hello I'm Professor Brian bé welcome back starting with this video we're going to look at an extended case study which will illustrate the accounting cycle the accounting cycle is all the steps that you have to follow to go from recording transactions all the way through preparing financial statements the case is going to be spread out over a number of videos interspersed with new topics that we introduce which will then illustrate in the case study let's get started let's start off with a quick review so we've seen in the last couple videos how journal entries and
te accounts can be used to track and record the effects of transactions and the key is to make sure that our debits equal our credits when we record these journal entries and if we do so then we know that the balance sheet equation will hold when we add everything up so the debits and credits substitute for the balance sheet equation we talked about how debit means left side entry and credit means right side entry so when I buy something at the store and the cashier says debit or credit should not point out that he is
really asking left or right please don't say that you're going to get me in trouble to make sure that debits and credits will preserve the balance sheet equation we set assets and expenses to have debit balances which means that debits will increase these types of accounts and credits will decrease them we set liab ability shareholders equity and revenues to have credit balances so that credits will increase these accounts and debits will decrease them we also looked at a visual picture that we could use to remember this the super t account which shows whether debits or
credits increase or decrease the various type of accounts and talked about how you should print this out to keep it handy until you memorize it or tattoo it on your arm whatever your inclination may be now we're going to talk about the accounting cycle woohoo Let's Take a Ride on the accounting cycle uh it's not that kind of cycle but it should be just as fun we're going to go through the entire accounting cycle with an extended case which follows a startup company from its first set of transactions all the way through its first set
of financial statements and that's what the accounting cycle is set up to do first as the business is operating during a fiscal period transactions happen and then you have to analyze those transactions to figure out how to come up with journal entries and then post those journal entries to te accounts once the period is over we do something called an unadjusted trial balance to make sure we haven't made any math mistakes or transposed any numbers then we do something called adjusting entries which are needed to get the books correct before we do financial statements after
another trial balance we prepare the financial statements when we're done with those we have to do something called closing entries which gets us all set to start the new period so that we can do this over and over and over and over and over and over again through the whole life of the business we're going to start the case with the first part of the accounting cycle where we analyze transactions and then figure out how to journalize them which is record each transaction as a journal entry and something called the general journal then we're going
to post that journal entry to te accounts or general ledger where we'll keep a running total of the balance in all the accounts so now now let's take a look at the facts of the case in March of 2012 Rebecca Park identified an excellent business opportunity while she's a firste MBA student at Wharton she read a story about an MBA student who tripped while jogging in Fairmont Park and found an ancient gold coin in the underbrush it was an old Viking coin that was appraised at 77,500 she realized she could set up a profitable business
that rented out portable metal detectors to people that wanted to search Fairmount Park for more Viking relics also Park had the of stocking her store with Sundries such as water bottles and energy bars that she could sell at a huge markup to renters before their expedition into the park park prepared a business plan and approached a fellow student Jay Gerard who had a sizable trust fund and who she believed would invest in this new Venture due to his Myriad of other Investments and his heavy course load Gerard agreed to invest as a silent partner and
allow Park to run the business which she named Relic spotter Incorporated so now what we're going to do is go through number of transactions for the company after each transaction is read you should pause the video and try to do the journal entry think about what accounts are involved did they increase or decrease and then do we debit or credit then resume the video to see the answer and the explanation and that's when we'll post the journal entry to te accounts first transaction on April 1st 2012 Gerard decided to invest $200,000 and park put up
$50,000 to purchase a total of $25 ,000 shares in the new company the par value of the shares was $1 in this transaction we're receiving $250,000 of cash for issuing Equity cash is increasing by $250,000 cash is an asset we increase assets through debits so we're going to debit cash for $250,000 to increase this asset we also have a $250,000 increase in contributed Capital which is sters Equity but remember we have to split this into two parts the par value and the additional paid in capital so first we have common stock at par which is
going up by 25,000 shares times $1 or $25,000 we make Stock's Equity go up with a credit so we credit common stock for 25,000 and then we credit additional paid in capital for the rest $225,000 which is the number we need so that our debits equal our credits excuse me are you allowed to have more than one credit in a journal entry Z value again yes you can have more than one credit and or more than one debit as we talked about last time the only requirement is that your debits equal your credits and it
looks like the parv value guy is back again and you're going to have to deal with par value a lot so get used to it after we do the journal entry we need to post these amounts to te accounts where we can keep a running total of the balancing each account so we create a t account for cash put the 250,000 on the debit or left hand side we put a little one there so that we can trace this number back to the original journal entry in the general journal we create a similar te account
for common stock of course the Balan is on the credit side and the same thing for additional paid in capital transaction two lacking the funds for her initial investment Park borrowed the $50,000 from the Imperial Bank of Philadelphia on April 1st using your parents house as collateral the journal entry for this one is well there is no journal entry because Rebecca Park is borrowing the money personally it's not Relic spotter that's borrowing the money in other words Relic spotter doesn't have to pay this loan back Rebecca Park does so there's something called the entity concept
which says the only thing that should go in a company's books are transactions for the company not transactions for the employees so we want to keep this separate Rebecca Park's loan personal loan does not show up in The Relic spotter books now having said that this is the only time I'm going to do this trick in the rest of the case I'll talk about Rebecca Park does this Rebecca Park does that but for the rest of the case she's doing things on behalf of the company so you're not going to see this trick again since
there's no journal entry there's nothing to post a te account so we can go right on to transaction number three on April 2nd Park hired lawyer to have the business Incorporated because this was a fairly simple organization the legal fees were only $3,900 so let's take a look at the journal entry I always recommend starting with cash if there's cash involved in the transaction because you'll quickly memorize whether to debit or credit cash based on whether you receive or pay cash so in this case we're paying $3,900 of cash for legal fees which seems quite
exorbitant but you know I guess it's lawyers so what are you going to do anyway if we're paying cash cash is going down cash is an asset so assets go down through credits so we're going to credit cash for $3,900 now notice even though I started with cash and it was a credit I don't write it first in the journal entry as we talked about in a prior video you always want to write debits first so I had to skip some space write the credit second and indent it so now we need to find a
debit so what are we getting for this cash we're not really getting an asset this is more of just a cost of doing business so it's going to be legal fees expense remember that expenses get increased through debits so we're going to debit legal fee expense which will increase expenses and reduce stockholders Equity by$ 3900 excuse me why isn't this an asset I guess you could say this is an asset because the future benefit is that we get to operate the business forever once we've Incorporated it it's a pretty lame rationale but there were companies
that used to call this an asset now the rules are explicit this kind of expenditure has to be expensed immediately let's post this to t account account so we bring back our cash t account account we put 3900 on the credit side or the right hand side with a little three to indicate that it's transaction number three and we create a t account for legal fee expense with 3900 on the debit side or the left side next transaction number four to house the business park bought an abandoned pizza parlor near Fairmount Park for $155,000 on
April 7th the building was old and needed renovation work the purchase documents allocated 103,000 to land and 52,000 to the building Park paid for the building with $31,000 cash and a $124,000 mortgage from the Imperial Bank wow this is a big transaction so it's going to require a a big journal entry always like to start with cash if we can we paid $31,000 of cash cash is an asset assets go down with a credit so we credit cash for 31,000 we acquired land and building land and building are both assets assets go up with a
debit so we want a debit building for 52,000 and debit land for 13,000 to make those two accounts go up now at this point our debits don't equal our credits so we can't stop we're missing one more piece and that piece is the mortgage a mortgage is a liability liabilities go up with a credit so we need to credit mortgage payable for 124,000 and now our debits equal our credits why do we need to have separate accounts for land and for buildings and why don't we record interest payable as well won't we have to pay
interest on the mortgage huh those two look like twins oh anyway both good questions we keep landed building in separate accounts because later on we're going to do something called depreciation and these two accounts will be treated differently as for the interest question I think we talked about this in a prior video but it's good to review it we don't owe any interest when we take out the mortgage we could pay back the mortgage immediately and not have to pay any interest only as time passes and we owe interest without paying it will we have
to record an interest payable we've got a lot of a posting to do for this journal entry we bring back our cash t account and put another credit on the right hand side create te accounts for building and land and one for mortgage payable transaction five Park felt that some renovation work would extend the life of the building to 25 years with an expected salvage value of $10,000 she ordered the renovation work costing $33,000 to begin immediately the work was completed on May 25th at which time she paid in cash the amount owed for the
renovations for this transaction the first thing we're going to do is ignore the stuff about salvage value in 25 years we'll come back to that in a later video instead we're going to focus on the transaction that happened on May 25th which is when Park paid the cash we paid $33,000 of cash cash is an asset we make an asset go down through a credit so we credit cash for 33,000 so now we're looking for a debit what did we get for this cash well we added to the building and so we're going to debit
building for $33,000 to increase the balance in the building account remember we make assets go up through debits excuse me why isn't this an expense instead of an asset all of the expenses seem like assets to me and the assets seem like expenses oh bother great question the general rule is if you spend money on maintenance an expected cost of maintaining the asset then you would expense it but if you spend money for a capital Improvement which would be something that would increase the value of the building or how long you plan to use it
then you get to add that to the building account but don't worry about this now this is something we're going to talk about in a lot more detail later in the course then we post this C accounts we add another credit to the right hand side of the cash account and a debit to the left hand side of the building account so now the balance in the building is $85,000 uh I would tell you what the balance in cash is but I can't do math in my head so you'd have to figure that on your
own next transaction transaction number six Park phoned a number of metal detector vendors until she found one that was willing to give her volume discount on June 2nd Park purchased 240 metal detectors at an average cost of $500 per unit so that's $120,000 total the innovation in the industry is so rapid that Park felt the units would only last for 2 years at which time they would have no remaining value in this transaction we're going to again ignore the two years no remaining value we'll come back to that in a later video we need to
record the transaction where we paid $120,000 cash to get metal detectors if we're paying cash cash is going down cash is an asset goes down with a credit so we credit cash for 120,000 what are we getting what's the debit well we're getting metal detectors metal detectors are an asset we make assets go up with a debit so we debit metal detectors for 120,000 wait why aren't the metal detectors considered inventory yes I thought any merchandise that a company purchases is called inventory we only use the inventory account for goods that we buy with the
intention selling as quickly as possible at a markup we don't call the metal detectors inventory because we intend to keep them for two years and use them over and over and over and over again to generate rental revenues so the metal detectors are more like a piece of equipment than what we would traditionally think of as inventory then we post this to te accounts we add another credit on the right hand side of cash good thing that we raised $250,000 because we're spending it pretty quickly and we create a t account for metal Det C
which now has a debit balance as an [Music] asset so we're about halfway done at this point so why don't we go ahead and stop this video and we'll pick up the case in the next video with the next transaction I'll see you then excuse me see you next video
