Accounting: 32 Things YOU SHOULD KNOW

Summary

James introduces 32 key concepts in accounting to help viewers grasp the fundamentals. He explains the purpose of accounting, the difference between single-entry and double-entry methods, the accounting equation, and the importance of debits and credits. He also clarifies the cash and accrual methods, the use of journal entries, and the significance of financial statements like the balance sheet, income statement, and cash flow statement. The video is designed to simplify complex accounting principles and guide viewers through the basics with additional resources provided.

Takeaways

• 📚 Accounting is the process of identifying, recording, summarizing, and analyzing a business's financial transactions and reporting them in financial statements.
• 🔍 Identifying transactions involves spotting events that affect a business financially, such as sales, purchases, or cash transfers.
• 📋 Single-entry accounting records transactions in a cash account, while double-entry accounting records two sides of every transaction, reflecting the accounting equation.
• 💡 The accounting equation states that a business's assets must equal its liabilities plus equity, representing the resources, obligations, and owner's claim on the net assets.
• 💼 Equity is composed of capital contributions and retained earnings, which include profits held for future use and accumulated profits minus withdrawals.
• 💰 Revenue is income earned from primary business activities, and expenses are costs incurred to produce revenue, including direct and indirect costs.
• 🔄 Debits and credits reflect the double-sided nature of transactions, with normal debit accounts increasing when debited and normal credit accounts increasing when credited.
• 🏦 The cash method of accounting recognizes revenue when cash is received and records expenses when cash is paid, whereas the accrual method recognizes revenue when earned and records expenses when incurred.
• 📝 Journal entries are records of financial transactions, balancing total debits with total credits to maintain the integrity of the accounting equation.
• 🗂️ The general ledger is a comprehensive database of all accounts and journal entries, while the chart of accounts is a structured summary of every account used by a business.
• 📊 Financial statements, including the balance sheet, income statement, and cash flow statement, provide insights into a business's financial health and activities over a period of time.
• 🔗 The income statement and balance sheet are inherently linked through current year profit, which affects retained earnings and equity.

Q & A

What is the definition of accounting as described in the script?

Accounting, specifically financial accounting, is the process of identifying, recording, summarizing, and analyzing a business's financial transactions and reporting them in financial statements.

What are the two basic methods of recording transactions in accounting?

The two basic methods of recording transactions are single-entry accounting and double-entry accounting. Single-entry accounting records one accounting entry for each transaction, usually in a cash account, while double-entry accounting records two sides to every transaction, with each entry having at least one opposite corresponding entry in a different account.

Can you explain the accounting equation mentioned in the script?

The accounting equation states that a business's assets must equal its liabilities plus equity. Assets are what the business owns and have value, liabilities are what the business owes to third parties, and equity is the owner's claim on the net assets of the business.

What is the difference between capital contributions and retained earnings in the context of equity?

Capital contributions are the funds invested into a business by its owners, while retained earnings are the accumulated profits of the business held for future use, consisting of opening retained earnings and the current year's profit less any withdrawals.

How does the script define revenue and expenses?

Revenue is the income earned by a business from its primary activities, typically the selling of products or services. Expenses are the costs incurred to produce revenue, including the direct cost of sales and the indirect costs of running and operating a business.

What is the purpose of debits and credits in financial transactions?

Debits and credits reflect the double-sided nature of financial transactions. They indicate the flow of economic benefit from a source to a destination, with debits typically increasing normal debit accounts and credits increasing normal credit accounts.

What is the cash method of accounting and how does it differ from the accrual method?

The cash method of accounting recognizes revenue when cash is received and records expenses when cash is paid out. It is simpler but can be difficult to measure profit accurately. The accrual method, on the other hand, recognizes revenue as it's earned and records expenses as they are incurred, regardless of when cash changes hands.

Why is the accrual method of accounting necessary for large businesses?

The accrual method is necessary for large businesses because it aligns with the revenue recognition and matching principles, allowing for accurate profit measurement. It is also required by international financial reporting standards (IFRS) or generally accepted accounting principles (GAAP).

What is a journal entry and why is it important in accounting?

A journal entry is a record of a financial transaction, showing the accounts involved, the amounts, and whether they are debits or credits. It is important because it ensures that every transaction is balanced, with total debits equaling total credits.

Can you describe the general ledger and its role in accounting?

The general ledger is a database that stores a complete record of all accounts and journal entries. It contains a t-account for every account, which records all journal entries posted to it, and is essential for summarizing a business's transactions.

What is the purpose of the trial balance in accounting?

The trial balance is an accounting report that shows the balances in every business account at a point in time. It is used to ensure that the total debits match the total credits, verifying the accuracy of the accounting records.

How are the income statement and the balance sheet related according to the script?

The income statement and the balance sheet are inherently linked through the current year profit, which is reflected in the retained earnings on the balance sheet. The income statement measures profit, while the balance sheet provides a snapshot of assets, liabilities, and equity at a point in time.

What role does the cash flow statement play in accounting, especially in accrual accounting?

The cash flow statement summarizes a business's cash inflows and outflows over a period of time. Unlike the income statement, which measures profit, the cash flow statement measures the actual movement of cash in and out of the business, which is crucial for understanding liquidity and operational efficiency.

Outlines

00:00

📚 Introduction to Accounting Basics

James introduces the topic of accounting, explaining it as the process of identifying, recording, summarizing, and analyzing a business's financial transactions. He outlines the importance of the accounting equation, which states that assets must equal liabilities plus equity. Assets are resources expected to bring future economic benefits, while liabilities and equity represent what the business owes. Equity is further broken down into capital contributions and retained earnings, with the latter consisting of opening retained earnings and current year profit minus withdrawals. The paragraph emphasizes the foundational concepts necessary for understanding accounting.

05:04

🔍 Deep Dive into Debits, Credits, and Accounting Methods

This section delves into the specifics of debits and credits, which are fundamental to the double-entry accounting method. It explains the categorization of accounts into normal credit and normal debit accounts, and how they affect the balance of economic transactions. The paragraph also clarifies a common confusion regarding bank transactions and the nature of cash as an asset. Furthermore, it contrasts the cash method and accrual method of accounting, highlighting the latter's adherence to revenue recognition and matching principles, which are essential for accurate profit measurement and compliance with IFRS or GAAP standards.

10:08

📝 The Mechanics of Recording Transactions and Journal Entries

The paragraph explains the process of recording financial transactions through journal entries, which include a unique journal number, a description, posting date, and the debit and credit amounts. It emphasizes the necessity for debits to equal credits to maintain balance. The discussion then moves to the general ledger, which is a comprehensive database of all accounts and journal entries, and the chart of accounts, which is a structured summary of every account used by a business. The paragraph concludes with an explanation of the trial balance, an accounting report that shows account balances at a specific point in time, and the importance of adjusting entries to align transactions with the accrual method of accounting.

15:10

📈 Financial Statements and Their Interconnections

This final paragraph discusses the preparation of financial statements, which provide insights into a business's financial health. It describes the balance sheet, or statement of financial position, as a snapshot of a business's assets, liabilities, and equity at a specific point in time. The income statement, or statement of profit and loss, summarizes revenues and expenses over a period and measures profit using the accrual method. The paragraph also highlights the link between the income statement and the balance sheet through current year profit, which affects retained earnings. Lastly, it introduces the cash flow statement, which is crucial for understanding a business's cash inflows and outflows, especially under the accrual method of accounting.

Keywords

💡Accounting

Accounting is the systematic process of identifying, recording, summarizing, and analyzing a business's financial transactions and reporting them in financial statements. It is central to the video's theme as it provides the foundation for understanding the various financial activities of a business. The script uses the term to introduce the concept of financial accounting and its importance in business operations.

💡Financial Statements

Financial statements are formal records that summarize a company's financial activities over a period of time and are a key concept in the video. They provide insights into a company's financial health and are used by various stakeholders to make informed decisions. The script mentions financial statements multiple times, explaining their role in reporting a company's assets, liabilities, equity, revenues, and expenses.

💡Double-Entry Accounting

Double-entry accounting is a method of recording financial transactions where every entry has a corresponding and opposite entry, reflecting the dual nature of transactions. It is a fundamental concept in the video that ensures the accounting equation's balance. The script explains that this method is more comprehensive than single-entry accounting and is essential for accurate financial reporting.

💡Accounting Equation

The accounting equation is a basic formula that states Assets = Liabilities + Equity. It is a core concept in the video, illustrating the fundamental relationship between what a business owns and owes. The script uses the accounting equation to explain how assets must equal the sum of liabilities and equity, which is a basic principle in accounting.

💡Assets

Assets are resources owned by a business that have value and are expected to provide future economic benefits. In the video, assets are discussed as part of the accounting equation and are used to explain how they contribute to a company's net worth. Examples given in the script include a printing press for a publisher, which is an asset that helps generate revenue.

💡Liabilities

Liabilities represent obligations or debts that a business owes to third parties. The script defines liabilities as commitments requiring a future economic sacrifice and contrasts them with assets, which a business owns. Liabilities are part of the accounting equation and are essential for understanding a company's financial obligations.

💡Equity

Equity, also known as net assets or owner's claim, is the residual interest in a business after deducting liabilities from assets. It is a key concept in the video, as it represents the owner's investment and the business's retained earnings. The script explains that equity is composed of capital contributions and retained earnings, which are crucial for understanding a company's financial position.

💡Revenue

Revenue is the income generated by a business from its primary activities, such as selling products or services. In the video, revenue is discussed in the context of the income statement and its importance in measuring a company's profitability. The script uses revenue as part of the expanded accounting equation to illustrate how it contributes to a company's financial gain.

💡Expenses

Expenses are the costs incurred by a business in the process of generating revenue. The video emphasizes the importance of expenses in the context of the income statement and the calculation of profit. The script explains that expenses include both the direct costs of sales and the indirect costs of running a business.

💡Accrual Method

The accrual method of accounting is a system where revenue is recognized when earned, and expenses are recorded when incurred, regardless of the cash flow timing. This method is highlighted in the video as a more accurate way to measure profit compared to the cash method. The script explains that the accrual method aligns with the revenue recognition and matching principles, which are essential for proper financial reporting.

💡Journal Entries

Journal entries are the records of financial transactions used in double-entry accounting. The video describes how journal entries are structured, with debits and credits balancing out to maintain the integrity of the accounting equation. The script uses journal entries to illustrate the process of recording transactions and their importance in summarizing business activities.

Highlights

Accounting is the process of identifying, recording, summarizing, and analyzing a business's financial transactions and reporting them in financial statements.

Single-entry accounting records one entry per transaction, usually in a cash account, but lacks a complete business picture.

Double-entry accounting records two sides to every transaction, reflecting the accounting equation where assets equal liabilities plus equity.

Assets are resources likely to bring economic benefit to a business, while liabilities and equity represent what a business owes.

Equity is the owner's claim on the net assets of a business, consisting of capital contributions and retained earnings.

Retained earnings are built up over time from profits less withdrawals, representing the business's accumulated profits.

Revenue is income earned from primary activities, such as selling products or services, while expenses are the costs incurred to produce revenue.

Debits and credits reflect the double-sided nature of transactions; debits increase normal debit accounts and decrease normal credit accounts.

The acronym 'DEALER' helps remember which accounts are normal debit or credit accounts in double-entry accounting.

The cash method of accounting recognizes revenue when cash is received and records expenses when cash is paid.

The accrual method recognizes revenue as it's earned and records expenses as incurred, regardless of cash flow.

IFRS and GAAP require the accrual method for accurate revenue and expense recording in line with the revenue recognition and matching principles.

Journal entries record financial transactions, ensuring total debits equal total credits for each entry to maintain balance.

The general ledger is a database storing all accounts and journal entries, essential for summarizing business transactions.

A chart of accounts is a structured summary of every account used by a business, arranged by type with unique codes for identification.

A trial balance is an accounting report that shows account balances at a point in time, with debits equaling credits.

Adjusting entries ensure transactions align with the accrual method, recognizing revenue and recording expenses accurately.

Financial statements outline a business's financial activities over a period, providing insight into its financial health.

The balance sheet is a snapshot of a business's assets, liabilities, and equity at a point in time, reflecting the accounting equation.

The income statement summarizes a business's revenues and expenses over a period, measuring profit using the accrual method.

The cash flow statement measures a business's cash inflows and outflows, differentiating it from the income statement under accrual accounting.

Transcripts

Hi it's James. Today I'm going to tell you 32  things you should know to help you understand  

accounting. Before we get stuck in I want to do  a quick shout out to all of my wonderful channel  

members. Thanks for supporting Accounting Stuff.  Let's do this! First of all, what is accounting?  

Accounting or specifically financial accounting is  the process of identifying, recording, summarizing  

and analyzing a business's financial transactions  and reporting them in financial statements. Let's  

break this down. Identifying transactions means  spotting events that affect a business financially.  

Maybe it sold something. Maybe it bought something.  Maybe it moved cash from one account to another. We  

identify the transaction, then we record it. There  are a couple of ways to do that. The simplest way  

is to use the single-entry accounting method.  In single-entry accounting we only record one  

accounting entry for each transaction usually in a  cash account. When cash comes in you record revenue  

and when cash goes out you record an expense. It's  straightforward but it doesn't give you a complete  

picture of your business. A better way to record  transactions is to use the double-entry accounting  

method. In double-entry accounting there are two  sides to every transaction. This means that each  

accounting entry has at least one opposite  corresponding entry in a different account.  

Why? Because in Double-Entry accounting, the stuff  that a business owns is equal to the stuff that it  

owes. This leads us nicely into the fourth thing  that you should know about accounting. Which is  

of course the accounting equation. The accounting  equation says that a business's assets must equal  

its liabilities plus equity. Assets are the stuff  that a business owns that have value. You can think  

of them as resources that are likely to bring  economic benefit to a business in the future. An  

example would be a printing press that allows a  publisher to print magazines which it sells for  

monie. Whereas liabilities and equity represent  the stuff that a business owes. Liabilities are  

the stuff that a business owes to third parties.  These are commitments or obligations that require  

a sacrifice of economic benefit in the future.  For example, a publisher might owe some money to a  

freelance writer or a journalist. Equity is the  stuff that a business owes to its owners. Let's  

think about this one for a moment. What exactly  is equity? If we rearrange the accounting equation  

we can see that equity is equal to assets minus  liabilities. Another name for this is net assets.  

So equity is the owner's claim on the net assets  of a business. And while we're here, what's equity  

made up of? There are two main components to  equity: capital contributions and retained earnings.  

Capital contributions are the funds invested into  a business by its owners out of their own pockets  

and retained earnings are a business's accumulated  profits held for future use. Retained earnings are  

gradually built up over time and are made up  of opening retained earnings and current year  

profit less withdrawals. Opening retained earnings  are what we start the year off with. These are brought  

forward from the end of the previous accounting  period. Withdrawals are the owners claiming their  

net assets by taking their money out of the  business. Withdrawals are also called drawings  

or dividends depending on how the business is  structured. We can work out current year profit  

by taking revenue less expenses. It's the financial  gain generated over a period of time when revenues  

are bigger than expenses. On the other hand a  business incurs a loss if its expenses outweigh  

its revenue. Revenue is the income earned by  business from its primary activities. That usually  

means selling products or services. And expenses  are the costs incurred in order to produce revenue  

they include the direct cost of sales and the  indirect costs of running and operating a business.  

What we have here is the expanded accounting  equation. This is the 14th thing that you should  

know about accounting, and trust me this one is  key to understanding how it works. As you'll  

soon find out. I know this is a lot to take in but  please don't panic. I have videos covering each of  

these topics in depth, so if we touch anything here  that you'd like to spend a little bit more time  

on then head on down to the description. You'll  find links to those videos there. I've also put  

together cheat sheets and question & answer packs  for each topic as well and I'll leave links to  

those in the description too. Number 15, debits  and credits. Debits and credits are words used  

to reflect the double-sided nature of financial  transactions. All transactions involve a flow of  

economic benefit from a source to a destination.  That means that there are two sides to every  

transaction. If we debit one account we have to  credit another. But how do we know which to debit  

and which to credit? We can separate all accounts  into two groups: normal credit accounts and normal  

debit accounts. Normal credit accounts represent  the sources the economic benefit flows from.  

These are liabilities, equity and revenue. When  we credit these accounts they increase in value  

and when we debit them they decrease. Normal debit  accounts work the other way around. They represent  

the destinations that economic benefit flows to.  Dividends, expenses and assets. These increase when  

debited and decrease when credited. There's a simple  acronym to help you remember all of this: DEALER. I  

think we're at 16 now. By the way if you think  I've missed anything else in this video please,  

please let me know in the comments. On the left we  have D E A or dividends, expenses and assets. These  

are normal debit accounts and on the right we have  L E R or liabilities, equity and revenue. These are  

normal credit accounts. Debits and credits always  work this way. But there is one situation that can  

cause some confusion. If you go to the bank and  deposit cash into a checking account the bank  

credits your checking account which increases your  balance. And when you take your cash out they debit  

your account which decreases your balance. But in  accounting, cash is a type of asset which makes it  

a normal debit account. So credits should decrease  your cash balance and debits should increase it. 

This is correct. But from the bank's point  of view, your checking account is actually a  

liability, not an asset. So when you put money  into your checking account, the bank debits  

their cash account increasing their assets and  they credit your checking account increasing  

their liability owed to you. So debits and credits  are never backward. The next thing you should know  

is the difference between the cash method and the  accrual method of accounting. The cash method says  

that revenue is recognized when cash is received  and expenses are recorded when cash is paid out.  

It's nice and simple but there is a major flaw with  the cash method. It can be extremely difficult to  

measure your profit. This is because revenue  and related expenses are often recorded in  

separate accounting periods. The solution is to  use the accrual method of accounting. The accrual  

method says that revenue should be recognized  as it's earned, and expenses should be recorded  

as they are incurred. Not when cash changes  hands. The accrual method is a must for all  

big businesses. This is because they usually have  to follow IFRS or GAAP. Either the international  

financial reporting standards or a variation  of the generally accepted accounting principles.  

Both of these rulebooks require you to use  the accrual method of accounting. Why is that?  

For one, the accrual method applies the revenue  recognition principle. The revenue recognition  

principle says that revenue should always be  recognized as it's earned, not when cash is  

received. This means a business records its revenue  when the substance of a transaction takes place. At  

the moment they deliver a product or a service.  It doesn't matter when they receive the cash.  

The accrual method also applies the matching  principle. The matching principle says that  

revenue, and all expenses incurred in order to  generate that revenue need to be recorded in  

the same accounting period. It aligns revenue  and related expenses so you can measure profit  

accurately. Now that we've got all of that out  of the way, how do we actually record transactions?  

We use journal entries. A journal entry  is a record of a financial transaction.  

It looks like this. We have the journal number which  is unique to the journal, a short description  

explaining what the transaction is. We have a  posting date, the names of the accounts that we're  

posting to and the amounts. Debits go on the left  and credits go on the right. Always remember that  

total debits must equal total credits. Because  every journal entry has to balance. When our  

journal's prepped and ready to go, we post it. Each  side hits a different account. If we jump back to  

our definition of financial accounting, then this  is how we summarize a business's transactions. We  

group similar transactions together and store  them in accounts. When we present an account  

this way we call it a t-account because it looks  like a "T". The general ledger is the 24th thing that  

you should know about accounting. It's a database  that stores complete record of all accounts and  

journal entries. We have a t-account representing  every account and each one contains every journal  

entry ever posted to it. If we take all of these  accounts and pop them in a list, then we have a  

business's chart of accounts. This is a structured  summary of every account used by a business.  

They tend to be arranged by type so we have assets  liabilities, equity, revenue and expenses. Each  

account has a description and we often give each  one a unique code to help us identify it. If we pop  

the numbers back in, then we have a trial balance.  This is an accounting report showing the balances 

in every business account at a point in time. As  always debits go on the left and credits go on  

the right. The total of the debit column must match  the total of the credit column because the trial  

balance must balance. At the end of each accounting  period we analyze the balances of every account  

in the trial balance and then we post adjusting  entries to make sure that all of the transactions  

align with the accrual method of accounting.  So that revenue is recognized as it's earned  

and expenses are recorded as they are incurred.  Once the adjusting entries have been posted  

we're ready to make financial statements. Financial  statements are accounting reports that outline the  

financial activities of a business over a period  of time. They give us insight into its Financial  

Health and help investors, lenders and creditors  make informed decisions. There are three main  

financial statements. First we have the balance  sheet, also known as the statement of financial  

position. The balance sheet takes the figures from  every account in the trial balance and gives us a  

snapshot of a business's assets, liabilities and  equity at a single point in time. Does this ring  

a bell? If we head back to our expanded accounting  equation and we can see that the balance sheet  

represents this top line. You could think of it as  a snapshot of the accounting equation at a point  

in time. Assets equal liabilities plus equity.  Another important financial statement is the  

income statement or statement of profit and loss.  P&L for short. We can build an income statement  

using the revenue and expense numbers from the  trial balance. The income statement summarizes a  

business's revenues and expenses over a period of  time. You'll notice that on the bottom line we have  

profit for the current year which we can measure  accurately using the accrual method of accounting  

by recording revenue as it's earned and expenses as  they are incurred. Which brings me on to the 31st  

thing you should know about accounting. The link  between the income statement and the balance sheet.  

Current year profit slots in right here on the  bottom line of the expanded accounting equation.  

This means that the income statement and the  balance sheet are inherently linked to one another  

through current year profit which rolls up into  retained earnings or profits held for future use  

which makes up part of equity. The owner's claim  on the net assets of the business. But don't go  

anywhere yet. There's one more financial statement  you should know about. The cash flow statement.  

The cash flow statement summarizes a business's  cash inflows and outflows over a period of time. When  

using the cash method of accounting a separate  cash flow statement isn't required, because it's  

equivalent to an income statement. But when we're  accrual accounting, the cash flow statement and the  

income statement are two very different beasts.  This is because revenue is recorded when it's earned 

not when cash is received and expenses  are recorded as they are incurred not when  

cash is paid out. So the income statement measures  profit and the cash flow statement measures cash  

flow. So there you go. 32 things you should  know about accounting. Did I miss anything?  

If so, please let me know down in the comments  and I'll see you next time. Thanks for watching!