Understanding the Accounting Cycle (Part 2)

1. The Foundation of Accounts : hi, guys. And welcome to section two off the accounting course for success in business and in life. I hope you've hopped over here from Section one. If you haven't considered jumping over the section one where you'll have the opportunity to learn some basic accounting Lingle, if you have made it or from section one, Congratulations and thank you. I'm really happy and excited that you made it so far into your counting journey. And thanks for choosing the scores to help you with that. Now, let me tell you a bit about this section. Think of building our counting system as building a skyscraper. When you start building any skyscraper or any building for that matter, initially you're gonna have to do the excavation, the basic groundwork and lay the foundation. This section is going to be similar in that sense, where you will learn how accounting systems are foundational he built. You're going to start off with learning about what the chart of accounts is, which is the foundation. This is one of the first things that accountants do to set up any accounting system. Then you're gonna learn about the accounting cycle, which is the process which all the contents follow. When a transaction happens in a business put in the accounting cycle, accountants past journal entries, prepared trial balances and so on. We're going to get familiar with all of this and much more. The end goal of this section is to give you a good overview off any accounting system. Once you understand this, the counting process will start making much more sense to you. And you will be able to use this understanding to become a better bookkeeper and accountant of business, owner or investor, or whatever it is you choose to do with your new farm knowledge. Okay, so without further ado, let's dive in and start with our first lecture, the chart of accounts. 2. Chart of accounts: when a transaction happens in a business, we can just record these transactions. Vilena Lee We need to know exactly where the transactions fit in the larger accounting system. The chart of accounts is the tool that helps us with that. So let's go wait in this video. Imagine your personal check book, where you diligently record all the checks that you write in your checkbook. Each check has a number, and you record a check with their date, the amount who the check is for and so on. Now for you, the checkbook is simply a tool to help keep your personal finances organized. Similar to your personal check book. Accountants use several tools to help them record, organize and maintain the transactions off a business. Once that stool is called the chart of accounts, the chart of accounts is simply a number Listed. Off accounts set up accountants in a business that lists all the accounts the business is likely to need. Organized in a specific order, the chart of accounts is unique to each type of business. For example, the chart of accounts set up for a supermarket will be very different from the chart of accounts for a car manufacturer, which will be very different from a company manufacturing rocket ships. Because the chart of accounts unspecific toe how the businesses operating, you're unlikely to find two businesses with the same chart of accounts. Let's take some time and talk about how chart of accounts is built manually. What you see on the screen is the order that accountants follow when preparing a chart of accounts in the order the balance sheet accounts always written, forced, followed by the income statement accounts. We'll be going through the balance sheet accounts and income statement accounts in much more detail later in the scores. But for the purpose of this lecture, all you need to know is the three main categories of balance sheet accounts are assets, liabilities and owner's equity. And the two main categories off the income statement accounts are revenues and expenses. The assets keep track off. All resource is there a company owns the liabilities, keep track off everything their company holes and the equity keeps track off all the money the owners have invested in the company as well as the money taken out of the company. The revenue accounts keep track of the money coming into the business and expense accounts track all the money that a business spends to keep running. Once accountants have listed all the categories and sub categories of account specific to the business, they decided to give each account on number based on a simple numeric system. The numbering system is used to make organization and record keeping easier. Let me explain. Based on the size of the organization, accountants assign a list of numbers to these men categories. So, let's say, for a small business, assets can be assigned the numbers between 101 299 or libraries between 201 and 299. Equity can have the numbers between 301 and 399. Revenue between 401 to 499 and expenses between 501 to 599. In bigger companies with many departments, such as a production department, marketing department and HR department and so on, you'll see that the numbers keep getting bigger. For example, instead of using 101 99 number assets like we just used accountants and bigger forms. Used numbers from 2999 insert off 200 to 99 track liabilities like we used accountants. Use 2000 to 2999. The bigger the company, the larger the numbers get. While setting up a chart off accounts, accountants will take these main categories and break them down to a granular level based on the type of business. Let me explain this very taking out forced me and category of the balance sheet assets, which we assigned the numbers 100 to 1 99 Accountant will take the assets and further subdivide them into current assets long term assets in intangible assets. Then they look up all the current assets of the business and list them out, such as cash accounts receivable in reentry and so on. After that, they take a look at each specific current asset and divide that even for the for example, cash in a business can be further divided into the cash kept in the petty cash box cash in the checking account cash in savings accounts, cash held US foreign currency in the bank and so on, they lose same thing with the long term assets where they take the long term assets of the business and preparing entire list of these, such as the buildings, the cars, the property, plant and equipment and so on for intangible assets, accountants are going to take a look at any patents, copyrights, goodwill except RA. And if necessary, I'm does as well to the list of accounts. Accountants continue the sequence and list out all the other main categories, such as the libraries, equity revenue and expenses. After doing this, it's likely they'll end up with hundreds of accounts. But that should be no surprise. The number of accounts can even end up in thousands for big organizations. Also, accountants don't need to worry if they've skipped off for garden. A few of these accounts, as these can always be added later in a business is life. Once they have a list off all accounts, they assign each account a number as a sample, they could look at the numbers given to the current asset accounts for our small business. The current assets for our small business accounts have been divided into cash accounts receivable, prepaid rained, prepaid insurance and so on all the current assets are starting with the number one, such as cash is 101. Accounts receivable is 100 too. Prepaid rent is 103 prepared insurance is 104 and the list continues. Similarly. Now take a look at the sample off liabilities that is similar to what you would find in a small organization. You'll see that all the liability accounts such accounts people, insurance, people, interest people and so on. All start with the number two. Accountant creates similar number listings for all other accounts, whether it's equity accounts, revenue accounts and expense accounts in most organisations. That expense accounts make up the longest list of individual accounts in the chart of accounts. Now, to summarize this entire process, it's pretty simple. If you're creating a manual chart of accounts of the start for business, we start with the main categories of the balance sheet, which are assets, liabilities and equity, and forward up with the main categories of the income statement, which are revenues and expenses. We keep subdividing these big categories into smaller accounts specific to the business till that can't be done anymore. After you have your entire list off accounts. We just give them a logical sequence of numbers and Walla. We have our chart of accounts. If you use a computer, a system the software uses this matter toe, prompt or automatically assign account numbers toe a company's accounts. Now, if at any stage of this process, you've gotten confused, or you may simply want to take some more time with the chart of accounts, you can always visit the resource website off the scores at www accounting superpowers dot com and type chart of accounts in the search field, and you will be able to see a written explanation off the chart of accounts with many samples off the chart of accounts. Increasing the number of digits allows accountants to have more and more accounts, with many of these accounts specific to each department. This allows accountants to be able to create reports for management specific their departments and to see how these departments are doing now. Accounts can also be added or deleted by way of adjusting entries at any time during the year. But it's wise not to do that too much since constantly changing and updating account numbers makes it very difficult. Obtain reliable, compatible financial information. Year after your planning is truly the key to success when designing your chart of accounts , as a well designed Charlie account provides a logical structure that facilitates the addition off new accounts and elation off old ones before we move on, I have a few special tips for you in case you ever find yourself in a situation where you're setting up a company chart of accounts from scratch. Number one, the company's organization chart can be a big help in the set up stage and provide a great outline for all the departments and function specific to a company number two. Many accounting Softwares provide a standard chartered accountants customized to suit different types of businesses. Therefore, you just have to build on these and do not have to start from scratch and such situations Number three. After you're done with setting up the list off accounts, make sure to distribute the list to any employees at me. Was it even employees there on North and more than the bookkeeping function may need a copy of the charter for counts if they ever court invoices or any other transactions. Thank you so much for joining me in this lecture. I'll see you in the next one 3. The Accounting Cycle : hi, guys. For a second, I want you to think about your favorite food and sorry guys. I think I got a big cattle either. Let's get back to accounts. Now let's say I told you today to prepare your favorite food for me and I, as you were nice enough to say Yes, let's go. To start you get together a list of ingredients that you need. You head down to the supermarket to buy some groceries, you come back. You assemble all the ingredients together in the kitchen. Follow the recipe and Walla. We have our favorite food. By now, you're probably wondering, what in the world does this have to do? Anything with accounting, but a lot. What you did is you just follow the process, a process to make your favorite food the same way that you follow the process to make your favorite food. There's a process which accountants used to record. Each transaction that happens in a business just like the Gola for cook is to take a bunch of ingredients, follow process and make a dish. The goal of an accountant in a business is to take a bunch of transactions are happening of business and eventually end up making financial statements in accounting. The process of steps start with collecting transactions and eventually end up creating financial statements. This process of steps is called the accounting cycle. I hope you are missing the concept. They're going to go with accounting cycle in much more detail with the next few lectures. For now, I'm gonna go get something to eat because all this talk about food has made me really hungry. Thanks. See in the next lecture. 4. Transactions and Breaking Down a Journal Entry: Hello there. Future royalty off account. Will. The goal off our lecture today is to learn the first few steps of the accounting cycle. Do you remember my friend Joey? Well, after Joey visited us from Mars, he liked art and decided to stay on. So to pay the bills, he gotten internship in a medium sized company that manufactures laptops. And lo and behold, he ended up getting a job working in the accounts department. What a coincidence. His new boss, Phil. There's Joey that his job is to process transactions of the company and prepare financial statements. Basically, that means Joey has been put in charge of the accounting cycle. So how's Joey being trained to do his job? Well, let's go through this step by step. Step one. Joey first collects and analyzes all the financial transactions undertaken by his company. Basically, he's given invoices, receipts for disorders and whatever he needs to verify the transaction. These documents are given to him our call source documents. Transactions in his company include sail off laptops or chases supplies, payment of salaries and so on and so forth and any other financial transactions which are undertaken within the company. Step two Join takes each transaction and records a journal entry recording a journal entry in walls. An easy three step process. First, the date of the transaction is recorded on the left side. Since transactions in any business happened to walk to your, it's important to properly date each one second we identify and write down which accounts have been affected by the transaction with a brief description. Remember, each transaction always has effects on two accounts. At a minimum, one is called a debit and one is called a credit. That's why the accounting system is often referred to us a double entry system. Lastly, we write down the amount that has been deputed, an amount that has been credited with the debit side always written on top first. Now, if you're wondering, OK, but how do I know which account gets debited and which account gets catered? That's a good question. Ah, clarify light in just a second, but I want you to fully understand the three step process. First, we record the need. Second, we identify the accounts getting infected in the transaction, with the minimum off to and lastly, the input amounts as a debit and a crate. This three step process for recording transactions as journal entries works the same in a coffee business, a car dealership, Ah, hair saloon or whatever business you can think off. 5. Debits and Credits: In the last lecture, we spoke about Joey having to prepare journal entries for his new job, but he would have to debit and credit certain accounts. But the question remained. Which accounts are to be debited, in which accounts are to be credited. I wanted to keep a completely separate lecture on debits and credits because their source of so much confusion to so many people, but because their fundamental elements of accounting we should really understand them. The only thing that I request for this lecture is I would like you to keep any preconceived notions you may have about debits and credits aside and start fresh. So let's begin. I want you to think about a sport. I'm gonna be picking basketball Now. Most of us know where the basketball court looks like. As you can see, it's divided into two house. I'm going to call the left side of the basketball court, the debit side in the right side of the court, the credit side now, like in any sport, we're going to select two teams. The team on the left has a blue uniform, and the one on the right has a green uniform. Let's call the team on the left side of the building and the one on the right as the girl steam. Now let's say I appoint you as the head selector, and you're in charge of selecting any players that you want to join either team. The only criteria is diffidence. Expenses, assets and losses should always join the deal demon. The left side gains income, whatever news, liabilities and stockholders equity should always join the girls team on the right side. That's it. That's your only great area. Now what I just did in the snapshot of this basketball court is explained to you the entire concept behind debits and credits. If you know and remember this the deal demon, the left and the girl steam on the right. You should be able to solve any debit or credit journal entry that comes your way. Remember, in accounting, debit means one thing. Left hand side and credit means one thing right hand side. That's it, period. Finito. Many people think of debits and credits is good or bad, but good or bad have nothing to do with debit and credit. All never it means is left and credit means right But you may be wondering, Yeah, but left and right with respect toward good question. Do you remember we covered the accounting equation in a previous lecture, which was assets is equal toe liabilities plus Owner's Equity. An accounting rule is that this equation must balance with the left side, must always equal the right side. So debits are left. It means assets have a natural 11. Violence and credits means right means that liabilities and owner's equity always have a natural credit balance. Since debit falls on the left the asset side, it means that an acid violence will always go up by debuting it. If you think of any asset account like inventor, your cash increase, all asset accounts always will increase with the debit and reduce with a credit. The right hand side of the equation has bought liabilities and stockholders equity and has a natural credit balance. So any liability of stockholders equity will always increase. For the credit, you're probably wondering that you know how our debit and credit affects assets, liabilities and owner's equity. But what about other parts of the business that we've not covered yet, such as revenues, gains, incomes, expenses and losses. Well, when we make a sale or have a gain or a profit, what really happens anytime a sale gain or profit is made, the owners network goes up. So since gains sales and profits increase, Owners Equity and Owners Equity has a natural credit balance. They also have a natural credit balance. So anything that increases owner's equity, such as revenue income or gain, must also be credited. Now expenses do the opposite. They decrees Owner's equity. And since owners equity always decreases with a debit, any expenses or losses always decrees owners equity and therefore have a natural debit balance. I use deal for debits on the left and girls for credit on the right, as acronyms to make my life easier. But it's important for you to understand the concept. I hope this was helpful to you. Thank you so much for joining me in this lecture. I'll see you in the next one 6. Basic Bookkeeping: so joy things that bookkeeping is something done by librarians at the library. Well, in reality, I guess Liberians are in charge of maintaining books and placing them in the proper shelves . But that's not really the kind of bookkeeping we speak about an accounting circles. Let's dive into this lecture and find out more Hi, guys. So for Joy's sake, let's do a quick recap. By now, we know that the accounting cycle begins whenever financial transaction takes place in a company. Once the transaction happens, we record the journal entry for the transactions using their dual entry method, maybe record one side of the transaction with her debit in an other side of the transaction with the credit. But where exactly in a business do we really record these Journal entries? Well, journal entries are recording a set of books called Journalists and Eat Journal Falls under our different category. To understand the concept of journals, think of me give you thousands of pieces of paper with each paper being either yellow, white or green and color. Then I give you three folders. Label yellow, white or green, and I tell you, please help me file them naturally, We're going to start filing the yellow paper in the Yellow, Fuller, the White Paper and the White Folder and the Green Paper in the Green folder. Similar to this concept, an organization can have thousands and thousands of journal entries. But once you know the nature of the journal entry, you can put the journal entry into the specific journal based on what type of journal entry it is. Five. The most common categories of journals found in most organisations are the Cash Receipts Journal, the Cash Displacements Journal, the sales journal, The Porches Journal and The General Journal. Now let me explain each type of journal and the type of journal entries that go into them. Like the name suggests. The cash receipts Journal records all entries related to cash coming into the business. Majority of the transactions here come from cash seals, though other cash receipts, such as deposits of cash from company owners, loan proceeds and interest from savings accounts are also recorded here, similar in nature To the cashier See journal, we have the cash disbursement journal, which record all the cash outflows that we typically have entries for cash payments. Such a salaries, rent bills paid and so on Go here for sales transactions made on credit. We typically see them in the sales journal for any poor chases that the company makes on traded. The credits are recorded in the Purchases Journal, the fifth type of journalist called the General Journal, which forms transactions are typically do not fit in any off the Big Four journals. Now companies are not restricted to the journals alone and can have as many journals as they like remember, whenever transactions going to journals, they go in chronological order. The other name for journals scored books of prime entry, and these are commonly referred to as the books for Sharp. That's actually where the tone bookkeeping comes from, the people in charge of managing the day to day journal entries and the books are called Bookkeepers. Now, if you're wondering what there's a difference between a bookkeeper in my country, most people who come from outside the accounting world like our friend Joey don't know that . Let me explain to you the differences between bookkeepers and accountants. Accounting, like we know, is a process. The counting process involves a series of steps to get to our eventual goal, which is having a set off accurately prepared financial statements. Now bookkeeping is simply a part of the entire counting process, and bookkeepers are in charge of the initial steps of this process because bookkeepers are only in charge of the initial steps. Typically, they do not have the same level of qualifications as an accountant who usually holds a bachelor's degree in accounting or a C p A and is in charge of the entire accounting cycle . Though I'm not sure changing bookkeepers bookkeepers are usually highly familiar with the company accounting systems and also familiar with all accounting principles. Many times you show the tone bookkeeper and accountant he was interchangeably because e. A. Most people don't know the difference and be in many organisations. You may just see a qualified accountant taking care of everything, but you're taking this course, and it's important that you be smarter than everyone else. So next time you are the cocktail party, you can always show off your new form knowledge. I'll see you in the next lecture 7. T Accounts: Hey, guys, just like you, Joy has become a priority recording journal entries. But like you, he's saying now what you made The journal entries in each one of those entries is affected . One account to another in some way, either Deborah Dora Credit. But what do you do with all the zonal entries? And how do you know they affect so many entries have had on account balances? For example, if you want to know the cash balance or invent re balance after passing so many journal entries, how do we do that? That's when Step three off are counting. Cycle comes in posting the journal entries to the general letter. To start explaining this, I'm gonna have to explain what's 30 account now. What you're looking at on your screen is what we call a T account. The accounts are no nasty accounts, because before are more than accounting software. When we used to do accounting on books, we used to split the page up off a book into two House, which used to look like a D. The left side of the D account, as usual, is called the debit side, and the right side is called the credit side. You should have gotten pretty used to their deputies left, and credit is right thing by now. So let's take a look at a few journal entries from Joey's company. Since every journal entry effects at a minimum of two accounts, we'll see the journal entry effect on Duby accounts. Let's take a look at invention and cash. Our first journal entry s porches off inventory for $300 with cash on the night. We're going to start with a blank slate with Artie accounts and assume that there have been no previous T account balances. So are beginning. Balance is zero. We take a look at the T account for in Men Tree. Now, as we can see in the journal entry, that inventory has been deputed for $300 since debit means left. We're just gonna take and add that on the left side of the T account, you will see the cash violence of 300 has been credited. And so we put it on the right side of the D account. That's it. It's a simple is that we're done with our first journal entry. The next journal entry shows that report is in Renji again on the 17th. For $250 since debit means left, we just can't take the $250 again added to the left side of the T account, and the credit of cash would be put on the right side of the cash account. No, let's take a look at the Torrent Re, which is a bit different in the torrid entry into entry has been sold and therefore credited by $100. So it goes in the right. The customer paid in cash. So cash has gone up and it's been deputed and will increase the debit side of the T account . So what's our ending balance? Foreign reentry. We have a beginning balance of zero, and then we have our additions off $300.250 dollars on the left side, which totals $550. We subtract $100 balance on the right or the credit side, and we end up with an ending balance or $450. Foreign Ministry. We do the same thing for cash. We don't love to credit balances off. 302 52 equal 5 50 We then deduct $100 debit balance and come up with an ending balance off $450. So, Joe, he was asked, What's your elementary balance? You can always take a look at the D accounts and look at the ending balance and, say, $450 for cash. Cash is an asset and usually has a natural debit balance. But in the case of these journal entries cashes the credit balance of $450 because we spent all our money and more on purchasing inventory and not sold enough. Now the D account concept applies to all sorts of accounts any asset liability or equity account. You can always get somebody off your journal entries and CIA somebody of them in 30 accounts, and you can always see the total off any account at any point in time. I hope that was helpful 8. Trial Balances, Adjusting Entries and Closing out the Accounting Cycle : fantastic. We seem to be moving on quite well. Well, even the joy may have a learning capability, which is out of this world. Let's just go through the steps we have learned so far in the counting cycle together for the sake off as normal folk us or somebody of four people learned so far. Step one we collected. Verify all financial transactions off a company through source documents, which are documents like receipts, invoices, purchase orders, etcetera, Steptoe. We create journal entries for each financial transaction, with at least one account being debited and one being credited. Step three. We allocate the debit and credit balances of journal entries into individual T accounts. This helps us know the balance of each type of account. Now the place where all the tea accounts get grouped together. It's called The General Ledger. In this step is called Posting Toe The General Ledger step For now, In step four, we prepare a trial balance. So what is the trial balance and why do we have to prepare one in the last lecture belonged that every T account will have an ending debit or credit balance. Right? Trial balance is simply a worksheet in which the balances of all ledgers are compiled into debit and credit columns. Let's take a look at one now. As you can see, all the combat is a listed on left side, with the corresponding ending balance totals in the debit and credit columns on the right. If the daughter amounts of debits and credits do not match, and this would be an indicator often enter that may have been made in one of the steps before preparing a trial balance. So this is an accuracy check to detect if any errors have been made previously. Now remember, companies go to thousands and thousands of transactions in Lifetime, and many have hundreds of accounts in such a dynamic environment. This step Selves is an important figure to ensure that the data being recorded is accurate . Our something we must note is this is not a perfect system. For example, if debits and credits were recorded in reverse or in the wrong accounts for transaction has been missed completely, they would still be errors which would be undetected through this step. But like I mentioned earlier don't are perfect. This step still acts as a good filter to catch many, if not all, the errors that may have been made previously. Now we've put together trial balance. Step five in the counting cycle is to prepare adjusting entries. You might be thinking, Why would we need to adjust entries? Aren't all the transactions already reflected in the trial balance by now? Well, no. In the real world, transactions are not updated on a daily basis. For example, a sales person may have taken a client out for lunch and maybe planning toe, but still not have been the company. Or you could have pre payments like insurance and rain, where you only paid in thymus past. But you've still not updated the trial balance. The purpose of adjusting entries is to identify these transactions and bring the trial violence in line with current reality. To illustrate, let's take a look at an example from Joey's company on the cemetery. First, Joey sees a trial violence with $200 off office supplies, but he works in a big organization, and so when he checks, he sees that in reality there's only $50 off office supplies. He comes to the conclusion that in the past few days, the employees of the company have used up $150 off sir plaques. In this case, Joe, you would have to go ahead, make water scored and adjusting journal entry to update the trial balance. He would debit to supplies expense by $150 he would credit the supplies account by $150. Now, when we go in close, are all such entries in the trial Balanced amounts change in the end, up with what is called an adjusted trial balance. Despite our best efforts. Unfortunately, so many times in the real world, our first calculations of the trial balance due, North balance frying doesn't this balance. So we keep finding the source and making adjusting entries toe all look on, finally ballots. And then they're so happy that we go out and be party body. I wish in the real world it was like that. But unfortunately, we still have more work left to be finished. Once we finally get our child balances in order with all the correct account balances, we move on to Step six that is, preparing the balance sheet and income statement with the correct account balances. One other balance sheet and income statement, you might ask. Well, the entire next section is dedicated to explaining just that. Once you close out and finalize the financial statements, then we party body. That's of course. Do we start all of the steps all over again? Hey, it's called an accounting cycle, right for Nago. Thank you so much for joining me in this lecture. And I will see you in the next one.