Accounting Crash Course - Be job ready in 1.5 hours!

0:00 welcome to learn accounting Finance in the next one and a half hour you will learn the basics of accounting so that if you have zero knowledge of accounting by the end of this video you will be able to prepare financial statements such as balance sheet income statement and cash flow as well as be able to explain how those financial statements are prepared and what is the meaning of each if you are interested in an accounting career or finding a job in the field of accounting I recommend that you watch this video till the end subscribe to my channel and like the video so that you can always come back to this video in case you need to refresh your memory if you understand the basics I share in this video you are pretty much ready to start a job as an accountant or maybe you already have a job as an accountant and you want to clarify the

0:46 concepts in your day-to-day work go ahead watch the video till the end and let me know if you found this information helpful do you have any additional questions and whether or not you find accounting boring or interesting let me know in the comments and let's get right into accounting accounting is the language of business why is it called the language of business well it records every business transaction for example if there is a buyer and a seller let's say the seller sells a mobile phone to the buyer this is a business transaction and there are certain rules and methods to record this transaction in the books of the seller's business similarly the buyer if the buyer is also a business they will record a transaction which records the

1:33 buying or the purchase of the mobile phone accounting defines the rules procedures and principles to record those transactions in the books of the business that's why it's also known as bookkeeping let's take a look at a few examples of a business of financial transactions a fast food restaurant purchases Burns for three hundred dollars so they produce burgers and they purchase buns that make the burgers another example is the fast food restaurant pays 100 for electricity it also buys a computer for one thousand dollars so these are three simple examples of business transaction note that all of them involve money and as per the rules of accounting there is a specific method to record these transactions each of

2:20 these transactions will be recorded in the language of accounting every transaction in accounting will always have two consequences this is one important thing to remember all transactions have two consequences in the language of accounting we call them debit and credit so one of them is debit there's always a debit and there is always a credit in all accounting entries there are no exceptions every transaction will always have a debit entry and a credit entry so let's take a look so the first example of purchasing of buds how will we record it well a non-accounting entry which is also sometimes called single entry will be for example cost of Buzz 300 so if you're not an accountant and you are recording this transaction you have this

3:06 business you would just be recording a single line showing the cost of bonds however an accountant will record it as a double entry with debit and credit and the entry will look something like debit Buzz inventory which is an asset of 300 and credit cash paid which is also an asset of 300 note that there is a debit and a credit the total of the amounts is exactly the same so the debit always equals credit and in this case we have an increase in asset which is inventory and we also have a decrease in another asset which is Cash we will discuss what our assets liabilities Equity income and expenses in detail the key in accounting is to start thinking about each

3:52 transaction in terms of the two consequences or results each transaction results in either an increase or decrease in assets liabilities expenses income and Equity that's pretty much it in a nutshell all of the transactions that an accountant will record related to a business will always impact one or more of these five categories which are assets liabilities expenses income and equity now let's look at the second example which was payment of the electricity bill so again a non-accountant will record it record a single line showing cost of electricity a hundred dollars but an accountant will record as debit electricity which is an expense 100 and credit cash because cash is paid out so

4:38 there is a decrease in cash so credit a hundred dollars as well the example of purchase of computer very similar non-accounting entry cost of computer one thousand dollars and accounting entry would be debit computer which is an asset so you now have an asset physically available in the business in accounting we record that separately as an asset and then credit cash because cash was paid out so whatever cash the business had at that point there is a reduction of one thousand dollars and that is shown through the credit entry let's look at the rules of debit and credit so this is an important slide this is these are the rules which as I mentioned there are no exceptions so you

5:25 can always count on these rules the rules say that you will debit assets when there is an increase and you will credit assets when there is a decrease in asset okay so in the previous example we saw that when we purchased a computer there was an increase in our computer assets so let's say the restaurant already had one computer and they purchased another one so now they have two so that's an increase in assets on the other hand we saw cash being decreased so when we paid out cash for electricity we paid out cash for the computer in those cases we have a decrease in cash so let's say if the company already had two thousand dollars and they paid one thousand dollars for the computer now the balance has decreased by 1000 and that decrease of 1000 is recorded as a credit to the

6:11 asset okay liability equity and income they are actually opposite of assets and expenses so in case of liability when the liability increases or Equity or income increases there is a credit and when they decrease there is a debit and expense actually follows the same logic as assets so assets and expense have similar debit and credit response while liability equity and income also have similar but opposite to asset and expense a point to note that out of these five categories assets liabilities Equity income and expense asset liability and Equity are part of the balance sheet which is a financial statement and if you're not aware of this we will discuss that in detail

6:58 and income and expenses are part of another financial statement which is called the income statement sometimes also known as profit and loss statement or p l statement as we noted assets and expenses have similar response or follow the similar principle of debit when increased credit when decreased liability equity and income credit when increased debit when decreased if you wanted to make it easy to remember you could think about only assets and expenses debit when increased and everything else is opposite right so if I focus on this alone assets and expenses debit when increased I can make an abbreviation of aedi now aedi is a little hard to remember because it doesn't make any word so do

7:45 you have any ideas if we Shuffle the letters around can we make a word how about idea itself now if I use this abbreviation of idea it will sound something like increase will debit expense and assets so although these are very few rules you can remember them even without an abbreviation but if you had to use one this is one suggestion so any increase in expense and assets will result in a debit and everything else is opposite to it so if there is an increase in a liability equity or income it will not be debit it will be credit and similarly if there is actually a decrease not an increase in assets and expenses then it will be a credit okay we'll actually

8:32 practice some examples don't worry if this is still confusing because of the rules that we just discussed there are default or common balance positions so assets and expenses you you will usually see a debit balance you can also see a credit balance but usually for most accounts you will see a debit balance in the books or trial balance and for liabilities income and Equity you will usually see a credit balance so we'll get back to the rules of debating but first we have to explain what are assets liabilities Equity income and expenses what is an asset what comes to your mind when you think about an asset maybe you're thinking about your house especially if it is paid for and you don't have to pay any money as far as

9:17 loan or mortgage is concerned you can live in the house you could also be thinking about the money you have in the bank that is money that you can use to buy stuff it can buy you things it can buy you happiness Maybe and you could also be thinking about your car or the bike that you have that you ride and can go to places you can also go to work using the car or the bike which will result in money flowing in in the form of salary or wages so an asset is something you own or you possess and expect to use or have some benefit from it in the future so let's look at the definition of assets according to International financial reporting standards we'll talk about International financial reporting standards in a moment the definition of

10:04 assets is a present economic resource controlled by the entity as a result of Pass events and an economic resources a right that has the potential to produce economic benefits so we'll get back to the definition of the assets according to IFRS in a moment but first what are IFRS a quick introduction about them IFRS on International financial reporting standards are accounting standards that are developed so that business entities corporations companies across the globe all over the world follow similar accounting standards and the real purpose is that you have internationally comparable financial statements so for example if investors

10:49 or decision makers are considering buying a business in Canada but they're also looking at a similar business in say UK take a look at their financial statements and try to compare which one is a better option right and if both of those companies are using international financial reporting standards it means that the investors or decision makers can be assured that similar accounting policies are being formed so they can really rely on the information that is presented on the financials to compare the two if both these companies were using different Accounting Standards it would be hard for them to make a decision because they don't really know for example what are the basis of arriving at the profitability for one company compared

11:35 to the other one and there could be misleading results so the purpose of international financial reporting standards is to have Global comparability to have consistent principles that are applied to financial reporting currently the ifrsr are required to be applied in more than 100 countries and a few more permit them but not all countries require the application of IFRS notably there is not a requirement to apply IFRS in the United States and the same for India so we can take a look at the geographies where IFRS are required to be applied or permitted so the first one is Africa and the Middle East you can see a lot of the countries highlighted as red require IFR standards for reporting or financial presentation especially for listed

12:20 companies and then you can also see a few countries where IFRS are permitted if you look at Asia you see again of quite a few countries but you can see India and China currently do not require IFRS but you see countries like Pakistan Australia requiring IFRS in the Europe IFRS is heavily adopted and you can see a lot of countries in Europe currently require IRS and then finally Americas on the left side you have North America and on the right side you have South America so you can see a lot of countries in South America currently have adopted IFRS in North America you can see United States has currently not adopted diaphras so if you want to check the profile of your own country wherever you live in you can

13:06 go to this website here at the bottom and when you go to this website you can select your country and it can show you some info information like this where for example I selected United States and it shows the extent of IFRS application in this case you can see that IFRS are not required for domestic public companies in fact U.S gaap is the requirement however IFRS standards are allowed or permitted for listings of foreign companies right so and also currently more than 500 foreign companies registered on the SEC are applying IFRS similarly for India you can see there's no application requirement for IFRS in fact India has its own Accounting Standards which are required but they are substantially converged with IFR

13:53 standards so uh there are a lot of similarities so I chose to use the definition from IFRS because it's a good different definition that can be applied to understand what are assets but as I mentioned different standards that are applied in different countries the understanding around the key elements of financial statements which are assets liabilities Equity income and expense are very similar usually you don't see many deviations from the treatment of assets liabilities inequities or the classification of assets liabilities Equity income and expenses so going back to definition a present economic resource controlled by identity as a result of past events and the definition also explains what an

14:39 economic resource is it's a right that has the potential to produce economic benefits it's similar to what we just discussed and as it is something that you own or control that has a potential of providing you future economic benefits so key points are it is an economic resource so there is some economic benefit right Financial benefit the entity the organization controls that asset and then that economic resource means there will be a potential to produce economic benefits so that's looking in the future right so it's not any benefit that you've already received is not considered considered as an asset it's only an asset when there is a potential in future that you will receive economic benefits this will be really clear when we look at the examples

15:24 this list that you see this is pretty much majority of the assets that you will encounter in accounting or when you are working as as an accountant this list pretty much covers everything so let's go through the list one by one the first one is cash at hand or Bank the cash or money in the in the bank or physically available at the business premises is an asset because of course it's something that the business controls or owns and then the business can utilize this money to receive benefits in future right so the company can buy stock the company can pay for rent pay for utilities for the business so the business will definitely get benefit from the cash with cash in a way is the ultimate asset a lot of the other

16:10 assets ultimately convert into Cash second one is building or office so the building where the business is located is also an asset computer hardware so it's all the computer equipment asset Furniture inside the building where the employees come and work the office desktop office chair office equipment is also an asset so the next one is inventory inventory is really the stock uh the goods the products that the company sells as long as they are with the company premises not sold yet they are also considered an asset because they will be sold in future and bring money to the business similarly vehicles in which the business conducts its business or it helps in bringing the employees to office to customer locations and perform business they're

16:57 also an asset any Machinery that the company has especially if it's a manufacturing organization all the Machinery is also an asset land or property that the company owns is on certain asset accounts receivable this is the amount of money that is receivable or due from the customer so if the company sells on credit and gives the customers a time some time to pay at that point the company records accounts receivable and this account receivable is an asset because of course this will convert into Cash When the customers settle the amount similarly prepayments prepayments are the amounts that are paid by the company in advance but the service or product that they expect to receive has not been received yet so again in future there's a benefit of that product or service so prepayments

17:44 are also an asset Investments so if the company has invested in other companies the shares or invested in bank or invested in metals such as gold silver all of those Investments are also asset because they will convert into money or cash computer software is going to be utilized by the business so an example would be the implementation of Erp for example sap or Oracle financials any Erp any computer software that the company purchases can also be considered as an asset and then we have some other categories of assets of Goodwill on the purchase of business if a company acquires another business the Goodwill that that other business has will result in positive profit or cash flows for the

18:29 company and there is usually a value determined or assigned for the amount of Goodwill which can also be recorded as an asset in the books of the company trademarks patents and copyrights purchased were are also considered an asset so this is a list of assets which pretty much covers most of the assets that you will encounter in real life let's look at type of assets so broadly there are three categories of assets two of them are based on time whether the assets are expected to be realized in short in a short term or a long term and the third one is whether the assets are touchable tangible or not right so let's go through them one by one current assets all cash and cash

19:16 equivalents are considered as current assets and cash equivalents are really not cash but very short-term Investments or any assets that can be quickly converted into cash if required current assets are also expected to be converted into cash or cash equivalents within 12 months and similarly any assets that are expected to be sold or consumed within the normal operating cycle of the business so normal operating cycle is really the business cycle you know when a company buys and sells so the average time it takes from buying something buying a product and then selling it and receiving cash for it is called a normal operating cycle and if any asset is usually expected to be sold or consumed within the normal operating cycle and really this refers mainly to inventory

20:03 the stock because it is converted in the normal conversion cycle or it is also referred to referring to accounts receivable the amount that is due on amounts sold to customers this is usually already converted into cash in a normal operating cycle so this represents cash and cash equivalents let's take a look at the examples so if we go back to our list of assets and if we had to highlight current assets the current assets would be cash at hand or Bank the inventory as we discussed normal operating cycle accounts receivable again normal operating cycle prepayments and some prepayments could be long term as well it depends on the the time within which that asset is expected to be realized but usually we see prepayments are mostly short term

20:50 and then Investments could also be both short term or current and long term so again it depends on the maturity of the Investments some Investments you will see as current or short term and some will be classified as long term now in which financial statement do we find assets you should know it by now yes it's the balance sheet so here is an example of Nike this is their Consolidated balance sheet for the year ended May 31 2022 and if you're thinking why it is May 31 and not December 31 well December 31 is the calendar year end but many organizations do not necessarily have the same year end as the calendar so their 12 months period their fiscal year or their financial year could be any other month during the

21:38 year depends on what is the year that they choose so in the in case of Nike they have chosen that May 31st is the year end so this is the balance sheet with balance sheet line items and we're looking at the asset side of the balance sheet this is not the complete balance sheet there is of course liabilities iniquity but we will see but the asset side has current assets with their amounts listed and in this section you see the top part is actually the list of current assets with the respective amounts here and the bottom part is non-current assets so so what are non-current assets really all the assets that are not current assets all the assets other than current assets are non-current assets but they are also expected to be utilized or converted to cash over more than 12 months let's take

22:24 a look at examples so going back to our full asset list if we had to identify the non-current assets there are quite a few in there here you can see building an office is a long-term asset so you will see that the expected time of realization of their benefit is more than 12 months right so buildings computer hardware we know they are used for longer than 12 months furniture and Equipment could be very long 15 20 25 years then you have vehicles of course more than a year Machinery land or property well land could be forever Investments yes if these These are long-term Investments then they are considered as non-current assets computer software Goodwill trademarks patents and copyrights all of them are considered as non-current assets again where do we find them in

23:12 the financial statements just saw that in the balance sheet and here in the case of Nike you can see at the bottom the non-current assets are listed here with the amounts of balances in the balance sheet let's look at intangible assets so depends on whether the assets by Nature are physical or not these assets can be created or acquired however created intangible assets have no Book value intangible assets can be definite or indefinite which means that they could they can have a fixed or defined period they could also have an indefinite or undefined period going back to our list of assets again the examples of intangible assets are computer software Goodwill trademarks patrons and copyrights and as you can see all of them are pretty much non-physical in nature that's why they

23:57 are considered intangible assets so the current and non-current distinction will really become important when we look at financial ratios it really helps to understand which of the assets and on the same note which liabilities are going to be settled in in less than 12 months or in the short term versus the assets that are long term and on the same note this applies to liabilities as well which liabilities are due for settlement in the short term versus long term because this really helps us understand the current balance position of a company so this distinction between garnet and non-government is important and we'll see that once we start analyzing the financial ratios okay in the case of Nike's balance sheet we can see that they also have a couple of intangible

24:43 assets that are listed on the balance sheet let's look at what is a liability so again the IFR is definition for liability is a liability is a present obligation of the entity to transfer economic Resource as a result of past events so the important points being it's a present application it's something that is due now and it arose as a result of a past event so event arising in an obligation was a past event and the liability is due now so it cannot be any future events that have not taken place yet that have not happened yet we cannot consider them as liability yet although in future we may need to record them as liability so let's take a look at examples

25:29 um here are majority of the examples that you will see for liabilities the first one being accounts payable which is kind of the opposite of accounts receivable in accounts payable these are the amounts that are due to be paid by the company to its vendors or suppliers so if the vendor or supplier has offered credit to the company to make payments the company purchased something from the vendor and the vendor has allowed them some time to pay the amount then this is recorded as accounts payable for the period that the amount is not settled the crude liabilities are recorded in accordance with the accrual concept and we will go through the accounting principles accounting Concepts in a future video but this represents expenses that have incurred but we have

26:16 not received invoices or bills yet so a good accounting press practice is to record those expenses in the period for example if the company has used electricity for the month of January and the bill has not been received at the end of January and the company is closing the period of January they will record and accrued electricity expense so there will be a debit to expense and credit to accrued liabilities in anticipation that the bill will be received in future but the service which is electricity has already been received the same applies for accrued salaries in various so company may be paying its employees every 30 days or every month can also be paying every week or every two weeks but at the

27:01 end of the month if there are wages or salaries that have incurred so the employees have already done the work but because the pay cycle is not there yet the company has not paid let's say at the end of January January 31st there is 10 days worth of salary that has not been paid although work has been done and those 10 days will be paid let's say on the 4th of Feb let's say the company is paying in two weeks time so there is this 10 days that need to be accrued for the month of January to truly reflect the cost of salaries and wages in the month of January similarly any taxes payable to authorities are a liability long-term debt long-term loans that the company have any current portion of the long-term debt so you know how if the

27:48 company acquires a loan there is a payment schedule so it could be that every month the company has to pay off some amount every quarter that portion becomes current usually the amount of debt that has to be paid within the next 12 months is considered as current so that is also a liability then we have deferred revenue this is the amount received from customers in advance but the service that the company needs to provide has not been provided yet so it is considered as deferred revenue because the company needs to settle this through providing the service or product that it promised and similarly Bank overdrafts any overdraft money facility received from bank is a liability because it needs to be settled and again any short-term debts similar to long-term debts are considered

28:34 liabilities so if you look at the balance sheet of Nike again now we are looking at the liabilities and the equity section so here you can see the top section shows all the liabilities that the company had for the year ended May 31st 2022 with the respective amounts shown in dollars types of liabilities similar to assets there is a current or short-term liability and then there is non-current or long-term liability and there is another category which is the contingent liabilities if we look at our list and if we need to identify the current liabilities the current liabilities would be all the accounts payable accrued liabilities accrued salaries and wages taxes payable usually the current portion of long-term loan bank

29:20 overdrafts and short-term debt and then if we want to look at non-current liabilities deferred revenue is one non-current liability and then a long-term debt of course is a long-term liability contingent liabilities so contingent liabilities are liabilities which are dependent on an uncertain future event so good example is lawsuits so for example a lawsuit has been filed against a company but the decision is spending so the company does not know exactly what the decision will be and how much amount they need to pay such liabilities are considered contingent liabilities so they are recorded in the financials depending on whether the amount can be measured reliably or how probable it is

30:08 that the amount will actually be settled another example is product warranties so any warranties that the company has offered to its customers this is a contingent liability because at the time of sales it's not clear how much will need to be settled in the form of warranties for example if company sells mobile phones and it offers a warranty period of 12 months then in that 12 months how many customers will come back and ask for their warranties because of defective product or issues with the with the mobile phone right so this is again an example of contingent liability and another example is Bank guarantee okay so by now we have looked at assets and liabilities two elements of balance

30:56 sheet and now we are looking at the final element which is equity so what is equity let's look at the IFRS definition first Equity is residual interest in the assets of the entity after deducting all its liabilities Equity represents ownership if you think about a company assume for a moment that the company only has assets and no liabilities right so in that case all of those assets that the company has belong to the company so we talked about buildings we talked about computer hardware any land or property we talked about the accounts receivable the amounts that are receivable from customers if the company only had assets all of those assets would actually equal Equity because this is the ownership the the owners of the

31:42 business own these assets right however in most cases companies also have liabilities so these are the amounts that the company has to pay that actually belong not to the owners but to Outsiders right that's why Equity is assets minus liabilities so you look at the assets which the company owns or the owners own but to deduct liabilities from the assets and that gives you equity Equity usually represents ordinary share shareholders of a company they own shares and the value of those shares represented under Equity could also be preference shares and any accumulated retained earnings which means that every year that the company earns profit or even loss the owners or the equity

32:29 holders own that right so again it goes into equity and we will see that when we go through the financial statements such as p l and balance sheet where accumulated radiant earnings come into play so accumulated retained earnings really show the accumulated profits over the years since the company has been in business for 10 years over the period of 10 years all the profits that the company has earned will be reflected as accumulated retained earnings now this brings us to a very important point which is the balance sheet equation so while understanding assets liabilities and Equity we could see that Equity is equal to assets minus liabilities we just discussed that

33:15 or we could also say that assets equal to liability plus Equity just a little bit of shuffling of the equation shows that assets are equal to liabilities plus equity so we're looking at the balance sheet of Nike again so this is the asset side and you can see the total assets are 40.3 billion and if you look at this other side which is liability and equity these all these lines are liability and from here you see shareholders Equity this is the section of equity you can also see retained earnings in there so the total of liabilities and Equity is 40.3 billion if you look at the prior year the balance sheet was 37.7 billion for equities and liability and if I go back to the assets you see assets were

34:02 also 37.7 billion so the equation will always balance the assets will always equal liability and equity here you can see again the numbers as we just saw on the financial statements of Nike so as mentioned you can find equity in the balance sheet usually in the liabilities and Equity section you see here total liabilities and shareholders equity and these are the line items for the equity represented in the balance sheet if you have looked at the balance sheet items assets liabilities and Equity now it's time to look at the income statement items income and expenses let's look at the definition first so income is increasing assets or decrease in liabilities that result in increases

34:48 in equity right so we have already learned about assets liabilities and equity and income is simply an increase in assets so it could either be an increase in assets or a decrease in liabilities but it results as always positively in increasing in equity we have to exclude any increase in equity directly done by shareholders or owners of equity for example if they provide additional funding to the business in the form of ownership shares that will not be considered income but other than that all the business transactions that result in an increase in equity and practically speaking this is really increased in profits this will be considered as income expenses on the other hand are the opposite of income they are decrease in

35:34 asset or increase in liabilities that results negatively or decreases in equity other than the equity holders contributions so the key points for increment expenses income will result in an increase in equity or increase in profits and expenses will result in a decrease in equity or decrease in profits what is income then income is money received or receivable from sales services or Investments it increase assets for example cash it decreases liability for example we discussed about accrued liabilities so the company records the bill for January in the month of January but Bill has not arrived yet it comes in later let's say the bill comes in and it's actually lower than what the company estimated so

36:20 that will be a reduction in liability that has already been recorded So that would be that difference of what was originally recorded as an expense versus now the revised amount will be an income so income increases Equity or profits and if you remember from the rules of debit and credit an income is a credit entry when increased and debit when decreased some examples of income when a business sells burgers for cash remember there is an increase in the cash asset right so the selling of burger results results in an increase in cash which is an asset and the accounting entry is Cash received debit and credit sale of burgers this is the income or Revenue so this section as

37:05 you see this is the recording of income if you remember there's always Double Entry dual impact so the asset increases and income also increases but in the form of a credit just a point to note here uh cost of sales will also be recorded in this case in accordance with matching principle and we will be discussing accounting principles in a separate section shortly examples of income include sale of goods service income dividend income this is the dividend that is received from any Investments That a company has in other companies interest income rental income and gain on sale of assets so any assets that the company owns when they sell them and if there is a profit on that sale that's also considered income

37:50 expenses so expenses are costs incurred in exchange for something remember from the definition it is a decrease in asset for example cash so when you pay for something that's an expense the asset cash is reduced it also can result in increase in liability for example accounts payable so when the company purchases something on credit it records An accounts payable liability and it results in decrease in equity or profit finally it's a debit entry when increased credit when decreased an example of expense when a business pays rent for the building accounting entry is debit rent this is the expense and credit asset which is cash so here you have the decrease in asset some examples there are many examples of

38:35 expenses a few of them are salaries and wages training costs meals rent cleaning office supplies electricity gas water repair maintenance taxes interest paid depreciation Insurance expenses leases rental equipment and travel expenses so all of these you can see are outflows for the company these are expenses where the company has to pay and as a result the asset is decreased but also profit is decreased so it has a negative impact on the equity let's look at Nike's income statement so here all the income and expenses are listed on the income statement if you look at this revenues and other income are the income in an income statement

39:21 when you see revenues and if you see other income which is a negative number in this case and in bracket you can see it shows if its income it will be a negative number or shown as in Brackets so these are the two lines for income and everything else is an expense so cost of sales so cost of the products and Nike sells plus any demand creation expenses operating expenses operating is really the business expenses to run the business interest expense and then tax expense all of them are expenses and finally you have net income which is a difference of income and expenses income minus expenses is your net income so for the year end date so for the 12 month period ending May 31st 2022

40:07 Nike had a net income of 6 billion roughly so now we have looked at all the elements of financial statements from assets liabilities Equity income and expenses as discussed earlier assets liabilities and Equity are part of the balance sheet and income and expenses are part of the income statement we'll now look at the accounting principles and then we will jump back into rules of debit and credit and some accounting entries as a practice okay now let's look at the accounting principles these principles are applied when preparing financial statements or preparing accounting entries so a few principles that we will be discussing are a cruel principle matching principle consistency

40:52 cost or historical cost principle going concerned materiality Revenue recognition these are the principles that we will be discussing but of course there are some more accounting principles as well so a cruel principle very important accounting principle rule principle states that we need to record transactions in the period when they actually occur not when related cash is paid or received this is the opposite of cash passes of accounting so we discussed a little bit of that earlier but an example would be if you pay the electricity bill for the month of January in the month of February according to the accrual principle record the expense in January so if you were not following a cruel principle you would only record the

41:37 transaction when you receive the invoicer when you receive the bill but according to accounting principle you know that the service has been provided electricity has been provided for the month of January that is the period when the expense has actually incurred so we will record this expense in the period in the month of January and you could also use an estimate if you don't have the bill and you don't know what the exact amount is but you want to be able to show the users of financial statements the the people who look at the results they should be able to understand truly when our expenses taking place this is one of the key principles to remember the next one is matching principle and another very important principle and it's somewhat similar to the accrual

42:23 principle and what it says is match revenue and expenses or costs and benefits so that they are recorded in the same period so an example is we record cost of sales expense in the same period as when the sales revenue is recorded So if a company buys some stock to sell again let's take the example of mobile phones right so so the company buys mobile phones and the company plans to sell them but let's say they bought 10 mobile phones in the month of January but they actually sold those mobile phones in the month of Feb okay so in the month of January we will not record any cost of sales although we did purchase those mobile phones and we actually even paid for them but they will be recorded as inventory

43:10 which is not an expense yet they will be recorded as an asset an inventory this is not an expense and this asset will only be converted into expense when the actual sales happen and this is in accordance with matching principle because we want to reflect the cost of sales in the same month as the sales is recorded so as soon as we record the revenue or sales which is the amount received from customers for those mobile phones and in that month or in that period we will record the cost of sales as well so this is what is matching principle if we did not do this then what would happen is we would be recording cost in the month of January and sales or revenue or income in the months of February and this way there is a mismatch in the timing of when income

43:58 and expenses are recorded which may be misleading another example is the recording of depreciation expense in each period for an asset according to its useful life so when we buy assets with uh which are long term or non-current assets for example if we purchase Furniture this furniture is going to be used by the company over a long period of time and usually a useful life is determined by a company for each type of asset so let's say for furniture a company has determined the useful life of 10 years as an example so the cost of furniture originally will be recorded as an asset the the day it is purchased it's not immediately expensed out but it will be actually be expensed or recorded as an expense in

44:43 the income statement over the period of its useful life so over the period of 10 years the cost will be allocated as expense this is a matching principle the next one is cost principle also sometimes called as historical cost principle and what it states is we have to record assets at their purchase price and do not adjust for inflation or market value fluctuations an example would be if a company purchases a vehicle a car so the company will record the cost in the books at the original cost of purchase and depreciate it over use over its useful life without considering any market value changes so if the car if you look at the market value of the car it may be fluctuating all the time and maybe in a year or two market value of

45:29 the car has either gone up quite a bit or has decreased quite a bit but those fluctuations are not to be recorded the historical cost the original cost at which the vehicle was purchased at is what will be recorded in the books for accounting purposes you have to make a note that this does not apply to all types of assets for example if we have short-term Investments the historical cost principle does not apply the historical cost principle also does not allow recording of assets which were not acquired in a transaction so we do not have a cost a reliable cost to measure them for example internally generated Goodwill or trademark the going concern principle it's also an important principle what it states is that there is an assumption that the business will remain in operations for

46:15 the foreseeable future we do not expect the business to be shut down in the near future so the business is expected to continue as it is the business is expected to have sales have customers have revenue and profits in the foreseeable future and we are not shutting down the business therefore as a result we do not need to write down assets because think about it this way if the business is continuing all the assets that the business have that have been recorded at original cost or historical cost are still valid it's it's still considered correct to keep the assets at their Netbook value the original cost less depreciation but if the business is discontinuing if the business is not going to continue the the management has decided to sell it

47:01 then in that case those assets may not be truly reflecting their value if we keep them at historical cost so for example a business has a very specific Machinery that costs a lot originally but that Machinery is not required Now by any other businesses there are no buyers for that Machinery so if the business is shutting down that asset value is then inflated it's overstated because really those Mutual economic benefits that were expected to be received from this Machinery are no longer valid the only way that Machinery was going to provide us those benefits was if we continued business and that Machinery continued to produce those products but now if when we are discontinuing the business for sure we are not going to use that machine and

47:48 nobody else is looking to buy that machine as well maybe we can sell that machine as scrap and that is really the true value of that machine then in that case the value of the assets needs need to be written down so unless there is a clear intention of management to sell the business or discontinue the business the going concern Assumption of principle applies which means that the carrying value of the assets which is their original cost less depreciation is still valid and can be kept in the books this is an important principle and you will notice that Auditors external Auditors when they audit the financial statements of a company they also assess the company's going concerned status they have to they have to do that and

48:34 they have certain criteria or indicators which help them make that decision that the company can present or prepare their financial statements with the going concern assumption the next one is materiality principle and what it states is that if the amount is not large enough to influence the decision of investors or decision makers a misclassification or Omission is not Material a there is an asset with a useful life of 10 years that costs only 25 dollars right so an example would be calculator some of the calculators last many many years right so in this case we if we look at a calculator which cost us only 25 dollars but we know its useful life is 10 maybe even more years right but according to the principle of materiality if we prefer to expense that

49:22 asset immediately basically not require it as an asset instead recorded as an expense in the income statement we can do that this is allowed so in this case we don't have to match the useful life of the asset with the allocation of its cost okay so this this is kind of an exception principle where only if the amounts are small enough you can choose to ignore some of the other accounting principles or you can even choose to ignore some of the practices materiality varies by size of organization so if it's a very very large organization of course its materiality would be larger it's amounts that are considered small or immaterial would be larger but if it's a small organization the amount that is considered in material will be smaller

50:10 based on this principle many organizations have a policy to record as expense asset costing less than a certain amount so you will see that very often that many organizations have an amount identified already that any amount that is less than this amount for example let's say five thousand dollars so a company may have a policy that any amount that is less than a five thousand dollars even though the nature of that item is an asset it's a it's an asset which has a useful life of more than a year still for accounting purposes that amount will be recorded immediately so entire amount will be recorded as an expense in the month of purchase Revenue recognition principles so the principle states that we have to record Revenue as and when goods or services are delivered regardless of when cash is

50:56 received so it's a combination of accrual and matching focusing on Revenue an example is when a product is sold for credit revenue is recorded when product is delivered not when cash is received okay similarly when revenue is related to a project work so it's a it's a long project it takes some time over which it's completed revenue is recorded based on percentage of completion not when payments are received so while the company may receive Advanced payments of let's say 50 on a project they will record Revenue based on the percentage of completion of that project and they are there are very specific guidelines in the standards on how to record the revenue in accordance with percentage of completion principle consistency principle but we need to

51:41 consistently apply accounting principles policies and methods unless a better one is available and this is again to help the users of the financial statements the decision makers understand the performance of the business over multiple periods of time if the company is changing its accounting policies and principles which also may change the treatment of accounting entries or assets liabilities income expenses in the financial statements then it is difficult for the decision makers to make decisions because they cannot compare the financial result between periods an example is a straight line method of depreciation so we discussed about an asset with a useful life of 10 years the company may choose either a straight line method to record depreciation which

52:27 is really total cost of the asset divided by 10 and then that is the amount that is recorded every year or they could also choose a reducing balance method which is not an equal allocation of depreciation over the useful life it's actually dependent on certain other factors which will result in higher depreciation being recorded in the first years or in the earlier years and then the amount of depreciation reduces every year company is allowed to choose any one of those methods but if they have chosen one the consistency principle requires that they continue to use that method over a long period of time unless there is a significant reason a major reason to make the change and it is better for the users of financial statements to have to make that change another example is the

53:13 capitalization policy we just discussed for example the amount of materiality the amount considered as the threshold under which all amounts are recorded as expense instead of assets the company should not change it every year right there should be a consistency in applying that threshold so now we will go back to the rules of deben and credit I think we have developed a very good understanding of assets liabilities Equity income and expenses we've also learned some of the key accounting principles we already know the rules of debit and credit so I think it's a good time to do some practice on the accounting entries and after we have done that practice we'll look at the flow of accounting entries into general ledger trial balance and finally financial statements such as balance sheet and income statement

54:00 okay so are you ready to apply whatever you have learned about the rules of accounting and accounting principles to actual accounting entries let's go so the first example that we are going to deal with is a business owner deposits thirty thousand dollars in the bank as Equity this is one of the very early entries or very early transactions in a business when a business owner is setting up the business initially they allocate some money they invest some money in the business and they have deposited thirty thousand dollars in the bank as original Equity of the business okay if you remember I mentioned the key in accounting is to understand the Dual impact that every transaction has so what will be the accounts that will be

54:45 impacted by this entry you can clearly see there is an entry in the bank so basically one count is asset which is cash and by the way in accounting we use the term cash roughly to also refer to About the Money in the Bank okay so uh the first item is Cash what is the other one well actually you can see that in the example it's the equity this initial deposit is made by the owner of the business as Equity so this is a contribution from the owner and it will directly impact the equity of the business okay so we have cash on one side we have owner's equity on on the other side what is happening to cash in this case is it increasing or decreasing well because the amount is being deposited it is increasing so cash is increasing what is happening to owner's

55:32 equity is it increasing or decreasing well for the business it is also increasing because the business had no equity or there was no business and with this deposit the business now has Equity so from zero to thirty thousand dollars there is an increase in equity what is the nature of the cash account is it an asset liability equity income and expense by now I'm sure you know cash is an asset and what about Equity well the name says it Equity is equity right so we can see that there is an increase in cash which is an asset and there is an increase in equity which is equity so what did we learn about the rules of accounting we know that when asset is increased there is a debit and when Equity is increased there is a credit remember assets and expenses debit when

56:19 increased everything else Credit One increased so the accounting entry would be debit cash 30 000. credit owners Equity thirty thousand okay so this was the first entry let's go to the next one okay the company buys furniture by paying ten thousand dollars cash okay what are the accounts here you can see that you can always see that in the in the example or the statement itself right so cash is one but what is the other one Furniture right so we have furniture and cash what is happening to the furniture of course there is an increase because the company purchased Furniture so company had has more of furniture by an amount of ten thousand dollars so there's an increase what about cash well this this time the cash is being paid out remember

57:07 in the previous example the business owner was paying cash into the business bank account so that's why there was an increase but in this case the company is paying gas so there is a decrease in cash okay what is the nature of furniture it's an asset what's the nature of cash it's an asset so we have an increase in asset but we also have a decrease in asset what we've learned from the rules of debit and credit as it increases debit as a degree asset decrease is credit so the accounting entry will be debit Furniture 10 000 credit cash 10 000. you see how the rules are applying and there are there is no exception let's move on to the next one the company now buys furniture on credit for ten thousand dollars so the company buys additional furniture they already

57:54 purchase for ten thousand and they purchase additional furniture for ten thousand but this time they did not pay cash they actually purchased it for credit which means they have some time before which they need to make the payment right so it's just Furniture coming in but what is going out well at this point nothing is going out but there is now a contractual obligation there's now a liability for the company and this should maybe jog your memory a little bit about a principle we discussed which is the accrual principle so we are not paying cash right now but we are purchasing and this needs to be recorded as a liability so the accounts that will be impacted

58:40 are again Furniture but the other side is account payable because whoever we purchase the furniture from is now expecting a payment from us of ten thousand dollars okay so the transaction has already happened the event that led to that ten thousand dollars of amount due has already happened and what we learned in the definition of liability is a past event resulting in an obligation to pay so the event has taken place we have purchased the furniture this has also resulted in a liability which is account payable although we're still not paying cash yet so what happens to Furniture in this case of course there's an increase what happens to liability or accounts payable there is also an increase and we know when asset increases there is a

59:26 debit but when liability increases there is a credit you see how every time there is always a debit and always a credit so entry would be debit Furniture 10 000 credit accounts payable ten thousand let's go to the next example the company now settles the amount payable for furniture okay so naturally we recorded the liability last time now the company has to settle that amount so there will be another entry at this point this is a financial transaction so what are the accounts now being impacted well first there will be the account payable that we recorded previously that ten thousand dollars that is that was a credit to the account payable now it will be reversed okay so account payable and the other side of the entry is of course cash because now

1:00:12 we are paying out the money okay so account payable is now decreasing because in the last entry it increased now we are settling it so it's going back to zero so it's decreasing and cash is also decreasing because now we are paying the ten thousand dollars so we know account payable is a liability cash is an asset liability decreasing is a debit and asset decreasing is a credit remember the rules of debit and credit so the entry would be account payable debit by ten thousand and cash credit by ten thousand let's look at another example the company pays twelve hundred dollars in rent for the building okay

1:00:57 now we know one side because this is again a cash payment we know one side of the entry is Cash what would be the other side of the entry it's not account payable because the company has already paid but this time this is an expense because this is a transaction which is resulting in a decrease in asset which is cash and we learn from the definition of expenses our expenses are items that decrease an asset and also negatively impact the equity or profits of the company because it's an expense it's a reduction in the profit so one side of the entry is rent expense and the other side is Cash is the rent expense increasing or decreasing well in this case the expense is increasing right because there was again

1:01:44 let's say the company started from scratch this there was no rent expense so far but now in the first month they have already paid twelve hundred dollars so there's an increase in rent expense and there is a decrease in cash because cash is paid out so this is a good example we know assets and expenses follow the same debit and credit logic right so if there is an increase in expense it's a debit and if there is a decrease in asset it's a credit right so the accounting entry would be rent expense debit 1200 and cash credit twelve hundred dollars let's take a look at our next example so the company receives 500 in dividend income from an investment okay maybe we we skipped a transaction where the company would have invested in another company as their investment but let's

1:02:31 say the company had invested in another company and now they have received dividend on that investment what are the accounts that will be impacted one again we know is Cash because the company has received 500 what is the other one well in this case this is the opposite of the expense because the company has received money which is actually increasing in asset so we know that definition of income is an increase in asset and also an increase in profit because now the company has five hundred dollars more for the owners of the company so one account is Cash the other one is dividend income what's happening to cash is it increasing or decreasing of course it's increasing dividend income is also increasing so we know when asset

1:03:17 increases there is a debit and when income increases there is a credit so the accounting entry would be debit cash 500 credit dividend income 500 dollars let's go to the next example the company buys 10 bicycles for resale at the cost of five thousand dollars in cash so what are the two accounts that will be impacted again one is easy if the company has paid cash and the other one bicycles these bicycles will be kept by the company as long as they are sold right so the bicycles are an asset to the company because they are expected to provide economic benefit or money in future right so one of the account is inventory

1:04:04 now any assets that the company buys for resale and as long as they are with the company and not sold yet are considered stock or inventory in accounting language and the other side of the entry would of course be cash so what's happening to inventory of course it's increasing the company has let's say zero inventory of bicycles now they have 10 bicycles so there is an increase in this asset and on the other side there is a decrease in the asset which is cash so increase in asset is debit decrease in asset is cash so accounting entry would be debit inventory five thousand dollars credit cash five thousand dollars so note that we discussed this in the accounting principles as well the matching principle although the company

1:04:50 has purchased this these bicycles for sales but they are not recorded as an expense yet and the reason is because they have not been sold yet the amount will be recorded as expense depending on when and how many bicycles are sold so we are waiting now we are keeping the bicycles in the inventory as assets

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