Slides 1-3 (2m:13s) Welcome to Introduction to Accounting Preparing for a User’s Perspective What are debits and credits? Get ready this is kind of an ambitious video in which I am trying to get a lot of things accomplished in a very short period of time but if you will really take the time to fully comprehend this video and really commit to memory all the different slides in this video you will have mastered a major part of an introductory accounting course. Now I don’t know that you can do that, at least not in 10 minutes, but we’re going to give it a shot. Certainly refer to this video as you go back and try to make sure you know your debits and credits and how they fit into the expanded accounting equation. So let’s begin. This is a T-account. T-accounts are used to represent a company’s accounting ledgers. Accountants use ledgers to keep track of each individual account’s balance in dollars. Ledgers simplify math because all increases are on one side and all decreases are on the other side of the ledger account. Entries on the left hand side are called debits. Debit is just another word for left. Entries on the right side are called credits. Credit is just another word for right. Where this gets a little tricky is that some accounts, such as assets, increase with debits whereas other accounts, such as liabilities and equity, increase with credits. Jingle: Debits on the left, credits on the right, debits on the left, credits on the right. This is the balance sheet equation. Assets are on the debit (i.e. the left side) of the balance sheet equation; therefore, asset accounts are increased by recording debit entries. Liabilities and equity are on the credit side (i.e. on the right side) of the balance sheet equation; therefore, liability and equity accounts are increased by credit entries. Decreases are always recorded on the opposite side of an account’s increase side. Therefore, if you have more liability you would record a credit entry. If you want to show that you paid off a liability you would record a debit entry. Jingle: Debits on the left, credits on the right, debits on the left, credits on the right. Slide 4 (2m:12s) Here is the basic accounting equation expanded to show the two key equity financing sources: capital contributions and retained earnings. Whenever any equity account is credited, meaning a right hand entry in the equity account, TOTAL EQUITY up here will increase. So that is what I have shown whether you credit revenues or credit expenses or credit dividends, any of these credits will flow up and wind up increasing the TOTAL EQUITY of the business. Whenever any equity account is debited, meaning a left handed entry, total equity will decrease. So whether you debit revenues or debit expenses or debit dividends the impact if you follow the arrows through will wind up decreasing TOTAL EQUITY. Now where this gets a little confusing is if you debit an expense that means you have more expenses but the impact will be that you have less net income less retained earnings and less TOTAL EQUITY. If you debit revenues that means you have less revenue which means you have less net income less retained earnings and less TOTAL EQUITY. Example: When expenses are debited what happens to TOTAL EQUITY? Hint: follow the arrows. Expenses would increase, net income would decrease, retained earnings would decrease, and TOTAL EQUITY would decrease. Example: What if revenues were credited? Revenues would increase, net income would increase, retained earnings would increase and TOTAL EQUITY would increase. If you were to credit an expense, that would reduce expenses. By reducing expenses your net income will increase, retained earnings will increase, and equity will increase. It is essential that you learn this expanded part of the accounting equation so that you know which accounts are increased with debits, such as expenses and dividends, and which accounts are decreased with debits, such as revenues, net income, and retained earnings. Jingle: Debits on the left, credits on the right, debits on the left, credits on the right. Slide 5 (0m:48s) Here are the increase and decrease rules by account. All assets, expenses, losses, and dividends are increased by recording debit entries. All liabilities and these equity accounts are all increased with credit entries. The opposite would then be true. Liabilities and these equity accounts would be decreased with debits whereas assets, expenses, losses, and dividends are decreased with credits. This is another way of remembering these rules. It’s essential that you learn these. You might just have to memorize them but there is some logic. Remember assets, since they are on the left- hand side of the balance sheet equation, are increased with debits. Liabilities and equity, since they are on the right-hand side of the balance sheet equation, are increased with credits. Slides 6-7 (1m:10s) This is what I call the super-expanded accounting equation because it includes the rules for all account categories in my introduction to accounting course. It includes contra-assets such as allowance for bad debts and accumulated depreciation and the way these work is you take the asset itself and deduct whatever this balance [in the contra-asset] is. For example, if you have a building and you have accumulated some depreciation on it, you would take the building less the accumulated depreciation [to arrive at its book value]. We’ll learn about that later. It also includes contra-revenues, such as sales discounts and sales returns and allowances. For example, a sales return allowance is when you make a sale to a customer and they return it. Sales discount is when you make a sale to a customer and you give them a discount for paying it off early. So, as these contra revenues go up, your net income goes down. Why, because people are returning goods [and obtaining discounts for early payment], they are effectively returning sales [or discounting previously recorded sales]. Jingle: Debits on the left, credits on the right, debits on the left, credits on the right. Here are those accounts included in the list of accounts. Contra assets are increased with credits, contra revenues are increased with debits. So contra revenues work just like expenses and losses as to their impact on the income statement. Slides 8-14 (2m:47s) In a prior video, I introduced to you these common asset accounts, we actually had a little video for each one of these so you know what each one of these are. But I just wanted to give you this list of asset accounts and note that they all are increased with debits. You’ve got to know these and we will dig into these one by one a little later as we go through the course, but you should already have a general idea of what these accounts are, and what they represent. You definitely need to know that they [assets] are increased with debits and decreased with credits. These are common contra asset accounts which I just introduced, Allowance for Doubtful Accounts and Accumulated Depreciation. Since they are “contra” to assets, their rules are exactly opposite [of the rules for assets]. Assets are increased with debits and contra assets are increased with credits. [These are] common liability accounts. I have already introduced these liability accounts. You may need to go back and review that but just remember these are liabilities and they are increased with credits. These are the common equity accounts, like capital, common stock, preferred stock, retained earnings. These [equity accounts] are all increased with credits and the revenues and gains are increased with credits. Now those things that work against equity [such as dividends, expenses and losses], although they are a type of equity account, by recording debits to them they reduce TOTAL EQUITY, just like if you had recorded it up here, you would reduce TOTAL EQUITY, but this is saying that if you have more withdrawals, you will have less TOTAL EQUITY. If you have more dividends, you will have less TOTAL EQUITY. If you have more expenses or more losses, you will have less TOTAL EQUITY. These permanent equity accounts keep a permanent running total of the company’s total equity and are not closed at the end of the year. They appear on the balance sheet. All these other [accounts] below are nominal equity accounts, and they are only temporarily used during a given year and at the end of the year are closed into Retained Earnings. These top ones appear on the statement of owners’ equity, or statement of shareholders’ equity, or statement of retained earnings and the lower ones appear on the income statement. These are common revenue and gain accounts. Sales revenue, rent revenue and interest revenue, gain on sale, they are all increased with credits and therefore equity would increase if you credit these. These are common expense accounts and I know we haven’t dug into all of these, but you can see almost all of them have the word expense. Be careful though, there is such a thing as a prepaid expense which is an asset so don’t think that’s an expense. These are all expenses, cost of goods sold is also an expense. So as you record more debits here, your net income will actually go down and your TOTAL EQUITY will go down.