Mark Farber: Hi, I'm Mark Farber and this is Accounting Fundamentals.
What we've been doing up until now is we started to record transactions.
We looked at transactions a few videos ago and keeping track of things that a company
does without using accounting so to speak but just keeping track of increases and decreases
in cash and revenue, et cetera.
Then we introduced the concept of debits and credits.
We recorded those same transactions into a journal.
We said that in order to make sure that our accounting equation remains in balance we
have to make sure that the debits and the credits from each transaction are always equal
to one another.
We next wanted to see how much we had in the various accounts, so we took all of our transactions
out of our journal and we posted them into the ledger accounts.
That's what we have over here from the last video, is those ledger accounts that we created.
We can look at this now and we can say that at a particular point in time, whenever we
decided to stop, and it's usually at the end of a month or at the end of a quarter or the
end of the year.
We've calculated the totals in each of our ledger balances.
They're very simple because we only have five transactions here.
We've determined that we had a debit balance of 500 in cash.
Notice that I say a debit balance, we don't talk about plus $500 or minus $500.
We talk always in terms of debit and credit, so a debit balance of 500 of cash, debit balance
of $3,000 in accounts receivable, a debit of $2,000 of equipment, a credit of $3,000
in revenue.
But we've lost that ability to see when we look at our ledgers, are we still in balance
vis-a-vis the accounting equation?
Did we make a mistake when we took all of our transactions out of the journal and we
posted them?
Did we accidentally turn a debit into a credit or vice versa, or recorded a number wrong
or something?
We need a way before we continue on to double check that everything still balances out,
because remember, once it's no longer in balance, our accounting won't work.
What we use is something called the trial balance.
A trial balance is a document that's prepared by companies and it's an internal document,
they don't show this to anyone.
It's used as a double check and also as a means of very quickly seeing the balance in
all of the accounts, all in one place.
What we're going to do is we're going to create a very simple trial balance over here.
As with any form or any report that we create, at the top it's going to have the company
name.
I didn't name our company so I'll just write, "Company Name."
Then it's going to have what kind of report it is.
In this case it's trial balance.
Then very importantly, and we haven't been putting in dates just to keep things simple,
but you always record the date that you did the trial balance on, because that's going
to tell us that on this date this company had $500 of cash, tomorrow it might have more
cash or less cash.
It's only good as of that date.
Then what we're going to do, I'll make a little column for debits and credits, is we're going
to list off all of the accounts.
They get listed in a particular order.
Remember when I did this?
I did assets, liabilities, equities, revenue and expenses.
We can put in our little pluses and minuses to remind ourselves again.
That's my little cheat sheet that I use to keep track of whether I should be debiting
or crediting something.
I wrote it in a very specific order.
You should get used to that order, assets, liabilities, equity, revenue, expenses.
That's the order that we're going to always list things off.
We'll see later on that there's a reason for that.
For now, let's just go with it.
I'm going to list off, first my assets.
I've got cash, and cash has a debit balance of 500, so I'll put in $500.
Next, I have accounts receivable.
That's also asset, I'm going to write it as AR.
That has a debit balance of 3,000.
Then we have equipment, also an asset, remember assets are things that the company owns, it
owns its equipment.
The equipment in this case was a computer, $2,000.
That's it for assets.
Now, there's no liabilities in this company.
They don't owe anyone any money so we can ignore that.
Next we have equity, there's capital.
Capital, and that's a credit balance of 5,000.
Again, be very careful that you get things in the right column here.
Withdrawals is a negative form of equity if you will, but it's a form of equity nonetheless
so we'll put in withdrawals.
It has a debit balance of 500.
Next we have revenue and my revenue is $3,000, it's a credit balance.
Finally we had one expense, rent expense.
That was $2,000, again a debit.
Okay, there's all of our accounts nicely organized in two columns.
What, you say.
Well, now I can add up the columns.
On the credit side I have 5,000 plus 3,000, that's 8,000.
On the debit side I have three, five, seven and another thousand is 8,000.
In other words, my debits equal my credits still.
I know that if all the debits equal the credits, I should still be in balance.
I haven't made any mistakes.
If there were mistakes, we can look at those later on and figure out how we're going to
fix them.
This tells me that after having gone through the process of taking all of my transactions
from my journal, posting them to my ledger, I haven't made any errors, everything is still
in balance and I can continue with the accounting process.
The other thing this does is it gives me another visual check, because remember we said assets
are debit accounts.
Here's my assets, and notice that they all have debit positions, which is good.
Liabilities, we don't have.
Equity is a credit account.
There's my equity accounts, the bulk of it is a credit, there's a small debit, the withdrawals
but remember we said withdrawals are kind of like a negative on equity, it's a reduction
in the company's equity.
Revenue is a credit account, in fact revenue will always, always, always only have credits
in it.
You can never ever debit, well, there's one time when you can debit revenue, we'll see
that shortly, but otherwise it will always have a credit balance.
My expenses are debit accounts, there's the expenses and it's in debit.
Another way of checking, to make sure that everything looks right before we continue
on, because now things are going to start to get interesting.
What we're going to do next is we're going to look at the difference between what's called
cash accounting and accrual accounting, and figure out what that difference is and how
it impacts what we're going to be doing going forward, which is going to be adjusting accounts.
Now it's going to start to get a little bit more interesting.
See you soon.