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S P O T L I G H T
A P P L E C O M P U T E R , I N C.
How do you manage your music library? You may use Apple Computer’s iTunes® , which along with the
company’s iPods® generates lots of income for the company.
How does Apple determine the amount of its revenues, expenses, and net income? Like all other
companies, Apple Computer has a comprehensive accounting system. Apple’s income statement (statement
of operations) is given at the start of this chapter. The income statement shows that during fiscal year 2006,
Apple made over $19 billion of sales and earned net income of $2 billion. Where did those figures come
from? In this chapter, we’ll show you.
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54 ■ Chapter 2 Transaction Analysis
Chapter 1 introduced the financial statements. Chapter 2 will show
you how companies actually record the transactions that eventually become part of
the financial statements.
LEARNING OBJECTIVES
1 Analyze transactions
2 Understand how accounting works
3 Record transactions in the journal
4 Use a trial balance
5 Analyze transactions using only T-accounts
Apple Computer, Inc.
Statement of Operations (Adapted)
Fiscal Year Ended September 30, 2006
Net sales........................................................................ Cost of goods sold......................................................... Gross profit................................................................... Operating expenses: Research and development expense ............................ Selling, general, and administrative expense ............... Total operating expenses.......................................... Operating income (loss) ................................................ Other income ................................................................ Income before income taxes .......................................... Income tax expense ....................................................... Net income....................................................................
(In billions) 2006
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TRANSACTIONS
Business activity is all about transactions. A transaction is any event that has a financial impact on the business and can be measured reliably. For example, Apple Computer pays programmers to create iTunes ®^ software. Apple sells computers, borrows money, and repays the loan—three separate transactions. But not all events qualify as transactions. iTunes ®^ may be featured in Showtime Magazine and motivate you to buy an Apple iPod. The magazine article may create
For more practice and review of accounting cycle concepts, use ACT, the
Accounting Cycle Tutorial, online at www.prenhall.com/harrison. Margin
logos like this one, directing you to the appropriate ACT section and
material, appear throughout Chapters 1, 2, and 3. When you enter the tutorial,
you’ll find three buttons on the opening page of each chapter module. Here’s
what the buttons mean: Tutorial gives you a review of the major concepts,
Application gives you practice exercises, and Glossary reviews important terms.
56 ■ Chapter 2 Transaction Analysis
Land. The Land account shows the cost of the land Apple uses in its operations.
Buildings. The costs of Apple’s office building, manufacturing plant, and the like appear in the Buildings account.
Equipment, Furniture, and Fixtures. Apple has a separate asset account for each type of equipment, for example, Manufacturing Equipment and Office Equipment. The Furniture and Fixtures account shows the cost of these assets, which are similar to equipment.
Liabilities
Recall that a liability is a debt. A payable is always a liability. The most common types of liabilities include:
Accounts Payable. The Accounts Payable account is the direct opposite of Accounts Receivable. Apple’s promise to pay a debt arising from a credit purchase of inventory or from a utility bill appears in the Accounts Payable account.
Notes Payable. A note payable is the opposite of a note receivable. The Notes Payable account includes the amounts Apple must pay because Apple signed notes promising to pay a future amount. Notes payable, like notes receivable, also carry interest.
Accrued Liabilities. An accrued liability is a liability for an expense you have not yet paid. Interest Payable and Salary Payable are accrued liability accounts for most companies. Income Tax Payable is another accrued liability.
Stockholders’ (Owners’) Equity
The owners’ claims to the assets of a corporation are called stockholders’ equity, shareholders’ equity , or simply owners’ equity. A corporation such as Apple Computer uses Common Stock, Retained Earnings, and Dividends accounts to record changes in the company’s stockholders’ equity. In a proprietorship, there is a single capital account. For a partnership, each partner has a separate owner equity account.
Common Stock. The Common Stock account shows the owners’ investment in the corporation. Apple Computer receives cash and issues common stock to its stockholders. A company’s common stock is its most basic element of equity. All cor- porations have common stock.
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STOP & think...
Name two things that (1) increase Apple Computer’s stockholders’ equity and (2) decrease Apple’s
stockholders’ equity.
Answer:
(1) Increases in equity: Sale of stock and net income (revenue greater than expenses).
(2) Decreases in equity: Dividends and net loss (expenses greater than revenue).
Accounting for Business Transactions ■ 57
Retained Earnings. The Retained Earnings account shows the cumulative net income earned by Apple Computer over the company’s lifetime, minus its cumulative net losses and dividends.
Dividends. After profitable operations, the board of directors of Apple Computer may (or may not) declare and pay a cash dividend. Dividends are optional; they are decided by the board of directors. The corporation may keep a separate account titled Dividends , which indicates a decrease in Retained Earnings.
Revenues. The increase in stockholders’ equity from delivering goods or services to customers is called revenue. The company uses as many revenue accounts as needed. Apple Computer uses a Sales Revenue account for revenue earned by selling its prod- ucts. Apple has a Service Revenue account for the revenue it earns by providing services to customers. A lawyer provides legal services for clients and also uses a Service Revenue account. A business that loans money to an outsider needs an Interest Revenue account. If the business rents a building to a tenant, the business needs a Rent Revenue account.
Expenses. The cost of operating a business is called expense. Expenses decrease stockholders’ equity, the opposite effect of revenues. A business needs a separate account for each type of expense, such as Cost of Goods Sold, Salary Expense, Rent Expense, Advertising Expense, Insurance Expense, Utilities Expense, and Income Tax Expense. Businesses strive to minimize expenses and thereby maximize net income.
ACCOUNTING FOR BUSINESS TRANSACTIONS
Example: Genie Car Wash, Inc.
To illustrate the accounting for transactions, let’s return to Genie Car Wash, Inc. In Chapter 1’s End-of-Chapter Problem, Van Gray opened Genie Car Wash, Inc., in April 20X9. We consider 11 events and analyze each in terms of its effect on Genie Car Wash. We begin by using the accounting equation. In the second half of the chapter, we record transactions using the journal and ledger of accounting.
Transaction 1. Gray and a few friends invest $50,000 to begin Genie Car Wash and the business issues common stock to the stockholders. The effect of this transac- tion on the accounting equation of Genie Car Wash, Inc., is a receipt of cash and issuance of common stock, as follows:
Every transaction’s net amount on the left side of the equation must equal the net amount on the right side. The first transaction increases both the cash and the com- mon stock of the business. To the right of the transaction we write “Issued stock” to show the reason for the increase in stockholders’ equity.
Liabilities
Cash = Common Stock
(1) + 50,000 + 50,000 Issued stock
Assets
Type of Stockholders’
Equity Transaction
Stockholders’
+ Equity
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OBJECTIVE
1
Analyze transactions
Accounting for Business Transactions ■ 59
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Liabilities
Assets +
Land Common Stock 50,
Cash + + 10,
Bal. (3) Bal. 3,
Accounts Payable
Stockholders’ Equity
Supplies
Liabilities
Assets +
Land
Common Stock 50,
Cash 10,
Bal. (4) Bal. 3,
Accounts Payable
Retained Earnings
+ 7,000 Service revenue
Type of
Stockholders’
Stockholders’ Equity Equity Transaction
Supplies
To the right we record “Service revenue” to show where the $7,000 of increase in Retained Earnings came from.
Transaction 5. Genie performs service on account, which means that Genie lets some customers pay later. Genie earns revenue but doesn’t receive the cash immedi- ately. In transaction 5, Genie cleans a fleet of UPS delivery trucks, and UPS promises to pay Genie $3,000 within 1 month. This promise is an account receivable—an asset—of Genie Car Wash. The transaction record follows.
Liabilities
Assets +
Common Stock 50,
Cash 17,
Bal. (5) Bal. 3,
Accounts Payable
Retained Earnings
+ 3,000 Service revenue
Type of
Stockholders’
Stockholders’ Equity Equity Transaction
Supplies
Accounts Receivable 3,
The new asset is Supplies, and the liability is an Account Payable. Genie signs no formal promissory note, so the liability is an account payable, not a note payable.
Transaction 4. Genie earns $7,000 of service revenue by providing services for customers. The business collects the cash. The effect on the accounting equation is an increase in the asset Cash and an increase in Retained Earnings, as follows:
60 ■ Chapter 2 Transaction Analysis
It’s performing the service that earns the revenue—not collecting the cash. Therefore, Genie records revenue when it performs the service—regardless of whether Genie receives cash now or later.
Transaction 6. During the month, Genie Car Wash pays $2,700 for the following expenses: equipment rent, $1,100; employee salaries, $1,200; and utilities, $400. The effect on the accounting equation is:
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Liabilities
Assets +
Common Stock 50,
Cash 17,
Bal. (6)
Bal. 3,
Accounts Payable
Retained Earnings
− 1,100 Rent expense
Type of
Stockholders’
Stockholders’ Equity Equity Transaction
Supplies
Accounts Receivable 3,
− 1,200 Salary expense
− 400 Utilities expense
The expenses decrease Genie’s Cash and Retained Earnings. List each expense sepa- rately to keep track of its amount.
Transaction 7. Genie pays $1,900 on account, which means to pay off an account payable. In this transaction Genie pays the store from which it purchased supplies in transaction 3. The transaction decreases Cash and also decreases Accounts Payable as follows:
Liabilities
Assets +
Common Stock 50,
Cash 14,
Bal. (7) Bal. 1,
Accounts Payable
Retained
Stockholders’ Equity
Supplies
Accounts Receivable 3,
Transaction 8. Van Gray, the major stockholder of Genie Car Wash, paid $30, to remodel his home. This event is a personal transaction of the Gray family. It is not recorded by the Genie Car Wash business. We focus solely on the business entity, not on its owners. This transaction illustrates the entity concept from Chapter 1.
Transaction 9. In transaction 5, Genie performed services for UPS on account. The business now collects $1,000 from UPS. We say that Genie collects the cash on
62 ■ Chapter 2 Transaction Analysis
The dividend decreases both the Cash and the Retained Earnings of the business. But dividends are not an expense.
Transactions and Financial Statements
Exhibit 2-1 summarizes the 11 preceding transactions. Panel A gives the details of the transactions, and Panel B shows the transaction analysis. As you study the exhibit, note that every transaction maintains the equality:
Exhibit 2-1 provides the data for Genie Car Wash’s financial statements:
Assets = Liabilities + Stockholders’ Equity
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Assets Liabilities +
Common Stock
Cash + +
Accounts Payable
Retained
Type of
Stockholders’
Stockholders’ Equity Equity Transaction
Supplies
Accounts Receivable
50,000 50,000 Issued stock
+ 7,000 + 7,000 Service revenue
+ 3,000 + 3,000 Service revenue
− 1,100 − 1,100 Rent expense
− 400 − 400 Utilities expense
− 1,200 − 1,200 Salary expense
− 2,100 − 2,100 Dividends
PANEL B—Transaction Analysis
Income Statement Data
Balance Sheet Data
Statement of RetainedEarnings Data
Bal.
Statement of Cash Flows Data
PANEL A—Transaction Details (1) Received $50,000 cash and issued stock to the owners (2) Paid $40,000 cash for land (3) Bought $3,700 of supplies on account (4) Received $7,000 cash from customers for service revenue earned (5) Performed services for a customer on account, $3, (6) Paid cash expenses: rent, $1,100; employee salary, $1,200; utilities, $
(7) Paid $1,900 on the account payable created in transaction 3 (8) Major stockholder paid personal funds to remodel home, not a transaction of the business (9) Received $1,000 on account (10) Sold land for cash at the land’s cost of $22, (11) Declared and paid a dividend of $2,100 to the stockholders
E X H I B I T 2 - 1 Transaction Analysis: Genie Car Wash, Inc.
Accounting for Business Transactions ■ 63
■ (^) Income statement data appear as revenues and expenses under Retained Earnings. The revenues increase retained earnings; the expenses decrease retained earnings. ■ (^) The balance sheet data are composed of the ending balances of the assets, liabilities, and stockholders’ equities shown at the bottom of the exhibit. The accounting equation shows that total assets ($57,000) equal total liabilities plus stockholders’ equity ($57,000). ■ (^) The statement of retained earnings repeats net income (or net loss) from the income statement. Dividends are subtracted. Ending retained earnings is the final result. ■ (^) Data for the statement of cash flows are aligned under the Cash account. Cash receipts increase cash, and cash payments decrease cash.
Exhibit 2-2 shows the Genie Car Wash financial statements at the end of April, the company’s first month of operations. Follow the flow of data to observe the following:
1. The income statement reports revenues, expenses, and either a net income or a net loss for the period. During April, Genie earned net income of $7,300. Compare Genie’s income statement with that of Apple Computer at the begin- ning of the chapter. The income statement includes only 2 types of accounts: revenues and expenses. 2. The statement of retained earnings starts with the beginning balance of retained earnings, (zero for a new business). Add net income for the period (arrow ①), subtract dividends, and compute the ending balance of retained earnings ($5,200). 3. The balance sheet lists the assets, liabilities, and stockholders’ equity of the business at the end of the period. Included in stockholders’ equity is retained earnings, which comes from the statement of retained earnings (arrow ②).
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Mid-Chapter Summary Problems ■ 65
MID-CHAPTER SUMMARY PROBLEM
Shelly Herzog opens a research service near a college campus. She names the corporation
Herzog Researchers, Inc. During the first month of operations, July 20X3, the business
engages in the following transactions:
a. Herzog Researchers, Inc., issues its common stock to Shelly Herzog, who invests
$25,000 to open the business.
b. The company purchases on account office supplies costing $350.
c. Herzog Researchers pays cash of $20,000 to acquire a lot next to the campus. The com-
pany intends to use the land as a building site for a business office.
d. Herzog Researchers performs research for clients and receives cash of $1,900.
e. Herzog Researchers pays $100 on the account payable it created in transaction b.
f. Herzog pays $2,000 of personal funds for a vacation.
g. Herzog Researchers pays cash expenses for office rent ($400) and utilities ($100).
h. The business sells a small parcel of the land for its cost of $5,000.
i. The business declares and pays a cash dividend of $1,200.
❙ Required
1. Analyze the preceding transactions in terms of their effects on the accounting equation
of Herzog Researchers, Inc. Use Exhibit 2-1, Panel B as a guide.
2. Prepare the income statement, statement of retained earnings, and balance sheet of
Herzog Researchers, Inc., after recording the transactions. Draw arrows linking the
statements.
Solutions ❙ Requirement 1
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Assets Liabilities +
Common Stock
Cash + +
Accounts Payable
Retained
Type of
Stockholders’
Stockholders’ Equity Equity Transaction
Office Supplies
- 25,000 + 25,000 Issued stock
- 1,900 + 1,900 Service revenue
− (^400) Rent expense
− 1,200 Dividends
PANEL B—Analysis of Transactions
Bal.
(a) (b) (c) (d) (e) (f) (g)
(h) (i)
Not a transaction of the business
− 100 Utilities expense
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Herzog Researchers, Inc.
Income Statement
Month Ended July 31, 20X
Herzog Researchers, Inc.
Statement of Retained Earnings
Month Ended July 31, 20X
Liabilities
Herzog Researchers, Inc.
Balance Sheet
July 31, 20X
Accounts payable ............................ Stockholders’ Equity Common stock................................ Retained earnings............................ Total stockholders’ equity............. Total liabilities and stockholders’ equity......................
Assets Cash............................... Office supplies................ Land...............................
Total assets.....................
Revenues Service revenue................. Expenses Rent expense .................... Utilities expense ............... Total expenses .................. Net income................................
Retained earnings, July 1, 20X3................. Add: Net income for the month .................
Less: Dividends .......................................... Retained earnings, July 31, 20X3...............
The analysis in the first half of this chapter can be used, but it is cumbersome. Apple
Computer has hundreds of accounts and millions of transactions. The spreadsheet to
account for Apple’s transactions would be huge! In the second half of this chapter we dis-
cuss double-entry accounting as it is actually used in business.
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E X H I B I T 2 - 4 The Accounting Equation after Genie Car Wash’s First Transaction
Cash
Stock- holders’ Equity
Cash Common Stock
Debit for increase, 50,
Credit for increase, 50,
To illustrate the ideas diagrammed in Exhibit 2-3, let’s review the first transac- tion. Genie Car Wash received $50,000 and issued (gave) stock. Which accounts are affected? The Cash account and the Common Stock account will hold these amounts:
The amount remaining in an account is called its balance. This first transaction gives Cash a $50,000 debit balance and Common Stock a $50,000 credit balance. Exhibit 2-4 shows this relationship. Genie’s second transaction is a $40,000 cash purchase of land. This transaction decreases Cash with a credit and increases Land with a debit, as shown in the follow- ing T-accounts (focus on Cash and Land):
Cash Common Stock
Bal. 50,000 Credit for Bal. 50, decrease, 40, Bal. 10,
Land
Debit for increase, 40, Bal. 40,
E X H I B I T 2 - 3
Credit
Debit −
Liabilities
Credit −
Debit
Assets =^ +
Credit
Debit −
Stockholders’
Equity
Accounting
Equation
Rules of
Debit and
Credit
Accounting Equation and the Rules of Debit and Credit
Double-Entry Accounting ■ 69
After this transaction, Cash has a $10,000 debit balance, Land has a debit balance of $40,000, and Common Stock has a $50,000 credit balance, as shown in Exhibit 2-5.
Additional Stockholders’ Equity Accounts: Revenues and Expenses
Stockholders’ equity also includes the two categories of income statement accounts, Revenues and Expenses:
■ (^) Revenues are increases in stockholders’ equity that result from delivering goods or services to customers. ■ (^) Expenses are decreases in stockholders’ equity due to the cost of operating the business.
Therefore, the accounting equation may be expanded as shown in Exhibit 2-6. Revenues and expenses appear in parentheses because their net effect—revenues minus expenses—equals net income, which increases stockholders’ equity. If expenses exceed revenues, there is a net loss, which decreases stockholders’ equity.
The Accounting Equation after Genie
Car Wash’s First Two Transactions
E X H I B I T 2 - 5
Land
Cash $50, Stock- holders’ Equity
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E X H I B I T 2 - 6 Expansion of the Accounting Equation
Common Stock
+ Retained Earnings
Revenues
Dividends
Statement of Retained Earnings
Income Statement
- Expenses
Stockholders’ Equity
Stockholders’ Equity
Liabilities
Liabilities
Assets
Assets = + Common Stock +^ – +
Retained Earnings Dividends^ (Revenues – Expenses)
Income Statement
Statement of Retained Earnings
Recording Transactions ■ 71
Step 3 Journalize the transaction as follows:
When analyzing a transaction, first pinpoint the effects (if any) on cash. Did cash increase or decrease? Typically, it is easiest to identify cash effects. Then identify the effects on the other accounts.
Copying Information (Posting) from the Journal to the Ledger
The journal is a chronological record of all company transactions listed by date. But the journal does not indicate how much cash or accounts receivable the business has. The ledger is a grouping of all the T-accounts, with their balances. For example, the balance of the Cash T-account shows how much cash the business has. The balance of Accounts Receivable shows the amount due from customers. Accounts Payable shows how much the business owes suppliers on open account, and so on. In the phrase “keeping the books,” books refers to the accounts in the ledger. In most accounting systems, the ledger is computerized. Exhibit 2-8 shows how the asset, liability, and stockholders’ equity accounts are grouped in the ledger.
Entering a transaction in the journal does not get the data into the ledger. Data must be copied to the ledger—a process called posting. Debits in the journal are
The Ledger (Asset, Liability, and
Stockholders’ Equity Accounts)
E X H I B I T 2 - 8
Individual liability accounts
Individual stockholders’ equity accounts
Accounts Payable
Common Stock
Individual asset accounts
Cash
Ledger
All individual accounts combined make up the ledger.
JOURNAL
Apr. 2 Cash 50, Common Stock Issued common stock.
Date Accounts and Explanation Debit Credit
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E X H I B I T 2 - 10 Flow of Accounting Data
AssetsCash 50,
Liabilities Deposits
=
BANKBANK BANK
Transaction Occurs
Transaction Analyzed
Transaction Entered in the Journal
Amounts Posted to the Ledger Accounts
50,000 00
listchecks50,000 00
mxmmxmmxmxmmxmmxmmmmx
000 00 total
LedgerAccounts and Explanations CashCommon StockInitial investment by owner 50, Cash
Cash 50, Common Stock Issued common stock.
Journal entry
The Flow of Accounting Data
Exhibit 2-10 summarizes the flow of accounting data from the business transaction to the ledger.
always posted as debits in the accounts, and likewise for credits. Exhibit 2-9 shows how Genie Car Wash’s stock issuance transaction is posted to the accounts.
E X H I B I T 2 - 9 Journal Entry and Posting to the Accounts
PANEL A—Journal Entry:
PANEL B—Posting to the Accounts:
Cash Common Stock
Cash 50, Common Stock Issued common stock.
Accounts and Explanation Debit Credit
Let’s continue the example of Genie Car Wash, Inc., and account for the same 11 trans- actions we illustrated earlier. Here we use the journal and the accounts. Each journal entry posted to the accounts is keyed by date or by transaction number. This linking allows you to locate any information you may need.
Transaction 1 Analysis. Genie Car Wash, Inc., received $50,000 cash from the stockholders and in turn issued common stock to them. The journal entry, account- ing equation, and ledger accounts follow.
