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're just starting your very first accounting course. Or perhaps this is your first exam. Either way, you 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 gonna know 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, less any liabilities you owe to others, equals your equity. We can 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 it can be sold to a purchaser outright for cash. A liability, on the other hand is an amount you owe to someone. banks will loan us money, and they expect us to pay them back. suppliers will ship us goods today. And they'll ask us to pay them at a later date. So we in essence, owe them money too.

We call this and accounts payable. set 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 it's 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. accountants use the terms debit and credit as a way of saying they're increasing or decreasing and account and account could be an asset account such as cash, or it could be a liability account such as an accounts payable. Now you need to remember this part has an 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 and 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 acid debits, and do the same for your credits in the liability and equity boxes. Hello the whole you'll discover that they always equal For this reason, we populate these boxes with numbers.

To create a report. We call this report hub 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, it's a debit amount. Assets are always debit accounts.

Below that we have accounts receivable of $1,543 which is to say that someone owes us $1,543. We have inventory of $1,342 and some investments worth $872. In property, plant and equipment are $6,832. The total value of all the assets in the business is $10,689. 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 $540.

In other words, the bank has lent us $540 on a short term basis, our suppliers, the people who we buy our inventory from our Oh $2,210. The bank or some other lender has given us a long term loan for $3,850. And our total liabilities are $6,600, which is the amount we owe to other people, which then leaves a residual amount of $4,089 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 owners 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. a.com company around the turn of the century. In other words, the business just kept on losing money. And instead of a positive $4,089 in equity, you've got a negative $4,089 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 in 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 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 two different accounts by doing this religiously and pardon the pun, because He was a mock, you preserve the integrity of our conceptual model that assets 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 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're just a subcategory of equity. Think of your chart of accounts as setting up and recording books. 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 will coming out of the back end. 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 an 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 Pass aggregated 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 accounts that 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 amounts 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 screen. As I show you here.

However, rest assured that in behind 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 Ledger's. A general ledger. We'll 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 100 200 and $500, respectively, and one credit entry for $800 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, Patsy all these handy work ensures 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. Once you have a trial balance, you can prepare financial statements, which we will cover in another lesson. And from the trial balance, 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. We'll break out these accounts into a separate statement in a moment.

Compare this statement to our conceptual model assets total $276 and 85 cents. This is a debit balance liabilities total $822 and 50 cents. This is a credit balance. equity is a negative $545 and 65 cents. Is this a debit or credit? That's right, it's a debit because the business has lost $595 and 65 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're 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 balance, 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 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 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 net 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 net income per se is not a general ledger account. net income is simply a mathematical difference between revenue and expenses. Item number two, 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 one of 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 chart of accounts set up. Basically there are three steps 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've 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 chart 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 asset 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 identify that this is an income transaction, we made money for services we rendered. Therefore, the credit side of this entry would be to an account like sales or revenue for the $40 we collected. The final step is to put the entry into the general ledger. The computer will do this for a superior using software, but I'm pretty sure your professors are going to ask you 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, pulling up, 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 in 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 of Home Depot, one of the world's largest retailers. I know what you're thinking 15 minutes ago, you've 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 40 billion and change which balance 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 in 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 and 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 second 2004 To 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 in sales, which is a credit in the accounting system and generated positive income and positive increase in equity of $5.4 billion. 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 were some stock options exercised. This is a positive contribution to equity, as when you exercise a stock option, an owner gives the company money and the company issue stock. we'll ignore the stuff in the middle as this is Advanced Accounting stuff But at the bottom we have dividends, which are showing as a negative number, because the 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. That's all for this lesson, but be sure to look for other lessons to help you develop your bookkeeping and accounting skills.