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Transcript of Accounting 101
This is Hal, your penguin companion that will take you on a journey to understanding the basics of accounting
don't understand is the
How to make a BALANCE SHEET?
Imagine for a moment that your organization takes a decision to stop maintaining accounts. Instead, it keeps a large box in the middle of the entrance lobby, and each time a financial transaction takes place, someone writes it down on a piece of paper and puts it in the box.
At the end of a certain period, the box is given to you and you are asked to make a Balance Sheet.
Can YOU do it?
Of course you can.
How will you go about it?
First of all, keep a template of a balance sheet as shown here:
Definitions and misconceptions
Accounting & Accountability
Accounting is about ACCOUNTABILITY:
: explanation for manager's conduct in front of external stakeholders. Basically, you explain to people that are interested in your activities why you took the decisions you've made.
financial and managerial
2 types of report
Accounting is used by two main users. Internal users (like the manager) and external users (like the government). Therefore, there are two types of accounting; one for each user. External accounting is known as
, and internal accounting is known as
Accounting is the
of financial transaction of a business.
Come on in for the bumpy ride; complications coming in!
"Bro, accounting is hard! I didn't understand shit during the lectures..."
"Why does it have to be sooooo hard?
Shut the f*** up Karl. Accounting is EZ
Let me show you
Its the "Eat, Sleep, Rave" version of the business world
3 steps of accounting:
Analysis & recording
Selecting and classifying information
Measuring profit & loss
Communicating the information
What is the point of accounting?
To get a clear image of what you own, and what you owe.
Helping in decision-making
Providing a way to measure productivity.
Helping the monitoring of economic activities by stakeholders.
Helping potential investors.
Statement of cash flow
Balance Sheet or Balance sh*t?
Now comes the part you've all been waiting for. How on earth can you understand a balance sheet?!?!
Well, lucky you, i can show you in a matter of 10 min!
A balance sheet is a financial statement that lists an organization's
It is also called a
Statement of Financial Position
"So what's an asset? And a liability?"
constitute what the organization owes, that is, what it has borrowed. For example, a bank loan.
on the other hand, represents what the company owns, or the things that were purchased with the borrowed money. For example, a factory.
Allow me to further explain those concepts to you
When a business needs money, it borrows:
If it borrows from the
of the business, it is called
(It may sound like contradicting terms 'borrow' and 'owner'. However, for accounting purposes, the owner is considered as independent and distinct from the organization.)
If it borrows from
, its called a
Any other liabilities are "
", which include creditors, the amount payable to suppliers and vendors, and bank overdrafts.
It should start to make sense now... Let's move on to assets
Typically, assets include investments in land, building, machinery, vehicle, computers, tools, etc...
The secondary category of assets, called
, include items like debtors, cash and bank balances, and inventory.
Land, building, machinery, Plant, ...
Creditors, bank overdrafts
Debtors, bank balance,
Makes sense... But how do i make a balance sheet after knowing this???
...but first, let me answer some FAQs
How do you define accounts?
Accounts are a record of financial transactions that takes place in an organization over a specific period of time.
When do we call a transaction a "financial transaction"?
Any transactions that either brings money in or takes money out of the organization can be considered a financial transaction.
ASSETS = LIABILITIES + STOCKHOLDER'S EQUITY
For some reason, this formula is little hard to understand, so i'll try to explain it.
If you re-arrange the formula, it becomes simpler to grasp its meaning, like so:
ASSETS - LIABILITIES = STOCKHOLDER'S EQUITY
You must understand that
is a complicated word for "
". This formula is much like the profit formula:
Basically, you subtract what you owe from what you own to know how much you truly have in your bank account.
Plant & Equipment
Long Term Liabilities
Get your shit together man. take a look at the explanation.
Now, put your hand in that large box, and pick a sheet of paper at a time, look at the item, and try identifying whether it is an asset or a liability.
Perhaps you feel this can't be done...
Well- let's try it out, shall we?
Let's say, on our first piece of paper that you took out of the box, is written "Salaries & Wages". Where will you record this? This appears to be a liability, because it is money owed to a party outside of the company. Even though employees work for the company, they are considered external parties.
wages & salaries
The next piece says "Loan taken". That's a
, because thats money you
Next one? "Equipment purchased". Now, because it has already been purchased, it is part of the company's property, and is therefore, an "
"Money invested in stocks of other companies"? Well, now that you
those stocks, they represent
of the company.
Investment in stocks
See? We can go on and on in the same manner, and you'll see that for every financial transaction you come up with (or piece of paper), you'll be able to classify it as either asset or liability.
Balance sheet is a financial "
" of a company at a given time. That means that the validity of every item on the balance sheet holds good only at a particular date.
For instance, if an amount of 500,000$ appears under the head
, that means that on December 31st, the organization had a bank balance of 500,000$.
Also known as
"Statement of Profit & Loss"
, or even
"Statement of Operations".
As its name suggest, it is used to see if the company is doing profit, or if it is in loss.
or even profit & loss
"Something the stupid penguin forgot to mention, is that there are 4 types of transactions actually:
Expenses, Income, Assets, and Liabilities"
Profit & Loss
"Remember the balance sheet the penguin made? Well, there is a version of it with the
(profit & loss account)"
Profit & Loss
You pick a piece of paper from the large box, and it says "salaries & wages". This appears to be an expense, right?
wage & salary
Another piece of paper, except this one says "Goods & services sold". This, is an income.
Goods & services sold
"Interest paid on loan"? EXPENSE!!
"Rent and electricity bills" => EXPENSES!!!!
Interest on loan
Rent and Bills
But what about "dividends received"? Well, that would be a source of income.
Dividends from stock
You get the gist of it, don't you...
Alright everyone, lets give Steven here the round of applause he so desperately wants...
Anyway, he has a point. But this shithead managed to confuse you between assets, income, expense, and liabilities, so we'll clarify this before you pull your hairs out of your head. Oscar, explain them.
Hey guys, I'm Oscar, the bear. You must understand that expenses and assets are correlated, much like income and liabilities.
Expenses & Assets
Look at any expenses, say "
". Pick any Asset, say "furniture". Both involve spending.
If we spend 100 000$ on payment of salaries today, it will be an expense. If tomorrow, we spend another 100 000$ on furniture, it will appear as an asset. In both cases, money was spent. BUT, in the first time, its an expense, and the second, it created an asset.
Income & Liabilities
If both expense and asset involve money going out, income and liabilities involve money coming in.
If i give you money in exchange for a product that you are selling, this receipt of money is an income to you.
If I give you more money, but this time for a loan, it will appear as a liability on your balance sheet.
1st case is an income, and second case it created a liability.
Now, if i give you a financial transaction, you'll be able to tell me if money comes in or if money comes out. So instead of having 4 choices, you can now narrow it down to 2 of them. Now, to distinct both, we'll see what differentiates them apart.
Expenses & Assets
To clarify thing, money spent is not
one or the other
. To differentiate the two of them, we need to clear out certain misconceptions;
Money spent on tangible items are
, and the rest is an
Raw materials and consumables are also tangibles, but are considered under the expenses category.
Expenses are small value items, while assets are of higher value.
Large companies spend millions on salaries, which appear as an expense, while a small value item such as a desk, would be shown as an asset.
What really decides whether money spent is an asset or an expense, is actually the life of the item considered.
Looking for clues
looking at the titles of the statement
profit & loss a/c for year ending...
This means if you are looking at the annual profit & loss account, every figure in it represents
numbers for the year. Sales would be for the entire year, salary would be salary for ll 12 months, etc...
Balance sheet is a statement of assets and liabilities AT A PARTICULAR DATE!!
Like I said before, validity of every item on the balance sheet holds good only on a particular date.
Now, what did i mean by "
it is the life that decides if its an asset or an expense
Here are some examples to help you understand.
December 31st. New year closing in. You're paying December's salary for the employees. But, one of them wants advance payment for the next 6 months, in addition to his December wage. Being the nice and loving person you are, you agree.
If the organization prepares a Profit & Loss account for the year ending December 31st, and a balance sheet for December 31st, where will the salary for the following month appear?
It will appear as an Asset in the Balance Sheet
This is because the life of the salary in this case was long.
Now imagine your $1.5 billion factory where you produce "Connect One"
HOW DOES HE KEEP WINNING?!?!?
Factory destroyed in November
If the company closes its accounts on December 31st, where will the cost of the building appear? The entire cost will be reflected on the expense's side of the Profit & Loss a/c.
What i want you to understand, is that salary is not an expense just because its salary, or that building is always an asset, just because its a building.
BUT FIRST, TAKE A BREAK! YOU NEED IT!!!
Simply put, anything that outlives the Balance Sheet date is an Asset
Money spent on something that gets entirely consumed, before the balance sheet is made, is called, an EXPENSE
Money spent on something that is not consumed at all, on the date of the balance sheet, is called an ASSET.
Starting to get the BIG PICTURE?