All right, on to lesson two in this financial accounting series. Lesson two is the balance sheet. Well, when we think about this lesson, what we're going to be digging into related to the balance sheet and accounting in general is defining and identifying assets, liabilities, and equity, recognizing how to complete transaction analysis, build a balance sheet from transactions, and let's go ahead and jump into it with an example. So what we have here is Nike's balance sheet off to the right. So I know it can be a little bit tough to see, so I'll highlight things as I ask some questions regarding it.
The one thing I just want to kind of point out up top, it says May 31st, 2023. So that is Nike's most recent year-end as of the time that I'm filming this, recording this. Companies can use different year-ends. My guess is Nike uses that to be seasonal.
We think about all just the sports apparel and equipment that they're selling. So it's probably between the spring sports seasons and then up to the summer sports season as well. So that's what's going on with this one. Also, so I'm recording this in July, but it takes 60 days oftentimes or close to it for companies to issue their 10K, which is where I gather financial information from. So that won't be out until July 31st.
2024 for the May 31st, 2024 year end. So that's why just a little bit of tidbit about how this all works. So the May 31st, 2024 year is done, but the information is not out yet. Nike's largest asset is inventories. So if we look down their list of assets, we see one number that's bigger, the 25.2.
And that's $25.2 billion, but that's total current assets. That's a group. The biggest asset, if we're looking at individual ones, is inventories.
And what this is getting at is that means $8.4 billion of inventories. That's what that means because these are in millions. So that's $8.4 billion of inventories.
Now, do they have more long-term debt or shareholders'equity? We could take a peek at their long-term debt and see they have $8.9 billion. Total shareholders'equity, they have $14 billion. They have more equity than debt.
Then if we wanted to ask a question, how does their shareholders'equity on the balance sheet compare with market capitalization? Well, market capitalization is off to the left here, $110 billion. So the balance sheet stockholder equity is much less. And that's because it uses accounting's historical cost principles.
It's a limitation of accounting. It's not reflecting all of the assets. and liabilities at their current values, more using a historical value concept.
But it's there because it's still a reasonable way to measure it. And if we try to do everything at fair value, it would just be constantly changing, and it would be very subjective too. So we'll get into now defining and identifying assets, liabilities, and equity.
So assets, first off, are resources a company owns. Sometimes we just say stuff a company owns. Any economic resource that'll provide future benefits to a business.
So when we think about that, we think about assets. The examples, the first one for pretty much all companies is going to be cash. That could be your checking account, could be your savings account, could be crypto, could be in different currencies, you know, Nike. Their cash is $7.4 billion. I'm sure they have dozens of bank accounts.
in dozens of different currencies in their entities around the world. But they sum it all up into one item. Accounts receivable, amounts owed to the company by customers, so $4.1 billion.
So that's when Nike is selling to Target and Walmart and Costco and companies like that. And the companies it's selling to is taking a little time to pay them. That's what an accounts receivable is.
They've sold it and someone else owes them money. If you went to a Nike store online at Nike.com and you paid instantly, you know, with a credit card, that would be actually considered cash right away to Nike, so that would not give an account receivable. Inventory, products to be sold by the company, $8.4 billion.
Again, this is their shirts, this is their sporting equipment, this is their, you know, shorts and hats and just everything that Nike sells, right? Now, the important thing is, once again, These items are in their manufacturing facilities, in Nike stores all around the world. They sum them all up into one amount for purposes of the balance sheet.
in U.S. dollars. So $8.4 billion is what they sum up. Productive assets, property, plant, and equipment.
So I think about this. This is their computers. This is their vehicles. This is their buildings, their land, their machines, their equipment, their furnishings and fixtures, things like that to $5 billion. We typically break assets down into two categories.
Current assets are $25.2 billion. That's the sum up of the items above it. The balance sheet is listed in the order of liquidity, so how quickly things are going to become cash. So all of the items above current assets are either currently cash or are going to be cash within one year. That's the expectation at least, so $25.2 billion of it.
And the non-current assets is the stuff kind of below current assets. above total assets. So it's the property, plant, and equipment and the other items that I didn't highlight. But those are not expected to become cash within a year. The company's not expecting to sell a manufacturing facility in the next year.
That's what that means. So those are a couple relevant definitions, current assets in a year. And I didn't highlight all the types of assets here, just some of the more common that you're going to see, kind of regardless of what company that you're looking at.
Now, liabilities, those are amounts a company owes. Future obligations of economic resources based on past events. Usually, liabilities are going to get paid off in cash.
We'll learn later in the course how there can sometimes be liabilities that will get paid off when we perform services to someone, that we owe them some services or deliver some products to someone. So we'll learn a little bit about that. Now, examples of liabilities, accounts payable. So the company received some goods and services, but it did not pay for them right away.
So this is Nike owing its suppliers some money. The next one, there's your accounts payable, $2.8 billion wages payable. Employees have worked for Nike, but there can be a couple-week lag before they get paid. So they don't have a separate line for wages payable, and it's probably because it's not a huge, huge number, but it is one of many accrued liabilities.
We're going to talk more about accrued liabilities in Lessons 3 and 4. Debt. When a company borrows money, typically from a bank, and it promises to repay it in the future, that is what is considered debt. So Nike went to the bank and asked for loans to the tune of $8.9 billion.
So those are just some of Nike's liabilities, typically broken down into two categories. Current liabilities are items that are going to be paid off within a year, and then... you think about like accounts payable suppliers want to get paid quickly wages employees want to get paid quickly and then debt it it says long-term debt here that can either be short-term or long-term but this one says long-term so it's stuff that's going to get paid off over a year so current liabilities paid within a year non-current liabilities longer than a year all right on to the equity section now so stockholders equity this one is definitely the most confusing for people, you know, assets, stuff you own, right? If you just think of it, it's pretty simply liabilities, amounts you owe. And I mean, those are overly simplistic, but that it's kind of the gist.
But equity is the owner's claim to the assets after the liabilities have been paid off. So that's not as easy to say, right? But with practice, you'll understand that. It's commonly broken into two parts, money contributed by the owners. We sometimes collectively refer to that as contributed capital.
The accounts that make up that are common stock and additional paid-in capital. Additional paid-in capital is sometimes called capital in excess of stated value. That's what's happening right there.
That's a mouthful right now. Think of that as money that Nike got from its owners to help it grow its business. Through an initial public offering was the first time, and then... if they did that more times, which they probably did through seasoned offerings. Now, if two people exchange a share of Nike, that cash is between those two people.
That does not go to Nike. So that does not get counted in the stockholder equity section. This is just when someone gets an ownership interest in Nike by giving something of value, usually cash, directly to the company. So we could basically say owners contributed $12.4 billion to Nike. in exchange for ownership.
Now, money that's earned by the business that hasn't been distributed is called retained earnings. That's 1.3 billion you can see right there. Now, Nike certainly has earned a lot more than 1.3 billion. $3 billion over the years, over its lifetime, because this is a lifetime concept here. This is over since it's been in existence, but it has paid a lot of dividends out to its owners.
So retained earnings, excuse me, net income increases retained earnings, dividends reduces it. Now, again, I kind of mentioned this on a previous slide, but this is equity for accounting purposes. It does not equal economic or fair market value, which is constantly changing, in which we just, you know, back a few slides ago saw that the market cap was about $110 billion.
That's actually when I pulled the slides together, which was a few days ago. I'm sure it's different even by now, and will be different by the time you watch the video. And that's part of the reason why we use accounting principles, is because at least this amount is going to establish.
should not change. At least not change every day. Just change when there's transactions. So a review question here. Could you look at these eight accounts?
And an account is kind of something where we want to group activities. Could we take these accounts and identify what category they fall into? Take a moment to see if you could do that. All right. Like cash is an example of what I'm trying to do.
to get you to do is just know that cash is a current asset. So kind of look at those others, right? Accounts payable, where does it go? Okay, current liabilities. Retained earnings, where does it go?
It's an account within the equity section, stockholders'equity. Debt, we'll just, and I probably could have typed long-term debt right there, didn't, but we can just, we'll just say that debt is a non-current liability. We'll assume it's going to be paid off more than a year.
Usually they'll either say short-term debt or long-term debt. Common stock, that's going to fall in the equity category. Equipment is going to be a non-current asset. We don't expect to sell our equipment within the next year. Inventory, we hope to sell inventory in the next year, so that's a current asset.
It's a bad deal if we don't. And then land, we don't hope to sell it in the next year, so that's a non-current asset. Well, the next area that we're going to jump into is...
into is recognizing how to complete transaction analysis. In my opinion, this is the kind of the toughest part about learning accounting is right here. So if you need to step away for a second, do whatever, this next few minutes is the toughest part and when you get this done there's certainly going to be really tough concepts that come you know throughout the rest of this course and throughout the world of accounting but it all gets back to transaction analysis right here.
So first, what is a transaction? It's an economic event which is going to impact an entity. So if you agree to purchase in the future or sell in the future or hire someone for work in the future, that is not...
a transaction under accounting principles because it has to have an economic event, something that has to have already happened. Most are external transactions with third parties, sales, purchases, paying employees, things like that. But there can be some internal ones.
When you use up supplies, that's a transaction. It's something that happened to the entity. When a machine wears out, that is something that has happened to you. the entity.
Now what are accounts? So, when we're looking at these transactions, we need to say, what accounts are affected? Well, first of all, to understand an account, it's like, what is a description we're going to use in order to discuss a grouping of activities?
So, it's a record which is going to track financial activities. You're like, I just need a broad classification to discuss. some sort of group of activity. It's kind of like when I walk into my closet and I look for an accounting shirt.
I got about 30 in there and it's like, I'm looking for an accounting shirt. I don't necessarily have to list all 30 of them individually. I just have the broad category of accounting shirt.
Assets itself is not an account. We give them specific names. Assets is a group of accounts. Current assets is a group of accounts. Non-current assets is a group of accounts.
Accounts are like cash. Accounts are receivable, inventory and equipment. They're not totals and they're not subtotals.
They're grouping that together. So you know, it makes sense. We want to track how much total cash does Nike have? How much total inventory?
inventory does nike have we don't care about tracking each and an investor doesn't care how many shirts they have around the world and how many pair of shorts they have around the world and all that kind of stuff and that would be absolutely madness if nike published a listing of its inventory. I mean, it'd be giving away some confidential information, but it'd also just be madness. I mean, no one would look at this Microsoft Excel file or wherever they're tracking it to look at hundreds of thousands or millions of items of inventory. People are like, I get it.
They got a lot. Just give me one number that sums it up. Well, transaction analysis, we're putting a transaction into accounting format.
There's three steps to it. So we see that a transaction has happened, some sort of economic event, and we said, okay, well, what accounts are we going to refer to this transaction as, and what amounts are involved? There's always going to be at least two accounts, there's no maximum. Most are probably going to be two, all right, but you can have three, four, you could in theory have dozens or hundreds or something like that.
You usually don't see that. It's usually two or a handful, but it has to have at least two. It can't have zero, it can't have one. You classify them then as assets, liabilities, or equity, and you determine whether the account is increasing or decreasing. Once you can do this, you can then put it into a framework, and then that framework will feed into your accounting systems, and the whole rest of your financial statements will come from that.
There's certainly more complexities, but these three steps right here is what is tough until you kind of... Get it. Now, assets, when you do this, have to equal liabilities plus shareholders'equity. So make sure you have that.
That's referred to as the duality of effects. All right, examples. Let's say a company borrows money from the bank.
Just think about it. I mean, that's a transaction. It's an economic event, right?
Now the company has some cash and they have a payable to the bank. So what should we call that? Like what accounts? Well, they got cash and they have a loan payable to the bank. So those could be a couple of accounts.
Cash is an asset. Loan payable is a liability. You owe it. The cash is increasing and the liability is increasing.
So, cash is up and then we have a notes payable is up as well. Notes payable and loans payable can be used somewhat interchangeably. I usually see the word notes a little bit more.
A company purchases inventory on account. Well, what's happened? They have more inventory, but they also have a payable to someone, whoever sold it to them.
Okay, so we have inventory and that's an asset and it went up and then we have an accounts payable. That's a term we give when we've made a purchase from someone but haven't paid them yet. Okay, we've got the goods or services but we haven't actually paid them. It's an accounts payable, it's a liability, it's increasing. What if a company receives payment from a customer for a past sale?
So the sale happened in the past, it was properly recorded in the past. Now they're just getting a payment. Well, they got some cash and...
The customer doesn't owe them as much money anymore, so they don't have as much receivable from the customer. So they got cash plus asset, they don't have as much for receivables minus asset. Then what if a company issues stock to an owner in exchange for cash?
This is probably the toughest of these four. People will generally understand the company got cash, but it's like, what else happened? Well, the owners now have more claim to the company's assets, which is going to be common stock. It's a contribution.
From the owner to the business. This is transaction analysis right here. This is the tough part.
Once you have this done and understood, you just put it into a formula and can start rolling forward. Which of these is not a step in transaction analysis? So if you look through that, which of these is not a step in transaction analysis? You could look for a couple seconds. Well, classifying the accounts, that's the second step.
Determining if the account is increasing or decreasing, that's the third step. And identifying the accounts, that's the first step. Prepare a balance sheet that is not part of transaction analysis. After we do transaction analysis and a couple other things, then we will be able to prepare the balance sheet. We're going to see a balance sheet before this lesson is done.
So then build a balance sheet from transactions. We're going to do that by putting... this transaction analysis into a debit and credit framework.
Debits are not good or bad. Credits are not good or bad. Debits and credits are not good or bad. I can't emphasize that enough.
They are just terms that we use to describe that the debit is on the left side of a T-account, credits are on the right. A T-account is something that we're going to learn about is how we're going to track activities. Now, in a journal entry, a journal Think about a journal as you're kind of writing down events. We think of diaries.
We think of journals, right? Someone has a personal journal. They're just kind of writing down maybe some events that happened or something of that nature.
But companies have journals, and they write down events. They put the debit. First, and then the credits.
The dollar amount, when they do this, has to equal. And then you use the T-account format to prepare the journal entries. So you take your transaction analysis, and then you say, okay, my assets have to equal my liabilities plus my equity.
And for assets, they are increased. Excuse me. If an asset goes up, there's a debit.
If a credit goes up, that's a liability. If equity goes up, that's a liability. Similarly, if an asset goes down, that's the minus right there, it's a credit.
If a liability goes down, it's a debit. If equity goes down, it's a credit. that is also a debit. And then we take our journal entries and we prepare them using kind of those concepts I just talked to you about. Now, the last couple minutes for a lot of you, probably really confusing.
All right, we're going to... going to apply this through some practice. And if you keep working at it, it will eventually come.
But you might need to practice this and then go back and re-watch some of that material. So let's say owners contribute cash to start a business. So we do our transaction analysis, and we said, well, the business has more cash.
And then I've known when owners contribute something to the company, it's called common stock. So yeah, cash and common stock. Now, if an asset increases, kind of look up here on the right, right? If an asset increases, that's a debit.
If equity increases, that is a credit. So the debits go first, the credits go second. This is a journal entry.
The second thing, a company borrows $500 from the bank. Well, it sounds like they've got cash, and it also sounds like they have a note payable to the bank. Cash went up, notes payable went up.
When an asset goes up, that's a debit. Debit, when a liability goes up, that is a credit. Debit to cash for 500 bucks, credit to notes payable for 500 bucks. All we're doing, the first part there is transaction analysis. We're just saying, what is the account?
Is it an asset, liability, or equity, and is it going up or down? And then we're taking that, whether it's an asset, liability, or equity, whether it's going up or down, to give it either a debit or a credit. The third one.
A company pays off $200 of an account payable with a supplier. Okay, so what do we have here? Well, we don't have as much cash, but we also don't have as much payable to the supplier.
So cash is down, and we call it an accounts payable, and that is also down. So when a liability goes down, that is a debit. And when cash goes down, that's a credit. So before, the first two examples, cash was going up, so that's why we debited it.
Here, cash is going down. it's a credit. And then the fourth and final example here, if a company buys equipment with a sticker price of $750 for $700, well the company has more equipment and they don't have as much cash.
Now we will record these items at the amount that we paid for them, we don't care about the sticker price, it's like well what is the amount that we paid, the $700. So now we see an asset went up so that's going to be a debit, an asset went down so that's a credit. credit. Debit equipment for $700. Credit cash for $700.
That is what we're doing with transaction analysis. So some of these, like this last one, it only affected assets, but it didn't affect liabilities and equity. Example three affected liabilities and assets.
But in each of these, assets equal liabilities and equity. Like example three, assets went down by $200, and then liabilities plus equity went down by $200. In example four, there's no impact on assets because they won't both up and down.
And then liabilities and equity, there's no impact on them either. So that always has to balance. Under the historical cost principle, assets recorded at the amount paid for them. Now, using T-accounts, a T-account is used to accumulate transactions and journal entries.
Each time a company makes a journal entry, an entry will also be made in a T-account. At the end of the period, we sum up the debits, we sum up the credits, and net them into the side which is larger. larger. So what this means is let's say that we started with $100 of cash.
Okay, so that's $100. We borrowed from the bank. The left side are debits, right?
Debits are increases. We borrow from the bank. That gives us cash.
We collect from a customer. That gives us cash. We sell equipment. That gives us cash. We use cash, paying a supplier, purchasing inventory, paying a dividend.
So the increases to cash go on the left because when an asset increases, that's a debit. But the... The decreases to cash go on the right because the decrease to an asset is a credit. And then what we do is we add a...
The left and then we subtract off the right and there's two hundred and fifty dollars more on the left than the right So we would say that our balance of cash is two hundred and fifty bucks now cash is actually pretty easy because we're gonna have A bank account that's also gonna say two hundred and fifty bucks But this becomes more important And then also like as an example if the company has maybe mailed checks and the checks haven't cleared yet or made a deposit And the deposit maybe hasn't cleared yet Or an account like inventory, as an example. There's no bank account for inventory, which you can cross-check against. So that's where you just have to look at what are the debits, what are the credits, and net them together.
So a full example here, let's say a company issues $100 of stock to its owners, and then it borrows from the bank, and then it purchases inventory on account, and then it purchases equipment for cash. We're going to do transaction analysis. journal entries, put this in the T-accounts, and then prepare a balance sheet.
Issuing stock to owners. And these are kind of new transactions here. This is not building off earlier in the lesson.
But we got cash. We got common stock, $100 each. Borrow from the bank.
We're going to have cash. We're going to have a notes payable. A company purchases inventory on account.
We've got inventory. We didn't credit cash here because we didn't pay cash for it, but we have more payable to our supplier, and that's a liability. And that increased. A company purchases equipment for cash.
Equipment's up. Cash is down. Debit equipment and credit cash. So each time that we did this, like that last one, okay, we purchased equipment for cash.
So equipment is up. That's an asset. So we debited it. Cash goes down because we paid cash.
That's an asset that went down, so we credited it. Each one of these, that's what you do. And then you pop them into T-Accounts. So basically what we did is we took all these journal entries right here. There's basically eight different line items.
There's four transactions, and they each had two journal entries. They don't have to have two. They can have more.
I just kept this first one simple. But we then put them. The debits always went on the left.
The credits always went on the right. So cash, there was two things that increased cash, one thing that decreased it. Inventory, we bought it. Equipment, we bought it. Accounts payable increased when we got some inventory but didn't pay for it right away.
Note payable increased when we got money from the bank. Common stock and equity account increased when we got money from the owners. So I wouldn't necessarily expect that you would find this Last part, super duper easy the first time, but this is something you can eventually get to.
You can literally just go, okay, there's my debits, there's my credits. Debits all go on the left, credits all go on the right. Like that first one, debit to cash, $100 goes on the left, common stock goes on the right. That's our $100 right there, that's our $100 right there.
And then we sum them up. There was 300 increases to cash, 125 decreases, so $175 in total. We then just... Prepare a balance sheet. Cash of $175.
Inventory of $60. Equipment of $125. Really easy. So total assets are $360. We've got this stuff in order.
Accounts payable is $60. Note payable is $200. Common stock is $100.
So total liabilities and equity are $360. Assets equal liabilities plus equity. The review question, what is true about debits and credits?
Is one of them good? Is one of them bad? You know what?
What do you remember that I taught you a few minutes ago? So we think about this, you've looked through them. Both debits and credits are good now. Credits are bad now.
Debits are good now. They're not good nor bad. Debits go on the left, credits go on the right. That is correct. It's what side of the T account they go on, and that's important because then we sum up the T accounts with all the transactions, and that's what we use to prepare a balance sheet.
So in this lesson, hopefully you learned a little bit about balance sheets, assets, liabilities, and equity, and you learned a little bit within those groupings, there's different accounts which will accumulate dollar effects of transactions. You learned how to use transaction analysis to prepare prepare journal entries, take those journal entries, and then enter them into T-accounts, take the balances in the T-accounts, and create a balance sheet. Thanks for tuning in. We'll see you back for Lesson 3.