Hello, I'm professor Brian Bruchey, welcome back! In this video, we're going to pick up where we left off last time and continue to do the initial transactions for the Relic Spotter case. Got a lot to get to, so let's get started. Let's start back up with transaction number seven. On June 15th, Park ordered $2,000 to sundries inventory, for instance, water bottles, energy bars, etc., to be delivered on June 30th. Park was able to purchase the inventory on account, which meant she had up to 30 days after delivery to pay the supplier. [SOUND] So, I'd like to start with cash, but there's no cash in this transaction. We're receiving inventory. And we owe the supplier money for the inventory within 30 days. So let's start with inventory. Inventory is an asset, assets go up through debit, so we're going to debit inventory for 2,000. We owe money to our supplier, that's a liability. Liabilities have credit balances, so we increase them with a credit. So we're going to credit something called accounts payable for 2,000. Accounts payable is the term we always use when we owe money to a supplier. >> Hey, why is the date for the transaction June 30th and not June 15th? >> Good spotting. On June 15th we placed the order, but there is no transaction yet, because we haven't had an exchange of cash, goods or services. It's not until June 30th, when we take physical delivery of the inventory, that we have to record a transaction. We post this one to T accounts. There is no cash T account this time, instead we create an inventory T account with a debit balance and create an accounts payable T account with a credit balance. Transaction 8, on June 30th, Park paid $2,100 for a three-year site license to use geo-contour mapping software in the metal detectors. For the journal entry we're back to paying cash, so we'll start with cash. Cash is an asset, cash is going down, we make assets go down with credits, so we credit cash for $2100. Now, what are we getting? What's the debit? So the debit here is that we are getting software. Now, I never knew that metal detectors ran on geo contoring mapping software but you know, I guess, they apparently do. Anyway, software is going to be an asset because it's something that we can use to run the metal detectors over three years. Assets go up with debits, so we debit an asset called Software for 2,100. >> Excuse me. I hate to sound like a broken phonograph record, but why is this an asset, and not an expense? >> Don't feel bad for asking a question. One of the trickier things to pick up in accounting is, when you spend money, do you recognize an asset or do you recognize an expense? In this case, we did an asset, because we're going to get three years of future benefits from buying the software. And in future videos, we'll talk about what has to happen for this asset to then turn into an expense, as it will down the road. We post this journal entry to T accounts by putting another credit on the right hand side of the cash account and creating a new T account for the software asset. Transaction 9, on June 30th, Park signed a contract with a local advertising agency to provide various forms of advertising for a period of one year. She paid $8.000 upfront for advertising through June 30th, 2013. For this journal entry we are paying $8,000 of cash. Cash is an asset, we make an asset go down with a credit, so we credit cash for $8,000. And by this point you should be able to credit cash in your sleep because we've done it so often. Every time we pay cash, it's a credit to the cash account. Now we need a debit so what are getting for this cash? Well, we're getting a year's worth of advertising without having to pay any additional cash, that's an asset. So we're going to create an asset called prepaid advertising. And since it, at, it's an asset, we increase it with a debit, so we debit prepaid advertising, 8,000. >> Do we also get to record the value that this advertising will create as an asset? I mean, this advertising could bring an extra $100,000 to the bottom line. Sounds like an asset to me. >> It's important to note that the asset here, only represents the cost of the advertising that's been prepaid. It doesn't represent any of the potential value that the advertising could bring us in the future. We don't record that value as an asset because the benefits cannot be measured with a reasonable degree of certainty. It's just like the brand name example we looked at in a prior video. If there's too much uncertainty about the value of the brand or the value of the advertising, we err on the side of reliability and don't include it as an asset. We post this transaction to T account. So we've got another credit to cash on the right hand side and we create a T account for prepaid advertising with a debit of 8,000. Transaction ten. On June 30th, Park needed cash to make a payment on the Imperial Bank loan that funded her purchase of Relic Spotter stock. She borrowed $5,000 from Relic Spotter at 10% interest, with the principal and interest due in a lump sum on June 30th, 2013. This transaction looks complicated but let's just start with what we know. So, what we know is that Relic Spotter paid $5,000 cash to Rebecca Park. We're paying cash, cash is going down since cash is an asset, assets go down with credits. We credit cash for 5,000. So, what is Relic Spotter getting for this cash? What's the debit? Well, essentially they're making a loan. That loan is going to be an asset because they're entitled to receive 5,000 of cash back from Rebecca Park at some point in the future. Since it's an asset we want to debit the asset to increase it. We're going to call it notes receivable and debit notes receivable for 5,000. Note that we call it notes receivable. And not accounts receivable. Accounts receivable is only used for customers, when customers owe us money. If an employee owes us money for a loan, we're going to call it a notes receivable. >> Hey, wait a minute! The last time Park borrowed money for herself, we didn't record it in the company's books. >> Yeah, is this another trick question? >> You're correct that in both cases Rebecca Park was borrowing money on her own account. What's different was that in the first example we saw she was borrowing it from the Imperial Bank. In this transaction, she's borrowing it from Relic Spotter. That means that Relic Spotter is giving some of it's cash to Rebecca Park. And Relic Spotter has to record a transaction for that disbursement of cash to Rebecca. We post this to T accounts with another credit to cash and we create a T account for notes receivable. Transaction 11. On June 30th, Park also hired two employees, Linda Carlyle and Charlotte Cafferly to run the shop. They signed employment contracts promising each salaries of 32,000 per year. So, the journal entry here, well, let's stop and think for a minute. Is there actually a journal entry needed? Has there been a transaction? We, we haven't paid any cash yet to these two employees. They haven't done any work for us yet. All that's happened is they've signed a contract, but that's the kind of promise that we don't account for. So there's going to be no journal entry. There's no journal entry for this employment contract because they haven't worked for us yet, we haven't paid cash yet. And so we don't consider this a transaction, we don't account for this type of promise. >> So here is your trick question. Where I come from, when you promise something, it becomes an iron clad obligation. >> So, why isn't this a liability? >> I'm sorry to cause so much stress, but, but we did talk about this in the liability video. Remember. One of the criteria for recording a liability is the obligation that has to be based on some benefits received currently or in the past. We haven't received any benefits from these employees yet because they haven't worked for us. In fact, they could quit tomorrow and we wouldn't owe them anything. So it's not until they work for us without being paid, that we would record a liability. Since there is no journal entry there is nothing for us to post, so let's go on to transaction 12. On June 30th Girard called from St. Tropez to check in on the business. Upon hearing that Relic Spotter only had $47,000 of cash left in the bank, Girard became concerned about his investment. Now, there is more to this transaction, but I want to cut in here for a second to show you how we could figure out how much cash Relic Spotter has in the bank. If we bring up the cash T account, at this point we could draw a line, add up the debits, add up the credits, subtract the credits from the debits and we'd have a balance of 47,000. So, at any point you can draw a line and figure out a balance. And at this point we have 47,000 in the cash account. Okay, back to the rest of the transaction. Thinking fast, Park stated she was so confident of Relic Spotter's prospects that she was declaring a $0.10 per share dividend, to be paid on August 31. So that's $25,000. This dividend seemed to reassure Girard. So, for the journal entry, is there a journal entry here? because we, we haven't actually paid any cash yet, has there really been a transaction? Well, as we talked about in a prior video, the custom is that when a company declares a dividend, you make a journal entry at that point even though the cash will be paid later. So, on June 30th we need to reduce stockholder's equity, reduce retained earnings to recognize the dividend. We reduce stockholder's equity, a credit account, with a debit entry, so we're going to debit retained earnings for $2,500 to take out the dividend. The other side of this is that, as we talked about in another video, once you declare a dividend, essentially you're holding the cash that belongs to the owners, until you write the checks. So, you have this obligation to write those checks and deliver the cash, that obligation is a liability called dividends payable. You make liabilities go up with a credit so we're going to credit dividends payable for 2,500. >> Whoa! I thought you said liabilities were obligations to non-owners. But dividends are owed to the owners! How can you possibly justify having a dividends payable here? >> And how can you record dividends on the date they are declared? I thought you said that we don't account for promises. Wouldn't it make more sense to wait until they are paid? >> Whoa, let's, let's settle down. Someone need to take a chill pill or something. We did talk about this in a prior video. I agree it's not very intuitive and that's why I wanted to review the transaction again. By convention, when a company declares a dividend it takes it out of retained earnings at that point, even if the cash is going to be paid later. And at that point, the owners become creditors because the company is holding their cash until the dividend checks are sent. So, just memorize this one, because again, it's not very intuitive We post this to T accounts, so we create a T account for retained earnings, a stock holder's equity account. And we have a balance on the debit side and a T account for dividends payable liability where we put in the credit entry. >> What! How can retained earnings have a debit balance? According to my notes, it is a stockholders' equity account and should have a credit balance. >> Wow, you've been taking notes? That makes me feel good. You are correct that retained earnings is a stockholders' equity account and stockholders' equity accounts have credit balances. But to make sure that the balance sheet equation always stays in balance, we need at least one account that can be either a debit or credit balance. Imagine if we had more liabilities then assets. The only way we could get the balance sheet equation to balance would be with negative stockholders' equity. And so we make an exception for retained earnings and allow it to have either a debit or credit balance because it's the one account that makes sure that the balance sheet equation always stays in balance. If retained earnings does have a debit balance often times we change the name and call it something like accumulated deficit or accumulated losses. Transaction 13, Relic Spotter opened for business on July 1, 2012, just in time for the big Independence Day weekend. On July 31st, Park paid the supplier the $2,000 it was owed. For this journal entry we're paying $2,000 cash. Anytime we pay cash, we credit it, so we credit cash 2,000. The debit here is that we're paying what we owe the supplier. Well, we owe the supplier is an accounts payable which is a liability. So, if we're paying a supplier the liability's going to go down and we make liabilities go down through a debit. So we debit accounts payable for 2,000 which reduces the obligation by 2,000. >> I think we actually understand this one, go on. >> We post this to T accounts, there's another credit entry on the right hand side of the cash T account. And a debit to accounts payable and notice, at this point, the balance in accounts payable would be zero. Which makes sense because we don't owe our suppliers any money anymore, we fully paid off the liability. Transaction 14. On August 31st, Park paid the $2,500 dividend that had been declared in June. For the journal entry here, we're paying $2,500 cash, so that's a credit to cash for $2,500. The debit is going to be to dividends payable because we are paying off what we owe the shareholders for the dividend, thus we are reducing the dividend payable liability. We reduce liabilities with a debit, so we debit dividends payable for 2,500. >> Excuse me. So, it looks like every time you pay cash to settle an obligation, you debit some payable and credit cash. Is that correct? >> Yes, that's exactly correct. Every time you paid out a liability, you debit the liability and credit cash. Looks like it's starting to sink in. We post this one to T accounts with yet another credit to cash and a debit to the dividends payable liability account which, as you can see, zeros out this account which makes sense because don't owe our shareholders any more money for the dividend. And that's a wrap for the first part of the case. We'll pick up the case again after we learn about revenues and expenses which will allow us to start generating some profits for Relic Spotter. I'll see you next time. >> See you next video.