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Current time:0:00Total duration:4:51

Video transcript

let's now account for the same series of events but instead of doing it on a cash basis let's do it on an accrual basis and the whole idea with the cruel accounting is to match your revenues and expenses to when you actually perform the service so it actually captures business activity as opposed to just capturing when cash is when cash changes hands so let's see what that actually means so in month one you cater an event where the cost to you was $100 the customer pays you $200 for your services and what I'll do I'll do the accrual accounting right here so this is kind of the cash income statement let's do the accrual accounting income statement so you actually provided the service of catering you got $200 for your services so I'll put $200 in for revenue and the expense is associated with that service that you provided in month one is $100 is $100 and so your profit is $100 so at least for one month one the cash basis and the accrual basis of accounting look exactly the same and once again you have $100 in cash now let's go to a month to you cater an event where the cost to you was $200 you and the customer agree that they can pay you $400 the next month so now it gets interesting because you performed the catering that month and the catering that you perform that month is worth $400 so in the accrual basis of accounting you would say that you earned $400 of revenue you would say that you earned $400 of revenue in this month even though the customer did not pay you they did not give you the cash and the way that you account for that is on your balance sheet you say that you are essentially owed $400 so this accounts receivable this is this is essentially stuff that other people owes you you need to receive this from other people but it's an asset other people have an obligation to you so you have an accounts receivable of 400 when they pay you the 400 it goes from accounts receivable to cash and then you Kate and then the cost to you was $200 so the cost to you was $200 so here all of a sudden you perform the service the revenue is an expensive for that service are in that month and now your profit here shows $200 so it is actually a better reflection of what you did that month now the reality is is that you didn't get the cash for it and you had to spend $200 of cash out of your pocket so you're still just like the cash accounting you're still going to have negative $100 you're still going to have negative $100 in cash now let's go to a month three you get $400 from the customer in the previous month now with cash basis you would have added that to your revenue but here we already we already accounted for it in the accounts receivable we already took that revenue but because you've got the $400 in cash it's going to disappear from receivables and then go into cash because you actually got it you get $400 the customer in the previous month you also get $200 in advance from a customer that you have to cater for the next month so you did no catering in month three and because you did no catering in month three you have zero revenue in month three and then you also have zero expenses the way that you account for the $400 that you got is that your accounts receivables goes to zero and that goes to cash so that the negative $100 gets you add $400 to it so it'll become positive 300 and the way that you account for this $200 in advance from a customer is you call that deferred revenue you got the cash there so you got the you wet we went from negative 100 added 400 to 300 then you get another 200 in cash so that gives us five hundred dollars in cash again but we didn't earn any revenue that $200 that was a kind of a cash advance so we put that right over here in deferred revenue that's the revenue that we're deferring to a future period in the in the future we will earn it this is now a liability because we are obligated to earn that revenue and then in month four we actually earn the revenue so in month four we can actually put it on our income statement at $200 and then we had a hundred dollars of expenses so that we have this hundred dollars right over here and so in month four we are earned we earned $100 and once again we $100 went away from our cash balance so we still have $400 so whether you do the cash basis through the accrual basis you have the same exact amount of cash but what's more interesting is how the profit relates in each of the periods and I'll talk about that a little bit more depth in the next video