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Current time:0:00Total duration:3:32

Video transcript

you buy a truck for $60,000 to start a shipping business the truck has a useful life of three years you then have to buy another truck so what I've done here is I've drawn our actual a series of income statements for our shipping business this is year 1 year 2 year 3 year 4 this is the revenue that we make in each of those years so it's kind of a business that right from the get-go we start making $100,000 a year this is all in thousands when we write it that way so this is all in thousands so this is a hundred thousand it kind of just stays steady there we just keep making a hundred thousand dollars a year in revenue for the first 10 years and then we have to pay a driver let's say that the cost of the labor is $50,000 a year so once again this is this is in thousands and what I want to address in this video so this would be a cost so when you just subtract out the labor cost you have 50,000 left and then your other cost is going to be the truck itself and what I want to think about in this video is how should we account for the cost of the truck so you might just say hey look to start off I spent $60,000 so in year one where I actually go out to the truck store and buy the truck why don't I just call it an expense of $60,000 so one reality is you could just say hey look in year one my truck costs $60,000 then in year two I don't have to spend any money on a truck because I have one year three I don't have to do it but then a year for my first truck is now has to be scrapped because I used it so much so year four after buy another truck for $60,000 and then again year five year six I don't have to do anything then in year 7 have to buy another truck for $60,000 8 9 don't have to do anything and then in year 10 I have to buy another truck for $60,000 so if you counted for the purchase of your truck every 3 years this way your profit would look like this in year 1 100 - so this is revenue in these two lines or expenses so 100 - 50 - 60 this is negative 10,000 of profit in that first year second year you make 50,000 earlier you make 50,000 just 100 minus 50 then 4th year again negative 10000 and then you make 50,000 and 50,000 and then again negative 10,000 and 50,000 and 50,000 so to someone who looked at this series of income statements they'd say my god there's some kind of this is some type of bizarre business in the first year every three years you learn of money I don't know why maybe it's being mismanaged maybe something strange is happening maybe it's because of bad weather who knows and then you make a ton of money then you lose some money then you make a ton of money so it seems like some type of very bizarre business when you look at it from the operating from the profit line just when you just expense the truck every three years an operating profit is the profit from the operations before you think about how you're paying for the operations how you're financing them or or taxes or any of that type of business but this is strange because this is a very stable business it's very strange for its operating profit to kind of jump around like this so the way that we kind of reconcile this is by doing something called capitalizing the expense of the truck and then depreciating it over the course of its life and I'll cover that in the next video