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0:01
>> Robert Smolin: Good morning. My name's Robert Smolin and this is Financial Accounting 101. Today we're going to be looking at the basics of financial statements. Now this is going to be covered in the first couple of chapters in our textbook and my goal here, is not to lecture on the entire chapter, but simply to go over what I believe are to be the most important elements that I want you to focus on so you can get a better understanding of accounting. Okay.
0:33
One of the first things we learn about accounting is the various components of what is accounting. And so on the screen, on your computer, you start to see a variety of different accounts. Now we have assets, we have liabilities, and we have stockholder's equity. The first thing that you need to do is you need to be able to sort this information into categories so you can then access the information because you're going to be flooded
1:07
with information in the early going, and to the extent you can sort out the information and start to put the pieces together, at that point in time you will start to get a better understanding of what we're trying to accomplish. So the first thing I want to focus on is what we call the basic accounting equation. And the basic accounting equation says assets equals liabilities plus, and I'm going to abbreviate, stockholder's equity.
1:45
(Assets = Liabilities + SE) I hope you can see that, and that remains to be seen. All right, so let's take a look at the list of the various assets. Cash, accounts receivable, okay that's when our customers owe us money. Supplies, and think of office supplies when we talk about supplies. Supplies get used up or consumed in the ordinary course of business. Inventory, which we're going to see a little bit later on, is basically a retail store
2:18
or a manufacturing company and inventory is something that as a retailer we buy, we mark it up, we raise the price and we sell it. Prepaid expenses, now notice that they're under the category of assets. It is a confusing term, but it's a commonly used term. A prepaid expense such as prepaid insurance and prepaid rent, these are things that sometimes are paid for in advance and then they expire over time. Okay, and so those are considered assets initially when we pay for them and then as
2:51
time progresses they will convert into expenses. We will of course talk more about that later. Property, plant and equipment is a category within the property, plant and equipment we have land, we have buildings, machines, equipment, vehicles, furniture, computers, all sorts of stuff. Okay. So that's a sufficient definition of property, plant and equipment for now and then there's intangible assets such as trademarks, patents, copyrights, franchise licensing agreements, etc.
3:27
Assets are resources that help us to run our business. Now, the next category is liabilities, and a liability is a debt or simply an obligation. The way we fulfill an obligation is either we pay for it with money in the future or we provide a service, okay. And so there are a wide variety of liabilities. This is a partial list. These are the accounts that we will most likely see in our class, but there are several others. Accounts payable.
4:02
Accounts payable is when we owe money to a company and we refer those companies that we do business with on a regular basis as vendors or suppliers, but vendors is the more common term. So we owe money to our vendors for buying stuff. We may buy inventory from them several times a month, office supplies, they may come in and clean our building and they bill us. So accounts payable is for your operational type expenses that you buy on account.
4:30
That's a term we'll come back to, but on account means credit was involved. Notes payable, this is a more formal loan when we borrow money from a bank we sign a promissory note and we call that a note payable. Wages payable is what we owe to our employees for their, you know, every day work. Unearned revenue is when a customer pays us in advance and we're going to provide service to them in the future. That's a liability even though we see the word revenue, because of the word
5:02
unearned, it tells us it's a liability. And again, we'll talk more about these -- all of these accounts in future lectures. Utilities payable for gas, electricity, water, mortgage for your building. There are -- if we issue bonds, there are bonds payable, there's pension liabilities, there's taxes payable, there's interest payable, so there's a wide variety of liabilities. And again, liabilities are obligations that we have to fulfill by either paying or providing service in the future.
5:34
And we have stockholder's equity, and in the early stages for the first couple of months or so we simply have two primary accounts. The first account we call common stock. It's also called capital stock. All right. And this is when the person who -- the owner who starts a business and they choose to incorporate, they put money in a separate bank account that we call this the economic entity concept where they take money out of
6:02
their personal funds and they put it into a new business checking account. Okay. And they issue shares of stock to themselves and that stock indicates ownership. Now they may have tracked money from other investors in which case other people would invest in the company and they would be given shares of common or capital stock, as well. So the word equity means ownership. The other account in stockholder's equity is called retained earnings, which
6:32
I abbreviate RE quite a bit, and retained earnings are all the profits that a company makes for the life of the business that have been reinvested back into the business. They're earnings that have been retained, retained earnings; the earnings have been retained in the business. Now notice on the slide it says retained earnings includes the following accounts: revenues, which increase retained earnings; expenses, which decrease retained earnings;
7:05
and, dividends, which also decrease retained earnings. Now, in your book I'm assuming you've read the information and you have to become familiar with the various definitions, okay. Revenue is when we provide a service to a customer or a client and they pay us for that service. So for example, if I'm a tax practitioner, I'm a lawyer, I'm a doctor, I'm a masseuse, any number of services can be provided and customers are willing to pay for this.
7:36
So when they pay us they give us cash for example, cash is an asset, but we keep track of all the work we performed and the dollar value of that service we provided and we call that revenue. Revenue must be earned. That's a key word in accounting, earned. So revenue has to be earned. How do we earn it? We provide the service. Okay. Now sometimes a customer will owe us money. In that case, we call it an account receivable. We still keep track of it.
8:12
We record a transaction and we say now we have an account receivable. The customer owes us money, but we still count that as revenue. So think of a score card. We're scoring points. The more service we provide the more points we are scoring. That's revenue. Revenue ultimately goes back into the retained earnings account at the end of the year when we prepare financial statements and again, this is something we'll be taking about. But revenue increases the retained earnings account.
8:44
We simply break out the revenues. We put a separate -- we put it in a separate account, okay, and at the end of the year we summarize all the revenue, and we put it back in retained earnings. Expenses, expenses decrease retained earnings. Now an expense is a cost that we have to incur in order to run our business. I have to pay rent for my office. I have to pay my employees their wages. I have to pay for utilities, for the lighting, for the air conditioning. I have to pay for insurance.
9:15
There's property taxes. I have something called depreciation expense, supplies expense, so there's a wide variety of expenses, which are costs, that I have to incur to run my business. Okay. If I didn't have a business I wouldn't be incurring all these costs, so an expense is a cost we incur to run our business. Expenses reduce retained earnings. They reduce stockholder's equity. Okay. Now a quick comment and I'll revisit this, is that it's very common for students
9:46
in the early stages to confuse an expense with a liability. An expense is a cost we incur. A liability is when we owe money in the future. It's an obligation. So let me give you an example to illustrate the difference between an expense and a liability. If I have a company vehicle and I go fill it up with gas and it costs me in today's dollars roughly$50 a gallon. If I pay cash, then I've incurred an expense, the gasoline, since I'm going to burn through
10:24
it in a day or two and then have to refill my tank, so that's a cost we have to incur, but there's no liability there because I paid in cash. Next time I fill the tank I don't have enough cash so I use my Visa card or my Chevron card, whatever, and so I've incurred another $50 expense for gas, but now I have a liability because I have not yet paid for it I owe a company money that will be paid in the future.
10:52
So notice the liability relates to an expense, but it's considered to be a separate concept. Okay. In accounting the concept of double entry accounting states, that every transaction that we engage in has to involve at least two different accounts. No transaction can only have one account. Some other account or more is always affected, okay. So notice in the first transaction I incurred an expense and I paid cash, which resulted in a reduction of an asset.
11:29
Second transaction I incurred an expense, but I also now have a liability. For every transaction we must have at least two separate accounts. So revenues increase retained earnings. Expenses decrease retained earnings. And then dividends decrease retained earnings. Now a dividend is when the company distributes money back to the owners. Now remember, the owner of course is the decision maker in the company, but they are choosing to pay themselves an amount of money called a dividend.
12:04
If this were a sole proprietorship, for those of you that took bookkeeping, this would be the drawing account where the owner is withdrawing money. It is a formal transfer of money. One of the important concepts which I mentioned earlier, the economic entity concept says we have to keep -- the owner has to keep a separate set of records for their personal lives, and a separate set of records for their business activity. So the investment to start the business is a formal transfer of money into
12:35
the business that's recorded by a receipt of cash and the issuance of common stock. A dividend is a formal transaction where the company is giving money back to the owner. Now it's very important for you to remember we are only accounting for the business. Only accounting for the business, we're not accounting for the owner's personal affairs. And when you're doing your homework and you're reading about a transaction you have to identify which side of the transaction you're on.
13:03
For example, if we buy supplies from Office Depot or Staples okay, and we buy it on account, which means we didn't pay cash, we would have supplies, which is an asset and we'd have an account payable, which is a liability. Now to Office Depot or Staples who's on the other side of the transaction they would have an account receivable, they would record revenue, and they would also have to adjust their inventory. Now we'll deal more with that later on in a future chapter, okay, but the
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concept is you have to know which side of a transaction you're on so you can record the proper journal entry, which we'll be looking at in a future lecture. Dividends decrease retained earnings. Now notice revenue expense dividends, R.E.D, what I call the red account. It's simply a memory tool or a pneumonic to help you remember that the red accounts, revenue R, expense E, dividends D, are really part of retained earnings. Okay, so it's very important for you to commit that to memory.
14:12
That revenues, expense, dividends are part of retained earnings. Revenue increases retained earnings. Expenses decrease retained earnings, and dividends decrease retained earnings. Please commit that to memory. So we've identified the various different components. Back to the previous slide we have assets; we have all these different assets, which I'd like you to commit to memory. We have all these different liabilities. Okay, and then we have stockholder's equity.
14:42
And right now we have two stockholder's equity accounts; common stock and retained earnings. And we know that retained earnings is a unique account because it includes revenues, expenses and dividends. And at the end of the period or the end of the year we're going to put all three of those back into retained earnings in what we call the closing process. Again, a future topic. Okay now, I'm going to head over to the board here, and I may disappear, but I will reappear shortly.
15:11
And we have on the board the accounting equation. The accounting equation tells us assets equals liabilities plus, stockholder's equity. And I refer to this as the left side. The assets are on the left side. Liabilities and stockholder's equity are added together on the right side. These two added together equal assets and what that says is that for every asset, which is a resource our company uses to run our business, we either put our own money into it.
15:50
We own it, or we borrowed money to obtain that asset, okay and so, for each asset think of liabilities as [background noise] them and equity as us. The left side are resources. The right side says who has a claim -- I'll get out of your way in a second -- on the assets. Now hopefully you can read that. We are experimenting with this, okay. Assets, which are the resources of the business, equals liabilities plus stockholder's equity. Who has a claim on these assets?
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If we borrowed money, we bought something on credit, on account from Staples for example, then we owe them money. They have a claim on the asset. Now that doesn't mean they're going to come in and take everything away. What it means is if we do not pay our bills, at some point in time, they can take legal action to recover their claims. The law requires that in the event a business liquidates, files bankruptcy, goes
17:19
out of business, you have to pay back all of your liabilities first to your creditors, and if there's anything left for the owners of the business you would get what's ever left over. Okay. Another way to write this equation would be assets [background noise] minus liabilities equals stockholder's equity. Assets minus liabilities equals stockholder's equity, it's the same as saying assets equals liabilities for stockholder's equity.
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And let me give you a quick mathematical analysis of this to illustrate the point. If assets were six and liabilities were four, equity would be two. Assets of six minus liabilities of four equals stockholder's equity of two. Okay, but this is the format of the equation we spend most time talking about. Assets equals liabilities plus stockholder's equity, and every transaction that takes place in any business falls within this equation because every transaction has to involve at
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least two or more different accounts. Back to [audio glitch]. Okay. Talking about revenues, depending upon the nature of our business revenues if we provide a service we would call service revenue. Sometimes it's referred to as fees earned. If we sell inventory like I'm Wal-Mart or I'm Foot Locker or I'm Home Depot, we call that sales revenue. We could also have rental or rent revenue. We can have interest revenue when we earn interest on money in the bank.
19:38
If we own stock in another company and they pay us a dividend that would be dividend revenue. Royalty revenue, there's a variety of different types of revenues depending upon the nature of your business. Expenses, there are even more expenses. There's a greater list of expenses than there is revenues typically. Look at some of the examples on your slide. Rent expense, wage expense, you can also say salary or payroll expense, same thing,
20:06
utilities expense, insurance expense, supplies expense, depreciation expense, we have warranty expense, we have bad debt expense, interest expense, property tax expense, so there's a long list of various expenses out there and we will see a lot of these, so again, you need to get comfortable with all these different accounts and which category they fall under. If it's an asset, if it's a liability, stockholder's equity, and then
20:38
within stockholder's equity we know that retained earnings is this unusual account because it has all sorts of stuff that ultimately go into it. Revenues, and here's a long list of revenues. Expenses, a wide variety of expenses. And then dividends, there's only one account called dividends, okay. And that again, that is a distribution back to the owners, but that is also part of retained earnings. So again, you need to study these and be able to sort this information, so that
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you can make sense of it, and you know where to put things when the accounting process actually begins. Okay. The end product, if you will, of the accounting process is the preparation of financial statements, and remember financial accounting has to satisfy the needs and the questions of both internal users of financial information, and external users of financial information. The internal users of financial information is management and the employees.
21:46
External users include investors, creditors, people we owe money to, unions, the government, vendors, customers, society at large, so various different groups have to have access to this information so they can make decisions. Now in your book, and I'm not going to spend much time on this, we talked about how corporations can either be a privately held corporation, which is simply a family business, it could be a very large family business. UPS up until about I don't know, 15 years or so,
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was a family business -- family owned business. Now they're one of the biggest companies in the world, and they were very big when they were privately held. They are now publicly held. Okay. So corporations can be privately held, which means you and I cannot buy stock in that company. Or they can be publicly held, also called publicly traded companies. Ford, Disney, Boeing, General Motors, Microsoft, Intel, Google, Apple, all these different companies you and I can buy stock in them.
22:50
So every company no matter what form of business, whether it's a sole proprietor, a partnership, or a corporation, public corporation, private corporation, they have to prepare financial statements, they have to follow certain sets of rules which we call GAP, generally accepted accounting principles, these are the rules we have to follow. And we prepare these four financial statements. The income statement, retained earnings statement, balance sheet and the cash flow statement.
23:22
Now a quick comment, this is the order in which we prepare them. We have to prepare the income statement first because we need information from the income statement in order to prepare the retained earnings statement. We need information from the retained earnings statement, in order to prepare the balance sheet. And we need both the income statement and balance sheet in order to prepare the cash flow statement. So please make note of the four financial statements and the order in which
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they have to be prepared. And this is the order, income statement first, retained earnings, balance sheet and then, cash flows. One of the assumptions talked about in the early phases when we're defining all the different elements of accounting is this concept called the time period assumption for financial statements. Now on the slide notice that on the far left we see January 1st of the first year and December 31st of the first year, the beginning of the year the end of the year.
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Now I commonly use the term "time period" as opposed to years, because a period can be a month, it can be a quarter, it can be half a year, or it can be a full year. All companies prepare annual financial statements. All publicly traded companies are required to release to the public quarterly financial statements, as well as, their annual financial statement. And most companies, public or private, will prepare monthly financial statements.
25:05
So through the end of the period, again it could be the end of the month, quarter, half year or year depending upon what the company is doing. We always prepare financial statements at the end of a time period. In our example here on the slide it's the end of the year. So notice the income statement, which is revenues minus expenses, and we're going to do an example on the board, we add up all the revenue for the entire year.
25:39
Okay so notice, [background noise] how the revenue keeps increasing throughout the year, at the end of the year my vertical axis right here, the X axis if I remember correctly is your dollars and your horizontal or Y axis is time. Okay. So we add up all the revenues throughout the year. We add up all the expenses throughout the year. And then our income statement is revenue minus expense, equals net income or net loss. If revenues exceed expenses as they did in this example, and hopefully
26:20
that's normally the case, then you have net income. If expenses are greater than revenues you would have a net loss. Now notice at the end of December 31st '01 we add up revenues and expenses, we prepare our financial statements and then, notice the beginning of the next time period we start out at zero zero, and for the next period we do the same thing. We add up all the revenues, we add up all the expenses, we determine if we have net income or a net loss, and that's what we do.
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Each time period we set revenues and expenses back to zero so we can begin a new time period. I like to compare it to a ball game. The Lakers are playing the New York Knicks and they beat them 105 to 104, then they win the game. Tomorrow night the Lakers play the Miami Heat -- okay [background noise] and they begin zero zero. They've set the score back to zero. It's a new time period; it's a new ball game. The same thing with your paycheck. Think about your paycheck.
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You see the current amount you've earned and you see year to date information. Well, your last paycheck in December will show you your current amount for the pay period plus what you've earned for the entire year. The very next paycheck in January you'll see current and year to date of the two same numbers, because they've set everything back to zero, and that's what the income statement does. Now the balance sheet is different.
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The balance sheet, which we prepare after the income statement -- and after the retained earnings statement says it is now five o'clock December 31st, our business is closed, the year is over and we want to know how much do we have in assets, how much do we have in liabilities, and what do we have in stockholder's equity. So we're kind of calling a time out. I call it a freeze frame. We're taking a picture or a snapshot of what we have.
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And on the board I'm not going to walk over here, but remember we saw assets, liabilities and stockholder's equity. That's our balance sheet. And what we're going to see is that we prepared the income statement first, revenue minus expense equals net income. That net income number, which is the summary of revenues and expenses, is then going to be put into the retained earnings statement, and we're going to update retained earnings and we're going to go through this.
29:03
We're going to show what we had at the beginning of the year, January 1st, we're going to add net income, which came from the income statement. We will subtract any dividends paid back to the owners and that will give us our ending retained earnings as of December 31st. It is the ending retained earnings at the end of the period which will then ultimately show up on the balance sheet in the stockholder's equity portion of the balance sheet, okay.
29:34
So notice revenues minus expenses equals net income. That falls down into our retained earnings statement. Beginning retained earnings plus net income minus dividends equals ending retained earnings and that drops down ultimately onto the balance sheet, so everything that takes place in our business is ultimately reflected in the balance sheet. And we look at the balance sheet at a moment in time, the end of the day December 31st. End of the time period. Okay.
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So the income statement measures performance over a time period, a month, quarter or a year, and then we take that summary, which is net income or net loss, and then ultimately it ends up on the balance sheet. And at the end of each period, December 31st '01, '02 we say time out let's take a snapshot of our balance sheet to see what are our assets, resources, liabilities, obligations and stockholder's equity, what's left for the owner as a result of running this business. Okay.
30:43
What I'd like to do is using this example on the slide we're going to build the financial statements. Okay, and so I would like to ask you to break out a piece of paper and something to write with and we're going to take this data on the board and we're going to prepare the financial statements. Okay, so let's read this together. On June 1st Eckers Leak Service Company was started with an investment of $26,200. So that would go into our common stock account.
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Here are the assets and liabilities of the company on June 30th and the revenues and expenses for the month of June, its first month of operations. And they give us all these various accounts. They are not in any particular order. In June the company issued no additional common stock, but they paid a dividend of $2,000. Completed income statement and a retained earnings statement for the month of June, notice that's covering a time period, in this case one month, and a balance sheet,
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at or as of, the end of the period June 30th, 2010. Okay, so I'm going to head over to the board and we're first going to prepare the income statement. Now this is what? Eckers Leak Company? We'll just say ABC Company, it doesn't make a difference, the name of the company [background noise], the time period. Now this was June 30th and I'm just going to put XX for whatever the end of the year is and this is our income statement. [ Writing on blackboard ] >> Robert Smolin: We call this the heading
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or the header of the financial statement. Okay. Now we'll keep the camera on the board here, but I may disappear briefly while I'm looking at the information. I will be back momentarily. We look at revenues minus expenses and we get net income. Okay, so our revenues we see $7,000 -- let us just make sure there's only one revenue account, maybe there's more, but I don't really see any other revenue accounts so, my revenue [background noise] is $7,000. Okay.
33:12
Then I look for my expenses and at this early stage in the game it doesn't matter what order you put them in. So we'll just put them in the order that we see them. I see advertising expense for $400. [ Writing on blackboard ] >> Robert Smolin: And notice I put brackets around the expenses. In accounting putting parenthesis or brackets around a number that's going to be subtracted or a negative number is common practice. I see supplies expense for $1,000.
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[ Writing on blackboard ] >> Robert Smolin: Gas and oil expense $600. [ Writing on blackboard ] >> Robert Smolin: Utility expense... [ Writing on blackboard ] >> Robert Smolin: ... $300. And wage expense... [ Writing on blackboard ] >> Robert Smolin: ... $1400. My revenues $7,000 minus my expenses, which total $2,000 -- $2,900 -- $4,300 equals [background noise] net income. Okay. So revenue minus expense okay, and what does that come to? We'll say $2,037 -- is that $3,300?
35:19
[ Writing on blackboard ] >> Robert Smolin: That's my net income. And notice I put two lines underneath it. That's called double underscoring. It simply means this is the last number on a particular financial statement or a column we double underscore. Okay, so revenues minus expenses, equals net income. [ Silence ] Now that we've prepared the income statement, our second financial statement is to prepare retained earnings and I refer retained earnings underneath the income statement
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or after the income statement, because I need net income from the income statement in order to prepare the retained earnings statement. So I will put the retained earnings statement over here, put a line in between these, [noise] whoops, [background noise] ABC Company 6/30/XX. [ Writing on blackboard ] >> Robert Smolin: I'm going to abbreviate. So there's my header. Okay now if we look at the slide -- I'll be back in a second here -- we notice
36:46
it says on June 1st the Service Company was started with an investment of $26,200 cash. It is now June 30th. So this was the very first month that this company has been in business. So the format of the retained earnings statement [background noise] we take beginning, I'm going to abbreviate, retained earnings and this was one June 1st. Now think about this. If this is the very first day we're in business, June 1st, eight a.m. in
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the morning we've simply just opened the doors, haven't done any business yet, we haven't sold anything, we don't have any earnings. In the very first time period only beginning retained earnings is zero. It has to be. We haven't done anything yet. So day one of the business, beginning retained earnings is zero. Then we add [noise] net income and that income comes from the income statement right here. [ Writing on blackboard ] >> Robert Smolin: Beginning retained earnings, plus net income.
38:13
Had this been a loss, and it's very common in the first couple of years of a business to lose money, had expenses been more than revenue we would have had a net loss. If that's the case I would have subtracted a net loss. Okay. Then [background noise] we subtract any dividends paid back to the owner. And again, if you refer to your slide I'll be back in a sec, it says they paid a $2,000 dividend. [ Writing on blackboard ] >> Robert Smolin: So I'm going to subtract the dividend.
38:53
Now let's go back for a moment. The retained earnings statement is a summary of what we began with and what we ended up with in retained earnings, which is a stockholder's equity account, and if we think back we remember revenues and expenses and dividends are in retained earnings. Revenues increase retained earnings. Expenses decrease retained earnings. So the summary of revenue minus expense is net income, so here's my revenues and expenses going into retained earnings.
39:28
Dividends we said decrease retained earnings and so [noise] ending, and I'm going to abbreviate, RE, retained earnings December 31st, at the end of whatever year, is going to be [noise] $1,300. Okay. Beginning retained earnings. Remember in the first period only, please remember that, this is the first period only it's zero, plus net income from the income statement, minus dividends paid back to the owners equals end of period retained earnings. Now a quick comment.
40:17
We said that revenues and expenses on the income statement would be set back to zero just like we're playing a new ballgame. Okay. And so we refer to revenues and expenses and dividends as temporary accounts. We'll talk about this more down the road. Assets, liabilities and equity we call permanent accounts, or real accounts because we don't set them back to zero. If on December 31st you have $1,000 in your bank
40:56
account then, when the clock strikes midnight and it goes from December 31st to January 1st you still have $1,000 in your account because cash is an asset and assets are permanent real accounts. If you owe $500 on your credit card on December 31st, well guess what? You still owe $500 on January 1st the next day because a liability is a permanent account. And stockholder's equity accounts, common stock and retained earnings, are permanent accounts.
41:34
We've taken revenues, expenses, and dividends, we've put them into their final home, retained earnings, we then set revenues, expenses, and dividends back to zero, and again we'll look at this in a future lecture, and now they are in their final place, retained earnings. Now -- I'm sorry, I put December 31st here. I meant June 30th. [ Writing on blackboard ] >> Robert Smolin: Okay. On July 1st, which is the next month, my beginning retained earnings will be $1,300.
42:15
So last period's ending retained earnings becomes the following period's, July in this case, beginning retained earnings. [Inaudible]. We're now going to prepare our balance sheet. We have the income statement and retained earnings and now we're going to prepare our balance sheet. Okay. I'm going to switch to the document camera and we're going to take the information from our example and we're going to build the balance sheet.
42:51
So ABC Company, June 30th [background noise] end of the period balance sheet. Again, here's our heading. Here are my hands. [Laughs] All right. On the left we'll have our assets. We have cash, $4,600. We have accounts receivable, which I'm going to abbreviate AR for accounts receivable and that's $4,000. Supplies [noise] $2,400, and equipment, which I'm going to abbreviate again. I'm going to simply say equipment or equip, $29,000 and this gives us [noise] total assets. Okay.
44:13
And that comes to $40,000 [noise] and I'm going to double underscore it. On the right I first list [background noise] my liabilities. I have notes payable [noise] for $12,000 and I have accounts payable [noise] for $500 [noise]. Total liabilities is $12,500 and then, I have stockholder's [noise] equity. Now they said on June 1st the company started with an investment of $26,200 in cash. That would be my common stock or capital stock, same thing, [noise] $29 -- excuse me,
45:32
$26,000, whoops [noise] and I have retained earnings [noise] of $1,300 and that number, I'll put a star next to it, that came from my retained earnings statement. So stockholder's equity [background noise] equals $27,500 and total liabilities plus, stockholder's equity equals $12,500 plus $27,500, $40,000. And hopefully you can see that. Now I'm going to come over here to the white board and we have all three financial statements now together.
46:49
We prepare the income statement first, revenues, and if we had more than one revenue account we would simply put service revenue, sales revenue, interest revenue, put all revenues together, and then I'd put total revenue, all my expenses. And if you want to put total expenses that's good, that's fine. Okay. Revenues minus expenses then, gives us net income. We have some flexibility in the early stages here in terms of how we present the information.
47:21
As we get further into the course we're going to tighten things up a little bit and we'll follow more specific rules, but right now our primary objective is to get you familiar with the concept of the income statement as being a measure of the company's performance for the time period. We take net income and when we prepare our retained earnings statement this shows the change in value in equity due to the operations of the business, hopefully the profitability
47:49
of the business increasing the equity, which of course is the owner's claim to the assets. This is how wealth grows in a business, through the retained earnings account. They make the initial investment and then hopefully through profitability and putting money back into the company, earnings that we retain for the business, we grow the business. Beginning retained earnings plus net income minus dividends, which is money that the owners take out of the business for personal use, they
48:20
can do that, equals ending retained earnings. It is the ending retained earnings which then goes on your balance sheet. And if you look at your balance sheet, balance sheets show assets, and I list all my assets, and again as we get more into the class we will learn there is a specific order in which we should present this information, but right now this is more than adequate. We list assets generally speaking in order of liquidity, which means how quickly they can convert into cash.
48:56
But this order is fine. And I would accept any order at this early stage as long as you have total assets of $40,000. I have my liabilities. Any time you see the word payable that tells you it's a liability. Notes payable, which is a loan from the bank, accounts payable, which is to our vendors for day to day services and purchases, total liabilities $12,500. In my stockholder's equity section there's that initial investment of $26,200, we put that in the common or capital stock account.
49:33
Then there's retained earnings from my retained earnings statement. Ending retained earnings, always put the ending retained earnings on the balance sheet, $1,300. Total stockholder's equity $27,500 and then, notice on the left assets equal $40,000, and on the right liabilities plus stockholder's equity $12,500 plus $27,500, on the right side total liabilities and equity equals $40,000. The balance sheet we have to be in balance. The left side has to equal the right side.
50:11
Assets equals liabilities plus stockholder's equity. So if you can review this information and try to learn the various different accounts, all the different assets, all the different liabilities, the stockholder's equity accounts, then retained earnings having revenues, expenses, and dividends within retained earnings, that's a good start. Then become comfortable with the four financial statements. Now notice we're not doing the statement of cash flows.
50:48
The statement of cash flows is a little bit unique and to introduce it right now, creates more confusion than it's worth. So we're going to look at the statement of cash flows at the end of financial accounting. Okay. So right now we're simply looking at the first three financial statements, the order in which we prepare them, and how to actually prepare them. So you have an example of preparing the three financial statements.
51:15
Again, you've got to remember which accounts go on the various financial statements and that's just going to be by you putting in the proper amount of time. Okay. That's it for this lecture.
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