[MUSIC] So far we have been recording the transactions directly on the balance sheet. However this method is not very practical. Because as we have more transactions on more accounts, we run out of space. In addition, accountants follow certain processes, certain methodologies that we should be familiar with. Not that we want to become accountants, of course, but at least we want to interact with them and speak the same language. This is why in this video I'm going to introduce a couple of things. First, T-Accounts, and second, Journal Entries. T-Accounts are a very simple way of recording and accumulating the effect of transactions in each one of the accounts. So, we just take all the accounts that we have on the balance sheet and we present them in the sort of T-shape. On one side of the vertical line, we are going to record increases in the account and on the other side, the decreases. So let's take a look at this. Obviously, in the balance sheet, you have asset accounts and owners' equity and liabilities accounts. For the asset accounts, let's take, for example, cash, one of the asset accounts. Increases are recorded on the left-hand side, whereas decreases in asset accounts are recorded on the right-hand side of the T-account. For liabilities and owner's equities, such as the bank loan, for example, we record the increases on the right-hand side and the decreases on the left-hand side. Now, the left-hand side is always called Debits and the right-hand side is always called Credit, the credit side. So, we abbreviate debit with Dr. from the Latin [FOREIGN] and we abbreviate credit with Cr., also from credited. So debit always means left, credit always means right, no matter whether we are talking about an asset account or owner's equity and liability accounts. It is very important that you don't get confused with these debits and credits so don't try to look into meanings, okay? Just left and right. Debit is left, credit is right. Okay, now that you're familiar already how these T-accounts work, let's try the system with the first transaction. For example, remember the bank loan we received of 20,000 Euros. First, let's record it on the cash side. So we are going to debit cash because we want to increase it in asset account and to increase the asset account we have to debit it. And now we want to increase a liability, the bank loan. So we are going to credit the bank loan, and this is the system we are going to follow for the rest of the transactions. Now at the end of the year, let's say that you have a beginning balance on each one of these accounts. For example, in cash you have 2,000 Euros as a beginning balance. In the case of the bank loan, let's say that you have a beginning balance of 0. So by adding on the transactions to the beginning balance, you're going to get the ending balance of the account. So, in the case of cash, it's going to be 22,000 euros. In the case of the bank loan, it's going to be 20,000 euros. Great. Now that you're familiar with this system, let's try the following example. Let's see if you can give me an answer for this, for this specific question. So how would you account for the purchase on credit of inventory worth 40,000 Euros? Okay. So what we have to look first is to recognize that we are receiving the inventory, because no matter what whether we pay it or not the inventory, the books have delivered to the store and therefore now we are the owners of them. So we need to recognize an increases in an asset. So we debit inventory. Second, we are not paying in cash so we cannot credit cash. We cannot decrease cash. But instead, we have a new source of capital. Suppliers are financing us. The publishing companies are financing our purchase of books. So, on the liability side, we're going to have an increasing liability, that we call Accounts Payable. So the correct answer is b. With every inventory, we credit Accounts Payable. In real life, accountants perform a previous step before they record the T-accounts. They actually record transactions as they occur by using journal entries. Journal Entries are just a standardized way to indicate which accounts are debited and credited. So, in practice, it's just a computer screen where the accountant tells the computer basically which accounts need to increase or decrease, with debits and credits. So let's take the example that we have seen before of the bank loan. This is how we accounted for the bank loan with the T-accounts and now the journal entry would be something as simple as the following. You would say debit cash, credit bank loan. So you're seeing cash increases by 20,000, and the bank loan increases also by 20,000. So now we have an obligation to return this money to the bank. Remember that accounting is a process that Records, Classifies, and Summarizes business transactions. Now the recording takes place with the journal entries we just introduced, and the journal entries are written in a book called a journal. Then the amounts are classified in different accounts and we have the T-Account, where we keep accumulating all the transactions that affect those accounts. All these accounts are found in a book called the ledger book. Finally, accounting summarizes everything with the financial statements. And we have introduced already The Balance Sheet and The Income Statement and this week, we are going to introduce as well, The Cash Flow Statement. All of these financial statements are presented in an annual report that companies have to prepare every year for external users. Especially for the shareholders of the company. In the next few videos, we are going to record the economic events that took place in the campus bookstore during year x2. [MUSIC]
