Accounting Class 6/03/2014 - Introduction

we offered and we're going to be covering some basic introduction to accounting concepts in terms this morning welcome to begin with when we talk about accounting we recognize the importance of the story that essentially is going to be told through reports that we call financial statements remember there are four we have the income statement which is going to tell us how's the company doing are they to match all the expenses incurred during the same period and whether or not they would result in a profit or net income we then progress to what is called the statement of owner's equity statement of retained earnings essentially what have we done with the profit are we keeping it in the company or are we distributing it to the owners we then go to the balance sheet and the balance sheet tells the part of the story about what's the value of assets properties of value that will benefit a company in the future how much debt do we have what do we owe our creditors and finally the net worth what belongs to the owners of the business we also have something called a statement of cash flows and that statement of cash flows essentially answers the question of where has cash come from and what do we use the cash for sometimes we call this statement of cash flows the statement of sources and uses so that's what the purpose is now how do we get to the numbers that will ultimately appear in the financial statements so the first part of our journey begins with determining how a company is going to raise money and we call those financing activities where will the capital a company needs come from what will be the source and essentially there are two you can either get owners to contribute we call that the owner contribution and we're gonna give that a nice big happy face and that's because whenever an owner essentially contributes something to a business whether that business is in the form of a small proprietorship partnership or larger corporation that ownership contribution always increases the value and that's because essentially what happens is the owners are giving money to the business and in exchange the business essentially is merely providing an opportunity for benefit the company has to become successful so that the investment made by the owner will ultimately be realized but as far as reporting the transaction on our financial statements we call that a win-win why the business has received the value of the money's transferred in from the owners and in exchange really all we've done is provided an opportunity in the future so the business doesn't really give anything tangible away second option for financing is if we borrow money and I always give this an unhappy face all right now does that mean every single time we have borrowings it is a bad business decision no of course not but the reason why I give it unhappy face is because the borrowing of money does place an obligation for repayment on the company so yes they've received the value the monies that were borrowed but they also have a corresponding liability or debt on the books of the company okay so when you borrow money what that does is it creates a liability and as we're going to see through our journey liabilities are obligations to repay debt in the future when we call owner contribution that is referred to as equity financing when we borrow money we refer to that as debt financing so if you're going to be involved in the financial community that's a lot of what you do you structure deals you advise clients as to what is the best way to raise capital so once we have decided how and usually for most companies it's a blend you don't just borrow money or you don't just take contributions or issue shares of stock you usually do a little bit of both the owner contribution especially if you're talking about a stock we call that an IPO an initial public offering that's when a company first issue shares of stock to the public the debt financing is something that will return to companies can do a lot more frequently you're not always taking contributions from owners or selling shares of stock we tend to do more of the debt financing on a continual basis after you've raised your capital after you have some money then a business has to decide what to do with it and generally those are referred to as our investment activities and when we have investment activities what a company needs to do is they need to acquire what are called assets an assets are going to provide a company with future value we always give our assets a happy face the hope is the assets that we acquire will provide us the opportunity very easily to repay those creditors all right so we're hoping that when we make the investment in the assets the assets we invest in will ultimately help us become more valuable the third and most probably the most important decision made by our management team is the operating activities and that's essentially why we do what we do IBM Facebook Twitter they're not in the business of borrowing money selling stock acquiring assets they're in the business of providing Internet services or computers or if your Starbucks you're selling coffee so what we call operating activities is essentially the day-to-day business that's your purpose all of our liabilities are going to be similar all liabilities represent debt money that has to be repaid in the future all assets will be similar all assets will provide future value when we get over to this segment of the decision-making and this really is what is referred to as the net worth piece it's more of a blended family and what I mean by that is some of these transactions and accounts will benefit and add value to our company and others will diminish the value of our company so why do we go into business well the first reason we go into business is because we want to earn revenue and we're gonna give that also a happy face earning revenue and you can do it in two ways you can either sell a product all right so you're selling computers you are having what is called sales revenue you can also earn revenue by providing a service so you go to a lawyer for some legal advice you go to a doctor for medical advice you hire an advertising agency that's what we refer to as service revenue and our economy the US based economy tends to be a little bit more in the service-oriented arena right now than we are more so in what we used to be which was manufacturing now the key to revenue is you have to have earned it and our guiding principles that we must adhere to as we tell the story of accounting are called generally accepted accounting principles known by the acronym GAAP and one of the primary pieces of the rules that we look at very closely is this principle which means we only want revenue that we have earned it can't be an idea it can't be a plan it can't be a hope from the service provider or the seller of the product their part in the process must be completed now we follow what is called a cruel based accounting generally accepted accounting principles recommends what is called accrual-based accounting and with a cruel based accounting as long as the revenues been earned we don't care whether it's been paid in cash or not so many times the earning of revenue will also trigger something called an account receivable so whenever you earn revenue what we say on account what that means is the seller or service provider has completed their job but the customer hasn't yet paid us there's a promise to pay us in the future and that promised to pay us in the future is called an account receivable so once we earn revenue unfortunately associated with that earning of revenue will be the fact that we will incur expenses and we're going to give expenses a sad face and we get expenses an unhappy face because expenses by definition are assets that have no future value salary expense rent expense utility expense it doesn't really matter what the first name is as long as the last name is expense we always place it in connection with the revenue that was earned during that time period and therefore there's another generally accepted accounting principle we follow and that's called the matching principle we want to make sure that all expenses incurred are going to be matched up in the same time period as the revenue that was generated so for example when we determine whether or not a company has earned a profit or what we call net income or a loss during a time period that time period is definite it's either a period that's covering a month or a quarter or a year and we report that information pertaining to revenue and expense on the piece of the story called the income statement so we're going to earn revenue yay unfortunately we're going to have expenses associated with that and the difference between revenue and expense will either create for us a profit which obviously would be good or a loss which obviously would not be good all right so revenue less expenses will generate for a company what is called the net income the profit or in some instances if the revenue is less than the expenses you will have a loss those are your day-to-day operational activities and the plan is that we're going to utilize assets very popular asset that we utilize especially for selling a product is inventory the goal is to sell the inventory in order to generate your revenue so these are the purpose in your investments you want to make sure that you're investing in the right amount of assets that will essentially enable you to generate a sufficient amount of revenue if you're a manufacturer if you're making the product that you sell you're also going to want to make sure you have a sufficient amount of equipment machinery and then your raw materials will consist your inventory will then consist of what we call raw materials well what happens if we have a profit again another decision must be made and we have two options we can keep it or we can pay it to the owners if we keep it the value of the company will increase all right so we call that in a corporation retained earnings I liken the retained earnings kind of to the piggy bank of the corporation you're putting the value aside for a future time period for sole proprietors or partnerships when the value is retained in the company what will happen is the owners capital account will go up so we always look very closely at what is the format of the business what is it that we initially decided when we formed our business and that will also determine a little bit of some of the account names we use whether you're a small business or a large corporation the owner contribution is the piece that's a little bit different liabilities are the same assets are the same revenue is the same expense is the same the only piece it's a drop different is the way in which we look at net worth if you pay it to the owners and many times that's the reason why people invest in your company for example in large corporations one of the reasons why the business is able to sell stock is because the investors called stockholders would like to share in the profits that's one of the benefits of ownership of the business if it's profitable I get some of it and so with a cooperation when you share in the profits we call that a dividend all right so if we're paying out a portion of the profit to the owners of a corporation it's called a dividend if on the other hand you have a small business entity similar to a dividend we call it a drawing dividends are going to reduce value as drawings will reduce value retained earnings will increase value as well if it's an owner capital account and so clearly if you were to open the books of IBM or Starbucks or Google you're not gonna see happy faces abounding in their reports but from a teaching vantage point I think when we're first learning some of the basic concepts and ideas it's good to be able to visualize what happens and obviously the goal always and we function in a capitalistic economy is to generate a sufficient amount of profit to make it worthwhile to those who believed in us and in essence provided the financing so the owners who contribute the money hope that we will be profitable and that will enhance their investment and clearly the creditors intent when they invest in us is that they expect repayment of the debt and usually that repayment will come with something called interest okay so those are the basic concepts and essentially it's very critical that in the very beginning of our process we are able to understand what an owner contribution represents what a liability is what an asset is what we mean by revenue what we mean by expense retained earnings and dividend for a corporation or owners capital and drawing for a small business and so essentially we take these financing activities decisions and we will ultimately provide information in the form of what I called earlier the financial statements the income statement the balance sheet etc but before we get to the point of preparing financial statements there are very specific steps that we must go through and we refer to these steps as the accounting cycle and really I liken them to rules there are very specific rules that we use in accounting to make sure that when the information is ultimately provided in the form of an annual port or the financial statements the information is useful it's relevant it's complete so that decision makers creditors and investors can make the best decisions possible so remember I said the accounting guidelines are called generally accepted accounting principles or GAAP we haven't exactly gotten together with the international community or not an agreement with all of the guidelines but many we have and those accounting guidelines essentially provide us with what is for lack of a better concept the do's and the don'ts and so we're gonna look at our accounting cycle and the accounting cycle is critical to ultimately having the information that is ultimately going to be reported in financial statements accurate so we start the process with what we call analyzing business transactions every single day corporations and small businesses engage in transactions they buy supplies they pay their rent they borrow money they make sales to their customers it's a wide array of different types of transactions and we want to make sure that these business transactions are reported or captured as accurately as possible because ultimately they're going to be part of a very important story called the financial statements so the first role in reporting these business transactions from an accounting viewpoint is there will always be two accounts affected and if there are more than two that's called a compound entry so when we first begin teaching accounting we try to keep it as basic as possible I like in everything we do in accounting to a seesaw we want to make sure that we're keeping our seesaw in balance if you don't have two people sitting on a seesaw it's no fun so there's got to be two accounts now what can those accounts consist of they can be assets properties of value they can be liabilities debt or they can be part of my blended family they can be revenue transactions expense transactions can pertain to either keeping value or making distributions to the owners so by account we mean that broad spectrum of asset liability or net worth rule number two there are only seven possible outcomes for any business transaction so even though we're just taking a beginning accounting class even if we were to be sitting at the boardroom at IBM making a very very complex decision there's still only seven possible outcomes that could take place and what are they but one is if you increase one asset you have to reduce another one a set up another asset death keep that seesaw unbalanced you could perhaps increase an asset and increase a liability now why do I liken it to a seesaw because what one of the fundamental aspects of accounting that we follow is something called the accounting equation everything we do in accounting is built upon this accounting equation it's like a seesaw what is the accounting equation its assets must be equal to liabilities plus net worth assets property's value and those assets some of those assets belong to the creditors and the remaining belongs to the owners okay so liabilities is what is owed to the creditors and this is what belongs to the owners the lenders are creditors the owners are the ones that in essence gave us money so my seesaw has assets on this side and liabilities and net worth on the other side and so if one asset goes up if you don't decrease another asset you have to either increase a liability or net worth which is our next option if an asset goes up your net worth would also have to go up and there are only two times that net worth goes up net worth goes up when owners contribute money yay and net worth goes up when we earn revenue all right we also have a situation where an asset will go down but another asset doesn't go up and so that is option where asset goes down but so does the liability so we've reduced the debt but in order to reduce that debt or that liability we had to pay it in cash is probably one of the most important assets a company has if an asset goes down and another asset didn't go up it could also be because our net worth went down and there are two times when we have an unhappy face with net worth that's when we incur an expense or we either pay a dividend or provide a drawing one two three four five these are by far the most common over here we'll see if we do nothing to an asset if a liability goes up then your net worth would have to go down so everything is happening on this side of your seesaw or if a liability goes down your net worth would have to go up we'll talk a little bit more about these two when we do accruals and adjustments but when we're first learning accounting we primarily see transactions that in some way shape or form involve an asset either cash is going up or cash is going down or equipments going up supplies are going up liabilities are going up etc okay so that's very very important now we also the next step when we're still in step one and I cannot stress to my students enough that the analysis of the business transactions is by far the most critical piece in the counting cycle because if you don't get that piece right everything else we do will be wrong we will just consistently carry that mistake along with us so we take a lot of care initially to make sure that the business transactions are analyzed correctly all right so we have to identify the two accounts it could be two assets could be an asset and liability could be an asset and net worth or could be a liability in a net worth okay if an asset goes up either another asset has to go down or a liability or net worth has to go up if an asset goes down either a liability has to go down or a net worth has to go down now once we're done figuring out the accounts deciding the outcome step C is determining whether to debit or credit debit and credit are literally Latin terms for left and right and there's no rhyme or reason why debits do what they do to assets and credits do what they do to assets and liabilities and so forth we've just determined that when we have a transaction and it is debited debits will always increase assets reduce liabilities and reduce net worth and remember the only time net worth goes down is if we have an expense or a dividend or if we're a small business that's it so when assets go up we debit when liabilities go down we debit when our net worth goes down we debit on the other hand when our assets go down we credit when our liabilities go up we credit and when our net worth goes up we credit and remember net worth goes up twice and that's when the owner makes a contribution or when we earn revenue those are the two times debiting and crediting is the foundation upon which everything we do in accounting is based so as we analyze business transactions and go through this multi-step process we have to make sure that we are understanding the importance of correctly identifying what's happening for example when a corporation or a business goes to the bank and borrows money that's a financing activity what's happening to the company two accounts are being impacted the cooperation is receiving cash from the bank yay our assets are going up but they now have an obligation or a liability to the bank to repay the money's borrowed that is a liability that also went up and so that would be outcome here said cash up liability bank loan up now once we've identified the two accounts and the outcome then we have to decide well how are we going to tell the story and we tell the story through debiting and crediting so in that transaction when our asset cash went up we would debit cash and our liability also went up we would credit the liability so another rule is with the debit and credit is every transaction will have one account debited and another account credited for alright so every transaction has one debit and one credit can it have more than a debit and a credit yes if you have compound transactions where you're impacting more than two accounts then you could have more debits than credits you could debit to accounts and only credit one account however in every business transaction your total debits must always equal your total credits remember my seesaw if you have more value on the debit side then you have on the credit side or vice-versa your seesaw is out of sync so throughout the process of accounting we are always focusing on this accounting equality and therefore the only way to maintain the accounting equation is by being consistent with the analysis of the transactions where we're saying okay it's got to be two accounts there's only seven possible outcomes there always has to be one account that we're debiting and another that we're crediting can be more but there has to be at least one of each and at the end the total of debits and credits must equal so step one is critical if you make the mistake and step one you've got a problem now once you've made all these decisions we can go to our second step which is record in the journal so once we've identified what accounts what the outcome is whether we're going to debit or credit we can then pick up the pen and put pen to paper when you record in a journal we refer to the journal as the book of original entry a journal is merely a piece of paper with columns that's pretty much what a journal looks like you have a date column you have an item or account name column you have a debit column and you have a credit column and when you record in a journal the account that is being debited always gets recorded first so let's return to my original example company goes to the bank borrows $10,000 in cash we've determined the two accounts that are being impacted are cash and bank loan cash is an asset it went up bank loan is a liability it also went up and based on my analysis here we're gonna debit the cash we're gonna credit the liability so today we would write the date whatever that is the account being debited is always recorded first and we put that under the debit column I always add a little error and again if you look at corporate America you're not gonna see in journals pluses and arrows and happy faces but it's just a visual so that you're seeing what's happening to my cash my cash is going up because I received that money from the bank the account being credited is always in debt indented a little bit to the right and usually liabilities have the last name payable so we're going to record under the credit column bank loan payable is the account name $10,000 credit and so you will go through every single business transaction in a similar way you record the account being debited first you put the amount under the debit column you indent a little bit to the right the account that is next being credited and you put that amount under the credit column remember in every business transaction your total debits and your total credits must equal if they don't your accounting equation will not be in balance all right once we're done with the journal the next step is to post or transfer that information to the ledgers every single account every asset account every liability account and my blended family our network revenue all the expenses the owner contribution for a cooperation that's common stock for a small business that's the owners capital account the dividend for the cooperation or the drawing for the small business they all have their own ledger accounts and what we do essentially is we transfer from the journal to the ledger and Ledger's really just look like big capital T's and as I said earlier debit means left and credit means right and so that's where we put the debit and credit in the ledger we put the debit on the left and we put the credit on the right and same idea I use my arrows and what we'll do essentially is we will transfer that's what post means the same information so this is transaction a I'm going to debit my cash $10,000 and I'm going to credit my bank loan payable $10,000 so every single transaction that you have analyzed and you have determined the names of the accounts what the outcome is and whether your debiting and crediting once you've record that information in the journal the journal is showing us the big picture what the total impact it had on the business the ledgers show us what the individual impact it had on each individual account and so that's where I would get my individual account balances in the ledger the fourth step is to prepare a trial balance and the trial balance is merely a listing of all of the asset that are in your ledger the liabilities that are in your ledger revenue accounts expense accounts dividend or drawing accounts it's a common stock or owner capital accounts you list them all in a trial balance you keep the families together all the assets are listed together all the liabilities are listed together and all of the owner's equity or net worth or stockholders equity same idea are listed together we expect assets to have a debit balance when you look in your ledger assets will normally have what we call a debit balance liabilities will normally have what is called a credit balance my blended family the owner contribution and the revenue will have credit balances the expense and dividends or drawing will have debit balances okay we call that the normal balance in your trial balance all assets are listed together they should all have debit balances all liabilities are listed together you should all have credit balances then we get to our equity the owner contribution common stock or capital account will have a credit balance revenue will have a credit balance expense will have a debit balance

Channel: Karin Colquitt

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Length: 44min 53sec (2693 seconds)

Published: Wed Jun 18 2014