accounting 101 basics, learning accounting basics, and fundamentals

0:06 Financial Accounting focus on communicating to people outside the company primarily lenders and investors who are providing money to the company to buy its assets that's the primary audience remember financial reporting people outside the company really these Financial reports can be thought of as three pieces of paper the balance sheet report the income statement report and the statement of cash flows report it's amazing how much information can be summarized about a company on just three pieces of paper think about Walmart and their 10 billion customer visits per year the results of all of that can be summarized in boom boom boom three pieces of paper these summary reports to people outside the company so let's remind ourselves let's review what's on the

0:52 balance sheet three things structured around our favorite equation it wasn't our favorite equation before today maybe but it is now the accounting equation assets equal liabilities plus Equity if I've got assets I had to get the money to buy those assets from somewhere I either borrowed it liabilities or it was provided to the company by shareholders Equity assets equals liabilities plus Equity that's the balance sheet the income statement revenues minus expenses is net income revenues the amount of assets generated through doing business expenses the amount of assets consumed in doing business and what we would hope in a company is that you generate more assets than you consume in your business operations that's the income statement statement of cash flows the baby only 25 years old there are three categories of cash flows operating cash flows the

1:44 things that you do every day investing cash flows investing in the productive capacity of the business buying more buildings and trucks and what have you and financing activities getting the money to buy the stuff that I need repaying loans paying dividends to shareholders of those three operating investing and financing which one is the most important yeah you remember operating activities because that summarizes the cash results of things that we do on a daily routine basis those three reports that you see right in front of you summarize everything about a company's performance and that's given to people outside the company that is financial accounting often the most difficult aspect of accounting is determining which events are

2:31 to be reflected in the accounting records and which are not suppose for example that Burger King introduced a new Big Mac clone at half the Big Mac price the proliferation of these Big Mac clones could have a serious impact on the future McDonald's however events that cannot be reliably measured in monetary terms will not be reflected in the financial statements since it would be virtually impossible to quantify the impact of the Big Mac clones on the future profitability McDonald's that information will be excluded from the financial statements while there is an obligation to inform financial statement users about this attack on the Big Mac the financial statements are not the place to do it the financial statements are only one part of the

3:17 information provided to users information relating to the competitive environment product development and marketing and sales efforts is included in the company's annual report to stockholders but not as part of the accounting information now once we've determined that we have a transaction that needs to be included in the accounting records the event must be analyzed to determine if an arms length transaction has occurred accounting is concerned primarily with reflecting the effects of transactions between two independent entities so Delta Airlines signing a contract with Boeing to purchase airplanes in the future would not be reflected in the financial statements until the airplanes are manufactured and delivered and Delta has agreed to pay for them while many transactions

4:02 between independent parties are routine some business events are quite complex and require a comprehensive analysis to determine how the event should be reflected in the financial statements consider the following example a company buys a building in addition to paying $20,000 in cash the company agrees to pay $110,000 per year for the next 10 years the company will also pay a $2,000 Property Tax Bill associated with the building from last year year as part of the purchase the company gave the former owners of the building 500 shares of stock finally the building will require $23,000 worth of repairs and Renovations before it can even be used now how much should be recorded as the cost of the building transactions like this can become quite complex but the framework

4:51 introduced in this topic will allow you to break complex transactions into manageable pieces and provide you with a self-checking mechanism to ensure that you haven't forgotten anything let's begin our analysis of transactions by reviewing some of the basics first remember the fundamental accounting equation assets must equal liabilities plus owner's equity that is a company's resources can be financed using two sources creditors or owners as we said previously the accounting equation must always remain in Balance to see how this balance is maintained when accounting for business transactions consider the following activities

5:38 in the first transaction $50,000 is invested by owners this would cause our assets specifically cash to increase and our Equity specifically Capital stock to increase both by $50,000 in the second transaction we borrow $25,000 from a bank again our assets cash increased by $25,000 and our liabilities since we will have to repay this nose payable increase by $225,000 as well note that so far our accounting equation balances after each transaction and in fact we can always count on that the accounting equation will always balance the only instance in which it will not balance is when we've done something wrong to the third transaction inventory that is an item that

6:25 we will resell later is purchased on credit we will pay for our inventory at a later date our assets specifically inventory increase by 14,000 and our liabilities specifically accounts payable increase by $144,000 as well as we now owe money to a creditor at some point in the future in the fourth transaction we purchase equipment by paying cash in this instance we are trading one asset cash for another asset equipment cash is going down by $155,000 and equipment is going up by a corresponding amount for each transaction the accounting equation remains inbalance because an identical amount is added to both sides subtracted from both sides or added to and

7:12 subtracted from the same side of the equation following each transaction we can ensure that the accounting equation balances note in this spreadsheet how after each transaction we can track the balance for our assets our liabilities and our owner's equity to ensure that the the accounting equation balances after transaction one assets equal $50,000 and owner's equity equals $50,000 after transaction number two Assets Now equal $75,000 while liabilities equal 25,000 and owners Equity equals $50,000 after transaction three where we bought inventory on account assets equal $89,000 liabilities equal $39,000 and owner's equity still equals $50,000 finally

8:01 after the fourth transaction where we purchased equipment paying cash in other words we traded one asset for another our accounting equation still balances assets equal $889,000 liabilities equal $339,000 and owner's equity equals $50,000 the accounting equation balances hold on to that concept when things get complicated and they can knowing that the accounting equation must always balance help helps us determine if we have considered all the effects of a transaction recall that the three primary financial statements are the balance sheet the income statement and the statement of cash flows the elements of the balance sheet are assets liabilities and owner's equity the elements of the income statement are

8:51 revenues and expenses each of these elements is comprised of many different accounts an account is a specific accounting record that provides an efficient way to categorize similar transactions thus we may designate asset accounts liability accounts and owner's equity accounts examples of asset accounts are cash inventory and equipment liability accounts include accounts payable and notes payable for example the equity accounts for a corporation are Capital stock or paid in capital and retained earnings you can think of an individual account as a summary of every transaction affecting a certain item like cash the summary may be recorded on one page of a book or

9:36 in one column of a spreadsheet as Illustrated here using our previous four transactions we can easily see how the accounting equation can be expanded to include specific accounts Under The Heading of assets liabilities and owner's equity we can also see that after each transaction the equality of the accounting equation can be determined by adding up the balances of all the assets accounts and comparing the total to the sum of all the liability and owner's equity accounts now when Double Entry accounting was formalized over 500 years ago all the adding and subtracting was done by hand you can imagine the difficulties of tracking multiple accounts involving hundreds of transactions using the spreadsheet method above while doing all the computations by hand

10:23 mixing pluses and minuses in one column would provide ample opportunity to make mistakes this problem was solved by separating the pluses and the minuses for each account into separate columns totaling each column and then Computing the difference between the columns to arrive in an ending balance the simplest most fundamental format is the configuration of the letter T this is called a t account note that a t account is an abbreviated representation of an actual account which we will illustrate later and is used as a teaching and learning tool the following segment includes examples of te accounts representing the transactions described previously the account Title Cash For example appears at the top of the te account transaction

11:11 amounts may be recorded on both the left and the right side of the t account instead of using the terms left and right to indicate which side of a te account is affected terms unique to accounting were developed debit abbreviated Dr is used to indicate the left side of a t account and credit iated CR is used to indicate the right side of a t account debit means left credit means right nothing more nothing less let me say that again debit means left and credit means right in addition to representing the left and right sides of an account the terms debit and credit take on an additional meeting when coupled with a specific account by convention for asset accounts debits refer to increases and credits refer to decreas increases for example to increase the cash account

12:02 we debit it to decrease the cash account we credit it since we expect the total increases in the cash account to be greater than the decreases the cash account will usually have a debit balance after accounting for all transactions thus we can make this generalization asset accounts will usually have debit balances that is their balance will typically be on the left side of the tea account the opposite relationship is true of liability and owner Equity accounts they are decreased by debits and increased by credits as a result liability and owner's equity accounts will typically have credit balances the effect of this system is shown here with an increase indicated by a plus sign and a

12:48 decrease indicated by a minus sign now remember that asset accounts will typically have debit balances whereas liability and owner's equity accounts will typically have credit balances in addition to assets equaling liabilities and owners Equity debits should always equal credits if you fully grasp the meaning of these two equalities you are well on your way to mastering the mechanics of accounting or learning the language of accounting debits and credits allow us to take a shortcut to ensure that the accounting equation always balances if for every transaction debits equal credits then the accounting equation will always always balance to understand why this happens keep in mind three basic

13:33 facts regarding Double Entry accounting first debits are always entered on the left side of an account and credits on the right side second for every transaction there must be at least one debit and one credit third debits must always equal credits for every transaction if you can grasp these three points you are well on your way to understanding the me mechanics of accounting the second flavor of accounting is financial accounting reporting the results of a business or an organization to people outside that organization it's summary information given to Outsiders Financial Accounting let's consider the case of a person applying for a loan a mortgage

14:23 loan for example you want to buy a house I just went through this not long ago so you go to the mortgage company say I'd like to have a mortgage loan so I could buy this house well here's what they do they ask you to verify your income you got to give them W2 forms and all kinds of paperwork to confirm what your income was in the most recent year actually the most recent several years they also ask you to verify what things you have accounts call these things assets do you have a house do you have a checking account do you have any Investments let's get those all listed down do you have any obligations do you have any credit card obl obligations do you have any other loans we want to see all those things the loan company wants to verify your income they want to verify the economic resources you have and the economic obligations that

15:08 you have basically you are asked for personal financial statements you're not telling the bank or the lender everything that you've ever done you're giving them a summary of what you've done through a summary of your income summary of your assets sum of your obligations this is financial accounting so what are the benefits to providing these personal financial reports when you're applying for a loan well the benefits to the lender are obvious the lender wants to know whether you're going to be able to pay them back so they want to see are you making money have you made money steadily over the past few years do you have e assets do you have resources do you have an investment account do you have cash in the bank do you not have too many other loans too much credit card debt so the benefit to the lender is very clear it helps them to be more able to forecast

15:54 the probability that you're going to be able to repay the loan so that's great for the the lender what about for me the borrower well imagine if you weren't allowed to provide financial information you go into the lender and say I'd like to borrow some money well we'd like to know no you can't ask anything about me you just have to lend me the money well that makes it a much more risky proposition lenders are going to be much less likely to loan money to anybody if they can't verify your income can't verify your resources so by reducing the uncertainty to the lender it makes it easier for me the the borrower to borrow money and also if I'm a creditworthy borrower if I've been prudent if I've saved money if I've got some resources it gives me an opportunity to reveal that I want to reveal that to the lender to make it even more likely that they'll give

16:43 me a loan so this process of providing personal financial statements to A lender when getting a loan benefits the lender they can make better decisions benefits the borrower because the borrower can reduce the uncertainty to the lender and therefore make it more likely that they'll get the Lo this is financial accounting a balance sheet is a very fundamental report it's a list of an organization's resources accountants call those assets and an organization's obligations accountants call those liabilities so the assets how much cash do you have how much do you have in land how much do you have in trucks and Equipment those would be a listing of a company's resources obligations how much money have you borrowed from a bank how much do you owe in taxes how much do you owe your employees and wages that you haven't paid yet let's see all those obligations

17:32 so that's a fundamental report for any business what do you have and what do you owe we call that a balance sheet next fundamental financial report is called the income statement how much money is this company making well anybody wants to know that if I'm thinking of loaning money to your company or investing in your company I need a report of how much money you're making the balance sheet and the income statement are fundamental reports that are provided by organ organizations buy businesses to people outside the company so those people outside can decide should we loan that company money should we invest in that company it's not all the details of the operations of the company it's a summary it's a balance sheet it's an income statement let's dig into a little bit more detail about financial accounting but first a quiz

18:23 Financial Accounting are those reports directed to people outside the business or are those reports directed to people inside the business you're thinking yeah you got it financial accounting is directed towards people outside the business so let's talk more about financial accounting these reports directed to Outsiders the key external users of financial accounting data are lenders and investors the people who provide the capital to a business so that you can turn your dreams into reality I need $100 million well I'm going to have to borrow it or I'm going to have to get new investors in my business those are the key users of financial accounting data without Financial Accounting data it would be impossible for companies to raise money from strangers the financial accounting data provide that environment of trust where lenders

19:12 and investors feel comfortable giving money to an entrepreneur to start a business or expand a business so lenders what do lenders want to know well is a loan going to be repaid it's really that simple if I loan you $100 million are you going to pay me back and what data can I use to assess whether you're going to be able to pay me back back well tell me how much money you're making now tell me how much money you made for the last 3 years I want to see that that's going to help me forecast how much money you're going to make in the future tell me what existing obligations you already have because if you're already loaded up with obligations I'm not sure I want to be one more person to loan you money I might not get paid back also tell me what resources you've got your assets tell me what those are and all those things will help me assess whether you're going to be able to pay back a loan investors what do investors want to know so investors they're

19:59 becoming your partners they're now part owners in the company they want to know is this profitable business have you made money the past few years so they want to know the same thing that the lenders do because really this is a very important point when you're an investor in a business you're not buying the past of the business you're buying the future of the business how's it going to do in the future so what you use the financial accounting reports for is to tell you the past so you can use that information now to help you forecast better what's going to happen in the future because the potential for the future is really what you're buying when you're an investor lenders and investors the providers of financing to a business to turn dreams into reality those are the key external users of financial accounting data lenders and investors aren't the only external

20:45 users of financial data lots of people you and me for example we use Financial Accounting data at least we do now so who some categories suppliers if I'm going to sell to you on credit then I want to know if you're going to be be able to pay me it's just like loaning somebody money if you sell the people on credit it's the same as loaning them money you want to know if they're going to be able to pay you so if you're considering entered into a long-term significant business relationship where you're selling on credit to another company the first thing you're going to do is get their financial statements have a little analysis done to see if they're going to be able to pay you back so suppliers are important users of financial accounting data customers anybody who enters into a long-term relationship with a business wants to know if they're going to be around in the future so if I'm going to be one of your customers and I'm going to start to rely on you and maybe

21:32 you're giving me a warrantee employees employees have long-term relationships with companies an employee too often they don't but employees should look at the financial reports of a companies it's a strong company do they have a strong track record can I count on them because I'm going to give them my Blood Sweat and Tears Are they going to be here in the long term are they financially viable competitors this kind of the other side of it because I provide these financial accounting data and they're available to people outside my company it's often the case that my competitors get their hands on them do you think that Koch wants to see the financial accounting reports of Pepsi of course they do do you think that Walmart wants to see the financial accounting reports of Target of course they do of course they look at those things so competitors want to see where your

22:18 strengths are where your weaknesses are they can do that by looking at these Financial Accounting reports government agencies there are some Industries banking industry the insurance industry the utilities industry companies that sell natural gas and electricity all of those are regulated by government agencies so they have to provide Financial Accounting reports to the government agencies in addition sometimes in some Industries people in general want to know hey you're a a health insurance company are you price gouging are you making profits that are too large you're an oil and gas company we're all paying a lot of money for gas at the pump are you making obscene profits we want to see those financial reports so government agencies and people with interest in the public responsibility of companies they'll look at the financial reports politicians

23:05 are also looking at Financial reports if I want to make a political argument against for example the oil and gas industry and I want to show that they're profiteering I pull out exhibit a their financial reports or if I'm a politician who wants to protect say the textile industry in my state I pull out the financial reports of some major textile businesses show that their profits are going down so politicians can make a political Point using the financial statements of companies and finally the press the Press commonly use Financial reports first just simple background information if I'm writing a story about Apple I ought to tell my readers okay here's how much money Apple made last year here's how many assets they have here's how much cash they have in the bank you can actually go into the details of their financial reports and find out

23:51 where their income was generated how much in the United States how much in Europe yeah I would to want to use the financial reports for background but but also the Press often use Financial reports to trigger investigations I'll give you an example let's say a company just announced that their profits have gone down by 70% that's a financial accounting report but that could trigger an investigation by an enterprising reporter who' say well why did their profits go down by 70% so it's an investigation trigger lots of people use external Financial Accounting data include I hope from now on you so we could write your name right down at the bottom of this screen financial accounting is based on these three primary financial statements the balance sheet and the income statement you've already seen so let's talk about those the balance sheet

24:39 is a listing of a company's assets and its liabilities its economic resources the assets and its economic obligations the liabilities it's a basic financial report the income statement how much money did you make last year how much money did you make last quarter how much money have you made each year for the past 10 years that's the income statement that's also important information provided to people outside the company the statement of cash flows we haven't talked about yet but it's the third primary financial statement it's a report of the cash that came into a company and a report of the cash that went out of the company a pretty basic thing but we're going to find out soon that the statement of cash flows is an awesome piece of work these three primary financial statements the balance sheet and the income statement the statement of cash flows they summarize the financial position and health of a company

25:29 really three sheets of paper summarize a lot of information about a company that's Financial Accounting let's talk about the balance sheet in a little bit more detail the balance sheet is built around one of the most awesome creations of the human mind the accounting equation there it is assets equal liabilities plus Equity now I can tell you're underwhelmed you thought I was expecting a little bit more something like eal MC s well this is just as great as eal MC s let me tell you where this accounting equation comes from first the asset side well you know what that is list of assets here's the thing people have been listing assets for thousands of years I told you that there's evidence that farmers were keeping lists of assets

26:17 7,000 years ago in ancient Mesopotamia there's no great insight there how many cows do I have how many goats do I have how much wheat do I have a list of my assets the insight behind this accounting equation was created a little bit over 500 years ago in Italy the traders in Venice and other traders in Italy they had this Insight listen let's keep it a list of our assets like we've always been doing but let's also every time we get an asset let's write down where we got the money to buy that asset we write down the asset and we write down the source of the financing to buy that asset did I borrow the money to buy the asset was it invested by the owners if I borrow the money then liability abilities is the name I give to the source of the financing to buy that asset if the money was invested by owners I say Equity was the source of the money to buy the

27:07 asset so we got the two sides of the accounting equation the first side the asset side that's the real world there you can go touch a company's assets that's the real part of a company the other half of the accounting equation just says where did you get the money to buy those assets it's the discipline of the accounting equation it seems so simple but this discipline is the foundation of all the sophisticated financial reporting that we now have in the world and we've been using this for 500 years it's an awesome invention I tip my hat to those medieval accountants in Italy who invented the accounting equation assets equal liabilities plus Equity assets and we're also going to keep track of the sources of financing to buy those assets so what are assets we kind of have an intuitive sense of this they're resources owned or controlled by a company that will provide

27:54 probable future benefit so let's take the simplest example if you look at the balance sheet of Apple you see they got lots of cash lot billions of dollars of cash is that a resource that will provide probable future benefit yeah cash is a good asset that's not the only asset if you're a financial institution like MasterCard like Wells Fargo Bank like Bank of America your biggest asset is an asset we call accounts receivable or loans receivable the asset you're going to collect money from people in the future based on contracts that exist in place right now so if I have a piece of paper that somebody has signed where they promis to pay me back $10,000 in the future is that a valuable thing is that an asset sure it is the primary asset of any bank is accounts or loans

28:42 receivable MasterCard is an example City Bank they have over a trillion dollars in accounts or loans receivable that's trillion with a t huge asset money that they expect to collect in the future from the people who have borrowed it from them in the first first place how about Walmart let's do a little mental trip into a Walmart location So Close Your Eyes drive into the Walmart parking lot get out of your car you're walking across the parking lot you're walking on one of Walmart's assets they own that land it's a Walmart asset you walk into the building they own that building that's another Walmart asset stand in the middle of the store and look around at all the stuff on the shelves that's called inventory the stuff that you can buy from Walmart those are all very important assets for Walmart Delta airplanes FedEx airplanes United Airlines airplanes these

29:33 are resources owned or controlled by the company that provide probable future benefit the things that a company uses to provide services to its customers so that their customers will pay them these are all assets the balance sheet also lists the liabilities of a company the obligations that will require the probable future sacrifice either by paying assets or by delivering some service I'll explain what I mean so let's talk about some examples Walmart accounts payable payable is a hint there an obligation to pay in the future when Walmart buys inventory they promise their suppliers Proctor and Gamble or black and& Decker or whoever will pay in the future we're not going to pay you cash now we'll pay you in the future well that's an obligation and Walmart better write

30:18 that down Walmart better not just write down hey we just bought some inventory from Proctor and Gamble they better also write down oh yeah and we owe them for it we got to pay them later you got to write down the asset you write down how you bought the asset in this case you promise to pay it later accounts payable is one liability Home Depo and Target and Walmart and almost every other business in the world has the employees work for a few weeks and then they pay them Home Depo doesn't gather all the employees together at the end of a day and say okay we're going to pay you cash for whatever you earned today no thanks for working for us today we'll pay in a couple weeks when it's payday so if Home Depot or Walmart or Target were to do a balance sheet at the end of any given day they would be required to write down okay wag is payable how much of our employees earned

31:04 that we haven't paid them yet another liability same thing works for taxes taxes build up slowly over time and if you're to do a balance sheet you better write down okay as of today here's how much tax we owe though we haven't paid yet exom mobile does a lot of accounting for taxes they pay taxes of All Sorts around the world they pay property taxes they pay income taxes they pay sales taxes they pay import export fees all kinds of taxes and they don't pay them up in cash at the end of every day so when they do a balance sheet they have to list down here are the taxes that we are going to pay them next month or a couple of months now sometime in the future long-term borrowing Disney has some long-term debt on their balance sheet that means money that they have borrowed that they're going to pay back sometime far in the future 5 years from now 10 years from

31:50 now 20 years from now the reason I've got Disney here is they're interesting because a number of years ago they got some really long longterm debt they borrowed some money and promised to pay it back in not one year not five years 100 years would you loan money to somebody on a promise that they'll pay you back in a hundred years well you wouldn't do that for many companies but You' do it for Disney there are only a few companies in the United States who have borrowed money on such a longterm basis but it's listed in Disney's balance sheet long-term at a 100 years from now we got to pay this back a little bit different liabilities this last one on the list United a lines unearned Revenue think about the last time you rode on United Airlines or Delta Airlines or or American Airlines or any other airline did you pay for your flight before you flew or after you

32:40 flew before they always make you pay before all right well they then have an obligation if you've paid for a flight and they haven't given it to you yet they have an obligation to give you a ride on an airplane that's what this unearned revenue is there are two ways to get the money to buy assets borrow it in which case we call liabilities or have it invested by the owners then we call it owner's equity owner's equity is the amounts that owners have invested in a company for the company then to use to buy assets there are two ways for owners to invest in a business one the simplest way to to visualize is the owners just say okay my business needs some money to buy assets I'm just going to pull it out of my personal pocket for my personal savings I've done some work elsewhere I've been prudent I've saved my money I'm not going to pull it out of my pocket and put it into

33:26 my business and the business will then use those assets to buy assets we call that paid in capital the amount that owners take out of their personal savings and invest in their business or Capital stock or Capital contributions they all mean the same thing so that's one way that owners invest in a business another way that owners invest in a business is this the business generates some income who owns the income generator by a business well the owners do it's theirs it's their business they own the profits well the owners can choose what to do with those profits sometimes the owners will say okay my business generated some profits I'm going to take those out or some of those out to use for personal uses to pay tuition to buy a boat to do whatever we call those dividends when owners pull profits out of the business but more often than not owners will say okay my business

34:16 generated profits I take out a little bit of dividends but most of it I'm going to put back in the business for expansion use these profits to buy more buildings to buy more equipment to buy more inventory if the profits are kept in the business then the label we give to that source of owner's equity is retained earnings owners can invest directly we call that paid in capital owners could say let's keep the profits in the business that's another way that owners invest in the business both those two things together paid in capital and retain earings the sum of those two is equal to owner's equity another source of financing to buy assets all right I'm a little embarrassed to tell you this but I got to tell you the whole

35:03 truth the balance sheet is not perfect there are some limitations so I better tell you what those are better that you hear from me than from somebody else first when you look at a balance sheet most of the numbers that you see are not Market values they're costs you say well what's the big deal well it can be a huge deal let's say you've got a company that has some land that it bought 50 years ago for500 ,000 all right and the land now 50 years later is worth $2 million well what's going to be reported on the balance sheet the amount reported on the balance sheet is the original cost the $5,000 50 years ago not the current market value this often misleads people because when they look at the balance sheet they trust the balance sheet

35:48 they love the balance sheet they're looking at they have to remind themselves this is not the current values these are the costs if I want to know the current value of all the assets I need to do some other investigation ations that's outside the financial accounting process so that's the first limitation so I'm embarrassed about that second probably worse some very valuable economic assets are not reported at all in the balance sheet especially in tangible assets what are the most important economic assets of Apple think about this well first the logo itself the name think how much would you have to pay to buy the worldwide rights to use that name Apple it would be tens of billions of dollars same thing with the logo and even more an intangible asset

36:34 are the relationships that Apple has with all of its customers around the world if you're an Apple user you are loyal and if they come out with a new product you're going to buy the thing that's valuable for a company to have an existing base of loyal users that's an asset that if Apple wanted to sell its customer list they could do that again for tens of billions of dollars how much are those crucial economic asss the logo the name those relationships how much are they recorded at in the balance sheet zero because Apple never had to pay to buy those apple never had to pay anybody else to buy its name it just developed that name didn't have to pay anybody else to buy its logo it created the value that logo it didn't have to buy its relationships with customers it's created those relationships itself so the intangible assets that a company

37:21 grows itself creates itself organically homegrown intangibles I call them are recorded at zero on a balance sheet and for many companies these assets are the most important ones they've got the name Apple the name Microsoft the name IBM the name McDonald's or cocacola all of those names are worth tens of billions of dollars and yet they're all recorded at zero on the balance sheets of the respective companies so accounting doesn't account for intangible assets very well at all I'm ashamed the combination of these two things means this the value of company on its books the book value we can say is often not equal to the market value of a company those are limitations of the balance sheet now you know the truth the balance Sheet's great I love it you love it but it's not

38:13 perfect as we know there are three primary financial statements the balance sheet the income statement and the statement of cash flows the balance sheet and the income statement have been around for over 500 years statement of cash flow has only been around for 25 years so we'll leave that one to the side let's just talk about a comparison between the balance sheet and the income statement those stately old financial statements that have been our friends for over 500 years the balance sheet listing of assets and liabilities as of right now what do you have and what do you owe as of today so you could theoretically do a balance sheet any old day let's do it at the end of today let's do it at the end of the next day it's as of a point in time it's of often spoken of as being a snapshot the balance sheet is a snapshot as

39:01 of right now what do you have and what do you owe the income statement on the other hand tells you how much you made and if you think about that for a second you realize okay how much I made what this week this month this year you have to define a period of time so the balance sheet is as of a point in time the income statement is for a period of time for large companies in the United States they are required to report an income statement every 3 months every quarter in addition at the end of every year they're required to report an income statement for the entire year so those are the periods of time that income statements are required for large companies in the United States so let's see if we've got this let's review close your eyes I don't want you looking at anything just close your eyes which one of these two a balance

39:51 sheet and income statement is for a period of time yeah you got it the income statement which one is as of a certain point in time that's the balance sheet balance sheet as of a certain date what do I have and what do I owe income statement for some period a quarter a year a month how much did I make that's the difference between a balance sheet and an income statement the income statement contains two items revenues and expenses revenues minus expenses equal the net income that's it that's the income statement now you shouldn't be saying to yourself okay that's not that bad you're right accounting is not that bad in fact we can

40:37 make a stronger statement accounting is great now what does the word revenue mean it's kind of subtle but important remember revenues are the amount of assets created from the sale of goods or services so how do companies generate assets through profitable business operations well depends on what the business is Microsoft for example generates assets by collecting it from you and me through selling software and Hardware we call that Microsoft's revenues how does Walmart generate assets through doing business well they sell products to you and me and they sell us memberships and their Sams Club so that's the way Walmart generates assets through doing business so those are Walmart's revenues Disney Disney has five major business segments their media networks

41:25 their cable TV and television networks parks and Resorts Disneyland Studio entertainment Pixar Marvel the Disney Studios themselves Lucas Films Star Wars Disney has all those consumer products yeah you still got that lunchbox that you bought when you were a kid that's got the Disney logo on that they make money from that and the fifth one not listed on the slide here they're interactive division so Disney generates assets through doing business in many different ways they're all called revenues revenues are ways that companies generate assets through doing business and whatever your company is that's the way you're going to generate Revenue differs depending on what industry you're in well they are revenues but they're also expenses like what well Microsoft in order

42:11 to generate those revenues by selling software and Hardware to you and me they got to pay programmers they got to buy equipment there all kinds of things that they have to pay for they got to pay for electricity they've got to pay for maintenance on all their facilities that they have those are expenses Walmart what is their major expense their major expense is the cost of the goods that they sell to you and me on average if they sell something to you and me for a dollar that thing cost them about 75 cents so that's an expense that's assets consumed in generating revenues they also have buildings that they build and slowly wear out over time those are all assets being consumed in generating revenues McDonald's what are their expenses well they have to buy the food that they sell to un me they have to buy the paper that they sell to un me they got to pay the

43:00 employees that are working behind the counter those are all expenses involved in generating the revenues so expenses are technically defined as the amount of assets consumed in generating revenues now another way that expenses are created is by generating liabilities for example let's say I've got employees that work for me for the year I pay them their wages that's fine those are expenses that's easy but what if I also promise them them a pension 30 or 40 years from now when they retire and they also earn those pension benefits this year that's also an expense even though I'm not going to pay them for 30 or 40 years they earned the benefits this year and so I'm going to report as an expense this year the definition of expense in that case is when I

43:46 create liabilities through doing business another common and unfortunate liability is environmental liability if I Mex on mobile through sucking oil and gas out of the ground and transporting it around the earth I'm going to do some damage to the environment every year I don't necessarily have to pay to clean it up this year but I did the damage this year those are also business expenses recorded this year expenses consuming assets or creating liabilities through doing business those are expenses so the income statement revenues minus expenses equals net income it's as simple as that now this net income is the overall measure of a company's economic performance During the period that's the one number that summarizes all the economic things

44:32 that the company did it's an economic measure accounting net income we've been working for over 500 years to fine-tune the accounting rules to properly measure revenues and expenses so that number net income the difference between revenues and expenses for the year is the economic performance for the year it's a good measure of a company's economic performance the statement of cash flows the statement of cash flows is the baby of the financial statements the balance sheet and income statement have been around for over 500 years statement of cash flows is just this let's take all the cash flows cash collected cash paid by a company and again that's a pretty easy concept cash we're just focusing on cash how much cash did you collect

45:17 how much did you pay and we're going to separate those into three categories operating activities investing activities and financing activities and let me tell you what those three activities are and then we'll look at examples of each one operating activities are the things that you do every single day your operations so when would you collect cash from operating activities if you sell some Goods if I'm Walmart I sell you something if you provide some Services if I'm a consulting company I provide consulting services to you and you give me cash so those are cash inflows from operating activities cash outflows from operating activities you pay wages you pay your chilies you pay your taxes you pay your interest those are all things that you do every single day so operating activities just the routine stuff that you do hundreds of times a day investing activities

46:03 here the word investing means investing in the productive capacity of the business so cash outflows from investing activities down at the bottom here is buying new buildings buying new land investing spending cash to enhance the productive capacity of the business those are cash outflows from investing activities cash inflows from investing activities well when I'm done with a truck when I'm done using some land I sell them I don't need them anymore so I'm going to sell them for some cash those will be cash inflows from investing activities how often do I do investing activities well occasionally but not every day these are not routine things I don't go out and buy a building for my business every single day so investing activities happen occasionally and it's investing in the productive capacity of the business and I'm generally spending money to

46:50 enhance the productive capacity of my business the third category of cash flows financing activities financing activities is just what it sounds like I'm getting the cash to do what I want to do in my business I'm borrowing some money I'm getting new investment from owners those are cash inflows from financing activities cash outflows well I'm repaying those loans I am paying dividends to my owners those are cash outflows from financing activities and how often do I do those things occasionally not very often so operating activities those are the things that I do every single day repetitively over and over it's what I exist for investing activities I want to expand the productive capacity of my business I'm spending money to enhance that productive activity financing activities I'm getting the cash to do what I need to do I'm borrowing money

47:41 and I'm repaying it back I'm getting cash from shareholders and I'm paying dividends to them that is a statement of cash flows it's only been around for 25 years but it's been 25 awesome years the third basic flavor of accounting is managerial accounting it starts with bookkeeping we have a system in place to gather the raw data sometimes we need to communicate some of those data to people outside the company that's called Financial Accounting communicating with Outsiders more frequently we need to use those data internally to make internal decisions that's managerial accounting the accounting data that are used internally to make daily decisions when I say

48:27 managerial accounting I want you to think details I want you to think inside the company I want you to think secret I want you to think daily these are the data that people inside an organization are going to be using intensively on a daily basis to make those daily decisions hey we're selling blue shoes should we start selling black shoes we're selling children's clothes should we start selling adults clothes we're selling strawberry ice cream should we start selling chocolate ice cream we've got a factory here in Nevada should we also build one in Illinois those detailed daily decisions that any organization has to make every day those decisions are made using managerial accounting data in fact if you've ever been involved in any kind of organization worked in a company been involved with a charitable organization you've used managerial accounting

49:15 data you might have provided input into managerial accounting reports you've probably used manager accounting reports it's what people use all the time to make decisions with respect to an organization and here's here the thing these data are not things that you're going to share with Outsiders see financial accounting is built to be shared with Outsiders managerial accounting no inside secret it's the stuff that we use internally to make decisions and here's the interesting thing about managerial accounting if done well managerial accounting can be a competitive tool it can make your company beat your competitor in the marketplace now I could tell you're a little skeptical account be a competitive tool managerial accounting can be a competitive tool let's think of an example we got two soup and salad restaurants let's put them

50:04 right across the street from one another one side we've got soup and salad restaurant number one on the other side of the street we got soup and salad restaurant number two so these are really competitors they both serve exactly the same soup and exactly the same salad they're not competing based on quality of food so how are they going to compete well accounting at restaurant number one is very traditional they don't do anything fancy they just want to make sure they get their bills paid they want to make sure that their employees get paid on time they really even though it's a soup and salad restaurant they've got a meat and potatoes accounting system very traditional now you and I are over here in restaurant number two we know that managerial accounting can be a competitive tool here's what we do with our accounting system we use bookkeeping to gather

50:50 the data and then we organize the data that's what managerial accounting is organizing all these data we've got in our company we know for example item by item how much each item on our menu costs you come on to our soup andell restaurant and Order tomato basil soup we know exactly how much it costs us to prepare that the raw materials and to cook it and serve it we know all the costs and if we know all our costs we know whether we can afford to give customers a 20% off coupon or a 30% off coupon or a two for one we know exactly how low we can go with our prices and how big our discounts can be because we know what our costs are we know by hour by minute inside our business what people are buying and when they're buying it we know how much tomato basil soup is sold

51:38 between 11 and 12 every day and how much is sold between 600 and 7 in the evening every night we know that that makes it easier for us to Target our promotions to our customers we also know when do we need to have more staff here and when can we afford to have fewer staff because we know exactly by the minute inside our business when people people are there we know our customer demographics we've probably got a system set up where customers can get points by registering with us and providing us their address and their email address so we know a little bit about our customers and we keep track of what they buy so since we've got their email address and we know what they like to buy we can send them little email coupons hey come in we're running a special on your favorite tomato basil soup 60% off bring a friend and your friend will also get 60% off we can Target our

52:26 sales efforts at individual customers based on their individual preferences now you say wait stop this is marketing this is advertising n it's marketing or advertising standing on the back of a good managerial accounting system it's the managerial accounting system and the data involved with it that make it possible to Target our individual customers you know the frequently ordered combinations you know that when somebody comes in and orders tomato basil soup they're probably going to have for dessert that strawberry cheese cake so package those together and give people a discount for ordering both of them at the same time you know all this stuff meanwhile the poor person trying to run restaurant number one across the street all their internal accounting system tells them is how much they're supposed to pay their employees this week and how

53:12 much they're supposed to pay for their supplies when they receive them that's all they know who's going to win in the long term in this competition between soup and salad restaurant number one and soup and salad restaurant number two the one with the better internal managerial accounting system good managerial accounting can be a competitive tool so how are managerial accounting data use these internal data inside a company well first product costs let's say I've got a wood furniture business somebody comes in and orders and customade Oak Table well in order to make an intelligent decision about whether I should sell that table or not and at what price I need to know how much it cost me to make that table so product costing is part of managerial accounting Break Even analysis let's say I'm considering opening up a scuba shop at the local mall well

54:03 that's a risky thing to do but okay go ahead think about it and one of the first things you should do is this figure out how much you're going to have to pay your manager figure out how much you're going to have to pay for rent and then figure out how many customers are going to have to come into my scuba shop each month for me to break even to avoid losing money that's an important part of managerial accounting analysis budgeting many startup businesses have been killed because they just haven't sat down and made a budget a numerical plan on paper budgeting is part of managerial accounting performance evaluation some employees are doing their jobs very well some employees are not doing so well we want to reward the one and not reward the other so we need a system in place to gather the data to evaluate different parts of our company let's say I want

54:51 to invest in a long-term project I want to build a new Factory facility in Rock Springs Wyoming it's going to last for 20 years well that's a decision that's going to require the use of manager County information how much is it going to cost to buy the land how much is it going to cost to buy the building the machines and what are the profits we're going to make and how long is it going to last all those data would be brought to bear in making that decision to invest in a long-term project what about Outsourcing production I've got a production facility right now in the Central Valley of California will'll say but should I stop producing my product here in California and Outsource it maybe it can be made in Brazil maybe it can be made in Ethiopia there are all kinds of possibilities managerial accounting data are used to make those kind of decisions

55:39 Outsourcing production and finally add a product line I've got a nice line of children's clothing here should I start selling adult clothing in my store as well let me run the numbers on that watch numbers these are the kind of decisions that are made using managerial accounting data managerial accounting is all about communicating to people inside the company it's the information that's used on a detail basis every single day inside the company managerial accounting it's secret it's detailed it's daily let me illustrate the difference between managerial accounting and financial accounting with this simple example we'll talk about w

56:26 Walmart again we saw before that Walmart's sales $466 billion now that 466 billion is that a financial accounting number or a managerial accounting number yeah it's a financial accounting number we saw it in their income statement that's report made available to people outside the company so that $466 billion is that sales number is a financial accounting number now let's imagine for a second that you run Walmart you're the CEO of Walmart let's go go crazy in our imaginations here and you're running the business that means you're making daily decisions about what needs to happen in Walmart and the financial accountants come and say hey our sales last year are 466 billion and you say okay that's nice thanks but I'm trying to run a business here I need to know

57:13 more details about that number 466 billion I need that sliced and diced and I need it cut down I need to know more specifics I need detail I need daily detail so let's think what addition things would you like to know about that one number 466 billion we're only talking about the sales that Financial Accounting number if you were to try to run Walmart what additional things would you like to know about that one number the 466 billion I say list 10 additional things we could list hundreds of additional things but here's a few that I thought of in addition to knowing that the total sales are 466 billion I don't want to know okay how many of those sales were in North America and how many of them were in Mexico and South America and how many in Europe and how many

58:01 in Asia I want to know it by region by country in fact I want to know it by store and I don't want to just know it by store I want to know how much did we have last year in that same store and what was our Target for this year in that store so did we have more than last year and do we have more than we thought we were going to have I wanted at the store level now let's go down even further I want to know by a department are we selling mostly groceries are we selling mostly children's clothing men's clothing outdoor lawn care kind of stuff what are our sales specifically in fact let's go to specific items how many of this kind of shoe did we sell how much milk did we sell how many bananas did we sell how many lawnmowers did we sell I wanted to buy specific items I want to drill down to as much detail as possible because I'm running a business here I wanted to identify

58:50 my best sellers my worst sellers I want to make a plan 466 billion total sales doesn't give me enough information to make a specific plan of running my business on a daily basis how about physical location in the store top shelf bottom shelf end shelf back of the store front of the store you tell me how we can influence ourselves by where we place stuff in the stores and there are some things that are safer to put in the back people won't forget about them and there are some things that unless we put them in the front nobody's going to buy them I want to know that stuff I want to know how much is sold by Seasons what's sold in January what's sold in Fe February what's sold during the holiday selling season in fact I want to go a little bit deeper how about day of the week what happened on Mondays Tuesdays Wednesdays by time of day

59:35 should we be open 24 hours should we even open before noon you tell me the sales by hour buy region buy item tell me all this stuff when it's raining outside what sales when it's hot outside what s hey we ran a bunch of AD campaigns I want you to show me the impact of those ad campaigns on on the sales numbers what were they the week before what were they the week after by payment

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