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Accounting FOR DUMmIES ‰ 4TH EDITION Accounting FOR DUMmIES ‰ 4TH EDITION By John A. Tracy, CPA Accounting For Dummies®, 4th Edition Published by Wiley Publishing, Inc. 111 River St. Hoboken, NJ 07030-5774 www.wiley.com Copyright © 2008 by Wiley Publishing, Inc., Indianapolis, Indiana Published by Wiley Publishing, Inc., Indianapolis, Indiana Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600. 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Library of Congress Control Number: 2008926448 ISBN: 978-0-470-24600-9 Manufactured in the United States of America 10 9 8 7 6 5 4 3 2 1 About the Author John A. Tracy (Boulder, Colorado) is Professor of Accounting, Emeritus, at the University of Colorado in Boulder. Before his 35-year tenure at Boulder, he was on the business faculty for four years at the University of California in Berkeley. Early in his career he was a staff accountant with Ernst & Young. John is the author of several books on accounting and finance, including The Fast Forward MBA in Finance, How To Read a Financial Report, and Small Business Financial Management Kit For Dummies with his son Tage Tracy. John received his BSC degree from Creighton University. He earned his MBA and PhD degrees at the University of Wisconsin in Madison. He is a CPA (inactive) in Colorado. Dedication For our grandchildren — Alexander, Ryan, Mitchel, Paige, Katrina, Claire, Eric, MacKenzie, Madison, Tanner, Karsen, and Brody. Author’s Acknowledgments I’m deeply grateful to everyone at Wiley Publishing who helped produce this book. Their professionalism, courtesy, and good humor were much appreciated. I supplied some words, and the editors and production staff at Wiley molded them into the finished product. Out of the blue, I got a call in 1996 from Kathy Welton, then Vice President and Publisher for the Consumer Publishing Group of the For Dummies books. Kathy asked if I’d be interested in doing this book. It didn’t take me very long to say yes. Thank you again, Kathy! I can’t say enough nice things about Pam Mourouzis, who was project editor on the first edition of the book. The book is immensely better for her insights and advice. The two copyeditors on the book — Diane Giangrossi and Joe Jansen — did a wonderful job. Mary Metcalfe provided valuable suggestions on the manuscript. Thanks to Holly McGuire and Jill Alexander who encouraged me to revise the book. The second edition benefited from the editing by Norm Crampton and Ben Nussbaum. I thank Stacy Kennedy, acquisitions editor, for asking me to do this and the previous revision. Joan Friedman was the project editor on this and the previous edition. Evidently, Wiley assigned me the best editor they have. Joan kept a steady hand on the tiller as we sailed through the choppy waters of the revisions. Joan was a delight to work with, and it goes without saying that she made the book much better. Thank you most sincerely Joan, and I hope to work with you again on the next revision. One reason I like to write books goes back to an accounting class in my undergraduate days at Creighton University in Omaha. I took a course taught by the Dean of the Business School, Dr. Floyd Walsh. I turned in a term paper, and he said that it was very well written. I have never forgotten that compliment. I think my old Prof would be proud of this book and might even give me an “A” on the assignment. Publisher’s Acknowledgments We’re proud of this book; please send us your comments through our Dummies online registration form located at www.dummies.com/register/. Some of the people who helped bring this book to market include the following: Acquisitions, Editorial, and Media Development Project Editor: Joan Friedman (Previous Editions: Norm Crampton, Pam Mourouzis) Acquisitions Editor: Stacy Kennedy Composition Services Project Coordinator: Katie Key Layout and Graphics: Brooke Graczyk, Melissa K. Jester, Laura Pence, Christine Williams Technical Editor: Michael Newman, PhD Proofreaders: Laura Albert, John Greenough, Nancy L. Reinhardt Editorial Manager: Jennifer Ehrlich Indexer: Infodex Indexing Services, Inc. Editorial Supervisor: Carmen Krikorian Editorial Assistants: Erin Calligan Mooney, Joe Niesen, David Lutton Cartoons: Rich Tennant (www.the5thwave.com) Publishing and Editorial for Consumer Dummies Diane Graves Steele, Vice President and Publisher, Consumer Dummies Joyce Pepple, Acquisitions Director, Consumer Dummies Kristin A. Cocks, Product Development Director, Consumer Dummies Michael Spring, Vice President and Publisher, Travel Kelly Regan, Editorial Director, Travel Publishing for Technology Dummies Andy Cummings, Vice President and Publisher, Dummies Technology/General User Composition Services Gerry Fahey, Vice President of Production Services Debbie Stailey, Director of Composition Services Contents at a Glance Introduction .................................................................1 Part I: Opening the Books on Accounting......................11 Chapter 1: Accounting: The Language of Business, Investing, Finance, and Taxes....13 Chapter 2: Financial Statements and Accounting Standards......................................31 Chapter 3: Bookkeeping and Accounting Systems.......................................................53 Part II: Figuring Out Financial Statements ...................75 Chapter 4: Reporting Revenue, Expenses, and the Bottom Line................................77 Chapter 5: Reporting Assets, Liabilities, and Owners’ Equity....................................97 Chapter 6: Reporting Cash Flows .................................................................................119 Chapter 7: Choosing Accounting Methods: Different Strokes for Different Folks....137 Part III: Accounting in Managing a Business ..............159 Chapter 8: Deciding the Legal Structure for a Business ............................................161 Chapter 9: Analyzing and Managing Profit ..................................................................183 Chapter 10: Financial Planning, Budgeting, and Control...........................................205 Chapter 11: Cost Concepts and Conundrums ............................................................223 Part IV: Preparing and Using Financial Reports ..........245 Chapter 12: Getting a Financial Report Ready for Release .......................................247 Chapter 13: How Lenders and Investors Read a Financial Report...........................271 Chapter 14: How Business Managers Use a Financial Report ..................................293 Chapter 15: Audits and Accounting Fraud ..................................................................311 Part V: The Part of Tens ............................................321 Chapter 16: Ten Accounting Tips for Managers .........................................................323 Chapter 17: Ten Tips for Reading a Financial Report ................................................333 Glossary: Slashing Through the Accounting Jargon Jungle ...........................................................343 Index .......................................................................357