8. Bank Loans and Interest

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En provenance du cours de IESE Business School

Accounting: Principles of Financial Accounting

737 notes

IESE Business School

Accounting: Principles of Financial Accounting

737 notes

Cours 1 sur 5 dans Specialization Foundations of Management

Financial Accounting is often called the language of business; it is the language that managers use to communicate the firm's financial and economic information to external parties such as shareholders and creditors. Nobody working in business can afford financial illiteracy. Whether you run your own business, work as a manager or are just starting your career, you want to understand financial information and be able to interact with accountants, controllers, and financial managers. You want to talk business! This course will provide you with the accounting language's essentials. Upon completion, you should be able to read and interpret financial statements for business diagnosis and decision-making. More importantly, you will possess the conceptual base to keep learning more sophisticated accounting and finance on your own. Do not forget that, as with any other language, becoming proficient with accounting requires constant practice.

À partir de la leçon

Week 3: The Cash Flow Statement

Now that you have a good grasp of the balance sheet and income statement, I'll help you master how to recognize the transactions we went over in week two. I'll also introduce a third financial report - the cash flow statement - and discuss liquidity. Course objectives: To understand the difference between liquidity and profitability, become familiar with T-accounts and gain insight into the purpose of the cash flow report.

1. Introduction to Week 32:10

2. Recap of Week 23:15

3. T-Accounts and Journal Entries5:45

4. Setting up T-Accounts for the Campus Bookstore3:06

5. Sales, Cost of Goods Sold, Collections from Customers and Payment to Suppliers7:05

6. Other Operating Costs4:10

7. Transactions with Non-Current Assets8:09

8. Bank Loans and Interest4:03

9. Taxes, Closing Entries and Payments of Dividends5:44

10. Preparing the Balance Sheet3:54

11. Preparing the Income Statement4:30

12. Introducing the Cash Flow Statement I7:29

13. Introducing the Cash Flow Statement II4:03

14. Recap of Week 3 and Conclusions3:12

Rencontrer les enseignants

Marc Badia
Assistant Professor
Accounting and Control

[MUSIC]

In this video we're going to record what happen in year x2 in the campus bookstore,

with the bank loan and the interest cost.

As you will remember, at the end of year x0,

Christina got a bank loan of 20,000 euros.

This is why you see a liability called bank loan

with a total amount of 20,000 euros.

Now, in year x2, we need to recognize the interest cost of this loan.

So, we have been using the loan for one year.

And that has a cost.

We need to pay this cost, this service, that the bank is giving to us.

Now, what's the total amount?

It's 5%, remember the interest cost was 5% of the principle we are using.

So how would you account for this?

Well, first thing, at the end of the year we are paying for this interest.

Therefore, cash will decrease and

therefore, we're going to credit the cash account for 1,000 euros.

Remember that the annual interest is going to be this

5% of the 20,000 euros of principal that we are using.

So it's going to be 1,000 euros.

Second thing, with this amount that we are paying,

are we generating an asset or it's an expense?

Does it have a future value?

Well, not really.

This is for a service that we have received in the past.

So we are not pre-paying anything here.

We are just paying for something that we have already consumed.

Therefore, we need to recognize an expense, so the profit and

loss account is going to decrease and we debit it by 1,000 euros.

After this transaction, shareholders are poorer by 1,000 euros.

And they are less liquid as well.

So in this case, profitability and liquidity coincide.

Remember that the loan we got in year x0, at the end of year x0,

was for three years.

So the maturity of this loan was three years.

So by the end of next year, but

the end of year x3, we'll have to repay the full amount of the principal.

You may think that there is nothing to account for yet.

Because we need to repay this at the end of next year.

Okay, so the first thing that we need to do here is to decrease the bank loan.

So remember, this is a liability account, therefore to decrease the bank loan,

what we need to do is to debit the bank loan account for 20,000 euros.

And what we are doing now is reclassifying this amount to a new account,

which is the current portion of this bank loan.

So let's create here a new account called bank loan current portion.

And we increase it by crediting it by the same amount.

So at the end of the year when we present the balance sheet,

you're going to see that under current liabilities,

you are going to have an obligation of 20,000 euros.

Next transaction.

Christina said that next year she's planning to make new investments

to expand the business a little bit more.

And this is why now she's getting a new bank loan to be repaid in five years.

The total amount of this loan received is 30,000 euros.

So how would you account for this?

Well, this is an easy transaction, you have seen it before,

we have practiced it now a number of times.

And so the first thing that happens here, obviously, is that cash goes up.

So we debit cash by the total amount of 30,000 euros.

This is the amount we'll receive from the bank on December 31st.

And second, now we have an obligation to repay this to the bank in the future.

And so the bank loan account, the long-term bank loan,

remember, it's going to increase.

So we credit bank loan by the same amount, 30,000 Euros.

So as you see here, liquidity's increasing,

but we also have an obligation that increases.

Therefore, this is money we need to return, and

here we have not made any business, so profits have not changed.

It will all depend on what you do with this cash that now you have.

If you invested well, probably in the future it's going to generate profits.

But what is clear is that this transaction, getting a bank loan,

doesn't make you richer.

Great, so getting close to the end.

We only have a few more transactions.

Actually three more transactions and we are done.

And then we're going to prepare the balance sheet, the income statement,

and a new financial statement, the cash flow statement.

[MUSIC]

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