I teach my 10 year son Accounting Principles

In today's video, I'm going to explain to a 10-year-old what accounting is. So I have my children here, three of them. The youngest of which is almost 10 years old. David, raise your hand. Thank you. So I'm going to simplify the concept as much that a 10-year-old can understand it. I've been working as a controller in New York City for the last 17 or 18 years. My wife here is also an accountant, so she can keep me honest on some of these concepts. All right. So guys, Dad as an accountant has to deliver at the end of each month 2 financial reports, the balance sheet and the income statement. I'm going to explain in a minute what that all means. So to understand what's going on with accounting today, I'm going to go back in time to when I was a kid and my dad used to have a store, kind of like a deli or a bodega. So my dad had this store that sells, you know, different things, candy, soda, milk, all kind of cold cuts, stuff like that. And he used to have a cash drawer. So he had one drawer that has cash. And the way that he used to know how the business is doing is money coming in, right? And money going out, right? So he would have $100, but maybe this— the currency was different. This was Egypt in the 1980s. So we're talking Egyptian pounds. And he had in that drawer 100 pounds in the morning. at the end of the week or whatever, or the day, he would look and he would see he has £500. So he knows that he made £400 that week, right? So he only looked at the cash, cash coming in and cash going out, to know how the business is doing, which makes sense, right? You just— cash is enough to know what's happening. If your cash is going up, that's a good sign, right? Okay, so that was with a simple business back in time. Now with modern, uh, business and the complexities of business, To start a business, sometimes you need capital. Does anybody know what capital means?

Capital is like startup money.

Startup money. Benji got it. Startup money. So capital just means money. So to get money to start a business, where do you go? You can go to a bank and you say to the bank, I want to borrow some money, right, to start a business. Or you can go to a family or a friend or an investor, somebody else, and you say, Give me some money to start a business, right? So the money that's coming in from these kind of things are different than the money that you sell stuff, right? So when you sell, you make money from selling stuff, but when you get money from a bank or from an investor, that is a different kind of money, right? So that's why we need to look at it differently. That's why we have these 2 different reports that shows the sources of these monies, right? There's money coming from customers, but there's also money coming from a bank maybe, or from an investor. That's different, right? So to know the kind of different sources of money that we're doing, we have to use these financial statements, and we have to use something called the accounting equation. The accounting equation is going to help us understand the sources of our money coming in and the way that we spend our money. So when you spend your money, what are different ways that a business can spend money? Okay, Benji has an answer.

Um, like, let's say like a place selling ice cream, they need to like buy the ice cream or like the materials to make the ice cream.

Yep, that's— so that's called inventory. That's actually a perfect answer, right? So if you're selling ice cream, you need to buy some ice cream so that you're able to sell it. We call that inventory, right? But the other ways is to spend your money as a business, maybe to advertise, or maybe to hire a lawyer that can help you set up the business, or maybe to hire an accountant. There's different ways to spend the money in the business, right? So to know how the money is coming in, the sources, and how the money's going out, we have to use these statements here to help us understand. All right, so to understand how this all ties together, we'll use an example of a seesaw. When you guys were younger, you used to go on a seesaw. Remember that, right? So with the seesaw, let's say you spent cash, right? You spent $10,000 in cash.

$10,000.

on advertising, right? So you go and advertise for your business for $10,000, right? So your cash is going down by $10,000 and your ad spending goes up by $10,000, right? Another example, seesaw. Again, with a seesaw, right, use your cash, right? Let's say $5,000 to buy ice cream in that example to sell it, right? So your cash will go down by $5,000. but your ice cream, which we call inventory in this case, right, will go up by $5,000, right? So you see that relationship— one thing changes, the other thing also changes in an opposite direction, right? So we simplify all of these relationships by saying that assets equals liability plus owner's equity, and I'm going to prove to you that it makes sense here in a second. So assets equals liabilities plus owner's equity. What does that mean? Assets, what are assets, right? Assets are things that you have in the business that has a future value, right? So does inventory has a future value?

Yes.

It can provide you a benefit in the future, right? If you have a computer in the business, does that provide you with future value?

Yes.

Right? So the things that you own in the business that has a future value, we call that assets, right? Liabilities are things that you owe, right? So you can owe it to a bank, you can owe it to somebody that you buy inventory from, and whatever is left over, we call that owner's equity, right? So in that sense, assets is own, stuff that you own in the business. Liabilities is stuff that you owe Right? And owner's equity is what's yours. So this stuff is yours, right? And that makes sense. If you subtract from liabilities, you subtract the stuff that you owe to somebody else, what is left over is the stuff that is yours, right? And in this equation here, when I say I want to borrow $100,000 from a bank, so I get $100,000, that's going to increase my assets because cash is an asset. Right, so that increases my assets by $100K, and it's going to increase my liabilities by $100K, right? So now we're balancing, right? Because you see it's an equal sign here, we're balancing. And guess what is the owner's equity in this case, right?

The final profit?

Uh, well, it includes the profit, you're right. But in this case, when a business has $100,000 in cash and it owes $100,000 to the bank, The equity is zero.

Yeah.

Right? That's what you were guessing. You were thinking that, right? Okay.

I didn't know you're looking for a number. That's what I was thinking.

That's what you were thinking?

I was doing $100,000 minus $100,000.

Exactly. That's exactly the answer, right? All right. So keeping all that in mind, now we're going to use the information that we learned here to create the 2 reports that I give my boss at the end of each month, right? So let's just use numbers here. If I'm going to take $100,000 as a loan from the bank, where do you think it goes in the balance sheet? This balance sheet, we call it balance, by the way, because you see this relationship here is called balanced assets, liabilities, and owner's equity. Assets, liabilities, owner's equity. There is a balance here because this side is going to always equal this side, right? So when you take $100,000 from the bank, that's going to go in your cash. So I'm going to write here $100K, right? But for this to balance, remember, these 2 has to balance. So $100K will have to go here in liabilities. I owe this $100K to the bank. Makes sense so far? Okay. Now let's say I got the money, I started the business, I want to start making some money. So what do I do? I go and I get some inventory for $10,000, right? So if I decide to use my cash To get some inventory, right? I'm going to put $10,000 in inventory. But guess what? I have to reduce my cash by $10,000, right? So what is left of my cash instead of $100K?

$90K.

$90K, right? So let me erase that. I have $90K, right? So I just— all I did so far is that I bought some inventory and I used the cash to do it. Now I have $10,000 worth of inventory. I can begin to sell it. Right. Let's say I'm going to sell some of that inventory, right? I'm going to sell $5,000 of it, right? So if I sell $5,000 worth of inventory, how much inventory will be left?

$5,000.

$5,000. Right. So the $5,000 that I, that I'm selling in inventory, I'm going to account here. I'm going to say, okay, I'm going to sell $5,000, but would I sell it for $5,000 or would I sell it for more?

More.

More than that, right? Let's say $8,000, right? So I'm going to sell it for $8,000. So that means my revenue is $8,000. Revenue just means the money that's coming in from selling to customers, right? So I'm going to sell it for $8,000. Do I have any expenses to put in here?

No.

Yes.

Yeah. Yes.

You know what are my expenses?

The $5,000.

The $5,000, exactly. The $5,000 of the inventory that I'm selling, I have to say that's my expenses here.

Then your profit will be $3,000?

$3,000, that's right. My profit is $3,000. All right, so let's go back to here because remember, the profit is $3,000. My boss is going to look at this and say, great, our profit is $3,000. So this here is complete. My income statement is complete. He's going to look at this and be happy that we made $3,000. This is not complete. I have to complete it. I haven't finished it yet. Because it has to balance. You see right now it doesn't balance. Assets, $90,000 plus $5,000, that's $95,000. I have $100,000 here, but I got to make it balance, right? So remember when we sold revenue, we sold revenue $8,000, right? That's cash coming in, right? So we have to add it to our cash. So instead of $90,000, we're going to have what?

$93,000.

No, $90,000 plus the $8,000.

Oh, $90,000 plus $8,000.

The entire $8,000 is going to come in as cash, right? Because I'm selling to customers $8,000. I'm not getting just only three from customers. I'm getting the entire eight from customers, right? So that's going to be ninety-eight. That's okay. Yeah. Yeah. So ninety-eight, ninety-eight thousand in cash, right? My inventory is five thousand. Owner's equity is going to change. Equity. Remember equity? We said what's yours? Equity is what's yours. We are going to add something here. There is something that happened here that's going to cause something to— a number to go in here. The profit. The profit that is ours. That belongs to the owner's equity. So the profit goes here. The profit that we made here will go in here, and that is the owner's equity. Now let's see if the balance sheet balances. Assets, $98,000 plus $5,000.

$103,000.

$103,000. Liabilities and equity combined is $100,000 plus $3,000. is $103,000. So this report is correct. Now when I have these 2 reports and I give it to the business owner, he's going to get a complete picture of what's happening in the business. He's going to see what we sold. He's going to see what we spent. He's going to see the profit. He's going to see how much cash we have, how much inventory we have, how much liabilities we have. This is much better than my dad's cash drawer. Remember my cash— my dad's cash drawer? He only has cash coming in and cash going out. He doesn't have this full picture of what's happening in the business. So this is the modern-day accounting.

Cool? Yeah. All right.

Thank you guys for watching. If you enjoyed the video, give it a big thumbs up and share it with someone else who can benefit from it. And I'll see you in the next video. When we say I want to borrow 100—