Transcript for:
Financial Accounting Overview

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 um so let's begin by talking about assets and when I begin a course I begin talking about assets and I ask 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 uh here's the things that they list out they'll list out things like uh cell phone they might say um 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 the the list generated by students but I also get some uh more interesting or creative answers some might say uh 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 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 uh 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 uh but anyway it's anything you own or you can typically think of it as owned in inro financial accounting but the least 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 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's 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 abs abolutely 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 uh 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 um 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 um 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 a million 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 um my 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 a number on it uh stuff like cell phones textbooks and carss absolutely yes we will so uh anything a company can own or control that has value that's good to owner 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 uh 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 [Music] reable and what accounts receivable are 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 excuse me 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 almost seems overly technical here property is land like literally land real estate property plant is buildings plant I 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 the 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 long 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 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 okay something of value that a company owns or controls and the value can be reasonably reliably measured uh 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 you know 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 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 um 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 uh examples on a balance sheet well uh we said for assets there's accounts receivable uh 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 uh 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 in bills like that and you're not far off um 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 pay and note pay is just a piece of paper you know 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 that a bank loan fits that a mortgage fits that an informal they call it a promissary note fits that all sorts of things fit that category uh 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 uh there there's no shortage of of items I could put on my list but we'll 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 uh 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 liquidated and I got 300 Grand 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 a 100 Grand right I have a $300,000 house I liquidated 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 my piece of the pie my piece of the house the shareholders 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 uh for my home we would call it home equity for a company I've 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 equal L plus SE so 300,000 = 200 + 100,000 okay so when I think about Equity I actually think of this formula I just think a equals l+ 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 worder I guess if I would 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 you're 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 um that's that's a common thing you'll see and a big important account is called ret retained earnings and we'll get into this more as as our videos go on here's the gist of retained earnings though uh 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 uh 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 retainer and the shareholders 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 uh that is uh 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 uh the things of value liabilities that's what's owed shareholders Equity that's the shareholders or the owners 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 ear earn revenues are what happens when the company does what it does to earn money Walmart sells me stuff they have sales revenue uh my University uh uh charges tuition they have tuition Revenue um you know I my my landlord or well I own my own house but if you were a landlord and you charge rent you would have rent Revenue right it's the 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 uh I love my job at the University but I don't do it as a volunteer I don't do it for free they 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's profitable and you would like to use the money for something else you should be able to and that's called a dividend okay uh 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 shareholders Equity if I take all the assets I sell off the LI I sell them all off for cash and I pay off all my debts how much money goes into the shareholders pocket what's the shareholders 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 one module one good luck I'm thrilled that you're with me on this journey to better understand accounting all right bye for now everybody okay let's examine problem 11a to download the problem there's a free pdf available on accounting workbook.com you just click the link uh download the file and you can work along with me so this problem has us exploring the accounting equation and if you're not sure what I mean when I say the word accounting equation go back and watch the last video it's going to be really help ful in just defining these terms assets liability shareholders Equity we also uh explained a couple more revenues expenses and dividends and I think it's just so useful to go through that video before you do this one but anyway assuming you've gone through that let's go through this problem so uh this just sort of says okay fill in the missing information and keeping in mind this formula that we introduced in the previous video assets equals liabilities plus shareholders Equity assets equals liabilities plus shareholders Equity that's called the accounting equation it's so fundamental to what we do so let's start with business one we don't know the assets we know the liabilities are 181 we know the equity is 212 so 181 plus 212 doing the math here that looks like $393,000 $3 93 and there we have it we've solved part one and again just sort of saying what they have $393,000 of good stuff that they own and control $181,000 of debts that have to be paid back if they liquidated all their assets got $393,000 cash paid their debts of11 $212,000 would flow through to the shareholders the shareholders piece of the pie is $212,000 for business number one let's do business number two uh the assets are $75,000 we don't know the liabilities but we know the equity is 36 so we know like 36 plus whatever is in this Blank Space equals 75 or stated differently 75 minus 36 equals whatever is in the blank space the blank space is $339,000 and you can double check right 39 + 36 equal 75 yes it works let's do business three $30,000 is the assets 21,000 is the liabilities uh our shareer Equity then the missing number has got to be $9,000 if I had $30,000 in assets let's assume we again sold them all off for cash we had $21,000 in debts or bills to be paid 30,000 in let's say we sold it for cash pay off all the debts 21 Grand how much money goes to my shareholders 9,000 okay the last one's a little bit funny and it says it's $10,000 you can see it's negative and it notes that business fors Equity is in an accumulated deficit position what does that mean it means they have negative shareholders Equity you see this happen once in a while right and it's the equivalent of somebody's morgage being higher than the value of their house they'll talk about this like the house is underwater they say in other words the debt is worth more than the asset is that the debt is sort of held against in the financial crisis this happened a lot happens with companies too where they have higher liabilities than they do assets and uh what does that mean it means they're going to need money from their shareholders or they're not going to be in business for long so uh business number four the liabilities have got to be $10,000 higher than the assets how do I know that because the equity is negative 10,000 so the if the assets are 25 the liabilities have got to be $35 $110,000 more 35,000 Plus -10 is 25,000 assets still do equal liabilities plus sholders Equity we call that accumulated deficit if we have negative uh uh retained earnings as this company certainly would okay there we have it problem 11a is in the books stay tuned for our next video bye for now let's take a look at problem one twoa from our accounting workbook this problem has us identifying accounts so in our very first video we explained what is an asset a liability uh shareholders Equity account Revenue expense dividend what are they what categories are they what does it mean to be an asset these types of things this video has us flexing those muscles so we're going to go down our list for each account we're going to say is it an asset is it a liability is it children's equity revenue expense or dividend and further if it's an asset or liability and many of these will be is it current or long-term now we haven't discussed this yet current versus long-term a current asset is one that is expected to be liquidated or we're expected to use it up within one year one year or less so uh an example of a current asset is inventory right Walmart expects to sell through any piece of inventory in less than a year so Walmart's inventories are current assets cash we're constantly moving it's very much considered a current asset now if I go back to the Walmart example I see that they have um in my Walmart they have like refrigerators where they sell stuff out of the refrigerator like that Refrigeration equipment uh that keeps stuff cold that is an asset of Walmart but it is longterm right those refrigerating units where you might buy milk from uh that is you know is going to last them years that's a long-term asset and so we can do the same for liabilities I have a phone bill that's a current liability I got to pay it in 30 days I have a mortgage that's a long-term liability it's going to take me 30 years right so one year is our distinguishing line between current and long-term okay I've rambled long enough let's get started we just worked it our way down the list identifying it and uh as asset liability shareholders equity revenue expense or dividend and is it current or longterm so uh number one long-term Investments this is something we can own or control that would be good to owner control this is an asset that it even says in the name long term well there's our dead giveaway it ain't current now we can have current Investments right I can buy and sell stocks and shares that I'm planning to hold for a week a month a couple months it can be current in this case though it's identified as longterm so it's going to be we're buying for the long run here accounts receivable absolutely an asset it's when somebody owes me money and you know it's part of normal business and so if somebody owes me money a customer I've done work for it I've given them a bill they haven't paid the bill yet that's a typical account receivable situation they're going to pay me in usually 30 days certainly 99% of customers are going to pay in less than a year this is a current asset see uh Consulting Revenue well it's got the word Revenue in it it is company doing what it does to earn money it's a revenue rent Revenue same thing it's a revenue not noted as current or longterm it's assumed it would have been earned in the last few months maybe the month or 12 months depending on the time period we're looking at computer that's an asset and yes computers go out of date quickly but still one would expect a computer to last more than a year so I would call that long term liability oh sorry I should say mortgage payable is a liability if it's got the word payable that's a dead giveway for a liability if it's got the word receivable you should be thinking asset mortgage payable is a liability and it is a long-term liability my mortgage is going to last 30 years salaries payable those are liabilities it's having to pay your employee salaries unpaid salaries they're not going to put up with you for not paying them for a year they won't be your employees they'll be suing you uh and so therefore this is a current liability not a longterm one cash is considered the most current of current assets supplies is indeed an expense retained earnings we said or supplies expense is an expense and we'll talk about that in a minute retained earnings we said said was one of our two shareholders Equity accounts it's the company choosing to keep profits within the company and uh uh there it's the account that tracks that temporary Investments asset the word temporary indicates to me that it is current or shortterm accounts payable liability think of your phone bill when you think of accounts payable and when I think of my phone bill I think 30 days so current income tax expense that's an expense uh car is an asset and it is a longterm asset right it'll last you more than a year salaries expense is an expense utilities expense is an expense land is an asset and it's a very long-term asset it'll be here long after we're dead well maybe after you're dead my head's going to be frozen in a vat somewhere so I'm going to live on for a long time we'll leave that for another discussion for another day inventory asset and it is current building asset longterm interest expense is indeed an expense bank loan payable liability it's not clear here whether it's current or long-term in most intro accounting classes assume a bank loan is longterm unless it tells you otherwise so let's assume longterm unless it says something else common shares that is shareholders Equity we don't need to know whether it's current or longterm supplies well if I think of office supplies like I got some Post-it notes right here if I think about Post-it notes these are assets they're things we can own or control that would be good to own or control and they are current um so we've answered the question but sometimes when I do this in a classroom students will call this out they'll say supplies expense are expense but supplies are an asset what's going on here like what isn't this like kind of the same thing like what's going on uh and so I just want to explain this if you don't feel like you need an explanation fine skip to the next video but just a brief explanation on like this is supplies but what is supplies expense then so if my University let's say they bought $1,000 worth of these sticky notes right and they put them in a sticky note cabinet and so they have supplies right they have $1,000 worth of sticky notes that is an asset they own and control $1,000 worth of sticky notes months go by and of course us professors are like vultures circling around the supply cabinet waiting for new order to come in and grab supplies for ourselves uh we we look at the supply cabinet a a month later and in that Supply cabinet that used to have $1,000 of sticky notes the vultures have circled and now there are only $100 of sticky notes left over well we have a $100 worth of assets right if we're the the company here we have $100 worth of assets we have $100 worth of sticky notes that is my supplies asset that is this one uh what about supplies expense well supplies expense is the amount of supplies I've used up in a given period of time and so from the the perspective of the company they've used $900 they had $11,000 now they only have a 100 their supplies expense for that period is 900 it's the amount of supplies they've used up over a given period of time so it sounds similar supplies the asset and supplies the expense but it is different supplies the asset how much physical stuff do I have supplies the expense how many dollars worth of supplies have been used up okay I hope that was fairly clear this is again is chapter one module one we really explore this concept in chapters two and three of the course but it's good to have sort of that the we've primed the pump now right when we get to it in module two or module three you're going to be ready for it okay stay tuned for our next video bye for now welcome to problem 13A in this problem finally we're here we will explore the financial statements in this video or this series of videos it'll be multiple Parts you're going to learn how to prepare an income statement a statement of changes in equity and a balance sheet we're not going to touch the statement of cash flows here but we'll talk about it a little bit um before we can jump into the problem we should understand understand what all three statements are and what they do so our first video is just going to explain the three statements what we're looking for what we're trying to do and then we'll actually jump into the problem in the next bunch of videos so uh here are the statements that we're kind of worried about here income statement statement of changes in equity balance sheet and cash flow statement and let's start with the income statement the income statement summarizes list is list is lists out the company's revenues and expenses so it's all about revenues and expenses and what this statement does is it captures this relationship revenues minus expenses equals net income or profit so what does the income statement tell us it tells us if the company was profitable or not and if they were profitable how profitable were they how much money did they make that's the question that's being answered here was the company profitable if so how much money did they make if not how much money did they lose right so when I'm sort of examining a company I want to see how they're doing this is typically a first place I look I say hey do they make any money this year how much money did they make right they make more this year than last year look at the income statement so tells you how profitable the company is this is also called the statement of operations and you'll hear it frequently called a p&l profit and loss like profit and loss statement uh and all it is is a list of all the revenues the stuff the company earned versus all the costs the expenses and we say did the earnings exceed the costs if so we were profitable okay moving over to the statement of changes in equity this one I find to be a little less useful but we do need to learn how to prepare it so across the top of the statement of changes in equity we list all of our shareholders Equity accounts and in an intro class and in my intro class I only introduced two accounts your Prof might introduce different accounts or more they might label them differently the two I think that really matter are common shares CS for common shares and re retained earnings common shares and retained earnings are our two accounts that really matter here and here's how it works we say what did we begin with as a balance how many dollars worth of common shares how many dollars worth of retained earnings did I have at the beginning of the period how did those amounts change and triangle just means change and what did I end with so it says how did my what happened to My Equity accounts this year that's what this statement is sort of summarizing for the user it's saying what happened to those shareholders Equity accounts so what did they begin with how did they change what did they end with that's what happens on the statement of changes in equity the third statement we're going to learn how to prepare is the balance sheet and this is another super important statement and it is one of the first places I look I do look at the income statement first balance sheet is second for me uh the balance sheet lists all of the company's assets it says how many assets does the company have what kind of assets does the company have right what are the good stuff that the company owns and controls that's what we can look up on the balance sheet it also lists out the company's debts the liabilities and finally lists out the equity accounts and what we find on the balance sheet is assets equals liabilities plus Equity that's what makes a balance sheet balance because the two sides are equal the asset side the liabilities and Equity side at the end of the day that's what makes a balance sheet balance and so it's sort of good to say okay what stuff does the company have what kind of debts does the company have that's what we learn by looking at the balance sheet the cash flow statement is one that we don't prepare at least in my cour as I've designed it uh we don't learn that until like module 11 so for weeks and weeks and weeks um the reason is it's more complicated but some courses do put it in module one they do sort of a basic version of it and then they come back at it again I don't even touch it in module one I will explain what it is it's very similar statement of changes in equity except it's just for cash so you say what amount of cash did I begin with how did it change and what did I and with for cash and there's lots of interesting subtotals and lots of interesting information on there why do I have a statement devoted to cash right all my other statements there's multiple accounts listed cash flow statement is all about cash the reason is two reasons one if a company runs out of cash they're dead so as a shareholder you're very interested in how they're managing their money their physical cash like or cash in the bank account because if they run out of that cash they're dead two uh it's hard to manipulate cash so you can manipulate various revenue and expense accounts cash is thought of as very difficult to manipulate that number right it's not uh an Airy up in the air number so for example the value of my car you know if I said it was $15,000 and somebody else said it's 14 and somebody else might say it's 16 because it's this used car it's actually hard to argue and there are numbers like that in a counting where it's like is the car worth 15 is it worth 16 is it worth 13 you know is this building worth you know a million bucks or is it worth 1.1 million or is it worth 900 you know it's debatable and reasonable people can disagree typically with cash reasonable people can't disagree and so the numbers around cash are thought of as very trustworthy so when a company discloses its cash flow you can really trust those numbers so a lot of times analysts and investors really like to see those cash flows flow numbers they think they're more honest than say income statement numbers but we're leaving those for later in module one I don't touch touch this at all when we get back to the problem we're going to prepare an income statement a statement of changes in equity and a balance sheet so we'll do that we'll begin to do that in the next video stay tuned we're continuing to work through problem 138 we didn't make much progress in the last video I kind of just laid out like okay we're going to in this problem be doing an income statement the summary of revenues and expenses the statement of changes in equity uh tells us how common shares and retained earnings and any other Equity accounts change during the year and the balance sheet uh the list of assets liabilities and shareholders Equity accounts so in this video Let's just kind of work through the accounts of Sherry shuttles and we'll try to prepare an income statement based on on what we see here so uh the question says Sherry shuttles is a bus company offering rides to outdoor adventurers in the Summer She caters to mountain bikers and in the winter to skiers Sherry's company has the following account balances all on December 31st 2024 and for the year then ended unless otherwise noted and there's a big long list of accounts below it notes the company did not issue or repurchase any common shares during the year and then it asks us first to prepare an in income statement so in this video I'll try to get to the end of that income statement and then we'll we'll pause there and and do a new video for the statement changes in equity and the balance sheet so before we can prepare an income statement we just need to identify our accounts now if you look back to the previous video Problem one 12a we just went through identifying accounts and we're going to do the same thing here so each account I want to say is it an asset liability shareholders equity revenue expense or dividend if it's an asset or liability is it current or long-term so here we go wages payable that is a liability and it is current right it's less than a year so current liability Dividends are dividends they're just their own thing cash is an asset and it is a current asset common shares is a shareholders Equity account accounts payable is a liability and again this is think of your phone bill it's less than a year that you're going to have to pay that thing buildings are an asset and they are a long-term asset the word net there is very relevant for now just know that uh this is our building this is the value of our building is $100,000 we'll get into how we calculate that net and what that net means in future videos shuttle Revenue it's Revenue fuel expense that is an expense depreciation expense is an expense it's got the word expense in it Insurance expense that's expense telephone expense that's an expense expense equipment again it's got that word net we'll explain that later but just think okay the value of our equipment is $30,000 that is a long-term asset uh bank loan uh in the absence of other information we're going to assume bank loans are long-term in nature and it's definitely a liability something to be paid back retained earnings shareholders Equity accounts receivable that's an asset and it's current this is uh our customer hasn't paid the bill right we did some work for the customer they haven't paid us yet we would expect to collect in less than a year office supplies another current asset wages expense are an expense utilities expense also an expense so we've identified our accounts and what we've said is when we prepare an income statement we're going to want to see the revenues and expenses so I'm going to highlight these now H just to note that this is what I need for my income statement so I need the revenues and any expenses I'm just highlighting all of them there's a couple more down here and so as I think about preparing my financial statements think about preparing my income statement I don't need any of the other accounts those non-h highlighted accounts are not relevant here they're not going to be used here they can be ignored for the time being so when you prepare financial statements and we'll do it a lot in this course you need to properly format your statements and that includes properly titling your financial statement they uh I'm not very picky on formatting in most of my course on the financial statements I'm super picky you need the title just to be just so you need the layout of the statement to be just so you need to put dollar signs in the right place I am super duper picky on all the little details surrounding financial statements and many professors are so maybe your Prof will be too so uh when you go to prepare your title know that all titles in accounting have three lines the first line is the name of our company the second line is the name of the statement we're preparing and the third line is the date and the date has little bit of special details that I want to get into so again name of the company name of the statement date let's get to it Sherry shuttles is the name of our company the name of the financial statement is an income statement now this again can also be called a uh statement of operations I've heard it called a profit and loss statement as well and then the date and we don't date this just by putting the date December 31st on it we have to put a time period on it and the reason is because if I compare Amazon's La statement income statement for last month to Google's income statement for last last year you know how much a company earns in a month is going to be very different from how much a company earns in a year so you just need to know the time period that applies otherwise you don't know what you're looking at so this is and here's how we'll phrase it for the year ended and then we give the date and how do I know it's for the year ended well the question said give me an income statement for the year ended the question is going to have to say what time period you're dealing with somewhere and in this case it's a year so it's going to be a year a month or maybe a quarter and a quarter is three months those are the typical dates you would see so for the year ended and then the date December 31st 2024 but you have to put that time period otherwise you don't know what you're looking at so anyway there we have a beautiful beautiful title uh now we just want to summarize our revenues and expenses we start with our something weird going on there with my pen we start with our revenues and we had I think it was like called shuttle Revenue yeah there it is uh shuttle Revenue 6,300 just right here so uh shuttle revenue of 69,3 shuttle re actually should be a lowercase R here Revenue uh 69,3 write the 69 three over on this side of the page so there we have our shuttle Revenue I'm having weird pen issues I'm really making an effort to write more neatly and I feel like it's being let down by the technology and the talent I don't have a lot of writing talent but I'm doing my best here folks I'm absolutely this is as neat as I can write I know it's pretty pathetic but I'm trying uh okay let's list our expenses and we're going to list our expenses in the order we see them uh you know you might list them in order from biggest to smallest or some in alphabetical order I'm just going to list them in your order I see them I'm not picky here about order fuel expense is the first one I see 11,000 oh my gosh I am I just said I was trying to write meat and I'm making a mess out of this fuel expense I forget the amount 11,000 we've got depreciation expense of 2,000 now one thing I'm not picky about is I allow my students write X instead of expense your Prof might or might not allow that insurance expense 4,000 telephone expense 400 wages expense 30,000 utilities expense 1,200 okay so there we have our long list of expenses now you'll notice something with revenues I wrote the number kind of on the right and with the expenses I've written them kind of on the left if you're kind of lining them up they're they're not aligned properly the reason is when I have a long list of numbers I'm going to list on the left I'm going to Total those numbers onto the right now with revenues it just so happened I had one Revenue stream so that was my total revenue so I wrote it on the right hand side now you'll see here when I total my expenses I add up that list and let's add this up so 11,000 plus 2,000 + 4,000 + 400 plus 30,000 + 1200 I add that up 48,600 and I write the number on the right hand side what we also said was the purpose of this revenues minus expenses we want to know if the earnings exceeded the costs did they well yeah 69,000 in money earned 48,000 in cost we're definitely above here and I think the number is 20 ,700 the difference I've just gone taken the difference between the two so 693 minus 48,600 I'm just double-checking my work yeah it's 20,700 this is the profit of the company was the company profitable yes how much money did they make $20,000 this is the net income of the company if I take all of the revenues I deduct out all of the cost all the expenses I get the profit and this is a very key number in fact so key it gets double underlined at the bottom it's the bottom line of this statement we're done the income statement just a couple of formatting flourishes and it'll be all over so this company made $20,700 we put dollar signs at the top of each column so there's a column there dollar sign goes at the top of that column there's a column here the dollar sign goes there we also put a dollar sign beside anything double underlined that's really the rule of thumb your Prof might have slightly different conventions but that's not a bad R of dollar sign at the top of every column and dollar sign beside the any number that's double underlined and you won't be going far wrong we don't want to see a dollar sign beside every number that is for sure okay so we've got ourselves a very nice looking income statement uh what can we learn from this we learned the company was profitable we learned it made $20,700 is this good or bad we don't know why don't we know well if last year they made $100,000 in profit we'd say oh $20,000 that's a disaster if last year they made $2,000 in profit we'd say oh $20,000 hey pretty good uh so it really just depends on the company and we'd need more years of data to to have a better understanding of whether this was good or bad okay we've finished the income statement in the next video we'll prepare the statement of changes in equity stay tuned okay we've just completed the income statement for Sherry shuttles in this video we're going to go through the statement of changes in equity so uh the statement of changes in equity just says how did our shareholders Equity change during the AA how did the accounts classified as cherl Equity accounts change during the year and to do it we are going to need a three line title so let's just start with our title very similar to that of the income statement so the income statement Sherry shuttle income statement for the year ended December 31st 2024 the statement of changes in equity we're going to say Sherry shuttles statement of changes in equity for the year ended December 31st 2024 so exactly the same name of the company sheres shuttles name of the financial statement statement of changes in equity this could also be called the statement of changes in shareholders equity and a very similar related statement that you might see in your intro accounting textbook is statement of retained earnings but we'll go with statement of changes inity here for the year ended December 31st 2024 okay uh we are ready to go we list our Equity accounts across the top and I know I just remember it but in our intro class we only do two Equity accounts common shares and retained earnings again you might have preferred shares and there's all sorts of other Equity accounts you can get into in a more intermediate level accounting class but for us common shares and retained earnings will be the two key columns as well as a totals column uh now the top line is going to be how much how many dollars worth of these common shares and how many dollars did we have in retained earnings at the beginning of the year and we actually give a date here so what is the date of the beginning of this year well the year end date is December 31st 2024 the beginning of the year must have been January 1st 2024 so there's not actually a a heading here other than the date January 1st 2024 and so what we want to say is how many dollars worth of shares did I have on January 1st 2024 let's scroll up to the question I'm going to undo the highlighting from before we're actually done with those now uh and let's highlight any Equity accounts so we got common shares we got retained earnings it's got to be ear here there it is there and we also have dividends that's going to be relevant here so under um common shares pardon me on January 1st you'll note the date here these are the only two that got dated January 1st and the reason is we need that January 1st amount to do our statement of changes and equity and under January 1st common chairs 60,000 retained earnings 10,000 so 60,000 for common shares 10,000 for retained earnings 70,000 for total okay now we're going to add to this uh any shares that were issued we'll deduct from it any shares that were repurchased looking up here it says the company did not issue or repurchase any common shares this year so common shares isn't changing again if we issued new shares we would add those if we bought back our shares as you hear big companies are doing share BuyBacks you would deduct from your common shares um but just because our common shares didn't change and ours didn't uh retained earnings will always change it goes up by the amount of the profit so again we had beginning retained earnings we made profit so that means there's more money to keep potentially within our company and we deduct any dividends that's us saying hey we didn't want to retain those earnings in the company we wanted to take them in the form of dividends so uh that's the shareholders making that decision so we're always going to add net income and our our net income here just comes from the income statement so we have to do our income statement first our net income was $20,700 we're going to deduct dividends and the amount of our dividends was 3,000 just looking at that highlighted row up there our total net income 20,700 our total div dividends 3,000 so we need Grand totals here and this is what we had at the end of the year this is December 31st 2024 our common shares didn't change they started at 60 there was no shares issued or repurchase they end at 60 our retained earnings was 10,000 plus 20 so 30,700 we took away $3,000 in dividends leave us 27,700 and our total here 87,7 you can get that total by adding down so 70 + 20 minus 3 or adding across 60 + 27 is 87 double underlines under all three lines these are final ending St amounts dollar sign at the top of each column and we have one two three column colums and dollar sign beside the bottom line of our financial statement right there and there we have it we have prepared a good statement of changes in equity in our next video we'll tackle the balance sheet bye for now okay everybody we've been working through problem 13A we've prepared our income statement our summary of revenues and expenses and we learned our company made a profit of $20,700 we work through our statement of changes in equity summarized how our common shares and retained earnings change for the year and now it's time to move on to the balance sheet so uh to start with let's just write in our title um now if you're preparing this and you've got a nice clean piece of paper I advise students the first few times they do a balance sheet to actually turn that piece of paper sideways so I guess if you're on a like printer you would say oh I'm printing in portrait mode when you're printing the normal vertical way when you turn it sideways you're in landscape mode you kind of want to do this one in landscape mode it's a pretty wide statement we'll be preparing and um it'll just help to have a little bit more real estate your first time and if you're not going to do that just be aware that we're doing a wide statement here okay so uh name of our company is a three line title as always the name of our company is sher's shuttles the name of our financial statement is the balance sheet this is also frequently called the statement of financial position but we call it a balance sheet and the balance sheet does not say for the year end for the month end for the quarter end the balance sheet just gets dated so we're just going to put the date December 31st 2024 on the top you might say well why we said for the year ended on the income statement we said for the year ended on the statement of changes in equity why don't we say that on the balance sheet why do we just give it a date December 31st the reason is if we think about what's on the balance sheet it doesn't make sense to say for a year so for example we want to know on December 31st how many dollars worth of cash the company has like how many dollars of cash in the bank does the company have well I don't need to know how much they had on you know if I'm looking at December 31st I don't need to know what their cash balance was on February 1st and February 2nd and February 3rd and March and April and May I want to know how much cash they had in the bank on December 31st 2024 no other date right for the year I'd have to get 365 numbers for cash right one for every day and in fact it would change throughout the day uh we just want to know at midnight or 11:59 p.m. on December 31st how much money did you have how many dollars worth of equipment did you have how many how big were your debts on that date in that moment so that's what we're looking at here on the balance sheet so we're going to list all of our assets and I I do this all in capital letters assets on the left on the right we're going to list all of our liabilities and somewhere down here we're going to list our Equity accounts now you don't have to write that se here because you know I can erase this really easily in my software it might be harder for you to erase so just know that okay I've got Equity coming somewhere down there and at the end of the day if I total my left side it's going to match my right side right the the assets equals liabilities plus shareholders Equity so let's get down to business we're going to list our assets so we'll start there I'm going to erase all my highlighting and I'm going to highlight just the assets got cash we got buildings we got equipment come on pen we've got accounts receivable we got office supplies I think that's it so we want to list them and we want to list them in order and the order is called order of liquidity and it just means the most current to the most longterm so looking at our most current assets like cash is considered to be the most current it's it's very very liquid um buildings and Equipment would be more long-term in nature now if I had to list like what comes first buildings or equipment what is more liquid or or shorter term of those two they're both longterm but what's the more short term I would say equipment lasts us like 5 to 10 years buildings last US 20 to 40 years building should be more longterm so buildings is going to come last equipment will come before that cash will come first now looking at our other current assets accounts receivable or office supplies accounts receivable we assume will be collected in 30 days so they're considered quite liquid more liquid than office supplies office supplies are not likely to be gone through that quickly and certainly they don't convert to cash very readily so they're not considered very liquid so my list is going to go for current assets cash first then accounts receivable then office suppli so again order of liquidity what's the most cash-like coming First Cash AR then office let's do it so under ass ass we have current assets as a subcategory here and we have cash accounts receivable which I always say is AR and office supplies under long-term assets and I'll leave a bit of room for total um actually I don't know you just write that now total current assets uh and then we'll have long-term assets this category can also be called property plantant equipment PPN uh and there might be other categories for like Investments and things like this uh but we've just got the two we've got equipment which we said comes before building so equipment net and then building net and uh let's just list those amounts and and total everything up so cash comes first 5,000 then AR 1,000 then supplies 500 5,000 1,00 500 5,000 under cash 1,000 by AR 500 by office supplies total 5 plus 1 is 6,000 plus 500 is 6500 remember if I have a list of sums I list them on the left I total them towards the right for long-term assets equipment is 30 Building 100 30 plus 100 well that's 130 and that is my total long-term assets again this also gets called property plantin equipment it also gets called Capital assets but the fair enough just to call them long term for now 130 + 6 is 136 500 and that is our total assets again I've added my current assets to my long-term assets 6,500 in current 130 in longterm to get a total of 136 500 we've done the left side of our balance sheet it's time to move over to our right side so we've done all of our assets we highlighted them and dealt with them let's deal with our liabilities now I got wages payable I got accounts payable I got a bank loan I think that is it with an L beside it so let's go from there uh so current liabilities I have two wages payable and accounts payable from my experience accounts payable generally gets listed first this is a big uh liability number it's going to turn over in 30 days wages payable may actually be less or around the same amount of time but just by experience I've seen accounts payable kind of come up first wages payable often gets grouped with other they call them acrude liabilities but uh uh let's deal with accounts payable first so we have current liabilities and under that we have accounts payable and wages payable and I've forgotten the amounts so let's go all the way back up 2200 and 1600 okay so that's $3,800 in total current [Music] liabilities now in terms of long-term liabilities I'm really making an effort to write more neatly I know it's probably hard to tell but I am trying uh we just have the one we have the bank loan $45,000 should tell you a story about my hand writing one of these days liabilities when I was in elementary school they let me use a typewriter and that was oh that was a bad scene I'm an older guy and so it wasn't like a laptop it was the clunkiest thing you ever saw in your life I forgot the amount bank loan $455,000 I got made fun of a fair bit for having a typewriter in elementary school um okay adding it up our total liabilities uh 48,800 uh okay so that's it for liabilities we don't double underline that because we're not done we also have to do shareholders equity and shareholders equity in again our intro class is composed of really two accounts common shares and oops common shares and retained [Music] earnings our common shares and retained earnings do not come from up here in the question you might be thinking hey I know those they're right here and here but remember we're doing a balance sheet for December 31st and these are January 1st amounts where do I get my December 31st Equity amounts the statement of changes in equity so I go down to my statement of changes in equity I note I have common shares of 60 and retain earnings of 277 those are the numbers I'm going to use common shares 60 retained earnings 277 the total here is 87,7 that's my total shareholders Equity now I need a grand total and that total is total liabilities and shareholders Equity 48 8 was my liabilities 8877 is my shareholders Equity let's see six oh not 60 uh 48,800 plus 87,7 yes indeed it does equal 136 500 uh at this point I know my balance sheet balances a very very good sign so we need to put dollar signs at the top of each column and in this case I have one top of that column a top there top here and top here I don't need to put any in the equity section it's the not not the top of any column your Prof May disagree with me there so make sure you go with what they think of in terms of formatting I also need dollar signs beside anything double underline so dollar sign there beside 1365 in both places so you can see here our balance sheet balances right assets equals liability plus shareholders Equity this is a properly working balance sheet it's got a good title it's properly laid out and we've done a good job on our balance sheet okay in our next video we'll uh do some basic ratios and we will wrap this up and I'm going to tell you all a very sad story about how I failed my first accounting exam so uh stay tuned for that one bye for now okay we've just been working through our Sherry shuttles problems problem 13A from our accounting workbook and now we are at the time where we are going to compute some ratios so we've prepared an income statement already statement of changes and equity and now balance sheet and the question we've solved part A the income statement B statement changes in equity and C the balance sheet another question saying hey compute these three ratios the current ratio the debt ratio and the equity ratio what are ratios well they're just quick little calculations you can do when you're looking at a company at a glance and you can get some useful information from them so the first one the current ratio let me just write it out down here current ratio tells us well the the formula is current assets over current liabilities what does that tell us it tells us can the company pay its bills does it have enough current assets short-term assets to pay off to cover its short-term debts literally it's on top here it's covering it does it have enough money to pay its short-term bills so let's calculate it for our company and I'll kind of comment on the current assets right here 6500 the current liabilities right there 3800 so we'll calculate a number this is not a percentage it's just a number 65 oops let just do it this way 6500 divided by 3800 1.71 again we're not going to write a dollar sign or a percentage here that's just the number so the rule of thumb here is anything above 1 .5 is considered to be safe anything one under 1.5 is considered to be riskier and if you think about it like if you're below one it means you don't have enough money to pay your bills some bigger companies these rules go out the window but I think if you were looking at just your your family business or a typical smaller business I think a good rule of thumb is you want to be above 1.5 here if you want to be considered safe otherwise you're a liquidity risk you're at risk of running out of money you're at risk of not being able to pay the bills so that's our current ratio bigger is safer and in an intro accounting class safer is better again I've seen real companies where uh the shareholders don't want the current ratio to be as high they're saying yeah we have too much cash you should either invest long-term or pay dividends but you shouldn't keep so much cash and obviously having more cash will make your current ratio higher so I've seen shareholders argue for a lower current ratio in our class we'll always Advocate that bigger is safer and therefore better um okay let's look at the debt ratio uh the debt ratio is computed as total liabilities divided by total assets so for our company the total liabilities not the current liabilities now the total liabilities is 48,800 the total assets 1365 so crunching the number here 48800 / 136 6500 we get 03575 now we do want to State this one as a percentage 35.75 per. what does this say it says if the company you know sold off the company today you paid off all the debts you took the rest of the money for yourself 35% of those assets have to go to pay the debts 36% almost uh meaning and that gets us to the equity ratio there are weird things happening and popping up on my computer right now um the formula here is total shareholders Equity divided by total assets now I don't actually need to calculate this I can say okay if the debt ratio is 35% I don't even need a formula I can just say Okay this has got to be the rest to get to 100% this has to be 64.2% right and that 35 + 64 it adds up to 100 um let's do the formula anyway our total shareholders Equity here was not 136 what was it it was 87 there 87,7 we're going to divide by 136 500 and let's compute it 877 divide by 1365 and we get 64249 so [Music] 6425 and that converts of course to 64.2% so what does this say well again if I took the company sold all the assets paid all the debts 64% of the money afterwards would land in my shareholders pocket 36% would go to the debt holders 35.75 per would go to the debt holders 64% would go to the shareholders so for the debt ratio bigger is thought of as riskier and in our class riskier is worse so you want to be lower in terms of a debt ratio you want to be higher in terms of an equity ratio all else kept equal again this isn't the case for all companies some companies it's very sensible to borrow and even borrow more and uh use what's called Leverage but in our class just think of uh debt ratio as bigger means riskier and risk is negative in in our view again and different uh companies and different Finance people may disagree with that statement but in a basic accounting class I think that's fair to say okay so that's it we've solved the problem now you can skip ahead if you don't want to sort of personal story but I uh I took this class as a student and and I I Gotta Give a bit of backstory here in fact I'm GNA drink a drink of water before I is very personal story so I I um from when I was a little boy I always wanted to be an accountant and I I look back and I have these like yearbooks not even yearbooks my mom would like take a picture from the year and then paste it to a page and on that page there would be a survey like Tony what's your favorite food and what's your who are your best friends and one of the things you know you ask a little kid is like what do you want to be when you grow up and I said accountant from a very young age from when I was like four years old accountant accountant accountant and you know I didn't know what accountant was how could you know but I I knew I liked numbers and I liked money and in reality somebody that really likes numbers and math and money should get into Finance but I I just had it in my mind accountant accountant accountant so I went through high school never took an accounting class but I'd tell all my friends and you know in the yearbook what do you want to be account accounted accounted account got through first year of University no accounting classes in first year so and I done well in school mostly B's and A's and uh I get into second year of University and I'm here I'm finally in my accounting class and I tried so hard in this class I worked so hard I studied so hard and most of my other classes I didn't even care I was lazy and I still did okay this class I was working my butt off and like because you know this is my life I'm going to be an accountant I've said this for the last 20 years I'm going to be an accountant and here I am in accounting class so I get to the first midterm exam and on that midterm exam was a financial statement question just like this one give me an income statement statement of changes in equity and a baling I ask my students to do this on my exams all the time income statement statement of changes in equity and balance she so anyway I'm working away I do the income statement I go okay great do the statement of change in equity seems like things are going well do the balance sheet get to the bottom of the balance sheet and what happens well my balance sheet did not balance and I did I made a mistake and this is the reason I'm telling you the story is because I don't want you to make the same mistake I made I said oh jeez I know these two numbers have to match assets T to equals liabilities plus shareholders Equity if there's one thing I know that must be true and for my question it's false clearly I did something wrong and I erased the whole thing and I start it over and I work through and I get to the bottom of my balance sheet and guess what the exact same number and by the way you know this question takes it took us you know 45 minutes in these videos but probably takes 20 minutes in real life to do like even if you're going quickly and so you know I've I've just wasted 20 minutes I got to the bottom and I see the clock's ticking I have a wrong answer I'm starting to sweat I start working on some other problem I start to cry in the middle of the test I just I broke down and uh you know so I I didn't finish the test I never finished the problem I erased it again I start again I run out of time it's kind of half there and half gone and I'm I'm just weeping in my seat like oh my God you know I've never failed the test before I I know I'm failing as I'm doing it and um I I just hand it in I say Prof like look I don't know what happened this was a disaster what can we do here and she just to her credit said listen you just have to do better on future tests like uh you know you this this exam happened and it counts and you'll have to do better going forward and so my advice to students a couple of things one if if you miss something and it causes your balance sheet to go out of balance just move on don't get hung up on that like this type of question is worth like double digit marks let's say 12 marks for me well you Pro you might get an 11 or a 10 out of 12 if you have most of the stuff right right you can still get an A+ level grade on the problem and still have it not bounc so don't lose your mind don't erase everything for sure the other bit of feedback here is I got like 28% on that test okay and this was like such an important subject to me and to get 28% really hurt but I passed the course I I didn't get a great grade I think I got a C+ overall but I had to work my butt off to pull it up to a C+ and I went on to be a CPA I went on to be a professional accountant and now I'm an accounting professor having got below 30% on the first accounting exam of my life so I have students all the time in my class that fail fail a test and it's not the end of the world and in fact it's not even the end of the world if you fail a course but really it's not the end of the world if you fail a test you can put it together you can put yourself together and you can improve and I'm I'm living proof of that because I bombed my first accounting exam ever so uh hopefully that's positive feedback hopefully that's helpful to you and uh good luck in your studies now I appreciate you watching these videos and I hope that helpful and I I made this little thing uh this is a new thing to me self-promotion but you know here I am if you're watching this on YouTube and you made it all the way to the end and you made it through my ridiculous story I hope you'll take the time to like and or subscribe uh and share with your friends let them know that this these videos are useful to you again uh it really helps uh to have the algorithm kind of know that my videos are good and know that they're worthwhile so I hope these videos were worthwhile to you and if so please don't be shy about liking and subscribing to them all right have a great day everybody and stay tuned for our next video bye for now welcome to module two of our course on financial accounting this module is the most important module of an accounting course if you want to survive your introduction to financial accounting course you need to understand journal entries the reason is you know in a couple chapters we're going to learn about receivables well what do we do with receivables we do journal entries when we learn about inventory we do journal entries of inventory when we learn about long-term assets journal entries journal entries will just come back again and again and again in any Financial Accounting course so you really need to understand them the good news is there not too hard there's a lot of harder topics but the bad news is if you haven't understood it well it's just going to haunt you for the rest of class so I'm glad you're here I'm glad you're watching this video this video assumes no prior knowledge of journal entries maybe you've been to a class or tried to do some readings and you're feeling very shaky you are in the right place so let's begin let's start talking journal entries and when I think about journal entries funny enough I don't think about accounting at all I think about physics now I didn't study a lot of physics in my life I think I took a grade 11 physics class that's it um but I know enough to know that like if you took a grade 11 physics class in Canada where I'm from um the star of the physics class if you could name a star is this guy Isaac Newton uh here's his Wikipedia page very important person in the world of physics apparently discovered a lot of important uh uh rules about how the the world works I guess and uh so you know he's very famous for like sitting under an apple tree and an apple falls on his head and he apparently discovered gravity I I don't exactly know how that works but obviously a lot of the math behind gravity he uh is thought of as one of the early um people to understand that um but if you take an a an again first year physics class or an early physics class you've learned about Newton's Laws so there's one like Force equals mass times acceleration or an object in motion wants to stay in motion an object at rest wants to stay at rest but it's his I think it's his third law that I want to talk about here and Newton's third law I think it's his third says for every action there is an equal and opposite reaction every time one things happens something equal and opposite is happening and that's what I want you to think about when we talk about journal entries there's there's not just one thing happening there's always kind of equal and opposite forces acting in a journal entry and uh this is core to the concept of journal entries and let me give you an example so let's say I go to the car dealership and I buy my dream car it's a Volkswagen Golf I think GTI I don't know I'm not a car guy but I really like the Volkswagen Golf it's my uh favorite car so I go and buy a Volkswagen Golf so my Volkswagen Golf I'm just going to say car here for short my car the amount of cars I have actually let's call it cars goes up by let's say it cost me $30,000 so I now have $30,000 in car assets I didn't previously have right my cars have gone up by $30,000 well at the same time something else has to happen I either have to take a loan or let's just make this as clean and simple as possible let's say I showed up with $100 bills you know $300 $100 bills so that's $30,000 in cash and I hand the car dealer $30,000 in cash they hand me the keys to my nice shiny red Volkswagen Golf well something simultaneous has happened then from an accounting perspective right and accounting is all about tracking Financial events uh and this is a financial event that has happened what has happened simultaneous to my car going up my cash has gone down I've lost $3,000 cash I no longer have that cash that cash belongs to the guard dealer so my cash goes down by $30,000 okay well we have followed a transaction this is business being transacted and it happens hundreds and even thousands of times in a day for many businesses no not buying cars every day but uh certainly you know Walmart will have hundreds and hundreds of sales transactions just one branch of Walmart not let alone the whole corporate entity so there's lots of little transactions every day and it's you know an accountant's role is to keep track of it all right we want to keep track of all of this in a logical way that's not going to drive you crazy right because the company wants to keep track of its assets its liabilities its shareholders Equity accounts it also wants to keep track of revenues and expenses to manage the business right just to understand what's happening with your own business let alone to prepare financial reports for you know investors and things like that which bigger companies absolutely want to do so uh starting with this micr level transaction we bought a car for cash cars went up cash went down this we've kind of recorded the transaction but this isn't how accountants record transactions maybe you're telling somebody you going to take an accounting course and they said watch out for those debits and credits well this is where debits and credits come in and again when I'm reviewing let's say a student has failed my class and they come into my office and they say you know I want to know why I failed and we're looking at their final exam nine times out of 10 it's journal entries it's this topic that syncs them so really you need to have your aame here so anyway let's talk about how journal entries work uh I'm going to make a little table and I'm going to make this table all the time uh and I hope it's going to be helpful to you so I write the accounting equation here a equal L + SE then I write an up arrow down arrow down arrow up arrow down arrow up Arrow then beneath I write Dr CR Dr CR R Dr CR um okay so it's a little bit convoluted so far as looks like a hieroglyphic but believe me by the end of this video and certainly by the end of this module you'll know what this hieroglyphic means um so a asset L liability SE shareholders Equity we're getting pretty good at identifying accounts by now right it was all module one and if you didn't do module one go back and watch those videos I think think they'll be useful to you but anyway we should be pretty comfortable with all that jargon drcr is new Dr well I mean cr makes great sense CR stands for credit CR credit and Dr makes lots of sense Dr stands for drebit wait a minute debit with no there's no R in the word debit why do we put Dr for debit um I I've done some research on this and it's uh unclear actually is conflicting reports the one like the best is just that like look accounting has existed for thousands of years and this was Latin or some foreign language where the word for debit was a Dr what I don't want you to think is that debit and credit mean like debit card and credit card or uh you know you have a credit on your account maybe you've heard that phrase don't even worry about that what I want every student to do is especially if you were in banking this is especially true for you forget what you know about the word debit and credit uh it's not going to help you here accounting has very specific use for the term and if you sort of bring some previous baggage in and go well I actually kind of know what this means forget it like it's going to help you just to work from a clean slate here so um let's look at this transaction my car for cash transaction I purchased a car for cash um what is a car in you know this uh chart here is it an asset liability share's equity car is an asset okay we have a car increasing by $30,000 therefore an asset is increasing by $30,000 therefore I should I was trying to highlight but it didn't work very well I should debit that asset because it's going up right I should debit that asset so let's debit our car now how am I going to debit my car well if I were If This Were My like piece of paper right if I were a student and I had like a spiral notebook and you know here's some whole punches on the side well this isn't to scale but you're getting the idea here's like the margin do it in red this is like the margin uh Etc okay I don't need to do this um uh at the top of the page I would write Dr with an underline and then CR with an underline then below I would write the date so uh today's date is July 17th so I would write July 17th 17th okay what happened on July 17th I I bought a car and I I've just said I want to debit that car so on the left side sort of close to the margin here I'm going to write the word car and under the Dr I'm going to write [Music] 30,000 that's saying I'm debiting my car by $330,000 I Don't Need a Dollar C uh now what's happening with cash well what is Cash Cash is going down but what is Cash Cash is also an asset to make an asset go down we credit it so let's credit cash so when I write the word cach I want to encourage you to write the word cach kind of over almost like we've uh hit enter on a computer and hit the space bar five times like write it over here is uh so okay I've written it over there now the number 30,000 goes on the credit side finally I have to describe what's happened and to describe what's happened I write purchased a car for cash and I might write some more details I might write like you know Volkswagen Golf you know these are the features or whatever you know you might write more details here but that's the gist of it right you're just trying to describe what's happened um Okay so we've done it we've done our first journal entry I'm looking for a few things one I'm looking for an account to be debited an account to be credited I'm looking for the value of the debits and credits to match so $330,000 worth of debits $330,000 worth of credits I'm looking for a date and I'm looking for a description I'm also looking for their not to be dollar signs so at this point I've got myself a very good journal entry and we are on our way to understanding journal entries I want to do a second version of this transaction so so um yeah I'm just going to what am I going to do I'm just going to redo things okay so uh transaction two I buy the car so my car goes up by 30k and rather than cash I just get a loan so I get a car loan to pay for it now when I get that financing and let's just say no money down right let's make this really simple it's purely a car loan 100% financed with a car loan um what's happening with my car loan is it going up or down well yesterday I didn't have a car loan today I do so my car loan is going up by 30k now I know what you're thinking you're skeptical right now you're saying Tony didn't you just say Isaac Newton and every action there's an equal and opposite reaction we got two things going up well this is absolutely a possible thing in accounting but I'll explain what I mean by equal and opposite in a sec let me just copy down my table in fact I can just move it down the page here so what's happening I got a car going up by 30,000 so this is an asset increasing by 30,000 I'm going to debit that asset so I'm going to put car again debit credit uh car going up by 30,000 car debit 30,000 car loan what is a car loan loan to me well a car loan is a debt right it's something I have to pay back it's a liability we said the car loan is going up I've got to credit my car loan so I credit car loan maybe I'll even write the word payable in there because I like to write the word payables after liabilities and again it's a liability going up so we credit it 30,000 so when I talked about Isaac Newton saying for every action there's an equal and opposite reaction what I meant was every transaction will have a debit and a credit at least one debit at least one credit and the values of those will be equal right the debits will equal our credits at the end of the day um we need to uh date this thing so again July 17th and we need to describe it purchased a car financed with a loan Okay so we've done our second journal entry time to move on to the third and final journal entry of this intro and then we're just going to do lots and lots of practice journal entry so let's do the third journal entry the third scenario scenario 3 I buy a car my car goes up 30,000 uh but I put 10,000 down and finance the rest with a car loan so my cash goes down 10,000 and my car our loan goes up 20,000 okay we should be able to do this so again let me bring this little thing down I like to have this close at hand uh maybe I can bring it down a little more okay there we go I've left the D in debit there we are um so what's happening here well my car is going up 30,000 it's an asset going up let's debit car car again debit credit now if I were doing all of my journal entries at once I wouldn't write drcr every time I would write it at the top of the page and that kind of holds for the call so anyway debit car 30,000 now what happened to cash cash went down cash is an asset going down it's an asset decreasing so credit cash 10,000 and car loan is an uh liability increasing and to increase a liability we credit it so we credit car loan payable or just car loan 20,000 so again we need to date this July 17th and we also need to describe it purchased a car put 10K down financed the rest with a car loan all right so we've got our third entry one final note regarding these entries because we haven't done any Equity transactions most companies there's not a lot of equity transactions but there are transactions that affect equity and those transactions involve revenues expenses and dividends so let's think about how revenues affect Equity revenues if you earn a revenue means you're more profitable you have higher retained earnings if you're earning more Revenue so it makes Equity go up revenues help shareholders Equity so revenues because they always make Equity go up they're always a credit expenses because they always make Equity go down they're always at debit and dividends the same because they always make Equity go down they are always a debit this little table is the key to the whole thing this is the key to your week this is the key to well however long you're working on this but this is the key to your understanding of journal entries uh this is the most important topic of the semester period Baron I don't think it's the hardest although I do think it's hard but there'll be harder things yet to come but if you struggle here you're going to struggle with everything in the course so it's worth taking your time worth practicing I've got I think it's eight really long problems giving you lots of chances to practice practice practice your uh uh journal entries it's like I said the most important thing okay that's all for this video if you stayed tuned this long I hope you've liked it and if you know again if you're watching this on YouTube I totally appreciate if you can share sh with your friends you can give me a thumbs up uh and just comment let me know what I can do to improve so anyway I appreciate that you're here I appreciate that you hung in there to The Bitter End that's all for this video see you next time bye for now in this video we are going to explore problem 22A this is a very important video it shows us how to do journal entries in the second part we'll make tea account and finally we'll do a trial balance um as mentioned in my previous video though if you don't understand journal entries you will be in trouble in an intro Financial Accounting course so if you haven't watched the intro video for this module please watch it we go over um the rules of debits and credits when we make a debit and when we make a credit but there's this little cheat sheet I'm going to keep referring to on the side of my page I encourage students to write it in the corner of their exam papers um and here's the rule uh if we have an asset that's increasing we debit it if we have an asset that's decreasing we credit it liabilities are the opposite debit them to make them go down credit them to make them go up shareholders Equity same as liabilities debits make them go down credits increase them now because of the way revenues work revenues always help our shareholders Equity so revenues always take a credit expenses and dividends always hurt shareholders Equity so they make shareholders Equity go down they take a debit so those rules are going to hold here let's go through the problem and see how we do in August Maria Chen started her new Taxidermy business the right stuff Inc the business focused on preserving family pets after they passed away the following transactions occurred during August okay August 1st Maria invests $1,000 cash in exchange for 250 common shares now remember Maria is separate from her company The Right Stuff Inc and we are the accountants for the company this class is all about corporate accounting so uh we are looking at this from the company perspective and uh the first question I always ask when I think of these journal entries is did any money change hands did cash change hands and the answer is yeah $1,000 of cash change hands changed hands so Maria invests $1,000 in cash in exchange for 250 common shares now this is Maria starting her company she's buying the initial shares just to begin the company the company is getting cash and Maria is getting common shares in this transaction so the company is getting cash so looking over at this table on the left cash is an asset the company's cash is increasing therefore debit cash so let's do that uh I'm going to date this because it's a journal entry Aug one and then under August 1st on the left I write cash and and thecr headings up here we're going to debit cash for $1,000 I don't put a dollar sign there uh now what's the other piece of this well she invested $1,000 of cash in exchange for 250 common shares this one is a little confusing as a first entry but just know that her equity in this company is growing right common Shares are one of our two Equity accounts we're worried about here so this is absolutely shareholders equity and before she had no piece of the pie now she has a thousand piece of the pie so her shareholders Equity is growing sometimes students can tie themselves into knots here thinking oh common shares aren't those assets and are our assets going down no no common Shares are always an equity account for us um and uh uh they are her Equity is increasing so let's credit common shares a th000 bucks now something that many professors will require I don't is to write a description if you wanted to write a description for this you would say Maria invested $1,000 cash in exchange for 250 common shares you would just write this underneath uh one other question I frequently get here is this number this 250 why haven't I written 250 anywhere in here and the reason is journal entries are all about the dollar amounts so again if I bought four C cars for $10,000 each I would go debit car 40,000 I wouldn't go debit car four right because there's four cars well here there's 250 Comon shares the number of shares doesn't matter it's the dollar value that's being exchanged so uh there we have it August 1st in the bag I'm going to try to work a little more quickly because that was four minutes for one entry uh let's move faster next rented workspace paid $600 for the month of August okay so first thing paid $600 that's telling me cash is changing hands so on August 1st I'm going to credit cash I'll leave room for a debit here and I should be clear here cash is of course an asset and it is an asset that is decreasing that's why I'm crediting cash I credit cash for 600 I don't need to write drcr on every entry it can sort of follow through for the rest of the page um now the debit here is a debatable one I think the most logical one most companies will use as they'll say look this is a cost of doing business rent is an expense so we should debit rent expense and I do think that's the most logical choice however if companies pay for multiple months of rent in advance certainly prepaid rent is not an unreasonable thing to say here prepaid rent is actually an asset account we'll learn all about it in chapter 3 but for now I think rent expenses is logically what most companies would do uh and so that's what we'll do here August 2nd the company borrowed $500 in the form of a long-term bank loan uh uh the money was planned to purchase much of the equipment that would be needed okay so first of all whenever it talks about the money being planned for something who cares what the plans are right plans fall through all the time this is financial accounting it's all about what happened it's not about what's planned to happen that's a managerial accounting thing financial accounting is like just give me the facts what happened so what happened we borrowed $5,000 so did money change hands the answer is yes we got cash we received cash so cash again is an asset it is an asset that is increasing let's debit cash so August 2nd we'll write cash on the left here and the amount was uh $5,000 the credit well what's the other piece of this it's long-term bank loan right we we have a liability here yesterday we had zero bank loans today we have $5,000 worth of bank loans our liability is indeed increasing that means we need to credit bank loan or bank loan payable I always like the word payable at the end of my liabilities whoa something crazy just happened payable there we go 5,000 bucks okay I think we're doing well let's continue on to August 5th it's a funny thing making these videos because in class I would always pause and say oh do anyone have any questions and there might be a question or two and I keep going but in the videos there's nobody to ask questions so I just I try to come up with typical student questions but that one I think that's straightforward purchased equipment $4,000 paid $1,000 with the rest payable at the end of August okay so we bought some equipment we B $4,000 worth of equipment cash did change hand so let's deal with that paid $1,000 that's all I need to see uh so I'm going to date this August 5th we've got an asset that's cash and we've got an asset that's decreasing so therefore we'll credit cash uh so I'm leaving room for a debit because I know one is coming but let's credit cash for ,000 let's deal with the equipment because we did acquire $4,000 worth of equipment so the fact that we got $4,000 worth of equipment means our assets our equipment assets are indeed growing so our equipment assets are going up debit equipment and they're going up by four grand like even though I only paid a th000 I got $4,000 worth of equipment and so debit equipment for 4,000 well what's the other 3,000 clearly I'm missing a $3,000 credit but what is it four um well let's see we purchased equipment four grand paid a th000 the rest is payable at the end of August okay the payable amount this is us doing a business-to business transaction we owe somebody some money at the end of the month it's a bill to be paid bills to be paid of course are liabilities they're something you owe and uh it's increasing right yesterday I didn't have any bills to be paid to this company now I have $3,000 worth of bills to be paid so we are going to credit our liability now what's the liability it's accounts payable a is our typical Bill to be paid again if I were writing a description I would literally just write this underneath I'm not going to say that every time but I just want to reiterate that if you are in a class that requires descriptions of you August 10th uh received and completed first Taxidermy job a poodle named Rex received $400 cash okay this is us doing work right we are doing our service we are doing work uh and This Is Us earning money and in fact cash did change hands so let's deal with cash first it's an asset it's increasing therefore debit that asset let's debit cash on August the 10th cash goes up by 400 bucks now uh what's the other piece of this well us earning money when I think earn I think revenue and that's exactly what this is this is Taxidermy revenue and of course we expect to see this be a credit and it is a credit of 400 bucks next purchase supplies on account 200 bucks okay let's scroll this down uh maybe even further uh purchase supplies on account 200 bucks okay so we got some supplies we didn't pay cash though so if we buy something on account this creates a liability we owe right we said hey we'll take those supplies send us the bill and when we say send us the bill what we're saying is give us an account payable right let us have store credit let us have credit with you um purchase supplies on account so supplies changed hands and there's this asset called supplies we acquired some assets so this supplies assets are going up by 200 bucks let's debit on August 12th let's debit supplies by 200 bucks the credit here is to accounts payable this is a normal businesso business transaction it's uh sorry a liability it is uh increasing therefore we credit that liability okay let's continue on to August the 13th completed second Taxidermy job do job easy for me to say a chocolate Labrador Retriever named KitKat $600 on account so we did some work we didn't get any money we sold it and we sent our customer a bill okay so uh this is clearly a revenue earning situation maybe we'll deal with that first uh we'll have to credit some sort of a revenue so on August the 13th I'm going to credit uh Taxidermy Revenue right I did some taxidermy work I'm earning Taxidermy rev and the amount is 600 bucks the debit here would normally be to cash when you're earning money but we didn't get paid so when a customer owes us money sort of like when we owe our um you know vendor money it's accounts payable when a customer owes us money it's accounts receivable debit AR accounts receivable for 600 smackers okay continuing took a dividend of $500 I think it's implied cash uh to pay for personal expenses so uh Maria takes a dividend $500 cash to pay for personal expenses doesn't matter what she wants to pay for we just know she took $500 cash from the company so uh cash is changing hands here let's credit it's an asset of course and it's going down so let's credit cash on August 14th uh cash takes a credit of uh 500 bucks the debit is well what did she take she took a dividend and dividend is its own class here now your Prof might teach you to debit retained earnings and we'll talk about that later but that's totally appropriate if you've learned to debit an account called retained earnings at this time totally inappropriate thing to do totally fine um I I debit an account called dividends in my classes so we'll do that and we'll explain why in the future chapter three module three received and paid the utilities Bill 200 bucks okay received and paid we paid a bill if you pay a bill that means money's going down we got an asset it is decreasing credit that asset and that asset of course is Cash August 19th cash goes down by 200 bucks the debit is utilities cost it's it's a cost of doing business this is an expense of our business debit utilities expense 200 bucks next paid for the August 5th equipment purchase okay paid already when I read that I don't even need to look up I know I'm going to credit cash for amount right uh this is August 20th and why am I crediting cash well again asset decreasing credit that asset and cash is an asset decreasing let's go back to August 5th figure out how much it was oh okay so this is interesting paid a th000 with the rest payable so we're paying not the full amount we're not paying four grand we're paying off the three grand that was payable at that time right we've already paid a grand so we're not going to pay another four we'll pay three ,000 here now a frequent mistake here is because students go oh they're paying for equipment debit equipment no no no we're paying off a debt we're paying off a bill we are reducing that payable liability if I debit equipment it would be like I bought $33,000 of new equipment here didn't do that right it's paying a debt it's we have this account payable this account payable says we owe them $33,000 what we're saying is I don't owe them that money anymore my liability my payables liability needs to be reduced it needs to go down debit accounts payable $3,000 okay next August 21st received a telephone bill $200 did not pay it yet okay so uh we got a telephone bill if we paid it we would credit cash U but since we didn't pay it obviously this creates a debt or a liability an account payable in this case let's deal with all of this August 21st what is a telephone cost to a business telephone cost is absolutely an expense and expenses need to be debited let's debit telephone expense and the amount I almost put a comma there in 200 $200 it's interesting just a random aside here I teach at a university where students from all over the world and not everybody puts commas in the same place as what I've discovered some European people would put like that uh comma up top uh students from India have all sorts of different places to put commas um but of course in North America it's like three zeros a comma three zeros a comma etc etc etc um okay anyway de weird as side we've debited telephone expense what's the other piece of this well it's a liability and we owe we're going to have to pay back it's an account payable and yesterday I didn't owe the phone company anything today I owe them 200 bucks so credit AP $200 next received payment for the August 13th job I think that was our chocolate Labrador Retriever uh let's see August 16th what date was it August 13th this one yeah this one over here um okay so yeah we did some more $600 of accounts receivable and now the person's coming in to pay so of course when they're paying us we debit cash 600 bucks August 24 debit cash 600 a common mistake here is to credit Taxidermy Revenue because they're paying us related to taxidermy work no we've already recorded the Taxidermy Revenue up here what we've got to say is this account receivable it's no longer receivable right we've got the money now we don't we don't have to collect from this client any longer so we don't need to track them as a receivable as an amount owed to us so we get rid of that asset we reduce the accounts receivable which of course is an asset it's decreasing credit AR a lot of these ones where I debit cash I just know the other ones at credit because that's how journal entries work right we need equal amounts debits and credits so clearly we're going to uh be crediting something for $600 completed a third Taxidermy job a a calico cat Nam spot $250 received payment so we got paid anytime I get paid I debit cash let's do that cash 250 bucks uh what's the credit here well the credit is to um what is it to Taxidermy Revenue I had like a real blank there I was like oh I'm almost to the bottom and I haven't made any obvious mistakes I was so happy with myself and then I totally blanked um we're going to credit tax atormy revenue though this is a company doing what it does to earn money and they do Taxidermy to earn money so Taxidermy rev 250 and uh we're almost there paid salaries of a th000 bucks salaries again are a cost of doing business that's an expense and whenever I read paid I think okay cash my asset is decreasing so let's de I just I hexed myself Stu cash is increas decreasing I I circled the wrong one I'm going crazy here uh let's credit cash here how about that good grief it going so well and then I commented on how well it was going and the wheels fell off we paid salaries credit cash for a th000 bucks you guys all knew it already for goodness sakes uh the journal entry here though this is a cost this is an expense this salaries are an expense so debit salaries x a th000 bucks um just a quick note about this so we we've gone through the journal entries we have answered part A and the next video we'll do B and then follow up video we'll do c but a quick comment before I close this out on on this thing uh I I always teach with this in my classrooms and it's I think useful and I think it's good and that's why I do it uh but I'll never forget I had a student at the end of one semester and he said hey you know you taught us this chart and I I didn't understand it why didn't you teach us dead curls and I was like what's dead curls I don't even know what you're saying and he said yeah dead curls and he writes this on the board d e a d c l s and I was like I'm sorry I have no idea still what you're talking about dead cross and he goes okay look debit uh expenses assets dividends credit revenues liabilities and shareholders equity and uh it's all true right a debit to expenses makes the expense go up debit to assets makes it go up debit to dividends makes it go up and the reverse is true right if I credit an asset it makes it go down uh same with credits credit to revenue makes it go go up credit to liability makes it go up credit to sher's equity makes it go up and just know that the reverse is true so I thought that's a useful trick I'm not going to refer to that but but you know if you were feeling like uh I'm a little bit feeling weird about that maybe dead curls will help you and the final thing that won't help you but it'll help me is if you got through to the end of this video you heard all the tips somebody told me I have to do this we'll see if it works if it makes a difference if it makes the YouTube algorithm favor me I really would appreciate a thumbs up though if you made it to the end uh let me know in the comments that you survived you're seeing the end of this video I think most people too note after about 5 seconds but if you made it to the end congratulations and thank you for being here regardless of you if you like or subscribe or dislike even I I do want to thank you for being here all right stay tuned for our next video we'll just continue on this journey okay we are continuing our journey through problem two 2A we have done all of the journal entries in the last video now we're going to post those journal entries into T accounts that's this step and this is sometimes called posting to The Ledger the general ledger looks a little different but it's the the same thing is essentially happening so if you're learning to post to a ledger your format's going to be quite different if you're prop posting to a proper J general ledger uh but it's the same technique you're just moving from journal entries into accounts and that's what we're going to learn to do and I te accounts are just the simplest way um so what is a te account well let's explain uh I'm going to and you might have noticed the the writing here is smaller I might even make it a touch smaller still uh a t account is just a big T with an account name on it so for example this first August 1 Journal here where I say debit cash credit common shares I'm going to need a t account for cash because cash is involved in that transaction so there's a cash t account uh and in fact I'm going to have a section here for my assets somewhere down here I'll do some liabilities a little bit further down I will do shareholders Equity accounts then Revenue accounts and last I will do expense accounts so it's not all going to fit on a page here it's it's you know this is for me it won't fit on a page for you it should fit on a page I would think so my cash T I actually want to be extra long because I know so many transactions involve cash the first transaction debit cash credit common shares so the t account has two sides the left side is for debits the right side unsurprisingly for credits so when I debit cash a th000 I literally just write a thousand underneath the word cash I have a six-year-old daughter and she says literally for everything Dad I'm literally coming upstairs right now like okay thanks kid um they just literally everything so I just said literally I caught myself um uh credit common shares uh so I go down to shareholders Equity I'm going to make a t called common shares and I credit my common shares for the same ,000 that goes on the right side you can see the t is a lot shorter that's a normal length t account for our problems of course when we're doing this on computer it's like an infinitely long te account it's as long as it needs to be uh we're dealing on paper so we have limitations here debit rent expense credit cash okay so I'm going to go down to my expenses I'm going to write one for rent expense and this is all this problem is it's just lit literally what's what's a replacement word it's actually just writing the numbers oh my gosh I'm going to say literally 800 times in this video I Can Feel It Coming debit rent expense 6 00 we're going to literally debit at 600 we're going to credit cash oh no I'm going to lose my mind in this video I can feel it debit cash credit bank loan payable that's our August 2nd journal entry so let's debit cash $5,000 and we'll credit bank loan payable that's a liability so I'm going to write that under my liabilities bank loan payable and that was for five grand next debit equipment four grand okay let's deal with that right away debit equipment so that's under my Assets Now I even like to break this down I know I've got some current assets coming I'm going to put the equipment over here sort of I like to try to sort that's pretty messy I like to try to sort this out almost in order of liquidity if I can so I know cash will be first then I'll have AR or supplies something like this uh and then equipment will come towards the end because it's a long-term asset so that's why I'm writing it over to the far right if you don't get this quite right or in a perfect order don't lose your mind it's fine it just makes your life easier later but it's it's no big deal uh debit equipment four grand credit cash one grand and credit accounts payable three so I've already screwed up my order of liquidity because bank loan payable is long-term AP is current and I've written AP to the right of it so it's already out of order but it's no big deal credit AP for three grand um okay continuing uh received and completed First Tax oh I don't have to read that debit cash credit Taxidermy Revenue 400 debit cash 400 credit taxy Revenue I'm going to need a new t for that 400 uh next debit supplies credit AP 200 so put supplies here credit AP 200 and if if you're feeling like I feel like I'm running out of space in that AP just make it longer uh you want to leave yourself room to be able to do that of course debit AR credit tax atery rev 600 so AR 600 Taxidermy [Music] rev 600 uh debit dividends credit cash 500 I'm going to put dividends in with my Equity uh you could also put this just at the bottom of your expenses like the very end dividends uh 500 pardon me and credit cash 500 debit utilities expense credit cash 200 so I'm going to make a new expense utilities expense uh what was it 200 and a credit to cash for 200 uh where were we utilities expense so next debit AP I'm here debit AP credit cash 3,000 debit AP P 3000 credit cash 3,000 now we are here debit telephone expense credit ap200 need a new t for telephone expense tone expense and uh debit that for 200 credit accounts payable for 200 debit AR credit tax atery revenue 600 so AR oops what am I talking about I just did that I I did that already I I was reading the wrong 20000 debit cash credit AR pardon me debit cash credit AR 600 so we're collecting that AR debit cash 600 credit accounts receivable 600 you do need to be careful because you can make mistakes I nearly slipped up debit cash credit taxad dermy Revenue 250 so credit tax or dery Revenue 250 debit cash 250 and last but not least debit salaries expense credit cash a th000 let's just do it here salaries expense a th000 and we're going to credit cash a th000 okay so at this point we've completed our T accounts we just need to Total them and so how do we total them I'm going to move this over how do we total them well if we only have one item like salaries expense it's already total you don't need to do anything tax at ear me Revenue though I have a bunch of credits because I earned a bunch of Revenue so 400 plus 600 plus 250 I have 12250 in total taxy revenue so I just was going to say literally I just draw a line across and I write the total underneath um common shares and dividends are AP the total is going to be you add the left side so I have 3,000 on the left side I have 3400 on the right side the big side minus the small side so if you have two sides if you have debits and credits just take whatever's bigger minus whatever's smaller so 3,400 minus 3,000 that's 400 and the astute among you might have been saying well why don't I just like cancel those out and I have 400 and that's totally true uh equipment no need to do anything AR 0 balance supplies 200 and now we need our calculator let's figure out how much cash we had so we're just going to add up the left side 1,000 + 5,000 + 400 oops plus 400 plus 600 plus 250 so 7250 in debits now again this is not a number I actually need to write anywhere I'm just writing this for R purpose 7250 in debits I'll write the credit number on this side you don't need to write this though 600 just to sort of show my work 600+ 1,000 + 500 + 200 plus 3,000 3,000 plus 1,000 and I get 6300 so I have 7250 on the left I have 6,300 on the right I take the big side minus the small side the big side gets the balance 7250 is the big side 6300 is the small side 950 is my ending balance on the debit side so we have now completed all of our te accounts let's see I'm zooming out quite a bit uh that's most of them on the screen I'm going to leave that there the only one off screen is salaries expense I'll leave that there you can pause it and see sort of scramble through and make sure you've got all the same numbers as I do but at this point we're ready to go we have completed Part B we've transferred all transactions to De accounts part c will be in the next video we will prepare our trial balance that's all for this video stay tuned for the next one bye for now all right in our last video we learned to prepare te accounts we've done that and now we're going to to prepare a trial balance for this company so let's get to it uh the the trial balance is kind of like a financial statement it lists all of our accounts so it just lists in order in like balance sheet order assets then liabilities then shareholders Equity accounts then revenues and last expenses and uh you know dividends could either go in with the equity or at the bottom of expenses so in our case we put it in with the equity um so that's it we're just going to list all of our accounts and the name of the the statement we're making is called the trial balance so what does that mean well we're trying this out to see if it's going to balance we're going to see if debits equal credits because if they don't equal credits we screwed something up so let's go ahead and do that for our company our company's name now this has a three line title our company's name is the right stuff Inc and actually let me make sure I've got that right yeah the right stuff oh I put a comma in there didn't need a comma The Right Stuff Inc we're doing a trial balance and this is for the month of August the month ended August 31st uh there we have it the month ended August August 31st uh so we're going to list our assets and we're going to list them in the order of liquidity the order they'd appear on the balance sheet so if I were listing these in order cash then AR then supplies then equipment now the beauty of this is there's no subtotals there's no like oh my current assets total current assets long-term assets total long no no no we're just going to list them so let's start with cash and the only headings here are d R and CR and you guessed it for debits and credits so our cash ended with 950 our supplies with 200 our accounts receivable zero so actually we don't even need to include it but we we have it's fine to include it as well equipment 4,000 um there's our assets moving on to liabilities we got the two we got the bank loan and we got accounts payable oh wait we got to do this in order um so just thinking of order of liquidity accounts payable should be of course first uh because it is more liquid more frequently paid off right now this is a credit balance of 400 so I'll WR on the credit side 400 the bank loan payable is 5,000 and again that goes on the credit side next on to equity we'll do common shares then dividends common shares a th000 because this was a new company there is no retained earnings that's unusual we would expect there to be retained earnings we can even put retained earnings zero there's going to be retained earnings uh uh when we finalize these uh amounts uh but it's just a new company and uh dividends 500 next we got our revenues and expenses so we've got Taxidermy revenue and I'm just literally writing the amounts from uh uh over here and I'm just writing it over to here 12250 just transferring those amounts and now my expenses rent utilities telephone and salaries rent exp uh utilities exp utilities expense telephone expense and salaries expense rent 600 utilities 200 100 telephone 200 salaries a th000 so at this point I'm going to actually erase this uh not that it's that important but uh this is my trial balance this is what a trial balance should look like the only thing left is totals we want to make sure our debits equal our credits if they don't then we've made a mistake so 950 + 200 + 4,000 I'm doing the left side first plus 500 + 600 + 200 plus 200 + 1,000 adding it up I get 7650 on the debit side uh the credit side 400 plus 5,000 + 1,000+ 0 + 1250 I get 7650 on the credit side at that point I'm feeling good my trial balance balanced dollar signs at the top of each column and beside the bottom line of this statement and we've got ourselves a beautiful trial balance now what's the use of a trial balance when I was an auditor I actually worked off of trial balances mostly um they let you see all of the accounts of the company in one shot right you can just look and see all of the accounts of the company that's useful if I had to generate financial statements I could because if I just look right here I've got myself just in what's highlighted the revenues in expenses well guess what revenues minus expenses re well I don't have to write right it revenues minus expenses makes an income statement right that's an income statement sitting right here at the top half I have my assets my liabilities and my shareholders Equity accounts that is my balance sheet data so I have all of the financial statement data kind of just laid bare there in one shot one snapshot of the company so anyway a very useful statement to be able to prepare we have done it we have completed problem 22A that's all for this video stay tuned for the next one bye for now welcome to module three of our course in financial accounting this I think you'll find to be a more challenging module than our first two this is a module on adjusting journal entries so it takes what we learned about journal entries but it does crank it up a notch it adds a little bit of math a few calculations to our journal entries not too much harder but I think it is a not harder so if you haven't understood journal entries well I do recommend going back and just doing all of those problems from module 2 really getting your practice in you want to be comfortable with the idea of debits and credits before jumping into these slightly more complicated versions of journal entries so what is an adjusting journal entry why are we here what is this challenge all about uh I'm going to explain this with an example so let's say our company buys a car so we can see this journal entry right here on October 1st our company's bought a car for cash $25,000 so we have this car right and if I were to look at a balance sheet if I were this company's account and I prepared a balance sheet on October 1 right on October 1st I make a balance sheet and of course on a balance sheet we're going to list our assets on the left and we got a big long list of assets and somewhere in that list of assets under our long-term assets or property patent equipment I'm going to show a car worth2 $5,000 and that's my October 1 balance sheet um let's say same company and a few more months go by and I keep driving my car and it's my financial year end it's December 31st and I go ahead and try to prepare a balance sheet on December 31st and again I list my assets got a big long list and somewhere on that list is a car is my car still worth $25,000 on December 31st I hope your answer to that question was no probably not right because it's not a new car anymore it's a used car we've been driving it around for a few months this car is not worth $25,000 it is deteriorated in value it has lost some value and the word an accountant would use is it is depreciated in value right it has lost some of its economic value so the accountant now has a job they're going to make a balance sheet but they've got to say hey our car is not worth $25,000 it has reduced in value now an important thing about this December 31st date is it's an arbitrary date right it's our company's fiscal year and it could be January 31st or May 31st it doesn't matter the date but it's it's this arbitrarily chosen date the car dealer is not calling me and saying just so you know our car lost value our car is not calling us saying this nobody calling us saying this the accountant has to sort of Institute this journal entry and that's what's different from our journal entries and module two in module two we there was a transaction right there's an invoice happening money is changing hands in many of those transactions there are outside factors telling the accountant oh you need to do a journal entry with this card appreciation the only one telling the accountant to do this is the accountant themselves so the accountant does the journal entry to say oh this car's value value of $25,000 that doesn't seem right to me it's you know now it's December 31st that the car can't be worth $25,000 so the accountant themselves has to sort of start the transaction so in this module we're going to learn five types of adjustments we're going to learn adjustments for prepaid uh expenses I call them prepaid assets uh we're going to learn adjustments for depreciation and that's what we're talking about here we're going to have to track the wear and tear on our assets like our cars or buildings things like this we're going to learn something called acred revenues acred expenses and finally unearned revenues I think rather than me describing each the best way to learn this is by doing examples and a terrific example where I'm going to take my time introducing each one is problem 31a from our accounting workbook so that'll be the next video I'm going to work my way through slowly and steadily problem 31a and by the end of it you should have an good understanding of all five of those types of adjustments that's all for this video this is going to be a good challenging module and I can't wait to get started see you in the next video let's take a look at problem 31a this has us exploring five different kinds of adjustments or adjusting journal entries the first kind we're going to explore is prepaids so the most common type of prepaid expense is for prepaid insurance and when we talk about prepaids in general and there's prepaid Insurance prepaid rent supplies those are all common prepaids you'll see in an intro Financial Accounting course all we're talking about is a cost that you've paid for in advance and you think oh costs those are expenses and the costs are expenses but a cost you paid in advance actually has the characteristics of not an expense but an asset and why an asset on expense because you're going to benefit from having paid the cost in the future it's a future economic benefit is in our textbook definition of the word asset so if I pay for my insurance today and I'm going to benefit from it for from it for the next year that is an asset that's something of value right you should want to have an insurance policy that's going to last you the next year that's valuable to you and so because of it it's actually an asset now as you use the ex as you use the asset up as you know the months go by and you're using your insurance up then it becomes an expense and uh I think this example will illustrate that point nicely so here we go ABC company purchases a one-year insurance policy on June 1st 20124 for $1,800 cash okay uh oh and record the entry for the purchase and for the year end adjustment okay fair enough so we buy some insurance for cash on June 1st 2024 so let's date that June 1st 2024 cash changed hands and cash is decreasing so going back to our module two stuff credit cash right so I'll leave room for a debit here but we're going to credit cash for $1,800 and put little headings up here for my debits and my credits the debit here is normally when you pay a cost we would debit Insurance expense or some expense related to the cost but here we know insurance is something we buy in advance and use over time so we're not going to want to debit an expense we're going to want to debit an insurance asset and the name of that asset again because this thing's going to last for a year so it's it's valuable uh the name of the asset is prepaid Insurance prepaid X right prepaid rent prepaid Insurance um and that's $1,800 is the value of that asset okay so we have this $1,800 Insurance asset so when I'm listing my current assets I would list it in that list you know with supplies and uh accounts receivable and all those other current assets that we might have so okay we've got our prepaid insurance on the books so a few months go by and now it's December 31st 2024 and I want to prepare my financial statements uh and so I'm listing out all my assets and of course prepaid insurance is among them and right now I would show $1800 of prepaid insurance but I got to ask you do I have $1,800 worth of prepaid Insurance left and the answer is no I've used up a bunch of my insurance because I bought this on June right so I had insurance coverage for June July August September October November December I've had insurance coverage for seven months of the year and this is a one-year insurance policy 7 months of that has expired or been used up so I've got to record the fact that my insurance policy has lost 7 months of its value so here's how I do it I have this $1,800 insurance policy and I've used up 71 12ths of it again uh June July August September October November December that's seven months it's a onee or 12 month insurance policy so 71 12ths of this insurance policy has expired just pulling up my calculator here 18 dear come on you touch screen is like really finicky right now eight holy mackerel 1800 times 7 / 12 is 1050 I've used up 1050 of my insurance 1050 of my insurance has expired I need to record that I need to say okay $1,050 of this $1800 insurance policy is gone so the journal entry here debit Insurance expense 1050 and the debit to Insurance expense is just to say this insurance is no longer with me this this insurance has expired this is the insurance cost for the period so 1050 is the insurance cost we credit prepaid paid insurance and the reason we credit prepaid insurance is we're saying the value of this insurance asset $1,800 has fallen because I've I've used a bunch of it up it's expired so I credit prepaid insurance $1050 this wasn't asked for but it's very interesting to know how much Insurance do I have left right we've used seven months we have five months worth of insurance left I would expect $750 of insurance to be left and let's let's just take a look at this prepaid insurance it was a debit of 1800 right when we started uh we credited it for 1050 1,800 minus 1050 big side minus the small side yes we have $750 of insurance left over and that should math out I should be able to say well it's an $1800 policy I have five months left like I have January February March April may it ends on June 1st 2025 so five more months left 1,800 time 51 12ths it should be and is $750 so that's how much insurance I have left but I don't record a journal entry debit prepaid Insurance 750 or something like that I'm just commenting on it I'm saying as a result of these two entries I have the proper Insurance expense I have the proper amount left in prepaid insurance I have answered problem 31a part a perfectly okay let's continue Part B is a depreciation entry um so this is where we're going to buy a longer term asset and we're going to say it's losing value due to usage or wear and tear or age and uh we'll have to track that ABC company purchased a vehicle on August 31st 2024 for $112,000 cash cash I I know it's coming so let's just do the journal entry for that sentence and this is not an adjusting journal entry adjusting journal entries happen on our fiscal year end August 31st was just like a normal transaction right we went to the car dealership we bought a car August 31st 2024 we got a car debit car 12 12,000 and credit cash 12,000 okay we got a car for cash pretty normal journal entry the vehicle is expected to be useful for 10 years after which time it will have no residual value we'll worry more about residual value in a future chapter but the gist of residual value is after 10 years we don't think we're going to get any money out of our car it's how much money you can get out of the asset when you're done with it and no residual value means we don't think we can get anything out of it the company wishes to use straight line depreciation that's the only method we're going to Lo use you learn this chapter in a future chapter we'll learn a couple of different methods for depreciation straight line being the easiest of the three okay so uh we have the makings of a good accounting question here we got this $112,000 car we think it's going to be useful for 10 years after 10 years it's going to be valueless so what we have to do is as the accountant systematically reduce the value of the car right we have to say Okay the value of the car is falling over the next 10 years straight line just means it's falling slow and steady for 10 years uh there's different methods where we might you know accelerate that uh depreciation or decelerate the depreciation but ours is just steady straight line um so what's the math on this well we got a $12,000 asset 10year uh life means it's going to depreciate at a rate of $1,200 per year and since there's 12 months in a year that's going to give us depreciation at a rate of $100 per month uh okay so uh our next relevant date is our year-end adjustment and on December 31st 2021 we need to say how much depreciation has happened here how much value has our car lost not what value is our car but how much value has been lost from our car so the answer here is well how many months have gone by let's see August doesn't count so September October November December four months have gone by so we said it was $1,200 a year we've uh used the asset for 4 12ths of a year so 1200 * 41 12ths means it's $400 in value lost on our car or we could have done it this way 100 bucks a month four months it's $400 so that's what we want to depreciate our car for we want to say our car has lost $400 in value the journal entry here debit depreciation expense credit accumulated depreciation now it's always the same journal entry when you're depreciation depreciating an asset December 31st 2024 um it's always the same journal entry debit depreciation expense credit accumulated depreciation you might have a specific account for each asset but that's the way you do it um what is accumulated depreciation because a common mistake here is students say oh my car lost value let's credit car uh this is not what we do we have this special account specifically to keep track of of the loss in value on our assets accumulated means how much is added up here depreciation means how much depreciation has added up here and so our accumulated depreciation our accumulated wear and tear on the car is $400 we call this account a contra asset account if you go back to chapter one we discussed this in problems 13 and4 um Okay so we've done the entry here what's my car worth well if we were to prepare financial statements we would have accounts that look like this we would say car $112,000 ad accumulated depreciation on my car $400 car net the netbook value of my car $11,600 and that's the number I would tell my shareholders right I would say oh I got a car wor $1,600 that's the number that would land on the face of the balance sheet Okay so we've learned two types of adjustments so far prepaids that's where you buy something pay for something in advance pay an expense in advance and then use up its value over time Insurance being a great example of that and then depreciation that's where you buy an asset and again use up its value over time and the accountant has to make an estimate in both cases for the Val okay ACW expenses is next acred acred expenses mean expenses that have built up but we haven't paid them yet and we'll see next acrude revenues are revenues that built have built up but we haven't got paid yet so acrude expenses if we have an expense that's building up we haven't paid it yet it's going to create a payable right it's like a cost that we haven't paid it creates a liability we owe somebody something acrude Revenue revenues that built up but we haven't been paid yet it's going to create a receivable so those are just things to keep in mind okay let's look at our accruit expense interest on May 1st 2024 ABC company borrows $10,000 from the bank and signs a note payable the debt carries annual interest of 6% and is in repaid and full with interest on July 1st 2025 so the next year record the journal entry for the initial borrowing The yearend Adjustment and the repayment of the debt okay so we borrow some money on May 1st 2020 4 we borrow $10,000 from the bank so when we borrow May 1 2024 we get cash right that's what we borrow we borrow money so debit cash 10,000 now what do we give up here well the other side of this is we have a new liability we have a note payable from the bank or a bank loan payable we'll call it note payable because the question calls it note payable uh for $10,000 so that's what happens on May 1st 2024 now almost the year goes by we have a fiscal year end of December 31st 2024 we've got to say what's happened up to this date has anything happened related to the note and the answer is yeah the interest clock started ticking on day one so our interest cost related to the note is 6% times $10,000 it's $600 per year and if you break that down that's 50 bucks a month right divide that by 12 it's 50 bucks a month um so it's 600 bucks a year in interest and between May and December 31st it hasn't been a full month right uh May to December how many months is that May June July August September October November December I get eight months so what we need to say is how much interest has built up in that eight months time well it's $600 time 8 12ths I can do the math that's $400 that's built up in interest that we haven't paid so our journal entry for an acred expense in this case it's interest because it's interest expense we debit interest expense to say interest costs are building up here 400 bucks and we credit interest payable right it's this liability we have to pay back the interest it's not an account payable an account payable is a typical transaction with a vendor we have interest payable with a bank or a lender right somebody who's lent US money so the account's called interest payable but it's a liability related to interest and you know the name kind of says it all okay the final uh couple of entries here well this takes us up to December 31st and it says we repay the note on July 1st 2025 the easiest way to do this is to actually say how much interest built up between December and July and the answer is well let's count the months January February March April May June six months so let's ACR six more months of Interest so our interest cost for six months would be was $600 for the year 600 * 61 12th it's 300 bucks so let's cre six more months of Interest debit interest expense 300 credit interest payable 300 to say okay we've got $300 more of Interest now how much do we have to pay back well we got to pay back the full amount of the Note 10 grand and we got to pay back $700 in interest now you might say wait it's $6 00 6% interest we borrowed the money for more than a year I borrowed the money on May 1st I'm paying back on July 1st that's a year and two months so I got to pay an extra couple of months of interest and that brings me up to 700 to pay back not 600 to payb so uh I got to pay back the the note plus $700 the total acred interest I'm going to pay back my uh uh lender $10,700 so on July 1 2025 I credit cash for 10,000 the amount I owed $700 uh now my debits are one to note payable I no longer owe the guy money right so I owed them $10,000 up here I don't owe them the money anymore so I debit my payable to say I don't owe you that money $10,000 comes off the books off the liabilities and also interest payable I'm paying you back all the interest that I said I owed you as well and I said I owed you 400 here and I said I owed you 300 here so 700 in total I got to get that off my books I don't owe you the $700 in interest so that goes away okay we have done our acred revenue or acred expense pardon me and again it's an expense that's built up this is our adjustment right here this is our adjusting journal entry and the reason this is an adjustment is it's pretty simple we're going to prepare financial statements on this date the lender isn't calling me saying hey it's December 31st where's my money no they know they're not getting paid till July so the accountant just has to know oh I've got a liability here that's building up I have to tell my shareholders about otherwise you know I'm not telling them the truth I have this extra $400 in in interest liabilities that they need to know about I'm going to adjust my accounts for this again not a simple transaction it is an adjustment and that's what this chapter is all about continuing uh Canadians I just said all about Canadians are famous for saying a boot I don't think I have an accent do I have an accent comment below if you think I said a boot uh like a Canadian does uh I think I said about like properly I don't know I wonder if I sound funny to you I sound beautiful in my own ears uh aw I don't sound beautiful in my own ears but I appreciate you uh hanging in there from my funny sounding voice acred revenues acred revenues are revenues that have built up over time but the money hasn't changed end we haven't been paid yet so again creates a receivable as at December 31st 2024 ABC company had provided three months of Consulting service to a client at a rate of a th000 bucks a month but had not yet build the client or collected any money now this is important I've done the work but I haven't build them just because I haven't build them though doesn't mean anything it's when the work happens the bill doesn't matter as much as the work so I've done three months worth of work I've earned three months worth of Revenue at a th000 bucks a month I've earned $3,000 I need to record that so here's what I would do uh on that date I would on on my fiscal year end December 31st 2024 I would say hey I've done all this work I've earned Consulting Revenue so credit Consulting rev I don't have to wait to build them $3,000 I would debit accounts receivable $3,000 they might debit a different account a crude Consulting revenue or something like that but this is receivable they might say oh we'll wait till we build to call it an account receivable but from our perspective this is a receivable this is money owed to us whether we've build it or not um on January 31st 2025 we build them for the fourth month of service so on January 31st 2024 we say hey we've earned another month of Revenue debit AR credit Consulting rev for an extra thousand because we're going to build them for 4,000 and then on February 8th they pay Feb 8th 2024 we got cash right they paid us what they owed us 4,000 and we credit AR for the full 4,000 now behind the scenes accounting systems May treat this a little differently because they hadn't sent the bill out yet they might call it something else but from our perspective this is just another receivable this is money owed to us that even though it's not yet been built okay last but not least unearned revenues unearned revenues are where we have gotten paid but we have haven't done any work oh this is the best if you can set up a business that works this way and many do this is the best place to be your clients are so eager for your service they pay you before you did anything they go here's the money just do the work eventually when you get to us get to us oh what a marvelous place to be universities work that way right the student pays tuition before the university Prof or anybody has lifted a finger this is wonderful because of course of the student bails well the university has their money right if your client if you're a business your client bails you've got their money it's it's much better than chasing them afterwards right if you are a tour company right you run tours way better to have their money in advance than you take them on the tour and guess what if they don't have a good time or whatever you've already got their money in your pocket it's it's not like you're going to fight them over the bill they're going to have to fight you for their money not the other way around so this is this is where you want to be unearned revenues again you've been paid paid for work you haven't done great a client prepays ABC company on November 1st 2024 for 5 months of Consulting service from November through the end of March so great position to be our clients paid us on November 1st for the next five months uh the company pays $155,000 so you know $15,000 for five months of work means they're paying us my math is terrible $33,000 per month is what that amounts to ABC company earns money evenly over the life of the project and has fulfilled its obligations up to December uh 31st says record the journal entry for November 1st and the year end adjustment okay so on November 1st we get paid right this guy gives us money so obviously there's a transaction here November 1st 2024 we get cash and our cash amount uh uh is $15,000 the credit here is to unearned Consulting Revenue now let's be clear about what this is when I get paid for work I didn't do even though it's called it's got revenue in the name it's not Revenue this is a liability it means I've got to pay you back not with money but I got to pay you back by doing consult in work I got to pay you back with with service I owe you $115,000 worth of service um but again a nice position to be in even though it's a liability so debit cash credit on earn Consulting Revenue $115,000 so on December 31st 2024 we've done some work how much of their money have I earned well if it was 3 Grand a month and we've been working from November 1st to December 31st that's two months don't November December uh I've earned two months worth of Revenue three grand a month I've earned $6,000 two times $3,000 is $6,000 uh I've earned six grand of this money so I credit Consulting Revenue to say I've earned money $66,000 and I debit the liability I debit unearned Consulting Revenue you say it's not unearned anymore this money has been earned debit une earned Consulting rev 6,000 and there we have it we have recorded our transaction um okay one last note to leave this on and this little chart is something I put up on the board and it might be useful to you it might not but this is just a way to keep track of these five types of adjustments kind of what what we got to do uh students struggle on this when I give this in a midterm or a final this is a question that generally is below a normal question uh like answered worse than a normal question and the shame of it is it's actually pretty formulaic like it's it's we always do the same stuff over and over again a lot of accounting is routine work and this is very much routine um and so I'm going to give you a little cheat sheet or a little template that you can use just to help you study for this a little a little bit better and I I'll do that here is at the bottom of the page let me get some empty space here uh okay I'm going to do this by hand and my handwriting is pretty messy but we'll do our best so we've learned five types of adjustments right we've learned prepaid expenses which of course are not expenses at all they're assets we've learned actually let me do the uh prepaid first before I list the other ones out so prepaid expenses there's always going to be a setup and the setup is this we'll always have purchased something in advance right the idea of a prepaid expense is it's a cost you pay for in advance so buy insurance for the year or you pay a few months of rent you buy some supplies before you use them uh so the journal entry is always going to be the same we're always going to debit prepaid something some sort of prepaid asset like prepaid insurance or prepaid rent credit cash or credit AP often it's cash now at the year end we're going to need to do an adjustment we'll have an adjusting journal entry and the journal entry is always the same debit whatever that asset is the expense related to it so you know debit Insurance expense if it's insurance or debit rent expense or supplies expense and then we credit our prepaid asset whatever that was so if it was prepaid Insurance prepaid rent but it's always the same two entries like when I ask these questions it's always the same two entries there you just got to calculate how many months and things like that but it's always the same entries um and and I got to think it just about any textbook not just me uh okay next we learned about uh depreciation setup's always the same at some point in the past at some point in time a company has bought an asset right I'll call it a long-term asset like equipment building a vehicle something like this that depreciates uh credit cash or mortgage or bank loan it could be a myriad of credits the credit here doesn't matter in our description I'll just say cash here the journal entry for the adjustment always the same debit depreciation expense and credit accumulated depreciation on that asset whatever the asset is always the same next uh we learned [Music] ACR expenses with an acrude expense there's no need for a setup but at the year end there's always some sort of expense being built up remember an recruiting expense is it's a cost that's being built up that I haven't paid yet so we de uh debit some sort of an expense we credit some sort of a payable sorry I see that's behind my head I'll zoom out so you can see all of these in a minute last not last second to last acred revenues acur revenues are revenues that have built up over time but the money hasn't changed hands yet so we're going to debit some sort of a receivable and credit some sort of a revenue every time right it's we're earning money that we haven't been paid for so it always creates a receivable receivable potentially accounts receivable some other receivable last but not least [Music] unearned revenues for unearned revenues 100% of the time at some point we've been paid cash without doing any work so we're always going to debit cash credit unearned blank Revenue unearned Consulting Revenue unearned tuition Revenue some sort of unearned earned Revenue then at the end of the year we'll have earned the money so we're going to credit some sort of Revenue and debit the unearned it is no longer unearned that's the idea we're earning their revenue so let me zoom out a bit here so it's can all fit on the screen without my big head blocking um so there we have it these are our five types of adjustments let's see I don't know if this is going to be useful or not but we're going to try my beautiful straight lines you know what there's a ruler tool in here but I think it's just as good go freehand there we are this table I find to be really useful I hope you do too uh it just helps us to do our adjusting journal entries so if you found this video useful please don't be shy in terms of sharing it with friends telling other people about it where there's lots more problems to practice and as always if you're watching this on YouTube it's a huge favor to me if you can hit the thumbs up if you want to hit the Subscribe button too that's very helpful in telling the YouTube algorithm that these videos are are good ones all right thanks for watching and I'll talk to you soon bye for now let's take a look at problem 33a this ladies and gentlemen is a ter horrific problem it has us doing adjusting journal entries we're going to prepare an adjusted trial balance and we're going to do financial statement so it's so comprehensive you're going to get a lot of good information in this it'll be a series of videos but what a great problem here we go below is the June 30th 2024 unadjusted trial balance of netlock security a firm that offers hacking Prevention Services to large companies so anyway there's their uh trial balance okay fair enough I guess things that kind of jump out at me I go okay well there's supplies so probably we'll do an adjusting journal for supplies there's prepaid insurance I see they have a long-term asset so I'm going to have to do depreciation entries and all sorts of other things you know I sort of scan down the list I see unearned security Revenue well where there's unearned Revenue there are adjustments to be done um it says the company's fiscal year end is June 30th and the following items require adjustment and there's a big long list ABC DFG so we're going to have what is that seven items requiring adjustment and part A says give us some adjusting journal entries now if you haven't done so and I will have uploaded this a video walkthrough of problem 31a just explaining what adjustments are and how to do them and at the end of the video I prepare this little cheat sheet that says in our class in my course there's five kind of introductory adjustments uh there's adjustments for prepaid expenses depreciation acrude expenses acrude revenues and unearned revenues and this problem has us doing just adjusting journal entry so we're not going to do any of these like setup entries we're going to be focused in on this column and uh let's see how it goes so let's look at the first one a a says uh account of supplies reveals that $300 of supplies are on hand on June the 30th okay so again all of our adust Ms are going to be dated June 30th so this is part A let's just do this June 30th and we're doing the journal entry for this one uh so we have $300 worth of supplies on hand well that's fine but remember what we're interested in this supplies are prepaid so we're looking at the top column there we're interested in how many dollars worth of supplies we used up or how many dollars we need to expense well here here's where we need to look we need to go up here and have a look at the supplies so according to my accounting records I have $5,000 worth of supplies I go out and I physically count the supplies and I have $300 worth of supplies there's a problem here right my accounting records do not match reality reality says $300 of supplies that's how many you've got in your supply cabinet my books say $5,000 I got to fix my books I got to adjust my books so by how much well again my books say 5,000 reality my count says 300 5,000 minus 300 means the difference here is $4,700 I have to reduce my supplies asset by $4,700 so I credit supplies 47 $0000 because they got to go down by 4,700 from 5,000 to 300 the debit here is to suppli expense to record the fact that I used up some of my supplies and you can see up here the journal entry for prepaids debit some sort of expense credit some sort of prepaid Assets in this case it's supplies expense and supplies uh we got another prepaid coming so I'll just leave this highlighted uh the 28,000 insurance policy was purchased on March 1st 2024 okay so uh if I scroll up here I'm expecting to see and I do see under prepaid insurance $228,000 so is there saying hey this was purchased and you know what what's not being said is this was a 12-month insurance policy a one-year insurance policy um now if it doesn't say that you got to ask your Prof because it could be a 2-year threee but the assumption would be unless it tells you otherwise assume you buy insurance a year at a time that's a good assumption um okay so it's a one-year insurance policy we bought it on March 1st 2024 today is June 30th 2024 so we got to say okay do I have $28,000 worth of insurance the answer is no right I've used some up some of that insurance has expired between March and June I've been using the insurance so March April May June that's four months so the math here is 28,000 times 4 12ths a mistake some students make here it's not really a mistake but something some students will do here is they'll buy the insurance policy so they'll go debit prepaid Insurance 28,000 credit cash or AP 28,000 that's fine except for we've already done it how do I know we've done it because it's already there in the books so some other accountant has done this already we're getting to this question at year end so somebody else has done the journal entry to buy the insurance we've got to record The Adjustment so we're not doing the setup debit prepaid Insurance credit cash or AP no no no we're doing the adjustment we're focused in on that right hand column so we want to know how much Insurance did we use up just like here we wanted to know how many dollars worth of supplies we used up so how many dollars worth of insurance did we use up uh I can't do this math in my head I think it's going to give me an awkward number I was hoping for nice even numbers 28,000 000 * 4 / 12 93 9333 9,333 of insurance got used up so June 30th and that this was journal entry a here's journal entry b a debit Insurance expense credit prepaid insurance for the insurance we used up 9333 I always say used up uh another way of of saying that is the amount of insurance that has expired right how much insurance has expired here uh okay that's B let's clean this up move on to C uh the computers were purchased years ago for $214,000 so long time ago we purchased these computers for 214 Grand at the time of the purchase the estimated life of the computers was 10 years with no estimated residual okay this is actually easier than we've done in previous problems in previous problems I've said oh they purchased these on June 30th and you got to figure out oh how many months have gone or on let's say April 3rd and you got to figure out how many months between April and June and do two 12ths or whatever the numberers uh here we purchased them years ago for $214,000 uh and at that time the estimated life is 10 so here's what we do we say okay well if we purchased them years ago we got to depreciate this for a full year we've own these for one full year so I have these $214,000 worth of computers I don't even need to look at the ad on those computers okay obviously you know they've depreciated a little bit because I've owned them for a little while that doesn't matter to my calculation I divide here by 10 years and I say the rate is $21,400 a year so obviously if there was 46,000 in depreciation already I've owned them for a couple of years which makes sense I've got you know more than years of depreciation I just have to put one more year of depreciation on these computers so the journal entry on June 30th is the journal entry that we always have for depreciation so we're done with um uh prepaids now we're doing a depreciation entry and again we're not doing the setup we're doing the year- end entry debit depreciation expense credit accumulated depreciation on our computers 21,400 bucks okay that's C let's move on to d d the note payable was issued in February 1st 2024 and AC Cruise interest at a 10% annual rate the note is expected to be repaid in late 2024 who cares when the note's expected to be repaid that doesn't matter expectations don't matter in financial accounting it is what happened so we lent somebody or we borrowed rather $30,000 there it is there's a note payable for $30,000 uh we borrowed $30,000 and it acrs interest at a rate of 10% annually so let's do some math here D $30,000 time 10% is $3,000 per year uh okay so $3,000 a year is our interest cost now we hadn't borrowed the money for a full year we borrowed it on February 1st 2024 so it's June 30th today so count February February March April May June why did I count February because it was February 1st right it it was February 28th I wouldn't count February but February March April May June five months so five months of Interest means it's 5 12ths of a Year 3,000 * 5 12ths it's going to be again an uneven awkward number clear clear clear clear clear oh this this thing works inconsistently 3,000 Time 5 / 12 if you ever think my writing is messy blame the computer screen don't blame me I have gorgeous writing in real life just gorgeous I'm lying uh okay the journal entry here uh June 30th it's a journal entry for interest and it's an interest cost this is an acred expense right it's a cost that is built up over time but we haven't let me get this in red that we haven't paid yet right we haven't paid them back so we're going to debit some sort of expense credit some sort of payable and to hopefully nobody's surprise it's debit interest expense credit interest payable let's do it debit interest expense credit interest payable and the amount is$ 12250 okay on to the next e says on May 1st 2024 the company entered into a three-month contract to provide security for a major corporation the corporation paid $155,000 for their 3-month contract on May 1st so we're getting paid in advance uh you know if I may 1 I enter into the contract I'm going to give do work for three months and they paid $115,000 on May 1st means they paid before I did any work this is an unearned Revenue I'm expecting to see unearned revenues of $15,000 and you know what I do there it is 15 $1,000 of unearned Revenue so back when that happened the accountant did a wonderful job they went debit cash credit unearned security Revenue um and that amount was correctly recorded as un revenue on June 30th netlock had fulfilled the first two months of the contract so what this is saying is look we said this was all unearned Revenue uh this is a liability we owe them service you know we owe them security work well guess what we've delivered two3 of what we owed them right it's a three-month contract uh May and June we fulfilled the first two months of that contract so we've done 2third of the work we've earned 2third of the revenue so here we go e 2/3 of 15,000 has been earned 2/3 of 15,000 is 10,000 we've earned $10,000 in security Revenue so the journal entry for an unearned Revenue looking at our cheat sheet here it's the bottom again sometime in the past we went debit cash credit on security Revenue now we debit unearned security revenue and we credit security Revenue just going to make sure we have an account called security Revenue we do so let's do it debit unn security Revenue credit security Revenue and the amount of course 10,000 moving on to F just two more here F says the company had three employees who were owed for two days of salaries each as implied at year end each employee earns $250 a day this is like a word puzzle okay so uh this is an acred expense by the way salaries unpaid salaries is an acrude expense uh so what's happening here we have three people they're both they're all owed $250 a day so that's $750 a day and we owe for two days uh so we owe $1,500 uh that was a mouthful right the company had three employees who were owed for two days salaries each employee makes 250 bucks a day I've kind of reconfigured that and said okay three people they all make 250 bucks a day so that's 750 bucks a day and salaries that I'm going to owe I owe two days 750 time 2,500 okay si500 of unpaid salaries the journal entry here is pretty simple debit salaries expense credit salaries payable $1,500 there we go there's F on to g g says clean this up a bit G says on June 1st 2024 the company entered into an agreement to provide service for a new client at a rate of $4,000 a month at the end of June the client had received their first month of service but had not yet been built Okay so we've done work for which we haven't been paid and we haven't even build it yet this is a great example of an acred Revenue it's Revenue building up because I'm doing work but for which I haven't been paid I'm going to debit some sort of receivable probably accounts receivable there could be some sort of AC crude Revenue receivable depending on the company's chart of accounts but I think we can fairly call this accounts receivable and just credit our normal revenues here we're doing work uh let's see are there any other receivables no so I would say accounts receivable and uh just plain old security Revenue are the two accounts here that make the most sense and it's a month we don't have any math to do here it's four grand a month and we've earned a month so uh G June 30th debit accounts receivable four grand credit security Revenue security rev for Grand okay we have done all of the journal entries the adjusting journal entries uh our next step is going to be to fill this in and to prepare an adjusted trial balance so we'll fill in these columns and we'll do that in our next video stay tuned okay we've just completed our adjusting journal entries it's time to move on and put those adjusting journal entries into our adjusted trial balance I've removed everything just it's easy enough on a computer I've just copied up all of my journal entries from part one and we're just going to transfer those numbers into the adjusted trial balance column I just want to give you a quick look behind the curtain here uh when I finish a video and I start the next one I just start right away I just go okay stop start and the reason I stop is if I make a mistake or something like that but I always take a drink in between and uh uh if you notice something let's see how do I go full screen that's is that's my full screen uh a Coke just exploded all over my shirt so if you're noticing look a little bit off or you're seeing the stain that's what happened I was just taking a drink and I don't know what happened it just went everywhere all over my computer all over my shirt so hopefully uh we all can cope with that um okay uh so our first job here in preparing our adjusted trial balance is literally just to write these numbers in here literally I I'm trying not to say that word anymore uh debit supplies expense credit supplies so I'm going to literally find the word supplies expense there it is and under the debit side I write $4,700 I credit supplies and supplies is under assets there it is 4700 uh debit Insurance expense credit prepaid Insurance 9333 so I find my insurance expense somewhere in the expenses there it is 9333 and I credit prepaid Insurance 9 333 it's a little bit painstaking you just got to be careful take your time here debit depreciation expense 21,400 credit accumulated depreciation computers 21,400 debit interest expense credit interest payable 12250 there's my interest expense there's my interest payable oops I almost did 2150 good way to mess up a problem just transpose to numbers debit unearned security Revenue credit security Revenue 10,000 debit unearned security Revenue 10,000 now I know and we've seen this that when we did our journal entries we actually credit security Revenue twice we credit here and then in journal entry G so I either got to make room in the cell for it or just know that okay I got 10,000 credit and a 4,000 credit so when I go to my security Revenue sell uh on this spreadsheet or whatever you want to call it I can just put 10,000 000 and I'm going to squeeze it over to the left because I know I got another 4,000 coming that I'm going to add in in just a minute so that's what I'll do here uh debit salaries expense credit salaries payable 1,500 salaries expense 1,500 salaries payable 1,500 debit AR credit security Revenue 4,000 there's my AR 4,000 my security Revenue I just add in 4 4,000 uh if I had just written 14,000 in that cell that's totally fine okay so we've done the first part here we just have to add up both columns and make sure things work uh 4,000 + 10,000 plus500 + 1250 plus 21,400 + 4700 + 9 9333 52183 5283 double underline there and let's add up the other side 4700 plus 93 33 + 214 +500 + 1250 plus 10,000 plus 4,000 so I'll add 14,000 5218 three my two sides do indeed match that's good news if they didn't match I would stop here because of course all my journal entries the debits equal to credits and this is just transferring the journal entry so I would have transferred something wrong maybe I put something in the debit side that should have been a credit or vice versa or maybe I transposed a number but this has to add up and if it doesn't add up stop like stop you've made a mistake uh okay moving over to the adjusted trial balance now with this row we just add our unadjusted plus our adjustments so uh cash 38 Grand debit there's no adjustments so it ends as a 38 Grand debit accounts receivable 12,000 and I debit that 4,000 so if I have two debits add them together 12 + 4 is 16 with supplies I've got a debit of five and I adjust a credit of 4700 so I take the big one the five minus the smaller one 4700 cuz I got a debit and a credit 5 - 4700 is 300 the big side gets the balance and that number is familiar to me if we look down at the problem you can see a count of supplies reveals 300 were on hand on June 30th well guess what today's June 30th and our accounting records show $300 of supplies as they should so that's good news prepaid Insurance 28,9 333 uh I got a debit of 28 a credit of 9333 I'm going to have to use the calculator for this 28,000 debit minus 9333 the big one minus the small one I get 18667 on the debit side here 18667 computers 214,000 there it is AD computers 46 plus 21 is 67,000 400 accounts payable 8,000 it remains a credit salaries payable a credit of 1,500 interest payable a credit of12 50 unearned security Revenue it's a credit of 15 a debit of 10 the big side is the credit so 15 minus 10 is five and the credit side gets it the credit side was the bigger of the two this one students screw up sometimes they go 15 minus 10 and they get credit of 25 somehow or they get some funny numbers here for whatever reason credit uh note payable 30,000 it was unadjusted common shares unadjusted retainer unadjusted dividends unadjusted uh security Revenue 45 credit and 14 is our adjustments credit so 485 and 14 is $4.99 credit 320 debit and 1500 debit is 321 oops I'm in the wrong column there 321 500 debit interest expense 12250 debit depreciation expense 21,400 debit 4700 debit for supplies $77,000 for repair expense 9333 for insurance expense 60,000 for rent expense and 7,000 for income tax expense and at that point we are ready to rock here let's total everything up so totaling the left side 38,000 plus 16,000 + 300 + 18667 plus 214 plus 10,000 plus 321 500 plus 1250 plus 214 plus 4700 + 177,000 + 9333 + 60 th000 + 7,000 and I get 739 150 73950 double underline there last column here 67,500 + 8,000 +500 + 1250 + 5,000 + 30,000 + 40,000 Plus 87,000 plus 499 7391 15 they do match that means when I go to prepare financial statements my financial statements are going to work technically we should put dollar signs at the top of each column and beside the bottom lines on both the adjustments section and the adjusted trial balance section but at that point we have prepared ourselves a very nice adjust trial balance in our next video we're going to look at the financial statements stay tuned okay so we have completed our adjusted trial balance and now it's time to do financial statements and what you're going to find is it won't be too difficult to prepare financial statements when you see the accounts in just perfect order and um just to be clear we do not need any of these numbers we don't need any unadjusted amounts we don't need the adjustments we are working purely from our adjusted trial balance so these are all the numbers that matter and uh in fact I I just sort of quickly did some photo editing you'll see that it's rough just to edit that middle part out so I'm going to work from my adjusted trial balance and I just cut out the sort of left uh those those middle two columns I guess so we're going to prepare an income statement you all recall that an income statement is the summary of revenues and expenses so here's our income statement information just sitting right here right right at the bottom right we've got our security Revenue we got all of our expenses let's go let's prepare an income statement for this company H I forgot the company's name I got to scroll a long way over to find it net loock security and it's a June 30th 2024 year ended June 30th 2024 income statement so let's go uh name of our company netlock security name of the statement we're preparing income statement statements get dated for the year ended for the month ended for the quarter ended but this is for the year ended uh June 30 2024 okay remember what this is It's a summary of revenues and expenses and what we find is revenues minus expenses equals the profit or the net income I'm going to highlight a couple of expenses here interest expense is a non-operating expense so will treat it differently income tax expense is also a non-operating expense it'll get treated differently so we'll just list our other expenses though as we see them so we have revenues of well the the one Revenue category or the one item under the category of Revenue is security Revenue uh 499,000 then we have our operating expense expenses and under operating expenses we'll just go through all but the ones I've highlighted so salary expense 321 500 depreciation expense 21,400 uh supplies expense uh 47 00 uh repairs expense 177,000 Insurance expense 9333 rent expense 60,000 our total operating expens is R 321 500 plus 21,400 + 4700 + 177,000 + 9333 + 60 433 933 uh so that g brings us down to our operating income our income from operations operating income $4.99 o our our total revenue minus our operating expenses 433 933 oops I got one too many threes in there 6567 now we have another expense other revenues and expenses and we just have other expenses and it is interest interest expense of $1,250 so 6567 minus 1250 63817 and that is our in inome before tax uh now we have income tax expense our income tax expense 7,000 63,000 minus 7,000 is going to be 56,000 56 87 this is the bottom line of our income statement this is our net income we know that this company made $56,000 in profit this past year dollar sign at the top of each column dollar sign beside the bottom line and there we have it our income statement is in the bag this went a lot more quickly than if you go back to chapter one and look at our financial statements and the reason is it's in nice order and the other reason is because we've done it a few times so my expectation is the income statement isn't a totally foreign concept to you okay let's move over to our statement of changes in equity we're looking at these three accounts being the key drivers of this common shares retain earnings and we know that Dividends are going to come up here as well so let's do it name of our company netlock security we're doing a statement of changes in equity and this gets dated just like the income statement for the year ended and then the date June 30 2024 so we list our uh Equity accounts and as we've talked about a few times in our intro class we really only have the two to worry about at least uh for now common shares and retained [Music] earnings and we'll do a totals column as well and we say how did did these accounts change so uh what was the beginning of the year if the end of the year was June 30th the beginning of the year was I can't do the math in my head July 1st 2023 we are making a bit of an assumption that these balances are July 1st 2023 balances reasonable assumption in the absence of any other information so we'll take our common shares of 40 and our retained earnings of 87 40,000 and 87 we could double check that ourselves but normally a bookkeeper is not going to enter in any transactions that hit common shares of retained earnings maybe if there's common shares issued that might be off but we'd have to look into that um okay so July 1st 2023 we assume there is no common shares issued to repurchase but retained earnings is absolutely impacted here uh in fact it might say in the question I'm going to just double check it doesn't say in the question about uh oh assume no common shares were issued during the year so yeah we can assume that those common share balances is from the beginning of the year um okay so uh common shares didn't change retained earnings goes up by the amount of the net income our net income comes from our income statement just goes up there 56,800 just highlighted there in the adjusted trial balance so I'll deduct dividends of 10 get rid of that Arrow so where does that leave us well let's see our ending balance our June 30th 2024 balances are as follows common shares didn't change it's 40 R retainer earnings goes up by 56 and down by 10 87,000 + 56 817 = - 10 = 133 817 40 + 133 is 173 817 double underlines across the board dollar signs at the top and bottom of each and every column and there we have it we have our statement of changes in equity we're just going to carry right on and prepare balance sheet so let's do that name of our company netlock I'm actually going to give myself a little more real estate here net lock security balance sheet and balance sheets just get dated this gets dated June 30th 2024 I'm going to pull over my uh this thing copy it over just paste it where's my where's my heading for the balance sheet there it is it like disappeared there for a moment I'll paste it over here here yeah just so I can have it off to the side that's good um okay I can see in the video it's going to be my head's going to be blocking some of the view but I don't think it's going to block any of the relevant balance sheet numbers um let's get going so assets on the left and the good news is a balance sheet just lists things in order here's all my current assets cash accounts receivable supplies prepaid insurance and in fact that's the order I want to list here so that's my current assets let's list them and just copy the numbers over current assets we have cash we have accounts receivable we have supplies and we have prepaid insurance so for cash 388,000 for supplies or for accounts receivable pardon me 16,000 for supplies 300 and for prepaid 18,6 167 my total current assets are is R 38+ 16 plus 300 plus 18 667 72 967 72 967 let's move over to our long-term assets which we know consists of the computers and we have Let's see we have computers and we have ad computers and we know what to do with that right at the bottom of my page here I'm just going to do it I'm going to say computers minus a [Music] computers equals computers net the netbook value of our computers is the computers minus any depreciation so 24,000 minus 67,500 equals 214 - 674 400 = 146 600 that number is what goes on the balance sheet computers net 146 600 so our total assets because that's the total long-term assets Put a Little Star there show how I calculate uh 72 + 146 so add that to 72 967 219 567 there we have the asset side of our balance sheet dollar sign at the top of each column dollar sign beside the bottom line and the assets are done let's move over to liabilities liabilities should be right below there there's our accounts payable our salaries payable our interest payable and our unearned security revenue and actually come to think of it I think the note payable was current it's there's a little note about the note pay I was thinking oh note payable would be long term but it says uh the note payable the note is expected to be repaid in late 2024 well if our balance sheet is dated June 30th 2024 guess what the not payable is current so so these are all current liabilities so here we go uh all of these are current even the note payable so let's list out our current liabilities then which again is all of them I've somehow zoomed in a little tighter than I wanted to be uh I think that's good so under current liabilities I've got accounts payable [Music] $8,000 I got salaries payable 1,500 I've got interest payable 12250 I've got unearned security Revenue five grand and I've got a note payable of 30 8,000 +500 plus 1250 + 5,000 + 30,000 is 45 5 750 and that is our total current and actually total liabilities so I'm actually just going to note this as total liabilities it's such a key number and total current liabilities is the same as total liabilities let's just call this our total liabilities which also happens to be our total current liabilities onto shareholders Equity shelder Equity should be dead simple because I just did a statement of changes in equity and I just take the numbers straight off of there common shares 40 retained earnings 133 817 I got to remember that number 133 817 our total shareholders Equity 40 plus 13387 is 173 817 so our grand total then our total liabilities and shareholders Equity I got my fingers crossed here I honestly don't know when I do these lives sometimes I get them wrong 4 45750 is my total liabilities my total sherd do Equity 173 817 219 567 oh phew 219 567 guess what assets equals liabilities plus shareholders Equity I don't know what the relieved Emoji looks like but I'll just give a happy face emoji dollar signs at the top of each column and at the bottom line of the statement and there we have it we've prepared a nice set of financial statements for net loock security that's all for this video in our last video in this group for this problem we're going to learn how to do the all important closing journal entry stay tuned on to the final part of problem 33a this has us doing closing journal entries and it might be a New Concept to you I'm going to introduce it as if this is a New Concept so we'll talk a little bit about what a closing journal entry is and then we'll just do it for this uh netlock security company so a closing entry every time a company finishes its fiscal year June 30th it starts it's a new year and guess what a lot of numbers have to start again at zero like it sales for 2014 were 499,000 or 2024 pardon me were 499,000 right it sales for 2024 just looking at its security Revenue pardon me for 2024 was $499,000 well we want to start a new year and so starting the new year what's it security revenue for 2025 fiscal June 30th 2025 the answer is zero right it's got to start again at zero you got to reset your numbers once in a while so you're starting again from zero and a lot of numbers in the financial statements need to get reset some numbers however do not get reset like when I start a new year it makes all the sense in the world to reset revenues to zero but I can't set like my notes payable to zero I can't say to like the guy I owe money to hey sorry it's a new year my note payable is now zero no no no that doesn't make sense my reset to zero and so I'm going to give you the list of what we need to reset to zero so again closing entry here's the job of a closing entry reset rest no reset uh uh revenues expenses and dividends to zero that's the job that's all we have to do we have to make those accounts go to zero so let's do it and I'll kind of explain as we go for this company we can use the adjusted trial balance so uh revenues expenses and dividend let's start with our revenues and expenses like from here down so this little boxed in area that's my revenues and expenses let's reset those amounts to zero so how am I going to do that let me actually move this over just so it's off out of my way uh well we do a journal entry and the journal entry is a June 30th entry June 30th 2024 I if I want revenues to go to zero they're sitting at a credit balance of $499 to make them go to zero I debit them so debit security rev $499 I want all my expenses to go to zero they're all sitting in debits I want to make them go to zero I credit them I credit salaries expense 321 500 interest expense 12250 uh depreciation expense 21,400 [Music] uh supplies expense 4700 uh repairs expense 177,000 uh Insurance expense 9333 rent expenses Grand income tax expense Seven Grand so summing these all up what you're going to find is they don't balance and and re in this case the debits are higher than the credits so let's figure out how far we're off um $499 on the left actually let's just total the right so 3215 Plus 1250 + 214 + 4700 + 17,000 + 9333 + 60+ 7 442 183 so 442 183 so what am I missing here what's the difference [Music] 499 - 442 183 I'm off by 56 uh 187 561 or 56 817 pardon me 5687 so I got to put a number in here of 56 817 just to make it bounce like this isn't a good journal entry right to have debits not equal credits breaks all the rules of journal entries so I need to fill in 56 817 on the right hand side now I'm going to tell you what to do and in one minute from now I'll tell you why we're doing it but just right now go with me credit or debit if we're off by a debit you know whatever number you're filling in here when you've zeroed out your revenues and expenses put it to [Music] retained earnings whatever that number is plug it through retained earnings we'll also zero our dividends so dividends we're sitting there as a debit of $10,000 we want to make it go to zero so I got to credit dividends $10,000 to make them go to zero and in this case we'll debit our retained earnings to sort of balance that out $10,000 and there we have our closing entries date that one as well uh those are our closing entries so that's it we answered the question but you might be saying why are we doing this again well the first reason is we want to reset revenues expenses and dividends to zero and we've done that but why is retained earnings our balancing account well to to figure that out I actually want to take a look at our financial statements and I want to go over to our statement of changes in equity so here we have net lock security statement of changes in equity and specifically the retained earnings column we said retain earning started at 87,000 it went up by 5687 because of the net income net income made this go up by 56 817 well if we want to make anything happen in accounting we need journal entries and you can see we've made retained earnings go up by 56 817 because of the revenues and expenses because of the net income so this is the journal entry that captures this line on our statement of changes in equity retained earnings goes up by 56 8117 because of the net income and it goes down by $10,000 because of the dividends well to make retain earnings go up it's a sherald there's Equity account to make it go up you credit it to make retain earnings go down you debit it and we debited at $10,000 because of the dividends so this closing entry is really tracking What's Happening Here in our statement of changes in equity it's saying hey our retained earnings changed we got to do a journal entry to make it so this is the journal entry that makes it happen so there we are our closing entry if you didn't quite follow why we did it I think it's okay just remember you're going to reset revenues expenses and dividends to zero and you're going to do it through your retained earnings there are a million different ways to do this and to line this up what I'm telling you is absolutely right what you learn in a different classroom I might be slightly different we're all going to end up in the exact same place I like the way I've done it obviously that's why I'm showing you this way uh but your Prof might do it slightly differently in your class but they're going to end up in the exact same place as I do and this is a good and totally acceptable way of doing a closing journal entry okay if you've made it to the end of this long video series I hope you here because it's useful to you and for goodness sakes if it's useful to you please do me the favor of giving me the old thumbs up please pass this along to your friend tell your props you found these videos tell them that that it's useful go back and like all my other videos well you don't have to do that but any uh thumbs up or likes I can get I really do appreciate and again it's just to tell YouTube that I'm doing good work here and uh it's a nice pad on the back for me too so I appreciate that and I appreciate your being here and being a supporter of this Channel that's all for this video I'll see you next time bye for now in the summer after my first year of University I got my very first white collar job I got a job working for a bank and I was full of myself I was so excited I was wearing a tie to work I was working in downtown cam loops it was uh a very exciting time in my life uh working at the bank and uh I didn't even know what I was going to do I just know I knew I had landed a job at the bank and they hadn't told me what I assumed I would be a teller but I quickly learned that nerdy uh looking people that have quirks like I have should not be customer facing and they quickly stuck me down in the basement of the bank in a room I didn't know existed it was a room called the cash room and what the cash room did was it took any cash deposit any cash coming into the bank and reconciled it against the customer's deposit slip made sure that the correct amount of cash was there and then just totaled up all the cash coming into the bank in a given day and this was in the 90s and there was a lot more cash just generally flowing in our economy now it's more cards and things like that but like physical dollar bills were moving around a lot more back then so there was it was a busy job there was I think five or six of us working in this room and our only job was to like count money for the bank yes we had machines to help us uh but even still you you did need people to do that work so uh you know first when I got in there I was like oh my goodness this mysterious cashroom but the longer you worked at the bank you realized oh no it's just another room between a bathroom and a lunchroom it's not some secret uh Society the cashroom and so you know as I worked the first few days it was interesting dealing with all this money I I was interested in money but I got to be honest like most jobs and this was a pretty repetitive job it got tedious and the fact that I was handling so much money tens of thousands of dollars a day the the the fun of it the novelty of it wore off quickly it became kind of a boring job after a while but there was one part of my job that always got my heart racing that always got me excited it was my job to carry the money at the end of the day from the cashroom back up to the main part of the bank because that's where the bank fault was and that's where the cash would be stored so you might be thinking to yourself and you'd be right that they gave me the money because I am just such a wonderful person I'm like an angel and I'm the most trustworthy person in the cash room and that's what I thought but the reality was the only reason I got the job of carrying the cash back up to the bank from the cash room was because it was really heavy $3,000 to $50,000 a day in cash and uh I was the new guy and they just gave the new guy the grunt work so that's what they did uh but that gave me the opportunity to have elaborate fantasies all I did was every day think about stealing that money I just every single moment of the day I thought okay if I if here's how I would do it and I would get away with it this way or I get away with that way or this is what I try to do and I you know imagine myself on some beautiful beach with palm trees in the ocean and I have ripped abs and I looked horrific I mean it is it was quite a fantasy I was very involved uh but it never happened and the reason this never happened is bringing us to the point of module 4 is because the bank had epic controls it had terrific controls and controls are just systems that companies put in place to make sure that their assets are being properly utilized so for a Bank Of course A bank's going to be worried about money they don't want to lose the money they don't want customers stealing the money they don't want employees stealing the money they are worried about money but other companies have other assets to be worried about whenever Tru uh gives me a Prof a laptop they put a big sticker on it that says this is property of Tru that's them controlling their asset uh if you have worked in a restaurant particularly one that like has high-end food like steak or caviar or something they would have controls to make sure employees aren't stealing the stakes or the caviar so companies put controls in place just to make sure their assets are being properly utilized and and used to their best efficiency right um and so at the bank the controls were intense and and you can imagine what were the controls that prevented me from stealing this even if I wasn't an angel well first of course they knew my name they had my employee record and everything in a bank is recorded it was all on camera so even if I made a run for it they would have all my information they know my family they know where I live uh you know I'd be on the news the 10 minutes later my face would be everywhere it' be very hard for me to get very far because it'd be very public but even that wasn't enough that wasn't the only control they put on me uh they only let us leave through one door at the end of the day and that door was locked and guess what I did not have the key for the lock the key for the lock was in the custody of a security guard named Julie and Julie was tougher than me so when I was having my elaborate fantasies about getting away with the money I always had to contemplate how I would get past jie you know I'd knock her over and get the key somehow and it just wasn't going to happen Julie was going to get the better of me in this exchange and so even in my fantasies I wasn't going to get away with it and it certainly wasn't going to be something I would do anyway so what this kind of taught me was an odd lesson and I I do actually consider myself a pretty moral person I don't cheat I really try to be honest in life uh but money made me go a little crazy it gave me these elaborate fantasies about like I'm going to get away with this money and how would I do it and there's a reason companies have to keep tight controls of their money there's a reason when you go to Walmart and the cash register opens the wrong time and they have to call a manager over to to properly open the cash register or to make sure those are all controls just to make sure that cash isn't being mishandled by the clerk because I imagine cash does get mishandled by the clerk both by mistake and on purpose um so the big control here that we're going to focus on is one that actually focuses on the accounting side of things so with cash of course the company keeps most companies keep most of their money in a bank account and the bank is keeping track of your cash at the same time your accountant is keeping track of your cash and so it makes sense that the bank's tracking of cash and the accountant's tracking of cash there should be some overlap there and that overlap is called a bank reconciliation it's to reconcile what the bank thinks versus what the accountant thinks and that's a great way to control cash it's a great way to say oh did we miss anything did we make any honest mistakes it's also a way to catch dishonest mistakes so every company I've ever seen and every company worth it salt does a bank reconciliation ever every month and that's going to be a big focus of this week we're going to learn how to prepare and understand Bank reconciliations let's get after it let's take a look at problem 41A this problem has us preparing a bank reconciliation and then the journal entries related to that bank reconciliation uh but let's start with the bank wck so uh the question says zip fer Inc cash to account for shows the following information there are some deposits which are are money coming in obviously debits on the left money coming in goes on the left credits to the right money going out goes to the right uh and you can see the ending balance of our cash it's a debit balance of $14,000 and change uh now we get the bank statement for the same period and uh we have some money coming in money going out something want to always caution students about is when you get a bank statement if it talks about debits and credits debits and credits whoa if I see that on a bank statement I just ignore it I just will not look at uh a banker's version of a debit and a credit because it's different from an accountant's version of a debit and a credit so I just ignore it in fact they do the opposite of what an accountant does so I just sort of say okay is our money going up or going going down and and if a banker talks about debits and credits I I tune them out um so anyway we look at this bottom of this bank statement and we see there's 16,777,216 to figure out why that's what a bank reconciliation is it's the accountant figuring out why their cash balance according to their records doesn't match the cash balance according to the bank's records and just being able to explain those differences okay so um let's well I guess we can just read the additional information it says the correct amount of check number 80 a payment of an account payable is 468 uh ZIP flyer is a bookkeeper made an error let's see check number 80 uh I see what's happened here we've written 486 the bank has said it's 468 and the correct amount is 468 so we got it wrong uh obviously there's going to be an error to be fixed on on our side right we've we've made a mistake uh B the bank collection was the note receivable the noted principal 4,000 interest to 300 okay uh I think we're ready to go I'm actually going to leave this thing I've highlighted this 468 versus 486 thing to the very end of my bankr just fixing our ER is a little bit tricky um but I think the rest of this is is not too tricky so uh let's begin with a title and uh we'll start with the name of our company ZIP flyer Inc name of the statement we're preparing we are preparing a bank reconciliation and a bankr can just be dated May 31st 2024 so remember how a bank reconciliation Works what we're going going to do is almost divide it up like a balance sheet the left hand side is saying here's what the bank thinks our cash is and here's why the bank is wrong here's everything the bank missed the right hand side is going to say here's what we think our cashes and here's what we've missed so let's start with the bank and figure out what the bank has missed so we say ending balance per and Pur just means according to B bank statement so the ending balance the May 31st balance according to my bank statement is right there 16707 so that's going to be my starting point for my bank reconciliation 16707 now I've got to say what did the bank Miss well let's go through all of our um t account and see if there's anything in our t account that the bank doesn't know about so we'll go through them one at a time here the opening balance matches 13846 on our side 13846 on the bank side that's important if they don't match we might have items from the previous month to clear if you want to see an example where the opening balances don't match problem four two we go through one where the opening balances aren't going to match this is our you know first problem so it's a little bit easier and gives you a bit of a boost there to start but you'll see it's not that much harder okay so the matching deposits 1,550 on our books, 1550 on the banks a deposit of 2700 shows up on ours shows up on the banks 4950 that shows up on ours shows up on the banks 2600 is on ours 2600 on the banks 3,000 is a number on our t account that is nowhere to be found on the bank statement now you might say well what about this 4,300 well that's something on the bank statement that's not an ourt account we'll deal with that on our side that's something we've missed that's not something the bank has missed though right now we're worried about what did the bank Miss so the bank missed a $3,000 check or a $3,000 rather deposit we call that an outstanding deposit or a deposit in transit oops let me change my ink color here deposit in Transit and I usually put a deposit number or a date and in this case it's May 31st May 31st it's $3,000 now if I had several I would list them on the left and total on the right just like I would do a balance sheet uh now let's do our outstanding checks let's see if there's any checks that I've recorded that the bank doesn't know about okay so check number 75 for 550 yeah the bank knows about that check uh for 875 yep the bank knows about that check uh check for 1256 yes I see it there I check for 3684 yes check for 1100 yes checked for 486 I'm going to put a check mark beside this and the only reason is it's not outstanding the bank knows about it right the bank hasn't missed this check this isn't a check that the bank's waiting to cash it knows it's there and and so it's not an outstanding check it's something else this is a bookkeeper's air and as we said we'll fix it on on the other side of the bank wreck but this isn't something the bank has missed and remember this side of the bank wreck is all about what has the bank missed I checked for $548 I think the bank doesn't have that one a check for $358 that the bank does have check for 1244 definitely the bank has that and the last few checks the bank does not have and this is very typical the last few checks just by their nature if you write a check at the end of the month and you uh uh send it out you lick a stamp odds are the the person doesn't cash it until the next month and so these end up being outstanding checks a lot of the time and that's where you spend a lot of your time as as an accountant looking right you look at the end of the month checks more than you do the beginning of month checks well that's where you find the outstanding checks anyway uh okay so we have our outstanding checks those are the four items I've circled let's list them oh I got to remember to change ink here outstanding Jacks and we I'll just go by numbers here 81 84 85 86 and because they're there's a list of them I'm going to list on the left total on the right 548 983 68 and 175 so let's total this up 548 + 983 + 68 + 175 my total outstanding checks here is 1774 okay so I've got to say to myself this uh ending balance for the bank statement when they learn about this deposit and Transit is it going to add money to my bank account or deduct money from my bank account and the answer is when they learn about the deposit it's more money in my bank account right it it adds to my bank account now when they learn about the checks it's going to subtract money from my bank account right my bank account is going to go down because they're going to draw out those checks right somebody's gonna has a claim on my bank balance and they're going to take it out so I put this in Brackets because I'm deducting it out and this brings us to our bottom line our reconciling balance and our reconciling balance here is just adding down this list uh 16707 + 3,000 - 1774 I get uh 17 933 just double check that number yep I was worried i' misread it okay so I can put dollar signs at the top of each column and bide the bottom line and I'm well on my way here to a bank reconciliation so we've said the left side is here's what the bank thinks are cashes and here's all the stuff the bank is missing the right hand side is for what we've missed so we're going to say here's what we think my cash balance is and we'll call that balance per or I I'll say ending balance I guess just to be consistent ending balance per books now I say ending balance we could say May 31st balance or whatever just you know uh uh to make sure this lines up but in any event ending balance per books just to be consistent between the two and the ending balance according to our records is right there 14,000 uh 619 14619 uh and now we've got to say is there anything on the bank statement that we've missed so I could go down everything obviously with a check mark beside it was already on the bank statement but anything that hasn't been checked off uh it warrants a little bit of of scrutiny so we have this item that $600 withdrawal and I just looked down this this this column here I don't see a $600 withdrawal $4,300 deposit it which we already established was not there $300 uh withdrawal $100 withdrawal and this five and this one so these six items plus we have this uh this different amount those are all things that are going to Warrant a little bit of a closer examination we'll start though with this NSF check W White and the NSF check represents something that's on the bank statement that is not on my book so I need to make note of that it's a $600 cash withdrawal so 600 bucks to the negative next up this Bank collection of $4,300 now that one had a little memo about it oh by the way NSF check if if you weren't sure what that was NSF stands for non-sufficient funds what this means is a customer has given me a check that bounced they gave me a check they paid for something and they didn't have enough money in their bank account to cover it and so when I went to to cash the check the the bank said sorry no the guy doesn't have the money um and they took the money pulled the money back up uh EFT no sorry Bank collection rather there was a note about that it says the bank collection was a note receivable the note included principal of 4,000 interest of 300 no previous interest acrs had been made on the Note okay uh so the fact that there's some principle and interest is going to matter for our journal entry but it doesn't matter here all that matters here is the amount of money that changed hands we got $4,300 in cash continuing down the line the next one is an EFT utilities Bill EFT stands for electronics funds transfer and all it means is we uh we paid our utilities bill with like online banking or some automated payment and it just automatically came out of the account $300 uh the check 46846 I'm going to save that till the very end EFT telephone another uh bill just another sort of automated payment came out of our account for a 100 bucks Bank plan fee well this is money again coming out of our account five bucks and uh interest a dollar and the interest helps your bank balance so um the only thing we've got left to deal with is this check number 80 for 468 we have mistakenly recorded as a check for 486 we screwed up so again we said uh well what did we say here we said credit cash 486 we should have said credit cash 468 where off by 486 to $468 that's $18 right and the question I always ask is did I credit cash too much or too little and the answer is I credited cash too much right I credited cash 486 I should have credited cash 468 so to fix this if I credited cash too much I got a debit my cash by 18 bucks so I need to increase my cash by 18 bucks so heading down to here what we would say is to fix the bookkeeper [Music] air our cash needs to go up by 18 bucks I need to add $18 to my cash so again this is can be a confusing concept but basically all we're saying is I took too much money away now I got to put money back into Cash because it's just an error on the bookkeeper part putting money back in is a debit to cash if I didn't take enough money out of cash you know you can make an error in the other direction uh it's the exact opposite right if I didn't take enough money away well guess what to fix it I got to credit cash I got to take more money away but in this case I took too much money out of the cash account I got to put that $18 back into the cash account how do I put money into a cash account I debit cash so our reconciling balance here well let's hope it works um let's add this thing up so 14 619 - 600 + 4300 - 300 - 100 - 5 + 1 + 18 17933 ah look at that it does work 17 933 is the reconciling balance dollar sign at the top and bottom of each column so there we have our bank reconciliation for zip fire in the next part of the video we're just going to do journal entries related to this bank reconciliation stay tuned for that we have just completed zip flyer inc's bank reconciliation time to do journal entries now you might say well wait what are the journal entries why do I need to do journal entries the answer is uh all about this uh right hand side all about this column below there um we've said hey here is what we thought our cash would be this is what our cash t account says and here's all the reasons our cash t account is wrong and this is what our cash t account should say well if these things all represent reasons why our cash t account is wrong let's fix them if these things are all things that we missed let's not miss those things let's catch them how do I catch them well how does count do just about anything with journal entries so we've got to do one two three four five six seven journal entries to fix all of this now I have some good news and the good news is these are the i in my my opinion the easiest journal entries of the semester um I I hate doing this because I got a student evaluation one time it was uh sorry to tell you this quick story fast forward a minute if if you're in a rush I got a student evaluation once sem master I I've just called these journal entries easy and I got a student evaluation saying you know Tony when he says stuff is easy it's not easy for me and he makes me feel really stupid and I agree with that person it's like oh geez this is bad I I shouldn't be calling things easy and I know they're not easy for everybody and I got to be sensitive to that so the next semester I taught the same class and I I went to the class and every topic I said this is challenging but you guys are up for it I know this is hard but we can do it we're going to get through you know putting a positive spin on it but letting them know that this is going to be challenging right because I want to send out the vibe that it's not easy for everybody and I'm sensitive to that and anyway I get my evaluation that semester and uh I got it a student evaluation that said Tony constantly says everything's hard well if he thinks it's hard imagine how I feel this is awful is really hard for me and so I just thought at that moment I was like I can't win here so now when I talk about something being easy or hard I got to bite my tongue a little bit and so I just want to tell you that this uh it's easy easier than chapter 2's journal entries module 2's journal entries but in terms of difficulty is it easy or hard it's just right I think you're going to say to yourself wow that was just the right level of difficulty not too easy not too hard just right okay uh sorry for that quick aside but I just I always catch myself when I say oh something's easy or something's going to be hard I always think back to those evils so I have seven journal entries to do one two three uh four five six and seven and these can all get dated um they can either get dated the date they happened so if I know the NSF checked from W white and I can see it there was May 7th we can either date the thing May 7th or or we're just fine to date this May 31st and I'll just sort of have a May 31st 202 for sort of standing date here um so the NSF check W white now here's why I said that I I found these journal entries to be easier than most they all involve the same account and in fact I can block this out let's see if this blocks out oh it didn't block out fill can I fill dot dot dot no cut copy paste okay you're watch this I'm gonna I'm gonna just overwrite this uh okay okay just hold on this is this is not turning out exactly how I had planned but here we go I've blocked everything out I can't see anything there uh I and you expect me to do journal entries well here's what we can do we can say this these entries that I'm about to do they all involve the same account can you guess what account is involved and the answer is cash right we're doing bank reconciliation so they all involve cash so let's do journal entry one I know that my cash has got to go down by 600 so I know for journal entry one I'm going to credit cash 600 I don't know my debit but I'm halfway there journal entry two debit cash [Music] 4,300 journal entry three credit cash 300 journal entry 4 credit cash 100 journal entry five cash is going down so credit cash five bucks Journal six debit cash uh $1 and journal entry seven debit cash $18 so without even seeing the accounts I'm halfway done the journal entries right which is why I thought these these entries were easier than normal so let me erase that because I do now need to see the writing get rid of this failed box and uh let's start with the NSF check W white so the NSF check W white uh remember what's happened this customer of ours W white has written a check that has bounced it has gone bad and we uh I always think like Ro play here okay so I I get news from the bank that W white has bounced the check the first thing I'm doing is I'm picking up my phone I'm calling W white and I'm saying W white you're check bounced you owe me money and I'm reinstating their account receivable I'm saying this person owes me money well when a client owes you money on a bill we debit accounts receivable now realistically this would have a couple extra Journal isues because we would charge him fees for having done this so the bank's going to charge him fees the bank's going to charge us fees and we're going to pass those fees right back to him for for bouncing the check so it's a very expensive thing to uh have an pass an NSF check okay the bank collection $ 44300 uh and this notes that there's principal of 4,000 and interest of 300 so uh let's deal with the interest first this is interest Revenue right it's money coming in uh related to interest it is interest Revenue now the 4,000 the principal amount they said this was a note so the credit is to notes receivable or to note receivable uh of $4,000 so we collected a note debit cash credit the note because we got the money EFT utilities $300 this is a cost being paid this is a utilities bill being paid debit utilities expense $300 credit cash $300 uh EFT telephone okay credit cash 100 debit well this is another cost telephone expense a 100 bucks number five a bank fee Bank fee is another cost it's another expense Bank fee expense five bucks uh interest on the account that's interest Revenue so we are crediting the revenue and that certainly makes sense with our rules of journal entries and last but not least the bookkeeper ER let's read this again the correct amount of check number 80 uh payment of an account payable is 468 okay so the the key there is given payment of an account payable so back when we said credit cash 486 the debit that went with it was debit AP 486 right it's a payment of an account payable so that's what we did and what we should have done was credit cash 468 and debit AP 468 and so to fix the air we debit cash 18 we credit AP because that's the other piece of it 18 so let's credit our accounts payable 18 bucks so we we screwed up cash but we screwed up AP at the same time so when we fix cash we're going to fix AP at the same time okay let me zoom out so all of our journal entries can be on the page and again I would I would probably want to see dates beside all these so May 31st May 31st May 31st May 31st May 31st May 31st and it wouldn't be wrong in fact probably is more right to actually go back and figure out the date like the day the guy passed the bad check May uh 13th uh or no May the NSF check May 7th it wouldn't be wrong to date that May 7th okay you've made it to the end of this series on uh bank reconciliations I do hope this has been helpful for you and as always if I've been helpful to you I hope you can be helpful to me given a nice thumbs up sends the right signals through the YouTube saying these are good videos and uh I I hope that uh I hope that they've helped you okay that's all for this video see you next time welcome to module five of our financial accounting course this module is all about receivables being owed money you know is a very common current asset and to be honest with you when I was a beginning student I always it was a mystery why companies had receivables at all CU I looked at the transaction and I sort of said well why wouldn't I just make my customer pay cash right away right a typical cash customer here on the left is a very simple transaction you debit cash you credit whatever your revenue is right they you make them pay you right away debit cash credit sales revenue in this case Consulting Revenue so you've earned their money right away and there you have it and a credit customer it's like twice the journaling entries there's two journal entries involved you know one to say debit AR credit Consulting revenue and then you know they pay you a month later so you debit cash and credit AR so uh even a a dream Credit customer uh it's more work than a cash customer and the reality of credit and and that's what we're going to learn in our accounting for credit is most customers fall into this category most credit customers fall into the category of good credit customer but not all customers are good credit customers can you guess what makes a bad credit customer I'll give you a hint bad credit customers don't pay so a big focus of our week today or our module I guess I should say is just dealing with the fact that some customers don't pay and I'm going to kind of walk you through a bit of an example here in our video but uh even still let's just assume all all customers are good so we have our typical cash customer they pay cash credit Consulting Revenue we have our money so we're not chasing anybody credit customers you just have to chase them like most of them will pay on time let's say 90% pay on time 10% they might forget they might lose the bill you're just you're chasing people there's a whole AR function like uh you know at most big organizations they hire accounts receivables clerks basically you're a bill collector you are collecting money and it's a pain to collect money so it's a pain point for a lot of businesses this this journal entry that looks so easy in an accounting class can be very hard in reality getting paid for work you've already done right it just entails chasing people down and it's painful even when it goes well it can be painful um so I don't want us to leave the fact that there's a human cost to this and uh that there's a real challenge just getting paid money from people who owe you money and that's a big feature or a big challenge of the week but the biggest challenge for an account this is the biggest challenge for an accounting function it's just getting paid by the people who owe you and most people end up paying the biggest challenge for the accountants is dealing with those that never pay and uh those do happen again if maybe 10% of your customers are a pay to collect from maybe one or two% of your customers just never pay they might go bankrupt they might dispute their bill or they might just avoid the bill they might recognize that they uh ohow but they might try to duck you for some other reason uh so scrolling down a little bit here um uh not all credit customers are good so let's go through an example of a bad credit customer and we'll kind of get into why this creates uh drama for us in the accounting function and this will be a big focus of your week so on December 1st 2025 I do some Consulting work and uh earn some revenue of course the person doesn't pay me right away they are a credit customer so debit accounts receivable from this let's call let's name them let's say BC bad customer ,000 so okay I got a canc receivable coming in from bad customer and you know I I in good faith I think they're going to pay me December 31st rolls around and I'm going to do financial statements because of course it's my fiscal year end I do my balance sheet and income statement Etc financials go out on this date okay so I I do my financials and by the way bad customer hasn't paid me yet because uh well they're not going to pay but on December 31st I don't know they're bad customer I think I'm going to collect uh so January 1st rolls around they haven't paid and let's say I give you know a week of leeway for checks to come in the mail and all this stuff and on January 7th 2026 I called them right I call them and I say hey just letting you know your bills overdue and this is like normal there's and 10% of my customers I'm going to have to make this call I'm going to have to do a little bit of chasing and they they say oh yeah don't worry I'll I'll get right to it and you know so I let a few weeks go by and you know maybe it's January uh 30th I I call them again because they they uh haven't uh paid their bill and they say oh you know what can you resend that bill we lost it we don't have the in our accounting system we need to process it through properly and so on again January 30th 2026 I call again and um they kind of give me a bit of a song and dance and uh so I send them the bill and I'm still waiting I don't want to send them out to some collections agency and because they'll take a cut of the money and this is pretty normal to have a bill a month overdue in fact I might not even call them this frequently if I were uh really in the business but uh We've called them twice so uh I let another few weeks go by and it's February 15th 2026 I I I try to reach out again and I get this the number you have dialed is not in service I start to think uhoh you know so uh uh no phone right they call there's no phone to call and I have this person who owes me $1,000 and they don't have a phone anymore or they've disconnected their number or change their number something is going wrong here uh clearly something is going wrong what to do uh well let's just say I you know I search them and I Google them and I track them down on social media and on February 20th uh 2026 I reach out on social media and they say uh I've moved to Japan and uh I'm not paying your $1,000 good luck getting it and at this moment I've got a decision to make right I can try to get a lawyer and try to sort of go to collections but they're in Japan and you know it's very expensive to I don't know anything about Japanese law or how how I would track down my money there or I can give up and companies do give up sometimes and this might be the moment uh so social media they've moved to Japan and uh they're saying they're not going to pay so illegally they owe me but they're not going to pay and they even acknowledge that uh I I might be able to get legal recourse but a lawyer is going to be expensive and it might not be worth you know of that ,000 I collect which I might not even get the money half of that goes to the lawyers I might just say I want this headache out of my life I'm G to give up so on February 20th 2026 I give up Okay so we've got a big accounting problem here because we don't know that this debt has gone bad until February 20th 2026 and so I'll tell you the journal entry I want to do but I'm not allowed to do on February 20th 2026 I want to do I'm going to write it in red we're not allowed to do this I wish we could but we're not allowed this is what I want to do I want to debit bad debt expense this is the expense related to an account receivable going bad we call it a bad debt so it's a bad it's cost of AR going bad and it's a very common thing because if you have every company has this if you have hundreds and hundreds of people that owe you money guess what some of them are going bad so this is what I want to do debit bad debt expense and credit AR to say hey that AR from Bad Company uh went bad this is what I want to do but I'm not allowed to do this and the reason is there's a rule in accounting it used to be called the matching principle and the rule is I'm not worried about rule names the rule here is is I need to record revenues and the expenses related to those revenues in the same period so if I earn the revenue in fiscal 2025 I need to record the bad debt expense in 2025 before I do my financial statements now you might be saying to yourself but Tony I didn't know this was a bad debt expense until like February of 2026 how can I record a bad debt expense on December 31st 2025 when I thought it was good I didn't think it was bad I had no idea it was bad well the answer is on December 31st 2025 we guess uh don't guess no we don't guess in accounting we estimate we make an educated guest we say well I know I've got a thousand customers that owe me money and I know 1% of these people aren't going to pay I'm going to take a shot in the dark and I'm going to put a number out there uh we don't know which customers aren't going to pay but we know some of them won't so this chapter you're going to learn how those estimates are made and how to account for those estimates that's a big focus of our chapter so we're not allowed to wait until February 2026 to give up we actually have to guess or estimate on December 31st 2025 and we're going to learn a new kind of adjusting entry for receivables so it's it's tough to be owed money it's tough to collect money from the the people who owe you and you know believe me uh if you've ever been owed money I bet you most of you have been owed money and you haven't been able to collect well businesses are the same and it's it's a challenge for us accounts so uh this chapter is all about that challenge stay tuned for some great examples on this in the introductory video for this chapter we talked about the big challenge of accounts receivable being collection right somebody owes you money it can be hard to collect and that takes a lot of time and effort and in fact the biggest problem is that some people just never pay uh now accounting for that gets tricky what we said was let's say we earn the revenue in December of this year and it could be several months before we realize the person's not going to pay but I need to record the expense the bad debt expense in the same year I record the revenue which becomes a problem now the way accountants have solved this is that we estimate I was going to say guess but of course we don't guess we estimate it's an educated guess uh and this module we're going to learn two ways of doing that estimate uh the first way is called the percentage of sales method this is also called nice Arrow this is also called the income statement method I don't know if Arrow number two was much better uh but you know you might be reading it in a textbook and they might call it income statement method or your Prof might call it that uh that I think the technical term is the percentage of sales method it's the simpler of the two and I think it's the worst of the two methods in problem 54 we're going to go over the uh balance sheet method also called the Aging of receivables method but let's jump into the percentage of sales method here we go Salazar Inc shows the following information on the May 31st 2024 no the there the company's fiscal year end accounts receivable 235 Grand debit allowance for ELO accounts this is a new account I'm going to really get into what it means uh in a few minutes but okay it's this account that's in a debbit of 2000 um this will always end these questions in a credit and when we see it on financial statements it's always a credit I'll explain how it gets to a debit a little bit later uh sales $448,000 cash sales but $11.85 million in total sales I know it says credit at the top these aren't credit sales 1.85 million in sales 448 are for cash let's figure out how many of these sales are on account then 1850k minus 448k are total sales minus our cash sales will tell us how many dollars are sold on account in other words if I sold 1.85 million in total and 448,000 of those were uh for cash the rest must have been sold on account so uh we'll call those credit sales so our credit sales here 1850 minus 448 uh I think that's 1402 I'm just going to calculate that just to be sure 1850 minus 448 yeah 1402 okay let's read on the company's account estimates bad debts to be 2% of credit sales okay well we've kind of jumped the gun here but uh here's the percentage of sales right this is called the percentage of sales method you would if you were running this company you would say well what percentage of the time do customers not pay this uh uh entrepreneur has said well 2% of the time my customers don't pay one in every 50 of my customers the debt goes bad and so they've said hey 2% of the my AR is going to go bad or 2% of the the credit sales rather are going to go bad so we've got our credit sales over here 1402 let's take 2% of that and figure out what this bad debt is for 1402 * 2% um let's compute that number 1402 time .02 that's 2% 2840 okay so this is a place where we have a distinction between our two methods now you haven't learned the um balance sheet method yet you haven't learned the Aging of receivables method but with the percentage of sales method the number we calculate here this number is our bad debt expense so we've just computed our bad debt expense for the period now we need to plug it into a journal entry so step one when you're doing this step one is to compute the bad debt expense take a percentage of your sales step two maybe I'll do this in red step two is to do a journal entry and here's our journal entry it's always the same entry uh it happens on our fiscal year and date which was May 31st 2024 we're going to debit well we just computed bad debt expense we always debit expenses so let's debit bad debt expense and we're going to credit an account called allowance for doubtful accounts again I'm going to explain what that account means but not till the very end of this problem so just kind of go with me on this one now in future when I write this I'm just going to write allowance your props may or may not allow you to do that but I'm just going to write the word allowance um this bad dead expense is also sometimes called uncollectible account expense it's the same thing so anyway the amount of this was 2840 all right so there we have it we've computed our bad debt expense uh we've done part A prepare an adjustment to allowance for Del full accounts based on the information about done now it says show how accounts receivable net would be disclosed on the balance sheet well um I'm going to skip a step so we'll we'll do step three in a minute step four is showing uh allowance or accounts receivable net on the balance sheet here's the computation for accounts receivable net it's accounts receivable minus the allowance for helpful accounts equals AR net so we take our total amount of our accounts receivable and the total amount of our accounts receivable is 235 we deduct our allowance now here's why we have a step three in between uh we don't know our allowance right now we have to update our allowance t account to get there so I'm going to update that allowance t account the allowance t account began the question in a debit of 2,000 but I've just done a journal entry to credit it by 28,000 so let's do the math here began as a debit of 2000 I'm going to credit it 2840 take the big side the 28 minus the small side two and I end up at 2640 that number that credit balance goes over to part four here the uh uh AR net calculation 2640 is the ending balance of our allowance it is a credit 235 minus 26040 gives us our net AR 208 960 Okay so we've answered the question but I haven't done a very good job of explaining what's going on here so mechanically let's just walk through the mechanics of this step one compute your bad debt expense you take a percentage of sales you get the bad debt expense step two plug that number right into a journal entry the journal entry is always the same debit bad debt expense credit allowance for dou full accounts step three update your allowance t account based on whatever you did in that journal entry step four show AR minus allance equals a net okay so we did a bunch of steps here but I I would forgive you if if you got to the end here and you're like what did any of this mean like I I get that I did it I can mechanically do it but what does it all mean so that's uh what I want to talk about uh now and I actually want to start uh with step four being sort of a a key step for explaining what's going on here so remember what we had said at our fiscal year end we are legally owed $235,000 right people our customers legally owe us that money but as the accountant you know not everybody's going to pay some people are going to go bankrupt some people are going to dispute their bill we are not likely to collect $235,000 because we don't know who's not going to pay if I know exactly who's not going to pay I should write off their accounts receivable I should not call it accounts receivable anymore because it's not going to be received it's not going to have any future economic benef it I should write it off but because for the most part I don't know which of these $235,000 in receivables isn't going to come in I don't know which customers aren't going to pay I can't write them off so what I have to do is I have to estimate how many dollars aren't going to flow in and the estimate is this account it's the allowance for helpful accounts and it's almost like a cookie jar it's almost like okay I know I'm owed 235 Grand but I'm setting aside $26,000 to not come in it's like rainy day fund or something like look I have this set aside I'm ready for the fact that $26,000 might not come in so what do I tell my shareholders I say I'm going to get 208 maybe close to $29,000 this is the number I think I can collect this is the number 28,000 that I put on my balance sheet I don't put 235 on my balance sheet I put 208 on my balance sheet because that's what I actually think I can collect remember the definition of an asset an asset is uh uh something you own and control that's good to owner control that gives you a future economic benefit right well 235 Grand that I don't think I'm going to collect that's no there's no future economic benefit there right I'm not going to get 10% of that money so $28,000 that is actually what I think I can collect that's what I should show as my asset and so that's what companies do show if you look up your favorite company under their receivables it's going to say net receivables and that means they've taken out an allowance that means they've estimated some amount of that is going to be uncollectible and it is an accounting estimate um okay so I just want to reiterate our steps here and I I hope the explanation was clear we've said we want to estimate our bad debts based on percentage of sales we take a percentage of our credit sales typically uh and the reason why don't I take a percentage of my cash sales well those have already been collected right there's 100% chance those are coming in those are all collectible so we took 2% of our credit sales uh we calculated our credit sales took 2% of that we got 2804 that becomes our bad debt expense debit bad debt expense credit allowance uh uh update our allowance te account in step three and step four show how AR would be presented uh sometimes a student will will ask me well wait if allowance always ends in a credit and we always are crediting it it always is going to end as a credit how on Earth did it get to a debit here I'd like you to think about that question how did the allowance become a debit and the answer is think of the allowance as a cookie jar and every time a debt actually goes bad we use some of the allowance so I'm going to make up a a part to this let's assume uh when was our fiscal year May 31st so let's let assume on July 1st 2024 we want to write off a $2,000 account receivable right somebody's debt goes bad what do we do well we credit their accounts receivable because we're saying hey we're giving up on them whoever they are $2,000 and we debit not bad de expense not the expense related is we debit the allowance we're using up some of this allowance that's right this 26 Grand in credit now we're going to use some of it up so I debit allowance 2000 so how did I end up with a debit balance of 2,000 in my allowance well the if I had a $26,000 Credit in my allowance I must have written off 28,000 I must have written off more than I allowed for if I and you'll see it in the next question if I end up with a credit balance in my allowance it means I didn't use up all of my allowance from last year again a debit balance in the allowance means used up more allowance than you had a credit balance in the allowance means you didn't use up all of the allowance so uh I think that point is important it's one I often ask my students about on midterm exams like how can we end up with a debit or a credit and they have to figure out okay I wrote off too much more than my allows or I didn't write off all of my allows uh but it's a confusing concept and I I hope that explanation at least helped to shed some light on it all right that's it for this video in our next video uh well in problem 54 anyway which should be the next video uh we're going to run through the Aging of receivables method that's all for this video stay tuned for the next one let's examine problem 54a this has us doing very much the same thing we did in 53a setting up an allowance for doubtful accounts getting ready for the fact that some of our receivables are going to go bad some of our customers will be able to pay us uh but this has us doing it in a slightly different way in this way I prefer most students like this way a little bit better than the uh uh percentage of sales method again it's called the Aging of receival method also sometimes called the balance sheet method let's jump into it and see how we do Stormer company shows the following information on July 31st 2024 the company's fiscal year ARS 5000 allowance for accounts a debit of 500 remember what that means it means last year whatever our allowance was let's say it was a $2,000 allowance last year we rode off more than we allowed for we rode off 2500 to end up at a $500 debit in our allowance for Del full accounts if you're looking for an explanation on that watch the end of the video on 53a uh sales 5,000 of which are cash sales so 75 grand in total sales must be 70 grand in credit sales the company's account generated the following aging schedule of accounts receivable so we have these five ,000 in AR and they've said let's break this down by age 3,000 is kind of fresh ar0 to 30 days outstanding 30 to 60 that's maybe a little bit overdue like slightly past du 6090 a month overdue and over 90 days a couple of months overdue so we add these up and that's $55,000 worth of receivables that's the 5,000 from up above in the question so uh what we do is we get the company's account to kind of examine those and say okay what are the odds we're going to collect each phase of inventory of course the I said inventory receivables uh the freshest receivables you're very likely to collect like stuff that's not overdue you're going to get most of the time and they've said 99% of the time we get a fresh receivable it's the older stuff we got to worry about so 3,000 times 1% means of this 3,000 we're estimating that $30 is going going bad 3,000 * 1% is $30 of our slightly overdue receivables 1,000 * 5% that's $50 is going to go bad 600 time 10% we're estimating that our more old receivables 60 bucks is going bad and 400 times 40% our really old receivables are the most likely to go bad this should make some intuitive sense right if you've got a friend that owes you money if you collect the best time to collect is right away if you let it wait a week a month a few months you become less and less likely to collect well the same is true of businesses right the longer they wait to collect or the longer the person takes to pay maybe putting it the shoe on the other foot the less likely it is you're going to see the money and so here we're saying there's a 40% chance we're not going to see our money only a 60% chance to collect 400 * 40% is $160 so we've computed these based on the age of our receivables let's add them all here 30 that was our top number I believe yeah 30 + 50 + 60 plus 160 I get $300 as my total here now when we took when I go back to problem 53 when we took a percentage of our sales the number we computed was our bad debt expense and we kind of went off to the races from here when we take a percentage of our aging receivables this is not our bad dead expense this is the ending balance of our allowance for doubtful accounts so of our allowance and this number is a credit must be a credit so when we're doing this problem step one is just to take those percentages of our aging receivable so we took a percentage of all of our receivables as they aged and obviously the older the less likely to be collectible we added them all together and we've computed the ending balance of our allowance now in the last 53 we just plug that right into a journal entry whatever number we compute there that's our bad debt expense goes out the door here we actually have to do steps in a different order here we're going to actually update our allowance t account allowance and our allowance te account we said uh began in a debit of $500 so let start there $500 and we know where it ends the ending balance of our allowance right there $300 credit now clearly this is not a working te account I am missing a credit to my allowance the question is how big a credit am I missing you'll always be missing a credit here how big a credit well a debit of 500 to end at a credit of 300 I need up a bigger credit I need 800 $0000 in credit if you just do the math here uh ignoring the 300 at the bottom 800 on the right minus 500 on the left would leave us a $300 balance on the right so it was an $800 credit well how do I insert a credit into this that that doesn't exist already I do a journal entry and I'm going to credit my allowance for $800 just that missing amount and the debit here is to bad debt expense and it's the exact same journal entry as we did last time and and for setting up an allowance it's always the same entry debit bad debt expense credit the allowance so that's what we'll do debit bad debt x 800 credit allowance 800 and the date on this was July 31st 2024 okay so we have done our adjustment uh so that was the answer to part A prepare the adjustment to the allowance for Del F accounts based on the information we've done that the final step then show how accounts receivable would be disclosed on the balance sheet AR minus allowance equals AR net our accounts receivable is 5,000 our allowance now a lot of times students will plug in this 800 number because that's the freshest in their mind no no no the allowance is right there the ending balance of allowance is what's at the end of the TA account it's $300 credit 5,000 minus 300 is 4700 and there we have it uh the big difference between this method and the percentage of sales method in terms of the steps there are difference in sort of the psychology or whatever the word is but in terms of steps these two are swapped so with the aging and receivables Method the balance sheet method we compute a percentage of our aging receivables we update our allowance te account then we do our journal entry and then our arnet with the other method we do we calculate a percentage of sales we do our journal entry right away then we update our TA account so those just those two get swapped but once you've got the handle on one you should be able to understand the other um okay I think that's it for problem 54a as always if this video has been helpful to you please I hope you'll be helpful to me and hit that Thumbs Up Button all right guys bye for now let's take a look at problem 55A this should be a very fast video on writing off bad debts so you've got a customer who you've determined is never going to pay you want to give up on them your you're not sending the Mone to the collections you're just writing it off you're saying goodbye I'm never going to see this money here's what you do you credit accounts receivable from the customer is never going to pay so let's actually read the question before I credit the account receivable uh it says on August 11th 20124 obviously I'm going to be wanting to date this August 11 2024 MCO carpet cleaners wants to write off a $44,000 account receivable from a customer good sleep Hotel so we're a carpet cleaner good sleep hotels is not paying their bill we're going to write it off we're giving up on them for for some reason so I credit AR good sleep obviously I'll credit that customers AR I'm saying I'm not going to see the money get rid of the AR now remember when I want to get rid of the AR I don't debit bad debt expense I have to get rid of the AR by dipping into the allowance so you debit the allowance for doubtful accounts little bonus work because that's that's the question we've answered it congratulations to us but here's a little bonus uh what happens if uh that was August 11th let's say on September 22nd very important date that's my wife's birthday 2024 uh so a month later good sleep pays the 4,000 bucks that they owed us right this can happen right we rote off their AR we said goodbye good sleep you're not a customer anymore and then good sleep came crawling back oh what a delicious moment that is for us when you've given up on the money and it's like oh found money first thing is they come in we're not going to say oh sorry we rode off your AR we won't take your money no we'll take your money please uh here's what we do all we do is on September 22nd we just reinst reinst rein Institute their AR we just pretend this journal entry never happened and we reverse it we go okay well uh right now you don't have any AR to pay off let's give you that AR back AR good sleep debit that to sort of put it back on the books then we uh credit our allowance to say okay that allowance that I said I used up debiting an allowance means you're using up your allowance for helpful accounts now we're going to credit to say oh you know what I I can put that back in the cookie jar still have that uh and then at the same time I'm just going to pretend like it's a normal AR collection debit cash 4,000 credit AR good sleep 4,000 so a nice situation to happen a little bit of bonus coverage for you a very nice thing when it happens and you know what else is a very nice thing when it happens you guys hitting that button for me uh if you could hit the likes button on this video all right hopefully this was helpful to you hopefully you're uh getting better in your journey to understand accounting have a great day and I'll talk to you soon bye for now I recently celebrated a milestone birthday count the candles see if you can figure it out I turned 40 and aside from the ice cream cake which was pretty awesome I was pretty lukewarm about the whole thing and I noticed something happening to me that happens to uh at least you hear about happening to men around my age I started to feel the pangs of a midlife crisis now for some men they buy sports cars or they want to change their spousal situation perhaps for me I started to have elaborate fantasies about getting an electric skateboard and I don't know trying to look cool and young or something something I'm not sure um but it also got me thinking about growing up because I have a little kid and just got me thinking about my birthdays when I was a little kid when I was growing up and something I always remember from my birthdays which is a weird thing this didn't happen everybody but it was something that my mom did every birthday was actually about a week before my birthday she would lead me into her bedroom and there would be toys or things laid out on her bed and and she would say Okay Tony here are some options for your birthday present pick one and so I'd pick one uh inevitably I would pick video games because that's the kind of person I am I wouldn't want the basketball or the roller blades or anything like that but uh something that didn't dawn on me was she would return everything else so she'd go back to wmart or Costco or wherever she had purchased the stuff from and she returned everything and in fact it wasn't just around birth says my mom bought stuff and returns stuff all the time I would say at least 50% of our purchases in our house were returned to the store and uh this has got to be a bit of a burden on the store not just on the staff for having to deal with extra transactions but it's also a burden on the accounting department you can imagine dealing with these sales transactions and then return transactions more than doubles your work and it actually gets even trickier than that because companies need to answer the question when is a sale a sale like have we earned the revenue for Walmart when we sell this stuff or do we have to wait till the return period to record our revenue or how do we deal with the fact that there's going to be these returns and then that it might not represent Bonafide Revenue so that's what a big piece of this module is about it's about dealing with people like my mom who make constant and frequent sales returns how do we account for that so we're going to explore when a sale is a sale we're going to look at just how to deal with inventory purchases from Walmart's perspective you know they buy inventory they uh mark it up and then they sell it to us well their special Arrangements around inventory purchases a lot of time and we'll answer the question does this change the financial statements spoiler alert the answer is going to be yes but more on that later by the way I did buy the electric skateboard and it's [Applause] awesome let's examine problem 63a this has us combining purchases and sales if you did 61 and you did 62 they kind of separated them and gave you just a small taste 63a kind of puts it all together and even adds a little bit more so let's get going uh the following transactions occurred for Romney Inc and big long list of transactions and it says give us journal entries okay so that's what we're going to do let's start with the first one Feb first uh purchased inventory and account $3,400 okay so we're buying inventory on account uh when you buy inventory on account debit inventory and the amount was 3,400 we credit a p3400 now remember the terms 2% discount if we pay within 10 days otherwise we got to pay the full amount within 30 February 2nd paid Freight on the inventory okay we haven't had to deal with this yet so uh paid cash of $200 so let's credit cash because that's the easy part here 200 now very interesting here when you pay to have inventory delivered the cost of acquiring the asset the cost to make any asset kind of useful to you is actually considered not an expense but part of the cost of the asset so part of the cost of the inventory is the delivery charge which is a little bit weird again I I think a logical person might look at this and say oh debit Freight expense or delivery expense or something like this we do not debit that we say look the cost of the inventory if if you wanted to get this inventory 3,400 it was necessary to pay the $200 on top to acquire the inventory that's part of your inventory cost so we actually debit inventory here for2 200 so again $3,400 of inventory plus $200 of shipping it's actually a $3,600 piece of inventory or bunch of inventory okay so that was February 2nd February 5th bad news here we returned $400 of inventory okay so we were returning some inventory credit inventory $400 uh debit AP we're saying we don't owe you that $400 anymore we are returning the inventory we're assuming everybody agrees to that um February 9th we pay for the inventory uh when I pay for the inventory I got to credit cash but we got to figure out how much now as we're looking at this I'm ignoring B ing this part of the transaction right this uh uh Freight part because I've already paid the freight I don't have to worry about that uh but I do have to worry about this $3,400 inventory purchase and the $400 return well guess what though it's $3,000 worth of inventory now the question is do I qualify for the discount the answer is well I paid within 10 days yes so I get a 2% discount which is a $60 discount meaning I pay $ 2940 right 2940 I pay $60 is Discount well if I pay 2940 credit cash 2940 on February 9th uh I debit AP to say whatever I owed on this I don't owe anymore I've paid the bill in full and the bill in full was $3,000 right it was the 3,400 minus the 400 I still owed $3,000 on the bill so I got a debit AP for that $3,000 and you can see now I've got 3,400 in debits to AP $3,400 in credits to AP but wait you say there's a $60 missing amount this reduces our inventory value we only paid $29.40 for the inventory so that $60 discount comes up of the value of the inventory uh okay moving on uh February 11th now sold inventory for $3,500 on account the inventory cost $1600 terms 210 uh net30 so we sold $3,500 of inventory or inventory that was priced at 3500 so let's deal with that February 11th debit cash no huh cash we sold on account debit accounts receivable credit sales rev for uh how much 30 I thought it was 30 yeah there it is 3500 sorry I was going blind there debit AR credit sales debit cost of goods sold credit inventory for what we sold so uh for the cost and that was $1600 now again there are discount terms on this so when I make this sale I'm keeping that in mind that I'm going to probably or possibly need to adjust this February 14th Valentine's Day uh oh now we're starting to juggle we purchase some inventory $2,500 terms 115 net30 all right so Feb 14th debit inventory credit AP for an inventory purchase and the amount was $2,500 we make another sale on February 19th oh my goodness sold inventory 15500 on account $600 was the cost uh terms 210 n30 okay whenever I sell inventory again I'm thinking two entries debit AR credit sales rev debit cost of goods sold credit inventory and the amounts were given up there the amounts were on February 19th 1,500 was the sales amount 600 was the cogs amount okay that's it for February 19th February the 21st paid for the inventory purchase from February 14th okay so on February 14th we purchased inventory terms 115 net30 yes when we pay we are taking our discount there are no sales returns in a in in between so it's a $2500 bill but we take a 1% discount you can see the terms are 115 net30 so this is a $25 discount meaning we pay 20 475 so let's do it February I think it was 2st uh let me just Tech on my key so I don't scroll back up yeah February 21st we're going to credit cash 2475 we're going to debit AP and the AP related to our February 14th amount was 2500 bucks so debit a $500 and then there's this $25 discount amount that is a reduction in our inventory value we did not pay the full 247 uh we did not pay the full 2500 for inventory we paid 2475 so we got to reduce our inventory value by that $25 discount it's the inventory value the inventory on the books is what you paid for it not some full price amount it's it's the discounted amount next febr February 24th customer from February 11th transaction paid the amount owing okay so let's see what happened on February 11th just remember the details of that sold $33,000 of inventory in account terms 210 net30 Feb 24th they pay they don't get their discount so they just got to pay the full amount uh okay so they got to pay us uh they owed us 3500 bucks guess what they got to pay us 3500 bucks so February 24th debit cash 3500 credit AR 3500 that was a simpler one uh next February 25th uh customer from February 19th transaction like that transaction returns $100 worth of inventory Co cost 40 the inventory was good condition and put back on the shelf for resale okay so they made a $100 return and we're going to give them a $100 credit to their account so again they made this purchase and $1,500 purchase and they said hey $100 this we didn't like we'll give them a $100 credit to their AR this was on February the 25th credit AR by 100 bucks the debit is to sales returns 100 bucks so they've returned the item it goes to this Contra revenue account called sales returns so far so good we got to put the inventory back on the shelf and it's $40 worth of our inventory the credit is to cogs to say okay that stuff that we said was Goods that we sold we didn't sell it right we went debit cogs credit inventory now we're saying reverse that that sale didn't happen flip that portion of the sale back so there we've done it uh last but certainly not least and one of the trickier ones and this is just a juggling act right all we're doing is juggling here customer from February 19th sale pays the amount owing uh okay so we got to figure out what they owe us so uh I'm going to erase this stuff just because we're not really referring to it anymore okay so February 19th sale it was a $1,500 sale and they've returned $100 worth of uh merchandise so it's really $1,400 that we are planning to collect but guess what they paid within 10 days terms were 2% discount February 19th to 28th it is within 10 days so they can take a 2% discount they get $28 off meaning they pay uh $1,400 minus $28 is $372 okay let's deal with that this is on Feb 28th debit cash I forgot the amount already 1372 we got to get rid of their AR their AR is was $1,400 it was 15 but it went down to 14 so we get rid of their AR and we're left with $28 in debits this amount again it's like a reduction of our sales revenue but there's a specific account for this called sales discounts we gave a discount and uh this gets as a cont ra revenue account it reduces our sales revenue by 28 bucks okay I think we have done it here ladies and gentlemen we've made it to the bottom of this problem all sorts of purchases returns discounts Etc a challenging problem but it's more of a juggling act I don't think it's if you look at each individual transaction I don't think it's any harder than 61 or 62 but it's just that there's so many of them that's all for this video stay tuned for our next one bye for now let's examine problem 64a this has us doing financial statements for a merchandising company a company that sells inventory we haven't done this so far so when we did chapter one and even chapter two and three financial statements all of the companies we looked at provided Services they were like Consulting companies in these types of places this company sells stuff and because they sell stuff their income statement is going to look a little bit different as we will soon learn now the good news is the way the question is sort of framed here it gives us an adjusted trial balance and it lists all the accounts in order that makes the financial statements easier than chapter one where we listed the accounts in random orders so uh I'm just going to highlight here we we're going to have to do uh so just looking through this trial balance just below it it says the first thing we got to do is do an income statement and uh when we've done the income statement compute gross profit percentage okay that's what we're going to do in this video um so an income statement as you'll recall is the summary of revenues and expenses so I'm just going to highlight them and again that's the good news about this uh the way this question is formatted like there's our income statement right revenues minus expenses equals net income literally if I took the credit account subtracted out all the debits accounts I'd get my profit or my net income but of course we know format really matters here so let's start with a title and this is called Julie plumbing puming plumbing supplies we are doing an income statement and these things get dated for the year ended and then the date which is March 31st 2024 how do I know it's for a year and not a month because the question says uh for the year so that's how I know um okay let's start with our revenues and the first sort of new piece of information here is our Revenue amount actually involves the sales returns as well so um sorry I wasn't meaning to highlight the six there um the sales revenues are 365 again ignore that for now the dividends uh the sales returns are 25 so our net sales what just happened here I've jumped into a whole another problem what is going on this is crazy um I'm going to keep it going here but if this start keeps fritzing I'll have a problem um okay our sales revenues were 365 our sales returns were 25,000 so we take one minus the other we say okay our sales minus our returns and allowances is our net sales this is a contra revenue account so uh I'll just do this calculation at what I expect to be like the bottom of the page I'll put a little star here sales rev minus sales returns and all allowances equals sales rev net right our net sales so $365,000 minus $25,000 equal $340,000 this is the number we tell our shareholders about if you look up Walmart or your favorite retail company on the internet you look up their financial statements this is the number they tell you they tell you the net sales so that's what we're going to tell our shareholders as well so we'll start there sales revenue net and it was $340,000 so that's the first new thing U because we have a retailer where there's sales and there's returns we end up with net sales the next new thing is this account cost of good sold and it's a special account it's an expense but it's an expense that gets top billing so we list our CS our cost of goods sold next and our cogs was 150,000 sales minus cogs equals gross profit a new subtotal 340 minus 150 equals trying to do the math in my head 190 then we're going to list then from here it's just a normal income statement we list our operating expenses gives us our operating income then interest then that gives us income before taxes then income tax then we're done so just very much a normal income statement from chapter one after this point so the key points are already done we have a new format for our income statement because we sell inventory we have this cost of good sold expense that gets top billing and also because we sell inventory we have sales returns to contend with so a couple of new elements from here nothing new so let's do it uh we have operating expenses and then it's like everything down to interest is considered an operating expense so wages bad debt advertising Etc I'm just going to list them out wages expense bad debt expense advertising expense you utilities X depreciation X rent expense Insurance these are all operating sometimes a student will say is Insurance really a part of the day-to-day business and the answer is yes you need insurance to run a business so it is no question in operating expense so uh I don't know I've pulled up my calculator I have to put put the numbers down wages were 55 uh bad debt is five advertising 12 uh utilities two depreciation six rent 15 and insurance 10 now I can total my operating [Music] expenses so totaling up here 55 + 5 + 12 + 2 + 6 + 15 + 10 I get 105 190 minus 105 is 85,000 this is my operating income or my operating profit I'm actually gonna I can just see I'm running out of space here I'm going to move this thing down that's one of the beauties of being on a computer it's very easy to move stuff I don't know maybe move it down even a little further still oh no what happened to it ah contrl Zed control Zed control Zed where's the undo button there we go what what on Earth sheesh this this touchscreen has just been fritzing lately uh anyway I've moved it down tragedy averted uh okay thank goodness for the undo button right if you're not familiar with undo buttons on a computer you are missing out control Z for my American cousins control Zed for my Canadians uh and maybe the rest of the world I don't know uh write in the comments below if you're watching on YouTube do you say z z or Zed e d uh and what country you're from I I know that UK people say Zed Canadians because we're in Commonwealth say Zed I know Americans say Z I wonder what other people say and what they learn right if you're from you know China or something did you learn Z or did you learn Zed when you were learning uh uh the English alphabet just curious just kind of a random thing okay we got our operating income sorry for the the sidebar the things you think about uh operating income uh next is our other stuff so we have other expenses and in this case it's just [Music] interest expense and our interest expense was 7,000 that brings us down to our income before tax our income before tax 855 minus 7 is 78 and uh now our income tax and our income tax expense was 21 that brings us down to our very bottom line here our net income 78 minus 21 is 57,000 that gets the old double underline dollar sign at the top of each column dollar sign beside the bottom line of the statement and there we have it we've got a good income statement part I of this question here just circle it in red says compute the gross profit percentage okay so we know our gross profit is right here it's uh 190 and the gross profit percentage is just the gross profit divided by the sales and the sales in this case are 340 so do the calculation down below here [Music] gross profit percentage equals gross profit divided by sales equals 190 / 340 and this will be a percentage of course 1 190 ID 340 5588 58 uh 88% 55 I think I said the wrong number 55.88% what does that tell us it tells us I'm going to double check that number okay yeah I was worried I had said the wrong thing uh 55.88% tells us the markup right we mark up uh more than double the cost right our gross profit is more than half of the sales in other words when i s for every dollar I sell 55 cents of It kind of covers my own expenses 45 cents of it 44 cents of it covers the cost of good sold covers just the buying the product from my supplier so that's what that means that's a key number and and for this If you're sort of looking at a company from the outside looking in bigger is better right you'd rather see higher margins Apple uh the famous phone company always brags about this right Tim Cook goes on the uh calls and he says our average selling price is up our margins are up these are things they want and when they talk about margins being up they're talking about this number the gross profit percentage so very useful number to know uh one that uh investors are very interested in and so too should you be all right that's all for this part of the video in the next video we'll do the statement of changes in equity stay tuned we have just completed our income statement for Julie's Plumping supplies time to move over and do the statement of changes in equity let's do it and this is going to take a three-line title start with the name of the company Jules plumbing supplies move on to the name of the statement statement of changes in shareholders equity and then the date and again for the year ended and then the date March 31st 2024 I haven't introduced anything new here so we just have the two key accounts common shares and retained earnings uh we could potentially have preferred shares or some other types of equity accounts that you'll learn about in Intermediate Accounting class but in intro class you might have common shares or share capital and retained earnings are pretty much par for the course uh and then of course totals those are our big three columns and we start with how much of this we had on the first day of the year and the first day of the year would have been April 1st 2023 so what were my common shares at the beginning of the year well that's the number off of the uh trial balance here 1,000 bucks and my retained earnings at the beginning was 41,000 totaling to 42 then we say how did they change the question notes I'm looking at being now let me erase my highlighting this highlighting is probably all in the way I'm looking at Part B Part B says assuming no shares were issued or repurchased due a statement of changes in equity so how did they change well my shares didn't change my shares started at a th000 ended at a th000 there was no change in common shares what about retained earnings retained earnings always changes we're going to add net income and there was net income how do I know because I just did the income statement the bottom line from the income statement 57,000 that comes up so we're going to add 57,000 to our retained earnings the total net income was 57,000 and we're always going to be deducting if there are any dividends so we deduct dividends and the dividends in this case were six just right I'm the worst Arrow drawer in the leag hold on I'm going to try to draw a beautiful Arrow wow not great not great ink to shape let's try this let's see what happens ink to shape huh nothing happened there's a little mode here that I I thought I was in anyway 6,000 you guys see it I see it we all see it it's 6,000 trying out new features on the Fly not the best idea when you're making a video ink to shape really it should have worked I'm going to try it again oh it did a line hold on it can't figure out an arrow you can figure out a line so if I do this no what about this no bizarre bizarre it's not a good feature Microsoft I'm giving you feedback on the Fly I use a software called one note to do these and I really quite like it but anyway it wasn't working there uh our end of period March 31st 2020 93 our common Shares are a th000 they didn't change our rained earnings 41 goes up by 57 then down by six this brings us up to 92 41 + 57 - 6 uh 1 + 92 is 93 and the math works both ways 42 + 57 minus 6 is also 93 double underlines across the board dollar signs at the top of each column and dollar signs beside the bottom line and there we have it our statement of changes in equity in the next video we're going to look at the balance sheet stay tuned okay we have been working through this Julie's plumbing supplies problem we've done the income statement we've done the statement of changes in equity and now it's time to work on the balance sheet uh so let's get started with the title as always with a balance sheet or any statement it's going to be a three liner I made I've left sort of wider room for my balance sheet so I'm going to sort of leave more width we've got Julie Plumbing whoa plumbing supplies we are preparing a balance sheet and balance sheets just get dated and the date here is March 31st 2024 we're going to list assets on the left we're going to list liabilities on the right and when we get to it we'll list shareholders Equity somewhere down the page on the right so uh looking over to our trial balance here um we basically have all the stuff we need uh for assets and liabilities right here and for uh shareholders Equity it comes from the statement of changes in equity so assets and liabilities are what we're worried about uh let's start with the most current and the most current is Cash who current assets and we'll begin with cash our company's cash was 24,000 bucks now next we have receivables and this is interesting we hadn't done uh chapter the chapter on receivables before but now we've done it and we have accounts receivable and we have the account below it allowance for helpful accounts this is another one of those darn Contra accounts what does it mean it means 18,000 is how much I'm legally owed but I I've estimated that 3,000 of that 18,000 isn't coming in so our net receivables is less than 18,000 it's 18,000 minus 3 it's 15,000 so let's put that in here AR [Music] net and it's 15,000 and just below at the bottom of my page I'm going to show that calculation I'm going to say AR minus the allowance equals my AR net and in this case it's 18 - 3 = 15 okay so there we have uh the AR we have we have inventory of course 54,000 and prepaid Insurance 6,000 prepaid insurance and preate insurance is absolutely current as is inventory so adding this up 60 8 999,000 I believe is our total kind of an interesting number total current Assets Now in terms of long-term assets I see equipment and I see accumulated depreciation equipment well again it's an asset with a contra asset I'm going to go 125 minus 20 to get 105 right equipment net so I'm going to have longterm assets and under there I'll have equipment net and oh you know what I didn't total in the right spot my total of course goes to the left here 999,000 my equipment net I believe was 125 minus 20 it's 105 and that gives us our total assets our grand total here 99 + 105 is 24 that's it we've done our total assets double underline there dollar sign at the top of each column and beside the bottom line I'm not spending tons of time explaining each step because if you're shaky about your financial statements go back to chapter one and and get a feel for them this is sort of just the build on onto that looking at liabilities accounts payable wages payable unearned revenues would all be current bank loan payable long-term there's no Current Port noted we'll just assume there isn't one uh so accounts payable wages payable unearned revenues all current liia [Music] bill uh AP wages payable unearned revenues unearned revenues might be have been one we haven't seen before on a balance sheet but of course it's even though it says Revenue it's a liability it's when somebody's paid you in in advance for service and you haven't delivered the service so uh it's something that you owe 157 and five total here is 27,000 that's our total current [Music] liabilities um onto long-term liabilities and it's really just the one so I'll call it a liability if you call it liabilities that would be fine with me it is a bank loan payable and the amount here is 84 Grand so the total liability 27 + 84 is [Music] $11,000 okay now we just have to do our equity and our Equity doesn't come from here it comes from our statement of changes in equity we have a thousand of common shares 92 of retained earnings that's it a th000 of common shares 92,000 of retained earnings shareholders Equity common shares a th000 retained earnings 92,000 this totals to 93,000 that's our total SE our total shareholders Equity bringing us down to our grand total total liabilities and shareholders Equity 111 Plus 93 it equals 200 oh is that right 111 + 93 I feel like it's right but maybe not I'm having second thoughts here 111 + 93 I think I'm off 111 + 93 204 I'm off by 10 grand why am I off by 10 grand I'm not sure why oh on the other side side 99 + 105 is 204 huh what a silly mistake it does equal 204 over here just shows you how to quickly fix a mistake uh put a dollar sign on top of each column a dollar sign beside the bottom line and there we have it ladies and gentlemen a balance sheet that balances so we've done it we've solved problem 64a as always if this video has been useful to you if it's been helpful to you I'd love you i' love you I'd love it if you hit the thumbs up button and uh would consider subscribing to this Channel on YouTube all right hope this helped have a great day talk to you soon welcome to module seven of our financial accounting course this module is about inventory and you might be saying to yourself wait a minute didn't we already do inventory wasn't that module 6 well module 6 we learned a lot about inventory we talked about purchasing it uh maybe at a discount selling perhaps with a discount we talked about returning inventory and all sorts of other inventory issues in this module we dive even a little bit deeper and to explain the fundamental issue we're exploring this module uh I'm going to give an example and if you're sort of looking for a big picture topic maybe you're coming at this from your uh your own textbook we're we're going to be talking about fifo lifo weighted average inventory costing methods here so inventory and cost of good solds is the big topic uh so let's jump into what this means and why it's an issue so let's say we're Walmart and we are you know a retailer like Walmart anyway and we uh uh I want to zoom in on a specific pair of socks that Walmart might sell so you know white Hanes uh you know just athletic socks I'll draw one sock I'm not going to draw two I'll draw two why not uh there's the second sock in the bear and uh we're haes and this costs us uh or not we're haes we're Walmart and this costs us $2 to buy from our supplier Hanes and we're going to turn around and sell it to our customer for $5 the for the pair of socks and we're going to make a tidy gross profit of of $3 and in fact let's just do the journal entries of that simple transaction so uh we buy the socks from haes debit inventory socks uh and again it would be more specific than that we would say you know these are white socks this is you know their large size and whatever other details we would need to distinguish because we carry so many other pairs of white socks we would uh have more detail tied to it than that but anyway we debit inventory socks two bucks and credit uh accounts payable because of course Walmart doesn't pay cash for much and then we turn around and the next day we sell the sock so our customer comes in and they buy the sock so we go okay our customer pays us cash five bucks there's sales rev of five bucks we're not worrying about any discounts or anything like this that we talked about last chapter and of course there's two pieces to this entry uh one to record hey there's money coming into the till the $ five amount but also two $2 worth of our socks $2 worth of our assets walks out the door with our customers so we credit inventory for two bucks and the debit here is to cost of goods sold $2 and that's that special expense account and we can see sales minus cogs equals gross profit also called gross margin and our gross profit on this deal was 5 - 2 we made three bucks in Ming out of the way of my three we made $3 in the sale and and that's certainly reflected in our accounting information so we've uh done it and there is a simple example now here's where things get a little bit more complicated and this is going to be the focus of our chapter so let's assume again Walmart buys that $2 pair of socks let's say it's January 1st so January 1 Walmart buys a pair of socks they go debit inventory I'm not going to say socks uh but you know you know it is socks $2 credit uh AP $2 let's assume that those socks do not sell and on January 2nd Walmart buys another pair of socks now of course Walmart wouldn't buy one pair of socks they would buy thousands of pairs of socks at a time but for this example we're just going to buy one at a time so on January 2nd they call Haynes and hayn says hey you know what the price of socks has gone up the price of cotton has gone up for us and therefore we're gonna we got to charge you $2 and5 for that pair of socks and Walmart uh eats it and they they buy the socks for 205 again Walmart probably fights over this because Walmart is known as a a pretty tough company a pretty tough customer uh they they will be very demanding but anyway let's assume Walmart goes along and buys the socks for 205 on January 3rd uh Walmart buys another pair of socks and ha says this is out to control these cotton prices and in fact we got to charge you uh let's say $216 for our socks now so Walmart goes g okay and debit inventory $216 credit AP $216 okay so that's all my sort of setup here January 4th a customer comes in and they buy the socks and so we have our normal sales right and and look listen to be abundantly clear these are all the same same same skew same type of sock right they come in the same package they have the same everything associated with it and from the customer's perspective they all have the same price tag on them the price is $5 so the customer comes in they see this pile of three socks on display in this sore three pairs of socks I should say and they buy a pair of socks so uh and and of course they all cost the customer $5 so Walmart receives $5 cash they have $5 in sales revenue the question is what is the cost of goods sold in other words how much inventory walked out the door with our customer what was the value of the inventory that walked out the door with the customer and this is the fundamental uh question of module 7 here and the answer is it depends and it depends on the company's accounting method there's really four accounting methods we need to be worried about the first method is called fifo fifo is uh short for I was I should have left more space here first in in first out fifo and what does fifo mean fifo is means the first one we bought that's the first one we sold so doesn't matter what actual pair the customer grabbed like the top one the bottom one or the one in the middle uh first in first out means the oldest inventory that's the inventory that's sold so when I debit cogs credit inventory under fifel I'm going to debit cogs credit inventory for two bucks so under fifo cogs equals two bucks um now there's another method last in first out now last in first out is very unpopular around the world in fact it's not allowed under most accounting systems except for there's a few notable exceptions the main notable exception is our cousins South of the Border I'm in Canada south of the border my American cousins are allowed to use lifo there are some specific rules around it but I don't think it's a very good method to be honest with you uh but that's it real companies use it so you American students will have to know what it is I don't require my students to know what it is but you know just eyeballing it you should be able to figure out the last in first out means the last one we bought this $216 is going to be our cogs our cogs will be $26 if you're curious about this maybe leave a comment below why I don't like lifo um I maybe I'll make a video about it down the road but it's probably a 5 to 10 minute talk that doesn't really fit here uh but standard Setters around the world pretty much agree that lifeo is a bit uh goofy uh anyway uh okay so that's lifo uh looking at number three we have What's called the weighted average method this can sometimes be called the average cost method the the word average is going to be uh included somewhere in in a third method and as you might suggest you take an average it's not a simple average it's a it's called a weighted average and we'll learn what that means in future videos around weighted average but here we'll we'll take the average of these three so if I add two well let me just do this in my calculator 2 + 205 + 2.16 621 ided 3 is 207 $27 sense I tried to do a weighted average reason I chose 216 here was because I thought oh the average is going to be an even number uh I just wanted to make an even number of course in real life the weighted average doesn't have to work out to an even number that was just my choice the final method here is called specific unit ID specific unit identification specific unit method something like this um what does specific unit ID say well says listen if we know what pair of socks the customer took like literally physically what pair of socks they took from the Shelf did they take the one that was on top did they take did they like when I'm buying milk I always reach around and grab milk from the back because that's how I roll did they grab the milk from the back or did they grab the milk from the middle or did they grab the milk from the front if I'm able to keep track of that why don't I just say the actual cost of the good that I sold right I know which one I sold why don't I just say okay well they bought milk number two or they built bought pair of socks number two therefore it's 205 or they bought pair of socks number one therefore it's two bucks or they bought pair of socks number three therefore it's 216 whichever one they bought that's my Cog so in this case cogs would be uh 2 or 205 or 216 whichever one was purchased now in this case we we aren't sure and if we're not sure sure then we can't use that method now where would we be sure well if I were a Toyota car dealership and I had four gray Toyota Corollas that were the same trim package same everything I would darn sure know which one my customer bought it would have a vehicle ID number I would keep track of each one separately or if I were an antique Sailor and I had or um maybe even um let's say I was one of these fancy painting auction houses right and I was selling like paintings uh I would know which was which I wouldn't say oh well it's the average cost of my picassos and I'll just average that out no I would keep track specifically each unit I would track separately so specific unit ID typically for bigger ticket items like pairs of socks you would just probably lump together it's not worth the effort of tracking them separately although we could we probably wouldn't but with uh uh sort of large or unique items we might track them all separately so that's a big Focus of this module is just figuring out the cost of the inventory we sold and the reality is we are allowed to use several different methods and you will be responsible I'm sure in your class to understand several different methods of tracking inventory all right I can't wait to get started I'll see you in the next video let's take a look at problem 72a this as as doing inventory records using the fifo lifo and weighted average methods in in this video we're going to solve it using the fifo method so abdan Automart uses a Perpetual inventory system and reports the following transactions for the month of May for one of its products and there is a list of transactions beginning inventory and purchase sale purchase purchase sale and it says do an inventory record using the fifl method under each of the methods compute sales cogs and gross profit and do some journal entries and we're going to do all of that says download the template that we're going to use at accounting workbook.com so let's just do that we go to accounting workbook if you Google accounting workbook first hit there accounting workbook.com uh under Financial Accounting videos this is mod 7 and inventory template used in problems that's the one and it's this Excel file I've already got it open here and the only difference between the one I've got open and the one you would open is I've copy pasted the problem into the Excel file so there we are um okay let's get going here with problem 72a uh now remember this uh template that I've provided you may or may not get one like this in your class or on the test it may or may not be provided but there's not a lot going on here and it's it's super useful just to be able to prepare it so the section on the left is for the date this section I'm highlighting now is anytime we make a purchase we fill that in there this third section is for cost of goods sold so whenever I make a sale I'm going to be tracking the cost of good sold here not the sales revenue but the cost of good sold and the final colum is a running total for inventory so let's get started with the first relevant date which is May the 1st now what happened on May the 1st did I make a purchase nope did I make a sale nope but I did have an inventory balance 20 units that cost $3 a piece 20 * 3 is uh $60 okay so we're done May the 1st I'll put an underline underneath it and we will move on to the next relevant date which is May the 5th what happened on May the 5th I made a purchase I purchased five units at $3.25 a piece now again keep in mind this is all the same type of product that that I previously bought for $3 the cost of me has gone up to 325 uh 5 * 325 IS $116.25 5 and so uh I didn't sell anything I have no cost to good sold uh my um total here my running total for inventory I have to say to myself okay I had $20 of inventory do I still have $20 of inventory the answer to that is yes I still do so I just bring it down I'm adding to it $5 at or five units at $325 for 1625 and now this is the key I don't attempt to add these I don't attempt to combine these in any way I just say okay that's what I've got I've got 20 units that cost me $3 and I got five units that cost me 325 that's it May the 13th I make a sale uh what did I sell I sold 22 units now I have to say which 22 units did I sell and the answer is well this is fifo we're doing here so I sold the first 22 units what are the first 22 units well I must have sold all of these and I must have sold that's 20 I must have sold two of the five right so I must have sold 20 units that cost $3 each for 60 and I must have sold two that cost $325 and that's $650 leaving me if I had 20 I sold 20 I got none of those left I had five I sold two I must have three left three at 325 and that's 975 next May the 20th we make a purchase we purchased seven units for 355 price keeps Rising here 7 * [Music] 355 is 2485 I didn't didn't make any sale on this day so I had three at 325 for 975 now I'm adding to it 7 at 355 42485 again don't attempt to Total this don't attempt a subtotal or anything just say okay that's what I've got I have 10 units in total uh 3 at 325 and 7 at 355 on May 24th we make another purchase we purchase five for $3.7 5 * 370 should be able to do this in my head5 18850 see if I'm right yes 18850 I didn't make any sales today so I had 3 at 325 for 975 I had seven at 355 so I just bring those down and I'm adding to it five at 370 for1 18850 okay May 31st I make another sale and actually when we did our first sale I don't think I spent enough time kind of just explaining it but we sell 13 units and we have to say to ourselves which 13 units did I sell right I have 3 10 15 now the common mistake students make here is they say oh 13 units 10 bucks they go it's $130 in sales that's true that is our sales revenue 13 * 10 $130 is our sales rev from that day just like 22 * 10 equals $220 is our sales rev from that day but that's not what we're asking for we're not asking for sales rev we're asking for cost of goods sold so the cost of the stuff we sold well we need to know which ones we sold so fifo says we must have sold the oldest units first we must have sold these three all three of them because we sold 13 in total we must have sold these seven and of these five well 3 plus 7 is 10 I must have sold three more I must have sold 13 in total so 3 plus 7 + 3 is 13 those are the goods that I sold so again in this section we're tracking the cost of the goods that we sold so three at 325 we sold 7 at 355 and last we sold 5 at 370 hello it's Tony from the future I hope you're yelling at your computer screen when I wrote 5 at 370 for1 1850 of course it's not 5 at 370 I'd said it right before it's three at 370 for 1110 so scratch that and because of that I'm going to do some calculations in the future where my air carries where there's an air I'll print the correction on the screen so right now I've printed the correction on the screen like three at 370 for 1110 instead of 5 at 370 for 1850 in the future you'll see there'll be block letters come up on screen when there's a mistake because of this error in my solution so I hope that helps and I'm sorry for the inconvenience back to the video just multiplying these all through 3 * 325 is 975 7 * 355 is 2485 and 5 * 370 is 1850 leaving me with just two units remaining right I had three I sold all three so I have zero at 325 I had seven at 355 I sold all seven I had five at 370 I sold three of them so I got two at 370 Left Right none of the other ones are left and 2 * 370 I can do that in my head it's 740 and there we have it we have completed our inventory record let's put a line under this um now it wasn't asked for but this is kind of an important number this one I'm highlighting yellow here this 7 40 is the ending value of our inventory right this number would be forwarded onto the balance sheet as our ending inventory at least for this unit right for this uh uh product um Okay so we've answered part uh AI using the fifo method let's do Part B it says under each methods under each of the methods uh you prepared in part A so we've done the inventory record compute sales cost of good sold and gross profit okay our sales Rev just comes from uh the question and it's these items right it's these are our sales revenues our total sales revenue for the month is the unit sold times the dollar that they sold for so two uh 22 * 10 is 220 13 * 10 is30 220 plus 130 gives us total sales here of $350 so our sales rev is $350 our cost of goods sold comes from the table our cost of good sold comes from this column on the table uh so just adding that up if I highlight it actually I'll just sum it up in Excel here equals sum bracket and just add up that column and it's 120 so I'll I'll write that in handwriting just to be consistent here our cost of goods sold our cogs is 120 sales minus cogs is gross profit sales minus Cog 350 and .00 I guess .00 minus 120 is uh 230 bucks that is our gross profit that's how much money we made by selling stuff above cost again it's not considering all of our other expenses paying employees wages paying utilities but that is our gross profit on this deal so that's Part B in the books on to part C it says do the journal entries for May 24th and May 31st a lot of times my students say well why don't we have to do all the journal entries and the answer is well an accountant really would have to do all the journal entries we're just doing two of them because if you can do these two you can do all of them and you know I'll explain this as I go so May 24th we make a purchase we purchase $18.50 worth of inventory so on that date I'm just going to uh debit inventory for uh $1850 and I'm going to credit either cash or accounts payable something for 18850 there we have our debit and our credit and we just have to date this May the 24th now in some theoretical world if I was asked to do it for May 20th I would just put in the amount 2485 right and it would be the the same entry just a different amount 2485 would be the amount and if I was asked for May 5th debit inventory credit AP or credit cash 162 the more interesting entry we're asked about is May 31st and on May 31st we do two entries remember one to sell the product the other two get the product off our book so uh part one we're going to debit cash or ar or accounts receivable credit sales rev and the second part of the entry we're going to debit cost of goods sold and credit inventory so again the first part is to say okay I got money coming in how much money do I have coming in well on May the 31st oops I hit the wrong highlighter I was trying to highlight with my pen uh May the 31st my sales Rev on May the 31st is 130 bucks so let's put that in debit cash credit sales for 130 bucks debit cogs the credit inventory for this amount the amount from our may31st Cog so 97 actually I'll sum this up equals that cell G13 plus uh G14 plus g15 975 plus 24 + 18850 oops yes I accept it's 53 bucks let's just make sure we don't have any rounding issues here I bet you there's some change there and this cell is just rounding up yeah $531 cents so uh 5310 is our credit to inventory 53 point one and there we have it uh we've done the journal entries for part C so we've solved 72a using the fifo method hope this has been helpful to you in better understanding fifo in our next video we'll try the same problem but we'll do lifo stay tuned bye for now okay we have completed the fifo method in problem 72a it's time to move on to lifo so so very very similar to fifo only this time when we sell our inventory we don't take the oldest we take the newest last in first out so let's do it uh May the 1st we didn't make a purchase we didn't make a sale but we did have a beginning inventory balance 20 units at three bucks a piece gives us $60 in beginning inventory on May the 5th uh we make a purchase five unit it's $325 each 5 * [Music] 325 IS $16.25 we didn't make any sales today so I bring down my previous inventory balance 20 * 3 is 60 and I add to it my new purchase 5 at 325 is 16 and A4 moving on to May the 13th I make a sale so when I make a sale I'm worried about the cost of good sold not that I had $220 in Revenue which of course we can all see 22 * 10 is $220 in Revenue I'm worried about not my Revenue but my cost of good sold so I have to say which of these 22 units sold and with lifo it's the newest or the most recently purchased stuff so five sold all of those sold all those ones and 17 of those gets me up to 22 so I sold five at 325 and I sold 17 at three bucks 5 * 325 and 17 * 3 what does that leave me with it leaves me with two $3 units or three $3 units pardon me three left over 3 * 3 is nine okay so that's really the key item now we make a couple more purchases May 20th we buy uh 7 that cost 355 equals that times that 2485 um there's no cost of good sold because we didn't sell any Goods so we had three at three for n bucks now we're adding to it seven at 355 for 2485 and that brings us to May 24th we buy five more May 24th we buy five at $370 5times 370 is 18850 I had three I didn't sell them so I still got them I had seven at 355 for 2485 again I didn't sell them I still got them and now I'm adding to it five at 370 for1 18850 so that's May the 24th now on May 31st my mother's birthday what happens we sell 13 we got to say which 13 did we sell we sold the most recently purchased 13 so we sold the uh well let's see what we just looking from bottom to top now we must have sold all five of those we must have sold all seven of those that gets us up to 12 and we must have sold one of those to get us to 13 so in order I sold five for 370 that's $18.50 I sold s at 355 7 * 355 2485 and I sold one at 3 bucks and I know 1 time 3 is three leaving me two at $3 for $6 uh put an underline under here and we are done that part of the question we have prepared our inventory record now let's compute sales cogs and gross profit our sales revenue is just we look on the sale date and we figure out how much we sold stuff for so 22 * 10 is 220 5 * 370 oh wait that's a purchase 13 * 10 is 130 so 220 + 130 3 $350 and this is the same across each method so our sales rev is 350 our cogs cost of goods sold is the sum of the cogs column here so add that plus that plus that plus that plus that I know there's quicker ways to do it in Excel just want to show you what I'd be doing in my calculator sales minus cogs is gross profit 350 minus 1133 is 23640 so there we've answered B on to C journal entry should be very straightforward here we are doing journal entries just for May 24th and 31st we could be forced to do them all but we're not here so May 24th and May 31st I know May 24th was a purchase so when I'm buying inventory debit inventory credit AP and I know May 31st was a sale so I know there's two parts to it deit AR or cash it's unclear here credit sales rev debit cogs credit inventory and now let's figure out our amounts on May 24th how much inventory did I buy well I bought $1850 worth of inventory just right here I bought $1850 so debit uh inventory credit AP1 1850 how much money did I take in on May 31st or how much did I earn on May 31st right there I earned $130 and that's my sales revenue what were my cogs on May 31st well it's the total of this section so it's uh 1850 + 2485 + 3 4635 is my debit to cogs credit to inventory and at that point I've done it I've completed my lifo section of the problem in our next video we'll tackle weighted average stay tuned we've been working our way through this 72a this fifo lifo weighted average problem and now we're on to weighted average the third one is the the trickiest of the three and I always like to and I will re-explain this uh when I think of weighted average I always think of this gas tank example if I put 99 l in my car and it cost me $1 per liter means I got $99 worth of gas in my car and let's say it's a 100 lit gas tank and I put one more liter in at $2 per liter so that's $2 worth of gas in the tank and somebody asked me what's the average cost of the gas in your gas tank I wouldn't say oh well it's a buck 50 you know the average between 1 and two 1 + 2 / by two right I wouldn't say it's a buck 50 because of course you know I've got some gas that's a dollar and some gas that's $2 so I've got a buck 50 on average is the cost of gas in my gas tank that's a simple average a weighted average would say no no no this 99 leader should take precedence so if the 99 leaders takes precedent that means it should have more weight in our average and it does if we take a weighted average here's how you do it you total the number of units in this case liters you total the total cost in this case $101 99 plus two and then rather than taking an average between one and two you just go 101 divided by 100 and you get 1.01 that's 101 over 100 and that is your weighted average well that principle is just all over this problem so let's do it our beginning inventory 20 uh at $3 on May the 1st so that is our average 20 at three for 60 bucks uh okay so next May the 5th we make a purchase now whenever we make a purchase we've got work to do as weighted averagers so we we uh oops sorry I missed the purchases column uh we purchase five at 325 and 5 time 325 IS 1625 uh we had 20 at $3 for 60 we're adding to it 5 at 325 for 1625 and now I need to re aage this how do I do that well I add my total quantity I add my total costs and then I divide the two so 20 + 5 is of course 25 60 + 16 is of course 76 76.2 divided by 25 gives us 3.05 and you can see it's not rounding at all 3.05 is the number so our average cost of inventory is 305 now when I make sales the sales are easy because I don't have to say what did I buy first what did I buy last and keep track I just say oh I sold 22 pieces of inventory they all cost 305 right that's the average cost of my inventory so 22 * 305 is 6710 if I had 25 units I sold 22 I'm left with 3 at 305 and 3 * 305 is 9:15 moving on to May 20th on May 20th I make a purchase I purchase seven units at [Music] 355 7 * 355 is 2485 uh okay so now I had three at 305 for 9.15 I'm adding to to it 7 at 355 for 2485 summing it up here 3 + 7 is 10 9 + 24 is 34 34 ided 10 gives us $340 as our weighted average there May 24th I make another purchase I purchased five at $370 5 * 370 is1 1850 now I had 10 units at 340 for 34 o $34 I'm adding five at 370 for1 1850 again summing it up re aaging don't want to shift sales up control U underline is what I wanted to do here uh 10 + 5 is 15 34 + 1850 is 5250 5250 ided by 15 is $3.50 that's my average cost now on May 31st I make a sale what do I sell I sell 13 units what's the average cost of goods sold 350 now again we're keeping in mind I I recognize that the revenue here is $130 but that number doesn't go anywhere on the chart right the chart is all about cost $22 2 * 10 is 220 we're going to use those numbers later uh 13 * 350 though 4550 leaving me two units at$ 350 for $7 and that point we have completed our uh uh inventory table here uh we got a compute sales cogs and gross profit our sales rev 220 plus 13 our total sales revenue is $350 this did not change across the methods same every time our cost of goods sold the sum of this column 67 + 45 equals 67 + 45 112 bucks 350 - 112 is 237 sales minus cogs is gross profit okay last step here do a couple of journal entries May 24th we make a purchase well this is always the same when you make a purchase debit inventory credit a p by the way I'm answering uh part C here just do journal entries for uh May 24th and May 31st under all methods so that's what we're doing uh debit inventory credit AP for the amount of the purchase on May 24th which was $18.50 this is not different under any method on May 31st I make a sale remember whenever we make a sale there's always two pieces debit AR or cash it's unclear here credit sales sales rev uh that amount hasn't changed it's 130 bucks uh the only difference between all of our methods is this cogs amount cost of good sold Duit cogs credit inventory for the amount from our table for this amount $45 50 in this case it was different in the other two methods okay there we have it we have solved 72a we've made it to the bottom and we've uh done the weighted average method which I think is a little more challenging if this has helped you in better understanding fifo lifo weighted average method I do hope you'll give this video the thumbs up all right that's all for this video see you next time welcome to module eight of our course on financial accounting this module is all about depreciable assets the depreciating assets doing it in different ways figuring out how much assets cost there's a lot going on in this module and just to illustrate one of the key points of the module I got a quick story to tell you and it's about a car I recently well a couple years ago I bought a car and it was uh a 201 Toyota Camry wow messy writing and at the exact same time my dad bought a used car as well and he bought believe it or not a 2011 Toyota Camry and these cars were it was surprising because we bought them sort of separately without having talked to each other and we basically bought the same car mine was black his was blue uh and it was the similarities Were Striking and just for the purpose of our conversation let's pretend that we bought basically the same car so we both paid uh [Music] 25,000 we both plan to use the car for 10 years after which time we both hope to sell the car for five $5,000 so again the price was 25 Grand the life is 10 years and the uh resale value at the end of its life is $5,000 and this's a term we use in this chapter it's called residual value so the residual value of our car we would think would be around $5,000 and so this is about a year or two ago that we bought our cars and something interesting has happened our car cars have lived very different lives um I well I'll start with my dad my dad is a bit of a crazy person he uh he has I I live here in the interior of British Colombia I live in a city called cam loops British Columbia you can look it up on a map uh it's about three to four hours drive sort of Inland from Vancouver and uh my sister lives in Vancouver and my sister has uh been prolific with having children and my dad lives in cam loops and so he drives to Vancouver several times a week twice three times a week he'll drive at like 4 in the morning he'll drive to Vancouver he'll babysit my sister's kids then he drives back to CBS at night his car is just pouring on the miles kilometers my car on the other hand I got to tell you something I know you probably see me in these videos and you think what a cool dude this Tony Bell character is the truth is I don't have much of a life I live close to my office I ride a bike to work I walk places in this town that I live in uh I barely drive my car at all and so as a consequence his car has about 20,000 km put on it and in that actually probably more than that probably like 50,000 km and mine has about 10,000 km since the time we purchased it but if my dad and I were using straight line depreciation here's what we' do we'd say okay our depreciation is this it's uh $25,000 purchase price of the asset minus that $5,000 residual value means we have to depreciate our asset for $220,000 over a life of 10 years we've got to take $2,000 in depreciation per year and so we would just say okay my depreciation is 2,000 2,000 2,000 2,000 each year and so our depreciation CU these cars are virtually identical our depreciation expense if we accounted for it in this way would be virtually identical even though our cars have lived very different lives and what this chapter gets at is maybe this simple straight line depreciation isn't good enough and we'll learn a couple of other depreciation methods we're also going to learn what happens when your estimates change right maybe uh uh my dad's car it's actually going to be worth less at the end of its life well how do we deal with that so that's what this module is all about just what happens when your estimates are off and uh also what other depreciation methods do we have available to us so I'm very much looking forward to the module in fact I can't wait to get started let's begin let's examine problem 82a this has us exploring depreciation and we're going to learn a few different methods so if you look back to chapter 3 we learned one method straight line the same depreciation every year and if you watched the intro video for this chapter I kind of indicated like maybe that doesn't make sense for all assets and there are other ways of doing it so this uh kind of this question has us review and just remember straight line that's what we'll do in the first video there's a few new tweaks to be added here uh and the second video of this series will be on units of production and the third video double declining balance which is notorious with my students uh but let's get started with straight line so let's read the question on March 31st 2024 Kemp company purchased a new vehicle for $25,000 the vehicle so again I'm thinking okay debit vehicle credit cash or accounts payable um the vehicle or some sort of bank loan but anyway the vehic that's not relevant to the question I don't know why I'm saying it the vehicle had an expected useful life of five years and an expected residual value of $5,000 uh now this is a term we haven't really discussed so far residual value and the key to the whole thing is the word residual and if you think residue is part of it if you ever watched an ad for like dish soap they talk about like residue is the stuff left over when the thing's done washing uh well residual value is like the leftover value so we got this $25,000 vehicle we're going to use it it for 5 years after which time we think it's going to be worth $55,000 another word here that you'll hear uh used for residual value is salvage value we think we can sell the thing for $55,000 afterwards so that creates kind of an interesting calculation and I'll just do it right at the top here uh the cost of an asset which in this case was uh $25,000 minus the residual value which in this case was $5,000 equals the depreciable cost the amount that we'll be able to depreciate this asset for so we're planning to over the life of the asset reduce its value by $20,000 uh again it's going to go from 25 the value of 25 down to five so that would mean a reduction of $220,000 is required and that $20,000 comes a very important number for our calculations okay reading on the company expected that in those 5 years the vehicle would be driven for 100,000 km based on the following schedule and there's a schedule of what they're expecting to drive uh now it says assuming at December 31st year end prepare depreciation depreciation schedule for the life of the asset using first straight line so let's do our straight line schedule um now the formula is pretty simple it's the depreciable cost divided by the number of years that we think the asset's going to be useful for it'll give us a rate and our rate is going to be 20,000 divided by 5 is $4,000 per year so we're going to own this asset for five years but remember 2024 is a partial year we'll own it for nine months in 2024 and in five years we'll own it for just a few months of that year so it's you can see here we're actually looking like we're owning it for one two three four five six years but remember it's like three or uh nine months here if everything goes according to plan and then we'll loan it for like three months here so it's the the ones on either end are partial years so anyway that's uh you'll see how that works in our calculation so we buy the thing on March 31st 2024 so let's do this year 2024 uh 2025 2026 2027 2028 2029 okay and uh this helps me think about it number of months that will own it during that year and the answer here is well we'll own it for nine months March 31st to December 31st March so April May June July August September October November December yes that's 9 months so I always go like 912 uh then 12 out of 12 months 12 out of 12 months 12 out of 12 months 12 out of 12 months and in 2029 if I own it for exactly five years I'm going to own it till March 31st 2029 so that's three months three out of 12 and if we add up all these months 9 + 12+ 12 + 12 + 12 + 3 you're going to find We own it for6 months in total which of course is 5 years okay so our straight line depreciation couldn't be more straightforward it's 4,000 bucks a year in year one 9 12ths of 4,000 let me get my calculator out although I think I can do this in my head 9 / 12 times our rate of $4,000 a year is $3,000 in year two We Own It for the full year so it's just a full $4,000 in year three full year $44,000 year four full year $4,000 $4,000 and in the final year 3 12ths time 4,000 is 1,000 now when I total this up 3 plus 4 plus 4 plus 4 plus 4 plus 1 I get $20,000 as my depreciation which shouldn't be a surprise because that was my depreciable cost right so these numbers match match and my amortization schedule is good and that's my game plan right my game plan might change but that's you know my best guess as to what's going to happen for depreciation for this asset so there we have it now this also would feed journal entries right every one of these would represent a year-end adjusting entry debit depreciation expense credit accumulated depreciation we weren't asked for that so I'm not going to do the journal entries at this time uh we've done straight line pretty straightforward why they call it straight line it's the same for every full year right if I were to graph this on a chart it would look like a straight line 4K 4K 4K every full year so that's why they call it straight line depreciation uh in our next video we're going to learn units of production stay tuned for that okay we've just finished our straight line depreciation for problem a2a we're going to move on now and we're going to do units of production so units of production uh look at the asset and they say why are we using time as a measure for loss and value shouldn't we use like usage like in years where I drive a car a lot shouldn't I depreciate it a lot and in years where I barely drive the car doesn't it depreciate just very little and so units of production says measure not time but measure usage and that's how you should do your depreciation so let's look at B here B says well we got this asset and again we we do the same calculation at the top the asset cost us $25,000 if you'll recall the residual value that salvage value if you will was uh five and so the depreciable cost is 20,000 so we kind of have the same starting point for straight line or units of production the uh uh depreciable cost being 20 in both cases okay so um where to go from here well last time we said okay we took that depreciable cost and we divided by the number of years here we're going to take the depreciable cost and divide by the total usage we think we'll get out of the asset and we've estimated 100,000 kilometers that's how we're measuring our usage so let's divide this by 100,000 kilomet and we get a new rate here rate is 20 cents per kilometer so when I go to calculate uh my depreciation I just take the number of kilometers driven and in reality you might prepare this schedule in advance and this would be an estimate in reality you would literally look literally I'm saying literally too much you would look at the odometer on your car like the how many kilometers you drove you would multiply it by 20 cents and you would say oh there's my depreciation this year so in this case 10,000 time 0. to zero and each of these numbers times 20 cents right I'm just taking my kilometers to be driven Times by 20 cents so 10,000 km time 20 cents is $2,000 20,000 km time 20 cents is $4,000 25,000 km * 20 is $5,000 22,000 km time 20 cents oh I I was doing so well with the math in my head I think that's $4,400 $18,000 km time 20 cents is $1,600 no $3,600 this the challenges of doing math in your head 5,000 time 20 cents is $1,000 when we add this up let's see 6 11 11 uh Plus 8 is 19 yeah it's 20 ,000 and to nobody's surprise that is my depreciable cost uh so my units of production depreciation 2,000 oh and and actually this is important the number of months I didn't take that first year and multiply by nine oops 9 12ths I didn't do that why didn't I do that why would that be dead wrong to do well because time doesn't matter for units of production it's all about kilometers doesn't matter if you drove all the kilometers in January right it's just depreciation is by the kilometer not by the month so we don't have to worry about 91 12s here we just take those numbers 2,000 4,000 5,000 4400 3600 and 1,000 and we get to $20,000 in depreciation okay so there we've kind of done I guess I called this all a this is a this one is B and we're going to do c double declining balance in our next video stay tuned okay we are into the last video of this series just solving problem 882a from our accounting workbook the trickiest the three double declining balance depreciation so we purchased this asset on March 31st 2024 and we want to depreciate it and this time we want to use double declining balance this is also called an accelerated depreciation method so units of production says hey you know you bought the car and and it matters what how much you use it not time going by double the cining balance says when does a car lose most of its value and there's a famous like saying about this they say a car loses most of its value when you drive it off a off the lot right as soon as the car goes from being a new car to a used car guess what a lot of the economic value is lost and we should depreciate an asset faster in the early years and slower in the later years that's what double declining balance method says we ought to be doing so it's it says depreciate the asset fast that's that's the fairest way to do it so let's do that with our asset so to do it we actually need to make a little table a chart and here's what our chart's going to look like we're going to have year here and uh number of months just as we've kind of done before uh I want this one to say beginning Book value uh we're going to have rate depreciation rate maybe I'll call it depre iation rate uh depreciation expense will have ending Book value over here so it's a bit of a table we're going to be making and it's going to have quite a lot of calculations on our part quite a lot of work to be done so uh our starting year was 2024 and actually I can just do all of our years 25 26 27 28 29 2025 20 26 20 27 2028 20 29 the number of months well again it's three was it 3 12 I think it was 912 because we bought it in March yeah 92s then in the first year and 3 12 in the last year and all other years were 12 12ths right just full years okay what was our beginning Book value what was the assets value when I purchased it now this is the first of these methods that doesn't use depreciable cost as a starting point we're not using that number we're using the purchase price of the asset just the cost of the asset Book value is is the cost of the asset minus any depreciation well guess what the beginning Book value is the cost of the asset there's no depreciation depreciation is zero on day one when you purchas purchased the asset so our beginning Book value is $25,000 depreciation rate now this is a place where we've got some work to do and this is I don't know just a little bit arbitrary I suppose here's what you do to get a depreciation rate you take the number of years you think the asset's going to be useful for so five years you take one divided by that number so one divided by whatever that number is one divided by five and you you give yourself a percentage here so it's one divided 5 is 0.2 which of course translates to 20% now that would be good if we were doing single declining balance we are not doing single declining balance we are doing double declining balance so we multiply this by two 20% * 2 gives us 40% that is our depreciation rate and again it's it's just kind of arbitrary steps here we say Okay number of years five you take one divided by the number of years you get a percentage multiply by two because this is accelerated we're trying to pre depreciate this thing fast so our depreciation rate I just put the wrong number here 40% okay so let's do our first Year's depreciation we take and and all you do for depreciation expense is you take these three first numbers multiply them 91 12ths time 25,000 time 40% time4 is $7,500 in depreciation in year one so what is my ending Book value well if I had beginning Book value of 25 and I'm going to depreciate this asset for $7,500 in year one my ending Book value is $2500 minus 7500 it's 17,500 right this thing has lost $7,500 in value value so my beginning Wick value for year 2 17,500 my rate still 40% now 122 so I'm not even going to bring into the calculation it's one one times anything is just the same thing I don't I don't even need to include it in in future years only partial years does this really matter uh so 17,500 * 40% is 7,000 uh so I had 175 I'm depreciating it by seven now I'm down to 10,500 take that as my next period 10,500 * 40% 10,500 time4 is 4200 and uh 10,500 minus 4200 is 6,300 okay I'm going to be have a problem here in just a moment 6,300 so actually I'm going to start writing this in red do not write what I write here okay there's about to be a problem here 6,300 * 40% is 2520 and 6,300 minus 2520 is 3780 and I have a problem and this is where a double declining balance can get a little tricky you cannot depreciate this below $5,000 why because that's our ending residual value we have to stop at $5,000 stop depreciating when you get to $5,000 so what do I need to do here I need to cancel this I need to say look I'm not going to multiply this by 40% I'm not going to depreciate 2520 and I'm not going to go down to 3780 I have to stop at 5,000 5,000 was my residual value I've got to stop there we hadn't Incorporated the 5,000 right we started at 25 we hadn't considered this 5,000 now we got to consider it so when we kind of go below 5,000 we say oh no no pump the brakes we've gone too far what we should have done was rather than taking a depreciation rate of 40 we should have just plugged that's the technical term for it we're going to plug in the number that makes this work I want to end at 5,000 how do I go from 6 63,000 and let's fill in the blank here let's make our ending balance 5,000 how do I go from 6300 to 5,000 it would take depreciation of 1300 and again that number is a plug plug so I've gotten to my uh ending Book value that I wanted what do I do in the next year well I have a beginning Book value of 5,000 again I'm not going to depreciate this I plug my next year's depreciation is zero why because I want to end at 5,000 and in the last year the 312s none of this stuff matters I started with 5,000 as my beginning book value depreciation doesn't matter it's a plug it's fully depreciated I'm I've depreciated as far rather as I'm willing to go here so I end up at 5,000 when I ask students to do this I do demand they tell me that the depreciation is zero in these last two years and also that they know when to stop so this can be tricky right it's not sort of intuitively you kind of get in the mode where you're just like take 40% next take 40% next and you just got to know where to stop and that's what double declining balance uh demands of us so I'm going to actually put this up in my table 7500 7,000 here we go [Music] 7500 7,000 and 2025 and 2026 4200 and in 2700 uh 2027 rather 1300 then zero and zero were our last two periods and 7500 + 7,000 + 4200 plus 1300 equals 20,000 okay let's kind of take a look at this whole thing big picture and I think I can sort of sum things up for you a little bit here so we've learned in this series of videos three different depreciation methods straight line units of production and double declining balance these in my class would all be testable I would expect students to know how to do these calculations not only that but the journal entries debit depreciation expense credit accumulated depreciation that's not too hard why do we have these different methods well they all serve different purposes straight line the simplest and it is certainly solves that problem units of production is useful if you notice in years where we drove the car the most we depreciated it the most in years where we drove the car the least we depreciate it the least so there's sort of some intuitive sense right the more you use an asset the more you depreciate it the less you use an asset the less you depreciate it so on that sense it makes a lot of intuitive intuitive sense double declining balance is by far the most aggressive it says look this asset loses value quick in the early years let's depreciate it quick in the early years and look at those first two years compared to the other methods way higher right and then less depreciation in the later year so it's saying almost like resale value this thing loses resale value a lot quicker than the other methods are giving it credit for that's what double declining balance says and so all three serve their own purposes when I was a student just learning this stuff I way preferred units of production I just said Yeah the more you use an asset the more you should depreciate it that was Tony Bell's favorite as a student however as a practicing accountant and most practicing accountants would agree most practicing accountants choose straight line and I I think I can give you a bit of a reason for it um straight line is by far the simplest and let's talk about the flaws of of well we'll start with units of production which was my favorite the first flaw is like lots of assets units production just doesn't make sense for you I'm sitting in a chair right now if I want to depreciate this chair how would I depreciate it on units of production would I say how many times my butt hit the seat and I estimate it'll last 100,000 butt hits of the seat or you know what if I gain a lot of weight you know it just doesn't make any sense and most of the assets I'm looking around my room here most of my assets don't work for this you know cars do but most other assets wouldn't work very well for this so most assets units of production just doesn't work the other reason unit production is less popular is I think of my mom's job my mom was a home care nurse she would drive a a province of British Columbia nursing car and go to like old folks houses and help them with their injections and things like that right help them with their medical care so uh I imagine the accountant for the province of British Columbia let's say they said look cars are make sense for units of production and they have a fleet of a hundred cars around the province right uh and they want to do units of production and so on December 31st they got to get nurses of each of those 100 cars to go out to the odometer and check how far did the car drive this year and each car they got to keep track okay that car drove 13,000 km oh that one drove 15,000 you know and they're all the same fleet of cars they're all the same car that car drove 18,000 and each one gets its own depreciation entry or or the accountant could say hey our cars are all all a year older they all depreciate $4,000 debit you know the depreciation entry takes 5 seconds or it takes hours and hours of coordination and for what benefit right the units of production it's a it's an estimate these are all estimates right these are all estimates the units of production might be a marginally better estimate but even that is debatable and so as I've become a more pragmatic accountant I think no straight Line's probably the way I'd go for just about all of my assets and it's the most commonly used double declining balance is second most common and the reason companies in Canada use double declining balance is because the government for taxes mandates a form of declining balance uh if you look up something called CCA in Canada it is the government regulated depreciation and the reason governments like declining balance methods is because it's harder to manipulate so if I were an une ethical accountant and I'm very very ethical and I wanted my expenses to be higher so my profits would be lower and if my profits are lower of course my taxes are lower I want to cut the government out as much as I can one way to do it would be to make the useful life shorter right rather than five years if I made this four years well guess what I'm dividing by four and uh my depreciation expense gets higher right if you have a shorter life the depreciation expense is higher each year and expenses are higher means profits are lower you're paying the government less the government doesn't like this they go oh we can see like uh companies are going to manipulate their residual value companies are going to manipulate their useful life change those numbers and guess what you change your taxes too and the government hates that so they just say look you bought a new car congratulations take I think it's uh 30% they say they allow 30% as the rate for a car you bought a new piece of equipment take 20% you got a new building take 4% so if we look at our table here you can't manipulate the beginning Book value because that's an actual number that's what you paid for the asset the number of months the government uh well they know the dates and so that doesn't really matter depreciation rate they tell you the rate so you can't manipulate that either and so therefore you can't manipulate your depreciation expense they feel pretty solid about that number so the government requires units uh companies to use a form of double declining balance that's fairly frequently used and it's 100% used when you do your taxes um that said companies by and large use straight line the most and and I do agree with that so again when I was a student I liked units of production the most made a lot of intuitive sense to me as a practicing accountant I don't care for it very much okay there you have it we've completed 82a hopefully you've got the technical understanding and a little bit about background and if you hung in there through all of that explanation if you got to the end of this video boy I hope you liked it all right hope you like the video hope it's been helpful and hope you have a great day that's all for this video stay tuned for our next one let's examine problem 83a this has us selling an asset for the first time so we're not just depreciating it for its life we're going to sell it at some point so here we go Bill's Towing purchased a new tow truck on April 1st 202 for $110,000 cash the company expects to keep the tow truck for 10 years after which time it plans to sell the truck for $10,000 lots of tens uh the company's accountant wishes to use straight line appreciation uh bills Towing has a fiscal year end of December 31st now it doesn't use it for the full life because on October 1st 2025 Bill sells the truck for6 grand so they use it for a year and a half or so and then they sell it for $106,000 it says record all relevant entries for the truck so every journal entry that relates to the truck we're going to need to record and the first journal entry that relates to the truck is buying the truck so we buy the truck let's do that April 1 April Fool's Day 2024 we bought the truck for cash so of course credit cash and we're going to debit truck 110,000 bucks okay that was April 1st next uh the next relevant date is well we sell it in October 2025 but I guess we have a fiscal year end in between so let's depreciate up to our fiscal year end of December 31st 2024 and uh we got to figure out how to depreciate this truck so I have $110,000 truck minus a residual value of 10,000 means the appreciable cost of my truck is $100,000 I'm going to depreciate this truck over 10 years straight line so 100,000 divided by 10 is 10,000 bucks per year so how much do I depreciate this truck well I didn't own it for a year I owned it from April to December that was April May June July August September October November December 9 months so 9 12ths of a year so I take my 10,000 a year I multiply by 9 12ths and I get 7500 in depreciation so debit depreciation expense credit accumulated depreciation truck $77,500 Okay so we've depreciated our truck for up to December 31st now we use the truck for the next year we use it up to October 1st 2025 uh that looks to me to be another nine months doesn't it January February March April May June July August September October is that 10 months I can't even count oh I don't count October that's why it's only n you know what let's let's have yeah let's just do it as it is so on October [Music] 1st 2024 I need to record depreciation you record depreciation up to an including the date of this sale and so from December 31st to October 1st we said it was another 9 months that's I don't love it that it's the exact same amount of time and therefore the same depreciation expense we go $10,000 time 91 12th another 7500 to be depreciated but okay you know I could have done it 81 12s or 612s or whatever uh this just so happens that it's 9 months later so 912 uh debit depreciation expense 7500 credit accumulated depreciation on the truck 7500 there we are so we've done our three entries so far and now we have to sell the truck that's what happens on October 1st so also on October 1st 2024 we sell the truck what happens we sell the truck for $106,000 cash well I'm curious what is this truck worth according to our books what is the book value of the truck the book value of the truck is the truck cost us 110,000 the accumulated depreciation so far the total depreciation it's 7500 and 7500 it's 15,000 in depreciation so far so on our books this truck is worth $95,000 that is the book value as of October 1st right it's $110,000 plus there's or minus rather there's been 15,000 of depreciation so far this is a $95,000 truck now we sell the $95,000 truck for 106 so when you're thinking about this do you think this is a situation where we experience a gain or a loss the answer here is gain right I sold the truck for more than I thought it was worth let's do the journal entry the journal ENT looks like this of course we got cash so debit cash when you get cash and it was $106,000 now we have to get rid of our truck so I credit truck now this is where things get tricky sometimes a student will credit truck for 95 it's the truck minus the depreciation you actually have to get rid of the truck and the depreciation separately so I get rid of the truck that was 110 and I get rid of the ad on the truck the accumulated depreciation on the truck which we said was 15 now looking at this my debits don't equal my credits I got 121,000 of credits I got 110 of debits I'm off by $111,000 credit and that credit is my gain I sold the truck for 106 Grand I thought the truck was worth 95 it's $111,000 different right 106 K versus 95k the difference is I guess I could have put instead of versus uh I guess the difference here is $111,000 well that difference is our gain right we sold it for $9,000 more than we thought it was worth this is a gain on sale of truck and there we have it ladies and gentlemen we have answered the first part we have sold our truck we've done all the journal entries all relevant entries for the life of the truck now Part B says let's look at the same transaction and just the last journal entry assume that instead of $106,000 Bill received $75,000 for the truck re-record the journal entry I'll do is a different color ink let's make this a little better uh so in this last entry October 1st 2024 assume that instead of 106,000 he only got 75,000 so of course we get $75,000 in cash we got to get rid of the truck just as we had done before so get rid of the truck which was on the books for 10 with accumulated depreciation of 15 and now I do the math and it works out the other way I have 990,000 in debits 110 in credits I'm missing a $20,000 debit and again I I I had a truck that I thought was worth 95,000 I got 75,000 for it I'm experiencing a loss and it's I'm $20,000 off so this is a $20,000 loss loss on sale so there we have it we have kind of sold our truck two ways uh I like this kind of question for tests maybe your Prof will too because it makes the student show me they know how to do depreciation entries and they understand how to do a disposal so you kind of get two birds with one stone with this kind of question as a Prof all right that's all for 83a hope it's been useful to you stay tuned for our next video bye for now in 2005 Microsoft released its second video games console the Xbox 360 the console was a major financial success for the company over the life of the product it generated over $0 billion in hardware sales and many times more in software sales the release of the Xbox 360 cemented Microsoft's position as one of the big three players in the console video games industry alongside Nintendo and Sony despite its success the release of the Xbox 360 was not without major problems Xbox 360s broke a lot the console frequently suffered from crashes and Hardware failures due to overheating when the console overheated its power light would flash red to indicate a failure Gamers referred to this as getting the red ring of death a typical failure rate in the consumer electronics Industry is 3 to 5% although Microsoft has never released official numbers analysts estimate that early Xbox 360s failed anywhere between 23 and 54% of the time as a gamer I know about this problem firsthand twice so why are we talking about this in our accounting class well here's why Xbox 360s and almost all major consumer electronics are sold under warranty meaning if an Xbox or a PlayStation or Nintendo or Apple iPhone or Samsung phone breaks within the first year of use the company will repair or replace it free of charge This Promise This warranty represents a major liability but the problem is the company can never know precisely how much it will owe so they need to estimate or estimate the liability the fact that some liabilities are known and some must be estimated represents a major accounting challenge this module is all about liabilities we'll learn a lot about known liabilities like loans and bonds and we'll also learn about estimated liabilities like warranties this is an interesting and a challenging module and I can't wait to get started let's examine problem 93a this is our first problem about a bond and bonds are difficult and Technical to deal with so actually before I jump into the problem I just want to explain what bonds are and kind of how they work and then we'll come back to the bond problem if you feel like no I know what a bond is just skip ahead I'll put the amount of time you need to skip ahead up here uh and for the rest of us let's just discuss what are bonds so a bond and particularly when you're looking at it from the perspective of an intro accounting class a bond is a company borrowing money and it's the company getting a note payable so they get cash and they write a piece of paper saying I promise to pay you back with money uh now this is big Company accounting and so typically and even big governments uh issue bonds as well and City governments issue bonds uh typically what they're doing is they're saying I want to borrow money uh the banks aren't giving me a rate or features that I like so I just want to have investors buy my bonds I want to borrow money from just people and so let's say I want to borrow $10 million it's hard to find somebody outside of a bank to lend $10 million but what I could do is I could find hundreds of people or even thousands of people willing to lend me $1,000 right and just a lot of little notes payable and so what a bond is is just a package of notes payable now what sort of distinguishes a bond they're typically quite longterm in nature and in fact they can be very very long-term in nature and I just want to discuss one Bond and it's going to help us kind of illustrate what we're talking about when we talk about Bond so I just Googled this MIT Century bond is what it's uh called if you Google it you'll get the same story there's a link there to the story it says MIT sells $500 million in taxable Century bonds and uh let's just read this first paragraph earlier today well this was 2016 but earlier today MIT sold $500 million of Series E taxable bonds maturing in 2116 and yielding 3.88 5% so MIT wanted to borrow that's a lot of money $500 million and presumably they looked at all of their options and uh you know maybe went to Banks and Banks don't want to lend and and look at the maturity 2116 so what does that mean MIT is going to borrow $500 million today and they're going to pay it back in 2116 now I don't know about you but I guess just about everybody watching this video is going to be dead in 216 I'm not going to be dead because I'm going to have my brain Frozen in some vat of liquid nitrogen and I I'm going to outlive uh everybody watching this video but most of you guys are going to be dead in 216 so let's think about this proposition MIT says hey we want to borrow $500 million we're going to slice it up into ,000 slices so you invest $1,000 in MIT and in 2116 you get your $1,000 back plus interest well that wouldn't make any sense because of course you're long since Dead uh before you can collect on that money and uh that's a problem so here's why this type of bond exists and here's why people actually buy these bonds they're not actually interested in the money coming back in 216 that's a small part of it what you're interested in is this number and MIT says okay I'm going to pay you let's just round this up 4% interest just for the purpose of our conversation so if you invest let's say you're a retiree and you've got a million bucks okay uh you've got a million dollars ready to retire a million dollar and you say I'm going to buy these MIT bonds so MIT pays 4% that's $40,000 per year uh now this is actually a pretty stable way to have a retirement if MIT exists as a university they will pay you back and so you could say okay I put away a million dollar I'm going to get $40,000 a year for the rest of my life until the day I die and then you know my Offspring my kids are going to have this $40,000 annuity uh every year they'll get $40,000 and in fact bonds don't pay interest every year they pay interest every six months so we divide that by two and we would say $20,000 each six months so the people who like to buy bonds are typically old people right and MIT bonds are attractive because people trust that MIT is going to going to be around to pay them back bonds get rated based on quality now MIT would be the highest rating of bond AAA meaning investors are very confident MIT is going to be able to pay them back uh countries like Canada is AAA rated and various other borrowing entities you know will be rated AA a double a single a triple B Double will be single B I think it even goes down to like C and D but you really don't need to worry when you get down that low this is based on risk so as you go higher your risk gets lower so in other words this is risky this one is safe and it's sort of a spectrum so what an investor would do is they'd look at these MIT bonds and they would say to themselves okay let's just say I want to invest my million that I've got set aside for my retirement and there's a market for these bonds I can buy MIT bonds that pay 4% well let's say at the same time so MIT is super safe let's say at the same time Harvard has a bond that pays 5% same term same everything else Harvard has a bond that pays 5% MIT has a bond that pays 4% well in my view har is just as safe a bet as MIT is now maybe some University expert will tell me why I'm wrong but in my sort of uninformed view I would think Harvard and MIT are basically identical in terms of their risk profile I think they're both super solid institutions that aren't going out of business anytime soon I would feel very comfortable to lend them money that they would pay me back so in this circumstance Harvard can give me 5% MIT gives me 4% if you're an investor there ain't an investor in the world that wouldn't buy the Harvard Bond over the MIT Bond you'd have to be a real MIT Super Fan to invest in MIT if you could get 5% from Harvard and a 5% guaranteed return from Harvard versus a 4% or very lowrisk return from Harvard versus 4% very low risk return from MIT so as a consequence Harvard bonds will issue at a premium what does that mean it means that Harvard bonds will sell for more if I want to lend Harvard $1,000 or have Harvard pay me back $1,000 in 100 years or 20 years or whatever the timeline is I actually have to lend them more than $1,000 so I pay more or lend more than they pay back uh MIT on the other end let's just say the market rate for these types of companies is like 4 and a half% so MIT is below the market rate Harvard is above MIT on the other hand would issue their bonds at a discount in other words you could pay less than $1,000 and lend them less than $1,000 and be paid back $1,000 at the end of the term so this chapter is all about this scenario uh accounting for this accounting for the fact that companies borrow money they borrow these complicated bonds and when they borrow the money they sometimes get more than they asked for for example if our interest rate is high or they sometimes get less than they asked for if their interest rate is low so that's what we're accounting for here and that's what we're dealing with and I think now would be a good time to jump back into the problem if I can find the problem where is the problem there it is geez took me a while uh okay so let's now jump in to problem 93a on February 1st 2024 tinger Inc issues a $100,000 10-year 5% Bond okay so the bond rate the rate we're promising to pay is 5% and again numbers are always annual bonds though pay interest every six months so our rate is 2.5% every 6 months that's 5% divid div by two the market rate of interest is 6% okay so again every 6 months that's 3% semi anually I guess I should say I keep saying every six months but the real word is semiannual the semiannual interest rate here is 6% so immediately eyeballing this I'm offering 5% they can get 6% with other investments in the market guess what nobody's going to pay full price for my bond now when I say 6% for uh other investments in the market I mean ones that are very similar to my company so uh with a similar risk profile to tinger Inc you can expect to get 6% tinger Inc is only offering at 5% tinger Inc is an unattractive uh Bond purchase and as a consequence is going to have to issue at a discount it's going to have to take less than $1,000 if they if they want to get $100,000 well too bad they either have to offer a higher interest rate or take less money and going to take less money here and that's why this is a bond issued at a discount again the uh market rate of interest is higher than our rate nobody's going to want to buy our bond unless we sell it cheaper okay uh because the market rate is higher than the bond rate the bonds issue at a discount the bond quote is 92.5 61 when you see a bond quote like this 92.5 61 just think percentage so we got 92.5 61% of what we asked for so actually let's do the math here we asked for $100,000 we got 92.5 61% of that so we got 92,5 61 okay so we can actually do our first journal entry and why don't we do it we we'll do this table in a minute let's let's solve B journal entry I the journal entry for the issuance of the bond so again we're looking at B journal entry I we issued this Bond on February 1st 2024 we asked for $100,000 we only got $92,000 so let's debit cash 92561 let's credit Bond B payable I'm going to leave room for another debit here [Music] Bond payable and at the end of this after 10 years I've got to pay back $100,000 now the difference here is the discount or the premium and in this case we got less than we asked for we have a discount of 7439 that is the discount on the bond payable okay Okay so we've done the first entry again I owe $100,000 I only got $992,000 today so I'm taking a discount of 7439 a different way to think of the discount is I borrow 92 in 10 years I got to pay back 100 this discount represents almost like extra interest right I have to pay 7439 I have to pay interest every 6 months but I also have to pay 7439 in extra money over the you know at the end of the life of the bond that's extra interest and so we'll we'll deal with that discount as the question goes on okay so that was we did B part ey says the bonds pay interest sem on February 1st I'm just looking here on February 1st and August 1st uh the company's fiscal year into September 30th prepare the bond amortization schedule okay so a discount amortization schedule so there's uh the First Column and you should have this in your accounting workbook um semiannual interest period is just the date and so the the first relevant date is Feb 1 2024 uh then it's just our interest dates so our first interest payment uh August 1st 2024 and you our second interest payment Feb one 2025 we don't put a fiscal year end on here even though that's a relevant date it doesn't go on the chart it's just Bond issuance date interest interest interest okay our interest payment blank percentage maturity value this is R rate divided by two so R rate was 5% ided two it's 2.5% this is actually a lot easier to do in Excel but I'll do it by hand because you might have to do it by hand interest expense uh market rate again divided by two because it's all semiannual on this chart uh so it's 6% divided by two is 3% discount amortization or premium amortization well it's a discount not a premium so I'll just scratch that out discount premium account balance again it's disc account account balance and bond carrying out blank minus D discount blank plus the premium and the blank here you can see it's dollars something missing minus D the blank here is the face value of the bond so in this case the face value of our bond is 100,000 okay we're ready to go so our interest payment blank percent or 2 and a half% of maturity value uh so I take well actually forgive me uh we're doing February 1st on the issuance of the bond so February 1st is the day tinger Inc sort of sells the bonds they say okay give us money we'll give you pieces of paper that say we promise to pay you back $100,000 you know it's $111,000 notes payable to different lenders right different investors um so uh tinger does not make an interest payment on day one they're just Bor bwing the money so nothing happening there there's no interest expense on day one and there's no discount amortization on day one these three cells are always blank they will never be used we do have a discount account balance on day one what's our discount on day one it's 7439 just what we put in the journal entry we do have a bond carrying amount 100,000 minus so it says 100,000 minus D so 100,000 minus 7439 is 92561 okay let's move on to line two interest payment uh 2.5% of maturity value our maturity value is 100,000 that's the amount we got to pay back at the end of the bond so two oops uh let's do it this way 100,000 times 025 $2500 interest expense three % of the preceding Bond carrying amount 3% now the preceding Bond carrying amount is right here 92561 so I take 3% of that number 03 time 92561 2777 we're just going to round to the dollar in this table again on a spreadsheet it would take to the the penny or Beyond 2777 discount amortization B minus a so whatever you have in cell b 2777 minus cell a 2500 2777 minus 2500 is 2 77 uh discount account balance D minus C so 7439 minus 277 again these two numbers 7439 and 277 let's do it 7439 - 277 7162 and last $100,000 minus D 100,000 minus 7162 and I get 92838 okay on to the next one and once you've done this a couple times it does get to be old hat I recognize the first time you do this it's really hard after you've done it like three four times it actually gets boring it gets easy um but it's hard the first few times for sure okay so let's do column A again for for February 1st 2025 interest payment blank percent of maturity value 2 and a half% of maturity value well it's still 2 and a half% our maturity value is always what we pay back at the end it's always 100,000 the face value so 2 and half% of 100,000 is 2500 and if we did this table you know for the full 10 years it would be 2500 every time that's why old people like this investment it is like Steady Eddy right it's the same every period in terms of a payment and companies like it do because they know they have some certainty around their debt it's not like variable rate debt interest expense okay the market rate is 3% and it says interest expense is 3% of the preceding Bond carrying amount so I'm going to take 003 times the preceding Bond carrying amount which this time is 92838 right it's column e the newest one 92838 2785 discount adverti 2785 minus 2 2500 is uh 285 discounted account balance D minus C so 7162 minus 285 716 2 - 285 6877 I don't know why that's still highlighted let me UNH highlight that and last now this placees people scrw up they go 92 minus 6 like 92 minus 6800 no no no it's 100,000 minus 6877 100,000 - 6877 is 931 123 okay there we have it we've completed part one or part A we have completed our effective interest table uh now we've got to do our journal entries and we've done journal entry I we just have a couple more so it says do the journal entry for the first interest payment August 1st 2024 well hopefully this is not a surprise we're going to use data from this line right the line marked August 1st 2024 and by the way what does this refer to it's a six-month period it goes from February March April May June July not August because we're on August 1st it's these six months that are kind of wrapped up in this yellow highlighted line so again this is related um okay so what's our journal entry then uh so it's August 1st 20124 we make a payment so credit cash 2500 that's the interest payment on that line so cash is going out 2500 now I'm going to skip over to interest expense 2777 so interest expense should be a debit no surprise there 27 77 and discount adverti 277 what we're doing is we're making our discount smaller by 277 so it was 7439 debit to make it smaller reduce it by 277 so we'll credit our discount now the idea here is and this is where again we'll hopefully help you to understand bonds uh the idea here is this 7439 this number this discount number remember what's Happening Here we borrowed 92561 we got a payback $100,000 this 7439 difference this is like extra interest right I borrow this amount I got to pay back that amount which is higher that's interest like no doubt about it that's interest but it's interest that happens over 10 years because this is a 10year bond and so what we're saying is a little bit of a at a time we're going to recognize that interest so here we're recognizing so I pay back 2500 in interest that's an interest payment $2,500 and so of course there's $2,500 in interest expense here right like 2500 of this relates to this cash payment the other 277 we're saying oh that extra 7 Grand in money I didn't get at the start of the uh Bond I got to recognize that interest expense over the 10-year life of the bond so I'm going to recognize $277 extra dollars of Interest right now related to that discount and so that's what that's what this table is all about that's what this problem is all about so hopefully that's a little bit helpful if you don't understand the concept behind it at least hopefully the mechanics aren't too bad because mechanically this is it's pretty straightforward okay let's continue on to our next entry so UNH highlight this and I'll actually even take away that comment there our next relevant entry is the company's fiscal year end September 30th 2024 so we're actually going to pull data from this line now this line carries us from August 1st so August September October November December and January not February because it's February 1st and that again is six months now we're interested in up to September 30th so we're interested in the months of August and September we're interested in two months so what we're going to do is take information from that highlighted line and multiply by 2 sixs we're interested in 26 of that data so let's do it we'll start with our interest expense 2785 well it's not 2785 because it's only two months so 2785 * 26 and again that's August 1st to September 30th is two months apart right it's two months later not 20 months two months later so that's why two out of six months on the uh table uh so our interest expense is going to be 2785 just the number from that column times 26s 928 uh our discount amortization 285 again times 26 and it's 95 so we credit our discount because we want to reduce it by 95 and the last thing is cash but I don't pay cash here right is $2,500 in cash but let's take that 2500 * 26 and I get 833 and sure enough this works if you add 833 and 95 you get 928 so the thing balances but since I'm not paying cash this is a payable it's a liability it's it's building up the interest that I owe this is interest that will be paid but right now it's payable so we have unpaid amount that were is building that hasn't been paid that's interest payable okay on to part four and this is on uh February 1st you can see here the second interest payment February 1st uh so we're going to use data from this line but we've kind of already dealt with the first two months now we're going to deal with the four months following because again again from August F or from September 30th to February 1st 2025 is October November December January don't count February because it's February 1st four months later and sure enough it's it's those four months October November December January it's going to be four sixths of things on the line so our interest expands 2785 well times 46 so let's start there 2785 * 4 4 6 * 4 / 6 1857 we're going to credit our discount and the discount again will be the discount amortization times 46 so 285 * 46 190 uh we're going to Credit Now this interest payment do I pay 46 of the interest on February 1st the answer is no I got to pay the full 2500 every six months I pay 2500 so credit cash 2500 here and I got a journal entry that doesn't balance 2500 + 190 2690 in credit minus 1857 in debits I'm missing a debit here of 833 is that number ringing any bells and it should be my interest payable was $833 and guess what I just paid $2,500 in interest I don't have any interest payable I've paid it off so we debit interest payable for the amount of 833 and there we have it we've solved this very difficult problem problem 93a bonds issued at a discount we've prepared our effective interest table and we've done the appropriate journal entries I hope this video was helpful in helping you helpful in helping you better understand bonds it's been about 30 minutes if you made it to the end of the video I hope it's worth a little click on that old Thumbs Up Button thanks uh for your support and uh have a great day everybody bye for now let's examine problem 94a uh we've just been doing a couple of bonds issued at discounts now we're going to look at accounting for bonds issued at premiums if you've understood the discount side the premium side isn't much of a stretch but if you haven't understood the discount side very well well this is your second crack at bonds and maybe the premium side will help bring things into focus on April 30th 2024 Smoky Inc issues a $10 million 10-year 7% Bond so we are giving 7% annual interest 3 and a half% semiannually that's our interest that we're giving to our uh Bond purchases the people loaning US money we're going to pay them back 7% the market rate of interest is 6% so okay similar companies to us are offering 6% in the market our risk profile kind of warrants 6% uh we're offering 7% people are going to really love our bond and they're going to want to pay and in fact overpay for our bond they're going to pay more than face value for our bond our bond is going to issue at a premium because the market rate is lower than the bond rate the bonds issue at a premium the bond quote is 107.4 39 remember what that number is that is the the quote but it's also a percentage 107.4 39% % uh that's how much we're going to charge 107% of what we were asking so we wanted 10 million well guess what we're getting 10.7 million uh we're getting over 700,000 extra dollars because we're paying more in interest over time now we've got enough information to do our first journal entry April 30th 2024 now I'm just Dawning on me as I work on this if you're just coming to this and going I want to start on 94a make sure you watched the video for 93a I really will spend a lot more time there explaining each step this kind of assumes a little bit of background knowledge it assumes you've tried 93a already so if you're just jumping into this don't start here start with 93a and then move over to 94a but anyway let's let's continue uh so on April 30th what happens well again again what is a bond we're borrowing money we're giving a bunch of pieces of paper out saying I owe you this much I owe you that much and there's to uh hundreds of potential lenders all at once uh we're getting cash though and how much money are we getting we're getting more than we asked for we asked for 10 million we're getting 10.7 10743 900 now what am I giving up well I'm giving up pieces of paper saying I promise to pay you back bonds payable 10 million and what's the difference here it's the premium now it's a missing credit of 743 900 they paid 743 900 above asking for these bonds they paid a premium Now what does a premium do well we're paying high interest through the bond we're paying 7% when the market rate was 6% the premium reduces that interest cost because it's almost like interest Revenue you can think of that as an extra 74 like extra cash of 743 th000 that I don't have to pay back at the end of the bond that's almost like an interest premium right it's extra interest it's good interest for me not interest expense uh but having said that to get that extra interest it means I've got to pay it out over the life of the bond Okay so we've done uh record the journal entry for the issuance of the bond uh now we got to do this table prepare a bond amortization schedule for the issuance in the first few uh actually it's only the first two interest periods uh so let's do the issuance of our bond on April 30th 2024 now on the issue date I don't have an interest payment I don't have an interest expense I don't have a discount or a premium to advertise I do have a premium account balance of 743 900 and I do have a bond carrying amount now uh if I had a discount it would be blank minus D because I have a premium it's 10 million plus d so 10 million plus whatever is in d d is 743 900 so it's 10,743 900 I should have uh dealt with these these headings as well a c um let's take a look interest payment blank percent of maturity value well this is what we're promising to pay and our rate is 7% % now again because everything's semiannual here we got to divide that by two we get 3 and 1.2% it's 7% per year 3 and 1.2% every six months and this table is a semiannual table it's an every six-month table so that's why we have that number uh the market rate is what's relevant for our interest expense our market rate was 6% again divide by two that gives us 3% is the percentage we're going to use for this Callum discount adverti well we don't have a discount we have have a premium uh discount account balance no premium account balance and we've done the bond carrying amount okay so that's April 30th 2024 our first interest payment happens 6 months later on October 31st so again May June July August September October yep that's six months what's happening on October 31st 2024 we make an interest payment we pay 35% of our maturity value so 035 time the maturity value which was $1 million we pay $350,000 in interest on this day the interest expense is 3% of the carrying amount 3% 10 743 900 is our carrying amount just colum e there uh we pay three or the interest expense is 3% of that so times 03 322 317 now this time premium amortization is a minus B you might have remember discount amortization was B minus a premium is the opposite a minus B so 350 minus 322 350 minus 322 317 is 27683 premium account balance D minus C 743 900 - 27 6 683 is 716 217 and our bond carrying amount 10 million plus whatever is in column D so 10 716 217 okay so that's October 31st uh the next uh interest payment is April 30th 6 months later so November December January February March April so yeah that's right April 30th 2025 we make a payment now again the interest payment is 3 and a half% of maturity value our maturity value is still 10 million bucks so it's still 350 and unless there's some sort of bond redemption or something going on here we expect this to be the same every six months that's the idea of bonds it's like steady Edy they call them fixed income for the investor they're fixed income for the uh borrower for the company they're like a fixed expense it's the same every six months or a fixed cash outlay I guess I should say um okay the interest expense here 3% of the proceeding Bond carrying amount 003 times the preceding Bond carrying amount which was 10 716 21 oops 2 one7 3 % of that 32148 we're going to Round Here 3 21487 our premium amortization a minus B so 350 minus 3 21 487 28513 uh premium count bounds D minus c 7 1 6 217 minus 28513 687 758 uh and last 10 million plus whatever is in column D 10 68 7 7 five 8 okay there we have it my Pen's on the fritz again so I hope it's uh reasonably legible um Okay so we've done the bond amortization schedule uh now we got to do journal entries we did the issuance of the bond onto the first interest payment for the first interest payment it's just this line This six-month period is covered by our first interest payment between April 30th the issuance and October 31st uh let's see what's happening we make a payment of 350 so credit cash of course 350 credit cash 350 the debit to interest expense is 322 3177 322 37 the uh premium amortization we reduce our premium our premium when we set it up was a credit to reduce it it takes of course a debit debit premium 27683 and there we have it October 31st 2024 our next relevant date is not April 30th as the uh item indicates it's our company's fiscal year end which is December 31st so what do we have October so November December two months right between uh uh October 31st in our fiscal year and well let's think about this this line noted by April 30th represents the time period between October 31st and April 30th it represents let's see October 3 so November let me just minimize this December January February March and April to get us up to April April 30th now we're interested our fisc end happens here we're interested in December 31st so we're interested in these two months out of a total of six we're interested in 2 six of whatever is going on here so for instance we're interested in this interest expense but because it's only two months we're interested in 2 sixs of that interest expense 321 487 * 2 / 6 10716 2 is our interest expense for uh our fiscal year in December 31st that amount again was 10762 our premium amortization just take a debit is uh 28513 again times 26 9504 now our credit would normally be to cash but we're not paying any cash today we pay cash every six months the people that have invested in us the people that have bought our bonds aren't expecting a cash payment today and they're not going to get one but the amount 350 * 26 is very relevant it's the amount of interest that is built up 11 66667 uh I can see I've got a rounding problem here 1 six 66 7 I've rounded and you can see 2+ 4 it's not going to equal exactly but it's no big deal um if I had rounded or not rounded at all this would have worked out perfectly I'm going to leave this as is if you're off by a dollar in my class no big deal your Prof might want you to go to the decimals but that's their prerogative so normally here we would credit cash we're going to credit interest payable and I just want to just show my debits don't quite equal my credits 1071 162 is my debit plus 9504 debit gives me 11 66666 I have 116666 7 and it's just a rounding thing going on okay so that was December 31st 2024 that's going to bring us to our final entry April 30th 2025 what happens on April 30th 2025 well we make our payment right we make a payment so I credit cash how much do I pay I pay the full amount I don't pay 46th or some uh smaller amount I pay 350 on April 30th so credit cash 350 any interest payable needs to go away so I'm going to debit interest payable 11 16667 I also need to get rid of or not get rid of record the interest now how much interest expense has built up well we dealt with the 26 up to December 31st now we're dealing with the period between December and April how many months is that January February March April that's the other 4 six that's the other four months that's these four months January February March April so hopefully to the surprise of no one that's 46 so I just for my uh interest expense it's going to be 46 of that number and uh for my premium amortization 46 of that one so let's do it 321 487 * 4 / 6 uh 214 325 214 325 that's my interest expense 2 4 325 and my premium amortization and that is 28513 * 4/ 6 1 199 now hopefully this adds up let's just see 214 again I think I'm off by a dollar three 325 + 1 199 plus 116 667 3501 and again it's it doesn't uh match because it's off by a buck because of rounding issues no big deal for me if I had made this a six and this one a six it would have worked out perfectly but again it's just because pennies which uh when we're doing this with our computers it's they're knocking around in the same way okay we've done it we have solved problem 94a if you found this video useful and I hope you have you're here at the end uh I do hope you'll consider hitting the old like button all right thanks a lot everybody have a great day and I'll talk to you soon bye for now welcome to module 10 of our financial accounting course this module fairly technical module on shareholders Equity now we're going to touch on a lot of topics common shares dividends things we've touched on before but we'll have a new angle on them but there's going to be a new account introduced this chapter and I want to discuss that account in this video uh so in this video I want to focus in on a new account called preferred shares when I was a kid I had this board game called stock ticker and the way it worked is you rolled Dice and you bought stocks and based on your dice rolls the price of the stock went up and down you sold for more money and you were trying to make more money than your friends and of course I was a kid when when I was a kid I was obsessed with money and one of the features in the game is you could buy common shars or you could buy preferred shars and the game actually didn't treat preferred chairs properly what it did I'm going by my best memory was it had like a multiplier effect so if if your common chairs went up by 10% while your preferred chairs were going up by 20% like this whatever the common chairs did the preferred shars would do more if they fell the preferred shairs would fall by more and so my whole life and in this game you were smart just to go for preferred shares if you could um so my whole life up before I became an accountant I just thought well if I'm looking at Investments preferred Shares are the ones to get because this stock ticker game told me they were and also because of the name right just look at the name let's compare the two names we've got preferred shares on top and common shares below what would you like you know just as a marketing exercise here I would prefer to be a Preferred Guest at a hotel I don't want to be a common guest at a hotel or an airline's preferred customer I would prefer to have preferred shares just the name itself makes you think oh these are the good ones but in reality not NE necessarily so and often not the case most often if you're investing in a company you are buying common shares and common shares give us the right to participate in the uh sort of gains and losses the good and bad parts of uh owning a company but mostly the good you're thinking of The Upside and common shares tend to have way more upside than do preferred shares and these are the Investments when you're investing in a company you should be uh considering most often or you will be considering most often so what on Earth then are preferred shares well preferred shares the the word preferred actually focuses in on really one thing we'll look at a couple of reasons they're preferred or might be preferred but really the main reason they're preferred they're called preferred is because it's it's actually talking about bankruptcy when the company goes bankrupt and they're liquidating and there's a lineup of creditors people the company owed money to uh and they're trying to get their money back out of this company that's you know bankrupt and can't afford to pay its bills uh preferred Shares are ahead of common shares in that line common shares holders get get the money last right once the the Bones have been picked over by the vultures common shareholders get their piece of the pie preferred shareholders will get made whole long before or or right before I should say common shareholders so they have prefer liquidation preference I think would be the word uh if the companies in solvent preferred shares get their money back sooner uh also often not always the case but often and I'll start writing this down preferred shares will have dividend preference and that's going to be the key feature here is features related to Dividends are something our chapter kind of focuses in on so the first thing is I say dividend preference the idea here is I can't pay a dividend to the common shareholders until I first paid a dividend to Preferred shareholders so they have diff uh preference when it comes to dividends and dividends is a good way to get money out of a company and so of course that's that's a nice preference to have right you get dividends first um so that's that's a a key feature uh other features and these are more optional uh I'll say cumulative dividends and this is something that will come up this chapter so like let's say my common shareholders expecting a $1 dividend and I don't pay them it's kind of like well you were expecting it but too bad you know I gave you bad information I'm not paying the dividend we don't have enough cash too bad for you if the preferred sharers have this cumulative aspect if they're expecting a dollar dividend they'll get it and if they don't get it they get a $2 dividend next year and if they don't get that they get a $3 dividend next year it just piles up that's what a cumulative dividend means and that is a a frequently cited feature of preferred shares so that's you know feature number one uh optional feature number two and this is one that won't come up in our chapter it's more for an intermediate uh class convertible we can uh have the option of a preferred chair to convert to a common chair if we feel like the common chair is the better way to go um you hear about this in Silicon Valley it's not really done with preferred shares as much it's convertible notes but they have notes payable that convert into common shares same can be done with preferred shares they can convert into common shares at some agreed upon rate uh the third thing is they can be callable so this is where the company can and redeemable is another word here this is where the company can say hey we want to buy back your preferred share so that's an option that benefits the company not necessarily the preferred shareholder but the company has the option to sort of buy it back they can also be uh what's the word retractable I was going to call it redeemable retractable and that's almost the flip side of the coin that's where the uh preferred shareholder has a right to sell their share just it's enforced liquidity right if if you can't find a buyer for me to sell this share you company have to buy it back that's what a retractable share is and five participating and again um the gist of participating is we can't pay our common shareholders until after we've paid our preferred shareholders dividends but let's say we want to pay our common sharehold let's say we promise our preferred shareholders a dollar a year and we pay them their dollar and our common shareholders we go well we got a lot of profit we're very profitless here we're going to pay you $30 because common shares sort of steer the company they they can opt to pay themselves a bigger dividend well if the preferred sholders are participating it means listen if you're going to pay the common shareholders more guess what you got to pay us more too we are participating in any dividends that they uh get as well so those features are are common ones uh our class is going to focus in on this we're going to focus in on the dividend preference the fact that the Dividends are cumulative uh to Preferred shareholders those are really going to be the features we focusing on but if you take an intermediate or Advanced accounting class you could expect to explore a lot of these other items okay so I can't wait to get to some problems in shareholders equity and uh you'll see preferred shares all over those problems all right that's all for this video stay tuned for the next one let's examine problem 101a this has us preparing uh some journal entries related to sherer's equity as well as a statement of changes in equity so so let's have a look the December 31st 2023 charer Equity section of Bossman inc's balance sheet is shown below so you can see they've got preferred shares now $10 means that's the sort of promised dividend and it's promised annually but you'll notice it's non-cumulative that means if they forget to pay it or they're not not that they' forget but they're unable to pay it or don't pay it in one year it doesn't carry over to the next they don't have to pay 20 the next year is 10 has to be paid in any year before they pay the common shareholders anything that's what that non-cumulative means 500 Shares are issued $50,000 in shareholders Equity so you can do the math and say oh that's $100 each right $50,000 divided by 500 means the shares were issued at $100 each common shares 20,000 issued uh $200,000 in equity so again you can do the math and say that's $10 each is what the common shares were issued for retained earning 750 Grand and you can see there's a million dollar in the following Equity transactions occur during 2024 and there's a big list of them and we're going to have to do journal entry so let's just go through them one at a time let's start with our January 31st entry January 31st it says issued 5,000 common shares for $12 each now you'll notice that's more than we had issued these previously for 20,000 issued $200,000 we're $10 each this is $12 each that the fact that there were less or more in the past doesn't really matter for our journal entry here uh when we issue common shares we expect to receive cash unless it tells us otherwise you can assume we got cash on the deal 5,000 time 12 is $60,000 in cash the credit here well what did we issue we issued common shares our shareholders Equity is increasing so debit cash credit common shares this is very much like a chapter two I believe transaction if you go back to mod two of this course we issued common shares in a lot of those questions okay May 14th it starts to get a little bit more unusual May 14th we issue a 100 preferred shares in exchange for equipment so okay all right it's not common it's preferred and we don't get uh uh cash we get equipment with a fair value of $90,000 so we're going to debit equipment because that's what we got it's an asset going up $90,000 and we credit preferred shares so this is just to kind of illustrate the point that when you issue shares be they common or preferred usually I mean really 90 plus percent of the time it's going to be for cash but it can also be for other assets right and we just say okay well the value of the shares we issued is the same as the value of the asset doesn't matter matter the number of shares again here it's all about the dollar value of the asset being exchanged July first declared the regular cash dividend on preferred shares and this is interesting on July 15th we pay so this is something we haven't dealt with before but we this is more typical of a a dividend transaction we've sort of said declared and paid happens all at once here they declare it on one day so they're promising and legally obligating the M elves to pay a dividend and then a couple weeks later on July 15th they pay it so let's get to it the regular cash dividend on preferred shares well it's $10 per share and we have 500 shares issued but we just issued 100 more so we have 600 shares out there again we have 500 plus the 100 we just issued that's 600 preferred shares outstanding so we pay a $10 dividend on everyone 600 time 10 that's the math here on July the 1st so again it's 600 preferred shares times $10 per share it's $6,000 worth of dividends that are being promised I'm going to debit now there's a many different accounts one might call this I'm going to debit an account called preferred dividends uh commonly we might call it just dividends I I think it's good to distinguish but on financial statements it's likely going to get lumped in with dividends you do see people debit retained earnings here as well uh going back to chapter three dividends get shifted into retained earnings so commonly when Dividends are paid people don't even debit a dividends account because they know it's going to retained earnings anyway they just debit retained earnings I like to keep it separated particularly as we're learning so debit preferred dividends credit preferred dividends payable right we're going to be paying these we haven't paid them yet okay so that was July the 1 July the 15th paid the dividend okay so this is just paying a payable right we sort of said we've declared the dividend it is payable now we're going to pay it credit cash $6,000 debit preferred dividends payable because they're not payable anymore they have been paid okay last one August 7th August 7th declared and issued a 20% stock dividend on common shares at a time when the market price was $13 per share okay so let's deal with our common shares and figure out how many we have now what is a stock dividend it's what it sounds like we're giving a dividend but we're not paying money we're just giving them new shares we're issuing new shares to our share our existing shareholders so I'm just going to highlight a few things we had 20,000 shares outstanding we're adding to it 5,000 more shares so I have 25,000 total shares outstanding and now I'm declaring a 20% stock dividend so I have 25,000 shares times 20% 25,000 time 20% is 5,000 new shares being issued now the market price of those is $5,000 time $13 that's $65,000 worth of new shares in the world so let's issue the shares that's what's happening on August the 7th uh credit common shares and the amount was uh 65 ,000 and our debit here is to stock dividends 65,000 bucks and there we have it we have done all of our journal entries and okay so Part B says prepare a statement of changes in equity so let's do it it's a three-line title and it's for the the following year so it's going to be December 31st 2024 the name of the company is Boss Man Inc so let's get at it so the name of our company Boss Man Inc we are preparing a statement of changes in equity and this is for the the year ended December 31st 2024 so what are we trying to do here we're just going to say what are our Equity accounts and our Equity accounts are preferred shares common shares and retained earnings so we'll list those out we're going to say what did they begin with and how did they change so our beginning balance are January 1st 2024 balances are just going to come from the very start of the question this was our December 31st 2023 that's the same as January 1st 2024 so we'll use those numbers 50,000 200,000 750,000 50,000 200,000 and 750,000 there was a million dollars in total shareholders Equity out there during the year so I always like to try to go from left to right when I can so I'll start with the preferred chairs column I'll say hey were any preferred chairs issued the answer here is yes we had preferred chairs issued uh how many dollars were the preferred shars God issued the answer is where is it right there $90,000 of new preferred shares so let's add that um preferred shares issued it was 990,000 bucks that's the only thing that affected our preferred shareholders Equity now we'll look at common did we issue any common shares and the answer is yes we issued $660,000 worth of common shares on January 31st so let's plug that in uh I guess I can put my totals as well 990,000 was our total preferred shares issued 60,000 was our total common shares issued now we issued more common shares with our stock dividend so I'm going to actually note that as well my stock dividend when I did that I issued 65,000 new common shares into the world $65,000 worth of new common shares into the world world now interestingly we issue common shares but it also hurts our retained earnings because we're paying a dividend when you pay a dividend it reduces your retained earnings so we'll deduct 65,000 there so the net effect here is actually zero and that's the way of stock dividends as well as stock splits there's just a net effect here of zero stock splits is a zero impact thing but a stock dividend it doesn't affect the company sholders Equity at all and seen is a weird kind of liquida move like for example if I have the exact same company I say okay everybody gets a 100 more shares nobody should be any richer for my having done that right the company's no more valuable everybody owns the exact same percentage they just have a few more shares just the the value of an individual share should drop is the the sort of theory here and it's it's pretty true um okay uh what else do I need to do uh did I have any other dividends and yes I had the preferred dividend of $6,000 so let's put that in here preferred dividends 6,000 that hurts my retained earnings did anything else hit retained earnings the answer is well I'm always like beginning retained earnings plus net income minus dividends I haven't plused net income yet and uh I I didn't really read this thoroughly but it says assuming net income for the year was 125 prepare your statement of CH changes in equity uh so assuming net income of 125 we're going to add net income of 125 and at this point folks we're done so we just need totals across the board to get our December 31st 20 24 balances so 50 + 90 140 20 200 + 60 + 65 325 750 - 65 - 6 + 125 is 804 and summing the three across the bottom 140 + 325 + 804 is 1269 double underlines under each of these dollar signs at the top of each not beside the words beside the numbers at the top of each column dollar signs beside the bottom line as well and there we have it we have completed our statement of changes in equity for Bossman Inc we've also done all the relevant journal entries we are done 101a and as I often say if you did make it to the end of the video I would love a like all right hope this helped talk to you soon bye for now welcome to module 11 of our financial accounting course this module is all about the statement of cash flows now you may be wondering like we have all sorts of assets we have all sorts of liabilities we have all sorts of equity accounts why is cash so special you know it's just a balance sheet account why is cash so special that it gets its own financial statement devoted just to it this is just all about cash and there's really a couple of reasons the first is Cash is a really important asset if a company runs out of money they're dead right they can no longer pay their bills they are bankrupt if you can no longer pay your bills if you credit or calls for money and you don't have it you are dead if you can't pay your employees anymore you are not going to be in business for long so it's such an important asset you know if a company runs out of uh inventory big problem uh but they can buy more inventory if they run out of cash they're dead so uh it's this life and death kind of an asset and so investors and Outsiders to a company are of course very interested in cash the other reason that the statement of cash flows is very interesting to investors is so many areas in accounting that we've looked at can be manipulated so my receivables I can set a higher or lower lower allowance for doubtful accounts and therefore I can change my receivables balance and my uh uh bad debt expense I can manipulate that because it's based on an estimate my depreciation is based on an estimate and therefore my the value of my long-term assets is based on an estimate and many of a company's assets are based on estimates not cash cash is thought of and I think is a very solid number when I look at a company's cash balance I can trust it so investors say look that number we can trust so let's look at the transactions sort of flowing around that number and it's a little bit more trustworthy than what we might see on the income statement or even on the balance sheet so that's sort of the reason there's a demand for a statement of cash flow from the producer side from the accountant side I always wondered about this as a beginning student because I said okay well cash flow obviously we're going to start with our beginning cash we're going to say here's how the cash went up and here's how the cash went down and here's what we ended our cash with like that's what I figure and that's what a statement of cash flow is here's what cash we started with here's how it's changed here's what we ended with so okay I thought that was a reasonable idea of a statement of cash flow and I thought well we already have that like we have this thing called the tea account right here's what cash started with here's all the deposits to cash here's all the withdraws from cash and here's the amount of money we had at the end of the year and truthfully this does a pretty good job of what a cash flow statement would do and for most of the companies we've looked at in this course where you know if you go back to chapter two and look at the journal entries where we would do a t account for cash at the end uh this t account for cash would be sufficient for a cash flow statement and the reason I say it would be sufficient is because we have all the information we need you know I could look at this transaction I could say oh I remember when I debited cash for $100 or whatever the number is and you could look back to the transaction and figure out what happened and so you could see the cash flowing in and the cash flowing out but for any normal company not even a big company but for a normal company a cash t account is going to be unwieldy and what I mean by that is like if I go to a food truck here in cam loops right and I consider their cash flow stat so the food truck is not a big business it's a small business uh but a food truck in camoo might see a 100 customers per day I think a 100 Trans actions most of them involving cash is a reasonable number for a cam loops based food truck to do so if I think 100 transactions if I'm looking at my t account I have to do a 100 lines so again if I do cash well this is one two 3 four five well I'd have to extend this let me zoom out here oops I don't know what that's doing there zoom out a bit and it would have to go and uh I think it would have to keep on going and keep keep on going and keep on going and that would be like maybe that would get us you know to why and that is one day of transactions that is one day worth of transactions for like a food truck in cuks Walmart Camas would be 10 times longer than that uh or a big business in in this small City would be 10 times longer than that and so you can quickly see okay a cash t account isn't going to do the job because it would be 30 pages long uh and it would just be like hard to even parse and so what we've said is or what sensible standard Setters have said is okay we have to summarize this these transactions that are in this big long t account into something a little bit more reasonable something that investors can sink their teeth into and they came up with a standard or semi-standard format for a cash flow statement they said look we want you to break your transactions down into three categories we want you to consider transactions to be either operating investing or financing and all of your cash flows we want you to classify as either being operating investing or financing here's the gist of each operating is all about the day-to-day business of the company so how is the company generating funds in its day-to-day business business so you know Walmart when they sell you stuff you know their their cash inflow from making a sale to a customer is an operating cash flow paying their employees to do work that's an operating cash flow paying for operating expenses like the utilities operating cash flow these are the daytoday business inflows and outflows of cash are operating activities uh these are kind of summarized by activities that build to give us net income so typical revenues and expenses and I'll say operating revenues and expenses uh it's not everything that gives us net income belongs here but most items that build to give us net income as well as changes to our current assets and current liabilities so those are the big three areas we're worried about with our operating and again there are exceptions but that's the gist of it so when a company buys more inventory uh this would be an operating cash flow when they pay off their uh accounts payable it's an operating cash flow so current assets and current liabilities there investing activities are all about the company buying and selling long-term assets so when I think investing I think about long-term assets so if I'm thinking of Walmart um they buy uh like the the cam loops Walmart location recently changed and they sell groceries now and they didn't use to sell groceries like you know milk you can buy milk and cheese at our Walmart you didn't used to be able to do that and they install these big refrigerators well Walmart isn't selling those Refrigeration units where they sell their meats and cheeses they're not selling them to customers that is a long-term asset they're buying for themselves that's not their inventory that's like uh an improvement to the store and that is a purchase of a long-term asset and that would be an investing activity when they buy the store itself that's an investing activity um so buying and selling long-term assets like shelves and uh refrigerator and other things like this are long-term uh assets of Walmart they are investing activities uh we could also have Investments here like when Facebook bought Instagram uh they spent a billion dollars cash I think it might have been to stock but let's say it's cash for our conversation well that would be an investing activity on the cash flow statement and again that's a long-term asset financing activities this is where is the company's long-term funding coming from think of long-term liabilities here borrowing money from the bank or shareholders Equity are we getting money from our shareholders and so under Equity we would also account for dividends right if a company pays a cash dividend that falls under Equity so that falls in the financing section so the majority of our interest here is actually in the operating section and because that's where the company's day-to-day business we want to know how company's day-to-day business is doing uh but also we can see where the the long-term funding is coming from the financing section and how they're using that long-term funding the investing section now making your life a little trickier is the fact that the operating section can be done two ways I don't know if that's a good color we can do it uh either the direct method or the indirect method and in my class we're going to learn to do both so when you go through problems with me you're going to learn how to do both methods both are accepted under uh Canadian Gap rules and I think pretty much around the world the the both methods are acceptable um the direct method is preferred by standard Setters but most companies choose the indirect method and we'll discuss that in uh as we work through one of the problems but just know we're going to learn how to prepare the cash flow statement uh operating investing and financing section and when we do the operating section we're going to do it both ways no company would ever do it actually both ways they would just choose one or the other we're going to do both for every problem we look at and with that out of the way I think we should jump in and do some problems now so in our next video we'll look at an EXA example of a cash flow statement that's all for this video I can't wait to get started bye for now before I jump into the problem uh we in this chapter are going to use a template Throughout the chapter you can find it on accounting workbook.com just go under Financial Accounting videos chapter 11 and link to cash flow template so you'll see I'm using a template throughout the problem you can just download it there it's an Excel template and uh anyway there we go uh let's jump in now to problem 111a uh the financial statements of bait and tackle are presented below and there's a balance sheet and an income statement and as a professional accountant I often found myself in this situation right I would have done the other financial statements the income statement the balance sheet the statement of changes in equity or the statement of retained earnings as it's sometimes called and I'd be moving on to the uh cash flow statement but I would have those statements in hand and this is a very typical position to be in as I read through the statement cash accounts receivable inventory equipment ad accumulated appreciation normally we would just say equipment net and we would have subtracted that but that's not how this statement is disclosed okay fine no no issues there it's I'm familiar with that accounts payable we haven't seen this before income tax is payable but you can very well imagine what that is company owes the government right it's just like an account payable to the government bank loan payable common shares retainer okay so nothing new there looking at the income statement sales cogs gross profit uh so sales minus cogs is gross profit deduct the operating expenses to get operating normally we'd see like a list of operating expenses you know salaries or uh uh depreciation or some other expenses coming there but here it's just like the one liner interest expense income before taxes income so so nothing new here right like nothing new on the income statement okay reading down it says operating expenses are composed of depreciation salaries loss on sale of equipment other operating expenses okay other operating expenses are cash my Spidey Sense is kind of tingling there whenever I see the word cash equipment was purchased in the year for $135,000 cash all right so again we're uh working on a statement of cash flows when I see the word cash your spidey sense should tingle a little bit uh equipment was sold again for cash there's that word the original cost was 60 and the accumul depreciation 45 and dividends were declared and paid during the year okay do a cash flow statement using the direct or indirect method or both well in these videos we're going to do both in this video we're going to walk through the direct method for the operating section in the next video we'll do the indirect method for the operating section and in the third video we'll do the investing and financing which is the same whether we go direct or indirect as promised we're going to use this template where is that template I must have there it is I knew I left it somewhere around here and um I'm just going to fill it in by hand but you know I do have the Excel version of the spreadsheet kind of Handy for us uh so let's get going to fill in the template and to start I want to give a title and the title is the name of the company bait actually I want to have a smaller font than this let's try that again bait that's better and Tackle uh we're doing a statement of cash flows for the year ended December 31st uh 2024 now honing in here we're going to focus in just on this section just the direct method and the direct method and the indirect method let's just do a kind of side by side here they're quite different aren't they the indirect method is longer Believe It or Not students I think when you give them a template would rather do indirect than direct if you made them choose even though the direct method appears to be shorter I think the direct method gives way better information to a user so the direct method says you know we're looking at operating cash flows and saying here's where our money came from as it relates to the day-to-day business so we collected money from customers we bought merchandise we paid our expenses we paid salaries we paid for interest we paid taxes uh that's where our money went to right here's where it came came from and these are all where it uh disappeared from uh so pretty straightforward right just I could explain that to somebody on the right side it's it says okay net income kind of represents cash flow but then there are things included in net income that don't involve cash like depreciation doesn't involve cash so we have to reverse it out if I have a gain or loss on sale maybe it does involve cash selling the asset but uh that doesn't belong in this section this is operating activities are selling long-term assets that happens in the investing section that is an investing activity so that doesn't belong here so we're reversing some things out then we're saying how did a change in a current asset or current liability affect our cash and again it's almost I don't want to say backwards thinking but it's like indirect thinking I think the word is quite right so I prefer the direct method for the information it gives but companies by and large have chosen the indirect method I I do prefer the direct method though uh in any event let's get down to business and let's prepare the direct method uh for this company so the first line cash collections from customers we got to think what is involved in collecting money from my customers what accounts are involved in collecting money from my customers and there's really two accounts that'll be typically in involved here sales because obviously if I sell to them I'm going to collect more money if I sell more I collect more typically uh and accounts receivable that's also involved in collecting money from my customers and so with the direct method we do these little formulas so cash collected from customers equals actually come back out here Sales Plus decrease in AR and let me explain what's happening here uh it should make sense that the more I sell the more I collect from my customers so sales is a contributor why decrease in AR well what happens when AR goes down why would accounts receivable fall really one big reason there's a couple but the main reason AR would fall is because I collected my money so I don't have the AR anymore right so cash Collections and customers is Sales Plus if AR is going down it means I'm getting the money if AR is going up it means I'm not collecting the sale and it's bad for cash flow so we would subtract it and I'll put this minus increase in AR now I won't always say this if I say Sales Plus decrease in AR it's implied minus increase in in AR right Sales Plus decrease in AR if it's an increase though we subtract it so let's see what's happened here our sales were 635,000 I'll just put K here uh accounts receivable it didn't decrease it increased by 14,000 what does that mean it means I didn't collect all my sales so I have to subtract this this is bad for cash flow accounts reable going up bad for cash flow you want accounts reable to go down it means you're collecting more of your money accounts reable going up is bad for cash flow it went up by 14,50 to 64 it's 14,000 so I'm going to subtract 14,000 635 minus 14 is 621,000 that's my cash collected from customers let's fill this in on our table cash collected from customers $621,000 okay next cash paid for merchandise cash paid for merchandise just clean this highlighting up involves a few accounts the first one that pops into my head immediately is inventory inventory is merchandise right so obviously if I have more merchandise paid more for my merchandise uh cash paid for merchandise also often will involve accounts payable and the income statement account that is involved here is cost cost of goods sold cuz that's the merchandise that I sold if I have higher cogs I must have bought more merchandise to have available for sale so cost of good sold accounts payable and inventory are three accounts involved here's our formula cash paid for merchandise is cost of goods sold plus increase in inventory now why plus increase in inventory well if inventory goes up it means I've spent more money on merchandise right if I have more inventory I've spent more on merchandise it's bad for your cash flow another way of thinking of it if you if your inventories are going up it means you have more money tied up in inventory so it's bad for cash flow right it's more cash paid more cash out uh plus decrease in a p now again minus decrease in inventory minus increase in AP now let's talk about the decrease in AP one why is that uh more cash paid well if AP is going down why does accounts pay will go down because I paid more right if AP goes up it means I'm keeping the money in my pocket I'm not paying my liabilities if AP goes down it's because I'm paying my debts and it's bad for cash flow to pay your debts it's more cash paid so let's do the math here cogs 320 plus increase in inventory what did inventory do it went from 88 to 58 it went down by $30,000 the fact that inventory went down we'll subtract it here it means we have less money tied up in our inventory it means we bought less inventory this is good for cash flow so my - 30k and uh plus decrease in AP let's see what did AP do AP did go down that means we're paying our bills we paid $8,000 there's an $8,000 difference there so we add $8,000 because again if AP goes down that's more money out of our pocket that is more cash paid so 320 minus 30 plus 8 292 I think 320 - 30 is 290 Plus 8 yeah 298 oh I'm glad I C I'm glad I double checked that 298 makes more sense yes okay let's fill it in cash paid for merchandise is 298 now because this is a cash outflow put it in Brackets right it's cash paid and all these ones that say paid all these ones are going to be negatives because it negatively impacts our cash balance cash paid for operating expenses let's have a look here it notes that operating expenses are composed of depreciation salaries loss onale equipment and other operating expenses I actually I know the question because I wrote it I I want to jump ahead and I want to do uh salaries first just because I saw it in that list and uh let's do salaries first our salaries were $50,000 that was our salaries expense operating expenses are up here 135 and salaries expense of 50 is a part of that operating expenses here's the formula cash paid for salaries is salaries expense plus decrease in salaries payable or wages payable here so our company's salaries expense was 50 our decrease in salaries payable let's see under liabilities I'm looking for salaries payable we didn't have any salaries payable so because we didn't have any salaries payable it's it was Zero last year zero this year it's zero it didn't increase or decrease so it's just 50,000 I only included that because in a question you're doing or in future questions in this workbook you'll see that there is salaries payable there are salaries payable but in this question there just weren't so we didn't have to deal with it and our salaries expense just is our cash paid for salar so let's plug that in $50,000 and of course it is a negative amount to your cash flow cash paid for operating expenses now we'll go back up to it so you can see our operating expenses were 135 we've already dealt with salary so I'm not going to include that here depreciation is called a non-cash expense why is it a non-cash expense it never involves cash think of the journal entry for depreciation it's always the same debit depreciation expense credit accumulated depreciation never credit cash so we're not going to include that because I didn't pay cash for my depreciation and loss on sale of equipment is the uh next one on the list well L on sale equipment 9,000 yes when I sell equipment there is Cash flowing but this is not an operating transaction this is an investing transaction so I'm not going to include it here because this is cash flow uh from operating activities so this 9,000 doesn't belong that leaves us with 64,000 in other operating expenses and the next bullet says other operating expenses are cash expenses so let's pull in that $64,000 as a cash paid for operating expenses 64,000 cash paid for interest I'm looking specifically for interest expense or interest payable I do see interest expense right here $1,000 I do not see any interest payable up above the math would be very similar for CA as cash paid for salaries cash paid for interest it would be [Music] interest expense plus decrease in interest payable and in this case we had an interest expense it was a th000 bucks just there at the bottom of the income statement our interest payable we didn't have so much like the cash paid for salaries we can assume it was a th000 bucks cash paid for income taxes did we have income taxes the answer is yes I can see my income tax expense right here on the income statement I can also see income taxes payable so these are the two accounts involved formula very similar to the previous two cash paid for income taxes it's income tax expense plus decrease in income tax payable I can see that's going to be behind my big head uh income tax expense is 43 Grand income tax is payable went from 11 to 10 now again a payable going down means you're spending more money on the thing right so it's it's cash outflow here so we're going to add that to our already 43,000 Cash Out flow 43 plus one it did decrease by one gives us 44,000 I'm going to do a proof of this uh kind of at the end of this video just because sometimes students are it helps sometimes so 43+ 1 is 44 let's pull that in cash paid for income taxes is 44,000 uh now we got a list of numbers to add up 621 - 298 - 64 - 50 -1 - 44 I get 164,000 dollars and this was positive right it was a positive number this is an inflow from operating activities it's not an outflow okay we're basically to the end here but I I do want to just sometimes students if you're feeling a little shaky having gone through all these calculations uh sometimes students need a proof or a proof helps for them to understand and an easy proof for me to do is on this one so again if you're feeling okay about this and you just want to move on to the next video go for it um uh but if you're feeling like I like a little bit more explanation or maybe that'll be helpful to me I want to prove this number or just kind of tell you the story of this number and that kind of explains why 44,000 is the correct answer here so let's look at our income tax the story of income tax payable okay so the story of income tax payable for this company the inome tax payable started the year at $111,000 credit right that's the beginning that's 2023 is December 31st well that's the beginning of 2024 so let's sort of start there it starts at $1,000 and of course that's a credit balance account because it's a liability and we can see it ends at $10,000 now let's think about what happened with income taxes payable almost for sure the company just paid its taxes right it $111,000 last year it would have paid $1,000 and so that bill would have just gone away so I'm putting it in green because that represents a cash outow debit income tax payable credit cash right ignoring this 10,000 at the end of the now during the year of course it did business and it acred $43,000 in total income tax expense debit income tax expense Credit Income Tax payable so during the year $43,000 in income taxes became payable now we know they didn't pay all 43,000 how do I know that they ended up with $10,000 left in their payable so how much did they pay an income tax well the answer is well they owed 43 they have 10 still owing they must have paid $33,000 of their income taxes uh to end at $10,000 so what happened this year they had an $111,000 bill they paid it they had a $43,000 worth of Bill that probably accured quarterly throughout the year they paid 33 out of the 43 leaving the mowing tan how much did they pay in total what was their cash flow related to income taxes in total it was 44,000 in income taxes that they paid off and so that formula it reflects what likely really happened for this company right that formula that showed us $44,000 was cash paid for income tax I hope my telling of the story kind of helped you to understand that concept okay uh we're going to leave it here we have completed the operating section the direct method in our next video we'll go a lot quicker and we'll do the indirect method stay tuned bye for now okay we've completed the direct method for bait and tackle now it's time to move on and do the indirect method again these are both for the operating section and as I mentioned in the sort of preview video here companies won't do both they'll just choose the direct or they'll choose the indirect they won't do both we're going to do both because both are allowed under accounting rules um and it's just good to know how to do both the indirect method I think is simpler and more straightforward I do think the direct method does provide better information but let's go with the indirect method we start with net income let me erase my highlighting here maybe even eras my cross outs uh the indirect method starts again with net income of 136 so let's put that in there and the reason we start with net income here is we say look net income kind of represents operating cash flow if you think of it like okay it's money coming in net income kind of represents that of course there's a lot of non-cash items involved in calculating net income and that's what our next little bit gets at adjustments to reconcile net income to net operating cash uh we have depreciation expense and what we're saying here is everything in this little gray box go backwards so expenses you would think oh I deduct expenses no we're going to add it back in it was deducted depreciation expense of 12,000 was already deducted to arrive at this 136 net income number but what we're saying here is we got to put it back in because it didn't involve any cash we've already deducted it to get to 136 we got to put it back in because it was a non-cash expense so we're going to add back $112,000 and gain loss on sale of assets if I have a gain it's a minus if I have a loss I add it back you do everything the opposite you do everything backwards in here so a gain is a minus a loss is a plus now why am I putting this back in well yes there are cash flows related to selling assets but they don't belong in the operating section they belong in the investing section so put them back in here yes they are part of net income we want to remove that effect from net income so we had a loss on sale of equipment of $9,000 a loss you think it's a minus no no no we're working backwards it is a plus here okay then we just look at our current assets and current liabilities and uh see how they changed and see how that change would affect cash change in taxes payable taxes payable went from 11 to 10 it went down by a th000 if taxes payable goes down think of it as a liability going down you are paying off your taxes payable right that is bad for cash flow a payable going way up means you're keeping the money in your pocket you're not paying the bills that's good for cash flow it might be bad for your other ratios but it's good for your cash not to pay your bills we're paying our bills maybe it's good for our other ratios but it's bad for our cash so it hurts your cash by ,000 change in wages salaries payable we didn't have wages salaries payable I'm looking in my liabilities don't see it anywhere change in accounts receivable we do have accounts receivable they went from 50 to 64 uh this is again a current asset growing it might be good for our ratios it's bad for our cash it means we're not collecting from our customers accounts receivable we want to see go down that means we're getting the money accounts receivable going up bad for cash flow minus 14,000 to our cash flow changeing inventory inventory went down this is great for cash flow when your inventory goes down means you're keeping the money in your pocket this is good for your cash flow $30,000 inventory going up means you're buying more inventory it hurts your cash inventory going down means you have less money tied up in inventory this is good for cash $30,000 prepaid insurance we did not have office supplies we didn't have accounts payable we had accounts payable went from 40 to 32 what does that mean it means you're paying your bills paying your bills is bad for cash right your bills went down guess what so two did your cash by 8,000 office suppies we didn't have accounts payable we oops I'm looking at the wrong thing here I wrote it on the wrong line we were there $88,000 to the bad interest payable we didn't have other we didn't have I think we're done here okay so now we just have to add it up 136 + 12 + 9 -1 -4 + 30 - 8 gives us 164,000 as a net inflow inflow from operating activities now I have fantastic news and these have to match our direct method we said the inflow was 164 our indirect method the info is 164 these do indeed match now as mentioned no real company does both but the fact that we do both is a nice Advantage it gives us something to double check and to see if we did something wrong but that that makes me confident that uh we are on the right track here um okay so we have completed the indirect method now I want to show you a little trick that might come in handy just as you're doing this for yourself here's a little rule of thumb maybe a cheat sheet would be a better way of saying this for the indirect method if we have an asset that goes up cash will go down if we have a liability that goes up cash will go up and if we have sherer's Equity that goes up cash goes up so you don't need to really think your way through it you can just sort of memorize that rule rule of thumb and you'll get your way through the bottom part of this the from you know here down uh that rule of thumb is going to hold so hopefully that's a useful rule of thumb for you and hopefully this video helped in preparing the indirect method in our next video we're going to do the investing and financing sections stay tuned for that bye for now okay we are cruising through problem 111a uh we've done the operating section we've done it two ways the direct method and the indirect method time to move on to investing and financing and we'll wrap this thing up in this video uh so the investing section is all about long-term assets did we buy or sell any long-term assets or Investments here and the answer is yes we had we didn't have any Investments but we did have equipment and it looks like we bought and sold equipment and down here I can see equipment was purchased for 135 cash well all right that's cash flow from purchasing equipment let's fill that in cash paid for equipment 135 they've kind of given it to us very directly here yes it's 135 I put it in Brackets because of course that is a negative cash flow right you're paying money out to buy equipment cash received on the sale of equipment equipment sold for cash during the year this is the next bullet point down uh the original cost was 60 and the accumulated depreciation was 45 okay so we sold equipment it doesn't say how much we got for it it says we had this equipment uh that cost us 60 the ad the accumulated depreciation was 45 so let's figure out what we thought the equipment was worth the equipment had a net Book value of $115,000 when we sold it did I get $15,000 for my equipment the answer is no how do I know I didn't get $15,000 well because we had a loss on sale of equipment of nine so if I sold equipment that I thought it was worth $15,000 and I lost $9,000 on the sale it means I got less $9,000 less than I thought it was worth I thought it was worth 15 I lost nine means I must have gotten just $6,000 when I sold the equipment so again the equipment net minus the loss or plus the gain in this case we'll go minus the loss equals I don't know cash received on sale cash received on the sale of equipment of 6,000 so we got $6,000 for selling our equipment now we did not have Investments right I would be looking under long-term assets you know below the inventory maybe above the equipment or in that ballpark I didn't have any uh so no cash paid no cash received on sale 135 Nega plus 6 gives us a negative $129,000 this is a cash outflow from investing activities onto financing onto our long-term debt section uh and Equity related section so here I'm looking at my sort of bottom half of my balance sheet here from the bank loan payable down these are the areas that are kind of interesting for me so the first question is did I issue any new debt do I have any new long-term debt the answer is yeah I have $20,000 in a bank loan that I didn't have before in the absence of other information we have to assume we borrowed cash from the bank I think that's a pretty safe assumption so yeah we had cash received on the issuance of new debt $20,000 we didn't repay any debt now in some theoretical World maybe I borrowed 25,000 I I paid back five netting me 20,000 of net borrowing here and maybe I should have had like -5k up here and plus 25k down there but we don't know we're just not told that so I think it's fair to assume that we just borrowed 20 grand now what about the issuance of shares did our shares change yes our shares went from 50 to 60 it means $10,000 of new shares and again in the absence of other information we have to just assume we issued new shares it's not like theoretically we could have redeemed 80,000 and issued Ed 90,000 for an overall $10,000 increase in shares but that's unlikely uh likely we redeemed zero shares and we issued 10,000 the last one cash paid for dividends uh let's see did we have any dividends payable no I don't see any dividends anywhere H but I do see this final line dividends were declared and paid during the year so we got a bit of work to do what I'd like you to do is think about how retained earnings works and I know it's kind of a pain to kind of flash back to oops I've got all sorts of writing here here's how retained earnings works we have retained earnings beginning plus net income I'm actually going to have a subtotal minus dividends equals retained earnings ending uh so for any year retained earnings at the beginning of the year you add net income you deduct dividends you get to your end ofe retained earnings there can be some other adjustments but in intro accounting class this is what you're looking at uh so let's figure out our dividends then we know our company's retained earnings beginning because we know our retained earnings ending last year is right here it was 186 and our our retained earnings ending this year is 272 so 186 is our retained earnings beginning we're going to add net income how much is our net income bottom of the income statement it's 136 186 + 136 is 322 now we don't know the amount of our dividend but what is the amount of our ending retained earnings our ending retained earnings is 272 so we got to figure out okay how did I go from 32 2 to 272 I must have had dividend how big is my dividend well it's the difference right 322 minus 272 our dividend is $50,000 this company had $50,000 in dividends now there is a formula for cash paid for dividends here's the formula it's dividends declared which in this case is $50,000 Plus decrease in dividends payable now in our company I don't think we had any dividends payable did we no we did not I would look under liability somewhere but I I'm not seeing it so in our case there was no dividend payable so it's $50,000 plus Z it's $50,000 is our cash paid for dividends let's fill that in come on there we are cash paid for dividends 50,000 this is a negative cash flow we're paying money out for a dividend so 20 plus 10 is 30 minus 50 is negative 20,000 and this is a cash outflow from financing activities okay now we're basically done here uh we've just got to add things up operating investing and financing are our three sections let's add them together 164 was our operating negative 129 was our investing -20 was our financing overall our cash should change by $15,000 and it's a positive 164 minus 129 - 20 is positive 15 this could be negative very easily uh this is a net increase in cash so my question is am I right did cash increase by $15,000 and is there a way to figure this out the answer is yeah look at the balance sheet did Cash go up by 15,000 let's take a look our cash started the year at 24,000 it ended the year at 39 the difference is plus 15,000 yes we did go up by 15,000 we did get this right now it's not 100% chance we got the question right you know if you're props marking your exam they might find some format errors or you might have made two mistakes that kind of counteracted each other but this is a very good sign and a very nice moment in an accounting class when you get to the end you go oh it worked you know you can pretty much say oh it worked so anyway cash balance beginning of the year was 24 cash balance end of the year was 39 and you can just eyeball that and say yes that is 15 ,000 apart yes that worked and at this point we've completed our statement of cash flows for bait and tackle the only other analysis I would do here is if I were looking at this just eyeballing It generally when you're sort of you know an investor you're interested in a cash flow statement here are the things you're looking at here what I'm looking at anyway I'm not a super expert analyst but this is what I'd look for operating cash flows to be a large number and growing you generally want the day-to-day business to produce positive cash flows right otherwise the company is burning money uh and unless you're a VC in Silicon Valley you don't like to see this you want to see positive and growing operating cash flows generally speaking investing interestingly you're generally hoping for negative numbers and expecting to see negative numbers here you know when um uh a company is is growing and just doing good business they're buying equipment they're buying assets right they're spending money to purchase equipment so you generally expect to see this to be a negative number financing might be positive might be negative depends on what they're boring what they're doing I'm generally if I'm an investor looking to see what they're doing in terms of dividend payments um but uh financing it's not a specific rule of thumb but operating I think it's fair to say you want to see positive and growing investing you're gen really expecting to see be negative unless there's something weird happening that year you know Facebook ever was forced to sell Instagram they would have a big positive cash flow from investing that year because it would be worth billions and billions of dollars uh but in a normal year I think Facebook's uh investing section will be quite negative uh and then financing depends if they're borrowing or repaying debt really uh what phase of the business they're in uh but I'm not expecting to see either positive or negative it's going to just be very com dependent okay we've completed the statement of cash flows for bait and tackle statement of cash flow is not an easy topic but I think we're on the right step if you're feeling like this helped you please don't be shy about hitting that like button all right that's all for this video stay tuned for the next one bye for now welcome to the 12th and I think final module of our course in financial accounting this is I think one of the most interesting of all the modules and lots of people that have to take accounting classes don't go on to become accountants right you're doing a general business degree and somebody said oh you better take an accounting class as sort of a breadth requirement or I think a necessary requirement just to help you understand the numbers of a business um and so many people will not go on and do debit or a credit professionally but most people that end up in business end up needing to read financial statements and so that's the scale that this chapter is going to help you develop uh I don't expect anybody to leave this chapter being a super expert on financial statement analysis leave that for the corporate finance crowd but I do think at the end of this you should have a clue when you get a financial statement in your head you should know what types of things to look for and some basic ratios to calculate I go to annual General meetings all the time and when the accountant gets up to read or give a report on the financials most or at least half of the audience zones out completely this is where this chapter gives you a superpower and an advantage in business so uh with that said I just can't wait to get going we're going to learn a lot this chapter about analyzing and understanding financial statements stay tuned let's examine problem 121a this has us doing a horizontal analysis now just wherever you are in your seat right now give me like a hand gesture for horizontal okay have you done it just with your hands show me what horizontal looks like horizontal looks like this doesn't it not like this not like up and down horizontal looks like kind of like that well horizontal analysis has us analyzing financial statements like this what does it mean well if we look at this elky company and look at its financial statements horizontal means we're comparing one year to the next right we're comparing two years to each other we're not looking up and down the statement to compare oh what's our sales versus our cost of good so no no no we're comparing 2023 sales to 2024 sales this is so fundamental right when I analyze a company this is one of the first things I do just I eyeball it and I look for big numbers that had big changes so I'll look and I'll say oh you know what were our year-over-year sales oh our sales grew right you can just eyeball this and you can say oh horizontally my sales Grew From 151 to 168 they grew by $177,000 already I'm saying something intelligent I can say oh our sales were up $177,000 how much were they up the year before you know they were up 50,000 the year before Oh only 17 this year that's not great you already know something about the company very quickly right big numbers with big changes tell you a story about a company so that's what a horizontal analysis sets out to do and this is the most basic horizontal analysis I put a triangle there I'll put it in Black Ink triangle means change and so our year-over-year change here is all we want to do so 151 to 168 means it's a change of plus $177,000 right our sales are up $177,000 our cost of goods sold up 12,000 our gross profit up 5,000 our operating expenses are up two our operating income up three our interest expense down a th000 our income before tax up 4,000 our income taxes are up a th000 and our net income is up 3,000 so already we've kind of learned something right we've learned okay most things are up interest expenses down that might be related that is related to long-term debt more than any financial performance so the change is relevant but what's even more useful and you'll see this stated very commonly is the percentage change year-over-year so to compute a percentage change you just take that change number and divide by the earlier year so for example for my sales the change was 17,000 I'm going to divide by the sales of the earlier year 151 and I'm going to say hey my sales are up 11.2 actually 11.3 I'm rounding the wrong way here 11.3% my cost of good sold 12,000 ID 78 15.4% my gross profit 5 ID 73 my gross profit is up 6. 8% my operating expenses up 6.7% my operating income 6.97% 7.0% I guess that rounds to uh my interest expense one uh divided by three it's down 33% 33 and A3 uh 4 divided 40 I can already tell you that that's up 10.0% I didn't put pluses here but these are all up up up up up uh income taxes are also up 10% and our profits up 10% okay so again we can say something intelligent our sales are up 11% that compares to last year's sales which were increased by 20% you know you can compare uh uh things by percentages and again it's it's useful like saying you know if I told you my company sales are up $177,000 it doesn't mean much because you don't know the size of the company if I say oh my company's sales are up 10% or 11.3% you get a better feel and you don't look at it in a vacuum I would say okay I'm looking at Home Depot or Lowe's you know this is very similar companies Home Depot sales were up 15% low sales were up by 9% well Home Depot outperform lows right where you know maybe Amazon sales were up 30% and they're just not comparable I would want to compare to similar competitors um okay which items would I call out if I were if I were analyzing this company if I were the operator here I would actually be most concerned with this one that would be the number I'd be calling out I'd say look sales are up 11% but cogs are up 15 we should have been way more profitable we generated uh 11% more sales uh but only 7% more gross profit and the reason was our costs were up why were our cost of good sold up did we have to reduce our prices and therefore our margins got squeezed uh was there uh were our costs just up generally maybe we should raise the prices what's going on that cogs was up at just a higher rate than everything else so that would be the number uh that I might investigate you might think well I should investigate the interest expense this wouldn't take much investigation I think you would look at the debt and you can see the terms of the debt were likely better or you just had less debt being serviced but the the alarming number from an investor standpoint or the number that you'd be worried about is that one cogs being up uh at a higher rate than our sales we would expect you know you sell 10% more stuff guess what your cost of good sold should go up by 10% well we sold 11% more stuff our cost of good sold was up 15% this is significant and worth investigating okay that's it for this video stay tuned for the next one we're taking a look at 122a this problem is on vertical analysis now we said our gesture for horizontal look like this our gesture for vertical looks like this we're analyzing the financial statements not by looking year over-year looking at a timeline or some sort of trend line we're looking up and down one single year and just looking how at how the accounts compare with each other uh now vertical analysis is often called common sized financial statements and we're going to learn how to prepare common sized income statements and common sized balance sheets if I have my hamburger company here in cops and I'm selling you know tens of thousands of dollars worth of burgers a year or a month even uh and I want to compare my income statement to McDonald's is they just don't compare because McDonald's has billions and billions of dollars in revenue and I might have tens or even hundreds of thousands it just doesn't even relate right uh vertical analysis helps us overcome that and we'll see that in this problem let's let's read through it harre Gil is concerned about his company's financial performance and financial position he's obtained the financial statements of his largest competitor Hussein Inc and notes that the company is over 10 times larger than his so it is making numbers difficult to compare below is a condensed financial information from hosein Inc and Gil in and you can see hosein is just a way big company um you know Millions more in sales and and just bigger balance sheet bigger everything so let's zoom in on the income statement and we're going to do a vertical analysis that was what the question called for and here's how you do a vertical analysis you restate everything you see on the income statement or the balance sheet as a percentage now on the income statement everything gets restated as a percentage of sales so I want to do vertical analysis I'll start with Gil we'll do hosein in a minute but we'll start with Gil so let's just ignore hosein for the time being don't you scratch that out you're going to use that in a minut I'll I'll erase it see it's easy for me to erase um uh but we're going to focus in on Gil and vertical right so I'm not comparing company to company just yet I'm just up and down so here's what you do you basically divide every number on here by the sales number whatever the sales number is just divide by that so 400,000 divided 400,000 gives us a 100 % 120 divided 400,000 let's see 120 / by 400 gives us 30% 280 divided by 400 gives us 70% it shouldn't be a surprise given the math 100 minus 30 is 70 130 ided 400 gives us 32.5% 150 ided 400 37.5% 10 ided 400 2.5% 140 divid 400 35% and the math by the way is working down as well like 37.5 - 2.5 is 35 uh 30 divid by 400 7.5% and uh 110 divided by 4 27.5% Double underline there let's do hosing uh 5 million now we divide every number by H's sales so 5 million divided by 5 million is 100% our Top Line here is always it's going to be 100% cost of goods sold 2.1 million oh my gosh divided by 5 million 42% 2.9 million divided by 5 million 58% 2.2 million divided by 5 million 44% 700,000 divided by 5 million 14% 60 divided by 5 million 1.2% almost said 12% there happens with students on tests 640 divided 5 million 12 8% 150 ID 5 million 3% and 490 divided by 5 million 99.8% double underline there and we've done it so let's kind of compare these and see if anything jumps out and hm just just eyeballing this it appears to me that Gil's costs are way more under control than hosein's right key numbers are again the big ones with big differences are like cogs we're able to mark up I'll do cogs and gross profit all at once we're able to mark up 70% over our cost where Hussein is not so we have way higher margin now maybe they're low cost low volume I'm not sure the the the competitive nature here but we have way higher margins than does our largest competitor uh the other thing is our operating expenses are lower so our costs are way more under control if you didn't know anything if you didn't know these numbers if you just saw the percentages right hosein or Gil whose income statement would you rather have I'd rather have Gil's so Gil is in a better profitability position than than is hosain that I think we can say and the reason is its costs are lower as a percentage of Revenue its costs are significantly lower um okay let's move over to the balance sheets and with the balance sheet you do something very similar you set everything to 100% based on or based on a percentage of total assets whatever the total assets is you make that number a percent you know they make that number 100% and every other number is a percentage just driven from that so let's do hosein a million divided by 4 million 25% current 75% [Music] longterm uh 500 divided by again 4 million is our denominator for all of this 12.5% there 1.5 million divided by 4 million 37.5% 50% for total liabilities 50% for shareholders Equity two divided by 4 is 50 and uh 100% for total liabilities and Sh because it's 4 million divided by 4 million let's move over and do Gil Gil is 75 divided by 250 30% for current assets 175 ID 250 70% for uh long-term assets moving down to current liabilities 60 ided 250 24% 24.0% for current liabilities 120 divided by uh 250 48% for long-term liabilities and uh 180 divided by 250 72% for total liabilities shareholders Equity 70 divided by 250 28% bringing us to 100% okay let's compare now the balance sheets um so ibing at a few things to look at one is just this current assets current liabilities that kind of ratio and you can see just eyeballing it that uh Hussein has like double the current assets required to pay its current liabilities where Gil has his covered but just barely and the other thing to look at is just like the total liabilities uh and gills are much higher the total Equity gills are much lower uh I definitely prefer Hussein's balance sheet right it's in a much more stable financial position and a much healthier financial position so in terms of financial performance I like Gil's income statement better in terms of financial position I like Hussein's much better so uh bit of both bit you know it's it's not a home run for Gil it's a mixed bag here mixed news so I think we've done it we've done our vertical analysis of the companies that's just those percentages we've commented on the common sized income statements I think a simple comment which is B say gills is better because his costs are more under control cost of good sold is lower operating expenses are lower and therefore Gil is more profitable than Hussein so Gil's income statement is in a stronger financial position Hussein's balance sheet is in a stronger or Gil's income statement actually not I said financial position the word is financial performance is better for Gil financial position is better for Hussein and the reason I say that is the current assets compared to current liabilities are stronger for uh Hussein the total liabilities and total Equity are both stronger for Hussein so Hussein is in the stronger financial position Gil had the better financial performance okay that's it for this video stay tuned for our next one bye for now let's take a look at problem 123a this problem has us doing ratios we've already learned a few ratios if you've gone through all the videos of this class uh this will add a few more and it'll review some of the ones that we already looked at so this is a very typical position to be in you are a potential investor you are an outsider to a company and you are looking at a set of financial statements thinking hm I don't know what to make of this right like there's a big long list of numbers they're usually comparative numbers given and uh you're just left to ponder is this good news or bad news and as mentioned you know a lot of times you'll go to an annual general meeting and some accountant will tell you what to think but it's it's useful to know what you think yourself and so this uh series of videos is going to help to give you the tools to do that um so we've got our set of financial statements some additional information and it says for 2023 and 2024 this are required compute all common financial ratios from the beginning of this module if you just go into your accounting workbook and um flip to the beginning of the module you'll see this page common financial ratios and we're just going to compute all of them and so this will give you a good feel for one Computing the ratio and two kind of deriving some meaning from it all like what does it mean um so let's begin and we're going to start I'm going to just take this in chunk so we'll do the liquidity ratios first the current ratio and the asset test ratio so here we are uh and so the current ratio is current assets divided by current liabilities our company's current assets are right here our company's current liabilities are right here and we're going to do this for two years we're going to do this for 2023 and 202 24 and we're going to determine if 2024 is better or worse than 2023 so let's do this uh for the current ratio for 2023 the current assets so actually we'll do this we order 2024 2023 and then better or worse so uh 2024 we'll start there the current assets are 775 ,000 the current liabilities are $387,000 uh$ 775 divided by 387 let's do the math 775 ided 387 is 2.3 2.03 uh for 2023 our current assets are 503 our current liabilities are 235 503 / 235 2.14 now these numbers are not percentages they are not um dollar amounts they're just numbers and remember what the current ratio says it's how able is this company to pay its current liabilities how well covered are the current liabilities well last year it was 2.14 times the the current assets as current liabilities this year 2.03 this is we would still consider this to be okay in terms of liquidity because anything above 1.5 is a little bit of a rule of thumb uh so we're above that but no doubt 2024 compared to 2023 we are getting worse we are getting less liquid marginally less liquid but less liquid nonetheless okay uh let's do the asset test ratio this is just uh another measure of liquidity and it's stricter it says hey look when we do our current ratio we include things like prepaid Insurance well prepaid Insurance isn't going to help you pay the bills right it doesn't help you pay the bills uh uh inventory if you're in a crisis time it's going to be hard to sell your inventory and recover the value of the inventory that doesn't really help you pay the bills in fact you can be in a country where you have too much inventory you don't know what to do with it you're unable to sell it so um that can be a problem uh so what the asset test ratio says is let's just take the most current assets cash short-term like stock market Investments Microsoft stock that you could liquidate tomorrow and net current receivables accounts receivable is thought of as pretty liquid your most liquid assets and see how well you cover the current liabilities here we're looking for a ratio of 0.9 to one as kind of a rule of thumb so uh current liabilities I've left highlighted the the most liquid current assets cash and net current receivables that's these ones uh inventory we won't do prepaid insurance we won't do short-term Investments we don't have so there we have it there we have our numerator and our denominator so for 2024 it's going to be uh 150k plus 140k the Cash Plus the receivables all divided by 387 for the year before it's going to be 53 + 80 oops man my writing's getting messy 53k plus 80k all divided by the current liabilities which were 235 so let's do the calculation for uh this year 2024 uh 150 + 140 / 387 we end up at [Music] 0.749 uh we're getting a little risky here 53 plus uh 80 divided by uh sorry I should hit equals there 53 + 80 equals divided 235 last year we were at. 566 0.566 and comparing the two no question they're both below 0.9 to one that range we're looking for but no question we are getting better and actually significantly better as far as that goes so our current ratio is a little bit worse our asset test ratio a lot better uh so overall in terms of liquidity if I were analyzing this company yes it's a mixed bag I would like this if I were an owner or an investor in the company I would say oh this is actually pretty good um okay that's it for liquidity ratios the next batch of ratios we have to do are turnover ratios turnover ratios measure efficiency so we look at two types here inventory turnover that's how well you're selling through your inventory as well as receivables turnover and that's how effective you are in collecting your debts right the people that owe you money how effective you are in collecting from them so uh here we go um like to actually kind to move this over if I could uh cogs divided by average inventory let's do I'm going to move all these over maybe I can squish them let's do that squish you move you over yeah I just want to have more real estate here I'm realizing I'm going to run out of room here squish that and move it over okay let's start with inventory turnover cogs divided by average inventory okay so for 20 2024 and 2023 and if is it better or worse um 2024 our cost of goods sold was 1.5 million 2023 our cost of goods sold was 1.6 million the average inventory for 2024 we take the inventory the beginning of 2024 was 350 the end of 2024 and just highlight this line was 450 we want the average of these two numbers so 350 and 450 the average just add them 350 plus 450 divided by 2 so 350 plus 450 is 800 800 divided by 2 it's 400k that's my average inventory so that'll be my denominator here 1,600 uh 1.6 million the year before the average between 300 and 350 is 325 when I was a beginning student I would average all three numbers that is not correct we take the beginning inventory plus the ending inventory divide by two so 300 plus 350 is 650 divided by 2 is 325 okay let's compute our uh ratios here get some numbers um 1500 divided by 400 3.75 so I'm selling through my inventory 3.75 times this year last year 1,600 ided 325 4.9 times 4.92 well would you rather sell it through your inventory four times as we did this year or five times as we did last year you want to sell through your inventory more right it's a measure of inventory management we did worse last year we did better Day sales in inventory measures the same thing but puts it in more human terms in my view you take 365 divide by the inventory turnover so in this case it's 365 / 3.75 last time it would be uh uh 365 / 4.92 Let's compute those numbers 365 / 3.75 gives us 97.33 this is days this one I guess we would measure as time like the number of times you turned over your inventory this is the number of days it took 365 / 4.92 last year was 74.2 days 74.1 one9 days so what does this mean it's saying how many days is it taking me how many days on average is inventory sitting on the shelf uh last year 97 days this year 7 sorry I did that backwards this year 97 days last year 74 days you want your inventory setting for less time so this is worse no question our inventory turnover is worse this year compared to last let's look at AR turnover net sales divided by average net AR now we might know not know the net credit sales as long as we're being consistent here and just using uh the same number year to year I think we're all right uh so we'll use net sales that's what we have average net AR we're going to take the average of what's on this second line of highlighted let's do the averages for net AR the average between uh uh 80 and 140 I think is 110 let's see 140 plus 80 equals divided by two yeah 110 and the average between 80 and 55 this is going to be a awkward number 80 + 55 ID two is 67,500 okay so we'll take our net credit sales or our net sales three 3.6 million ided 110,000 and for the year before it's going to be 3.9 million I'll write all the zeros here because I've got the whole 0.5k 67,500 is my denominator so let's compute that 3.6 million divided 110 Grand what oh I I messed this up 3.6 million divided by 110 I forgot the three zeros that's a more reasonable number 32.7 two times the year before 3.9 million divided by 67,500 57.76 times so this tells us how many times during the year I collected through my AR more is better it means you're collecting more frequently this year we collected 32 times last year 57 times it's better to collect more so this year we are doing worse lots of worses here uh the next one 365 divided by the AR turnover so 365 divided a turnover which was 32.7 to and this one is 365 divided by 57.7 S let's crunch those numbers 365 divided 32.7 I get 11.16 uh days so that means from the day I make a sale to the day I get paid on average it's taking me 11 days uh the year before 365 divided by 57.76 uh there from the day I make a sale to the day I get paid it's 6.32 days oops I think it was was probably hiding behind me there uh 6.32 days so what would you rather would you rather wait 6 days to get paid or 11 days to get paid I'd rather wait six days to get paid this is getting worse so looking at this page we' sort of said uh for liquidity we said yeah one's better one's worse but overall I I you know the the one that's worse is just marginal the one that's better is a lot better so we are in a better liquidity position overall in terms of our um turnover in terms of our efficiency here we're worse just worse across the board and and it is significant we're significantly worse in terms of turnover and that's a measure of efficiency and how well and how efficiently we're being run okay next uh long-term debt paying ability the debt ratio total liabilities divided by total assets uh okay let's highlight what we're looking at here the total liabilities is right here the total assets that line is right here so uh for 2024 I'll just do it right in here 2024 and 2023 our total liabilities is uh 937 our total assets 1375 for 2023 our total liabilities 735 and our total assets 1053 we'll compute these numbers these are stated as percentages 937 / 1375 68.1 15% and the year before 735 / 1053 69.8% so what's happening here well 68% of our assets are covered by liabilities or debt uh in the year before it was 69.8% of our assets being covered by liabilities and debt this is getting better right we're have this is a measure of debt and we have less debt now now not all companies believe this some companies think no you should borrow more and make use of that l average you can do more if you have more debt in our class and in intro class generally here smaller is safer right smaller means you have less debt less risk and that's considered to be safer and we'll call that better for our purposes again a more sophisticated read would say just riskier and riskier is not necessarily worse but in our class we're saying safer is better and 68% is safer than 69% this is better a little bit better not crazy better but better let's do times interest earned again for 2024 and 2023 income from operations divided by interest expense this says how readily can we pay our interest bill so it's our income from operations which is operating income divided by interest expense so 500 divided 200 300 divided 150 oops get a pen out here 500 divided by 200 2.5 and the year before was 300 / 150 and that's two so last year I could cover my interest bill twice over two times over this year two and a half times over well I'm more able to cover my interest bill this is better right I I just have more uh uh operating income with which to pay my interest this is better I'm in a better long-term debt uh paying situation here okay so that's the uh so long-term debt it's better across the board not crazy better but it is better this company is in a better position to service its debts and that's a good thing uh let's move over to uh 123a uh there's a lot of ratios here I'm going to I'm just thinking about how to lay this out to to make it fit more nicely I think I think I going to do that thing where I squish it squish you over I hope it Still Remains legible I'm going to zoom in a bit on each of them as we go so hopefully that kind of covers up for any problems I know I'm causing in terms of legibility and readability uh so gross profit percentage gross profit divided by net sales that's the formula from the formula sheet here we go our company's gross profit line is right here our net sales line is right here so 2.1 million divided by 3.6 million 2024 2.1 million divided by 3.6 million and that compares to 2023 when it was uh 2.3 million divided by 3.9 million okay let's crunch those numbers 2.1 million divided by 3.6 million this is the our margins right this is our markup we're able to mark up 58% of our our sales turn into profits so uh gross profit so 58.3% uh this year and last year let's crunch that number 2.3 ID 3.9 58 basically 59% last year so would you rather have 58% margins or 59% margins bigger is better this is marginal this is minor but it is better right uh this is a this is a key number though Apple will always tote this in their earnings call their margins their profit margins they're always looking for higher markup items and in this case we got a little bit worse didn't we we uh are marginally less profitable okay return on sales net income divided by net sales let's see what our company's net income was we already have net sales highlighted net income is the bottom line this just says every sales dollar how well are we converting our sales into profits this year 25 divided by 360 last year one 10 ided 3.9 million 215 divided 360 is. 597 5.97% last year 110 divided 3900 2.82% so again this is a measure of how well we're converting sales into profits this year 6% of every sales dollar becomes a profit dollar last year it was about 3% of every sales dollar becomes a profit dollar you'd rather be more profitable so this is much bigger this is much better the one before the gross profit percentage marginally worse not much worse marginally worse The Profit number here much better return on sales much better so the better here is is much more important to me than the worse in the line above return on assets net income plus interest divided by average total assets Okay so we've got our net income here we're going to add in interest so let's do that just real quick net income plus interest 215 plus 200 is 415 that'll be our numerator and 110 + 150 is 260 that'll be our numerator for 2023 let's fill that in four oh dear 450 ID by something and 260 divid by something over here average total assets okay so I've got my total assets here and I want to take an average of them so I'm going to average these two for my 2024 average and for my 2023 average it's the average of the two on the right so let's average the two on the left to average two numbers add them together divide by two so 1375 + 10 53 equal / 2 equals the average is 1214 and the year before 1053 plus 905 average so divide by two and we get 979 okay so my denominator here is the average total assets 1 2 1 4 and 9 79 let's compute the numbers here return on assets this is a measure of how effectively we're using our assets right how profitably we're using our assets under our control so 415 divided by 1214 gives us a return on assets of 34.2% means every dollar I've invested in assets is returning me 34 cents of profit uh 260 divid by 979 last year it was 26.6% so again bigger is better here for any of these returns you would rather see more profits than less I know I sound like a greedy capitalist here when I talk like this but it's truthful if you are putting your assets to work you would rather see more return than less that is for sure all else being equal return on Equity net income minus preferred dividens and this is return on on common shareholders Equity net income minus preferred dividends divided by average common shareholders Equity okay so this one's a bit of a mouthful net income minus preferred dividends we got our net income up here we've highlighted it already let me reh highlight that there's my net income preferred dividends well we do have preferred shares so preferred dividends what are our preferred dividends well whenever we see a number beside preferred shares that's their guaranteed dividend $20 and there's a th000 shares so what are my preferred dividends going to be 20 times a th000 my preferred Dividends are going to be $20,000 so let's because the net income the first claim on net income goes to the preferred shareholders we're going to deduct uh uh preferred dividends so I'll just make a new line here net income minus preferred divs 215 minus 20 is 195 and 110 - 20 is 90 again the preferred Dividends are 20,000 and the formula here is net income minus preferred dividend so it's uh 195 and 90 so let's put that in as our numerator here 195 90 divide by average common shareholders Equity okay so again this one's a bit of a multiple uh um we've got shareholders Equity total shareholders Equity here of 438 343 and 260 but each year 150 belongs to our preferred shareholders so we got to take that out common shareholders Equity is going to be 438 minus 150 or another way of thinking of it is just common shares plus retained earnings is what belongs to our common shareholders so 100 plus 188 maybe that's the easier way of think it uh 288k this year last year 193k and the year before 110k now I need the averages so I got to average between those so 288 plus 193 ided by 2 gives us 240 24,500 for 204 2024's average 193 + 110 divided by 2 151 500 is our average there let's put these numbers in 24.5k 151.50 K and we can compute our return on Equity here 195 divided by 24.5 gives us 81.1% is extremely high as an Roe and 90 / 151.50 gives us Roe of 59.4 again very high uh but we would say that bigger is better here and so certainly our Roe is better in 2024 than in 2023 okay next earnings per share this is a headline number if you ever uh listen to an earnings call or are interested in corporate earnings they lead with earnings per share they tell you what the EPS is it says for every stock for every share you own how many dollars did the company earn you and it's a good basis for determining stock prices um so net income minus preferred dividends and that's the same numerator as the last one so I'm just going to put in the same number we have it written up here again it was 215 - 20 110 - 20 so it's 195 and 90 as my numerator and this can get Complicated by the way if you take an intermediate or Advanced Financial Accounting class you'll see all sorts of different calculations for this fully diluted earnings per share and all sorts of challenges in Computing earnings per share uh we're doing a simple version so anyway our earnings related attributable to our common Shares are 195 and 90 the number of common shares outstanding and again this can get complicated here we've simplified it we've said if you take a look at the common shares row here it says 50,000 shares all years so what's the average number of common shares outstanding well it's 50 195 divided 50 and 90 divided by 50 3.9 $3.90 and this is per share and 90 divided 50 $180 per share so if you earned a share of a company and it earned you again exact same company's share price one company earns you $3 per share $4 per share almost and one earns you two bucks a share you would rather earn more per share so bigger is better and this is no question bigger and better so when I look at profitability uh taking a look at the big picture this is a good news uh income statement right this is a good news profitability ratio situation uh this is significantly better year-over-year the only one that was worse was gross profit and that was marginal so uh the profitability of this company is unquestionably better okay one more set of ratios uh stock market performance so we're interested in the stock market price to earnings ratio is a measure of how much the stock market values us uh in other words does it give us good value so market price per common share divided by earnings per share now our denominator earnings per share it's this that we just calculated EPS earnings per share so 3.9 and 1.8 that's our denominator 3.9 and 1.8 so uh let's do it for 20 24 2023 and I know the denominator is $3.90 per share and a buck a 80 per share the year before our numerator market price per common share it was given in the additional information 2024 150 bucks 2023 50 bucks this is a company that's done well it's start shock stock price has tripled this year uh so let's do the math 150 divided by uh 3.9 come on calculator 150 / 3.9 3846 this is huge multiple here on earnings per share 3 38.46% [Music] was 27.78 so as a measure here if you are an owner of this company or you were operating this company this is a very good sign it's saying Outsiders of the company the stock market thinks that we are an attractive investment and getting more attractive the fact that they're willing to pay a higher multiple of earnings says something that's not captured in the earnings they like so bigger is better here and we are doing better an example company like this with really high priced earnings ratios like Tesla which is not a very profitable company but has a high stock price Amazon for years and years and years reflected this and it was just something in the market said we like this company even though it's not as profitable as the stock price seems to indicate right something else is in The Ether here that we like and that's what's happening here where our uh uh price is outstripping our earnings this is a good thing though if you're running the company or you're involved in the company you like to see this if you're thinking of investing this is a bad thing it means the stock is highly priced and maybe even overpriced that's uh certainly debatable here people might debate that about Tesla and certainly may have debated about Amazon at a time okay dividend yield dividends per share divided by market price of share so uh it's all in this little table our market price is 150 this year our dividends per share is two bucks 150 divided by two have I done this backwards yeah I did this backwards I was like this shouldn't be such a big number two is our numerator dividends per share divided by the market price of 150 uh two divided by 150 for 2024 gives us dividend yield of 1.33% last year it was one divided by 50 that gives us dividend yield last year of two% well you would rather have a higher dividend yield all else being equal you would rather have more dividends this is worse um okay so kind of a mixed bag here for stock market performance it's going to depend on what you're looking for as an investor if you're looking for that dividend and cash flow this stock became a worse investment this year if you're looking at just stock market returns this is a very high performing stock and so I would say overall I I would rate the top ratio as maybe more important than the bottom but it's going to depend on the investor so let's kind of go back through this whole thing and just kind of evaluate the company so stock market performance my bias says it's better again a dividend investor will tell you it's worse uh profitability it's just way better no doubt about that uh long-term debt paying ability they're doing much better in terms of internal efficiency and turnover much worse significantly worse and in terms of liquidity I would argue a little bit better uh even though it's one worse one better I think that asset test ratio being higher much higher is more important than the current ratio being a little bit lower uh so that's my view on this company uh you'll find most of the time when you do ratio analysis it is a mixed bag you don't just go to list and go better better better better better worse worse worse worse worse there is a mixed bag to be had here all right right we've come to the end of problem 123a I hope this video has been useful to you if you've made it we're over 30 minutes here if you've made it write in the comments below that you've made it because good grief I don't think many people watch the end and if you watch the end I hope you got something out of the video and I hope you've gotten something out of this video series I really hope it's helped you I hope you do well in your accounting studies and in your accounting career that's all for now I'll see you soon bye for now