[MUSIC] In fiscal year X1, the campus bookstore has opened the doors to the public and has started selling, has started it's operations. In this video clip, we are going to learn how to account for the sales of books and the cost of the goods sold. The campus bookstore has two kinds of customers. On the one hand, individual customers that go to the store and they purchase books and pay in cash. On the other hand, the school itself. The school purchased textbooks directly from the bookstore and this purchases are on credit. And normally the payments are done 60 days later. Let's account first for the cash sales to individual customers. The total amount of cash sales during year X1 has been 120,000 euros. Christina keeps track of the cost of the books she has sold with the barcode system and the software she purchased in the last period. She estimates or the system calculates that the total amount of cost of these books that she has sold is 80,000 euros. We will account for this transaction in two steps. First we're going to recognize the cash increase, because of the payment of customers that purchase this books in cash. Do we need to return this cash? No this cash belong to us, this cash belong to the shareholders. So now we are richer. So we need to recognize at the same time that the net worth of the shareholders has increased. Owner's equity has increased. And we do it through the profit and loss account. Are we more liquid? Yes, because cash has increased. So we are more liquid and we are richer. So in this case cash and profits go hand in hand. In the profit and loss account we're going to recognize the increase and decrease in the net worth of the shareholders thanks to operations. We're going to call increases revenues, so revenue's an increase in the shareholder's net worth thanks to operations. I'm willing to call decreases expenses. And the result of revenues minus expenses is going to be the profit or loss for the year in the firm. It is true that we are richer by 120,000 euros but at the same time, we have to admit that we have incurring some expenses in order to generate the sales. So we need to recognize the cost of the books that we have sold. Therefore, our inventory has decrease by 80,000 euros because we have given this books to the customers. They don't belong to us anymore. Now customers are the owners of these books. Next we need to recognize that now we are poor. The network of the shareholders has decrease so we need to recognize an expense. This expense is the cause of goods sold. So after this transaction, what is the total increase in the net worth of the shareholders? 40,000 euros. On the one hand you have the revenue of 120,000 euros and on the other you have the cost of goods sold of 80,000 euros. So cash goes up by this amount, and asset goes up by 120,000. And inventory goes down by 80,000. That difference corresponds to the increase in the net worth of the shareholders. Great. So we already accounted for the first sales in the business. Now lets take care of the credit sales, the campus bookstore is selling 60,000 euros in books, in textbooks in this case to the school. And the school pays in 60 days. So these are not cash payments. So these are credit sales, they don't pay in cash. Now the cost of these books sold to the school are 45,000 euros. My first question to you is, do you really need to account for these credit sales? Clearly in this case, we do not receive any cash. But still, we have to recognize the revenue, we have to recognize the sales. Why? Because the books are already in the hands of the school, so we have delivered the. And now they have the obligation to pay us, and we have the right to collect this money. So first, let's account for the revenue for an increase of the net worth of the shareholders. As a result of this operation we are richer. Now, obviously here we are not receiving cash so cash remains the same. We need another account to reflect the right we have to collect this money. So on the one hand, we recognize that we are richer. And therefore owners equity goes up through the P& L account, the revenue, the sales, this is the price we get for these books. And on the other hand we recognize this right, under an account called accounts receivable, that we're going to abbreviate with A/R so that we have more space for the next transactions. My question to you is the following is accounts receivable an asset? Why is it an asset? Well, remember the three parts of the definition of an asset, the three elements? First, we own it, so we have this right to collect the money, the cash. Second, it will give us future economic benefits. In this case, we expect to collect this cash on the school. And third, is the result of a past transaction, in this case, the sale of books, and we have a right to deliver, so the past transaction is done. Therefore, accounts receivable is an asset. After this one section, are we richer?. Are the shareholders of this company richer? Yes, they are. The P& L has gone up by 60,000 euros. So we are richer by this amount. Second question, are we morally. Well the truth is that cash has not changed. So liquidity has not changed. So here you have a situation where profitability goes up but cash remains the same. So this is a very important distinction to bear always in mind. Liquidity and profitability are not the same. The second part of the transaction is to account for the cost of goods sold. Now how would you account for this cost of goods sale of 45,000 euros? So the inventory of books goes down by 45,000 euros. This was the purchase cost of the books that we are now selling and therefore, we need to recognize the decrease of inventory accordingly. We don't have those books anymore. And we also need to recognize that now we are poorer. Our inventory went down by 45,000 euros, and at the same time we need to recognize that we are poorer by the same amount. So, what is the overall effect of this transaction in the net worth of a shareholders? Well shareholders are now richer by 15,000 euros. The difference between the revenues and the cost of the books they have sold. In this video we accounted for sales and the cost of the books that we have sold. Now, in the next video, we are going to start accounting for other operating costs that do have in this business. [MUSIC]
