Lesson #10 - Jack And The Beanstalk - A Double Entry Story

Once upon a time, there was a young boy named Jack who lived with his mother in the countryside. They owned a cow which was their only source of income.

Mooooo!!!

1. Revenue from sale of goods
The cow's milk was sold in the market for cash. Jack sold $50 worth of milk a day.

Note: To record this transaction, just run through the 5 Questions introduced in the previous "Double Entry Accounting" post.

The 5 Questions:
1. What items are involved?
2. Which team are they on?
3. Are the teams Debit or Credit in nature?
4. Do the items increase or decrease?
5. Do we Debit or Credit the item?

2. Purchase of fixed asset

Timmmberrrrr!!!

With the money, Jack bought a new axe for chopping firewood. The axe is a Fixed Asset and it cost him $20. It was expected to last him for 4 years.

3. Depreciation of fixed asset
One year passed and as Jack used his axe, the axe had depreciated by 1/4th of it's value. So depreciation expense for the first year was $5.
 

4. Exchange of assets

Aren't they pretty? Please can I keep them?

One day, his cow stopped producing milk. Jack's mother told Jack to go to the market to sell his cow. Instead, Jack exchanged his cow for some "magic beans". His cow was worth $80 to him.

Note: No cash was involved as it was considered a "barter" trade or exchange of goods!

5. Write-off of assets
Jack's mother was furious as he had wasted the cow on some "useless" beans. She threw the beans out of the window. The beans were written-off or "expensed".

Overnight, a gigantic beanstalk grew. Jack climbed the beanstalk until he reached a castle in the sky.

The air up here is a bit thin, isn't it?

There, he meets a Giant.

Helloooo!!!

6. Borrowing money
He borrowed $200 from the Giant, which he needs to repay 3 months later

7. Purchase of stock

Quack!

Jack saw the Giant's golden goose (which laid golden eggs). Using the cash borrowed, he bought 10 golden eggs at $3 each to sell the market. The eggs were considered as Jack's stock or inventory.

8. Sale of stock

Oh, I can't decide! Sunny side up or scambled?

He sold 8 golden eggs in the market for cash. Each egg was sold for $5.

Note: There are 2 entries here! One affects REVENUE, the other one affects EXPENSES.

Entry 1 - REVENUE

 

Entry 2 - EXPENSES

The 8 eggs that Jack sold had a cost of $3 each. This was an Expense to Jack. His "Cost of goods sold" was $24.

You may notice that the total PROFIT made on the sale was $16. This is calculated as the difference between the REVENUE of $40 and EXPENSES of $24.

9. Paying worker's wages

So, we are selling flowers right?

As selling eggs was too much for Jack to handle alone, he employed a worker to assist him. He paid the worker $10.

 

10. Repayment of borrowings

He used the cash from the sale of the golden eggs to pay back a portion of the borrowings to the Giant. Jack generated $40 from the sale of the 8 eggs at $5 each.

 

One day whilst the Giant was asleep, Jack steals the golden goose and the Giant's harp.

While trying to make a quick getaway, Jack drops the harp and awakens the Giant. Jack runs and climbs down the beanstalk, golden goose in hand.

The Giant chases but before he reaches the ground, Jack uses his axe to cut down the beanstalk, causing the Giant to fall to his death.

Hmmm...Not a bad view from up here...

Jack and his mother became rich selling golden eggs in the market…

...and they lived Happily Ever After!

Summary:

Sooooo...what does it all mean? Is Jack better-off or worse-off?

Question: How much Cash does Jack have left in his pocket?

Answer: $190

Workings: 

Bear in mind that Cash is an ASSET. When ASSETS increase, we DEBIT, when ASSETS decrease we CREDIT.

Question: How much is Jack's axe worth after he's used it for one year?

Answer: $15

Workings:
Bear in mind that the axe is an ASSET. When ASSETS increase, we DEBIT, when ASSETS decrease we CREDIT.

Question: How much sales did Jack make?

Answer: $90 

Workings:

Bear in mind that Sales is REVENUE. When REVENUE increases, we CREDIT, when REVENUE decreases we DEBIT.

Question: How much stock did Jack still have left?
Answer: $26

Workings:

Bear in mind that Stock is an ASSET. When ASSETS increase, we DEBIT, when ASSETS decrease we CREDIT.

Question: How much did Jack still owe the Giant?

Answer: $160

Workings:

Bear in mind that Borrowings is a LIABILITY. When LIABILITIES increase, we CREDIT, when LIABILITIES decrease we DEBIT.

Did that make sense? Yes?

Good!

Are you starting to see how Accounting helps Jack keep track of the value of his Accounting "Elements" i.e. ASSETS, LIABILITIES, REVENUES?

DOUBLE GOOD!!!

Here's Better Than Ezra with "Good"...

Enjoy!!!

Lesson #9 - Double Entry Accounting

We live in a world of duality - There's up and down, left and right, black and white, Yin and Yang and the list goes on...

You spin my head right round, right round...

The same rule applies to Accounting in the form of DEBITS and CREDITS!

The Accounting Equation states that the Debit (Left) side must balance with the Credit (Right) side, such that the difference always equals to NIL.

As such, every Accounting Transaction or Accounting Entry has 2 equal and opposite effects, hence the term "Double Entry".

Not to be confused with this classic arcade game...

The 5 Questions:
In mastering Double Entry, you have to ask yourself 5 simple questions.

1. What items are involved?
2. Which team are they on?
3. Are the teams Debit or Credit in nature?
4. Do the items increase or decrease?
5. Do we Debit or Credit the item?

Here's an example.

I purchased some stock (or inventory) with cash for $1,000.

Question 1 - What items are involved?

- Cash
- Stock

Question 2 - Which team are they on?

- Cash = ASSET
- Stock = ASSET

Question 3 - Are the teams Debit or Credit in nature?

- Cash = ASSET = DEBIT in nature
- Stock = ASSET = DEBIT in nature

Question 4 - Do the items increase or decrease?

- Cash = ASSET = DEBIT in nature = Decrease as I used it to pay for my stock i.e. less cash in my bank account!

- Stock = ASSET = DEBIT in nature = Increase as I converted my cash into stock which I can sell to future customers!

Question 5 - Do we Debit or Credit the item?

- Cash = ASSET = DEBIT in nature = Decrease = Goes against it's nature = CREDIT!

- Stock = ASSET = DEBIT in nature = Increase = Goes with the flow of it's nature = DEBIT!

Double Entries:
DR             Stock                     $1,000
CR                         Cash                          $1,000

Note:
1. When we write or record a Double Entry, we usually put the DEBIT entry on top first, followed by the CREDIT entry at the bottom.

2. When there is a DEBIT there must always be a corresponding CREDIT to even it out, such that the balances cancel out to NIL. Remember the "Accounting Equation"!

3. Usually, we write DEBIT as "DR" and CREDIT as "CR".


SIMPLE RIGHT?

Try it out for yourself and see if you can master it!

To round it all up, here's a song on duality - "Hello, Goodbye" by The Beatles.

Enjoy!!!

Lesson #8 - The 5 Accounting Elements That You MUST Know - A Summary

Now that you've been introduced to the 5 Accounting Elements, let's do a quick summary: -

We can see above that ASSETS and EXPENSES behave in the same manner as they are both DEBIT in "nature".

On the other hand, LIABILITIES, REVENUE and EQUITY behave in the same manner as they are all CREDIT in "nature".

Imagine a tree. If it grows, it increases in size. If it increases in size, it's following the flow of nature. If the tree shrinks, it decreases in size. If it decreases in size, it's going against the flow of nature.

It's soooooo preeeeetttttyyyy...

If we use Green to mean Increase and Red to mean Decrease, the DEBITS and CREDITS will be determined by whether they follow the "nature" of the Element, or they go against the "nature" of the Element.

For example, we know that ASSETS are DEBIT in nature. So, if an ASSET Increases, then it follows it's nature, so it gets DEBITED. On the other hand, if an ASSET Decreases, then it goes against it's nature, so it gets CREDITED.

Try running through this same logic for all 5 Elements and see if you can get the concept drilled into your brain.

Is your mind blown yet?

Good!!!

You are now ready to move on to the next section...

But before that, here's another cheesy song!

"Didn't I (Blow Your Mind This Time)" by New Kids On The Block.

Enjoy!!!

Lesson #7 - The Fifth Element – EXPENSES

Definition:

EXPENSES (also known as Costs) are outflows of economic benefits or cash.

Imagine EXPENSES as your “river” or “stream” of cash flowing outwards, and ASSETS as your “lake” or “reservoir” of cash. The larger the cash outflows i.e. EXPENSES that occur, the smaller the corresponding ASSET that will be left as its value diminishes or disappears.

Rising costs seemed to have another effect on Mr Smith...

EXPENSES are measured over a period or duration of time (for example over a year, a quarter or a month) whereas ASSETS are measured at a certain date or point in time (yesterday, today or tomorrow).

Examples:

1. Cost of Goods Sold

If you are in the business of buying and selling goods at a profit, you need to firstly purchase the product from your supplier.

You usually pay for the product at a lower cost then the price you will sell it, right? So that you can make a profit, otherwise, you will make a loss!

You generate REVENUE the moment the product is sold (as you receive cash) but at the same time, you will incur an EXPENSE. The EXPENSE is the ‘original cost’ that you purchased that product for. That ‘original cost’ is called Cost of Goods Sold.

2. Staff wages and salaries
When you pay wages and salaries to your staff, employees or workers, there will be an outflow of cash, which is an EXPENSE.

3. Bills! Bills! Bills!
When you pay bills, there will be an outflow of cash, which is an EXPENSE.

There are tons of examples of bills, a few of which are listed below: -

• Utilities – Electricity, Water, Heating, Internet, Phones

• Administration expenses – Postage, Cleaning, Stationery

• Rental of office premises

4. Depreciation

A fixed asset that you purchase and use will over time, reduces in value. Why? This is because there will be ‘wear and tear’ on it. This reduction in the value of your fixed asset is called “Depreciation” and is an EXPENSE.

For example, if you purchase a car, and that car lasts you for
10 years, the value of the car will 'drop' by 1/10^th of its value
every year. That ‘drop’ in value is Depreciation. By the 5^th year, it would have halved its value and by the 10^th year, its value would be zero as it is fully depreciated.

Maybe I shouldn't have chosen red as my car colour?

The Nature of Expenses:

EXPENSES are DEBIT in nature.

When EXPENSES get BIGGER or INCREASE, they will head in a DEBIT direction, which is its nature. Conversely, when EXPENSES get SMALLER or DECREASE, they will head in a CREDIT direction.

In Conclusion:

As EXPENSES are outflows of economic benefits, and a lot of EXPENSES relate to Bills, let’s listen to a song called “Bills, Bills, Bills” by Destiny’s Child.

Enjoy!!!