Journal Entries: Business Formation Example

Alright. So now let's get a lot of practice making journal entries by following through an example of a business formation. Let's check it out. So for this example I thought I would pay homage to clutch tutoring back to when we started back a few years ago. We actually just focused on one university here in Miami F. I. U. And we had live tutoring sessions where we would have the students actually come to our office and we would have tutoring sessions with them, live reviews for their exams and things like that. Now obviously the business models changed but you can see through our example. Kind of an homage to the business. So let's check it out here upon establishing clutch tutoring. Inc johnny clutch paid $50,000 for which the company issued common stock. Alright so in this case remember what we're doing is taking all these sentences and analyzing them and finding out what the transaction is. Right? So what do we see johnny clutch? He's an owner of the business. He paid 50,000 in cash into the business. So he so the business received 50,000 in cash. What did they give up for that? 50,000 will the company issued common stock they gave common stock to to Johnny Clutch for starting the business. Right? So now clutch tutoring exists with this $50,000 of cash that Johnny put into the business. Right? So you can imagine before this transaction Everything was zero, right? There was zero assets, zero liabilities, zero equity. There was nothing. This company didn't exist. And now here we go. We're gonna start the company and we're gonna input 50,000 in cash cash, right? That was an asset account. Now, what about common stock? What is common stock? Do you guys remember? Common stock is an equity account, right? It's the equity and it totally makes sense here, right? The owner of the business put money into the business and they get equity right? They own that part of the business. They didn't loan this money from a bank or anything. This is money that the owners put into the business. So it's equity. So if you remember, we have to in this situation, what's gonna happen? The company is increasing its cash, right? They they're increasing cash but they're also increasing equity, right? There's equity that just got put into the company. So the equity has to go up, right? Remember there's gotta be two things at least that happened in every transaction. So to increase our cash, do we need a debit or a credit? Cash is an asset and assets go up with debits. Right, So cash, we're gonna debit cash. So we're gonna write cache here and we're gonna put the amount 50,000. So there's 50,000 in cash. What about the other side of the equation? We had equity and we're trying to increase our equity. Now, remember when we went over this, we said equity accounts go up with a credit. So that should make total sense here. We want to increase our equity because of the common stock that we just issued. So that's what we're gonna do. We're gonna put common stock as the credit. Right? It's the credit cause it's indented and we're gonna give it 50,000 as well. Okay, so the common stock increased by 50,000. So cash went up by 50,000. Common stock went up by 50,000. Let's see what happens in our accounting equation down here, assets, equal liabilities plus equity. Well, This goes up by 50,000 right to a total of 50,000. Nothing happened with liabilities. Right. We didn't take out any loans. We don't owe anybody any money, But our equity also went up by 50,000. Alright. So now we've got equity of 50,000 and our balance, our equation balances right? Our assets equal our liabilities plus equity, right? 50,000 assets equal zero plus 50,000. So that gives us a balanced equation. So, we're totally good here. So, this is everything that goes on in this problem. All right. So, let's go on and we're gonna pause here in the next video. We'll do the next transaction. Alright, let's do that. Now

All right, so let's continue here, Clutch purchased $40,000 of land with cash. Alright, so clutch purchasing land with cash, right? They had 50,000 in cash. That Johnny Clutch put into the business and now they're going to spend some of it on this land. Alright, so let's see what happens. We gotta figure out what accounts are going to be affected. We have 40,000 of land, right? We know that land is going to be affected and cash, right? We paid for that land with cash. Okay, so how are we gonna do this? We need to build our journal entry with debits and credits. So let's think of the accounts first. We have land is land and asset liability equity. Well, it's a long term asset, right? Land is a long term asset. It's something that the company owns and is gonna use in their business. Right? So this 40,000 in land. That's an asset and cash. Well, I'm not gonna ask you about cash again, but cash is an asset, right? That's our first purest asset, right? There is the cash. So they're both assets. That means they go up with debits and down with credits. Right, assets. So which one's gonna go up? Land or cash? Well, we purchased land, right? We purchased land. So we want the land account to go up. So will that be a debit or a credit? It's gonna be a debit. Right? So we're gonna write land And we're gonna put 40,000. So this is increasing the land account by $40,000. But we gave up a cash for that. Right? So our cash is going down and we have to credit it To make it go down. Right assets go down with a credit, so the cash is going to decrease by 40,000 in this transaction. Right? So if we go back above, we had ended the final the previous transaction with a balance of 50,000 0 and 50,000. Right? That's what we got out of that first transaction. And now let's add the effects of this transaction. Well the land is going up by 40,000. Right? So our assets are increasing by 40,000 but our cash is decreasing by 40,000. Right? So those are gonna wash out there. So after this transaction Our assets are still 50,000. Our equity is still 50,000 still no liabilities. But if you if you think about it, we are assets have changed right before this transaction, we just had $50,000 in cash. Now our assets are made up of a mix. Now we have $40,000 worth of land in our assets as well as another $10,000 of cash. Right? So we converted some of that cash into a different asset. Alright, so that's about it for this transaction. Let's pause and move on to the next video

Alright now let's try this one clutch purchased $8000 of supplies on account. Okay. So I put this in bold because it's the first time we're seeing this. But what on account means they use they use this term in sentences all the time. When you see on account, that means you didn't pay cash. Didn't pay cash. Okay. So you basically gave an iou you gave an iou you're gonna pay at some future date. Okay. So the journal entry here, What's gonna happen? We have $8000 of supplies. Right? So you can imagine that 8000 supplies is gonna be one of the things that we're gonna we're gonna be dealing with in this transaction. Right? So the supplies is gonna be one of our one of the accounts we're gonna work with here And his supplies. What kind of account is that? Is that an asset liability equity? Remember that supplies could be like office equipment. You know, like pens and paper, note pads, things that we needed to start the tutoring company. Right. So he bought all these supplies. Those are assets to the company. Right? There are things that are owned by the company. They have this value of $8,000 and they're gonna be used by the company. Right? So supplies is an asset. But what's gonna be the other side of this transaction? We didn't pay cash, right. We didn't pay for this in cash. So how could we how could we account for that? Well, the trick is we have a liability now. Right? Since we didn't pay it yet. We have a liability to pay in the future. Right? We didn't pay it off already. But at some future date, we're going to have to do that. So the other side of this transaction is going to be a liability. Alright. Which liability are we gonna use? Well, the one we use for all our day to day operations, it's kind of a catch. All is going to be our accounts payable. Okay accounts payable. And that's usually the one you're gonna hit. When you see this this sentence form where you see on account where you buy something on account. That means you're gonna hit accounts payable as the liability. Remember accounts payable. That's a liability. And that means we have accounts that we have to pay out. Right? So let's go ahead and build this journal entry. We know that we got supplies. Right, supplies are an asset. And we increase those with a debit. So we're gonna start with supplies here as our debit. And we're gonna give it 8000. Right? That is the value of the supplies. And what's the value of the liability? That's the amount we're gonna have to pay in the future. And that's the 8000 as well. Right. So what we're gonna do is we're gonna credit accounts payable. Okay? So we will write it here with the indentation to show that it's a credit. And remember that our liabilities such as accounts payable. They go up with credits. Right. When we credit a liability that is increasing the value of the account. So this is now telling us that we owe $8000. Right now, our balance sheet is gonna show an accounts payable that says, hey, you owe $8000. Okay. So let's go ahead and see what happened to our, our balance sheet equation here. So from the previous equation, we ended in a situation where we had 50,000 in assets and remember that 50,000, we had some cash in there and we have land value in there. There were no liabilities And there was 50,000 in equity. From when Johnny Clutch started the business. Right, So now what's gonna happen? Well, supplies was an asset account, right, this was an asset here and this was a liability, write accounts payable was a liability. We're gonna have to pay this 8000 in the future. So our assets are gonna go up by 8000. Now, the total value of the company here has 58,000 of assets. But how are we funding those assets now? Well, our liabilities went up by 8000. Right? We have 8000 that we have to pay in the future. And our equity hasn't changed. Our equity is still just 50,000. Right, so there we go. We're balanced. We're still balanced. I'm in the way notice we're still balanced. We've got 58,000 of assets, 8000 of liabilities. 50,000 of equity. The the equation stays balanced. Alright, so let's go ahead and keep doing more transactions. You're kind of going to see a flow and you're going to get better at this as we do more and more practice.

Alright, now let's try this one clutch held several reviews throughout the month, charging $5,000 to its customers on account. So on account. Look, we're seeing that again. Alright. So remember that when we saw on account before it was a situation where we didn't pay something right? We had received something but we didn't pay in this situation. It's the opposite. We gave something to the students. We gave them the reviews, right? The reason we're in business is to create these reviews and get the students to come in, but we didn't charge them right away. This might have been an old business model. I'm just kidding. We never really did an on account system, but it just helps with our, our example here. Right? So the idea is we had this review and we had so much faith in the students that they would pay us. We're like, hey, you don't have to pay us right away. Just come to the review and then you can pay us later. Right, Well, so what happens in that situation? We charged $5,000 to the customers, right? But we didn't receive that in cash, right? We told, we told them they can pay us later. So this one's actually gonna be kind of tricky. This is where things get a little hairy in the, in the minds of students when they see this charging 5000, they might think that we received $5,000 in cash. No. What we did is we gave the students $5,000 value of services, right? We provided these services that were worth $5,000. And these reviews are the reason we're in business. So this this $5,000. This is actually revenue, right? This is the reason we're in business is to do these reviews. And we earned this $5,000 by having this review throughout the month. And we we brought in $5,000 worth of revenue. Right? So this notice, it's not cash that we got in this in this situation, we got 5000 in revenue. But what else on this side? They didn't pay us right away. So we didn't get cash. What we got was an Iou from the customer? From the customer. So in this case we're receiving the IOU right? So what we have is accounts receivable in this case, right? We have an asset where we're going to eventually receive some money. Right? Let me write receivable better for you. So you can see it accounts receivable. Right? So this means that at some future date we're gonna receive some money. Right? And that is due to this 5000, from the review. So since the 5000, is revenue, does revenues go up with a debit or a credit? So remember that revenues go up with the credit. Right. And what about accounts receivable? Is that an asset, liability or equity? Well, that's an asset, right, accounts receivable. We have the right to get money in the future. So that is an asset to the company. We we are gonna eventually get some money from our customer, okay. That they already owe us, right? Not eventually, they're gonna take another review in the future. No, this is money they already owe us because we gave them the review. So the accounts receivable is an asset. Alright, So assets go up with debits, right? And we received this accounts receivable. We need to increase the accounts receivable account, Right? So we're going to debit accounts receivable because we want to increase the value of that account. We want accounts receivable to show to reflect this $5,000 that the students owe us right now, what's the other side of the transaction? We have a debit here. We need to credit something, Right? And we said we're going to credit revenue, right? This is the money we brought in uh from from having these reviews. So there's a bunch of different things. We could call it, we could call it sales, we could call it revenue, sales revenue, service, service revenue, fees, earned, all sorts of things, right? There's no correct way to label it. But the most common is gonna be something like sales revenue. Okay. That is what I suggest you always use if you don't have any other uh inkling to go, you know, the teacher didn't qu to use something else. Just use sales revenue for your revenue account. Okay. So we're going to credit that 5000 and remember that revenue accounts increase with credits, right? So that's what's happened here. And if you remember from our previous problem, we had ended with assets of 58,000 Liabilities of 8000. And equity of 50,000 write our equation was balanced. And we had these amounts. So what's gonna happen here? If you think about it? Our accounts receivable? Well, we know that's an asset, right? What about sales revenue? Where do you think that's gonna fall? Is it gonna fall under an asset, a liability or equity? So we had talked about this a little, but I feel like it could be tricky. It's a it's a tricky topic. The revenues and the expenses are all equity, right? Everything that the company does every time we hold the review and make money, every time we pay our tutors, every time we do something that goes into the equity of the company. Alright. So every time we have a revenue that's going to increase our equity and every time we have an expense, it's going to decrease our equity. Okay? So this should make sense. Right? Um because we we receive more money, right? We are we received more assets in this case of $5,000, But we don't owe anybody money for that, there's no liability, right? We don't owe somebody money for earning this, this money is ours because we earned it. So what's gonna happen is our assets go up by 5000, bringing it to a total of 63,000. Right? That 5000 increases the accounts receivable. Eventually our customers are gonna pay us and we're gonna have that 5000 in cash, right? But we already have rights to that money. Our liabilities aren't gonna change, right? There's nobody that we owe anything from this transaction. But our equity is going to increase as well, right? We're going to increase it by that 5000. Bring it to a total of 55,000. Right? So all those revenues increase our equity, all the expenses will decrease our equity. Alright. In general, when we when we prepare this stuff, these revenues and expenses, we're gonna wait to produce an income statement before we affect equity, right? We would total all our rep news for the year. All our expenses get a net income. And that's what would affect our equity. But really on a transaction by transaction basis, this is what's really happening, right? This revenue increased our equity. And if we have an expense, it's going to decrease our equity. Cool. Alright. Let's pause here and move on to the next transaction.

Alright Let's try. This one clutch paid its tutors for the month in cash for a total of $3,000. So boom. When you see in cash. Well we've got that part down, right? Cash is going to be affected here for $3,000 and was cash increased or decreased in this case? Well Clutch had some money and they paid it to their tutors. Right? So they're gonna have less cash. So we're gonna end up crediting cash. So what I'm gonna do is I'm gonna write the cash part and I'm gonna leave it indented already. I know cash is going to be credited for $3,000. Right? We're going to credit cash for $3,000. That one's the indented one because we know we have 3000 less in cash. Now, what about the other side of the transaction? We know it's gonna be a debit. Right? So what debit is it gonna be? We paid our tutors an amount of money? Is there an asset related to this? A liability, maybe a revenue or what about an expense? This is an expense. Right? We're paying our tutors, the tutors are employees of the company and we're paying them for doing their job for doing what earns us our revenue. Right? So this money that we pay to our tutors is going to be an expense. Okay. So it's going to be an expense but we always want to be a little more clear. We want to be transparent with what kind of expense this really is. So when we talk about paying our employees, we usually say something like wage expense. Okay, wage expense? Maybe salary expense if they're salaried employees something like that. Right? So wage expense is going to be our debit here. Right. Remember that expense accounts go up with a debit? So let's go ahead and put that in and notice notice that I had done my credit part of the entry first because it was easy because I knew that cash was gonna be credited. So I got it out of the way and then I spent my time figuring out the more difficult part the wage expense. Right? So we have the debit to wage expense for $3,000. So there's our full journal entry, right? It balances out our debits equal our credits, wage expense for 3000 cash for 3000. All right. So what's gonna happen here? Let me scroll up and see our final balances from before. So we had ended with 63,000 in assets, 8000 in liabilities and 55,000 in equity. And we were balanced at that point, assets equal liabilities plus equity. And what happened in this transaction for cash went down by 3000. Right, so our assets are gonna decrease by 3000 to a new total of 60,000. What about the wage expense? We just talked about this, right, revenues increase our equity and expenses decrease our equity. Right, So that's what's exactly what's gonna happen here. We don't owe anybody any more money. Right? We don't owe the tutors anymore money. We don't have a liability to them. We just paid them. So what's gonna happen is an equity transaction and we're going to decrease, sorry, I'm trying to get out of the way here. I'm just gonna do that. And we're gonna decrease equity by 3000 right -3000 to a total of 52,000. Okay. And I want to make one more point about this revenue and expenses in equity. If you remember, equity goes up with credits. Right? And when we have a revenue, we're crediting equity to increase equity. And when we have a debit to expenses. Well, that's a debit to equity, which decreases equity. Right? You following me? Equity goes up with credits. So do revenues and debits debits to equity. Bring it down. Which is what the expenses do. Alright. So that's kind of the flow there and notice we still have a balanced equation. Now we have assets of 60,000 liabilities of 8000 and equity of 52,000. All right, so let's go ahead and pause and continue on to the next transaction.

Alright, Clutch received payments on account from customers totaling $3500. So, remember when we had those reviews for the customers. Well, they were allowed to pay us on account, we didn't tell them to pay us right away. They could pay us in the future. We had some accounts receivable, Right? And what's happening in this transaction is we're receiving some of that money, right? We had an iou where people were gonna pay us money in the future and the time has finally come, the money has been received Um and we have now received it. Right? So that's exactly what I'm getting at. So, we received $3,500. Right? So there's actual cash that we received in the mail or whatever. We got 3500. So this 3500. It's cash, right? That we received. But what's the other side of the transaction here? Well, if you think about it, we were previously owed $5,000. Right? The accounts receivable was $5,000, but we're no longer owed $5,000. We received some of that money. So, our accounts receivable need to go down, right? We no longer have the 5000 in accounts receivable. We have less. Right, minus this 30 500. So the other side received payments when we see this received payments on account, we're receiving something. So it had to be receivable. So this is accounts receivable is the other side of the transaction, accounts receivable. And I'm gonna take this liberty right now to uh use an acronym for accounts receivable. A. R is a very common acronym that we use. Sorry, a ar for accounts receivable. Okay, so throughout the course, we'll probably just start using a r to save time And we'll get used to all sorts of little uh acronyms and stuff that we'll use throughout the class. So what happened here? Cash? We received 3500 in cash. So is that a debit or a credit? Well, we debit cash, right, assets, go up with a debit. That's an asset right there. So we're gonna have 3500 right here. And that's a debit to cash to increase the cash since we just receive some and the other side is going to be the accounts receivable. Right? We have to credit that we have to decrease the value of accounts receivable because we're no longer owed the same amount of money. Some of that money has come in. So I'm gonna go ahead and I'll just write it all out here since it's still early accounts receivable. And that was 3500. Right, So there's our credits for 3500. So we decreased the amount of money that is owed to us because we received some of it. All right, So we ended the last transaction with 60,000 in assets, 8000 in liabilities and 5200 in equity. Excuse me. 52,000. All right. So what happened in this transaction? Cash is an asset? Accounts receivable is also an asset. Right, So we're gonna increase our cash, excuse me, increase our assets by 3500, but then also decrease our assets by 3500. And we're left with 60,000 in assets again, 8000 in liabilities and 52,000 and equity. Alright. So nothing changed in the accounting equation, but the balance of the accounts changed. Right? Cash. Now, there's more cash on our books. There's less accounts receivable on our books. Right? So that that's about it for that transaction. Let's go ahead and pause and move on to the next one.

Alright, how about here, Clutch paid a dividend to its stockholders in the amount of $500. Okay, so they're gonna pay a dividend to their stockholders. So then, you know, we're gonna be dealing with dividend expense? Just kidding. Right, dividend expense does not exist, right? There's no such thing as dividend expense. This dividend is a pull from our retained earnings from the money that the company has brought in. Well, we're gonna take $500 out of that money out of our equity and pay it out to the stockholder. Right? So that's what's gonna happen. This $500. It's cash, right? We're gonna pay the stockholder cash, but it's coming out of our equity, it comes out of the equity of the company when we pay a dividend. Okay, so there's no such thing as dividend expense. This is strictly coming straight from retained earnings. This isn't going through the income statement, We're not going revenues and expenses and dividends is going to be listed in there. No dividends comes straight out of the equity, It doesn't affect our income statement or revenues expenses. None of that. Okay, so dividend is an equity account, But it's an interesting equity account because it works opposite of equity. If you think about it. We're not increasing our equity in this case, right? We're decreasing our equity, right? We want to decrease our equity because we're taking $500 out of the company. So what's gonna happen here? We know that this cash, right? We had $500 in cash and we paid it to the stockholder, right? So what's gonna happen is a credit to cash, right? We need to decrease our cash with a credit for $500, right? So that's the credit side of this transaction. To decrease crash, decrease cash. But what about the debit side? We need to decrease equity. Reit equity if you remember equity goes up with credits and down with debits. Right? So what's gonna happen here is we're going to debit this dividends account And this dividends account is basically where we're gonna hold all the amount that we paid in dividends and it's gonna go into our retained earnings. Okay, so $500 was paid in dividends. And remember that a debit to dividends being an equity account And this one was an asset account, right, dividends being an equity account. A debit there decreases the value of the equity. Okay, so that's what's going to happen here. In our last question, we ended with 60,000 in assets 8000 in liabilities and 52,000 in equity. Right? But now our assets are going down, right? We paid $500 out But it doesn't affect our liabilities. This is nothing we have to owe people. This is coming straight out of our equity. We're going to decrease our equity by $500 as well. Okay, so this is gonna get us to a total here. 59 500 Liabilities are still 8000. We never paid them for those supplies unless we got our equity of 51 500. So this still balances out our assets equal our liabilities plus our equity. Cool, let's go ahead and move on to the next one.

Alright, let's try this one here. Johnny Clutch was excited about the company's success and bought his girlfriend a new car for $20,000. Alright, so in this case we've got a new car for $20,000, right? But this is a trick, right, johnny clutch bought this car for his girlfriend. This has nothing to do with the company itself. This is a personal transaction of johnny clutch, right? This this doesn't have anything to do with the company clutch tutoring. He took his own money and bought his girlfriend a car. Regardless of whether the money came from the company or not, this has nothing to do with the company. So there should be no journal entry. Okay. And it's not gonna affect the books at all. There should be nothing written about this. This is just a personal transaction of johnny clutch. This goes back to the assumptions that we have in financial accounting. One of the assumptions is the economic entity assumption. And this is where we separate the economic entity being clutch tutoring from johnny clutch the stockholder. Right, So the personal transactions of johnny clutch should not affect the company clutch tutoring. Alright, so this was a trick question here, and you could expect to see things like this where you're gonna see that they give you some kind of odd entry that has nothing to do with the company. Okay. In that case we don't make a journal entry, it shouldn't go into the company's books. Alright. Obviously in future accounting classes, we're gonna teach you all sorts of ways to evade taxes and you know, do all sorts of accounting gymnastics. But as of now, I'm just kidding. We're not gonna get into any of that, but it would be pretty fun. Right? Alright, let's go ahead and move on to the next video.