Hi.
Else here.
And in this video we'll be analyzing and recording
business activities using the account
names and the basic accounting equation.
If you have not as yet memorized the definition
of the financial reporting elements,
or you don't know how to analyze business transactions using
the critical and enhancing question,
you'll be lost in this video.
I highly recommend you go back to my previous videos
to get a handle on that before continuing here.
Remember that any accounting system
should provide information that is ready to use
by decision makers.
Stakeholders use accounting information
to make resource allocation decisions, basically, what will
they do with their money.
In the previous videos, we use the basic accounting equation
to record transactions.
But remember that we discovered, although it provides
information about the financial position of the company,
it's not able to tell us much more than that.
For instance, here we know that assets equal $1,975.
That's equal to liabilities of $250 plus equity of $1,725.
But we don't know what the profit for the business
was, because the basic accounting equation will not
tell us that.
We then use the expanded accounting equation
to gain additional information that the basic accounting
equation wouldn't give us.
For instance, using the expanded accounting equation,
we know that the profit was $1,375.
That's made up of revenues of $1,450 less expenses of $75.
However, we still don't know any details
about what makes up our assets or our liabilities.
For instance, do we have a lot of equipment
and almost no cash?
This is important information if, for instance,
the stakeholder looking at the information is a bank,
and they're deciding whether or not to loan money
to our business.
Even though the expanded accounting equation gives us
more information than the basic accounting equation,
there are still questions that cannot be answered for decision
making purposes.
In this series of videos that you'll
be introduced to accounts, common subgroups
of financial reporting elements that are used to
accumulate-- that means gather together-- business activities.
With the addition of accounts, the accounting system
can be used to produce the financial statements.
That's what stakeholders need in order to better understand
the business.
The financial statement tells the story
of the business, its financial position and profitability.
They're used by external stakeholders
to make decisions about their interactions with the business.
Similar to the previous videos, we
have to have a set way to analyze business transactions.
The best way to do that is to have a series of questions
that you can ask yourself every time you analyze a business
activity.
Let's remind ourselves of the critical and enhancing
questions that you should use every time you read and analyze
a business activity.
The critical questions are the ones you should ask first.
The questions are: what did the business get?
What did the business give away?
If you're still having a problem determining
the impact of the business activity,
then move on to the enhancing questions
in order to clarify your thinking.
The enhancing questions are: What did the business earn?
What did the business use, consume, or incur?
And what does the business owe?
Always start with the critical questions,
and then move on to the enhancing questions
so you're sure of the impact of the business
activity on the accounting equation
before you record them.
Before we can move forward with analyzing transactions,
we need to understand what accounts we'll be using
and their definitions.
That way, when we analyze a transaction,
we'll already have an idea of the accounts, their definition,
and the financial statement element they belong in.
Recall that there are five basic elements: assets, liabilities,
equity, revenue, and expenses.
Accounts are grouped using the same financial reporting
elements, so we can review the common accounts
under each element in that order, starting with assets.
Remember that assets have three characteristics.
They are owned by the business, or the business
has a legal right to use that asset.
The asset will benefit the business in the future.
And the asset exists due to something
that the business did in the past.
As with all the elements, assets increase with a plus
and decrease with a negative indicator.
So, what are some common asset accounts?
First and foremost is cash.
You'll notice that every asset account has
very similar characteristics to the financial reporting element
assets.
For instance, cash is owned by the business.
It will benefit the business in the future when they use it,
and it was received by the business
during a past transaction.
When the business receives cash, the indicator is a plus.
And when they get rid of cash-- say, to pay a bill--
the indicator is negative.
You'll see something similar for every single asset account.
The characteristics match, because if they
didn't, the account wouldn't even be an asset account.
Accounts receivable are the next asset account.
They represent a business's legal right
to collect cash from a customer at some point in the future.
When a business sells on account, also called
for credit, they give away a service,
but they get nothing from the customer but a promise to pay.
That's an accounts receivable.
Every sale made on account increases
accounts receivable with a plus.
When the business collects the cash from the customer,
the accounts receivable is decreased with a negative.
Prepaid expenses are next.
They're the one asset account that causes the most confusion,
likely because they have the word expense in the account
name.
But a prepaid expense is not an expense.
Instead, it's an asset that will become
an expense in the future.
For instance, say a business purchases a two year magazine
subscription for $120.
The business pays for the subscription now,
but what do they get?
Nothing.
But they do have a legal right to receive magazines
in the future.
When they receive those magazines
the cost will become an expense, because you
got what you paid for.
When you pay for something in advance,
you record a prepaid expense with a plus.
When you receive it, you reduce the prepaid expense
with a negative.
Other common prepaid expenses are things like insurance
that you bought now for the upcoming year, rent
that you pay now for next month's use of the space,
or advertising you pay now but will not
come out in the newspaper until next month.
All of these are assets because you have a legal right
to receive a good or service at some point in the future.
When your business buys office supplies,
you receive something now like pens, pencils, and staples,
that will benefit your business in the future.
So it's an asset.
When you receive the office supplies,
it increases your asses with a plus.
But when you use up the supplies,
and that will only happen in the future,
you will have to record a negative to the office
supplies accounts.
Assets will decrease.
Equipment is another asset account
that you buy now to benefit your business.
But in the future you will use it up.
When you receive the equipment, your equipment account goes up.
But when you use it up over time,
the value of your equipment will decrease with a negative.
Intangibles are assets which are not physical.
You can't touch them, sit on them, or kick them.
Instead, they are a legal right that the business
has that will benefit them in the future.
Common intangible assets are things
like patents, which is a legal right
to use something exclusively; licenses, which is again,
a legal right to use something exclusively;
and copyrights, my goodness, a legal right
to use something exclusively.
None of these are physical.
But they are just as much asset accounts,
because they are rights that will benefit
the business in the future, and they are due to something
the business did in the past
We've now finished up with all the common asset accounts.
So let's move on to liabilities.
Like assets, liabilities have three characteristics
that define them.
They are all owed to third parties, entities outside
of the business.
They are always settled by giving up either cash, goods,
or services.
And finally, they are always due to something
that the business did in the past.
The most common liability account is accounts payable.
This happens when the business buys
a good or service in the past, but they have not
paid for it yet.
They therefore, have an account with a supplier
that they will have to pay in the future.
When a business buys on account, also called for credit,
they increase their accounts payable.
And when they pay it off with cash, the account decreases.
There are other payable accounts that
have the exact same characteristics as accounts
payable, but they are not recorded as accounts payable.
Instead, more specific account names are used.
Remember, they have the same characteristics.
They are owed to a third party, paid with cash in the future,
due to something the business did in the past,
but their names are more specific.
The most common account names for these accounts
are things like salaries or wages payable, rent payable,
income tax payable, and interest payable.
As you can see, all of these represent
cash that is owed to someone outside of the company that
will be paid at some time in the future.
A very similar account is loan payable,
but I've listed this one separately because in this case
the business did not receive a good or service.
Instead, they received money, cold hard cash from a lender,
also called a creditor.
Loans are legal agreements with a set interest
rate and a deadline when they're due, called a maturity date.
The business owes their creditors the money
back once the maturity date is reached.
Loan payable has other names too, such as bank loan payable
or note payable.
Be sure you read the transaction carefully
so you know which account to use.
If the transaction doesn't give you the exact name,
then you, the person recording the business transaction,
gets to choose the account name to use.
The last liability account is an unusual one: unearned revenue.
Like a prepaid expense, students often
think that this account is a revenue account,
and that it belongs in the revenue financial reporting
element.
But they would be wrong.
Unearned revenue is what a customer pays the business now,
but they get nothing in return.
Instead, they will get something in the future.
For instance, assume this time that the business
is a publishing business, and they provide magazines.
When they receive the $120 from their customer, they got cash,
but they have not as yet provided any magazines.
That means they owe their customer a lot of magazines
in the future.
And that's a liability.
Unearned revenues are when a business owes their customers
a good or service in the future for which they have already
been paid in the past.
Definitely a liability account.
We've now completed both the common asset
and liability accounts.
In the next video, we'll move on to equity.