[MUSIC] Remember that at the end of year X1, Christina estimated the total amount of taxes she had to pay in year X2 once she did the tax filing. The total amount was 3,600 Euros, and we recognized that as an obligation we had with the tax authorities. Now during year X2, Christina paid this amount. And so, the next transaction is to account for the payment of taxes during year X2. So, how would you account for this transaction? Let us start with the easy part. First, cash will decrease, because we are paying cash. And therefore, we credit the cash account for 3,600 Euros. Next, we are honoring this obligation we have with the tax authorities. So, we recognize the decreasing the liability of taxes payable and we do that by debiting taxes payable. Remember, to decrease liability accounts, we debit the account. And to increase liability accounts, we credit the account. So these made reference to the payment of taxes that we had already recognized, as an expense in year X1. Now, we need to estimate the taxes we will have to pay next year corresponding to the profits we have in year X2. So the estimation that Christina has made of the tax expense corresponding to the profit of this year is 3,060 Euros. How would you account for this? Well, first thing, we need to recognize the expense right now, because we know that we have to pay this for sure. So, we are poorer already. And therefore, we recognize a debit in the profit and loss account. In accounting, expenses are recognized as soon as you smell them. So you try to anticipate them, and as soon as you know that you have to pay something that you have an obligation the future, you recognize the expense right now. You recognize that you are poorer, you are going to be poorer right now even though you have not paid yet. The tax expense is 30%, the corporate tax rate applied to the profit before taxes. In this case, we said that the tax rules and accounting rules are the same. And therefore, we don't need to make any adjustments to the accounting profit in order to get the taxable profit. Second thing, we are not paying for the taxes yet, remember. Actually, Christina has not even done the tax filing for this year profits. So we need to recognize that in the future, we have to pay this. And therefore, we need to recognize an obligation, a liability. This is why we credit taxes payable for 3,060 Euros. So in this case now, we are poorer. Liquidity has not changed, but we have an obligation to pay this amount. Very good, we are close to the end of our transactions here. The next thing that we have to do is the closing entry. Remember, I told you this is something that companies do every year at the end of the year, and it consists of taking calculating the profit from the profit and loss account. So in this case, as you see the profit for the year is going to be 7,140 Euros. And so this is a credit balance, ending balance you have in the P&L account. And we have to move this profit to retained profits. And the reason why we do this is so that next year the profit and loss account will start from zero. And so, we are not mixing profits from one year with the previous year profits. And so what we have to do here is debit the profit and loss account for the total amount of the profit, so that the ending balance is zero. And we are moving all these profits to another account that is called retained profits, where we accumulate the profits from previous years. And we do that by crediting the retained profits account for the same amount. So the only thing that we did here, this is not the real transaction. The only thing that we did is an accounting of reclassification. So, we move the profits from the P&L account to retained profits. Okay, so we are going to finish this with one last transaction that is the first time that we see here, the payment of dividends. So by the end of the year, Christina thought that she had all of cash and she wanted to distribute part of this cash to the shareholders, that is to herself and to her uncle. And so she decides, together with her uncle, to pay cash dividends of 10,000 Euros. Now, let's see how to account for the payment of dividends. Actually, first of all, let's think about the concept of dividends. So, what is a dividend? Well, a dividend is a way to reward the shareholders for the capital they have provided to the company. We could understand the dividend as a sort of partial liquidation of the firm. So basically, we are taking some of the cash from the firm and giving it to the shareholders. So, the value of the firm is shrinking actually. So, let's see how to account for this. The first thing we should do is to credit cash. So, cash is going to decrease by 10,000 Euros. Now the next thing we need to do is to decrease the value, the accounting value of the company. So, owner's equity should decrease by the same amount. And we do that through the retained profits account. So, we debit the retained profits for 10,000 Euros. Note that dividends are paid out of retained profits. Obviously, they are paid in cash. So, the first thing is that you need to have cash in your cash account. Second thing, they are paid out of retained profits. So, not from the profit and loss account. So, dividends are not part of the profit and loss account, remember. So even in the case that you have losses in the year, you could still pay dividends as long as you retain profits from previous years are positive. So in most of the countries, one of the conditions to pay dividends is that retained profits are positive. Excellent. So believe it or not, we are done with all the transactions for the year X2. Our next step now is to prepare the balance sheet and we're going to this in the next video. [MUSIC]
