Lesson 1
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Lesson 1 - Intro to Accounting
Hello, and welcome to Arnold Grundvig’s crash course in business accounting. The course is affectionately subtitled: “Bean Counting 101.” This course is intended as an introduction to the basics of accounting. CPAs and other professionals who might be offended by the title, “Bean Counting 101,” can be assured that this is not a course intended for them.

In the days of old, accounting was literally done by bookkeepers writing in books. These books were called journals, or ledgers. In these days of computers, anyone with a computer and accounting software can do accounting. However, having a computer and accounting software does not guarantee that we understand accounting. So, we need to understand what accounting is, how accounting works, what debits and credits are, what journals and ledgers are, what a balance sheet is, what an income statement tells, and what accounting information reveals.

Now what exactly is accounting? Well first, it’s a numerical history of our business. Second, it’s a photograph of our financial status. And how does accounting work? Business transactions are entered into our books, and each entry has two components, a positive and a negative. The positive part is called a debit. The negative part is called a credit. This is known as double entry bookkeeping. It works because the positives are always equal to the negatives. That keeps our accounts in balance. So, let’s see what this means.

Let’s start a business. We’ll start with $20,000 cash. Now, how do we account for it? Before we can start, we need a chart of accounts, which is nothing more than a listing of categories for our assets, such as cash, equipment, and the like; liabilities, such as accounts payable, loans, debts, and the like; income, such as sales; and expenses, such as payroll, rent, and the like. Before we go on, let’s compare a debit and a credit. All of our transactions will have two entries: a debit and a credit. And we need to remember that the debit is the positive part of the transaction and the credit is the negative part of the transaction. Now, back to the $20,000 we started our business with. We need to debit cash, and we need to credit equity.

Well, what is equity? If we are a corporation, equity is common stock, or capital stock. If we are a proprietorship or partnership, equity is owner’s equity. We didn’t list equity as a category of accounts before. Equity is a special kind of liability. Equity is the amount a business owes to its stockholders or its owners. So, we have $20,000 to account for. Our entry is to debit cash for $20,000, because we’ve added $20,000 in cash. And we will credit common stock for $20,000. Debit equals credits, so our transaction is balanced.

Let’s look at our financial statement and see what it looks like. Notice that the only accounts with amounts are cash and common stock. Notice also that total assets equals total debts and equity. That part of the financial statement, the amounts above the line, is called the balance sheet. It’s called a balance sheet because the left side is always in balance with the right side. The bottom part of our financial statement, with expenses and income, is called the income statement, or the profit and loss statement.

After a few transactions it will become obvious that accounts that usually have debit balances are on the left side of the page, and accounts that usually have credit balances are on the right side of the page. This is a tradition. Accounting is full of traditions that must be observed. These traditions are referred to as Generally Accepted Accounting Principles, or GAAP. Sometimes laws are enacted that become part of GAAP.

Now, back to our business. Let's start by paying a bill. In order to pay the rent, we need to debit our Rent account for $500 and credit the Cash account for $500. Let's see how this effects our financial statement. The first thing we notice is that our financial statement is now out of balance because Total Assets no longer equal Total Debt & Equity. That means there's more accounting to do in order to complete this transaction. Because we've paid $500 in rent, we'll need to add that amount to our Total Expenses. Now Total Expenses are subtracted from Total Sales, making our Net Profit -$500. Finally, our Net Profit is added to Earnings, making our Total Debt & Equity equal to Total Assets. Now the entire financial statement is in balance.

Let's talk a little more about debits and credits. Crediting an account usually means money is being taken from it. However, when the bank "credits" your account, they add money to it. The reason they use the term "credit," in this case, is because the bank has to credit their own account in order to give you money. For the bank, it's considered a credit because they're losing money. For you, it's actually a debit because you're gaining money.

Now, let's get back to accounting. Let's buy a truck for $5,000. We pay $1,000 down and we finance the rest with a short term loan. Let's take a second and discuss bank loans. Businesses often arrange short term loans called Lines of Credit. A Line of Credit is a pre-arranged amount that the bank will lend to a business at their convenience. Payment terms are also pre-arranged. Usually the business has to pay it back after 90 days, or 180 days, depending on what has been arranged. Sometimes a business needs cash for a short-term basis, but doesn't need an open line of credit. In this case, a business can obtain a short-term loan, or "note," from the bank. These are called commercial loans.

Back to our accounting. Because our $5,000 truck is considered a Fixed Asset, we debit Fixed Assets for $5,000. Then, we credit Cash for $1,000 and credit Short Term Loans for the remaining $4,000. Our balance sheet it now updated. Cash went down $1,000, Fixed Assets went up $5,000, and Short-Term Loans were added to by $4,000.