Welcome. In this video we're going to discuss journal entries. There are nice concise way to record the impact of an individual transaction on the company. Journal entries are part of bookkeeping. Bookkeeping is the process of recording the transactions in the company's books. This is an important part of accounting. It's the part where we keep track of things and keep them organized so that over time we can go back and understand what's happened. But a lot of people think that bookkeeping and accounting are exactly the same thing. Bookkeeping is just one subset of accounting. The more important part of accounting is the analyzing portion. That's where we're going to focus most of this course. That said, without bookkeeping we won't be able to record that analysis and pull together a set of financial statements. Remember, our end goal is to put together financial information that can be used by decision makers to make their job easier and more effective. Now, bookkeeping is based on the debit credit system. It's often called the double entry system of accounting. This double entry system draws on the balance sheet equation which you have seen earlier to create its structure. Basically, what the double entry system recognized is, if something happens in a firm there's at least one other impact. For example, if I increase an asset it means I either have to decrease another asset or I have to have borrowed it from somebody which means the liability goes up or my shareholders have to have contributed which means shareholders equity goes up. This fundamental idea that when something happens in a firm it impacts multiple components of the firm, is what makes double entry bookkeeping so powerful in capturing the economics of what's going on in the firm. Now, let's get back to those journal entries. To really be an effective tool, we need them to help structure so that we can capture a transaction and record its impact on the firm. To do this we want to be able to say, "Did this transaction impact assets?" If it did, did they go up or down? So you would think when we show a journal entry I would talk about up and down but this is another place where accounts have come up with their own words. Instead of saying up or down, they've decided to say debit or credit. In the case of assets, they've decided to say that debits increase in asset and credits decrease in asset. You're probably asking yourself, "OK, why did they decide debits are an increase and credits are a decrease?" I honestly don't know the answer to that question. Several people have given me different stories. Every one of those stories sounds plausible. I'm not sure which one is true. It's going to be pretty rare for me to tell you, "Just don't worry about it, memorize it" but in this case I'm going to say, "Don't worry about it, memorize it." Just remember that when an asset increases we say we debit it and when an asset decreases we say we credit it. Now of course we want to be able to do this with the rest of the balance sheet as well and we've got to remember that the balance sheet has to stay equal. So even though we're going to use the word debit and credit, if we use the word debit to mean increase for liabilities as well we'd have a problem because we would say we're debiting assets and debiting liabilities and we wouldn't get that double entry part of it. Think of this like when you learned about negative numbers or when you first started with algebra and learned that when you take something from one side of an equal sign and move it over to the other side of the equal sign, you need to change its sign. That is, a positive number on the left hand side becomes a negative number on the right hand side. Have I confused you enough yet? Maybe we should go back to the memorizing. If you memorize that debits decrease liabilities and credits increase liabilities, you'll be in good shape. If it's easier for you to think about though why this happens, just take a look at this right now. You'll see that when it's on the left hand side of the equal sign, the debit increases things like assets and since liabilities are on the right hand side of the equal sign, we're just going to flip what the debit does. Now, shareholders' equity seems a lot easier after that. It's on the same side as liabilities. So the debits and credits go the same way. That is, a debit decreases shareholder's equity and a credit increases shareholder's equity. Take a minute, look at this, memorize it. Now if you are also thinking when you're memorizing it you're probably saying, "Hey, wait a minute. I always thought a credit was a good thing but here you're telling me credits decrease assets and I'd like to have more assets." Well, I've heard this a lot and there's usually two reasons. The first is just kind of definitional, the way the word credit sounds. People think if I get credit for something that's good. You know, he's giving me credit for having made a really good video means I've done something well. Well, forget all about that. This is accounting and that's English. We're going to use the accounting jargon instead. Now here's the other reason that you think of credits as being a good thing. When you go into the bank and you put money into the bank, the teller will thank you and tell you that he'll credit your account. What he's doing when he's telling you that he's going to credit your account is saying, "Now that you gave us money, your asset, that's become a liability that we have to you thus we credit it." Now, imagine a similar situation. You call your public utilities company and you say, "You charged me for something that I didn't actually use." After doing all the analysis the customer representative tells you, "You're right, you didn't use it and I'll credit your account." What she's telling you in that situation is, "We now have a liability to you that we owe you something and so I'm going to put that down as a credit." In both of those cases the companies are talking from their own aspect and so for them every time you're getting something it's a credit to them, meaning they either owe you something, a liability or they're going to immediately give you one of their assets. So they have to credit that asset so that it goes down. OK, let's get back to using our journalising to help record what's going on in our company. Let me do that by giving you an example. We'll start with something really simple. You borrow $500 from a bank. So, how does this change your company? Well, let's start with the cash part of it. You now have cash. So we're going to record that we have cash of $500. I put a little Dr there in a lighter color as well as the brackets saying it's an asset. You don't always have to do that in a journal entry. I just wanted to make it clear for you here that because that we've increased an asset or debiting it and I do want to point out to you that it is in fact an asset. What's the other side of this transaction? We got $500 but that didn't come for free. We owe somebody in the future. That's a liability. That liability is increased. So we credit that liability for $500. Notice again I put the Cr in the bracket there for you. Think of those as training wheels as we learn this technique. Now, I want to point out a couple of things about this journal entry. It's going to turn out it's true in all journal entries. Notice that the debits are on the top and as you're looking at your screen they are to the left. All debits are always going to be put on the top of a journal entry and they're always going to be put to the left. The credits are always going to go on the bottom of the journal entry and they are always going to be indented to the right. Because everybody uses this format, you'll be able to look at journal entries across lots of different organizations and very quickly understand what they're getting at. Again, I'm not sure exactly why we decided debits go on the top and to the left and credits go on the bottom and to the right, but for whatever reason we did, think of this like all of us driving on the same side of the road. If you decide that you're going to change the way you drive and just do it your own way, it just imposes costs on everybody else and maybe even will cause an accident. So, as you look at journal entries just always remember, debits on the top and to the left, credits on the bottom and to the right. In fact, let's look at a couple of more journal entries so that you can practice this a little more. Let's think of another simple transaction. In this case we pay a $100 cash to the supplier. I'm going to start with the cash impact again. I in fact, I'm always going to start with the cash impact. I found that cash is one of the easiest things for us to understand. So if we start a journal entry with the easiest part to understand, it just makes the rest of it go much better. So we know that our cash has gone down. It's an asset. When an asset goes down we call that a credit. That means it goes at the bottom and to the right and we reflect the fact that it's gone down by $100. Now, the company didn't just lose a $100 in cash, something else happened to the company. What happened here? I no longer owe the supplier for that $100, so I'll reduce my accounts payable. That's a liability and since it's gone down, I debit that liability. Notice the same basic format here. We've got the debits on the top and to the left and the credits on the bottom and to the right but it's flipped in the sense that we now have a liability that's being debited and an asset that's being credited. That's because both of these items have actually gone down in what the company has. Let's do one more just to make sure we've got this down. We pay $200 in cash to purchase inventory. Now, once again we'll start with the cash part of the transaction. Just like before cash has gone down. Since it's an asset we credit it. It goes down at the bottom and gets indented to the right. Our cash has gone down by 200 but how else has the company changed? We no longer have cash but we now have inventory. That's another asset. That asset has gone up, so we debit it. That means it goes up on top and to the left. If you look at this journal entry, you'll notice one big difference between this and the other ones we've done. In this case they're both assets and the other ones we had an asset and a liability. What this journal entry is telling you is, I took one asset, cash and I turned it into another asset, inventory. Notice how concisely this journal entry is able to communicate that to us. I hope that this video has helped you to understand how we do journal entries and also showed you what a useful tool they are for putting structure around individual transactions.
