Learn Accounting in 1 HOUR First Lesson: Debits and Credits

Today we are going to

learn

how to do

accounting

without nonsense, without nonsense, without frills, just what you need to know. I'm assuming you just started your

first

accounting

course, but maybe this is your

first

accountant or either way we don't have exposure to accounting at the end of this

lesson

. I'll do it by looking at the books of a Fortune 500 company and I guarantee you that what you're seeing is that one of the biggest attractions of accounting is that the math is simple, it's not like calculus or trigonometry, where you need a scientific calculator. to determine an answer that is just a number.

Accounting only requires your basic four-function calculator. In fact, you don't even need multiplication and division functions to do accounting, but the best part of all. is that accounting math always balances this keeps you on track and makes you feel warm and fuzzy inside when you're done The most important formula in all of accounting is this: assets must equal liabilities plus equity is a residual amount which represents the value of your interest in the business. In fact, let's do some simple algebra to rework this formula and give you proof of the value of the assets you own, unless any liabilities you owe to others equal your equity.

We could also convert this formula into three conceptual boxes on the left we have assets, this box represents the value of our assets on the right we have a liabilities box and a capital box these boxes represent the value of liabilities and capital an asset It is something that you own of value that is cash or can be converted to cash in the future, so obviously your bank account is an asset, when someone owes you money, it is called accounts receivable and that is also an inventory of assets. , it is something that you can sell to convert it into cash, so it is an asset and if you own any property or Equipment that is also an asset because it can be used to manufacture inventory or can be sold directly to a buyer for cash.

On the other hand, a liability is not an amount you owe someone. Banks will lend us money and expect us to pay back. Subsequent suppliers will ship the products to us today and ask us to pay for them at a later date, essentially keeping the money too. We call this Accounts Payable. He said another way that the assets of your business must be financed with money if you are using other people's money we call it liabilities if the money of its owner, for example yours, we call it equity. Note that the boxes are precisely aligned. The asset box can never be larger than the combined liability and equity boxes.

I still have time to

learn

. Ledger accounts used the terms debit and credit as a way of saying they are increasing or decreasing an account. An account could be an asset account, such as cash, or it could be a liability account, such as an account payable. Now you must remember this part. your accounts always have a debit balance, so if you have $100 in the bank account, your books will record that you have an asset with $100 in debit, the box on the right side, the liabilities in the capital accounts tab, balances creditors because the box on the left must always be equal to the boxes on the right, you can add up all the

debits

of your assets and do the same with your

credits

in the liabilities and capital boxes and, lo and behold, you will discover that they are always equal for this reason when we fill these boxes with numbers. to create a report, we call this report a balance sheet, let's just put some numbers in these boxes for fun and to help you connect a conceptual model to reality, our assets are on the left, starting with $100 cash, pop quiz , is this a debit or a credit amount yes as a debit amount the assets are always dead count down we have accounts receivable of one thousand five hundred forty three dollars you mean someone owes us one thousand five hundred forty three dollars we have an inventory of one thousand three hundred and forty-two dollars and some investments worth three hundred and seventy-two dollars and property, plant and equipment or six thousand eight hundred and thirty-two dollars the total value of all assets in the business is ten thousand six hundred and eighty-nine dollars but we are not entitled to that full amount because we owe other people money for some of these assets.

On the right side we list our liabilities. We have a line of credit with the bank for five hundred and forty dollars, in other words, the bank lent us. five hundred forty dollars short term our suppliers the people we buy our inventory from two thousand two hundred ten dollars the bank or some other lender has given us a long term loan for three thousand eight hundred fifty dollars and our total liabilities are six thousand six hundred dollars, which is the amount we owe other people, which then leaves a residual amount of four thousand eighty-nine dollars of capital that represents the value of our interest in the business.

This is not a bank account. It's a mathematical representation of our interest, the seniors' interest in the business and nothing more, let's just test your understanding of this balance sheet, let's say your business sucks, it sucks like a turn of the century dotcom company, in other words, the business. I kept losing money and instead of positive four thousand eighty-nine dollars in equity, you have negative four thousand eighty-nine dollars in equity. My question for you is: is that balance a debit or a credit? Hmm, in fact, you have a debit balance when you have a negative equity balance, it is not normal, but it is very possible that you do not see this phenomenon in your assets or liabilities.

You cannot have a negative asset or a negative liability, but you cannot have positive or negative capital. Luca Pacioli is nicknamed the father of modern accounting because he was the genius behind double-entry accounting. He was the first to suggest that every transaction should be recorded with a debit and credit for exactly the same amount in different accounts, doing this religiously and pardon the pun because he was a monk, you preserve the integrity of our conceptual model, which always must equal liabilities plus equity to understand the mechanics of accounting and doing accounting, you need to know a little bit about accounting systems, that balance sheet, I just showed you a few moments ago is a report of an accounting system, Those numbers I shared with you don't happen by accident or all at once, they are the result of dozens, hundreds of thousands, sometimes millions, of accounting entries to record business transactions, so let me.

Show you how an accounting system works. There are five stages in a typical accounting system and we look at each of them in turn. Your chart of accounts is a list of all your accounts within the categories of assets, liabilities, and equity that we haven't talked about yet. on income and expense accounts, but in reality they are just a subcategory of capital; Think of your chart of accounts as setting up and recording groups for various types of transactions; You can have as many accounting groups as you want; It all depends on the type of detailed information you have.

I want to get out of the backend, the idea behind setting up a chart of accounts is to aggregate similar activity in the same account, so for example you might want to capture all your travel expenses in one account to set up a travel expense account. travel in your plan. Accounts If you have six bank accounts, you may want to set up six separate general ledger accounts to keep track of the accounts. Journals are where we record business activities. Think about all kinds of activities that could occur in a company, from selling products to making payroll to collecting accounts receivable.

From purchasing inventory to paying suppliers, all of these types of transactions result in what in accounting we call a journal entry. A journal entry is made up of an equal number of

debits

and

credits

and the respective accounts that you want Hagrid to post to when you are When using accounting software, you may see several entry screens, some of which look like a journal entry. standard, as you can see, this comes from a module of the accounting system that we call general journal, which is a free way to allow you to debit and credit any The journal entries account always has a description so that the foundation of the journal entry is documented and clear, then selects the related accounts from the chart of accounts, finally enters a mouse to debit one or more accounts and the same to credit others. accounts when you are in a sales or purchasing module, it is common that you do not even see the words debit or credit anywhere in the sequence, as I show you here;

However, you can be sure that NBI, the interface, the system is doing the comparison of the debits and credits on your behalf, all these debits and credits are added up in what we call books of accounts. A ledger will give you the details of all the transactions that have been recorded in a particular account, so here I show you the details of the ledger. From the cash account there are three debit entries for cash received and deposited of one hundred two hundred and five hundred dollars respectively and one credit entry for one hundred dollars for an expense note which are four separate transactions with four separate journal entries now, in In this view, you are only looking at one side of the journal entry to see the other side, you must look at the other accounts, so for example, the $800 travel expense was a cash credit since the cash left the business. and the travel expense account was debited for the same $800.

A trial balance is a list of all the balances in each of the general ledger accounts. Once again, that is the manual work that ensures all the debits equal. to all the credits, the only thing relevant about the totals is that matching the total number is meaningless, otherwise you have a trial balance, you can prepare financial statements which we will cover in another

lesson

and, in front of the tests, We classify accounts according to whether they are assets, liabilities or capital and for the moment, let me continue by saying that capital accounts include income and expenses.

We will split these accounts into a separate statement in a moment. We will compare this statement with our conceptual model. The assets total two hundred and seventy-six dollars and eighty-five cents. This is a debit balance. The liabilities total eight hundred. and twenty-two dollars and fifty cents, this is a credit balance, the principal is negative, five hundred and forty-five dollars and sixty-five cents, is this a debit or a credit? That's right, it's a debit because the company has lost five hundred ninety-five dollars and sixty-five cents so far, if the company had earned income, it would have been shown as a positive number and a credit balance.

Pause the video and ask yourself if you understand how numbers are processed through an accounting system. I hope that's clear because now we're I'm going to add another layer. I have alluded to income and expense accounts and we looked at some of these when we looked at the accounting system so far. All I told them is that these accounts are really part of the estate. In truth, we often want information. about how much money we are earning during a given period of time, so there is another statement that helps give a little more information about the equity, namely the statement of changes in equity, to complete your understanding of debits and credits that we need to understand the accounts that bring up the statement of changes in equity this statement tracks the continuity of the equity balance from the beginning of the period to the end of the period there are two elements to consider in this statement first transactions on account of Income and Second Capital Account Transactions Let's start with income transactions, which are essentially the transactions of business activity that produce income and expenses.

Here we take all the income and expense accounts for the trial and prepare what is called an income statement. The income statement tells us how much money the business has made over a period of time. We typically measure revenue in terms of a physical month, quarter, or year. When we collect cash from customers, we debit cash and the credit goes to revenue. We think that income has positive capital and what is positive capital. a debit or a credit, that's right, it's a credit, income is always a credit, expenses arise when we pay our bills, we credit cash to reduce an asset account and the offsetting debit goes to an expense account, once again , think of expenses as negative capital, as we saw.

The above negative capital and expenses, by definition, are therefore debit balances. The net amount of income minus expenses is your net income. If your business has made money, you should have more assets and no liabilities at the end of the period than at the beginning, which works out. in a net credit to your capital balance, on the other hand, if your expenses are greater than your income, then you will experience a net loss which is a debit to your capital balance. Please note that net income is notNote that net income per se is not net income from a general ledger account is simply a mathematical difference between income and expenses.

Element number 2, which deals with capital account transactions, is the other way that capital can change during a period in which the owners contribute or withdraw assets to or from the business. changes in the capital balance, for example, suppose you invest $50 cash in the business to start, your journal entry would be to debit the cash for $50 and credit the capital for $50 if later in the year the business writes to you a check to allow you If you withdraw $100 from the business, this time you would credit cash for $100 and debit capital for $100 for new accounting students. The statement of changes in equity is the most difficult to calculate, so we'll come back to it, but for this lesson just keep in mind that Every journal entry you make has two sides and often those sides impact equity, either directly through contributions and withdrawals or indirectly through income and expense accounts.

Let's summarize how you prepare journal entries, as that seems to be the key starting point once you've set up your account shift. Basically, there are three steps in step one. Something happens in the business that warrants a journal entry. There are hundreds of different types of journal entries that can arise, but. To keep things simple in our example, let's say you've completed a babysitting job and collected cash from your client worth $40. This is a reportable transaction, so let's see if we can work on the accounting. In step two, we prepare the journal. entry considering your account turnover and our debits and credits when we collect cash we want to increase our cash account remember that cash is an asset and since the accounts are debit balances, therefore, to increase the cash we will debit $40 in cash, this is will add to the balance that is already in the general ledger account but now we need the other side of the entry, we need to think about an account to credit the credit side does not affect a liability account because we don't know that $40 for anyone, in fact , they are It's ours to keep, so it must go to capital, so a few moments ago I just told you that capital is generally made up of contributions and withdrawals from the owner or from income accounts.

You must decide whether this is an income or equity transaction. Take a moment to Consider, hopefully you have identified that this is a revenue transaction that we generate money for the services we provide, therefore the credit side of this entry will be for an account such as sales or revenue for the $40.00 we raised. The last step is to place the entry in the ledger. the computer will do this for us if we use software, but I'm pretty sure your teachers will ask you to do it manually to show your understanding when posting the entry. You would debit the cash account for $40, which means adding $40 to Whatever balance is currently in the cash account, you will do the same by crediting the sales account in later lessons.

I'll demonstrate the mechanics using a spreadsheet. Hey, take it out. Your entry has been published and you can move on to the next one. transaction, so let's summarize what you need to know from this lesson, firstly, assets must equal liabilities plus equity, secondly, total debits must always equal total credits, thirdly, no There is no such thing as a unilateral journal entry for each transaction, at least two accounts must be adjusted. one credit and one debit, although you can have more than two accounts included in the same journal entry, but that is another lesson number five, assets must have debit balances, liabilities must have credit balances, finally number six, the change in equity must be reconciled by calculating net income and adjusting for owners' contributions in the drawings.

Do you think it's time to show you what this looks like in the real world? Introducing the Home Depot financial statement center, one of the largest retailers in the world. I know what you're thinking for fifteen minutes. You've never heard of accounting in the past and now I'm about to show you the finances of one of the largest companies in the world, but I believe in you and I believe you can do it, let's start with the balance sheet, there's the total. Assets per billion and change that bounce off the total liabilities and capital. Note that the various types of assets we talked about, most of them will save goodwill for much later lessons.

We have liabilities of $28 billion in all accounts payable and debt, just as I told you. Some accounts, such as deferred income taxes, are handled by those of you who will move into intermediate accounting in your second or third year program and into stockholders' equity. This is a little more complicated than what I presented, but the idea is exactly the same. Depot has $12.5 billion of capital on the books, but the balance sheet alone doesn't tell us the full story of what happened throughout the year, only where the company is as of February 2, 2014. get the rest of the story.

We need to delve deeper into changes in capital, so let's bring up the status of changes in capital. The first line says net profit, aha, we know where it comes from. It comes from the income statement. Home Depot has about $79 billion in sales, which is a credit to the accounting system, and generating positive income and a positive increase in equity of $5.4 billion, that's a big credit, so it explains A large part of the change in equity, the rest of the change in equity comes from contributions and withdrawals, so looking further down the statement we see that some stock options were exercised, this is a positive contribution to equity, as that when a stock option is exercised and the old version gives money to the company and the company issuing shares will ignore things in the middle like This is some advanced accounting, but at the bottom we have dividends that are shown as a negative number because these shareholders and Home Depot are taking a portion of the money earned by the company.

Holy shit, did you just understand the statements of a Fortune 500 company? I surely hope it is the first step to finally becoming an accountant. If you want to practice your journal entries more. Literally today I have an app to download the ledger to your electronic device. Allows you to practice anywhere and anytime. It will also connect. Access the resources on my website, so have fun and in no time you will master debits and credits, that's all for this lesson, but be sure to look for other lessons to help you develop your bookkeeping and bookkeeping skills.