cengage Unlimited is a first of-its-kind digital subscription designed specifically to lower costs.
Students get total access to everything Cengage has to offer on demand—in one place. That’s
20,000 eBooks, 2,300 digital learning products, and dozens of study tools across 70 disciplines and
over 675 courses. Currently available in select markets. Details at www.cengage.com/unlimited.
New to This Edition

In all chapters, the following improvements have been made: ▪▪ New items have been added to the Take It Further
▪▪ Chapter schemas have been revised throughout. section of the chapter.
▪▪ Link to, Analysis for Decision Making, and Make a Deci- ▪▪ New Certified Management Accountant (CMA®) Exam-
sion page references added at the beginning of the ination Questions help students prepare for the CMA
chapter, as appropriate, allow students to easily locate exam so they can earn CMA certification.
the ties to the opening company throughout the chapter.
▪▪ New learning objective for Analysis for Decision M
aking. Chapter 1
▪▪ Stock ticker symbol has been inserted for all real- ▪▪ Enhancing characteristics added to discussion of
world (publicly listed) companies. This helps students GAAP.
to use financial websites to locate real company data. ▪▪ Discussion of fiscal year added to time period discussion
▪▪ Years are now identified as 20Y1, 20Y2, …., 20Y9. of GAAP (moved from Chapter 6). This is consistent with
▪▪ New Pathways Challenge feature added, consistent with use of fiscal years throughout Chapters 1–4 and with the
the work of the Pathways Commission. This feature fact that many publicly traded companies use fiscal years
emphasizes the critical thinking aspect of accounting. not ending in December 31.
A Suggested Answer to the Pathways Challenge is pro- ▪▪ The statement of stockholders’ equity replaces the
vided at the end of the chapter. retained earnings statement. This is consistent with
▪▪ New Make a Decision section at the end of the the financial reporting of publicly held companies
Analysis for Decision Making directs students and that report a statement of stockholders’ equity rather
instructors to the real-world company end-of-chapter than a retained earnings statement.
materials related to Analysis for Decision Making. ▪▪ Exhibit 8 revised to show the interrelationships of
Also, the continuing company analysis is identified the statement of stockholders’ equity with the income
and referenced in this Make a Decision section. statement and balance sheet.
▪▪ New exercise based on Analysis for Decision Making has
been added to the Let’s Review section of the chapter.
Preface xi
Chapter 2 the financial reporting of publicly held companies

that report a statement of stockholders’ equity rather
▪▪ Revised the discussion of correcting entries and inserted
than a retained earnings statement.
new exhibit to better enhance student understanding.
Chapter 3 Chapter 6
▪▪ New Check Up Corner on weighted average inventory
▪▪ Exhibit 1 (Accruals) has been revised to make it con-
method has been added.
sistent with Exhibit 2 (Deferrals).
▪▪ New exhibit on weighted average flow of costs has
▪▪ The chapter has been changed so that accruals are
been added.
discussed and illustrated first, followed by deferrals.
▪▪ Weighted average illustration has been added to
Accruals are the simplest adjustment (no entry has
Check Up Corner 6-3.
been made). Thus, the chapter discussion now goes
▪▪ Added an illustration of the lower of cost or net real-
from simple to complex, which facilitates student
izable for inventory applied by different classes of
understanding of this complex topic.
inventory (Exhibit 10).
Chapter 4
Chapter 7
▪▪ New learning objectives for Appendices 1 and 2.
▪▪ Presentation of bank reconciliation has been refor-
▪▪ The statement of stockholders’ equity replaces the
matted.
retained earnings statement. This is consistent with
the financial reporting of publicly held companies
Chapter 9
that report a statement of stockholders’ equity rather
than a retained earnings statement. ▪▪ New Check Up Corner on selling fixed assets was
▪▪ Exhibit 1 revised to show the interrelationships of added.
the statement of stockholders’ equity with the income ▪▪ Lease discussion was modified to reflect the latest
statement and balance sheet. accounting standard.
▪▪ Simplified and updated the closing process so that two
Chapter 10
rather than four closing entries are required. Doing so
eliminates the temporary (clearing) account Income ▪▪ Simplified Exhibit 1 by removing cash/sales discounts.
Summary, which students have difficulty understanding.
▪▪ Exhibit 8 (Accounting Cycle) revised and made more Chapter 11
readable. ▪▪ Present value formulas have been added to Appendix
1, “Present Value Concepts and Pricing Bonds Pay-
Chapter 5 able.”
▪▪ Chapter has been retitled as “Accounting for Retail
Businesses.” Using Retail in the title rather than Mer- Chapter 12
chandising is more current terminology that students ▪▪ Added brief discussion of different classes of common
can identify with. stock (Classes A, B, and C).
▪▪ Schema revised to only focus on the financial state-
ments and the key accounts that will be discussed Chapter 15
within the chapter. ▪▪ “Managerial Accounting in the Organization” section
▪▪ New learning objective and separate discussion for significantly revised to discuss horizonal and vertical
the adjusting process of a retail business. business units; McAfee, Inc., is used as an illustration.
▪▪ New learning objective and Appendix “Gross Method ▪▪ New Why It Matters features the IMA and CMA.
of Recording Sales Discounts.” This gives instructors ▪▪ New Why It Matters features vertical and horizontal
flexibility as to whether to cover the net or gross functions for service companies.
methods of accounting for sales discounts. ▪▪ Discussion of sustainability and accounting moved to
▪▪ Chart of Accounts for NetSolutions as a Retail Busi- new Chapter 28.
ness (Exhibit 2) has been moved earlier in the chapter
so that students can focus on the new accounts spe- Chapter 16
cific to retail businesses.
▪▪ Discussion of sustainability and accounting moved to
▪▪ Customer refunds, allowances, and returns discussion
new Chapter 28.
has been simplified to progress from simple to com-
▪▪ Added one new Analysis for Decision Making item.
plex, as summarized in Exhibit 7.
▪▪ Closing process for a retail business has been revised
to use a two-entry closing process. Chapter 17
▪▪ The statement of stockholders’ equity replaces the ▪▪ Why It Matters feature (Sustainable Papermaking)
retained earnings statement. This is consistent with moved to Chapter 28.
xii Preface
▪▪ Lean manufacturing discussion with related home- Chapter 24

work items moved to Chapter 27.
▪▪ Balanced scorecard discussion moved to Chapter 28.
Chapter 18 Chapter 25
▪▪ Added Learning Objective 7: Describe and illustrate
▪▪ Total cost and variable cost concepts for product pric-
the use of activity-based costing information in deci-
ing were moved to an end-of-chapter appendix.
sion making.
▪▪ Added one new Make a Decision item.
Chapter 19—NEW Chapter Chapter 26
▪▪ Learning Objectives:
▪▪ Analysis for Decision Making on capital investment
•• Describe support departments and support depart- for sustainability has been moved to Chapter 28.
ment costs. ▪▪ Added new Analysis for Decision Making entitled
•• Describe the allocation of support department costs “Uncertainty: Sensitivity and Expected Value Analyses.”
using a single plantwide rate, multiple department ▪▪ Added six new Make a Decision items.
rates, and activity-based costing.
•• Allocate support department costs to production Chapter 27
departments using the direct method, sequential
▪▪ Added Objective 4: Describe and illustrate the use of
method, and reciprocal services method.
lean principles and activity analysis in a service or
•• Describe joint products and joint costs.
administrative setting.
•• Allocate joint costs using the physical units,
weighted average, market value at split-off, and
Chapter 28—NEW Chapter
net realizable value methods.
•• Describe and illustrate the use of support depart- ▪▪ Learning Objectives:
ment and joint cost allocations to evaluate the •• Describe the concept of a performance measure-
performance of production managers. ment system.
•• Describe and illustrate the basic elements of a bal-
Chapter 20 anced scorecard.
▪▪ Added one new Analysis for Decision Making item. •• Describe and illustrate the balance scorecard,
including the use and impact of strategy maps,
Chapter 21 measure maps, strategic learning, scorecard cas-
cading, and cognitive biases.
▪▪ Contribution margin analysis deleted from chapter.
•• Describe corporate social responsibility (CSR),
▪▪ Revenue variance portion added as an appendix to
including methods of measuring and encouraging
Chapter 23.
social responsibility using the balanced scorecard.
•• Use capital investment analysis to evaluate CSR
Chapter 22 projects.
Appendix D Investments
Chapter 23 ▪▪ The investments appendix has been updated to be con-
▪▪ Added new appendix on revenue variances. sistent with Financial Instruments, Subtopic 825-10,
▪▪ Nonfinancial performance measures (previously FASB Accounting Standards Update, Financial Account-
Learning Objective 6) moved to Chapter 28. ing Standards Board, Norwalk, CT, January 2016.
▪▪ Added four new revenue variance exercises.
Acknowledgements
The many enhancements to this edition of Financial and Managerial Accounting are the direct result of reviews,
surveys, and focus groups with instructors at institutions across the country. We would like to take this opportunity
to thank those who have helped us better understand the challenge of the financial accounting course and provided
valuable feedback on our content and digital assets.
John Alpers, Tennessee Wesleyan Dave Fitzgerald, Jackson College Dr. April Poe, University of the
Anne Marie Anderson, Raritan Valley Kenneth Flug, St. Thomas Aquinas Incarnate Word
Community College College Francisco Rangel, Riverside City
Rick Andrews, Sinclair Community John Giles, North Carolina State College
College University Jeffery Reinking, University of
Maureen Baker, Long Beach City Marcye Hampton, University of Central Florida – Orlando
College Central Florida Jenny Resnick, Santa Monica College
Surasakdi Bhamornsiri, University of Christopher Harper, Grand Valley Benjamin Reyes, Long Beach City
North Carolina at Charlotte State University College
Alan Blankley, University of North Thomas Heikkinen, Jackson College Vernon Richardson, University of
Carolina at Charlotte Melanie Hicks, Liberty University Arkansas
Cindy Bolt, The Citadel Susanne Holloway, Salisbury University Patrick Rogan, Cosumnes River
Julie Bonner, Central Washington Jose Hortensi, Miami Dade College College
University Md Safayat Hossain, Florida Lauran B. Schmid, The University of
Charles Boster, Salisbury University International University Texas Rio Grande Valley
Salma Boumediene, Montana State Su-Jane Hsieh, San Francisco State Jennifer Schneider, University of
University – Billings University North Georgia
Jerold K. Braun, Daytona State College Aileen Huang, Santa Monica College Mary Sheil, Kennesaw State University
Louise Burney, University of Mississippi Julie Ying Huang, University of Meghna Singhvi, Loyola Marymount
Shauna Butler, St. Thomas Aquinas Louisville University
College Ann Kelley, Providence College Margie Snow, Norco College
James N. Cannon, Iowa State University Daniel Kim, Midlands Technical College Mona Stephens, Southern New
Kirk Canzano, Long Beach City College Angela Kirkendall, South Puget Hampshire University
Jack Cathey, University of North Sound Community College Linda Stoller, Bentley University
Carolina at Charlotte Satoshi Kojima, East Los Angeles Michael Stoots, UCLA extension
Donna Chadwick, Sinclair College Nirmalee Summers, University of
Community College Charles Leflar, University of Arkansas Wisconsin – La Crosse
Ming Lu Chun, Santa Monica College Tara Maciel, San Diego Mesa College Dominique Svarc, Harper College
Anne Clem, Iowa State University Annette Maddox, Georgia Highlands Patricia Tupaj, Quinsigamond
Dixon Cooper, Ouachita Baptist College Community College
University LuAnn Bean Mangold, Florida Bill Urquhart, Florida Atlantic
Bryan Corsnitz, Long Beach City Institute of Technology University
College Eric Martin, University of Tennessee Rodney Vogt, Kansas State University
Pat Creech, Northeastern Oklahoma Robert A. Martin, Kennesaw State Rick Warne, University of Cincinnati
A&M University Randi Watts, Baker College
Stephan Davenport, University of Michelle McFeaters, Grove City College Cammy Wayne, Harper College
Tennessee – Chattanooga Dawn McKinley, Harper College Vivian Winston, Indiana University
David Deboskey, San Diego State Allison McLeod, University of North Jan Workman, East Carolina University
Daniel De La Rosa, Fullerton College Texas Glen Young, Texas A&M University –
Heather Demshock, Lycoming College Rodney Michael College Station
Scott Dotson, Tennessee Wesleyan Shawn Miller, Lone Star College Mellissa Youngman, National Technical
University Jill Mitchell, Northern Virginia Institute for the Deaf, RIT
Hong Duong, Salisbury University Community College – Alexandria Mustafa Younis, Tulane University
Desiree Elias, Florida International DeeAnne Lynn Peterson-Meyer, Fang Zhao, Florida International
University University of Wisconsin – Eau University
James Emig, Villanova University Claire Terri Ziegler, Ohio State University
Valerie Evans, Kansas State University
xiii
xiv Acknowledgements
Special thanks to our Financial Accounting Advisory Board Members:
Reb Beatty, Anne Arundel Steven Hegemann, University of Don Minyard, University of Alabama
Community College Nebraska – Lincoln Micki Nickla, Ivy Tech Community
Amy Bourne, Oregon State University Todd Jensen, Sierra College College – Gary
Rachel Brassine, East Carolina Sergey Komissarov, University of John Robertson, Arkansas State
University Wisconsin – La Crosse University
Gregory Brookins, Santa Monica Anthony Kurek, Eastern Michigan Philip Slater, Forsyth Technical
College University Community College
Marci Butterfield, University of Utah Joseph Larkin, Saint Joseph’s University Bob Urell, Irvine Valley College
Lawrence Chui, University of St. Gary Laycock, Ivy Tech Community Alycia Marie Winegardner, University
Thomas College – Terre Haute of Tennessee – Knoxville
Jerrilyn Eisenhauer, Tulsa Kristy McAuliffe, San Jacinto College
Community College – Southeast Melanie McCoskey, University of Akron
Shari Fowler, Indiana University – East Allison McLeod, University of North
Micah Frankel, California State Texas
University – East Bay
About the Authors
Carl S. Warren
Dr. Carl S. Warren is Professor Emeritus of Accounting at the University of Georgia, Athens.
©TERRY R. SPRAY INHISIMAGE STUDIOS

Dr. Warren has taught classes at the University of Georgia, University of Iowa, Michigan
State University, and University of Chicago. He has focused his teaching efforts on prin-
ciples of accounting and auditing. Dr. Warren received his Ph.D. from Michigan State
University and his BBA and MA from the University of Iowa. During his career, Dr. Warren
published numerous articles in professional journals, including The Accounting Review,
Journal of Accounting Research, Journal of Accountancy, The CPA Journal, and Auditing:
A Journal of Practice and Theory. Dr. Warren has served on numerous committees of the
American Accounting Association, the American Institute of Certified Public Accountants,
and the Institute of Internal Auditors. He has consulted with numerous companies and
public accounting firms. His outside interests include handball, golfing, skiing, backpack-
ing, motorcycling, and fly-fishing. He also enjoys interacting with his five grandchildren,
Bella and Mila (twins), Jeremy, and Brooke and Robbie (twins).
Jefferson P. Jones
Dr. Jefferson P. Jones is an Associate Professor of Accounting in the School of Accountancy
at Auburn University where he teaches financial accounting and applied financial research
courses. He received his Bachelor’s in Accounting and Master of Accountancy degrees
© THOMAS BOUTWELL, T2PHOTOGRAPHY

from Auburn University and his Ph.D. from Florida State University. Dr. Jones has received
numerous teaching awards, including the Auburn University Beta Alpha Psi Outstanding
Teaching Award (ten times); the Auburn University Outstanding Master of Accountancy Pro-
fessor Teaching Award (five times); the Auburn University Outstanding Distance Master of
Accountancy Teaching Award (three times); and the Auburn University College of Business
McCartney Teaching Award. In addition, he has made numerous presentations around the
country on research and pedagogical issues. Dr. Jones has public accounting experience
as an auditor with Deloitte and Touche, holds a CPA certificate in the state of Alabama
(inactive), and is a member of the American Accounting Association, the American Institute
of Certified Public Accountants (AICPA), and the Alabama Society of CPAs (ASCPA). His
research interests focus on financial accounting, specifically investigating the quality of
reported accounting information, and accounting education. He has published articles in
numerous journals, including Advances in Accounting, Review of Quantitative Finance and
Accounting, Issues in Accounting Education, International Journal of Forecasting, and The
CPA Journal. When not at work, Dr. Jones enjoys playing golf and watching college football.
William B. Tayler
Dr. William B. Tayler is the Robert J. Smith Professor of Accountancy in the Marriott
School of Business at Brigham Young University (BYU). Dr. Tayler is an internationally
renowned, award-winning accounting researcher and instructor. He has presented his
research as an invited speaker at universities and conferences across the globe. Dr. Tayler
earned his Ph.D. and master’s degree at Cornell University. He teaches in BYU’s Executive
MBA Program and in BYU’s School of Accountancy, one of the top ranked accounting
programs in the world. Dr. Tayler has also taught at Cornell University and Emory Uni-
versity and has received multiple teaching awards. Dr. Tayler is a Certified Management
© EMORY UNIVERSITY
Accountant and consultant specializing in cost accounting, performance measurement,

the assignment of decision rights, and incentive compensation. His work has been pub-
lished in top journals, including Accounting Horizons, Accounting, Organizations and
Society, The Accounting Review, Contemporary Accounting Research, IMA Educational
Case Journal, Journal of Accounting Research, Journal of Behavioral Finance, Journal
of Finance, Review of Financial Studies, and Strategic Finance. Dr. Tayler serves on
the editorial boards of The Accounting Review, Management Accounting Research, and
Accounting, Organizations and Society. He is also director of the Institute of Manage-
ment Accountants Research Foundation.
xv
Brief Contents
1 Introduction to Accounting and Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

2 Analyzing Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
3 The Adjusting Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108
4 The Accounting Cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158
5 Accounting for Retail Businesses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232
6 Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 298
7 Internal Control and Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350
8 Receivables. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396
9 Long-Term Assets: Fixed and Intangible . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 442
10 Liabilities: Current, Installment Notes, and Contingencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 494
11 Liabilities: Bonds Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542
12 Corporations: Organization, Stock Transactions, and Dividends . . . . . . . . . . . . . . . . . . . . . . . . 580
13 Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 626
14 Financial Statement Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 686
15 Introduction to Managerial Accounting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 748
16 Job Order Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 792
17 Process Cost Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 840
18 Activity-Based Costing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 896
19 Support Department and Joint Cost Allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 950
20 Cost-Volume-Profit Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 994
21 Variable Costing for M anagement Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1048
22 Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1098
23 Evaluating Variances from Standard Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1156
24 Evaluating Decentralized Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1206
25 Differential Analysis and Product Pricing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1256
26 Capital Investment Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1310
27 Lean Manufacturing and Activity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1358
28 The Balanced Scorecard and Corporate Social Responsibility. . . . . . . . . . . . . . . . . . . . . . . . . . 1400
Appendix A Interest Tables. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-2

Appendix B Revenue Recognition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B-1
Appendix C International Financial Reporting Standards (IFRS). . . . . . . . . . . . . . . . . . . . . . . . . . . . C-1
Appendix D Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . D-1
Appendix E Nike Inc., Form 10-K for the Fiscal Year Ended May 31, 2017 Selected Excerpts. . . . E-1
Appendix F Special Journals and Subsidiary Ledgers (online). . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-1
Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . G-1
Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1
xvi
Contents
1 Introduction to Accounting
and Business 2
Analysis for Decision Making 80
Horizontal Analysis 80
Make a Decision 104

Nature of Business and Accounting 4 Take It Further 106
Types of Businesses 4 Pathways Challenge 75, 107
Role of Accounting in Business 5
Role of Ethics in Accounting and Business 6
3
Opportunities for Accountants 7
Generally Accepted Accounting

Principles (GAAP) 9 The Adjusting Process 108
Characteristics of Financial Information 9
Assumptions 10 Nature of the Adjusting Process 111
Principles 12 Accrual and Cash Basis of Accounting 111
The Accounting Equation 12 Revenue and Expense Recognition 112
The Adjusting Process 112
Business Transactions and the Accounting Equation 13 Types of Accounts Requiring Adjustment 113
Summary 17
Classifications of Stockholders’ Equity 18 Adjusting Entries for Accruals 114
Accrued Revenues 114
Financial Statements 19 Accrued Expenses 115
Income Statement 21
Statement of Stockholders’ Equity 21 Adjusting Entries for Deferrals 118
Balance Sheet 22 Unearned Revenues 118
Statement of Cash Flows 23 Prepaid Expenses 119
Interrelationships Among Financial Statements 24 Adjusting Entries for Depreciation 122
Analysis for Decision Making 26 Summary of Adjusting Process 124
Ratio of Liabilities to Stockholders’ Equity 26
Adjusted Trial Balance 128
Make a Decision 52
Take It Further 53 Vertical Analysis 129
Pathways Challenge 11, 55 Make a Decision 153
2
Take It Further 155
Pathways Challenge 128, 157
Analyzing Transactions 56
Using Accounts to Record Transactions 59
Chart of Accounts 60
Double-Entry Accounting System 62

4 The Accounting Cycle 158
Balance Sheet Accounts 62 Flow of Accounting Information 161
Income Statement Accounts 62
Statement of Stockholders’ Equity Accounts (Dividends) 63 Financial Statements 163
Normal Balances 63 Income Statement 163
Journalizing 64 Statement of Stockholders’ Equity 163
Balance Sheet 165
Posting Journal Entries to Accounts 68
Closing Entries 168
Trial Balance 77 Journalizing and Posting Closing Entries 169
Errors Affecting the Trial Balance 78 Post-Closing Trial Balance 174
Errors Not Affecting the Trial Balance 79
Accounting Cycle 175
xvii
xviii Contents
Illustration of the Accounting Cycle 178 Financial Statements and Closing Entries for a Retail
Step 1. Analyzing and Recording Transactions Business 254
in the Journal 178 Multiple-Step Income Statement 254
Step 2. Posting Transactions to the Ledger 179 Single-Step Income Statement 256
Step 3. Preparing an Unadjusted Trial Balance 179 Statement of Stockholders’ Equity 256
Step 4. Assembling and Analyzing Adjustment Data 179 Balance Sheet 257
Step 5. Preparing an Optional End-of-Period Spreadsheet 181 The Closing Process 258
Step 6. Journalizing and Posting Adjusting Entries 182
Step 7. Preparing an Adjusted Trial Balance 182 Analysis for Decision Making 259
Step 8. Preparing the Financial Statements 182 Asset Turnover Ratio 259
Step 9. Journalizing and Posting Closing Entries 185 Appendix 1 Gross Method of
Step 10. Preparing a Post-Closing Trial Balance 185
Recording Sales Discounts 260
Analysis for Decision Making 188 Transactions 260
Working Capital and Current Ratio 188 Adjusting Entry 261
Subsequent Period 262
Appendix 1 End-of-Period Spreadsheet 190 Comparison with the Net Method 262
Step 1. Enter the Title 190
Step 2. Enter the Unadjusted Appendix 2 The Periodic Inventory System 263
Trial Balance 190 Chart of Accounts Under the Periodic Inventory System 263
Step 3. Enter the Adjustments 191 Recording Merchandise Transactions Under the
Step 4. Enter the Adjusted Trial Balance 192 Periodic Inventory System 264
Step 5. Extend the Accounts to the Income Statement and Adjusting Process Under the Periodic Inventory System 265
Balance Sheet Columns 193 Financial Statements Under the Periodic Inventory System 266
Step 6. Total the Income Statement and Balance Sheet Closing Entries Under the Periodic Inventory System 266
Columns, Compute the Net Income or Net Loss, and
Complete the Spreadsheet 194 Comprehensive Problem 2 291
Preparing the Financial Statements Make a Decision 293
from the Spreadsheet 195
Take It Further 294
Appendix 2 Reversing Entries 195
Comprehensive Problem 1 226
Make a Decision 227
Take It Further 229
Pathways Challenge 175, 231 6 Inventories 298
5
Control of Inventory 300
Accounting for Retail Safeguarding Inventory 300
Businesses 232 Reporting Inventory 301
Inventory Cost Flow Assumptions 301

Nature of Retail Businesses 234 Inventory Costing Methods Under
Operating Cycle 234 a Perpetual Inventory System 303
Financial Statements 235 First-In, First-Out Method 303
Last-In, First-Out Method 305
Merchandise Transactions 236
Weighted Average Cost Method 307
Chart of Accounts for Retail Business 236
Subsidiary Ledgers 237 Inventory Costing Methods Under
Purchases Transactions 237 a Periodic Inventory System 309
Sales Transactions 242 First-In, First-Out Method 309
Freight 246 Last-In, First-Out Method 309
Summary: Recording Inventory Transactions 249 Weighted Average Cost Method 311
Dual Nature of Merchandise Transactions 249
Sales Taxes and Trade Discounts 249 Comparing Inventory Costing Methods 313
The Adjusting Process 251 Reporting Inventory in the
Adjusting Entry for Inventory Shrinkage 251 Financial Statements 314
Adjusting Entries for Customer Refunds, Valuation at Lower of Cost or Market 314
Allowances, and Returns 252 Inventory on the Balance Sheet 316
Adjusted Trial Balance 253 Effect of Inventory Errors on the
Financial Statements 317
Contents xix
Analysis for Decision Making 320 Allowance Method for Uncollectible Accounts 400
Inventory Turnover and Number of Days’ Sales in Inventory 320 Write-Offs to the Allowance Account 401
Estimating Uncollectibles 403
Appendix Estimating Inventory Cost 322
Retail Method of Inventory Costing 322 Comparing Direct Write-Off and Allowance
Gross Profit Method of Inventory Costing 323 Methods 409
Make a Decision 345 Notes Receivable 410
Characteristics of Notes Receivable 410
Take It Further 346 Accounting for Notes Receivable 412
Pathways Challenge 317, 348 Reporting Receivables on the Balance Sheet 414
7
Accounts Receivable Turnover and Number of Days’ Sales in
Receivables 415
Internal Control and Cash 350 Make a Decision 437
Take It Further 439
Sarbanes-Oxley Act 352
Internal Control 354
9
Objectives of Internal Control 354
Elements of Internal Control 354 Long-Term Assets: Fixed and
Control Environment 355
Risk Assessment 356 Intangible 442
Control Procedures 356
Monitoring 358 Nature of Fixed Assets 444
Information and Communication 358 Classifying Costs 444
Limitations of Internal Control 359 The Cost of Fixed Assets 446
Cash Controls over Receipts and Payments 360 Leasing Fixed Assets 447
Control of Cash Receipts 360 Accounting for Depreciation 448
Control of Cash Payments 362 Factors in Computing Depreciation Expense 448
Bank Accounts 363 Straight-Line Method 449
Bank Statement 363 Units-of-Activity Method 451
Using the Bank Statement as a Control over Cash 365 Double-Declining-Balance Method 453
Comparing Depreciation Methods 454
Bank Reconciliation 366 Partial-Year Depreciation 457
Special-Purpose Cash Funds 370 Revising Depreciation Estimates 457
Repair and Improvements 458
Financial Statement Reporting of Cash 371
Disposal of Fixed Assets 460
Analysis for Decision Making 372 Discarding Fixed Assets 460
Days’ Cash on Hand 372 Selling Fixed Assets 461
Make a Decision 392 Natural Resources 462
Take It Further 394 Intangible Assets 464
Patents 464
Copyrights and Trademarks 465
Goodwill 465
8
Financial Reporting for Long-Term Assets:
Fixed and Intangible 468
Receivables 396
Fixed Asset Turnover Ratio 469
Classification of Receivables 398
Accounts Receivable 398 Appendix Exchanging Similar Fixed Assets 471
Notes Receivable 398 Gain on Exchange 471
Other Receivables 399 Loss on Exchange 472
Uncollectible Receivables 399 Make a Decision 490

Direct Write-Off Method for Uncollectible Take It Further 491
Accounts 400 Pathways Challenge 467, 493
xx Contents
10 Liabilities: Current,
Installment Notes, and
Contingencies 494
Appendix 1 Present Value Concepts and
Pricing Bonds Payable 556
Present Value Concepts 556
Pricing Bonds 559
Computing Present Values 560
Current Liabilities 496 Appendix 2 Effective Interest Rate Method
Accounts Payable and Accruals 496 of Amortization 561
Short-Term Notes Payable 497 Amortization of Discount by the Interest Method 561
Current Portion of Long-Term Debt 498 Amortization of Premium by the Interest Method 562
Payroll Liabilities 499 Make a Decision 577
Liability for Employee Earnings 499
Deductions from Employee Earnings 500 Take It Further 578
Computing Employee Net Pay 501 Pathways Challenge 553, 579
Employer’s Payroll Taxes 501
Recording Payroll 502
12
Paying Payroll 504
Internal Controls for Payroll 504 Corporations: Organization,
Employees’ Fringe Benefits 504 Stock Transactions, and
Vacation Pay 504
Pensions 505 Dividends 580
Postretirement Benefits Other than Pensions 506
Installment Notes 507 Nature of a Corporation 582
Issuance 507 Characteristics of a Corporation 582
Periodic Payments 507 Forming a Corporation 583
Contingent Liabilities 510 Paid-In Capital from Stock 585
Probable and Estimable 510 Characteristics of Stock 585
Probable and Not Estimable 510 Types of Stock 586
Reasonably Possible 511 Issuing Stock 588
Remote 511 Premium on Stock 589
No-Par Stock 590
Reporting Liabilities 513
Analysis for Decision Making 513 Accounting for Dividends 591
Cash Dividends 592
Quick Ratio 513
Stock Dividends 593
Stock Splits 594
Make a Decision 536
Treasury Stock Transactions 595
Take It Further 539
Reporting Stockholders’ Equity 597
Pathways Challenge 512, 541 Stockholders’ Equity on the Balance Sheet 597
Reporting Retained Earnings 598
11
Statement of Stockholders’ Equity 600
Reporting Stockholders’ Equity for Alphabet 601
Liabilities: Bonds Payable 542 Earnings per Share 602
Nature of Bonds Payable 544
Bond Characteristics and Terminology 544 Make a Decision 621
Proceeds from Issuing Bonds 545 Take It Further 622
Accounting for Bonds Payable 547 Pathways Challenge 588, 625
Bonds Issued at Face Amount 547
Bonds Issued at a Discount 547
13
Amortizing a Bond Discount 548
Bonds Issued at a Premium 550 Statement of Cash
Amortizing a Bond Premium 551 Flows 626
Bond Redemption 552
Reporting Bonds Payable 554 Reporting Cash Flows 628
Analysis for Decision Making 555 Cash Flows from Operating Activities 629
Times Interest Earned 555 Cash Flows from Investing Activities 631
Contents xxi
Cash Flows from Financing Activities 631 Analyzing Solvency 700

Noncash Investing and Financing Activities 632 Ratio of Fixed Assets to Long-Term Liabilities 700
Format of the Statement of Cash Flows 632 Ratio of Liabilities to Stockholders’ Equity 700
No Cash Flow per Share 633 Times Interest Earned 701
Cash Flows from Operating Activities— Analyzing Profitability 702
The Indirect Method 633 Asset Turnover 703
Net Income 635 Return on Total Assets 703
Adjustments to Net Income 635 Return on Stockholders’ Equity 704
Return on Common Stockholders’ Equity 705
Cash Flows from Investing Activities 638
Earnings per Share on Common Stock 706
Land 638
Price-Earnings Ratio 707
Building and Accumulated Depreciation—Building 639
Dividends per Share 708
Cash Flows from Financing Activities 640 Dividend Yield 708
Bonds Payable 640 Summary of Analytical Measures 710
Common Stock 640
Dividends and Dividends Payable 641
Corporate Annual Reports 711
Management Discussion and Analysis 711
Preparing the Statement of Cash Flows 642
Report on Internal Control 712
Analysis for Decision Making 644 Report on Fairness of the Financial Statements 712
Free Cash Flow 644
Appendix 1 Unusual Items on the Income
Appendix 1 Spreadsheet (Work Sheet) for Statement Statement 713
of Cash Flows—The Indirect Method 645 Unusual Items Affecting the Current Period’s
Analyzing Accounts 646 Income Statement 713
Retained Earnings 647 Unusual Items Affecting the Prior Period’s
Other Accounts 647 Income Statement 714
Preparing the Statement of Cash Flows 648
Appendix 2 Fair Value and Comprehensive
Appendix 2 Preparing the Statement of Cash Income 714
Flows—The Direct Method 648 Fair Value 715
Cash Received from Customers 649 Comprehensive Income 715
Cash Payments for Merchandise 649
Cash Payments for Operating Expenses 650 Make a Decision 743
Gain on Sale of Land 650 Take It Further 744
Interest Expense 651
Cash Payments for Income Taxes 651 Pathways Challenge 707, 746
Reporting Cash Flows from Operating
Activities—Direct Method 651
15
Make a Decision 680
Introduction to Managerial
Take It Further 683
Accounting 748
Managerial Accounting 750
14 Financial Statement Differences Between Managerial and Financial Accounting 751

Managerial Accounting in the Organization 752
Analysis 686 The Management Process 754
Uses of Managerial Accounting Information 755
Analyzing and Interpreting Financial Manufacturing Operations 757

Statements 688 Nature of Manufacturing 757
The Value of Financial Statement Information 688 Direct and Indirect Costs 757
Techniques for Analyzing Financial Statements 689 Manufacturing Costs 758
Analytical Methods 689 Financial Statements for a Manufacturing

Horizontal Analysis 689 Business 763
Vertical Analysis 691 Balance Sheet 763
Common-Sized Statements 693 Income Statement 764
Analyzing Liquidity 694 Analysis for Decision Making 767

Current Position Analysis 695 Utilization Rates 767
Accounts Receivable Analysis 696 Make a Decision 787
Inventory Analysis 697
xxii Contents
Take It Further 789 Appendix Weighted Average Method 864

Determining Costs Using the Weighted Average Method 864
Certified Management Accountant (CMA®) The Cost of Production Report 866
Examination Questions (Adapted) 791
Make a Decision 888
Take It Further 891
Certified Management Accountant (CMA®)
16
Job Order Costing 792
Cost Accounting Systems Overview 794
Job Order Cost Systems 794
Process Cost Systems 794
18 Activity-Based
Costing 896
Job Order Cost Systems for Manufacturing
Product Costing Allocation Methods 898
Businesses 795
Materials 796 Single Plantwide Factory Overhead Rate
Factory Labor 798 Method 899
Factory Overhead 800
Work in Process 806 Multiple Production Department Factory Overhead
Finished Goods 807 Rate Method 901
Sales and Cost of Goods Sold 807 Department Overhead Rates and Allocation 902
Period Costs 808 Distortion of Product Costs 903
Summary of Cost Flows for Legend Guitars 808 Activity-Based Costing Method 906
Job Order Cost Systems for Service Businesses 810 Activity Rates 908
Types of Service Businesses 810 Allocating Costs 909
Flow of Costs in a Service Job Order Cost System 810 Distortion in Product Costs 911
Dangers of Product Cost Distortion 911
Analyzing Job Costs 812 Activity-Based Costing for Selling and Administrative
Expenses 913
Make a Decision 832
Activity-Based Costing in Service Businesses 914
Take It Further 835
Certified Management Accountant (CMA®) Using ABC Product Cost Information to Reduce Costs 919
Examination Questions (Adapted) 838 Make a Decision 945
Pathways Challenge 805, 839 Take It Further 947
17
Process Cost Systems 840
Process Manufacturers 842
Comparing Job Order and Process Cost Systems 843
Cost Flows for a Process Manufacturer 844
19 Support Department and
Joint Cost Allocation 950
Cost of Production Report 847 Support Departments 952
Step 1: Determine the Units to Be Assigned Costs 848
Step 2: Compute Equivalent Units of Production 848 Support Department Cost Allocation 953
Step 3: Determine the Cost per Equivalent Unit 852 Single Plantwide Rate 954
Step 4: Allocate Costs to Units Transferred Multiple Production Department Rates 954
Out and Partially Completed Units 853 Activity-Based Costing 955
Preparing the Cost of Production Report 855
Allocating Support Department Costs to Production
Journal Entries for a Process Cost System 858 Departments 956
Direct Method 957
Using the Cost of Production Report 862
The Sequential Method 959
Analysis for Decision Making 862 The Reciprocal Services Method 963
Analyzing Process Costs 862 Comparison of Support Department Cost Allocation Methods 967
Contents xxiii
Joint Costs 968

Joint Cost Allocation 968
The Physical Units Method 968
The Weighted Average Method 969
21 Variable Costing for
Management Analysis 1048
The Market Value at Split-Off Method 969 Operating Income: Absorption and Variable
The Net Realizable Value Method 970 Costing 1050
Comparison of Joint Cost Allocation Methods 971 Absorption Costing 1050
By-Products 973 Variable Costing 1051
Effects of Inventory 1053
Using Support Department and Joint Cost Allocations for Analyzing Operating Income Using
Performance Evaluation 973 Absorption and Variable Costing 1056
Make a Decision 989 Using Absorption and Variable Costing 1061
Controlling Costs 1061
Take It Further 991 Pricing Products 1061
Certified Management Accountant (CMA®) Planning Production 1062
Examination Questions (Adapted) 992 Analyzing Market Segments 1062
Analyzing Market Segments 1062
Pathways Challenge 967, 993 Sales Territory Profitability Analysis 1064
Product Profitability Analysis 1065
20
Salesperson Profitability Analysis 1065
Cost-Volume-Profit Variable Costing for Service Businesses 1067
Analysis 994 Reporting Income 1067
Analyzing Segments 1068
Cost Behavior 996 Segment Analysis and EBITDA 1070
Variable Costs 997
Fixed Costs 998
Make a Decision 1092
Mixed Costs 1000 Take It Further 1094
Summary of Cost Behavior Concepts 1002 Certified Management Accountant (CMA®)
Cost-Volume-Profit Relationships 1004 Examination Questions (Adapted) 1095
Contribution Margin 1004 Pathways Challenge 1060, 1096
Contribution Margin Ratio 1004
22
Unit Contribution Margin 1005
Mathematical Approach to Cost-Volume-Profit

Analysis 1007 Budgeting 1098
Break-Even Point 1007
Target Profit 1011
Nature and Objectives of Budgeting 1100
Graphic Approach to Objectives of Budgeting 1100
Cost-Volume-Profit Analysis 1012 Human Behavior and Budgeting 1101
Cost-Volume-Profit (Break-Even) Chart 1012 Budgeting Systems 1102
Profit-Volume Chart 1014 Static Budget 1103
Use of Spreadsheets in Cost-Volume-Profit Analysis 1015 Flexible Budget 1104
Assumptions of Cost-Volume-Profit Analysis 1016
Master Budget 1106
Special Cost-Volume-Profit Relationships 1018
Sales Mix Considerations 1018
Operating Budgets 1107
Sales Budget 1107
Operating Leverage 1020
Production Budget 1108
Margin of Safety 1021
Direct Materials Purchases Budget 1109
Analysis for Decision Making 1023 Direct Labor Cost Budget 1110
Cost-Volume-Profit Analysis for Service Companies 1023 Factory Overhead Cost Budget 1112
Cost of Goods Sold Budget 1112
Make a Decision 1043 Selling and Administrative Expenses Budget 1114
Take It Further 1044 Budgeted Income Statement 1115
Certified Management Accountant (CMA®) Financial Budgets 1116

Cash Budget 1116
Capital Expenditures Budget 1121
Pathways Challenge 1002, 1047 Budgeted Balance Sheet 1121
xxiv Contents
Analysis for Decision Making 1122 Responsibility Accounting for Cost Centers 1210
Nonmanufacturing Staffing Budgets 1122
Responsibility Accounting for Profit Centers 1214
Make a Decision 1150 Support Department Allocations 1214
Take It Further 1151 Profit Center Reporting 1216
Certified Management Accountant (CMA®) Responsibility Accounting for Investment

Examination Questions (Adapted) 1153 Centers 1218
Return on Investment 1218
Pathways Challenge 1116, 1154 Residual Income 1222
23
Transfer Pricing 1225
Evaluating Variances Market Price Approach 1226
Negotiated Price Approach 1226
from Standard Cost Price Approach 1229
Costs 1156 Analysis for Decision Making 1229
Franchise Operations 1229
Standards 1158 Make a Decision 1250
Setting Standards 1158
Types of Standards 1159 Take It Further 1252
Reviewing and Revising Standards 1159 Certified Management Accountant (CMA®)
Criticisms of Standard Costs 1159
Budgetary Performance Evaluation 1160
Budget Performance Report 1160
Manufacturing Cost Variances 1161
25
Direct Materials and
Direct Labor Variances 1162 Differential Analysis and
Direct Materials Variances 1162 Product Pricing 1256
Direct Labor Variances 1165
Factory Overhead Variances 1168 Differential Analysis 1258

The Factory Overhead Flexible Budget 1169 Lease or Sell 1260
Variable Factory Overhead Controllable Variance 1170 Discontinue a Segment or Product 1261
Fixed Factory Overhead Volume Variance 1170 Make or Buy 1262
Reporting Factory Overhead Variances 1172 Replace Equipment 1264
Factory Overhead Account 1173 Process or Sell 1265
Accept Business at a Special Price 1265
Recording and Reporting Variances
from Standards 1176 Setting Normal Product Selling Prices 1268
Cost-Plus Methods 1269
Analysis for Decision Making 1178 Product Cost Method 1269
Service Staffing Variances 1178 Illustration 1270
Appendix Revenue Variances 1179 Target Costing Method 1271
Comprehensive Problem 5 1199 Production Bottlenecks 1273

Managing Bottlenecks 1274
Make a Decision 1201 Pricing Bottleneck Products 1274
Take It Further 1202 Analysis for Decision Making 1275
Certified Management Accountant (CMA®) Yield Pricing in Service Businesses 1275
Examination Questions (Adapted) 1204 Appendix Total and Variable Cost Methods to
Pathways Challenge 1164, 1205 Setting Normal Price 1276
Total Cost Method 1276
24
Variable Cost Method 1279
Evaluating Decentralized Make a Decision 1303
Operations 1206 Take It Further 1305
Centralized and Decentralized Operations 1208 Examination Questions (Adapted) 1307
Advantages of Decentralization 1208
Disadvantages of Decentralization 1209 Pathways Challenge 1263, 1308
Responsibility Accounting 1210
Contents xxv
26 Capital Investment
Analysis 1310
Make a Decision 1395
Take It Further 1397
Nature of Capital Investment Analysis 1312 Examination Questions (Adapted) 1398
Methods Not Using Present Values 1313 Pathways Challenge 1365, 1399
Average Rate of Return Method 1313
Cash Payback Method 1314
Methods Using Present Values 1316
Present Value Concepts 1317
Net Present Value Method and Index 1319
Internal Rate of Return Method 1322
28 The Balanced Scorecard
and Corporate Social
Responsibility 1400
Factors That Complicate Capital
Investment Analysis 1325 Performance Measurement Systems 1402
Income Tax 1325
The Balanced Scorecard 1403
Unequal Proposal Lives 1325
Performance Perspectives 1403
Lease Versus Capital Investment 1327
Strategic Objectives 1405
Uncertainty 1327
Performance Metrics 1405
Changes in Price Levels 1328
Strategic Initiatives 1406
Qualitative Considerations 1329
Performance Targets 1407
Capital Rationing 1329
Using the Balanced Scorecard 1407
Analysis for Decision Making 1330 Strategy Maps 1407
Uncertainty: Sensitivity and Expected Value Analyses 1330 Measure Maps 1409
Strategic Learning 1411
Make a Decision 1351 Scorecard Cascading 1413
Take It Further 1353 Cognitive Biases 1413
Certified Management Accountant (CMA®) Corporate Social Responsibility 1416

Examination Questions (Adapted) 1355 CSR Reporting 1417
Corporate Social Responsibility and the Balanced Scorecard 1418
Pathways Challenge 1321, 1356 Encouraging Corporate Social Responsibility 1420
27
Lean Manufacturing and Capital Investment in CSR 1420
Activity Analysis 1358 Make a Decision 1438

Take It Further 1439
Lean Principles 1360 Certified Management Accountant (CMA®)
Reducing Inventory 1361
Reducing Lead Times 1361
Reducing Setup Time 1363 Pathways Challenge 1415, 1442
Emphasizing Product-Oriented Layout 1366
Emphasizing Employee Involvement 1366
Emphasizing Pull Manufacturing 1366 Appendix A: Interest Tables A-2
Emphasizing Zero Defects 1367 Appendix B: Revenue Recognition B-1
Emphasizing Supply Chain Management 1367
Appendix C: International Financial Reporting
Lean Accounting 1369 Standards (IFRS) C-1
Fewer Transactions 1369
Combined Accounts 1369 Appendix D: Investments D-1
Nonfinancial Performance Measures 1371
Direct Tracing of Overhead 1371
Appendix E: Nike Inc., Form 10-K for the Fiscal Year
Ended May 31, 2017 Selected Excerpts E-1
Activity Analysis 1372
Costs of Quality 1372 Appendix F: Special Journals and Subsidiary
Quality Activity Analysis 1373 Ledgers (online) F-1
Value-Added Activity Analysis 1375
Glossary G-1
Process Activity Analysis 1376
Index I-1
Lean Performance for Nonmanufacturing 1378
1 Introduction to
Chapter
Accounting and Business
Chapter 1
Transactions
ACCOUNTING SYSTEM
Accounting Equation
Assets = Liabilities + Equity
Chapter 2
ANALYZING TRANSACTIONS
Chapter 3
THE ADJUSTING PROCESS
Chapter 4
THE ACCOUNTING CYCLE
Twitter, Inc.
W hen two teams pair up for a game of f ootball, there is often

a lot of noise. The band plays, the fans cheer, and fireworks
light up the scoreboard. Obviously, the fans are committed and
Twitter, Inc. (TWTR) is one of the most visible
companies on the Internet. It provides a real-time information
network where members can post messages, called tweets, for
care about the outcome of the game. Just like fans at a football free. Millions post tweets every day throughout the world.
game, the owners of a business want their business to “win” Do you think Twitter is a successful company? Does it
against their competitors in the marketplace. While having your make money? How would you know? A ccounting helps to an-
football team win can be a source of pride, winning in the market- swer these questions.
place goes beyond pride and has many tangible benefits. Compa- This textbook introduces you to accounting, the language
nies that are winners are better able to serve customers, provide of business. Chapter 1 begins by discussing what a business is,
good jobs for employees, and make money for their owners. how it operates, and the role that accounting plays.
©CJG – TECHNOLOGY/ALAMY STOCK PHOTO
Link to Twitter ��Pages 4, 5, 6, 7, 10, 11, 13, 21, 23

Analysis for Decision Making�� Page 26
4 Chapter 1 Introduction to Accounting and Business
What's Covered
Introduction to Accounting and Business
Nature of Business Nature of Accounting Analyzing Business Financial Statements
▪▪ Types of Business (Obj. 1) ▪▪ Managerial and Financial Transactions ▪▪ Income Statement (Obj. 5)
▪▪ Role of Accounting (Obj. 1) Accounting (Obj. 1) ▪▪ Generally Accepted Accounting ▪▪ Statement of Stockholders’
▪▪ Ethics (Obj. 1) ▪▪ Career Opportunities (Obj. 1) Principles (Obj. 2) Equity (Obj. 5)
▪▪ Accounting Equation (Obj. 3) ▪▪ Balance Sheet (Obj. 5)
▪▪ Transactions (Obj. 4) ▪▪ Statement of Cash Flows
(Obj. 5)
Learning Objectives
Obj. 1 Describe the nature of business and the role of Obj. 4 Describe and illustrate how business transactions can
accounting and ethics in business. be recorded in terms of the resulting change in the
Obj. 2 Describe generally accepted accounting principles, elements of the accounting equation.
including the underlying assumptions and principles. Obj. 5 Describe the financial statements of a corporation and
Obj. 3 State the accounting equation and define each explain how they interrelate.
element of the equation.
Analysis for Decision Making

Obj. 6 Describe and illustrate the use of the ratio of liabilities to stockholders’ equity in evaluating a company’s financial condition.
Objective 1 Nature of Business and Accounting

Describe the
nature of business A business1 is an organization in which basic resources (inputs), such as materials and labor,
and the role of are assembled and processed to provide goods or services (outputs) to customers. Businesses
accounting and come in all sizes, from a local coffee house to Starbucks (SBUX), which sells over $15
ethics in business. billion of coffee and related products each year.
The objective of most businesses is to earn a profit. Profit is the difference between the
amounts received from customers for goods or services and the amounts paid for the inputs
used to provide the goods or services. This text focuses on businesses operating to earn a profit.
However, many of the same concepts and principles also apply to not-for-profit organizations
such as hospitals, churches, and government agencies.
Types of Businesses
Three types of businesses operating for profit include service, retail, and manufacturing busi-
nesses. Some examples of each type of business follow:
▪▪ Service businesses provide services rather than products to customers.
Delta Air Lines (DAL) (transportation services)
The Walt Disney Company (DIS) (entertainment services)
▪▪ Retail businesses sell products they purchase from other businesses to customers.
Wal-Mart Stores, Inc. (WMT) (general merchandise)
Amazon.com (AMZN) (Internet books, music, videos, ...)
▪▪ Manufacturing businesses change basic inputs into products that are sold to customers.
Ford Motor Company (F) (cars, trucks, vans)
Merck & Co., Inc. (MRK) (pharmaceutical drugs)
Link to Twitter Twitter is a service company that provides a platform for individuals to send text messages called tweets.
1
A complete glossary of terms appears at the end of the text.
Chapter 1 Introduction to Accounting and Business 5
Role of Accounting in Business note:

The role of accounting in business is to provide information for managers to use in operating Accounting is an
the business. In addition, accounting provides information to other users in assessing the eco- information system that
nomic performance and condition of the business. provides reports to users
Thus, accounting can be defined as an information system that provides reports to users about the economic
activities and condition
about the economic activities and condition of a business. You could think of accounting as
of a business.
the “language of business.” This is because accounting is the means by which businesses’
financial information is communicated to users.
Twitter communicates to investors in an annual report that includes accounting information. Link to Twitter
The process by which accounting provides information to users is as follows:
1. Identify users.
2. Assess users’ information needs.
3. Design the accounting information system to meet users’ needs.
4. Record economic data about business activities and events.
5. Prepare accounting reports for users.
As illustrated in Exhibit 1, users of accounting information can be divided into two groups:
internal users and external users.
Exhibit 1
1 Accounting as
Identify
Users an Information
System
Internal External
Company Company
2
Assess
Users’
Information
Managers, Needs Investors, Creditors,
Employees Customers, Government
3 4
Design Record
Accounting Economic
System Data
5
Prepare
Accounting
Reports
Managerial Accounting Internal users of accounting information include managers and

mployees. These users are directly involved in managing and operating the business. The
e
area of accounting that provides internal users with information is called managerial account-
ing, or management accounting.
The objective of managerial accounting is to provide relevant and timely information for
anagers’ and employees’ decision-making needs. Often, such information is sensitive and is not
m
distributed outside the business. Examples of sensitive information might include information
about customers, prices, and plans to expand the business. Managerial accountants employed by a
business are employed in private accounting.
Financial Accounting External users of accounting information include investors, credi-

tors, customers, and the government. These users are not directly involved in managing and
operating the business. The area of accounting that provides external users with information is
called financial accounting.
The objective of financial accounting is to provide relevant and timely information for the
decision-making needs of users outside of the business. For example, financial reports on the
operations and condition of the business are useful for banks and other creditors in deciding
whether to lend money to the business. General-purpose financial statements are one type
of financial accounting report that is distributed to external users. The term general-purpose
refers to the wide range of decision-making needs that these reports are designed to serve.
Later in this chapter, general-purpose financial statements are described and illustrated.
Link to Twitter Twitter is a service company that provides a platform for individuals to send text messages called tweets.
Role of Ethics in Accounting and Business

The objective of accounting is to provide relevant, timely information for user decision mak-
ETHICS ing. Accountants must behave in an ethical manner so that the information they provide users
will be trustworthy and, thus, useful for decision making. Managers and employees must also
behave in an ethical manner in managing and operating a business. Otherwise, no one will be
willing to invest in or loan money to the business.
Ethics are moral principles that guide the conduct of individuals. Unfortunately, business
managers and accountants sometimes behave in an unethical manner. Many of the managers
of the companies listed in Exhibit 2 engaged in accounting or business fraud. These ethical
violations led to fines, firings, and lawsuits. In some cases, managers were criminally prose-
cuted, convicted, and sent to prison.
Exhibit 2 Accounting and Business Frauds
Nature of Accounting
Company or Business Fraud Result
Computer Associates Fraudulently inflated its financial results. CEO and senior executives indicted.
International, Inc. Five executives pled guilty. $225 million fine.
Enron Fraudulently inflated its financial results. Bankrupcty. Senior executives criminally con-
victed. More than $60 billion in stock market
losses.
HealthSouth Overstated performance by $4 billion in false entries. Senior executives criminally convicted.
Qwest Communications Improperly recognized $3 billion in false receipts. CEO and six other executives criminally convicted
International, Inc. of “massive financial fraud.” $250 million SEC fine.
Xerox Corporation Recognized $3 billion in sales prior to when $10 million fine to SEC. Six executives
it should have been recorded. forced to pay $22 million.
What went wrong for the managers and companies listed in Exhibit 2? The answer nor-
mally involved one or both of the following two factors:
▪▪ Failure of Individual Character: Ethical managers and accountants are honest and
fair. However, managers and accountants often face pressures from supervisors to meet
company and investor expectations. In many of the cases in Exhibit 2, managers and ac-
countants justified small ethical violations to avoid such pressures. However, these small
violations became big violations as the company’s financial problems became worse.
▪▪ Culture of Greed and Ethical Indifference: By their behavior and attitude, senior manag-
ers set the company culture. In most of the companies listed in Exhibit 2, the senior man-
agers created a culture of greed and indifference to the truth.
As a result of the accounting and business frauds shown in Exhibit 2, Congress passed
laws to monitor the behavior of accounting and business. For example, the Sarbanes-Oxley
Act (SOX) was enacted. SOX established a new oversight body for the accounting profession
called the P
ublic Company Accounting Oversight Board (PCAOB). In addition, SOX estab-
lished standards for independence, corporate responsibility, and disclosure.
How does one behave ethically when faced with financial or other types of pressure?
Guidelines for behaving ethically follow:2
1. Identify an ethical decision by using your personal ethical standards of honesty and
fairness.
2. Identify the consequences of the decision and its effect on others.
3. Consider your obligations and responsibilities to those who will be affected by your
decision.
4. Make a decision that is ethical and fair to those affected by it.
Twitter’s “Code of Business Conduct and Ethics” can be found at https://investor.twitterinc.com/

corporate-governance.cfm. Link to Twitter
Opportunities for Accountants

Numerous career opportunities are available for students majoring in accounting. Currently,
the demand for accountants exceeds the number of new graduates entering the job market.
This is partly due to the increased regulation of business caused by the accounting and busi-
ness frauds shown in Exhibit 2. Also, more and more businesses have come to recognize the
importance and value of accounting information.
As indicated earlier, accountants employed by a business are employed in private account-
ing. Private accountants have a variety of possible career options within a company. Some of
these career options are shown in Exhibit 3 along with their starting salaries. As shown in Ex-
hibit 3, several private accounting careers have certification options. Accountants who provide
audit services, called auditors, verify the accuracy of financial records, accounts, and systems.
Ethics: Don’t Do It!

ETHICS
Bernie Madoff investors, rather than basing returns on the investments’
Bernard L. “Bernie” Madoff was sentenced to 150 years in actual performance. As long as the investment manager is
prison for defrauding thousands of investors in one of the able to attract new investors, he or she will have new funds
biggest frauds in American history. Madoff’s fraud started to pay existing investors and continue the fraud. While most
several d ecades earlier when he began a “Ponzi scheme” Ponzi schemes collapse quickly when the investment man-
in his investment management firm, B ernard L. Madoff ager runs out of new investors, Madoff’s reputation, pop-
Investment Securities LLC. ularity, and personal contacts provided a steady stream of
In a Ponzi scheme, the investment manager uses funds investors, which allowed the fraud to survive for decades.
received from new investors to pay a return to existing Source: Bernie Madoff
2
Many companies have ethical standards of conduct for managers and employees. In addition, the Institute of Management
Accountants and the American Institute of Certified Public Accountants have professional codes of c onduct, which can be obtained from
their Web sites at www.imanet.org and www.aicpa.org, respectively.
Exhibit 3 Accounting Career Paths and Salaries
Accounting Annual Starting

Career Track Description Career Options Salaries* Certification
Private Accounting Accountants employed Bookkeeper $40,000
by companies, govern- Payroll clerk $40,000 Certified Payroll Professional (CPP)
ment, and not-for-profit General accountant $51,000
entities. Budget analyst $53,000
Cost accountant $55,000 Certified Management Accountant (CMA)
Internal auditor $62,000 Certified Internal Auditor (CIA)
Information technology $71,000 Certified Information Systems Auditor (CISA)
auditor
Public Accounting Accountants employed Large firms (over $250 $68,000 Certified Public Accountant (CPA)
individually or within a million in revenue)
public accounting firm Mid-size firms $61,000 Certified Public Accountant (CPA)
in audit, tax, or manage- ($25–$250 million in
ment advisory services. revenue)
Small firms (less than $56,000 Certified Public Accountant (CPA)
$25 million in revenue)
*Average salaries rounded to the nearest thousand. Salaries may vary by size of company and region.
Source: Robert Half 2017 U.S. Salary Guide (Finance and Accounting), Robert Half International, Inc. (www.roberthalf.com/workplace-research/salary-guides).
Accountants and their staff who provide services on a fee basis are said to be employed in
ublic accounting. In public accounting, an accountant may practice as an individual or as a
p
member of a public accounting firm. Public accountants who have met a state’s education, ex-
perience, and examination requirements may become Certified Public Accountants (CPAs).
CPAs typically perform general accounting, audit, or tax services. As can be seen in Exhibit 3,
CPAs have slightly better starting salaries than private accountants. Career statistics indicate,
however, that these salary differences tend to disappear over time. The American Institute of
Certified Public Accountants (AICPA) provides information and resources for students inter-
ested in accounting at www.startheregoplaces.com.
Because all functions within a business use accounting information, experience in private
or public accounting provides a solid foundation for a career. Many positions in industry and
in government agencies are held by individuals with accounting backgrounds.
Why It Matters
CONCEPT CLIP
Pathways Commission
T
he Pathways Commission recently issued its study titled Chart-
ing a National Strategy for the Next Generation of Accountants.
The Commission was made up of diverse members and was
jointly sponsored by the American Institute of Certified Public Accoun-
tants (AICPA) and the American Accounting Association (AAA). The
Commission emphasized the importance of accounting for a prosper-
ous society and good decision making. The Commission also empha-
sized that accountants must be critical thinkers who are comfortable
addressing the shades of gray required by accounting judgments.
Source: Charting a National Strategy for the Next Generation of

Accountants, The Pathways Commission, July 2012.
Generally Accepted Accounting Objective 2

Describe generally
Principles (GAAP) accepted
accounting
Financial information in the United States is based on generally accepted accounting princi- principles, including
ples (GAAP). GAAP is a collection of accounting standards, principles, and assumptions that the underlying
define how financial information will be reported. assumptions and
principles.
▪▪ Accounting standards are the rules that determine the accounting for individual business
transactions.
▪▪ Accounting principles and assumptions provide the framework upon which accounting
standards are constructed.
Within the United States, the Financial Accounting Standards Board (FASB) has the pri-
mary responsibility for developing accounting standards. The FASB maintains an electronic
database, called the Accounting Standards Codification, that contains all the accounting
standards that make up GAAP. Changes in the FASB Codification are made using Accounting
Standards Updates.
The Securities and Exchange Commission (SEC), an agency of the U.S. government,
has authority over the accounting and financial disclosures for companies whose shares of
ownership (stock) are traded and sold to the public. The SEC normally accepts the accounting
standards set forth by the FASB. However, the SEC may issue Staff Accounting Bulletins on
accounting matters that may not have been addressed by the FASB.
Outside the United States, most countries use accounting standards and principles adopted
by the International Accounting Standards Board (IASB). The IASB issues International
Financial Reporting Standards (IFRS). Major differences between FASB and IASB accounting
principles are identified throughout the chapters of this text and in Appendix C.
Characteristics of Financial Information

The primary goal of financial accounting is to provide information that is useful for decision
making. To be useful, financial reports must possess two important characteristics: relevance
and faithful representation.
▪▪ Relevant information has the potential to impact decision making.
▪▪ Faithful representation means that the information accurately reflects an entity’s eco-
nomic activity or condition.
The characteristics of relevant and faithful representation are enhanced by the following:
▪▪ Comparability allows users to identify similarities and differences among reported items.
▪▪ Verifiability allows users to agree on the meaning of reported items.
▪▪ Timeliness requires distribution of financial reports in time to influence a user’s decision.
▪▪ Understandability requires clear and concise financial reports that facilitate user interpre-
tation and analysis.
International Connection
International Financial
IFRS in deciding how business transactions are recorded.
Reporting Standards (IFRS) Many believe that the strong regulatory and litigation en-
IFRS are considered to be more “principles-based” than vironment in the United States is the cause for the more
U.S. GAAP, which is considered to be more “rules-based.” rules-based GAAP approach. Regardless, IFRS and GAAP
For e xample, U.S. GAAP consists of approximately share many common principles.*
17,000 pages, which include numerous industry-specific *Differences between U.S. GAAP and IFRS are further discussed and illustrated in
accounting rules. In contrast, IFRS allow more judgment Appendix C.
Assumptions
Financial accounting and generally accepted accounting principles are based upon the follow-
ing assumptions:
▪▪ Monetary unit
▪▪ Time period
▪▪ Business entity
▪▪ Going concern
The monetary unit assumption requires that financial reports be expressed in a single
money unit, or currency. This provides a common measurement of the effects of economic
events and transactions on an entity. The monetary unit used is normally determined by the
country in which the company operates. For example, in the United States, the U.S. dollar is
used as the monetary unit.
The time period assumption allows a company to report its economic activities on a regu-
lar basis for a specific period of time. In doing so, financial condition and changes in financial
condition are reported periodically on a consistent basis. In the United States, reports are nor-
mally required on a yearly basis supplemented with quarterly reports.
Link to Twitter Twitter publishes quarterly as well as yearly financial reports that are available at https://investor.
twitterinc.com.
The annual accounting period adopted by a company is called its fiscal year. The fiscal
year most commonly used is the calendar year beginning January 1 and ending December 31.
However, other periods are not unusual, especially for companies organized as corporations.
For example, a corporation may adopt a fiscal year that ends when business activities have
reached the lowest point in its annual operating cycle, which allows more time to prepare
financial reports. Such a fiscal year is called the natural business year. For example, a compa-
ny’s fiscal year could begin August 1, 20Y7, and end on July 31, 20Y8, as follows:
20Y7 20Y8
Aug. 1 Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May June July 31
Fiscal Year
August 1, 20Y7 to July 31, 20Y8
The business entity assumption limits the economic data in financial reports to that di-
rectly related to the activities of the business. In other words, the business is viewed as an
entity separate from its owners, creditors, or other businesses. For example, the accountant
for a business with one owner would record the activities of the business only and would not
record the personal activities, property, or debts of the owner.
A business entity may take the form of a proprietorship, partnership, corporation, or lim-
ited liability company (LLC). Each of these forms and their major characteristics are listed in
Exhibit 4.
The three types of businesses discussed earlier—service, retail, and manufacturing—may
be organized as proprietorships, partnerships, corporations, or limited liability companies.
Because of the large amount of resources required to operate a manufacturing business, most
manufacturers such as Ford Motor Company (F) are corporations. Most large retailers such
as Wal-Mart Stores (WMT) and The Home Depot (HD) are also corporations. Companies
Exhibit 4 Forms of Business Entities
Form of Business Entity Characteristics and Advantages Examples
Proprietorship is owned • 70% of business entities in the United States. • A & B Painting
by one individual. • Easy and inexpensive to organize.
• Resources are limited to those of the owner.
• Used by small businesses.
Partnership is owned by • 10% of business organizations in the United States • Jones & Smith, Architects
two or more individuals. (combined with limited liability companies).
• Combines the skills and resources of more than one
person.
Corporation is organized • Generates 90% of business revenues. Alphabet Inc. (GOOG)

•
under state or federal stat- • 20% of the business organizations in the United States. • Apple Inc. (AAPL)
utes as a separate legal • Ownership is divided into shares called stock. • Ford Motor Company (F)
taxable entity. • Can obtain large amounts of resources by issuing stock.
• Used by large businesses.
Limited liability • 10% of business organizations in the United States • Boston Basketball Partners,
company (LLC) combines (combined with partnerships). LLC
the attributes of a part- • Often used as an alternative to a partnership.
nership and a corporation. • Has tax and legal liability advantages for owners.
Although Twitter is organized as a corporation in Delaware, its principal offices are in San Francisco. Link to Twitter
organized as corporations often include Inc. as part of their name to indicate that they are incor-
porated. For example, Twitter’s legal name is Twitter, Inc.
The going concern assumption requires that financial reports be prepared assuming that the
entity will continue operating into the future. This assumption justifies reporting items such as
equipment, buildings, and land at their initial or historical cost rather than liquidation or forced
sale values.
Pathways Challenge
This is Accounting!
Economic Activity
Over 20 years ago, Starbucks (SBUX) and Pepsi (PEP) c reated a business, called
The North American C offee Partnership. The business combined Starbucks’ ex-
pertise in coffee with Pepsi’s ability to manufacture, market, and sell ready-to-drink cof-
fee products. Its first product, Frappuccino, took off and today the business dominates
the ready-to-drink market with over $1.5 billion in annual sales.
Critical Thinking/Judgment
Should the $1.5 million in annual sales be reported as part of Starbucks’ annual report?
Should the $1.5 million in annual sales be reported as part of Pepsi’s annual report?
Should the $1.5 million in annual sales be reported as part of a separate business’s annual report?
Suggested answer at end of chapter.
Principles
In addition to the preceding characteristics and assumptions, the following four principles are
an integral part of financial accounting:
▪▪ Measurement
▪▪ Historical cost
▪▪ Revenue recognition
▪▪ Expense recognition
The measurement principle determines the amount that will be recorded and reported.
The measurement principle requires that amounts be objective and verifiable. An amount is
objective if it is based upon independent, unbiased evidence. An amount is verifiable if it can
be confirmed by a third party. Transactions between two independent parties, called arm’s-
length transactions, provide amounts that are objective and verifiable.
To illustrate, assume that Aaron Publishers purchased the following building from Schenk
Enterprises on February 20, 20Y1, for $150,000:
Price listed by Schenk Enterprises on January 1, 20Y1 $160,000

Aaron Publishers’ initial offer to buy on January 31, 20Y1 140,000
Aaron Publishers’ purchase price on February 20, 20Y1 150,000
Estimated selling price on December 31, 20Y3 220,000
Assessed value for property taxes, December 31, 20Y3 190,000
Aaron Publishers would record the building at the February 20, 20Y1, purchase price of
$150,000. This amount is both objective and verifiable, as it was the result of a transaction be-
tween two independent parties. Recording an item at its initial transaction price is called the
historical cost principle or cost principle. Under the historical cost principle, amounts do
not normally change until another transaction occurs.
To illustrate, the fact that the preceding building has an estimated selling price of $220,000
on December 31, 20Y3, indicates that the building’s value has increased. However, the $220,000
is not recorded in the accounting records because Aaron Publishers has not sold the building.
If, however, Aaron sells the building on January 9, 20Y4, for $240,000, a profit of $90,000
($240,000 − $150,000) would be recorded by Aaron Publishers.
Revenue is the amount earned (received) from providing services or selling goods to cus-
tomers. The revenue recognition principle determines when revenue is recorded in the ac-
counting records. Normally, revenue is recorded when the services have been performed or
goods are delivered to the customer.
Expenses are amounts used to generate revenue. The expense recognition principle,
sometimes called the matching principle, requires expenses to be recorded in the same period
as the related revenue. Doing so allows the reporting of a profit or loss for the period.
Objective 3 The Accounting Equation

State the
accounting The resources owned by a business are its assets. Examples of assets include cash, land,
equation and buildings, and equipment. The rights or claims to the assets are divided into two types: (1)
define each the rights of creditors and (2) the rights of owners. The rights of creditors are the debts of the
element of the
business and are called liabilities. The rights of owners are called equity. Since stockholders
equation.
own a corporation, equity is called stockholders’ equity. For a proprietorship, partnership, or
limited liability company, equity is called owner’s equity.
The following equation shows the relationship among assets, liabilities, and equity:
Assets 5 Liabilities 1 Equity
This equation is called the accounting equation. Liabilities usually are shown before equity in the
accounting equation because creditors have first rights to the assets.
Throughout this text, we use the corporate form of business. However, most of the con-
cepts and principles described and illustrated also apply to proprietorships, partnerships, and
limited liability companies.
Given any two amounts, the accounting equation may be solved for the third unknown amount. To
illustrate, if the assets owned by a corporation amount to $100,000 and the liabilities amount to $30,000,
the stockholders’ equity is equal to $70,000, computed as follows:
Assets 2 Liabilities 5 Stockholders’ Equity
$100,000 2 $30,000 5 $70,000
Twitter’s accounting equation for a recent year is: Assets ($6,870 million) = Liabilities ($2,265 million) +
Stockholders’ Equity ($4,605 million). Link to Twitter
Business Transactions and the Objective 4

Describe and
Accounting Equation illustrate how
business
Paying a monthly bill, such as a telephone bill of $168, affects a business’s financial condi- transactions can be
tion b ecause it now has less cash on hand. Such an economic event or condition that directly recorded in terms of
changes an entity’s financial condition or its results of operations is a business transaction. the resulting change
For example, purchasing land for $50,000 is a business transaction. In contrast, a change in a in the elements
business’s credit rating does not directly affect cash or any other asset, liability, or stockhold- of the accounting
equation.
ers’ equity amount.
Why It Matters
The Accounting Equation
T
he accounting equation serves as the basic foundation local convenience store, to the largest business, such as The
for the accounting systems of all companies. The account- Coca-Cola Company (KO). Some examples taken from
ing equation is used by the smallest business, such as the recent financial reports of well-known companies follow:
Company Assets* 5 Liabilities 1 Stockholders’ Equity

3 Alphabet Inc. (GOOG) $147,461 $27,130 1
To simplify, we assume that NetSolutions issued no-par stock. Types of stock as well as5par and stated values are discussed in Chapter 12.
$120,331
The Coca-Cola Company (KO) $90,093 5 $64, 539 1 $25,554
DuPont (DD) $41,166 5 $31,173 1 $9,993
eBay (EBAY) $17,785 5 $11,209 1 $6,576
McDonald’s (MCD) $37,939 5 $30,851 1 $7,088
Microsoft Corporation (MSFT) $193,694 5 $121,697 1 $71,997
Southwest Airlines Co. (LUV) $21,312 5 $13,954 1 $7,358
Wal-Mart Stores, Inc. (WMT) $199,581 5 $119,035 1 $80,546
*Amounts are shown in millions of dollars.
note: All business transactions can be stated in terms of changes in the elements of the accounting
equation. How business transactions affect the accounting equation can be illustrated by using
All business transactions
can be stated in terms of some typical transactions. As a basis for illustration, a business organized by Chris Clark is used.
changes in the elements Assume that on November 1, 20Y3, Chris Clark organizes a corporation that will be known as
of the accounting NetSolutions. The first phase of Chris’s business plan is to operate NetSolutions as a service busi-
equation. ness assisting individuals and small businesses in developing Web pages and installing computer
software. Chris expects this initial phase of the business to last one to two years. During this
period, Chris plans on gathering information on the software and hardware needs of customers.
During the second phase of the business plan, Chris plans to expand NetSolutions into a person-
alized retailer of software and hardware for individuals and small businesses.
Each transaction during NetSolutions’ first month of operations is described in the follow-
ing paragraphs. The effect of each transaction on the accounting equation is then shown.
Transaction a Nov. 1, 20Y3 Chris Clark deposited $25,000 in a bank account in the name of
NetSolutions in exchange for shares of common stock in the corporation.
A corporation issues common stock to investors as proof of their ownership rights.3

This transaction increases Cash under Assets (on the left side of the equation) by $25,000.
To balance the equation, Common Stock under Stockholders’ Equity (on the right side of the
equation) increases by the same amount.
The effect of this transaction on NetSolutions’ accounting equation is as follows:
Assets 5 Stockholders’ Equity

Cash Common Stock
a. 25,000 5 25,000
The preceding accounting equation is only for the business, NetSolutions. Under the busi-
ness entity assumption, Chris’s personal assets, such as a home or personal bank account, and
personal liabilities are excluded from the equation.
Transaction b Nov. 5, 20Y3 NetSolutions paid $20,000 for the purchase of land as a future
building site.
The land is located in a business park with access to transportation facilities. Chris Clark plans
to rent office space and equipment during the first phase of the business plan. During the sec-
ond phase, Chris plans to build an office and a warehouse for NetSolutions on the land.
The purchase of the land changes the makeup of the assets, but it does not change the
total assets. The items in the equation prior to this transaction and the effect of the transaction
follow. The new amounts are called balances.
Assets 5 Stockholders’ Equity

Cash 1 Land Common Stock
Bal. 25,000 5 25,000
b. 220,000 120,000
Bal. 5,000 20,000 25,000
25,000 5 25,000
Transaction c Nov. 10, 20Y3 NetSolutions purchased supplies for $1,350 and agreed to pay the supplier
in the near future.
You have probably used a credit card to buy clothing or other merchandise. In this type of
transaction, you received clothing for a promise to pay your credit card bill in the future. That
is, you received an asset and incurred a liability to pay a future bill. NetSolutions entered into
a similar transaction by purchasing supplies for $1,350 and agreeing to pay the supplier in the
3
To simplify, we assume that NetSolutions issued no-par stock. Types of stock as well as par and stated values are discussed in Chapter 12.
near future. This type of transaction is called a purchase on account and is often described as
follows: Purchased supplies on account, $1,350.
The liability created by a purchase on account is called an account payable. Items such
as supplies that will be used in the business in the future are called prepaid expenses, which
are assets. Thus, the effect of this transaction is to increase assets (Supplies) and liabilities
(Accounts Payable) by $1,350, as follows:

Accounts Common
Cash 1 Supplies 1 Land Payable 1 Stock
Bal. 5,000 20,000 5 25,000
c. 11,350 11,350
Bal. 5,000 1,350 20,000 1,350 25,000
26,350 5 26,350
Nov. 18, 20Y3 NetSolutions received cash of $7,500 for providing services to customers. Transaction d
You may have earned money by painting houses or mowing lawns. If so, you received money
for rendering services to a customer. Likewise, a business earns money by selling goods or
services to its customers. This amount is called revenue.
During its first month of operations, NetSolutions received cash of $7,500 for providing
services to customers. The receipt of cash increases NetSolutions’ assets and also increases
stockholders’ equity in the business. The revenues of $7,500 are recorded in a Fees Earned
column to the right of Common Stock. The effect of this transaction is to increase Cash and
Fees Earned by $7,500, as follows:

Accounts Common Fees
Cash 1 Supplies 1 Land Payable 1 Stock 1 Earned
Bal. 5,000 1,350 20,000 5 1,350 25,000
d. 17,500 17,500
Bal. 12,500 1,350 20,000 1,350 25,000 7,500
33,850 5 33,850
Different terms are used for the various types of revenues. As illustrated for NetSolutions, reve-
nue from providing services is recorded as fees earned. Revenue from the sale of merchandise is
recorded as sales. Other examples of revenue include rent, which is recorded as rent revenue, and
interest, which is recorded as interest revenue.
Instead of receiving cash at the time services are provided or goods are sold, a business
may accept payment at a later date. Such revenues are described as fees earned on account or
sales on account. For example, if NetSolutions had provided services on account instead of for
cash, transaction (d) would have been described as follows: Fees earned on account, $7,500.
In such cases, the firm has an asset, called an account receivable, which is a claim against
the customer. The effect of the transaction increases Accounts Receivable and Fees Earned.
When customers pay their accounts, Cash increases and Accounts Receivable decreases.
Why It Matters a company “sells” goods and services to another company

and then, under a prearranged agreement, the customer
Round-Tripping
resells the exact same goods and services back to the original com-
A
ccounting principles require that a transaction have pany. Round-tripping has been used by companies to artificially
commercial substance. Commercial substance means inflate their sales. However, such agreements do not have commer-
that the transaction has an economic impact on the cial substance, since there is no economic change to either company
entity. An example of a transaction lacking commercial sub- after the round-trip. Thus, round-tripped sales are not transactions
stance is round-tripping. Round-tripping is a situation whereby from an accounting perspective.
Transaction e Nov. 30, 20Y3 NetSolutions paid the following expenses during the month: wages, $2,125; rent,
$800; utilities, $450; and miscellaneous, $275.
During the month, NetSolutions spent cash or used up other assets in earning revenue. Assets used
in this process of earning revenue are called expenses. Expenses include supplies used and pay-
ments for employee wages, utilities, and other services.
NetSolutions paid the following expenses during the month: wages, $2,125; rent, $800; utili-
ties, $450; and miscellaneous, $275. Miscellaneous expenses include small amounts paid for such
items as postage, coffee, and newspapers. The effect of expenses is the opposite of revenues
in that expenses reduce assets and stockholders’ equity. Like fees earned, the expenses are re-
corded in columns to the right of Common Stock. However, since expenses reduce stockholders’
equity, the expenses are entered as negative amounts. The effect of this transaction is as follows:
Accounts Common Fees Wages Rent Utilities Misc.
Cash 1 Supplies 1 Land Payable 1 Stock 1 Earned 2 Exp. 2 Exp. 2 Exp. 2 Exp.
Bal. 12,500 1,350 20,000 5 1,350 25,000 7,500
e. 23,650 22,125 2800 2450 2275
Bal. 8,850 1,350 20,000 1,350 25,000 7,500 22,125 2800 2450 2275
30,200 5 30,200
Businesses usually record each revenue and expense transaction as it occurs. However, to sim-
plify, NetSolutions’ revenues and expenses are summarized for the month in transactions (d) and (e).
Transaction f Nov. 30, 20Y3 NetSolutions paid creditors on account, $950.
When you pay your monthly credit card bill, you decrease the cash and decrease the amount
you owe to the credit card company. Likewise, when NetSolutions paid $950 to creditors
during the month, it reduced assets and liabilities, as follows:

Accounts Common Fees Wages Rent Utilities Misc.
Cash 1 Supplies 1 Land Payable 1 Stock 1 Earned 2 Exp. 2 Exp. 2 Exp. 2 Exp.
Bal. 8,850 1,350 20,000 5 1,350 25,000 7,500 22,125 2800 2450 2275
f. 2950 2950
Bal. 7,900 1,350 20,000 400 25,000 7,500 22,125 2800 2450 2275
29,250 5 29,250
Paying an amount on account is different from paying an expense. The paying of an ex-
pense reduces stockholders’ equity, as illustrated in transaction (e). Paying an amount on ac-
count reduces the amount owed on a liability.
Transaction g Nov. 30, 20Y3 Chris Clark determined that the cost of supplies on hand at the end of the
month was $550.
The cost of the supplies on hand (not yet used) at the end of the month is $550. Thus, $800
($1,350 2 $550) of supplies must have been used during the month. This decrease in supplies
is recorded as an expense, as follows:

Accounts Common Fees Wages Rent Supplies Utilities Misc.
Cash 1 Supplies 1 Land Payable 1 Stock 1 Earned 2 Exp. 2 Exp. 2 Exp. 2 Exp. 2 Exp.
Bal. 7,900 1,350 20,000 5 400 25,000 7,500 22,125 2800 2450 2275
g. 2800 2800
Bal. 7,900 550 20,000 400 25,000 7,500 22,125 2800 2800 2450 2275
28,450 5 28,450
Nov. 30, 20Y3 Paid dividends, $2,000. Transaction h
Dividends are distributions of earnings to stockholders. The payment of dividends decreases

cash and stockholders’ equity. Like expenses, dividends are recorded in a separate column to
the right of Common Stock as a negative amount. The effect of the payment of dividends of
$2,000 is as follows:
Assets 5 Liabilities1 Stockholders’ Equity

Cash 1 Supp. 1 Land Payable 1 Stock 2 Dividends 1 Earned 2 Exp. 2 Exp. 2 Exp. 2 Exp. 2 Exp.
Bal. 7,900 550 20,000 5 400 25,000 7,500 22,125 2800 2800 2450 2275
h. 22,000 22,000
Bal. 5,900 550 20,000 400 25,000 22,000 7,500 22,125 2800 2800 2450 2275
26,450 5
26,450
Dividends should not be confused with expenses. Dividends do not represent assets or
services used in the process of earning revenues. Instead, dividends are considered a distri-
bution of earnings to stockholders.
Summary
The transactions of NetSolutions are summarized in Exhibit 5. Each transaction is identified by
letter, and the balance of each accounting equation element is shown after every transaction.
Exhibit 5 Summary of Transactions for NetSolutions

Cash 1 Supp. 1 Land 5 Payable 1 Stock 2 Dividends 1 Earned 2 Exp. 2 Exp. 2 Exp. 2 Exp. 2 Exp.
a. 125,000 125,000
b. 220,000 120,000
Bal. 5,000 20,000 25,000
c. 11,350 11,350
Bal. 5,000 11,350 20,000 11,350 25,000
d. 17,500 17,500
Bal. 12,500 1,350 20,000 1,350 25,000 7,500
e. 23,650 22,125 2800 2450 2275
Bal. 8,850 1,350 20,000 1,350 25,000 7,500 22,125 2800 2450 2275
f. 2950 2950
Bal. 7,900 1,350 20,000 400 25,000 7,500 22,125 2800 2450 2275
g. 2800 2800
Bal. 7,900 550 20,000 400 25,000 7,500 22,125 2800 2800 2450 2275
h. 22,000 22,000
Bal. 5,900 550 20,000 400 25,000 22,000 7,500 22,125 2800 2800 2450 2275
26,450 5 26,450
You should note the following:

▪▪ The effect of every transaction is an increase or a decrease in one or more of the account-
ing equation elements.
▪▪ The two sides of the accounting equation are always equal.
▪▪ The stockholders’ equity is increased by amounts invested by stockholders (common stock).
▪▪ The stockholders’ equity is increased by revenues and decreased by expenses.
▪▪ The stockholders’ equity is decreased by dividends paid to stockholders.
Classifications of Stockholders’ Equity

Stockholders’ equity is classified as:
▪▪ Common Stock
▪▪ Retained Earnings
Common stock is shares of ownership distributed to investors of a corporation. It represents
the portion of stockholders’ equity contributed by investors. For NetSolutions, shares of common
stock of $25,000 were distributed to Chris Clark in exchange for investing in the business.
Retained earnings is the stockholders’ equity created from business operations through
revenue and expense transactions. For NetSolutions, retained earnings of $3,050 were created
by its November operations (revenue and expense transactions), computed as follows:
NetSolutions Retained Earnings

November Operations
(Revenue and Expense Transactions)
Fees Wages Rent Supplies Utilities Misc.
    
Earned Exp. Exp. Exp. Exp. Exp.
Transaction d. 17,500
Transaction e. 22,125 2800 2450 2275
Transaction g. 2800
______ ______ ______ ______ _____ _____
Balance, Nov. 30 7,500 22,125 2800 2800 2450 2275
______
______ ______
______ _______
_____ _______
_____ ______
____ __
_____
___
$3,050
Stockholders’ equity created by investments by stockholders (common stock) and by busi-

ness operations (retained earnings) are reported separately. Since dividends are distributions
of earnings to stockholders, dividends reduce retained earnings. NetSolutions paid $2,000 in
dividends during November, thus reducing retained earnings to $1,050 ($3,050 2 $2,000).
The effects of investments by stockholders, dividends, revenues, and expenses on stock-
holders’ equity are illustrated in Exhibit 6.
Exhibit 6
Stockholders’ Equity
Effects of
Transactions on
Types of
Stockholders’ Transactions Stockholders’ Distributions of
Revenues Expenses
Equity Investments Earnings to
(Common Stock) Stockholders’
(Dividends) Net Income (Net Loss)
(Retained Earnings)
Check Up Corner 1-1 Business Transactions and the Accounting Equation

Drive Time Delivery is a local delivery service operating in Cleveland, Ohio. On F ebruary 1, Drive Time has the
following balances: Cash, $32,500; Accounts Receivable, $5,000; Accounts Payable, $2,500; Common Stock,
$32,500; Fees Earned, $5,000; Wages Expense, $2,500.
Drive Time Delivery completed the following transactions during February:
a. Received cash from owner as an additional investment in common stock, $20,000.
b. Paid creditors on account, $2,000.
c. Received cash from customers on account, $5,000.
d. Billed customers for delivery services on account, $18,000.
e. Paid wages expense, $10,000.
f. Paid utilities expense, $3,000.
g. Paid dividends, $4,500.
Indicate the effect that each of these transactions has on the following accounting equation elements: Cash,
Accounts Receivable, Accounts Payable, Common Stock, Dividends, Fees Earned, Wages Expense, Utilities Expense.
Solution:
Each transaction affects one or more accounting equation elements.

Accounts Accounts Common Fees Wages Utilities
Cash 1 Receivable 5 Payable 1 Stock − Dividends 1 Earned − Expense − Expense
Bal. 32,500 5,000 2,500 32,500 5,000 −2,500
a. 20,000 20,000
b. −2,000 −2,000
c. 5,000 −5,000
d. 18,000 18,000
e. −10,000 −10,000
f. −3,000 −3,000
g. −4,500 −4,500
Bal. 38,000 18,000 500 1 52,500 −4,500 23,000 −12,500 −3,000
56,000 5 56,000
Check Up Corner
Financial Statements Objective 5

Describe
After transactions have been recorded and summarized, reports are prepared for users. The ac- the financial
counting reports providing this information are called financial statements. The primary financial statements of a
corporation and
statements of a corporation are the income statement, statement of stockholders’ equity, balance
explain how they
sheet, and statement of cash flows. The order in which the financial statements are prepared and the interrelate.
nature of each statement are described in Exhibit 7.
Exhibit 7
Order
Financial
Prepared Financial Statement Description of Statement
Statements
1. Income statement A summary of the revenue and expenses for a specific
period of time, such as a month or a year.
2. Statement of stockholders’ A summary of the changes in stockholders’ equity
equity that have occurred during a specific period of time,
such as a month or a year.
3. Balance sheet A list of the assets, liabilities, and stockholders’ equity
as of a specific date, usually at the close of the last day
of a month or a year.
4. Statement of cash flows A summary of the cash receipts and cash payments
for a specific period of time, such as a month or a year.
The four financial statements and their interrelationships are illustrated in Exhibit 8, The data
for the statements are taken from the summary of NetSolutions’ transactions in Exhibit 5.
All financial statements are identified by the name of the business, the title of the state-
ment, and the date or period of time. The data presented in the income statement, the
statement of stockholders’ equity, and the statement of cash flows are for a period of time. The
data presented in the balance sheet are for a specific date.
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It is fortunate that two men with swags upon their backs are passing at the
time, who carry the unfortunate youth into the sunlight, and rub his body
vigorously with their hands until the vitality that was almost extinct begins to
revive again within him.
When Tom had partly recovered and could speak, he told his uncle, the
captain, that when he dived he struck his head against a snag, which
rendered him insensible, and no doubt in that state he was being carried
away by the current when the dog found him.
And poor Tom was grateful for the service, for [227]when he was quite well he
bought the Newfoundland a grand collar, and had the following inscription
engraven on it:—
“Sailor,
“Rescued Tom Anson Blake from drowning on the 18th January, 187-, at
Anchordale, River Murray.”
[228]
[Contents]
NELLIE.
[Contents]
CHAPTER I.
R
ain, rain—nothing but rain on this Christmas Eve, in the New South
Wales metropolis. Although it was in the heat of summer the wind
from the coast blew keenly through the almost deserted streets, and
caused the fine mist-like wet to penetrate the stoutest overcoat. It was such
weather that no one who had a roof over his head would care to be out in.
But there was one wearily toiling from street to street, beneath the protection
of the verandahs—a delicate-looking girl. With one hand she was trying to
wrap her scanty rags round her wasted body, and in the other she held a half-
dozen boxes of wax matches. Her face was worn, and pinched, and dirty, but
it was a very beautiful, patient, little face; her hair, too, would have been a
bright golden in natural hue, save that it was shaggy and dirty also. It was to
little purpose that she offered her matches [229]to the passers-by, who were
few and far between on this wet evening—they were all too anxious to get
home out of the rain. From the brightly lighted streets the little wanderer
crossed Hyde Park, and wended her way slowly up Oxford Street, and from
thence to the left, along the Bay Road, where dwell the wealthy and the great.
Why she had left the shops and all the busy part of the city for the wide, bleak
road, dotted with high, massive houses standing out dark and cold in the
falling rain, the poor child could not tell. Impelled by some strange fascination,
she had quitted her usual haunts, and taken the opposite direction leading
from her wretched home. Although it was getting late, and past the time when
she should have returned, she had no thought of going home. Her memory
was full of faint, indistinct thoughts, whether dreams or faraway realities, who
shall say? She wondered why she had rambled so far from the city; but she
also felt she must go on. Her ragged dress was soaked with rain and the
keen wind was cruel and cutting, yet the poor little thing did not feel the rain
or the wind; on the contrary, she felt as if she was on fire, save now and then
there would pass a cold feeling all over her, which caused a shivering fit. The
match girl was well aware that she would be [230]beaten when she returned to
her wretched dwelling, yet, strange to say, she felt perfectly happy as she
wandered farther away from it.
Half way up the Bay Road there came over the little waif a feeling of
dizziness, accompanied by a feeling of thirst, and again that burning
sensation which again changed into a cold shiver, as she stood there. Close
at hand there was a friendly porch belonging to a grand mansion, so the child
crept into it, out of the wind and rain, and crouched down. No sooner had she
done so than all her light-heartedness appeared to leave her, and she burst
into tears. It was very strange that directly the little match vendor began to cry
she heard a confusion of sounds around her—wild, mocking laughter, and
shouts, and stamping of feet, and strange lights were dancing before her
eyes. The stones on which she was lying seemed to be heaving and tossing,
and she felt very frightened just for a moment, and then she fell fast asleep.
These sounds still went on in her slumber, but they gradually got softer and
softer, and sweeter and more subdued, until they changed into the most
lovely music. And the little outcast thought she was standing in the midst of a
very beautiful garden, and somehow it appeared to her that she [231]had
known it all a long time ago. The rain and wind and the murky clouds had
passed away, and it was glorious, sunny day; the flowers were in full bloom.
Voices of birds and insects filled the balmy air, and gay coloured butterflies
flitted here and there. While she was standing, wondering that all these
strange things should seem so familiar to her, a handsome boy, with golden
curls, approached, and exclaimed,—
“Oh, dear sister Nellie, come and play. Why did you go away and stay away
so long?”
The dreamer looked up; she appeared to know the happy face quite well, and
she assured him in a voice, that was not like her old thin, weak voice, but soft
and clear, which seemed like a voice that had belonged to her a long, long
time ago,—
“Indeed, I don’t know where I have been, Frank; nor why I went away. Is it a
long time since?” she asked timidly.
“Such a long time, sister.”
“I am here at last, Frank; and I will never go away again. Come, let us play in
the garden.” And then she took his hand, and they walked on together
amongst the flowers, while the thousand voices round about gave gladsome
welcome. All the old miserable life of the beggar child seemed to fade quickly
away here, leaving nothing save the [232]feeling that she had always been
accustomed to the grand objects by which she found herself surrounded.
“Suppose we have a game of hide and seek?” suggested Frank.
“That will be very nice; but who shall hide first?”
They had a little consultation about that very important matter, when it was
decided that Nellie should hide first. It was most peculiar that the name Nellie
came quite natural to the dreamer, though she had been called Maggie, Meg,
and sometimes Peggy as long as she could remember.
So Nellie went to hide, and she hid behind a rosebush, and there she found a
great hole in the ground big enough for her to creep into. Ere she had settled
herself, Nellie found that the hole led to a dark passage, with a soft light
glimmering at the end of it. Still wondering, she went towards the light.
Passing along through several archways, the child emerged into a splendid
cavern, lit up with many coloured, sparkling lights from thousands of precious
stones, with which the sides and roof of the place were studded. While she
was standing awe-struck with amazement at this magnificent place, she
heard by her side a flutter of light wings, and turning, saw hovering [233]over
her a beautiful little creature with long hair, which glittered like woven
sunbeams. The form was rose-hued in colour, and from its shoulders sprang
green wings, sheeny and lustrous as the throat of a humming-bird.
“THE LOVELY BEING TOOK NELLIE BY THE HAND.”
“Come!” warbled the being, and the voice was dreamy and sweet, like the
“coo” of a stock dove. “Come, and I will show you something wonderful.”
And the lovely being took Nellie by the hand, and led the child through a cleft
in the rock to [234]another room which was lined, roof, walls, and floor, with
soft green moss. All round the room were hung beautiful garlands adorned
with diamonds. Some fairly blazed again with gems, others contained only a
few, fixed here and there, while fairy-like forms flitted to and fro continually,
bearing in their hands more gems, which they fixed into the garlands. The
dreamer was very much surprised at what she beheld.
“Where do they get all those diamonds to put into the garlands?” she inquired
of her companion.
“The diamonds,” answered her conductor, “are the tears of sorrow shed by
the unhappy people in the world; for always while they are weeping there are
unseen watchers ready waiting to receive their tears and convey them here.”
“And what are those very large gems, that shine so brightly in the middle of
the finished garlands?”
“Those are tears of joy; no garland can be finished without them.”
The child wandered round the chamber, and saw that almost all the wreaths
had some tears of joy and some of sorrow; but she came at last to one that
was quite full of tears of sorrow and in it no tears of joy at all, while on it was
a name, “Peggy the Beggar.” [235]
Scarcely had her eyes fallen upon the name than she awoke; awoke, and
beheld bending over her a lady with a lovely face; but she looked proud and
stern, and the little wanderer instinctively shrank away from her and crouched
closer to the wall.
“How very tiresome that this wretched child should choose my porch, of all
places, to creep into for shelter,” cried the lady, in a cold, unfeeling tone. “Yet I
cannot turn the unfortunate thing away on such a night as this. It’s a poor
Christmas indeed for the poor child,” she added, in a more tender way. “Here,
Smith, take up this little beggar and carry her to the kitchen, give her
something to eat, and tell Jane to put some dry things on her.”
A tall servant came forward and lifted the ragged bundle of humanity in his
arms as tenderly as a mother would have done. The man had just such
another little girl at home, and his heart yearned with sympathy for the
outcast as he bore her along the great hall of the house. Certainly the place
was strange to the child; but as in her dream she seemed to remember
everything, so now it appeared to her that the objects upon which she gazed
had been familiar to her a long, long time ago, and her dream came back
[236]to her so vividly that she cried out aloud, “Oh, Frank! Frank! Dear brother,
where are you hiding? Do come to me. Come to sister Nellie. I am not playing
now.”
The stern lady had followed her servant with his living burden; but when that
cry reached her she stopped short, and grasped at the wall for support. What
sudden spasm caused the beautiful, haughty face to grow instantly pale, and
the tall form to bend trembling down as if struck with palsy?
“Oh, Frank, come to sister Nellie. Dear brother, come.”
With a wild, hysterical sob the stately figure bowed lower yet, and pressed
her arms upon her throbbing bosom as if each of the little outcast’s words
had been cruel dagger-thrusts that were piercing her through and through.
Coldness, pride, the vigorous will, that moulds martyrs and devils alike, was
strong within the woman, yet the combination of all three had no power
against that weak out-cry—“Come to sister Nellie, Frank!”
Ere the low, faint wail had died out, the proud lady had snatched the poor
child to her bosom, and covering the hot, unwashed face with passionate
kisses, cried aloud,—
“I—I had a darling Nellie once, and a golden-haired [237]boy also, whom we
called Frank, but they were buds that faded here to bloom in heaven. And
now their dear voices will never fall upon my ears again. Alas! Alas!”
Then like all else she had seen in this place, it seemed to the child that the
face of the beautiful lady was not altogether strange to her. The very caress
was like the endearing embrace of a mother, whose heart had longed and
yearned for her lost ones, and the poor little outcast wondered how it all could
be, until she lost all consciousness and began to dream again.
[Contents]
CHAPTER II.
It was a long and troubled dream. Days and weeks appeared to pass away in
which the little sleeper could remember nothing clearly. At one time the
beautiful lady would appear to be bending fondly over her, and then the face
would change suddenly to that of a wretched hag, whom she had known and
called mother, in the miserable home she had within the slums of the city.
From this place came terrible voices in her ears, and terrible things struggling
round the bed. Flames of fire darted and danced in her poor, weary eyes; but
through all this she beheld the fairy of the [238]cavern appear again, holding in
his hand the wreath whereon was written her name. He held it towards her
gleaming with diamond tear-drops. How she struggled to reach it! The more
she tried the weaker she became, but it seemed to her that there was an
invisible arm round her for her to rest upon, and though faint and weary, her
failing footsteps ever got nearer and nearer the precious circlet. Then
followed an interval of soft, soothing quiet, and the eyes of our heroine
opened drowsily upon the waking world again. She felt very weak, but
somehow very happy. She was lying on a clean, white bed in a comfortable
room, which appeared as if she had seen it before somewhere in her dreams.
As the child raised her weary eyelids her gaze rested upon the prostrate form
of the lady kneeling by her bedside, with her face hidden in the bedclothes,
sobbing. The poor wanderer felt sorry that one who had been so kind to her
should weep in trouble, and raising her little warm hand, she laid it on the
beautiful head of the kneeler, and uttered the familiar word, “Mamma.”
The little sufferer knew not why that tender word rose to her lips before any
other; she only knew that the affectionate term was in her heart and mind—
that was all. [239]
At the sound the grand lady raised her head, and kissed the child again and
again with maternal fondness, her lips murmuring the while, “My own darling
child. My Nellie, whom I thought had departed from me for ever. Heaven has
been good to me.”
Then for the first time the little match vendor shed tears of joy. Sleep came to
her again, from which she was aroused by the sound of voices talking in
whispers close to the bed.
“I am so sorry to have disobeyed you, ma’am, but you must forgive me, and
let me stay and nurse my own little pet,” cried a girl’s voice in pleading
accents. “When they told me at home that the stolen child had come home
again to you, I couldn’t keep away. I know it’s all along of my carelessness
that she was took away. Yet I loved the deary and was compelled to come,
although you must hate the very sight of me.”
“Hush, nurse, hush!” replied the lady’s voice sadly. “I am so glad you have
come. Since I lost my Nellie, and Frank died, and my dear husband perished
at sea, I have been a friendless, lonely, and unhappy woman. Now my lost
darling has been restored to me again the world will not seem so bleak and
weary. You shall stay and help me nurse my stolen baby into health again.”
[240]
It seemed very strange to the child, as she lay back in the bed, to learn the
early history of her own life; how she had been stolen away when she was
only a wee toddler; how her brother, just one year older than herself, had
pined and died for his sister; how the poor mother, with all her grand and
fashionable friends, had felt herself deserted, and had hardened her heart
against all good influences, until the cry of the frightened little outcast had
reached and softened it.
There were long, weary watchings by the couch of the sufferer, filled with
anxiety and suspense. For the mother who had found her lost one had a
vague dread haunting her that her darling might be snatched ruthlessly from
her a second time, and by a foe more terrible than a kidnapper. The child’s
sleep was filled with dreams of angels. They carried her again and again to
that rocky chamber where hung the garlands; and each time she found her
own all ablaze with tears of joy, and nearly finished.
On one occasion she stretched forth her hand to take it, but the fairy came up
to her and said,—
“Not yet, my dear; you shall wear it very soon.”
The child related these dreams to her mother, who answered nothing, but fell
down upon her [241]knees and prayed that the garland should not be
completed yet awhile.
Nellie could not understand all this, but one night she felt very weak and cold.
Her mother was seated by the bedside gazing with greedy eyes at the poor,
worn, pinched-up little face. There were others in the room, but the patient
now saw only her mother.
“Dear mamma!”
“What is it, my darling?”
“I have seen the garlands again. Mine is finished at last.”
The face of the lady grew very pale. She hid her weeping eyes and muttered,
—
“A little while longer, only a little while.”
“I know what the garland means now, mamma; I am going to die,”
“Oh no! my dear, long lost pet, not yet, not yet. I cannot spare you, now you
have come back to me. Stay with me a little while—just a little while. You are
so very dear to me.”
Who shall say what agony of supplication in that low wail of entreaty? Who
shall fathom its intensity?
“But you will come too, mamma?” said the weak voice, now grown very weak
and feeble. “You have cried so much, your garland must be nearly ready.”
[242]
A great sob, which shook the tall, shapely figure like a reed, was the only
answer. She raised her head at length, and the eyes of mother and child met.
“Oh, when I get there, I’ll prepare your garland, mamma,” came the faint
voice, almost in a whisper now.
For a moment there was a wild light in the poor mother’s eyes. The words
appeared to stir some old memory in her heart. She looked into the peaceful
face of her dying child, and the voice became more calm and steady.
“It is very hard to part, my darling, very hard; but I will try to bear it all, so that
tears of joy may mingle with tears of sorrow in my wreath of immortality.”
The words fell on an ear that heard them not. There was a look on the child’s
face that caused the mother to rush forward and throw her arms about the
poor weak clay, as if to stay the departing spirit in its flight.
“Oh, mamma! there is little brother Frank with my garland. See! he is

beckoning to me.”
And then the weary little head fell forward on the mother’s shoulder, and the
tired spirit entered into rest. [243]
[Contents]
IN THE CLOUDS.
T hey came to the boy one night when he was abed, and said they would
take him with them in their fairy balloon.
Willie Fenton told his father and mother that he had seen the elfins, and what
they had promised him, but they only laughed at him and told him he had
been dreaming.
Our hero wasn’t to be convinced that it was only a dream. Hadn’t he seen
them—three fairy creatures no higher than his top—enter his bedroom
through the keyhole, and seat themselves on his pillow, and begin talking
about the glorious sights to be seen in the clouds?
If Willie Fenton had been born up in a balloon his youthful fancy could not
have been imbued with a greater passion for the sport. Indeed, since he was
a child of four or five years old our youthful aeronaut had blown soap bubbles,
and had watched them soar away in the sun, glistening with all the hues of the
rainbow, and his dreams [244]at night and aspirations by day had been to
emulate those daring spirits who surpassed the mighty eagle in his flight into
the bright blue sky above the clouds.
Willie’s home, situated on Mount Pleasant, was in the vicinity of many a

romantic spot calculated to favour the elves in their adventure, and one fine
morning, as the lad was returning from a neighbouring farm, he espied his
three nocturnal visitors seated under a large gum-tree awaiting him. Willie
recognised them in a moment, and doffing his cap said, “Good-morning,
gentlemen.”
The fairies rose and saluted him, and answered that they were quite ready to
fulfil their promises. Our hero thanked them for their kindness, and at the
same time expressed himself quite ready to accompany them. Whereupon the
three elves conducted him in silence along a narrow ravine which opened out
on a still, quiet glen on the banks of the river. Fastened securely between two
huge trees, Willie beheld a great, pear-shaped thing, swaying to and fro with
the motion of the breeze, and at which the elves pointed and said, “Behold,
our cloud car.”
“IT WAS A GRAND BALLOON.”
Yes, it was a grand balloon, already inflated and with a cage attached,
bordered with wild roses and creepers, that reached from the apex of the
[245]monster down to the car beneath, which hung suspended, like a flower-pot
in a balcony. How it surged and struggled desperately with the wind, as if it
were endowed with life, and wished to escape from fastenings that held it, and
soar upward! And how frail it appeared, as Willie approached and examined it!
Was it made of cloth? No, too fine for cloth. Cotton? Nay, it was too soft for
cotton, or silk either. Yet the whole fabric seemed no weightier than a
gossamer. The fairies smiled at the boy’s curiosity, and invited [246]him to enter
the car. Our little hero had no sooner complied than the elfins seated
themselves at his side. And one of them, who had a bright diadem glittering
upon his breast, stood up and waved his hand as a signal, when instantly the
balloon shot aloft with inconceivable velocity.
The young mortal closed his eyes and held his breath for one brief moment;
but when he looked forth, the earth appeared to be miraculously vanishing
from his sight. Although the ascent was fearfully rapid, the motion of the
balloon was quite imperceptible. The morning was bright and sunny, the sky a
deep, Prussian blue, and as the boy craned his neck over the cage and gazed
below, what a glorious sight met his view. There stretched beneath him were
the golden valleys of his birthplace, with hundreds of farms dotting the
landscape, and no bigger than a child’s toy. From his elevated position the
houses were as so many dots, and the people in the fields as tiny ants. The
flowing Torrens, that had seemed so broad and deep, appeared as a silver
thread, and the high cliffs and hills were on a level with the dull round earth.
Willie Fenton felt not the least alarm; on the contrary, his courage rose with
the balloon, as it sped upward to the sky. The elfin with the diadem threw out
some pieces of paper, which [247]seemed to drop like stones. This, however,
was not so, but only the effect of the terrible rate at which they were travelling.
Higher, higher, still higher. Now they disappeared from view, in a thick vapour
forming the white clouds, which looked so light and fleecy from earth. The
balloon did not remain long in these, but quickly rose into a clear atmosphere
beyond. And here the scene changed to one splendid in the extreme. Above
them nothing but the big round sun, and the deep azure of the heavens.
Beneath no dingy earth, dim and gloomy, but a brilliant sea of sparkling cloud,
rose tinted, dancing and flashing in the sun’s rays. The cloud completely hid
everything below, and lay beneath like a huge, rolling billow, the top of which
flashed back the sunlight till our hero almost fancied it was a wave of driven
snow spangled with diamonds. How long Willie might have remained in his
rapt trance of wonder it is hard to say, but he was aroused by a feeling of cold,
and a difficulty in breathing.
“Our mortal friend will find it very chilly up here,” said Pippin, who wore the
diadem, answering the boy’s unspoken words.
“It has grown very cold indeed, gentlemen,” rejoined Willie, his teeth chattering
as he spoke.
“Ha, ha! Listen to him, Needle; hear him, [248]Bobbin; he’s beginning to cry out
already!” cried Pippin to his companions. “Cold, eh? Well, we have a cure for
cold, and for frost and snow—whole mountains of it. Eh, Needle?” As Pippin
spoke, he unrolled a parcel which had been lying unnoticed at the bottom of
the car, and produced a cloak made of the same material as the balloon.
Without more ado they enveloped Willie from head to heel in the garment, with
just sufficient space left clear about his eyes so that he could see, the rest of
him being completely covered. In a few moments he began to breathe more
freely, and the rarity of the air made no impression upon him at all.
“You feel all right now, Willie Fenton?” questioned Bobbin. Willie mumbled,
and nodded his head in the affirmative.
“Let us mount higher then, my brethren. Excelsior!” exclaimed Pippin of the

diadem. “Bold indeed the mortal who first conceived and carried out the idea
of making the unstable element water subservient to his genius, as witness
the ships that come and go on the bosom of the ocean; but it is left to us, the
elves of Australia, to curb the air and make it do our bidding. Higher and
higher go we, to show this mortal the wonders of the upper world.”
Upward still, beyond the cloud which breaks [249]for a moment and gives them
a glimpse of the sea, and the coast-line away to the westward seeming no
broader than a single thread. And now the cold became intense, but the fairies
and their companion felt it not, for their gaze was fixed upon a sight that no
emperor or king had ever seen—and perchance never would. If all the
diamonds in that rich valley visited by Sinbad the Sailor, also all the gems
which Aladdin’s lamp could have procured, and all that ever have been seen
in the world had been pressed into the service—they would have failed utterly
in producing one tithe of the strange sight Willie now saw. The whole dome of
the balloon was covered as it were in a diamond mantle. A shower of glittering
gems was falling in all directions, apparently coming from the blue void above,
and sprinkling down, with a fluttering motion like that of butterflies, and then
disappearing in the vast abyss below.
Lost in amazement at this marvellous vision, the boy frees one of his hands,
and reaches to catch one of the heavenly gems; but he discovers the diamond
shower is in reality only thin sheets of newly-formed ice.
The elves laugh at him and the look of wonder on his face. And Pippin
explains in a grave [250]tone, “Boy, we have entered a region where some
watery vapour hath been, which the cold hath turned into ice, and now being
heavier than the atmosphere falls fluttering to the earth. Towards the earth, I
say, since I know well it will never reach it, because before it can do so it will
encounter a warmer region, when the ice will again become water and the
water vapour. Do you understand?”
“Oh yes. It’s the vapour which makes the clouds, isn’t it?” answered Willie.
“Just so,” replied the elfin. “And now having fulfilled our promise, we will
descend again to old mother earth.”
Like a streak of light the fairy balloon shot downward through the glittering,
diamond shower, through the mist and cloud, until the bright landscape
appeared in view. The elfins, Pippin, Needle, and Bobbin, landed Willie safely
by the river-bank, and the boy reached home just in time for dinner.
* * *
The three elves still haunt that dell by the Torrens, so if any of my readers are
anxious for a trip in the fairy balloon, I have no doubt Messrs. Pippin & Co. will
be only too glad to oblige them—that is, if they are at home. [251]
[Contents]
WONDERLAND.
M ount with me, my little friends, upon the wings of fancy. Don’t be
alarmed—the conveyance is perfectly safe, and warranted free from
accidents. Hi, Presto! Here we stand upon the famous Blue
Mountains of our neighbour, whose glens, dells, and deep ravines are
haunted by creatures beautiful beyond conception, and grotesque, and
stranger than any painter dreamed of. Yonder, on the mountain-side, the
western train is seen puffing its way along the gigantic “zigzag,” like a huge
serpent, and whose hot breath takes weird shapes before it is lost in the blue
haze above it. Beneath, on that natural terrace of rock, stands the humble hut
of the charcoal-burner, whose single window overlooks a deep valley of
monster trees—fallen and half-buried amongst great blocks of stone and rank
vegetation.
But who is that woman who is wringing her hands, and calling and weeping by
turns, as she runs to and fro among the chaos of undergrowth [252]and the
ledges around? It is the wife of the charcoal-burner, and she calls for her two
children, who have wandered away and become lost in this wild region. It was
early morn when they strolled forth to play—Edith and Winnie, both little
toddlers, and quite helpless—yet the sun is on the rim of the horizon and they
cannot be found.
“Coo-ee, coo-ee!—Winnie—Edie, my darlings, where are you? Oh, where are

you?” cries the poor mother; and her voice grows faint and weary as she calls
to the echoing cliffs about. She becomes aware that some one is answering
her as she is about to retrace her steps to the hut. The voice is far off at first,
but it becomes gradually nearer and nearer, until a rough mountain goat with
long horns presents itself before her.
“I am here. What do you want with me?” it said, bowing itself before her.
It was a beautiful animal, with a soft, white, silky fleece, and large, kind-
looking eyes, while its voice sounded so full of sympathy that the suffering
mother answered readily,—
“Oh, sir! I have lost my two children; pray tell me, have you seen them?”
“I have seen them,” answered the goat. “And if you have sufficient courage to
follow my advice [253]they shall soon be restored to you. I am the guardian
sprite of this glen, which my race have occupied since the Flood. Here on this
mountain are two kingdoms; the one on the surface called Love; the other,
beneath the surface, termed Hate. We are ever at war with each other;
therefore, I am here to serve you. Learn, O mortal, that Croak and Gloom, of
the lower world, have stolen your children, and they have hid them within the
bowels of the mountains.”
“Then they are dead, and I shall never see them more,” replied the woman,
falling on her knees and weeping bitterly.
“I have said they shall be restored to you again,” replied the goat quickly. “My
power is far mightier than the whole nation of Hate combined. Have you faith
that I can help you?”
“Yes,” she answered, “because Love is stronger than Hate.”
“Good. Extend your hand and pluck a tuft of hair from my right side, roll it in
your fingers, then twist it round your finger above your wedding-ring.”
The charcoal-burner’s wife did as the goat desired her, but she had scarcely
finished before the animal vanished from her sight, and she felt herself bodily
lifted up, and borne away over the deep ravine, [254]and across over-hanging
cliffs and the tops of tall trees, and away down into a yawning chasm, which
seemed like a deep and bottomless well. Down, down, she went swiftly, yet
with an easy, sliding motion that was not at all unpleasant, while she felt no
fear, save for the fate of her little ones. She had a feeling of a powerful
presence being near and about her—extending from the finger on which was
twisted the goat’s hair round and round her person, and beneath her feet, like
the strong net-work of a balloon. Even when the void grew dim and black, a
strange glow, emanating from the ring, lit up the darkness and revealed to her
wondering eyes many earth-bound treasures. Here gleamed thick seams of
coal, and there slabs of tin and copper ores, and beyond these shone white
masses of stone, like marble, with thick veins of gold therein, which sparkled
athwart the woman’s eyes, and made her almost forget her children, so great
became her desire to possess some of it While she cogitated she suddenly
became conscious that she was upon her feet, standing before a large cavern
gate, guarded by a tall griffin, who cried out the moment he espied her, “Who
dare enter into the realm of Hate?”
And the woman answered quickly, “Love. Love [255]dares everything, because,
being pure, it is fearless. I have come to demand my children.”
“THE MONSTER … ADVANCED WITH A LARGE STONE.”
The monster laughed at her, and advanced with a large stone to dash out her
brains; but the white goat, transformed now into a handsome youth, with a
sharp, gleaming sword in his hand, advanced boldly to the rescue, and soon
defeated the grim warder, took his keys without more ado, and opening
several doors, led his companion through a labyrinth of caves until they
reached a second gate guarded like the first, the warder having the [256]body
of an ass and the head of a wolf. “Who knocks at the gates of Hate?” he said
fiercely.

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