Learn Accounting in 1 HOUR First Lesson: Debits and Credits

[Music] today we're going to learn how to do accounting with no nonsense no fluff no frills just what you need to know I'm assuming you are just started your very first accounting course but perhaps this is your first accountant or either way we have no exposure to accounting whatsoever by the end of this lesson I'll have you looking at the books of a fortune 500 company and I guarantee you're a no what you're looking at one of the greatest attractions of accounting is that the math is simple it's not like calculus or trigonometry where you need a scientific calculator to determine an answer that's just a number accounting only requires your basic four function calculator in fact you don't even need multiplication and division functions to do accounting but the best part of all is that accounting math always balances this keeps you on track and makes you feel warm and fuzzy inside when you're done the most important formula in all of accounting land is this one assets must equal liabilities plus equity equity is a residual amount that represents the value of your interest in the business in fact let's do some simple algebra to rework this formula to give you proof the value of the assets you own unless any liabilities you owed to others equals your equity we could also convert this formula into three conceptual boxes on the Left we have assets this box represents the value of our assets on the right we have a liabilities box and an equity box these boxes represent the value of the liabilities and the equity an asset is something you own a value that is cash or can be converted to cash in the future so obviously your bank account is an asset when someone owes you money it's called accounts receivable and that too is an asset inventory is something you can sell to convert to cash so that's an asset and if you hold any property or equipment that is also an asset because it can either be used to manufacture inventory or can be sold to a purchaser outright for cash a liability on the other hand isn't amount you owe to someone banks will loan us money and they expect us to pay the back suppliers will ship us Goods today and they'll ask us to pay them at a later date so in essence hold them money too we call this an Accounts Payable said another way your business assets need to be financed with money if you're using other people's money we call that a liability if its owner's money for instance your own we call it equity notice that the boxes are precisely lined up the asset box can never be larger than the combined liability and equity boxes still with me time now to learn accounting accounts used the terms debit and credit as a way of saying they're increasing or decreasing an account an account could be an asset account such as cash or it could be a liability account such as an account payable now you need to remember this part has it accounts always have a debit balance so if you have $100 in the bank account your books will record that has an asset with $100 debit the box on the right side the liabilities in the equity accounts tab credit balances because the box on the Left must always equal the boxes on the right you can add up all your asset debits and do the same for your credits in the liability and equity boxes and lo and behold you'll discover that they always equal for this reason when we populate these boxes with numbers to create a report we call this report a balance sheet let's just put some numbers in these boxes for fun and to help you connect a conceptual model to reality our assets are on the left beginning with cash of $100 pop quiz is this a debit or a credit amount yes as a debit amount assets are always dead counts below that we have accounts receivable of one thousand five hundred and forty three dollars wishes to say that someone owes us one thousand five hundred and forty three dollars we have inventory of one thousand three hundred and forty two dollars and some investments worth three hundred and seventy two dollars and property plant and equipment or six thousand eight hundred and thirty two dollars the total value of all the assets in the business is ten thousand six hundred and eighty nine dollars but we aren't entitled to that full amount because we owe other people money for some of these assets on the right hand side we list our liabilities we have a line of credit with the bank for five hundred and forty dollars in other words the bank is lent us five hundred and forty dollars on a short-term basis our suppliers the people who we buy our inventory from our own two thousand two hundred and ten dollars the bank or some other lender has given us a long term loan for three thousand eight hundred and fifty dollars and our total liabilities are six thousand six hundred dollars which is the amount we owe to other people which then leaves a residual amount of four thousand eighty nine dollars of equity which represents the value of our interest in the business this is not a bank account it's a mathematical representation of our interest the olders interest in the business and nothing more let's just test your understanding of this balance sheet let's just say your business sucks it sucks like a dot-com company around the turn of the century in other words the business just kept on losing money and instead of a positive four thousand eighty nine dollars in equity you've got a negative four thousand eighty nine dollars in equity my question to you is is that balance a debit or credit hmm indeed you have a debit balance when you have a negative balance of equity it's not normal but it is entirely possible you don't see this phenomenon in your assets or your liabilities you cannot have a negative asset or a negative liability but you can't have a positive or a negative equity Luca Pacioli is dubbed the father of modern accounting because he was the genius behind double entry bookkeeping he was the first to suggest that every transaction should be recorded with both a debit and a credit in the exact same amount to different accounts by doing this religiously and pardon the pun because he was a monk you preserve the integrity of our conceptual model that has this must always equal liabilities plus equity to understand the mechanics of accounting and performing bookkeeping you need to know just a little bit about accounting systems that balance sheet I just showed you moments ago is a report from an accounting system those numbers I shared with you don't happen by accident or all at once they are the results of dozens hundreds thousands sometimes millions of accounting entries to record the transactions of the business so let me show you how an accounting system works there are five stages to a typical accounting system and let's look at each of these in turn your chart of accounts is a listing of all your accounts within the categories of assets liabilities and equity we haven't talked yet about revenue and expense accounts but really they are just a subcategory of equity think of your chart of accounts as setting up and recording buckets for various transaction types you can have as many accounting buckets as you like it all depends on what sorts of detailed information you want coming out of the backend the idea behind setting up a chart of accounts is to aggregate like activity in the same account so for instance you might want to capture all your travel expenses in one account so you set up a travel expense account in your chart of accounts if you have six bank accounts you may want to set up six separate general ledger accounts to track them journals are where we record business activities think of all sorts of activities that could happen in a business from selling product to making payroll to collecting receivables to buying inventory to paying suppliers all these sorts of transactions give rise to what we call in accounting a journal entry a journal entry is composed of an equal amount of debits and credits and the respective accounts you want the transaction hagrid gated within when you're using accounting software you may see various input screens some look like a standard journal entry as you see before you this one comes from a module of the accounting system we call the general journal which is a free hand way of allowing you to debit and credit any account of will journal entries always have a description so that the rationale for the journal entry is documented and clear then you pick up the related accounts from the chart of account finally you input a mouse to debit one or more accounts and the same for crediting other accounts when you're in a sales or a purchasing module it's common that you won't even see the words debit or credit anywhere on the stream as I show you here however rest assured that NBI the interface the system is doing the matching of the debits and the credits on your behalf all these debits and credits get added together in what we call ledgers a general ledger will give you the details of all transactions that have been posted to a particular account so here I'm showing you the general ledger detail of the cash account there are three debit entries for cash that has been received and deposited of one hundred two hundred and five hundred dollars respectively and one credit entry for a hundred dollars for an expense note that these are four separate transactions with four separate journal entries now in this view you're only seeing one side of the journal entry to see the other side you have to look in the other accounts so for instance the $800 travel expense was a credit to cash as cash left the business and it was debited to the travel expense account for the same $800 a trial balance is a listing of all the balances in each of the general ledger accounts once again that's the oles handiwork insures that all the debits equal all the credits the only thing relevant about the totals is that they match the total number is otherwise meaningless you have a trial balance you can prepare financial statements which we will cover in another lesson and front the trial bouts we sort the accounts according to whether they are assets liabilities or equity and for the time being allow me to continue saying that the equity accounts include revenue and expense will break out these accounts into a separate statement in a moment compared this statement to our conceptual model assets total two hundred and seventy six dollars and eighty five cents this is a debit balance liabilities total eight hundred and twenty two dollars and fifty cents this is a credit balance equity is a negative five hundred and forty five dollars and sixty five cents is this a debit or a credit that's right it's a debit because the business has lost five hundred and ninety five dollars and sixty five cents so far if the business had earned income it would have been shown as a positive number and a credit balance pause the video and ask yourself whether you understand how numbers get processed through an accounting system I hope that's clear because now we're going to add another layer I've alluded to revenue and expense accounts and we saw a few of these when we were looking at the accounting system so far all I told you is that these accounts are really part of equity in truth we often want information about how much money we are making over a given period of time so there's another statement that helps give a little more insight into equity namely the statement of changes in equity to complete your understanding of the debits and credits we need to understand the accounts that make up the statement of changes in equity this statement tracks the continuity of the balance of equity from the beginning of the period to the end of the period there are two items to consider in this statement first transactions on account of income and secondly transactions on account of capital let's start with income transactions which are essentially the transactions of the business activity that produce revenue and expenses here we take all the revenue and expense accounts from the trial and we prepare what is called an income statement the income statement tells us how much money the business has made over a period of time typically we measure income in terms of a month a quarter or a physical year when we collect cash from customers we debit cash and the credit goes to revenue think of revenue has a positive equity and what is positive equity a debit or credit that's right it's a credit revenues are always a credit expenses arise when we pay out our bills we credit cash to reduce an asset account and the offsetting debit goes to an expense account once again think of expenses as negative equity as we saw earlier negative equity and expenses by definition are therefore debit balances the net amount of revenue less expenses is your net income if your business has made money you should have more assets none of liabilities at the end of the period than you did at the beginning which results in a net credit to your equity balance on the other hand if your expenses are higher than your revenues then you will experience a net loss which is a debit to your equity balance note that the net income is not note that net income per se is not a general ledger account net income is simply a mathematical difference between revenue and expenses item number 2 which deals with the transactions on account of capital is the other way equity can change during a period when the owners contribute or withdraw assets to or from the business the balance of equity changes so for instance say you put in $50 of cash into the business to get started your journal entry would be to debit cash by $50 and credit equity by $50 if later in the year the business writes you a check to allow you to withdraw $100 from the business this time you would credit cash for $100 and debit equity for $100 for new accounting students the statement of changes in equity is the hardest one to figure out so we'll come back to it but for this lesson just realize that every journal entry you make there are two sides and often where those sides impacts equity either directly through contributions and drawings or indirectly through the revenue and expense accounts let's summarize how you prepare journal entries since that seems to be the key starting place once you have your turn of account setup basically there are three steps in step one something happens in the business that warrants a journal entry there are hundreds of different types of journal entries that can arise but to keep things simple for our example let's just say that you have completed a babysitting job and you've collected cash from your client of $40 this is a reportable transaction so let's see if we can work through the accounting in step two we prepare the journal entry considering your turn of accounts and our debits and credits when we collect cash we want to increase our cash account remember that cash is an asset and as it accounts are debit balances therefore to increase cash we will debit cash by $40 this will get added to the balance that's already in the general ledger account but now we need the other side of the entry we need to think of an account to credit the credit side does not impact a liability account because we don't know that $40 to anybody in fact it's ours to keep so it must go into equity so moments ago I just finished telling you that equity is usually made up of either owner's contributions and withdrawals or the income accounts you need to decide is this an income transaction or a capital transaction take a moment to consider hopefully you identified that this is an income transaction we made money for services we rendered therefore the credit side of this entry will be to an account like sales or revenue for the $40.00 we collected the final step is to put the entry into the general ledger the computer will do this for us if we're using software but I'm pretty sure your professors are going to ask to do this manually to show your understanding to post the entry you would debit the cash account for $40 which means add $40 to whatever balance is currently in the cash account you'll do the same with the credit to the sales account in later lessons I'll demonstrate the mechanics using a spreadsheet hey pull it out your entry has been posted and you can move on to your next transaction so let's summarize what you need to know from this lesson first of all assets must equal liabilities plus equity second total debits must always equal total credits thirdly there's no such thing as a one-sided journal entry for every transaction must adjust at least two accounts one credit and one debit though you can have more than two accounts included in the same journal entry but that's another lesson number five assets must have debit balances liabilities must have credit balances finally number six the change in equity must be reconciled by calculating net income and adjusting for owner contributions in drawings do you think you got it time now to show you what this looks like in the real world I present to you the financial statements hub home depot one of the world's largest retailers I know what you're thinking fifteen minutes ago you'd never heard of accounting and now I'm about to show you the financials of one of the largest companies in the world but I believe in you and I think you can do it let's start with the balance sheet there are the total assets for a billion and change which bounce to the total liabilities and equity notice the various types of assets most of which we talked about will save goodwill for much later lessons we have liabilities 28 billion dollars at all payables and debt just like I told you a few accounts like deferred income taxes are dealt with by those of you who will go on to intermediate accounting in your second or third year program and stockholder equity this is a little bit more complicated than what I presented but the idea is exactly the same the Home Depot has 12 and a half billion dollars of equity on the books but the balance sheet alone doesn't tell us the whole story about what happened throughout the year only where the company is on February the 2nd 2014 to get the rest of the story we need to drill further into the changes in equity so let's bring up the statement of changes in equity the first line says net earnings aha we know where this comes from this comes from the income statement the Home Depot has about 79 billion dollars in sales which is a credit in the accounting system and generate a positive income and positive increase in equity of 5.4 billion dollars that's one heck of a big credit so that explains a big part of the change in the equity the rest of the change in equity comes from contributions and withdrawals so by looking down the statement further we see that there was some stock options exercised this is a positive contribution to equity as when you exercise a stock option and older gives the company money and the company issue stock will ignore the stuff in the middle as this as advanced accounting stuff but at the bottom we have dividends which are showing is a negative number because these shareholders and Home Depot are taking a cut of the money earned by the company holy crap did you just understand the statements of a fortune 500 company I surely hope so it's the first step to becoming an accountant finally if you want to practice your journal entries more I've literally got an app for that download general ledger to your electronic device today it allows you to practice anywhere anytime it'll also connect you to resources on my website so have some fun with it and in no time at all you'll master the debits and credits that's all for this lesson but be sure to look for other lessons to help you develop your bookkeeping and accounting skills [Music]

Channel: Executive Finance

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Keywords: Blair Cook, finance learning academy, accounting, debits, credits, bookkeeping, financial statements, Accountancy (Field Of Study), Debits And Credits, accounting 101, accounting learn one hour, accounting learn 1 hour, accounting fast, intro accounting, introduction to accounting, accounting how to, accounting learn fast, book keeping, jen nicholson, principles of accounting

Id: ii91oi0OpXM

Length: 22min 5sec (1325 seconds)

Published: Wed Jun 25 2014