Lesson 2
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Lesson 2 - Financial Statements
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. Traditions must be observed. In fact, accounting has formalized its traditions and called it generally accepted accounting principles. This is sometimes referred to as GAAP, spelled G-A-A-P. Sometimes laws are enacted that become part of GAAP. During this class, we will also show the debit amounts in green, and the credit amounts in red.

Now, let’s pay some bills. Business always has bills when it gets started. Let’s pay the rent for $500. That’s not much rent, but it is all we owe. We have to account for it, so we debit rent expense for $500 and we credit cash for $500. Let’s see how this affects our financial statement. The first thing we notice is that our financial statement is now out of balance. That means total assets no longer equal total debt and equity. We’ll fix that in a minute. Before we do, notice that we credited cash. Remember, cash is an account that usually has a debit balance, or a positive balance. Obviously, we can credit or debit any account. Think about it. If we could only debit cash, wouldn’t that be great. Our cash would never go down, It would only go up. In the real world, we have to pay cash out. So, we have to credit our cash amount, sometimes more than we want.

Okay, back to getting our financial statement in balance. First, we total up expenses. Then, we calculate the net profit. Because we have no sales yet, we have a rent loss of $500. This leaves our financial statement out of balance. What we have to do is include earnings in our balance sheet. Once this is done, total assets equal total debt and equity. We are back in balance. The great thing about A-Systems software is that it does all of this automatically. We do the debit and credit side, and A-Systems software does everything else.

Everyone with an account at the bank is happy when the bank credits our account, because when they credit our account, they add money to it. This sounds just the opposite of what a credit is supposed to do. What’s going on here? Well, let’s look at the bank’s balance sheet and figure it out. When a bank adds money to our checking account, it actually increases the liability of the bank. They actually do a credit to their balance sheet – not ours. When we have money in the bank, they owe us that money. Isn’t it nice to have the bank owe us money?

Now, let’s get back to accounting. Let’s buy a truck for $5,000. It’s not much of a truck, but it’s what we can afford for our little business. We pay $1,000 down, and we finance the rest. For purposes of demonstration, we are going to put the $4,000 balance on a short-term loan. Let’s take a second and discuss bank loans.

Everyone knows about mortgages. They are long-term loans secured by real estate. Car loans are long-term loans secured by cars. Businesses often arrange short-term loans called lines of credit. A line of credit means the business has a pre-arranged bank loan that allows them to borrow amounts they need 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 at the bank. Sometimes, a business will need money for a short-term basis, but not need an open line of credit. When this happens, a business can obtain a short-term loan, or a note, at the bank. Usually, these are for 90 days. They’re called commercial loans. Individuals may borrow money this way also, but they have to show the same kind of financial information a business would.