Hello in this lecture we will discuss the accounting building blocks and the double entry accounting system. At the end of this we will be able to define and describe the double entry accounting system, write down the accounting equation and define each individual part of it, define and describe debits and credits, define a balance sheet and list its parts define an income statement list its parts and explain the relationship between the balance sheet and the income statement. Okay, so starting off every business and accounting software uses the double entry accounting system. So the double entry accounting system, it’s kind of like the math behind the calculator, every software is going to use it. In order to understand what the system is doing, we need to understand the double entry accounting system.
Many people can work in the accounting department and start to learn database programs and how to enter data without understanding the double entry accounting system. And that’s possible you can learn a lot that way but you become a lot more valuable and you can become a lot more attuned to what other departments are doing and how things fit together if you can understand the double entry accounting system similarly to your get along more understanding. If when you punch, you know, two plus two into a calculator, you understand why the answer came out to wait, it came out. And that gives you some insight in terms of decision makings and how to help things out. So that’s what we’ll discuss that double entry accounting system as we go. So we’re going to compare this to a puzzle. So I want to think of the double entry accounting system.
Being that we’re going to compare it to kind of a game here, a puzzle, we got to first learn the rules of the game, how the how the thing is set up, we want to know what the board is, we want to know what the pieces are. We want to know how to set the pieces on the board, then how to move them. Once we know that then it becomes a lot more interesting for us to play the game just as it would be for a game of checkers. So a game of checkers is obviously on a spreadsheet, we have different colored pieces. And we have different colored squares, we move those pieces in accordance to a set of rules. The set of rules for accounting are that we have a T account so our spreadsheet is not a spreadsheet like checkers, it’s going to be basically a T account will use various T accounts as we go the rules of the game is we’re gonna have debits on the left hand side credits on The right hand side, debits and credits aren’t inherently good. They’re just like the black and white or whatever the color squares are on the board, they have no inherent goodness or badness there just happen to be.
This is on the left hand side debits on the left credits on the right, then we need to know how the pieces line up. So what are the pieces assets, liabilities and owner’s equity. So the green accounts are going to be asset type accounts here. And notice that they line up on the left hand side they are debit normal balances. For the most part, liabilities are credit normal balances for the most part, which I’ve have on the right hand side. And I’m also going to start showing them with brackets. And then equity section is generally on the right hand side includes capital revenues on the right hand side and then expenses on the left hand side, then we have the concept of balancing that you’ve heard of. And that concept means that the total debits equal the total credits. There’s going to be different ways that we can think about that balancing concepts. But that’s the board. These are the pieces we need to understand And then we can talk about how to move those pieces. And those are the building blocks that we need to know and understand and basically memorize.
Before we can play the game, just like we have to memorize how to set up the board, how to move the pieces in a game of checkers or a game of chess. So the other rules that we’re going to start to come in to play will be that every business transaction will affect at least two accounts. These are our accounts in this case, and every transaction will have an equal number of debits and credits. Those are the rules. Alright, so first, we’re gonna take a look at the balance sheet here. Just to note that the balance sheet, we’ve seen that we have assets, liabilities and owner’s equity, we can see that this balancing concept that we talked about that total debits and credits can also be expressed in terms of total assets equal total liabilities and owner’s equity. So the balance sheet is going to report our information as of a point in time and, and so it doesn’t have a timeframe. It doesn’t have a beginning and an end. It’s as of this point in time. It shows our assets, liabilities and owner’s equity. Assets are what we’re going to own in order to generate revenue in the future. We have those to help us generate revenue in the future.
Cash is probably the first thing you want to think of when you think of assets. And then liabilities are something that we’re going to owe in the future, either cash owed to the in the future or our services or something in the future for something that we consumed or bought in the past. And equity represents the book value of the company or the amount that’s owed to the owner. So you can also think of it as the assets are what the company has. These are who they owe it to the either a third party or the owner. That’s why the assets equal to liabilities and owner’s equity. Now, you might be saying, Well, I don’t see debits and credits in this statement, and we just talked about debit and credits being the building block. And the reason we don’t see debits and credits here is because we’re presenting the financial statements generally to people that may not understand the debits and credits, so we need to present it in a plus and minus format.
We’re going to use the building blocks of debits and credits to create the financial statements so that we can then show those financial statements in a different format. Which is going to be assets equal liabilities plus owner’s equity, because that’ll be easier for others to understand. If we were to look at the balance sheet in terms of debits and credits, it would look something like this meaning that the assets are generally debits. Here’s our T account again, and we would see that the we can see that the assets add up to 78. And the credits are generally liabilities and owner’s equity. This is a simplified system. Later on some assets will be credits. But for the most part, this is how it would line up assets are all debit balance accounts in this example. And so we can see the double entry accounting system and a few different ways we can see that the debits equal the credits here and we can also see that the assets equal to liabilities plus the owner’s equity. And we can express that in terms of debits.
We can express the double entry accounting system in terms of the debits equal the credits, or the assets equal to liabilities plus owner’s equity or the balance sheet is in balance. So the three ways we can say basically the same thing. Notice that the balance sheet is assets, liabilities and owner’s equity the balance sheet is the double entry accounting system. It has all the components of the accounting equation, the accounting equation being assets equal liabilities plus owner’s equity, we can also write that accounting equation as three different ways. algebraically, we can subtract liabilities from each side and that would be assets minus liabilities equals owner’s equity. This is a useful way to write it because it tells us that this owner’s equity is the book value. If the company has 78,000 they owe someone else 10. Then owner’s equity is 68,000. The owner if it’s one person theoretically could sell the business and walk away with 60,000. income statement shows the profitability of a company over a year or other timeframe.
So notice the income statement. The big thing you want to note here is that it has a timeframe in this case, the month ended here so that means December 31. That means the timeframe is from December 1 to December 31. And the way you want to think about that is is the income statement. Kinda like how did you do over time, similar to running a race. And when you when you run a race, it has to have a beginning and an end? Or if we were to ask someone, how much money do you make? They would have to make an assumption. Are you talking about a year? Are you talking about a month? Are you talking about a pay period? We need a timeframe in order to answer those types of questions. Because the income statement itself is dealing with how are we doing over a certain time? Notice we have revenue and we have expenses here. And how do we calculate it? We say how much did you make? How much did it cost to generate that revenue in terms of expenses, therefore, revenue minus expenses gives us our net income. And so there’s our net income.
Once again, you don’t see debits and credits on the financial statement, because we’re going to give it to people that may not know debits and credits. If we were to look at the debit and credit format of an income statement, we can see that credits are actually the income is actually a credit. And here’s our T account again, and the debits are expenses. So we can see that the credit Right, it’s in this case are beating the debits by the net income. And you might be saying, well, that’s kind of weird what we we thought that the debits and credits have to be imbalanced in order for the double entry accounting system to work. Is there something wrong with this statement? Why is it that I don’t see the double entry accounting system having an equal number of debits and credits on the income statement? And why is it I don’t see the any of the equation accounts here I don’t see assets, liabilities or owner’s equity, all I see is revenue and expenses. How is it that the income statement fits into the double entry accounting system and as part of the double entry accounting system? And the answer to that is that the whole income statement is part of the balance sheet.
So we got to remember that the balance sheet is as of a snapshot f of a point in time. So as of this point in time you are watching this video. If you can’t change that it is what it is. It’s there. If you want to know how you got to this point in time watching the video Well, we then have to go back in some timeframe and say what You woke up at this point in time we we did that we did the other thing and we ended up watching this video for whatever reason. That’s the story of how it came to be. In this case, we’re saying that the assets minus the liability means we have a book value of 68,000. Here. That is what it is can’t change it as of 1231. It is what it is can’t change it. If we want to know how we got there, then we tell the story we can say, Well, you know, last month, we made 100,000 of revenue, and we had to extend 60,000 in order to do it. So last month, we earned 40,000.
That 68,000 right there includes 40,000 from last month. If you want to know more of the story, then we’ll have to go back to the prior month and look at the income statement for the prior month. We can go back years and look at the story in terms of how are we performing year over year in order to get to the place that we are currently at. Now if we if we broke down this number a little bit more you notice this number. We’re just breaking down this number into its history, basically, in terms of, of income generation. And if we looked, take this back to the trial balance, the trial balance is what we generate what we use to generate the financial statements, we can see that this capital account includes the beginning capital, that’s what was owed to the owner before the time period being in this case, November 30, the end of last time period, because this time period began on December 1 to December 31. So this is what was owed to the owner before we started, and then we had the the revenue, minus the expenses. So we got the beginning balance plus the revenue minus the expenses.
That’s how we’re getting to our Indian capital number. So if you think of this in terms of the balance sheet, you notice we have our assets which would add up to the assets on the balance sheet, the liabilities, and then really this whole thing is is the equity section. If we added up this whole blue area, that would be the equity section on the balance sheet here. And part of that equity is the income statement there on the trial balance