Financial Accounting in an Economic Context / Edition 6

Financial Accounting in an Economic Context / Edition 6

by Jamie Pratt

ISBN-10: 0471655287

ISBN-13: 9780471655282

Pub. Date: 02/25/2005

Publisher: Wiley

"The goal of every successful manager is to generate the best return on equity possible - creating, in turn, long-term value for shareholders. The tools of every good manager are a thorough understanding of economic factors, measurement issues, and the principles of decision making" The integrative approach to accounting and finance found in Jamie Pratt's Financial…  See more details below


"The goal of every successful manager is to generate the best return on equity possible - creating, in turn, long-term value for shareholders. The tools of every good manager are a thorough understanding of economic factors, measurement issues, and the principles of decision making" The integrative approach to accounting and finance found in Jamie Pratt's Financial Accounting in an Economic Context, Seventh Edition helps you acquire these essential tools so you can make proper decisions based on a complete financial picture. And its real-world cases, rooted in today's business environment, enable you to develop an intuitive grasp of the balance between economics, internal controls, international standards, and ethics in your decision making.

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Table of Contents


1. Financial Accounting and Its Economic Context.

Financial Reporting and Investment Decisions.

Economic Consequences.

User Orientation.

The Demand for Financial Information: A User’s Orientation.

Consumption and Investment.

Where to Invest?

The Demand for Documentation.

The Demand for an Independent Audit.

Martin and the CPA: Different Incentives.

The Auditor’s Report, the Management Letter, and the Financial Statements. Descriptions of Financial Statements.

Analysis of Financial Statements.

What Form of Investment: Debt or Equity?

A Decision Is Made, but Important Questions Still Remain.

The Economic Environment in which Financial Reports Are Prepared and Used.

Financial Accounting Information: More Than the Financial Statements.

Providers of Capital: Investors and Creditors.

Companies (Managers).

Independent Auditors.

Relationships Among Capital Providers, Management and the Independent Auditor.

Legal Liability.

Ethics and Professional Reputation.

Generally Accepted Accounting Principles.

The Securities and Exchange Commission.

The Role of the Accounting Profession.

The Financial Accounting Standards Board.

Accounting Standard Setting: A Political Process.

Reactions to Economic Consequences: Lobbying Accounting Numbers.

International Perspective: Accounting Practices and Standards Throughout the World.

Different Accounting Systems.

International Accounting Standard Setting.

2. The Financial Statements.

Businesses Are Like Fruit Trees.

The Classified Balance Sheet.

A Photograph of Financial Condition.

Balance Sheet Classifications.



Stockholders’ Equity.

The Income Statement.

Operating Revenues.

Operating Expenses.

Other Revenues and Expenses.

The Statement of Stockholders’ Equity.

The Statement of Cash Flows.

Cash Flows from Operating Activities.

Cash Flows from Investing Activities.

Cash Flows from Financing Activities.

Relationships among the Financial Statements.

International Perspective: An Example of International Financial Reporting Standards.


3. The Measurement Fundamentals of Financial Accounting.

Assumptions of Financial Accounting.

Economic Entity Assumption.

Fiscal Period Assumption.

Going Concern Assumption.

Stable Dollar Assumption.

Summary of Basic Assumptions.

Valuations on the Balance Sheet.

Four Valuation Bases.

Valuation Bases Used on the Balance Sheet.

The Principles of Financial Accounting Measurement.

The Principle of Objectivity.

The Principles of Matching and Revenue Recognition.

The Principle of Consistency.

Two Exceptions to the Basic Principles: Materiality and Conservatism.



International Perspective: Measurement Fundamentals and International Reporting Standards.

4. The Mechanics of Financial Accounting.

Economic Events.

Relevant Events.


The Fundamental Accounting Equation.



Stockholders’ Equity.

Business Transactions, the Accounting Equation, and the Financial Statements.

Transactions and the Accounting Equation.

The Accounting Equation and the Financial Statements.

The Journal Entry.

Recognizing Gains and Losses.

Periodic Adjustments.



Revaluation Adjustments.

Financial Statement Presentation in a Multinational Environment.

Appendix 4A.  Mechanics—A User’s Perspective.

5. Using Financial Statement Information.

Control and Prediction.

Financial Accounting Numbers and Management Control.

Financial Accounting Numbers as Prediction Aids.

Framework For Using Financial Statements to Predict Future Earnings and Cash Flows.

Business Environment.

Unrecorded Events.

Management Bias.

Elements of Financial Statement Analysis.

Assessing the Business Environment.

Reading and Studying the Financial Statements and Footnotes.

The Audit Report.

Significant Transactions.

Financial Statements and Footnotes.

Assessing Earnings Quality.

Overstating Operating Performance.

Taking a Bath.

Creating Hidden Reserves.

Employing Off-Balance-Sheet Financing.

Earnings Quality and Unrecorded Events.

Analyzing the Financial Statements.

Comparisons across Time.

Comparison within the Industry.

Comparisons within the Financial Statements: Common-Size Statements and Ratio Analysis.

Predict Future Earnings and/or Cash Flow.

Annual Report Information and Predicting Stock Prices.

International Perspective: Financial Statement Analysis in an International Setting.

Appendix 5A. Financial Ratio (ROE) and Cash Flow Analysis.

Analyzing Financial Ratios.

Example of Ratio Analysis: Home Depot vs. Lowe’s.

Cash Flow Analysis.

Cash Flow Profiles.


6. The Current Asset Classification, Cash, and Accounts Receivable.

The Current Asset Classification.

The Relative Size of Current Assets across Industries.

Measures Using Current Assets: Working Capital, Current Ratio, and Quick Ratio.

The Economic Consequences of Working Capital, the Current Ratio, and the Quick Ratio.

Limitations of the Current Asset Classification.


Restrictions on the Use of Cash.

Proper Management of Cash.

Control of Cash.

Accounts Receivable.

Importance of Accounts Receivable.

Net Realizable Value: The Valuation Base for Accounts Receivable.

Cash Discounts.

The Allowance Method of Accounting for Bad Debts (Uncollectibles).

Inaccurate Bad Debt Estimates.

Accounting for Sales Returns.

Accounts Receivable from a User’s Perspective.

When Should a Receivable Be Recorded?

Balance Sheet Valuation of Receivables.

7. Merchandise Inventory.

The Relative Size of Inventories.

Accounting for Inventory: Four Important Issues.

Acquiring Inventory: What Costs to Capitalize?

What Items or Units to Include?

What Costs to Attach?

Carrying Inventory: The Perpetual Method.

Errors in the Inventory Count.

Selling Inventory: Which Cost Flow Assumption?

Specific Identification.

Three Inventory Cost Flow Assumptions: Averaging, FIFO, and LIFO.

Inventory Cost Flow Assumptions: Effects on the Financial Statements.

Inventory Cost Flow Assumptions: Effects on Federal Income Taxes.

Choosing an Inventory Cost Flow Assumption: Trade-Offs.

Ending Inventory: Applying the Lower-of-Cost-or-Market Rule.

The Lower-of-Cost-or-Market Rule and Hidden Reserves.

International Perspective: Japanese Business and Inventory Accounting.

8. Investments in Equity Securities.

Equity Securities Classified as Current.

The Existence of a Ready Market.

The Intention to Convert: Another Area of Subjectivity.

Trading and Available-for-Sale Securities.

Purchasing Trading and Available-for-Sale Securities.

Declaration and Receipt of Cash Dividends.

Sale of Securities.

Price Changes of Securities on Hand at the End of the Accounting Period. Reclassifications and Permanent Market Value Declines.

Mark-to-Market Accounting and Comprehensive Income.

Long-Term Equity Investments.

Accounting for Long-Term Equity Investments.

The Cost Method.

The Equity Method.

Some Cautions to Financial Statement Users about the Equity Method.

Business Acquisitions, Mergers, and Consolidated Financial Statements.


The Equity Method or Consolidated Statements?

Special Purpose Entities.

Accounting for Equity Investments: A Summary.

Preparing Consolidated Financial Statements for Multinationals.

Appendix 8A. Consolidated Financial Statements.

Accounting for Business Acquisitions and Mergers: The Purchase Method.

Other Issues Concerning Consolidated Financial Statements.

9. Long-Lived Assets.

The Relative Size of Long-Lived Assets.

Long-Lived Asset Accounting: General Issues and Financial Statement Effects.

An Overview of Long-Lived Asset Accounting.

Acquisition: What Costs to Capitalize?

The Acquisition of Land.

Lump-Sum Purchases.

Construction of Long-Lived Assets.

Postacquisition Expenditures: Betterments or Maintenance?

Cost Allocation: Amortizing Capitalized Costs.

Estimating the Useful Life and Salvage Value.

Revising the Useful-Life Estimate.

Cost Allocation (Depreciation) Methods.

Cost Allocation Methods and the Matching Principle.

How Does Management Choose an Acceptable Cost Allocation Method?

Depreciation Methods for Income Tax Purposes.

Disposal: Retirements, Sales, and Trade-Ins.

Retirement of Long-Lived Assets.

Sale of Long-Lived Assets.

Trade-Ins of Long-Lived Assets.

Intangible Assets.

Copyrights, Patents, and Trademarks.

The Costs of Developing Computer Software.


Organizational Costs.

Research and Development Costs.

International Financial Reporting Standards: Revaluations

of Property, Plant, and Equipment.


10. Introduction to Liabilities: Economic Consequences,

Current Liabilities, and Contingencies.

What Is a Liability?

The Relative Size of Liabilities on the Balance Sheet.

Reporting Liabilities on the Balance Sheet: Economic Consequences.

Stockholders and Investors.




Current Liabilities.

The Relative Size of Current Liabilities on the Balance Sheet. Valuing Current Liabilities on the Balance Sheet.

Reporting Current Liabilities: An Economic Consequence.

Determinable Current Liabilities.

Accounts Payable.

Short-Term Debts.

Dividends Payable.

Unearned Revenues.

Third-Party Collections.

Income Tax Liability.

Incentive Compensation.

Incentive Compensation.

Contingencies and Contingent Liabilities.

Contingent Liabilities: A Scenario 416 Accounting for Contingencies.

International Perspective: Moving Toward a Single Global Accounting System.

Appendix 10A. Retirement Costs: Pensions and Postretirement Health Care and Insurance.


Defined Contribution Plan.

Defined Benefit Plan.

Postretirement Health Care and Insurance Costs.

Appendix 10B. Deferred Income Taxes.

The Concept of Deferred Income Taxes.

Accounting Entries for Deferred Income Taxes.

Deferred Income Taxes: Additional Issues.

The Conservatism Ratio.

11 Long-Term Liabilities: Notes, Bonds, and Leases.

The Relative Size of Long-Term Liabilities.

The Economic Consequences of Reporting Long-Term Liabilities.

Basic Definitions and Different Contractual Forms.

Effective Interest Rate.

Installment and Non-Interest-Bearing Obligations.

Interest-Bearing Obligations.

Accounting for Long-Term Obligations: The Effective Interest Method.

Accounting for Long-Term Notes Payable.

Bonds Payable.

Bond Terminology.

The Price of a Bond.

The Effective Rate and the Stated Rate.

Accounting for Bonds Payable.

The Effective Interest Method and Changing Interest Rates.

Bond Redemptions.

Financial Instruments and Off-Balance-Sheet Risks.


Operating Leases.

Capital Leases.

Operating Leases, Capital Leases, and Off-Balance-Sheet Financing.

International Perspective: The Importance of Debt Financing in Other Countries.

Appendix 11A. The Determination of Bond Prices.

Determine the Effective (Actual) Rate of Return.

Determine the Required Rate of Return.

Compare the Effective Rate to the Required Rate.

Factors Determining Bond Prices.

Appendix 11B. Investing in Bonds.

Appendix 11C. Interest Rate Swaps and Hedging.

12. Stockholders’ Equity.

The Relative Importance of Liabilities, Contributed Capital, and Earned Capital.

Debt and Equity Distinguished.

Characteristics of Debt.

Characteristics of Equity.

Why Is It Important to

Distinguish Debt from Equity?

The Economic Consequences Associated with

Accounting for Stockholders’ Equity.

Accounting for Stockholders’ Equity.

Preferred Stock.

Common Stock.

Market Value.

Book Value.

Marketto-Book Ratio.

Par Value.

Accounting for Common and Preferred Stock Issuances.

Treasury Stock 516 Stock Options 520 Retained Earnings.

The Statement of Stockholders’ Equity.

International Perspective: The Rise of International Equity Markets.


13. The Complete Income Statement.

The Economic Consequences Associated with

Income Measurement and Disclosure.

The Measurement of Income: Different Measures for Different Objectives.

Financing, Investing, and Operating Transactions: A Framework.

Classifying Operating Transactions.

A Complete Income Statement: Disclosure and Presentation.

  1. Operating Revenues and Expenses: Usual and Frequent.
  2. Other Revenues and Expenses: Unusual or Infrequent.
  3. Disposal of a Business Segment.
  4. Extraordinary Items: Unusual and Infrequent.
  5. Changes in Accounting Principles.

Intraperiod Tax Allocation.

Earnings-Per-Share Disclosure.

Income Statement Categories: Useful for Decisions but Subjective.

International Perspective: Investments and Income Statement Disclosure.

14. The Statement of Cash Flows.

The Definition of Cash.

A General Description of the Statement of Cash Flows.

Cash Provided (Used) by Operating Activities.

Cash Provided by Investing Activities.

Cash Provided (Used) by Financing Activities.

How the Statement of Cash Flows Can Be Used.

Analyzing the Statement of Cash Flows 604 The Importance of Cash from Operating Activities.

The Importance of Significant Noncash Transactions.

The Statement of Cash Flows: Economic Consequences.

Deriving Cash Flow from Accrual Financial Statements.

Cash Provided (Used) by Operating Activities.

Cash Provided (Used) by Investing Activities.

Cash Provided (Used) by Financing Activities.

The Complete Statement of Cash Flows.

The Direct Method 617 The Indirect Method.

Analyzing the Statement of Cash Flows: An Application.

Summarizing the Cash Effects of Operating Transactions.

Summarizing the Cash Effect of Investing and Financing Transactions.

Two Additional Observations.

International Perspective: The Statement of Cash Flows.


A. The Time Value of Money.

B. Quality of Earnings Cases: A Comprehensive Review.

C. Home Depot.


Subject Index.

Company Index.

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