BA 211 Chapter 1-1: “Accounting Equation”

SPEAKER: Hello. My name is Haitham Abdel-Hadi. I'm your instructor for
this accounting course. And we will start chapter one. And before we start chapter
one, I would like to talk to you about, what does accounting mean? What is the main
purpose of accounting? So the main purpose in
accounting is to keep records of your accounting transactions. And then when you keep records
of accounting transactions, usually you're going
to use some accounts. So each and every
company would have a list of accounts, 10, 15, 20 accounts. It depends on the company. And then they're going to use
those accounts for reflecting and recording transactions. Usually, in each and
every transaction, you're going to use at
least two of those accounts. The first thing we
will talk about is the accounting equation
in accounting, which is the heart of the accounting. Each and every transaction,
every company has to reflect, either directly or indirectly, it
has to reflect on that equation.

And then we will see
how we're going to use these accounts for
recording the transactions and reflecting them on the equation. So the accounting
equation, it's basically– and I will explain that now
after I have it written. It's assets equals liabilities
plus stockholder's equity. OK. Now, let me explain
what each one of those means before we start recording
transactions and reflecting them on this equation. Assets means any company
belonging that has a value. So if a company has cash in
the bank, that's an asset. If they have a building, if
they have a piece of land, if they have a piece of
equipment, anything they own, it must have its own account. And it's going to be
considered an asset. And it must have a value. So we cannot just say
that, OK, there's an open tissue box that the company owns. So if you try to sell that,
you are probably not going to get cash back for that. But if you have a piece of
equipment or a land or a building, obviously, you can still sell it
and get some cash back for that.

So this will be considered an asset. So it has to be
owned by the company, and it must have some value. That's an asset. The other side of the
equation, liabilities and stockholders' equity. Liabilities, it's the creditors'
or the lenders' claim against the asset. So in other words, liabilities,
it's what we owe to the lenders or to the creditors. The stockholders' equity, it's the
owner's claims against the assets. So if you add what the stockholders
can claim against the asset plus what the lenders can
claim against the assets, that will be the assets. If a company does not
have any liability at all, the assets will equal
the stockholders' equity. So for example, if I have my
own car and I paid it in full, I do not owe anything
to the bank, that means the total
assets will equal what I can claim against that asset.

If the car is worth $10,000,
when I sell it for $10,000, I'll be able to get the
entire $10,000 back for me as a stockholder. That's the same concept. But if I owe $4,000 out of the
$10,000, if I sold it for $10,000, that's the asset. I have to pay back
$4,000 to the bank, and then I get back, as
a stockholder, $6,000. So the $6,000 plus $4,000
equals the $10,000, which is the car, which is the asset. Now, going back to
companies, let's look what each one of
those, what accounts– or actually, we're going to take
some examples on some accounts that fall under each one of these
classifications, we call them. So assets. Obviously, cash,
it's the main account that falls under the assets. It can be cash in the bank
or cash– portable cash. The other very common account
that almost every company has is equipment.

The other account is,
let's say, Supplies. And then when I say supplies here,
I'm talking about the supplies that we purchased, but
we did not use them yet. We still have them sealed. That means they still
have some value in them. Remember, once you use them, they're
not going to have value in them anymore, so we're not going to
consider them as assets anymore. They have to be transferred
to a different place. So before you start using
them, once they still have some value, some
holding value in them, we will consider them assets. If it is a merchandise company,
they will have inventory. So that's how they make business. They buy inventory, it becomes
one of their belongings, and then they sell them
eventually for making money from. We can say Building, Land. Maybe not every company
has buildings and lands. We consider prepaid accounts,
for example, prepaid rent or prepaid insurance. I would just say, for
example, Prepaid Rent. And that is considered an asset,
because when you prepay money, let's say, to the landlord for
the property that you're renting, if you did not consume
that amount yet, it means you did not actually
start renting the property.

Or maybe you paid it at the
beginning of the period, so the period is not over yet. You did not start using
that place with that amount that you paid initially. So it's like depositing
cash in the bank. It's not in the bank, but
it's with the landlord, but then you will start
consuming that amount over time. So at least from the
accounting perspective, it's still considered
part of our assets, because it's cash that
still belongs to us, and we did not consume it yet. Now, later on, once you
consume it, then it's not going to continue
being an asset anymore.

We have to take it away from asset. The other account is
Accounts Receivable. Accounts Receivable, it's the
money owed by someone to us. When I say us, I mean the company. It's us. If we provide a
service, for example, if we provide a
service to a customer, and then we finish
providing the service, we're done with the
service, that means it's officially becoming a revenue. And that's another account
that we'll talk about soon.

So because that service
was provided and is done, the amount owed by
the customer to us becomes officially
one of our assets. The way how I explain it to
people, at least my way, just to make it more clear, it's
like cash in someone's pocket that belongs to us already, OK? So this is considered
accounts receivable. So accounts receivable, it's
the cash that will be received. It will be. You can squeeze, at
least in your head, you can squeeze the words "will be." It's cash that is not yet with us. It will be coming in
future from the customers.

So we are already considering
that amount part of our assets. So once you add all these
accounts– so each one of them, we call it an account. Once you add them up, you
get the total assets, OK? So those are examples on assets. Let's talk about the liabilities. Again, liabilities, it's any
amount that we owe to someone. The most important account
under the liabilities, it's called Accounts Payable. And it's called Accounts
Payable, because it means that there's a
specific amount that we will pay to someone in future, OK? We will pay it. So that's why we call it payable. There's another example
for Notes Payable, which is very similar to Accounts
Payable, but it's more official. It's documented. Usually, sometimes
we charge the– so we get charged interest on top
of that amount that we owe. But in Accounts Payable,
it's not that official.

We don't pay interest, normally. We don't sign documentation,
too much documentation for that, like the Notes. There's also Loan Payable. It can be Salaries Payable. There is something that we
call Accrued Liabilities. And what that means is if
we have any, for example, utilities, any utility bill that
becomes due, it has been accrued. Accrued means it's due for payment. It's officially money we owe for
the service provider of that bill. That means it's going to
be one of the liabilities, because we owe that amount now.

We can also say Utilities
Payable, for example. Utilities Payable. And there's one more account
that is called Unearned Revenue. That account is called
Unearned Revenue, because when someone
pays us money in advance, let's say, a customer that
we are going to provide them a service in future, and he
pays us money in advance, once we get that money, we
become liable to provide a service to that customer
sometime in future. So that amount becomes
a liability until we provide a service to that customer.

So in the meantime,
between the day we receive the cash until we provide
the service to the customer, that amount will be considered a
liability under Unearned Revenue. Stockholders' Equity. We've got Common Stock. So when a company issues stock,
that means they will raise cash. They will raise fund from stocks. They will give stocks
to the stockholders, and they will get cash from them. So the stockholders will
become one of the owners, and they will become part of
the ownership in the company. And the amount of cash we
get from those stockholders goes to common stock. There's also Retained
Earnings account, which I will explain
in my following videos, because it has too many
things involved in it. There's also– we will talk
about the revenue and expenses. Revenue, it's the cash
coming in from– it's the value of the service or the
inventory we sell to customers or the value of the service
we provide to customers. That amount becomes revenue,
because that's what we will expect from them to be paid to us.

And it does reflect on
the Stockholder's Equity, but indirectly, OK? Indirectly. It's not one of their accounts. It's not one of the
Stockholders' Equity accounts, but it reflects on
stockholders' equity. So I'm just going
to put it down here. Revenue, it reflects positively. So more revenue will reflect
on more stockholders' equity. And then, also,
Expenses and Dividends. Expenses, it's anything we pay
for operating the business.

So for example, wages expense,
utilities expense, advertising, tax expense, all those are expenses. That means we pay that amount
for running the business. It's for operating the business. It's not like paying cash
for buying equipment, because there's a
holding value there. But when you pay cash for utilities
or wages or rent or insurance, this is money gone,
and the value is gone. So it's not going to
be considered an asset. We consider that an expense, OK? Dividends, it's the portion of
the net income– net income is the profit that the company makes. The portion of that profit or the
portion of the net income that gets paid to the stockholders, that
part is considered a dividend. That amount is dividends, OK? Revenues will reflect positively
on the stockholders' equity, and expenses and dividends
will reflect negatively on stockholder equity.

And then I forgot to mention
here that once you add up all those liabilities,
you get Total Liabilities. And then here, whenever
you add common stock and add the retained
earnings, it's actually going to combine revenues
and expenses and dividends all in one account. And that's what we will
explain in the following video. So once you have all
those added up, you will get Total Stockholders' Equity.

That was the first
video for chapter one. That's just the part one. We will talk about part
two in the next video..

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