Accounting 101

You're taking out a loan to expand Best Bikes, and before they give you the money the bank would like to understand Best Bikes' financial health. They ask questions that seem simple, like "what are your assets?" but you're not sure how to respond.

You see last week you had 20 new bikes delivered, but you haven't paid the manufacturer yet. Should you count the bikes in your assets even though you haven't paid for them yet? They are in your stockroom right now. If you do count them, can you also count the money that's still in the safe but that you owe to the bike manufacturer?

You've also rented out five bikes to a tech startup across town. They agreed to pay $50 per month for the next six months. When you're adding up your assets should you count the bikes, the $50 you'll  earn this month, the $300 you'll earn over the life of the contract or all of it? You'd like to put a big number because then the bank will think you're doing better and give you a better deal on the loan.

The bank asks, "What are your liabilities?" Again, not so simple.

You've issued five year warranties on about a thousand bikes this year. Given past history, you'll probably have to replace five or ten bikes. That's going to cost real money. Should you tell the banker that you owe five to ten bikes to someone at sometime over then five years? That may seem ridiculous if you don't know to whom, how many or when. But would it be fair to not even mention these expected costs?

You've also sold about $2,000 worth gift cards. Most folks will use or resell the gift cards, but about 1% of those gift cards will be misplaced or never used. Can you count unused gift cards that as revenue?  How long do you have to wait before you do? How do you count the gift cards that you expect will be used? Are they a liability? You'd like your liabilities to look small, but you also have a preference for not going to jail for fraud.

Accounting is beautiful. It is more than going to a warehouse and counting all the widgets or adding up numbers in a spreadsheet. High level accounting is nuanced, requiring judgment calls, with the ultimate goal of presenting fairly the finanical health of a company. This lesson will introduce basic accounting concepts and make you regret coming to law school rather than getting that masters in accounting your aunt was pushing for.