now would start with transactions and we will learn if we can prepare balance sheet using them so the typical process through which
accounting is done first step in the cycle is you start with transactions then those transactions we have seen recorded into which book
transactions are recorded into journal book after being recorded in the
journal book we would put them in ledger books after ledger books by the end of the year
to be prepared trial balance and after having prepared trial balance then in the last step we will prepare financial statements primarily three of them income statement balance sheet and cash flow statement
now we do not want to becomes accountants with this
program what we want to learn is to read balance sheets and try to make analytical sense of them so the process we will be using today we
will start with transactions we will skip Journal will skip ledger will skip trial balance we will see that
what effect every transaction will have on the income statement and balance
sheet and cash flow statement of the organization’s so the process that we would be
following is we will first have a small setup or small setup transactions I will prepare financial statements then I will give you one to prepare and in this fashion we will keep on moving further so let’s start with first example ok I will keep it relatively simple transaction number one lets a new businesses started and we have invested capital of 1000 in our business now your first balance sheet which is going to look like a simple box the box is made of two parts: the left in side of the box we’re going to
call this as liabilities and right hand side of the box
we’re going to call as assets now there is no rule for this it is just a convention in lot of countries assets are return on
left liabilities are written on right so it does not matter you can write
anything any where now capital one thousand what have we
learned capital is what capitalism liability so I am writing capital here you observe carefully I’ll give you time to write capital one thousand and this is where we would be learning a system of accounting called Double entry system and what double entry tell us that every transaction is going to have
two parellel effects so think from a business perspective a
capital of 1000 that means a incur liability but this
businesses receive anything business receive cash and cash is what cash is an asset so we will write down cash here which would be one thousand make sense then second transaction a let’s say there’s a bank loan that
we have taken of 10,000 bank loan should be what liability so will write bank loan here 10,000 but when you take a bank loan what should be the second effect cash
should increase so now you cash will become how much
11,000 so I’m just going to make that adjustment here itself ok two transactions we have done so far
first was capital which was liability cash second was bank loan which was again laibility and cash 3rd transaction let us say out of that cash
you decided to purchase a building worth five thousand now tell me buidling is what asset so I am writing building here to asset side 5,000 but when you purchase an asset to what goes out from you cash will go out
so your cash which was originally 11,000 now it will be how much 6,000 now if you observe carefully you realize it after every transaction
your balance sheet is tallying and balance sheet tallying means total of
liability and total assets are same and why are
the same because you’re making it this way now in the first case we said
thousand-year we added 1000 here on the liability side
we added 10,000 here we added 10,000 here now we added 5,000 here we remove 5,000
here we are making balance sheet in such a way
that to your balance sheet total is going to tally four trasactions you purchased furniture let us say of1000 furniture should be where assets so furniture 1000 what should be second effect cash will reduce so now cash would
become how much 5,000 is your balance sheet still tallying now the total is 11,000 on both the
sides all these entries are of capital nature meaning of which is we’ve not done any business activity so far now let us do the first business
activity let us say we made some amount of sales so it must concerning business
because we don’t have any goods so far so we made some consulting sales
let us say of 5,000 now the moment you do activity of
review nature what you will also have to prepare
is income statement which is again made of two simple boxes the box on the left we
are going to call this as expense and box on the right we are
going to call this as income now be made of we’ve made sales of five thousand is
that expense or income are you sure sales income how many if will income so sales is an income of five thousand but when you make sales you cash was out
right comes in so cash will increase so now with this transaction you’re
having one effect on the income statement and second effect on the balance sheet your cash which was originally 5,000 now
it will become how much 10000 now let’s see if your balance
sheet is tallies how much is a total of left hand side 11,000 right hand side is it tallying no now it will not tally because there is some unfinished
business in your income statement I are you together on this so the moment income statement comes into picture your balance sheet will not tally after every trasaction your balance sheet will tally at the end of the financial year or accounting year we will see that how that happens let’s say transaction no. 6 you made some salary expenses of 3000
why should I write this so here would write salary 3000 what should be second effect cash
will reduce or go out so cach is now how much 7000 so let’s stop the business here is your balance sheet tallying now no it
is not tallying but for step is now this is called finalization
process so the first thing that we will do now is we will see that my total income is five thousand my total expenses are 3000 difference
between your total income and expenses should be how much 2000 and will call that as profit so you have made a profit and you’d be surprised to know that profit we write on expense side
the reason we write that on the expense side because it is a clock figure or it is a balancing
figured we written in such way that the total of the both the sizes is same and profit for a business is what profit
for a business is liability so we will take this profit we will transfer this balancing sheet side when profit is transferred on the
balance sheet that number is called as Reserved Ideally it should be written below capital but I’m writing it here and reserves here would be 2000 and
now you take a total on the both the sides so here total is 13,000 here total is 6 and 7 13 thousand and then your balance sheet will tally all are OK here now just wait for a minute these
liabilities at times are called sources of funds and assets are called application of fund now forget the needy crities and think of it from a broader perspective that to do a business you need to have assets you need to put money into your manufacturing process so you needs funds this business has got
those funds from which places owner invested one thousand of their own bank invested how much 10,000 and the profit that they had made they reinvested that profit in the business which is called Reserves 2000 so your total sources work 13,000
and what did you do with those sources out-of-date 13,000 5000 you invested
into building 1000 you invested into furniture and remaining 7,000 you
kept in the cash and if next time someone says that why balance sheet tallies it has to tally because your sources and application of
funds is always going to match all are fine here so know you can write down quickly so I am writing trasactions and then you try to prepared balance sheet and income statement here should I increase level one can it be slightly more difficult for first trasaction Capital 100 bank loan 500 let’s purchase a building of 200 lets purchased furniture of 100 let us make sales of 1000 the only small trick here is that eighty percent of the sales is on cash if if eighty percent is on cash then remaining
twenty percent is on credit so eighty percent of the cash you received twenty is yet be received that’s the only small difference and then let us have electricity
expenses of 200 prepare a balance and income statement so this is your balance sheet this your income statement in case if you’ve not been able to tally please observer carefully so that you will
understand where it went wrong capital one hundred
where should it go liability second effect should be in cash bank loan 500 where should be put
this liability second effect again is cash which will make our cash is 600 now when you make financial statements you don’t make the adjustment directly here the way I am doing is but it easier to
understand that way that’s how I am doing it building 200
where should be write this assets side second effect cash will reduce so now cash is how much 400 furniture 100 same effect so furniture 100 second effect cash will become 300 so far all of these work capital nature transaction we did not touch
income statement is a balance sheet tallying right now yes the total is 600 now the next item would be revinue nature sales should I write 800 or 1000 should we write 1000 or 800 how many if you feel thousand 800 okay so because we are following accrual system of accounting accrual means it does not matter how much cash we have
received what matters is how much income we have earn we will see entire one thousand is
going to be your Income but have we received cash of 1000
now we received cash of only 800 so to the cash we will add only 800
here and we are not going to add 1000 because we haven’t received that so your cash will become how much 1100 so here I am writing 1100 but then how about that remaining 200 that 200 yet to be received
what do we call them Daters or account receivable and is that an assets yes so will say account receivable two hundred now try to see big picture here had this sales been on cash entire 1000 in cash we would have added
one thousand here correct but now what we did is we added 800 to cash and we added 200 to account receivable the effect is still
the same on the asset side we’re still adding one
thousand we are dividing that in two parts are we okay with this and then the next
entry electricity expense 200 second effect cash and cash now should
be how much 900 now we will calculate profit 800 where it should be transferred reserves so let me write bank loan here and reserves would be how much 800 and then the balance sheet total which is 1400 and 1400 and this step we repeat again clear so what are my sources of funds owner invested 100 then owner reinvested profits of 800 bank loan 500 and what is the
application of these funds 200 into building 100 into furniture 200 in account receivable and 900 with you an cash are you fine now there is a short cut way to tally your balance sheet I generally disclosed the shortcut towards the end of the session otherwise everyone uses shortcuts now
observe the assets side carefully what assets do you have here building furniture account receivable and cash the problem is with cash because cash is
changing after every trasaction so if you want to find out how much is
a cash we will have to solve for the entire set of trasaction but look at the left hand side we have capital we have bank loan capital can we find out easily bank loan easily and what do we have here reserves could we have find out reserves directly by saying 1000 -200 would be the reserves which is eight hundred as your profit which means on the left hand side total
should be how much 1400 so your liability side total 1400 on the right hand side we know we have
biulding we know we have furniture we know there’s going to account receivable so balancing in Figure cash would be 900 and this is the accountants way of forcing the balance sheet to tally once you build perspective like this then
within fraction of second you can tally your balance sheet because you just have to imagine what are my sources Capital, Bank loan reserves these are the most
popular sources on any balance sheets should be increase one level above or two level above capital 1000 bank loan 1000 interest on bank loan so I’m trying to make it
more realistic now bank loan would not come for free will
have to pay interest let us say 10 percent let us purchase a building of 400 let us charge depreciation on building 25 percent of the
value of assets let us makes sales of 4000 50 percent in cash let us pay salary expenses of 2000 50 percent outstanding outstanding means yet to be paid now prepare income statement and balance sheet how many of you got forty eight
hundred this your balance sheet this is income statement in case if you could not tally yet please observe carefully so that you will be able to identify the mistake capital one thousand I’m taking on the
liability side second effect cash 1000 bank loan 1000
2nd effect cash would be 2000 interest on bank loan 10% so which means we’ll have to pay interest of 100 is that
liability or expense it is an expense we are making an
assumption that interest is paid so on the expense side interest 100 what should be the second effect yes
whenever you will have an expense your it’s a cash expenses reduce cash so
now you cash will become how much 1900 how many of you got this transaction
right ok fine building 400 why should I write this assets side so building 400 what should be 2nd effect second effect would be cash so cash will
all become how much 1500 deprciation on building 25 percent 400* 25% is 100 can I say depreciation is an income depreciation is an expense its an reduction value of assets so depreciation 100 here and then cash will reduce by 100 no cash will not reduce cash reduce and we have pay depreciation
to the Income Tax Department no sales tax department so non cash expense so one sentence you want to remember is we never write checks for depreciation that means depreciation is a non-cash expense write that four
hundred for building you paid sometime in the past now you just
reducing the value that building which means for some other expenditure you would have reduced cash of hundred
but for depreciation we will reduce value of building 100 and we will make that building equal to
300 are you fine on this how many of you got this okay next step sales four thousand but only 50 percent
in cash how much should write on sales 4,000 but cash will increase how much only two
thousand so 1500 will become how much 3500 but how about remaining two thousand we will show that as account receivable 2000 how many of you got this one right great salary expense 2000 how much should I write on expense side entire two thousand so salary 2000 what
should be 2nd effect cash we should reduce by how much only one thousand because we paid only
1,000 cash so cash would become how much but then
how about that remaining 1000 it is still to be paid and therefore it would be a liability so
will say outstanding salary 1000 and then we will go into the finalization process so how many of you got the last entry right should I repeat that again we said that salary expense entire thousands is an
expense but cash we reduce only by 1000 remaining 1000 we created a
liability of outstanding salary then the finalization process where you find out profit how much should be the profit 1800 and this profit we will transferred to
reserves but I’m writing that here reserves 1800
and then the balance sheet total 4800 this is also 4800 and then we will say that balance sheet has tallied