Hello and welcome to our video series on financial accounting and welcome to module one. In this module we will learn all about the financial statements but before we can prepare and understand the financial statements which we will do in this video series we need to understand some terminology some jargon. When I was a beginning accounting student I thought accounting was all about numbers all about math it really isn't accounting is all about language, they call accounting the language of business. And if you want to have a prayer to survive your accounting class, you're going to need to understand these six words that we're going to introduce in this video.
So let's do that this video, I bet you it'll be over 10 minutes. And all we're going to do is talk about these six words, but you need to have them super internalized, you need to be an expert on understanding what these words mean, and how they make sense in the world of accounting. So let's get to them. Here are the six words, assets, liabilities, shareholders equity, I guess that's two words I've counted as one shareholders equity, revenues, expenses and dividends. And the three that are in color there are really going to be key to your life as an accountant.
Well, they'll all be key, but those three particularly will be. So let's begin by talking about assets. And when I begin a course, I begin talking about assets.
And I asked my students, Hey, make a list of all the assets you think a typical undergrad student at this university will have. Make a list of typical assets of an undergrad. And so here's the things that they list out.
They'll list out things like cell phone. They might say, you know, textbook. They're looking around the classroom. They see textbooks. That's a typical asset of an undergrad.
Maybe a car. You know, that's the list generated by students. But I also get some more interesting or creative answers.
Some might say they have beauty or youth or even something like a high school diploma. Because, of course, you're an undergrad student at a university. You probably have a high school diploma. So these are all, I think, good examples of assets of an undergrad. Now, the first three on my list are much simpler to discuss than the second three, but we'll discuss both here.
The thing that all of these things on the list have in common, though, and this is how I want you to think about assets, they're anything of value. The word I want you to think of is they are things of value. So that word should just be really tied to assets.
The. Technical definition gets a little bit more complicated. I don't ask my students to give a technical definition, but your prof might. If they ask for a technical definition, it's anything that a company owns or controls, created from a past transaction, that gives us a future economic benefit. That's a pretty technical definition.
But anyway, it's anything you own, or you can typically think of it as owned in intro financial accounting, but they would. Leased assets also can count under this category, but most of the time it's just owned. Stuff you own, that's good to own.
99% of the time, that's a sufficient understanding of what an asset is. Now, let's think about this list. So cell phones, textbooks, cars, those are all things of value.
And absolutely, these types of assets find their way onto company financial statements. When a company is listing its assets, It would list any cell phones the company has, any textbooks or any cars the company has. Those would all fit very easily under the definition of asset.
The last three, however, absolutely would not find their way onto a company's balance sheet, even though I think they're assets. I think they are things of value, right? Your high school diploma is certainly something valuable to you. It's useful for the rest of your life. It makes you more employable than not having a high school diploma.
Your youth, your health, these types of things absolutely are very valuable and should not be taken for granted. But why don't they find their way onto financial statements? And there's a simple reason. And the reason is it's hard to put a number on it. It's hard to say how much they're worth, right?
I have a CPA designation that allows me to teach at this university. Well, my CPA designation is definitely my most valuable sort of academic. achievement. But how many dollars is it worth? Is it worth $1,000?
Is it worth $10,000? $100,000? $1,000,000?
It's really hard for me to put my finger on how much that's worth. Now my car I can put a number on it and be pretty close. My cell phone, I have an iPhone 8, I can look up online, what's an iPhone 8 sell for, right?
That I can put a number on. My beauty, what's my beauty worth? Not much, I would guess, but who knows, right?
What's the number you would put on somebody's beauty? Very difficult to measure. And so companies say, look, that stuff, yes, we agree, there may be a value there.
We're not going to try to put a number on it. Stuff like cell phones, textbooks, and cars, absolutely, yes, we will. So anything a company can own or control that has value, that's good to own or control, that can be reliably measured. That's sort of another piece of what makes an asset an asset. So what are typical assets we find on a company's financial statements on their balance sheet?
Well, we would find something like cash. Of course, that's something you should want to own and own more of. There's something called accounts. receivable.
And what accounts receivable are when somebody owes you money. So you're going to collect money in the future, a future economic benefit. I use that word. Well, we're collecting money in the future. That's a future economic benefit.
So that is absolutely something that would be categorized as an asset. Easy for me to say. Inventory. If you walk into a Walmart or a retail store near you look around right all the stuff you see that they've bought from their suppliers that they're planning to sell to you the customer that is inventory and that is assets right that's stuff they own that's good for them to own uh we have the broad category which i'll call property plant and equipment and uh you know it It almost seems overly technical here. Property is land, like literally land, real estate, property.
Plant is buildings. Plant. I wish it's such an outdated term, but you do see it used all the time. It's buildings. So you can own a building, right?
That's something of value. And equipment, all this stuff in there. Computer equipment, or you might have machines, these types of things.
A car would categorize as equipment. It's a broad category of assets. Now the list here I could... make a lot longer.
We have things like investments, right? Like Facebook bought Instagram. Well, they spent a billion dollars buying Instagram.
That is an investment. Instagram is an asset that belongs to Facebook. And our list could go on and on. But these are typical assets you find on company financial statements.
Moving over and actually before I move over just to reiterate, when you think asset, I want you to think something of value, something of value that a company can own or control. Something of value that a company owns or controls and the value can be reasonably reliably measured. Looking at liabilities, if my keyword for asset was value, my keyword for liability is even simpler. It's O. Liabilities are anything that has to be repaid in the future.
So, from a student perspective, you might have student loans. Those are liabilities. They're things you're going to have to pay back. If you have a phone bill sitting on your table and you haven't paid it yet, great example of a liability. I have a mortgage on my house.
There's a liability. And companies can have very similar types of obligations, right? They have similar things they have to pay back.
And these are the liabilities of a company. So anything a company owes, and I think to give a technical definition, we would say any future economic. obligation, meaning anything they have to pay back in the future. So examples on a balance sheet. Well, we said for assets, there's accounts receivable.
For liabilities, there's something called accounts payable is a very common liability that you'll see on a balance sheet. And it just means within typically within 30 days, you've got to pay it back. And so I always think of a phone bill. When you think account payable, just think of phone bills and bills like that and you're not far off. Other types of liabilities, well, all sorts of, we'll call them, there's a broad category here called notes payable.
And, you know, within that category is things like bank loans, student loans, mortgages. The category is called note payable. And note payable is just a piece of paper, you know, a contract you've signed saying I promise to pay you back on this date with this much interest, right?
That's a note payable, and so a bank loan fits that, a mortgage fits that, an informal, they call it a promissory note, fits that. All sorts of things fit that category. But those are typical liabilities, and we can have all sorts of other ones.
We can have wages payable to our employees and bonuses payable, things like this. There's no shortage of items I could put on my list, but we'll cut it off there. So when I talk to my students about these categories, people generally have a pretty good idea about assets and about liabilities. Where things get a little bit shakier is when I ask about shareholders'equity.
Not very many people have a good definition of shareholders'equity, and largely because it's defined by what it's not. And I'm going to explain shareholders'equity actually by explaining my house. I own a little house and it is a house that cost $300,000.
So there's this asset, right? And it's this house and it's a $300,000 house. Now, as I already suggested to you, when I bought the house, I did not have $300,000.
So I took out a mortgage. And if I look at that mortgage statement today, it's around a $200,000 mortgage. And a mortgage, of course, we've said is a liability. So I have a liability of $200,000. I have a $300,000 house against which there is a $200,000 debt or $200,000 liability.
If, and this is where equity comes in, if I were to sell my house today and I were to liquidate it and I got $300,000 cash, I pay off all the debts against it, so I pay off the mortgage, how much money goes in my pocket? Well, the answer is... 100 grand, right?
I have a $300,000 house. I liquidate it. I get 300 grand cash.
The mortgage company isn't going to allow me to keep the mortgage if they don't have the security of the house. So they take their $200,000 back, $300,000 proceeds on the sale. 200 goes to the mortgage company.
100 goes to me. My piece of the pie, my piece of the house, the shareholder's piece of the company is called their equity. Equity is the concept of What's left over if I sold off all the assets, I paid off all the debts, what goes in the shareholders pockets, that is their equity.
So for my home, we would call it home equity for a company I've abbreviated here as SE. And SE stands for shareholders equity. And so my shareholders equity is $100,000.
This relationship creates something and you'll you'll learn about it in chapter one of any accounting book in the world, this thing called the accounting equation. Assets equals liabilities plus shareholders'equity. A equals L plus SE. So $300,000 equals $200,000 plus $100,000.
Okay, so when I think about equity, I actually think of this formula. I just think A equals L plus SE. Or alternatively, shareholders'equity is what's left over when I take my assets and I subtract my liabilities, right?
That's what I think of when I think of equity. So there's not a sort of fancy one word or I guess if I were trying to put it into words, I would say what's the owner's piece of the pie, right? They pay off all their debts, how much money is going into the owner's pocket. That's what I think of when I think of equity. What are the accounts?
Well, one is called common shares. So if you buy into a company, you buy shares, you're buying equity of the company, right? putting in thousands of dollars, they're giving you shares, you're buying a piece of the pie.
So it's called common shares. There's also preferred shares. If you're taking an intro class, you might see this referred to as share capital.
That's that's a common thing you'll see. And a big important account is called retained earnings. And we'll get into this more as our videos go on.
Here's the gist of retained earnings. You invest or buy into a company or you run a company to make profits, right? You want to make money, right? You want to earn money.
If your company is profitable in making money, you have two choices with what you can do with the money. You can keep it in the company, retain those profits, in which case the amount goes into retained earnings and the shareholder's piece of the pie gets bigger. Or you can take it out of the company and you can pay yourself a dividend, in which case...
the retained earnings gets smaller, the shareholders equity gets smaller. So it might seem a little complicated right now. Just know that there's retained earnings is an account that keeps track of how much profit is being kept in the company versus and again, the alternative is pay it out as a dividend.
So that is what retained earnings is. So we've got these three key accounts, assets, the stuff we own and control that's good to own or control. the things of value, liabilities.
That's what's owed. Shareholder's equity, that's the shareholders or the owner's piece of the pie, what's left over if I take all my assets, sell them off, pay off all my debts. What goes into my pocket, that is my equity in the company.
Very quickly, revenues, expenses, and dividends. I'll be much quicker here. Revenues, the word I want you to think with revenues is earn.
Whoops, not erm. Earn. Revenues. or what happens when the company does what it does to earn money. Walmart sells me stuff, they have sales revenue.
My university charges tuition, they have tuition revenue. You know, my landlord, or well, I own my own house, but if you were a landlord and you charged rent, you would have rent revenue, right? It's the business doing what it does to earn money.
Think of revenues as being earned. How is the money coming in? It's the revenue generating part of the business.
Expenses, think of costs. So again, thinking of a university, I love my job at the university, but I don't do it as a volunteer. I don't do it for free. They've got to pay my salary.
They have a salary cost, a salary expense. They also have to pay to keep the lights on. Well, that's a utilities expense.
They also have to pay to keep the carpets clean and the place maintained. That's a maintenance expense. There's all sorts of costs of running a university, and those are the expenses.
Those are the costs. Dividends, as discussed earlier, are at the end of the year, if the company's revenues exceed the expenses. In other words, if we earned more than we spent, we are profitable.
And if we're profitable, we have a choice to make. We can keep the money, keep those profits in the company, or the shareholders can say, I'd like some of that money. I'm going to take a dividend, and they'll pull their money out of the company.
So dividends are... shareholders pulling profits from the company, taking it from the company's retained earnings. I used to think that was a problem. I used to think like there's something wrong with that. I no longer think that I think, look, if your company is profitable, and you would like to use the money for something else, you should be able to and that's called a dividend.
Okay. So these six terms should be ingrained in your brain right now. And going forward through the course, you need to understand these six terms. Asset, things of value, things the company can own or control that are good to own or control. Liabilities, that is owed, that is a company's obligation.
They've got to pay something back in the future. Shareholder's equity, if I take all the assets, I sell them all off for cash, and I pay off all my debts, how much money goes into the shareholder's pocket? What's the shareholder's piece of the pie? That is their equity. Revenues are the company doing what it does to earn money.
Expenses are the costs of earning that money. And dividends are when the shareholder wants to pull money from the company. They want to withdraw money from the company. They take a dividend.
All right. With those six words in mind, you are ready to take on the rest of Chapter 1, Module 1. Good luck. I'm thrilled that you're with me on this journey to better understand accounting. All right, bye for now everybody.