We're going to continue our case discussion of a startup firm through its first set of financial statements. In a prior part, we had followed the company as it had raised some cash by issuing stock and then invested that cash in some property plant equipment and acquiring some inventory. Now, we're going to add some transactions and events that impact the income statement and see how we record those as well. So remember that for each transaction, we have to decide, is this something we record? And if so, which asset, liability, and shareholders' equity accounts go up or down? And we have to make sure that the balance sheet equation stays in balance. So, our first transaction is, we're actually going to sell some inventory that had cost $5,000 for 8,000 in cash. So, any assets go up or down, clearly, cash goes up 8,000, and inventory goes down 5,000. Well, that doesn't balance. That's a net increase in assets of 3,000. So there has to be something else and that is our profit on the transaction. So that's going to show up in the owner's equity account, okay? The owners' equity account that it shows up in is retained earnings. It's part of the income statement. But really, the way that we would record this in a real set of financial statements is 8,000 of it is revenue and 5,000 of it is cost to goods sold, the net 3,000 is what's going to ultimately show up in the income statement and in earnings. Now, since we've gotten some cash, suppose that we make a payment to our merchandise supplier that we had bought some stuff on credit for before. And at the same time, we place a new order. So we're going to make a payment of $17,000. So cash goes down 17,000 but that's not an expense. Instead, our liability that we had recorded, accounts payable, goes down by 17,000. Asset goes down 17, liability goes down 17. So that balances. No impact on income this period. The new order, we don't record anything for yet because we haven't actually received anything or made a payment. Cash flow statement would be impacted by this. But income statement, not. Now, we make another sale but this time, it's a more complicated sale. This time, we're going to sell some stuff that costs 15,000. We're going to sell it for 25 but not all for cash. Six of its cash and the rest is on credit. The balance due in 30 days. So we've got inventory that went down 15. We've got cash that went up six. And if the total sales price was 25, we must have receivables that went up 19. So we sold stuff for 15 that cost 15 for 25, that's a $10,000 profit that goes into retained earnings and owners' equity account. Again, the details would be revenues of 25, cost of goods sold of 15. So, the cash flow statement would just show the cash part but the income statement shows the cash and the credit part because the sale is the key event here. Now, the cash part, we're pretty sure about, okay? So, we got 6,000 in cash. The receivables part, we're not as sure about. We know people owe us 19 but we're not 100 percent sure we're going to collect 19, okay? So here, there's more judgment involved. If we think there's a chance we're not going to collect it all, we might want to knock down the receivable, okay? The asset's not worth that much. But to keep the balance sheet in balance, if we knock down the asset, we have to knock down something on the other side as well. And implicitly, we would be saying income is not really 10,000 because we don't expect to collect all of that. Suppose we do receive some of the cash. We collect 2,000 of the cash. Well, we've got cash up 2,000 but we don't record any income here because we recorded the income back when the sale was made. You can't record income both when the sale is made and when the cash is collected, okay? We already counted it. So, what happens instead is we just record that the receivable goes down. Cash goes up too, receivable goes down too, no impact on income. But here, there is an impact on the cash flow statement. So again, cash flow and income aren't the same. Now, some of that inventory that we had ordered is received. What do we record? Well, we record the inventory and we also record the fact that we haven't paid it yet. So, an asset goes up and the liability goes up and things balance again. No impact here on the cash flow statement or the income statement. Then last, the board of directors declares and pays a dividend of 3,000. Here, cash clearly goes down 3,000 and retained earnings goes down 3,000. But the important point is, here, it doesn't go through the income statement, okay? A dividend is not an expense needed to generate sales or to generate income. Instead, a dividend is a return or a distribution of some of that income to shareholders. So, this doesn't go through the income statement but instead, it's a direct deduction from the retained earnings account. So, let's pause at this point and total things up and see where we are. Again, assets equals liabilities plus owners' equity, all the individual account balances are different because of the transactions that have happened. In a future video, we're going to continue this example and talk about some adjusting entries that we have to make at the end of the period to reflect things that we haven't recorded so far.
