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1.7

## Introduction to Financial Accounting

Skip to 0 minutes and 11 seconds Now that we have seen what happened in the first half of the year let’s move on and see what happens in the second half of the year. The company - as you may recall - has engaged in different series of purchases of services work force and long lived assets. Eventually the company starts settling services and product. Well you may argue hopefully the company can actually realize some revenues and in fact if you look at Operation number nine what for less sell to training services to a new customer. Now bear in mind that the company has just started its own operations so it will try really hard to make contacts and retain customers.

Skip to 0 minutes and 55 seconds And in fact to make the sale attractive they offer a discount by 20 percent and the cash in sales for services which is otherwise called the revenues for 48000 on August the 1st. The customer pays in cash cash and therefore now you should be accustomed to the idea that this is a relevant transaction from an accounting point of view. If you see the upper part of the table you see that there is an increasing cash by 48,000 that corresponds to an increase in sales of services for the same amount. This is also reflecting on what happens in the statement like form which you are using that you see in the bottom part of your slide.

Skip to 1 minute and 45 seconds First, there is an increase in the value of cash from 36000 to 84000 and this is the result of the sale. That also generates an increasing cash now. Some of you may argue would it be different if instead of cashing in the company would get the receivable meaning that the customer does not pay on the spot but would rather pay in the future. From an accounting point of view this is irrelevant. Meaning that the transaction would still be recorded but instead of cashing in and record and increasing cash we would have recorded an increase in receivable. But hold on with us because we will come back to this later on.

Skip to 2 minutes and 31 seconds Going back to the table in the bottom part of the of the slide you will see that we keep recording all the same assets as before and in fact we had raw materials for 5000. We have plant for 60000. We have a patent bought and paid for 20000. We have salaries paid for 8000. And insurance as well. If you look at the right hand side of the table we still have equity which is the stockholders wealth invested in the company and for 100,000. We have a payable and we have sales of services as you may recall. The total amount of the left hand side the columns and the right hand up two columns is the same.

Skip to 3 minutes and 20 seconds Let’s move on to a different transaction. These are fairly important one because the company is now starting to work and sell and they decide that they need some additional funding which the owners don’t have. and therefore they resort to a third party financing. Therefore on October the 1st work-for-less negotiates a five year loan with the bank. The loan is for one thousand and they agree on an interest rate of 4% each year. Now for the sake of keeping things manageable. But this is not so realistic. Let’s assume that the interest at the company will repay is stable over time and that equals to 4000 in a year.

Skip to 4 minutes and 10 seconds Now I can already hear some of you saying but this is not realistic and I agree with you. This is not realistic but for the sake of simplicity let’s keep it as such for now Capital repayments on these non will happen twice in a year. So I say that capital will be repaid. March the thirty first and then September the 30th each year same amount. How do we record this transaction. First we realize that the company increases its cash by 100000. And it is in the upper part of the table on the left hand side. And that increasing cash corresponds to an increase in loans or debt by the same amount.

Skip to 4 minutes and 53 seconds By now you should be familiar with this concept that if you increase something on your left hand side something by the same amount would increase on the right hand side. Let’s see what happened in the statement like Form which is in the bottom part of the slide. What do you notice here is a significant increase in the rate of cash that goes from 84000 to one 184,000 and correspondingly there is a new item on the right column which is the loan that increases by one hundred thousand. As of now the company has neither repaid the loan which should be done in March in the next year. Nor started paying back the interest. The interest for the company.

Skip to 5 minutes and 41 seconds Are a cost, they are an expense that are connected to The fact that the company has at its own disposal some financial resources that are not there on the will to spend a lot of time on debt and financing for what we need now is more than enough. Let’s move on to transaction number 11. The company keeps producing and selling and in fact on November the 1st. Work for Less sells products and services for 50000. The payment is half in cash and half via a receivable.

Skip to 6 minutes and 18 seconds This is different from the previous transaction because in the previous transaction in order for the customer to get a discount everything was paid in cash whereas now half is in cash for 25,000 and half fees receivables. Now let’s see how we record this transaction which is clearly relevant from an accounting point of view. Here we had an increase in cash for 25000 and an increase in receivables for the same amount 25,000 on the left hand side of the upper table. On the right hand side. We record something that you will start calling now revenues saves our services and products for 50000. I’m going to ask you something that I already mentioned in the previous video.

Skip to 7 minutes and 9 seconds Would it be any different if the company cashed in the whole amount? or if the company instead of cashing in the whole amount would have received receivables for the full amount? From an accounting point of view.

Skip to 7 minutes and 25 seconds This is irrelevant: It does not make any difference because cashing in now means that you have cash at your disposal at times zero 1 whereas a receivable is a promise from the customer to repay us in the future.

Skip to 7 minutes and 42 seconds From an accounting point of view:no difference. Let’s have a look at the bottom part of the slide where we see the statement like for what is different here. Now we see clearly that there is an increase in cash that goes from one hundred eighty four thousand. Two two hundred nine thousand and that is an increase in receivables which is the very last row labeled. Item number 11 and receivables go up by 25000. On the other hand you will notice that there is a new item also on the right hand side of the table and this new item is called sales of products for 50000 if you know this.

Skip to 8 minutes and 24 seconds The total amount of the left hand side the columns and the right hand side columns is the same 328,000. Let’s move on to transaction number twelve. One of the engineers on December the 1st resigned and works for less start searching for a replacement. The key question for us is is this transaction relevant for the firm? Of course it is. Is it relevant from an accounting point of view? Well, no. Why? Because there is no cash in nor cash out. So this is an important fact for the company that is not reflected into the accounts. And in fact if you look at the bottom table it is unchanged vis a vis the previous one.

Skip to 9 minutes and 11 seconds We are done with the Web transactions that occurred throughout the year. But some of you may remember that transaction number five entailed a payable. If you recall the company purchased a new plant and paid half in cash and half through the generation of payable. Now it is time to face the cash disbursement connected to the payable and in fact if you see the transaction the way we recorded it we see that there is a decreasing cash for 30000 on the right hand side that corresponds to a decrease in payable by the same amount. And everything is reported into the table that is in the bottom part of the slide.

Skip to 10 minutes and 1 second The value of cash has gone down from 209,000 to one 197,000. And likewise the amount of payable has gone down from thirty thousand to zero. Everything else is identical. In the latest video we left with the analysis of all the transactions. Actually we didn’t answer key question at accounting tries to answer. Has the company generated a positive result or a negative result? So, let’s start from the statement-like-form which we had in the very last slide and here I highlight in red the negative components of the income - namely expenses. And in light blue we have the positive components of income - namely the revenues. So let’s see what we have. We have raw materials which were purchased for 5000.

Skip to 11 minutes and 0 seconds We have plant which was paid 60000. We have a patent which was worth 20,000 and then the company paid salaries for 8,000 and an insurance for 1000. These are all negative components of income but the key question is Has the company really used all these factors in the production?

Skip to 11 minutes and 25 seconds And the answer is: at this stage we don’t know. We know that these are services and investments that the company made but we don’t know whether they had been used in the production. On the right hand side. We can see that there are two positive components of income. Sales of services and sales of products. So as of now we would be tempted to compare and say that the company has generated the revenues for 98000. Any incurred expenses for 94000. And this is something that we can clearly see in these slides here where we merely compare the positive component of income and the negative component of income.

Skip to 12 minutes and 13 seconds Now in order to assess whether the company has really generated a profit or it has generate the loss or even assessing what is the amount of the income or the loss you will have to wait for week two in which we will start dealing with accrual accounting. Thank you very much.

# How Do Companies Record Business Transactions? (Part 2)

This video complements the previous one on how companies engage with transactions and how they account for them!