Financial Accounting Summer Term 2020 Prof. Dr. Thomas Kotulla Introduction Prof. Dr. Thomas Kotulla 2002‐2011: Master’s and Ph.D. studies in the fields of business and economics BiTS, Iserlohn | Harvard University, Cambridge | ESCP Europe, Berlin 2002‐2017: Professional activities in the fields of management, strategy, and finance, lastly as consultant, department head, and managing director Bosch, Johannesburg | Porsche, Stuttgart | Kraft Foods, Bremen TBWA, Düsseldorf | BBDO Consulting, Düsseldorf | Wertikale, Berlin PE Automotive, Wuppertal | Stiftung Bildung.Werte.Leben, Berlin Since 2017: Professor of value‐based corporate management and finance University of Applied Sciences Europe, Berlin Contact: thomas.kotulla@ue‐germany.de 2 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Introduction Main elements: • 12 lectures of 90 minutes each Theoretical and conceptual input Several exercises and calculations • 6 tutorials of 90 minutes each • 2‐hour module exam with Business Mathematics 3 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Introduction Literature: • English literature: Bragg: Bookkeeping Guidebook Publisher: Accounting Tools ISBN‐13: 978‐1938910418 • German literature: Schmolke/Deitermann: Industrielles Rechnungswesen Publisher: Winklers ISBN‐13: 978‐3804568488 4 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Introduction Brainstorming • Bookkeeping = numerical capturing and structuring of each and every business transaction based on vouchers Brainstorming: • Financial Accounting = based on bookkeeping data, What is your of the following terms? yearly illustration of a understanding firm’s financial situation; result: annual financial statement Bookkeeping • Financial Reporting = based on Accounting bookkeeping data and Financial accounting data, quarterly/semi‐annual/annual illustration Financial Reporting and communication of the firm’s financial situation; Try to find a definition or keyreport characteristics! result: quarterly/semi‐annual/annual 5 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting What is a balance sheet? A student’s “balance sheet” as an example Assets December 31, 2019 Fixed assets Computer Clothes Household appliance Literature Current assets Frozen food Cigarettes Bank account Cash Total assets 6 Kotulla/Biethahn/Helms/Morich Equity & Debt € 14,000 3,000 5,000 5,000 1,000 2,147 50 40 2,000 57 16,147 December 31, 2019 Equity € 8,147 Debt Bank loan Parents loan Accounts payable 8,000 3,000 4,500 500 Total equity & debt University of Applied Sciences Europe 16,147 Financial Accounting How to get there The “Accounting Cycle” 1. Transactions 8. Financial statement 2. Booking vouchers 7. Closing the books 3. Postings/ Book entries 6. Adjusted trial balance 4. Trial balance 5. Adjusting book entries 7 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Let’s go Objectives of this lecture • Learn the core principles of bookkeeping: Gain an understanding of a firm’s operational processes from a numerical perspective Know how to prepare and read a firm’s financial statement (esp., balance sheet, income statement) Know where the numbers in other departments (e.g., controlling, finance) come from Bookkeeping is an important basis for all matters of financial reporting, corporate finance, and controlling 8 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 1st Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 9 Difference between financial and management accounting Objectives and functions of bookkeeping German legal term of “Kaufmann” (merchant) and its implications Generally accepted accounting principles (Germany) Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Accounting Objectives and target groups of accounting Owners Financial accounting External reporting Management accounting Internal reporting Objectives Informing and giving account to external target groups Objectives Internal Calculations, Planning, Budgeting, Controlling Creditors Employees Suppliers Customers Tax authorities Public interests Management Source: Möhlmann (2010) 10 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Accounting Instruments of accounting Financial accounting Management accounting Management report Notes Income statement Balance sheet Annual financial statement Bookkeeping Cost accounting Revenue accounting Profitability accounting Performance accounting Other statistics, planning, and budgeting Source: Möhlmann (2010) Based on legal requirements 11 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Legal requirements Duty to keep accounting records Sec. 238 (1) HGB: All merchants shall keep accounting records and shall record in them their business transactions and their financial position in accordance with Generally Accepted Accounting Principles (GAAP). Merchant (in German “Kaufmann”) = natural person who runs a business that exceeds a specific size; three types: “Ist‐Kaufmann” (≈ “actual merchant”) “Kann‐Kaufmann” (≈ “can‐be merchant”) “Form‐Kaufmann” (≈ “formal merchant”) 12 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting The German Merchant (“Kaufmann”) “Ist‐Kaufmann” (≈ “actual merchant”), Sec. 1 HGB • Kaufmann (merchant) = natural person who runs a business that exceeds a specific size • Business = any economic activity on one’s own account, own authority, and on a permanent basis, intended to make profits; not included: Liberal professions (self‐employed scientific, artistic, authorial, teaching, or educational professions) Agricultural and silvicultural professions • Size = usually the criterion is satisfied when the business requires “professional business operations”; indicators: profit, revenue, employees, IT systems, etc. • Registering the Ist‐Kaufmann in the Commercial Register is “declarative”, i.e., the status of being a merchant is independent of the registration 13 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting The German Merchant (“Kaufmann”) “Kann‐Kaufmann” (≈ “can‐be merchant”), Sec. 2+3 HGB Option • Everybody who does not fulfill the criteria of being an Ist‐Kaufmann (e.g., farmers or liberal professionals), can still become a merchant by registering in the Commercial Register • Registering in the Commercial Register is “constitutive“, i.e., you become a merchant by registering • Motivation: you signal your “professional work habit“ “Form‐Kaufmann” (≈ “formal merchant”), Sec. 6 HGB • Merchant by definition, triggered by the legal structure (e.g., Ltd., PLC) • Existence of a business not relevant 14 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Legal requirements Duty to keep accounting records Legal basis Note: Exemption based on Sec. 241a HGB, if Revenue < 600,000 € and Profit < 60,000 € Commercial law Sec. 238 ff. HGB Independent from legal form ”Ist‐Kaufmann” “Kann‐Kaufmann” 15 Kotulla/Biethahn/Helms/Morich Tax law Sec. 140 ff. AO Based on legal form Duty based on other laws Revenue > 600,000 € or Profit > 60,000 € or Value of agricultural or silvicultural land > 25,000 € “Form‐Kaufmann” University of Applied Sciences Europe Financial Accounting Generally Accepted Accounting Principles (GAAP) Bookkeeping‐related German GAAP Objective: Firm owners and creditors shall be protected against incorrect information and unexpected losses Since 2014: Accounting records, vouchers, and other relevant documents may be retained as photographic reproductions or on other data storage media Most important principles: 1. Correct documentation of all business transactions 2. No book entries without vouchers 3. Bookkeeping results shall be clearly and understandably presented 4. Correct storage of all accounting documents 16 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 1 Questions for self‐review • What are the objectives of bookkeeping and accounting? • What are the key differences between financial and management accounting? • What does GAAP mean? • Explain the German legal term “Kaufmann” (merchant) • What are the accounting‐related duties of a merchant in Germany? • What kind of information instruments are available to the accounting department? 17 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 2nd Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 18 Inventory and how to record it Balance sheet and its basic structure How to prepare a balance sheet Initial thinking about equity Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Difference between inventory and balance sheet Inventory and balance sheet Inventory record Balance sheet Presentation Staggered form Account form Content Quantities and values Values Key terms Assets ./. Liabilities = Net assets Assets ./. Debt = Equity Sec. 240 HGB: When commencing business, all merchants shall prepare accurate inventory records of their real property, receivables and payables, the amount of cash funds and of all other assets, and assign a value to each asset and liability. Thereafter, they shall prepare such inventory records at the end of each financial year. The length of the financial year may not exceed twelve months. 19 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Inventory Inventory records = physical inventory of all assets and all debt of a company at any given time by measuring, weighing, counting or detecting. Inventory describes the process (“Inventur”) as well as the documented outcome of that process (“Inventar”) Inventory methods 20 Base case: At the end of the period (Sec. 240 (2) HGB) Ongoing or permanent inventory (Sec. 241 (2) HGB) 3 months prior/2 months after the period (Sec. 241 (3) HGB) Statistical sampling methods (Sec. 241 (1) HGB) Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Difference between inventory and balance sheet Inventory and balance sheet Inventory record Balance sheet Presentation Staggered form Account form Content Quantities and values Values Key terms Assets ./. Liabilities = Net assets Assets ./. Debt = Equity Sec. 242 (1) HGB: When starting a business and at the end of each financial year, all merchants shall prepare financial statements (opening balance sheet, balance sheet) presenting the relationship between their assets and debt. 21 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting The simplest balance sheet Disposition of funds Assets Anlagevermögen Source of funds Balance Sheet Equity & Debt Fixed assets (long‐term) Equity (Net assets) Current assets (short‐term) Debt („from third parties“) Balance sheet classification for corporations, acc. to Sec 266 (1) HGB: […] On the assets side, large and medium‐sized corporations shall include, separately and in the required order, the headings shown in subsection (2) below, and on the equity and debt side the headings shown in subsection (3) below. Small corporations need only to prepare a condensed balance sheet in which only those items designated by letters and Roman numerals in subsections (2) and (3) below are presented separately and in the required order. […] 22 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Balance sheet in more detail Balance sheet classification acc. to Sec. 266 HGB The asset side (condensed form) 23 A Fixed assets B Current assets I. Intangible fixed assets II. Tangible fixed assets Land and buildings Technical equipment + machinery Other equipment, operating and office equipment Prepayments and assets under construction III. Long‐term financial assets Shares/Loans to affiliated companies Other long‐term equity investments Long‐term securities I. Inventories Kotulla/Biethahn/Helms/Morich Raw materials, consumables, and supplies Work in progress Finished goods and merchandise Prepayments II. Receivables and other assets Trade receivables Receivables from affiliated companies Other assets III. Securities IV. Bank balances and cash‐in‐hand C Prepaid expenses D Deferred tax assets University of Applied Sciences Europe Financial Accounting Balance sheet in more detail Balance sheet classification acc. to Sec. 266 HGB The equity & debt side (condensed form) A Equity C Liabilities I. II. III. IV. 1. Bonds 2. Liabilities to banks 3. Payments received on account of orders 4. Trade payables 5.‐8. Other liabilities Subscribed capital Capital reserves Revenue reserves Retained profits/Accumulated losses brought forward V. Net income/Net loss for the financial year B Provisions D Deferred income E Deferred tax liabilities 1. Provisions for pensions and similar obligations 2. Provisions for taxes 3. Other provisions 24 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting From inventory to balance sheet Assets Balance sheet as of 2019/12/31 A. Fixed assets Equity & Debt A. Equity • Tangible fixed assets B. Provisions B. Current assets • Inventories C. Liabilities • Receivables • Liabilities to banks • Cash and bank accounts • Trade payables Inventory of the Computer GmbH as of 2019/12/31 • 2x desks à 500 € = 1,000 € • 2x cupboards à 1,000 € = 2,000 € • Billings not yet paid by the customers • 1x PC in use à 1,000 € = 1,000 € • Bank account • 1x car à 8,000 € = 8,000 € • Cash • 10x PC on stock à 1,200 € = 12,000 € • Billings not yet paid to the suppliers • 10x TFTs à 200 € = 2,000 € • Loan 25 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe 3,500 € 5,000 € 1,000 € 3,000 € 10,000 € Financial Accounting Equity Accounting for equity in a nutshell • Equity has to be distinguished from debt – Equity is what remains after subtracting all debt (provisions and liabilities) from the assets (residual approach) – Thus, equity represents the net assets attributable to the owners, recognized and measured under the corresponding GAAP • Individual jurisdiction might elaborate on subclasses of equity (e.g., subscribed capital, reserves, earnings) • Equity can be negative 28 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Exercise Example 1: Preparation of a balance sheet Consider the following transactions at the foundation of the Smart and Partner GmbH (S+P) in 2019, owned by Mr. Miller. 1. Mr. Miller contributes € 100,000 in cash to the new company. 2. S+P buys a plot of land for € 50,000 in cash. 3. S+P buys desks in the value of € 10,000 on account. 4. S+P creates a report for a customer and gets a payment of € 20,000 in cash. 5. S+P takes out a loan in the amount of € 60,000. The money will be transferred to the company account at the “Happy and Easy” bank. 6. S+P pays rent for a warehouse in the amount of € 1,000 by bank transfer. How do you bookkeep these transactions? Please prepare the balance sheet! 29 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 2 Questions for self‐review • What is an inventory? And how do you record it? • What is the structure of a balance sheet? • Can you find a simple explanation of “assets” and “liabilities”? • What is equity and how is it determined for accounting purposes? • Why do total assets always match total equity & debt on the balance sheet? 30 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 3rd Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 31 Introduction of T‐Accounts Know what “debit” and “credit” is all about Organizing accounts: Chart of accounts The closing procedure: Opening and closing accounts Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting The term “Account” in the context of the balance sheet Assets (disposition of funds) Fixed assets Property Office equipment Current assets Accounts receivable + 50,000(Schulden/ € (Increase Mittelherkunft) Account “Property”) Passiva Account Eigenkapital Property + Total assets 32 Kotulla/Biethahn/Helms/Morich T‐Account 50,000 ‐ 50,000 € (Decrease Account “Cash”) Account Cash T‐Account + 50,000 Cash Bank account - Verbindlichkeit/Example Fremdkapital S+P GmbH buys a(BS) property (50,000 € cash). Bilanzsumme University of Applied Sciences Europe Financial Accounting The term “Account” in the context of the balance sheet Assets (disposition of funds) Fixed assets Account Property + Equity & Debt (source of funds) Equity Account Equity - - 50,000 + 10,000 Current assets Account Cash + Example - 10,000 Mr. Miller contributes 10,000 € to the Verbindlichkeit/ Fremdkapital entity in cash. Bilanzsumme (BS) 50,000 Total assets 33 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting The term “Account”: Debit and Credit entries Assets (disposition of funds) Equity & Debt (source of funds) Equity Account Property + Account Equity - - + Increase Decrease Decrease Increase Debit Credit Debit Credit Debt The terms “Debit” and “Credit” are labels for the left and the right side of an account. 34 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Nature of an account Different types of accounts in the balance sheet Equity & Debt account Asset account 35 • Increases are accounted for on the debit side of the account (left) • Decreases are accounted for on the credit side of the account (right) • Opening balance (usually) is a debit entry • • • Increases are accounted for on the credit side of the account (right) Decreases are accounted for on the debit side of the account (left) Opening balance (usually) is a credit entry Debit (+) Asset account Credit (‐) Opening balance Decreases Decreases Increases Closing balance (Net) Increases Closing balance (Net) Kotulla/Biethahn/Helms/Morich Debit (‐) E&D account Credit (+) Opening balance University of Applied Sciences Europe Financial Accounting Organizing accounts Using a chart of accounts A chart of accounts represents a complete list of accounts that may arise in financial accounting of an entity. For industrial businesses, there are two commonly used types of charts of accounts: • Accounts sorted by function and process • Accounts sorted by balance sheet items Your material is based on accounts by function Purpose: Unique coding and structuring of accounts 36 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Organising accounts Take a look at traditional examples and “The World of DATEV” • German example for sorting by function and process – Gemeinschaftskontenrahmen der Industrie (GKR): Introduced by the Bundesverband der Deutschen Industrie e.V. (BDI) in 1948/49 • German example for sorting by balance sheet items – Industriekontenrahmen (IKR), followed the GKR in 1971 • Modern standard chart of accounts “The World of DATEV” – www.datev.de/web/de/m/ueber‐datev/datev‐im‐web/datev‐von‐a‐z/ skr‐standard‐kontenrahmen 37 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Closing the accounts System of financial accounting: From bookkeeping to balance sheet Opening balance account (Carry forward) Opening balance = Prior year closing balance (PYCB) (Aggregation of individual accounts to balance sheet items) Balance sheet accounts Asset accounts E & D accounts Equity account Closing balance account (Carry forward next year) 38 Kotulla/Biethahn/Helms/Morich We consciously consider the equity account at this point in a very simplified form! In the next lecture, we will have a closer look at this account. Closing balance = Next year opening balance (Aggregation of individual accounts to balance sheet items) University of Applied Sciences Europe Financial Accounting Exercise Example 2: Preparation of a balance sheet – Part 2 Prepare the opening balances of the individual accounts on the basis of the balance sheet as of 2019/01/01. Assets Balance sheet Property 50,000 Equity Office equipment 10,000 Liabilities to banks 60,000 Trade payables 10,000 Trade receivables Cash 70,000 Bank account Happy and Easy 59,000 Total assets: 39 Equity & Debt Kotulla/Biethahn/Helms/Morich Σ 189,000 Total equity & debt: University of Applied Sciences Europe 119,000 Σ 189,000 Financial Accounting Exercise Example 2: Preparation of a balance sheet – Part 2 Consider the business transactions of Smart and Partner GmbH, which occur in the course of the year 2019. Post the transactions in T‐accounts. 1. Mr. Miller contributes another € 15,000 in cash to the new company. 2. S+P buys a plot of land for € 30,000 in cash. 3. S+P buys PCs on account, € 20,000. 4. S+P creates a report for a customer for a payment of € 10,000 in cash. 5. S+P takes out another loan in the amount of € 30,000. The money will be transferred to the company account at the “Happy and Easy” bank. 6. S+P pays salaries of € 2,000 by bank transfer. 7. S+P creates another report for a customer on account for a fee of € 17,000. 8. The invoice of transaction 7 is paid by bank transfer. Prepare the closing balances of the individual accounts. What does the balance sheet as of 2019/12/31 look like? 40 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 3 Questions for self‐review • What is a chart of accounts? Why do we use it? • What is a T‐account? • How do you post increases and decreases of items to the individual accounts? • What does “debit” and “credit” mean? 41 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 4th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 42 Journalizing business transactions and posting journal entries The four basic types of bookkeeping transactions Understand double‐entry bookkeeping Taking a closer look at equity: Income and expense Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Journalize each transaction Booking entry / Journal entry / Accounting record Example: A trade receivable (€ 100) is settled by a customer by bank transfer. What does the booking entry look like? Assets 14 Trade receivables (11) Bank Debit (+) Credit (‐) Credit 100 100 (14) Trade receivables Credit (‐) 100 11 Bank Debit Debit (+) 100 Booking entry: Debit (11) Bank 100, Credit (14) Trade receivables 100 Booking entry = written instruction for posting a business transaction 43 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Journalize each transaction Steps in the Posting Process 1 2 Which accounts are affected? What are their account No.? Where do I expect the accounts in the BS? (Asset acount or equity & debt account) 3 How are these accounts affected? (Increase oder decrease? / Debit or credit?) 4 What does the booking entry look like? (Posting „Debit … Credit …“) Assets Assets Debit (+) Credit (-) Equity Debit (-) Credit (+) Debit (+) Credit (-) Debt Debit (-) Credit (+) ... ............... / ... .............. ........ (No. Description Account, on which a DEBIT‐Entry is posted 44 Kotulla/Biethahn/Helms/Morich Equity & Debt University of Applied Sciences Europe No. Description Amount) Account, on which a CREDIT‐Entry is posted Financial Accounting Posting of journal entries The four basic types of bookkeeping transactions 1. Accounting exchange on the asset side: One (or more) assets account(s) increase(s), one (or more) other assets account decrease(s). Total assets and total equity & debt remain unchanged. Example: A trade receivable (€ 100) is settled by a customer by bank transfer. What does the booking entry look like? Debit (11) Bank (14) Trade Receivables 45 Kotulla/Biethahn/Helms/Morich Credit Assets 14 Trade receivables Debit (+) Credit (‐) 100 11 Bank 100 Debit (+) Credit (‐) 100 100 Total assets unchanged. University of Applied Sciences Europe Financial Accounting Posting of journal entries The four basic types of bookkeeping transactions 2. Accounting exchange on the equity & debt side: One (or more) E & D account(s) increase(s), one (or more) other E & D account decrease(s). Total assets and total equity & debt remain unchanged. Example: A convertible bond (€ 100) is converted from debt to equity. What does the booking entry look like? Debit (06) Debt (07) Equity 46 Kotulla/Biethahn/Helms/Morich Credit Equity & Debt 07 Equity Debit (‐) Credit (+) 100 06 Debt 100 Debit (‐) Credit (+) 100 100 Total equity & debt unchanged. University of Applied Sciences Europe Financial Accounting Posting of journal entries The four basic types of bookkeeping transactions 3. Balance sheet extension: One (or more) assets account(s) increase(s), one (or more) equity & debt account increase(s). Total assets and total equity & debt increase. Example: Purchase of a machinery (€ 100) on account. What does the booking entry look like? Debit (01) Machinery (16) Trade Payables 47 Kotulla/Biethahn/Helms/Morich Assets E&D 01 Machinery Debit (+) Credit (‐) 16 Trade Payables Debit (‐) Credit (+) 100 100 Credit 100 100 Total assets and total E & D increase. University of Applied Sciences Europe Financial Accounting Posting of journal entries The four basic types of bookkeeping transactions 4. Balance sheet contraction: One (or more) assets account(s) decrease(s), one (or more) equity & debt account decrease(s). Total assets and total equity & debt decrease. Example: Payment of an invoice (€ 100) by bank transfer. What does the booking entry look like? Debit (16) Trade Payables (11) Bank 48 Kotulla/Biethahn/Helms/Morich Assets E&D 11 Bank Debit (+) Credit (‐) 100 16 Trade Payables Debit (‐) Credit (+) 100 Credit 100 100 Total assets and total E & D decrease. University of Applied Sciences Europe Financial Accounting Recap Lesson 1 Recap: A student‘s “balance sheet” Assets Equity & Debt in € Fixed assets Computer Clothes Household appliance Literature Current assets Frozen food Cigarettes Bank account Cash Prepaid rent Total assets 49 19/12/31 20/03/31 11,000 3,000 2,000 5,000 1,000 5,147 50 40 2,000 57 3,000 16,147 Kotulla/Biethahn/Helms/Morich 11,000 2,600 2,400 5,000 1,000 4,777 60 20 2,390 57 2,250 15,777 in € Equity 19/12/31 20/03/31 8,647 8,377 7,500 3,000 4,500 0 7,400 2,500 4,500 400 16,147 15,777 Debt Bank loan Parents loan Accounts payable Total equity & debt University of Applied Sciences Europe Financial Accounting What is an income statement? Introducing a corresponding profit and loss (P&L) statement Revenue (Job) Personnel expenses (Food) Material expenses (Cigarettes) Depreciation (Computer) Other operating income (Sales on ebay) Other operating expenses (Rent) Operating income Interest expense (Loan) Income taxes Loss for the period 50 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe 20/01/01 – 20/03/31 in € 1,600 ‐600 ‐120 ‐400 +300 ‐750 30 ‐100 ‐200 ‐270 Financial Accounting Accounting dualism The accounting dualism Dualism Two ways to determine financial performance Double‐entry bookkeeping Accounting equation: Debit entry = Credit entry 51 Kotulla/Biethahn/Helms/Morich Balance sheet: Total assets = Total equity & debt Balance sheet: Compare total assets and total equity & debt University of Applied Sciences Europe Income statement: Summarize income and expenses Financial Accounting Accounting terms Performances in financial accounting 52 Management Accounting Cash inflow Receipts Income Performance Inflow of cash and cash equivalents Immediate cash inflow or increased receivables or decreased payables Measured effective creation/sale of goods in the period Income for the period in the ordinary course of business Cash outflow Spending Expenditure Cost Outflow of cash and cash equivalents Immediate cash outflow or increased payables or decreased receivables Measured effective consumption of goods in the period Expenses for the period in the ordinary course of business Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Recap of lecture 3 System of financial accounting: From bookkeeping to balance sheet Opening balance account (Carry forward) (Aggregation of individual accounts to balance sheet items) Balance sheet accounts Asset accounts Opening balance = Prior year closing balance (PYCB) E & D accounts Income statement accounts Expenditure accounts P&L account Equity account Closing balance account (Carry forward next year) 53 Kotulla/Biethahn/Helms/Morich Income accounts Closing balance = Next year opening balance (Aggregation of individual accounts to balance sheet items) University of Applied Sciences Europe Financial Accounting Introducing income statement accounts Interaction between equity, P&L and income statement accounts • Income represents an economic benefit whereas expenses represent an economic disadvantage for the owners of the reporting entity • Profit (or Loss) = Income less expenses (residual economic benefit attributable to the owners of the reporting entity) • Profits increase equity whereas losses decrease equity Equity account Income statement accounts Expenditure accounts Income accounts P&L account • Income‐ and expenditure accounts are sub‐accounts of equity. • Therefore they are shown on the right‐hand side of the balance sheet. • A debit entry for an expense account is reducing equity. 54 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Posting journal entries on income statement accounts Interaction between equity, P&L and income statement accounts Debit (‐) Expenditure account Credit (+) Reimbursements and corrections Individual expenses Total expenses (Net) Debit (‐) Income account Reimbursements and corrections Credit (+) Individual income and revenues Total income (Net) 55 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Equity and income statement accounts Interaction between equity, P&L and income statement accounts Assets Equity & Debt Fixed assets Current assets Equity 07 Equity Debit (‐) C. Balance Credit (+) Expense Debit (‐) O. Balance Expense P&L C. Balance Expenditure accounts Debit (‐) P&L account Credit (+) C. Balance Credit (+) Income Income accounts Debit (‐) C. Balance Credit (+) Income Debt 56 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Equity and income statement accounts Interaction between equity, P&L and income statement accounts Assets Equity & Debt Fixed assets Current assets Equity 07 Equity 10 Cash Debit (+) Credit (‐) 100 50 Debit (‐) Credit (+) 50 100 Transaction 1 Owner contributes 100 € of his own money to the petty cash of the entity. 57 Kotulla/Biethahn/Helms/Morich Transaction 2 Owner takes 50 € from the petty cash of the entity. Liabilities University of Applied Sciences Europe Financial Accounting Equity and income statement accounts Interaction between equity, P&L and income statement accounts Assets Equity & Debt Fixed assets Current assets Equity 07 Equity 10 Cash Debit (+) Credit (‐) 100 200 50 100 Transaction 4 Entity pays a rent in cash: 100 € 58 Kotulla/Biethahn/Helms/Morich Credit (+) 50 100 Expenditure accounts Debit (‐) Credit (+) 100 Transaction 3 Entity gets 200 € in cash for services provided. Debit (‐) Income accounts Debit (‐) Credit (+) 200 Debt University of Applied Sciences Europe Financial Accounting Equity and income statement accounts Interaction between equity, P&L and income statement accounts Assets Equity & Debt Fixed assets Current assets Equity 07 Equity 10 Cash Debit (+) Credit (‐) 100 200 50 100 Debit (‐) Credit (+) 50 150 100 100 Expenditure accounts Debit (‐) 100 P&L account Debit (‐) Credit (+) 100 200 100 Income accounts Credit (+) Debit (‐) Credit (+) 100 200 200 Financial Statements Calculate Profit or Loss 59 Kotulla/Biethahn/Helms/Morich Debt University of Applied Sciences Europe Financial Accounting Transactions with Shareholders Retained earnings, dividends and contributions by the entity‘s owners • Profits increase and losses decrease the equity of the reporting entity; if profits are not paid out to the owners, they are summarized as “retained earnings” or “reserves” as a separate line within equity • Dividends to or capital contributions from the owners decrease/increase the equity without representing a profit or loss – Transactions by a shareholder in his/her capacity as a shareholder – In case of a German partnership: Separate equity accounts for each owner (no. 19 “Private account”) as pre‐accounts of no. 7 “Equity” – Business transactions with owners are treated as business as usual 60 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Exercise Example 3: Income statement accounts and posting journal entries Consider the following business transactions of Smart and Partner GmbH, owned by Mr. Miller. Equity of S+P at the beginning of 2019 amounts to € 12,000. S+P has cash of € 2,000 and a bank account amounting to € 10,000. Visualize all T‐accounts and post the journal entries. 1. S+P rents an office for € 600, payment by bank transfer. 2. S+P pays salaries of € 8,000 by bank transfer. 3. S+P gets invoices about the membership fee of € 500 from the Consulting Association due date for payment: 14 days later 4. S+P creates a report for a customer for a payment of € 25,000 in cash. 5. S+P creates another report for a customer on account for a fee of € 2,000. 6. Mr. Miller takes € 1,500 from the petty cash. Determine the Profit for the Year by closing the income statement accounts. What does S+P’s equity amount to at year‐end 2019? 61 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 4 Questions for self‐review • What is a journal entry? • Which are the basic types of bookkeeping transactions? • What are the key steps in the posting process of a journal entry? • What is the difference between cash and income? • How do the terms “Income”/“Expense”, “Profit”/“Loss” and “Equity” interact? • How do you treat transactions with shareholders in their capacity as shareholders? 62 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 5th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 63 Purchase of inventories and inventory changes Sale of trading goods How to consider the production process of goods Presentation of inventory transactions in the P&L statement Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Overview Three types of transactions with inventories 1. Purchase of inventories Raw material Purchase price 2. Sale of purchased inventories Trading goods Trading goods Purchase price Margin 3. Sale of produced inventories Raw material Production Purchase price Production cost Labor Machinery 64 Kotulla/Biethahn/Helms/Morich Selling price Finished goods Selling price Margin Sales process University of Applied Sciences Europe Financial Accounting 1. Purchase of inventories Changes in inventories (asset‐driven approach) Assets Equity & Debt 30 Raw material Debit (+) Credit (‐) OB 100 600 (3) 1,000 (1) CB 500 (2) 10 Cash Debit (+) Credit (‐) Debit (‐) Credit (+) OB 2,000 1,000 (1) CB 1,000 600 (3) CB 600 Transaction (1) Purchase: Raw material of 100 pieces times 10 €, cash 65 40 Cost of raw material Kotulla/Biethahn/Helms/Morich Inventory record (2) Changes in raw material to 50 pieces times 10 € Closing (3) Posting the change of raw materials inventories University of Applied Sciences Europe Financial Accounting 1. Purchase of inventories Changes in inventories (expense‐driven approach) Assets Equity & Debt 30 Raw material Debit (+) Credit (‐) OB 100 400 (3) CB 500 (2) 10 Cash Debit (+) Credit (‐) OB 2,000 1,000 (1) CB 1,000 Transaction (1) Purchase: Raw material of 100 pieces times 10 €, cash 66 Kotulla/Biethahn/Helms/Morich 40 Cost of raw material Debit (‐) 1,000 (1) Credit (+) 400 (3) CB 600 Inventory record (2) Changes in raw material to 50 pieces times 10 € Closing (3) Posting the change of raw materials inventories University of Applied Sciences Europe Financial Accounting 2. Sale of purchased inventories Purchase and sale of trading goods Assets Equity & Debt 39 Merchandise inventories 85 Sales of merchandise Debit (+) Debit (‐) Credit (‐) OB 100 1,000 (3) 2,000 (1) CB 1,100 1,500 (2) 10 Cash 67 Credit (+) 14 Tr. receivables Debit (+) Credit (‐) Debit (+) OB 3,000 2,000 (1) 1,500 (2) Expenditure account (4X) Credit (‐) Debit (‐) Credit (+) 1,000 (3) Transaction (1) Transaction (2) Purchase: Merchandise of 200 pieces times 10 €, cash Sale: Merchandise of 100 pieces for 15 €, on account Kotulla/Biethahn/Helms/Morich Closing/Inventory r. (3) Posting the reduction of merchandise inventories University of Applied Sciences Europe Financial Accounting 2. Sale of purchased inventories Journal entry: Purchase of trading goods 1. Buying trading goods, 6,000 € on account Debit Assets Credit 39 Merchan‐ 6,000 dise invent. 16 Trade payables 6,000 E&D 39 Merchandise inv. 16 Trade payables Debit (+) Debit (‐) Credit (‐) Credit (+) 6,000 6,000 Assets E&D Journal entry: Sale of trading goods 2. 68 Selling trading goods, 10,000 € on account 14 Trade receivables Debit Credit 14 Trade receivables 10,000 85 Sales of 10,000 merchandise Kotulla/Biethahn/Helms/Morich Debit (+) Credit (‐) 10,000 University of Applied Sciences Europe 85 Sales of merchandise Debit (‐) Credit (+) 10,000 Financial Accounting 2. Sale of purchased inventories Purchase and Sale of trading goods (P&L closing) 39 Merchandise inventories OB 85 Sales of merchandise 2,000 1,000 CB Purchase of goods 6,000 7,000 Cost of sales 8,000 8,000 Asset‐driven approach: Inventory adjustment is done at end of period CB 10,000 Sales of 10,000 goods 10,000 10,000 989 P&L 1) Cost of sales 7,000 2) Trade 10,000 revenues Net amount: Profit 3,000 10,000 69 Kotulla/Biethahn/Helms/Morich 10,000 University of Applied Sciences Europe Financial Accounting 3. Sale of produced inventories Brainstorming: How to read a profit & loss statement • From what we have learned so far, a P&L account should faithfully represent the financial performance of an entity also in the following cases: 1. A company purchases raw material (purchase costs), uses them to produce goods (production costs), and sells the goods The costs (purchase costs + production costs) should be covered by the revenues (revenues > costs) 2. A company purchases raw material (purchase costs), uses them to produce goods (production costs), and keeps the goods as inventories (either “work in progress” or “finished goods”) How is the value creation (covering all costs) reflected on the balance sheet? 70 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting 3. Sale of produced inventories 78 WIP Debit (+) OB 12,000 79 FG Credit (‐) Debit (+) Credit (‐) CB 10,000 Ch 2,000 2 OB 22,000 Ch 8,000 CB 30,000 1 89 Changes in WIP & FG Debit (‐) WIP 2,000 P&L 6,000 98 P&L Debit (‐) Credit (+) FG 8,000 Credit (+) Ch 6,000 3 The amounts of work in progress (WIP) and finished goods (FG) are accounted for on separate accounts (GKR class 7). They include costs related to the production process, e.g.: • Consumption of raw materials, consumables and supplies • Personnel expenses and other general and administrative expenses • Depreciation for fixed production assets Changes in the amounts of WIP and FG from the beginning to the end of the period are accounted for as income or expense. 71 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 5 Questions for self‐review • How do you account for changes in raw material and merchandise inventories? • Why is no journal entry immediately posted to a merchandise inventory account after a sales transaction? • What are the specific accounting treatments for changes in work in progress and finished goods? • How far does the account “Changes in WIP & FG” accurately reflect the real P&L situation? 72 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 6th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • Introduction of the German and EU VAT system • Posting journal entries for purchases and sales with VAT • Calculate and book a monthly VAT payment charge 73 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting VAT principle Value added taxation of the purchase and sale of goods Purchase Sale Incoming invoice Outgoing invoice Purchase price: VAT 19 % : Amount payable: 100 € Sales price: 300 € 19 € VAT 19 % : 57 € Amount receivable: 357 € 119 € Net purchase price Gross amount to be paid Net sales price Taxation of the Value added (e.g. 19 %) Value added = Net sales price minus Net purchase price Value added = 300 minus 100 = 200 74 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Tax authorities get: 200 € x 19 % = 38 € Financial Accounting Excursus: German/EU VAT background Legal environment • European Law – Council Directive 2006/112/EC of November 28, 2006 on the common system of value added tax – For more: www.europa.eu/legislation_summaries/taxation/l31057_en.htm • German Law – The legal sources of VAT taxation are: • Value Added Tax Act (VATA) • Implementing Value Added Tax Regulation • Value Added Tax Guidelines • Directives of tax authorities 75 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Excursus: German/EU VAT background Scope • Taxable persons and entities: Entrepreneur – The term “entrepreneur” in the meaning of the VATA means natural persons and/or corporate bodies that • perform a commercial or professional activity on an independent basis • on a continuous basis • in order to achieve income (not necessarily profits) • Taxable transactions: Turnovers – Turnovers in the meaning of the VATA include: • Supplies, other services, importation, intra‐Community (EU) purchases (not supplies!) 76 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Excursus: German/EU VAT background Amount of VAT • Taxable Amount – Consideration received, i.e. everything spent by a recipient of a performance in order to obtain the performance, however, minus the value added tax. – For importations, the taxable amount is based on the customs value. • Tax Rate – The standard tax rate in Germany is 19%. – However, quite a lot of transactions are eligible to a reduced rate of 7%. (e.g. food products, print media, works of art and cultural performances (listed in Annex 2 to the VATA)). 77 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Excursus: German/EU VAT background Input VAT and Invoices • An entrepreneur gets VAT refunded, paid for: – supplies and other services provided by another entrepreneur – importations – intra‐Community (EU) purchases 78 Kotulla/Biethahn/Helms/Morich Requirement: Existing invoice Invoices must contain the following information: • Name and address of the performing entrepreneur and of the recipient of the performance; • the performing entrepreneur’s tax number or, if applicable, value added tax identification number; • the date of issue; • quantity and type (customary commercial description) of the goods supplied or volume and type of the other service; • the time of supply or service; • the consideration, listed according to tax rates and applicable tax exemptions; and • the applicable tax rate and tax amount relating to the consideration or information about an applicable tax exemption. University of Applied Sciences Europe Financial Accounting Excursus: German/EU VAT background VAT exemptions and options • Tax Exemptions – In particular, for the following transactions: • financial services (banking, insurance, investment services etc.) • letting and sale of real estate • medical services • school and educational services • Optional Taxation – Option is granted, in particular, for certain services related to real estate and financial services. The option can be exercised for each individual turnover. 79 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting VAT payment charge Value added taxation of the purchase and sale of goods Purchase Sale Incoming invoice Outgoing invoice Purchase price: VAT 19 % : Amount payable: 100 € Sales price: 300 € 19 € VAT 19 % : 57 € Amount receivable: 357 € 119 € From the buying perspective, the value‐added tax (VAT) is a tax on the purchase price/initial value of the good. From the selling perspective, it is a tax on the value added to the product, material, or service, as the tax on the initial value of the good is refunded (and instead paid by the supplier). The manufacturer remits to the government the difference between these two amounts, and retains the rest for themselves to offset the taxes they had previously paid on the inputs. VAT receivable (+): 19 € VAT payable (–): 57 € Net VAT payment: ‐38 80 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting VAT calculation Example VAT Calculation (VAT 10%) Net amount / (1 + Tax rate) = 10,000 / 1.1 = * (Tax rate) = VAT * 0.1 = 1,000 Gross amount (Amount payable/receivable) * (1 + Tax rate) = 11,000 81 Kotulla/Biethahn/Helms/Morich * 1.1 = University of Applied Sciences Europe Financial Accounting Closing VAT accounts Two different cases Case 1: VAT > input VAT (Base case) There is a tax payable (VAT payment charge). Case 2: VAT < input VAT There is a tax receivable (VAT credit). 1. CB of Acc. No. 154 “Input VAT” is transferred to Acc. No. 174 “VAT”: 1. CB of Acc. No. 174 “VAT” is transferred to Acc. No. 154 “Input VAT”: • D 174 VAT Cr 154 Input VAT • D 174 VAT Cr 154 Input VAT 2. Closing Acc. No. 154 “Input VAT”: 2. Closing Acc. No. 174 “VAT”: • D 15 Other receivables Cr 154 Input VAT • D 174 VAT Cr 17 Other payables 3. Bank transfer to the tax authorities: • D 17 Other payables Cr 11 Bank 82 Kotulla/Biethahn/Helms/Morich 3. Reimbursement by the tax authorities • D 11 Bank Cr 15 Other receivables University of Applied Sciences Europe Financial Accounting Exercise Example 4.1: Posting VAT journal entries You are a young entrepreneur and consider the following business transactions. Please prepare the journal entries and T‐accounts. (Assumption: VAT 10%) 1. You buy trading goods, net purchase price 6,000 € on account. 2. You sell trading goods, net selling price 10,000 € in cash. 3. At the end of the month, you calculate the VAT payable to the tax authorities. 4. Three days later, you settle the VAT payable by bank transfer. 83 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Exercise Example 4.2: Booking and closing VAT accounts Consider further business transactions of Smart and Partner GmbH, which occurred in October 2019. Post the transactions in T‐accounts and prepare the journal entries. (Assumption: VAT 10%) 84 1. Mr. Miller contributes € 100,000 in cash to the company. 2. S+P buys a plot of land for € 50,000 by bank transfer. 3. S+P buys PCs on account, for a net amount of € 10,000. 4. S+P creates a report for a customer for a payment of net € 20,000 in cash. 5. S+P takes out another loan in the amount of € 50,000 (cash). 6. Determine the total VAT payable and close the VAT accounts. 7. S+P pays the resulting VAT payable by bank transfer. Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 6 Questions for self‐review • Please explain the core German/EU Value Added Tax principles. • What is the difference between VAT and input VAT? • How do you calculate and account for the monthly VAT payment charge? How do you close the VAT accounts? 85 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 7th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 86 Recap accounting for transactions with inventories and VAT Accounting for credit vouchers and returns Accounting for sales discounts Accounting for cash discounts Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Transactions with inventories Dealing with revenue adjustments • Three types of transactions considered so far: – Purchase of raw materials – Sale of trading goods – Sale of produced goods • Now to consider – Credit vouchers/returns – Price reductions (sales discount, cash discount, bonus) • Also to consider: – Incidental acquisition expenses (e.g., assembly, freight charge) – Selling expenses (e.g., promotion, marketing, freight charge) 87 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Credit vouchers / returns Journal entries when considering a pay back / credit voucher (Purchase) • Purchase of raw materials (100 pieces times 10 € net) on account Assets Debit 30 Raw Material 154 Input VAT 88 € Credit 1,000 16 Trade payables 100 Kotulla/Biethahn/Helms/Morich € 1,100 E&D 30 Raw material Debit (+) Credit (‐) 16 Trade payables Debit (‐) Credit (+) 1,100 1,000 154 Input VAT Debit (+) Credit (‐) 100 University of Applied Sciences Europe Financial Accounting Credit vouchers / returns Journal entries when considering a pay back / credit voucher (Purchase) • Getting a credit note for the purchased raw materials (100 € net) Assets Debit 16 Trade payables € Credit € 110 30 Raw Material Kotulla/Biethahn/Helms/Morich 30 Raw material Debit (+) Credit (‐) 100 100 16 Trade payables Debit (‐) Credit (+) 110 154 Input VAT 154 Input VAT 89 E&D 10 Debit (+) Credit (‐) 10 University of Applied Sciences Europe Financial Accounting Credit vouchers / returns Journal entries when considering a pay back / credit voucher (Sale) • Sale of goods (200 pieces times 10 €) on account Assets Debit 14 Trade receivables € Credit 2,200 80 Sales of goods 174 VAT 90 € Kotulla/Biethahn/Helms/Morich 2,000 E&D 14 Trade receivables Debit (+) Credit (‐) 83 Sales of goods Debit (‐) Credit (+) 2,000 2,200 174 VAT 200 University of Applied Sciences Europe Debit (‐) Credit (+) 200 Financial Accounting Credit vouchers / returns Journal entries when considering a pay back / credit voucher (Sale) • Granting a credit note for the goods sold (100 € net) Assets Debit 88 Rev. reversals 174 VAT 91 € Credit € 100 14 Trade receivables E&D 14 Trade receivables Debit (+) Credit (‐) 110 Debit (‐) Credit (+) 100 174 VAT Debit (‐) 10 Kotulla/Biethahn/Helms/Morich 110 88 Rev. reversals Credit (+) 10 University of Applied Sciences Europe Financial Accounting Price reductions Overview of price reductions Cash discount Bonus Sale Customer cash discount Customer bonus Purchase Supplier cash discount Supplier bonus • Bonuses are price reductions granted after the billing process, e.g., when the client exceeds a specific amount of revenue • Cash discounts are also price reductions granted after the billing process, but only if the invoice is paid within a certain period of time • In contrast, sales discounts are granted/advertised prior to the billing process as a spontaneous incentive to buy 92 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Bonus Example: 10% Bonus after a purchase (10% VAT) Purchase price [€] Raw material (net amount) VAT Raw material (gross amount) Booking entry for the billing D 30 Raw material D 154 Input VAT Cr 16 Trade payables 93 Kotulla/Biethahn/Helms/Morich Discount [%] Discount [€] Adjusted purchase price [€] 10,000 € 10 % 1,000 € 9,000 € 1,000 € 10 % 100 € 900 € 11,000 € 10 % 1,100 € 9,900 € Booking entry for the discount D 16 Trade payables Cr 30 Raw material Cr 154 Input VAT € 10,000 € 1,000 € 11,000 University of Applied Sciences Europe € 1,100 € 1,000 € 100 Financial Accounting Bonus Example: 10% Bonus after a sale (10% VAT) Selling price [€] Trading goods (net amount) VAT Trading goods (gross amount) Booking entry for the billing D 14 Trade receivables Cr 85 Sales of merchandise Cr 174 Payables from VAT 94 Kotulla/Biethahn/Helms/Morich Discount [%] Discount [€] Adjusted selling price [€] 10,000 € 10 % 1,000 € 9,000 € 1,000 € 10 % 100 € 900 € 11,000 € 10 % 1,100 € 9,900 € € 11,000 € 10,000 € 1,000 Booking entry for the discount D 88 Revenue reversals D 174 Payables from VAT Cr 14 Trade receivables University of Applied Sciences Europe € 1,000 € 100 € 1,100 Financial Accounting Bonus Journal entries when considering a bonus (Purchase) • Purchase of trading goods (net amount 10,000 €) on account • Afterwards getting a 5% bonus Assets Debit 39 Trading goods 154 Input VAT 95 € Credit € 10,000 16 Trade payables 11,000 E&D 39 Trading goods Debit (+) Credit (‐) 16 Trade payables Debit (‐) Credit (+) 11,000 10,000 154 Input VAT Debit (+) 1,000 Credit (‐) 1,000 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Bonus Journal entries when considering a bonus (Purchase) • Purchase of trading goods (net amount 10,000 €) on account • Afterwards getting a 5% bonus Assets Debit 16 Trade payables € Credit 550 39 Trading goods If already paid: 10/11 Cash/Bank or 14/15 Trade or other receivables 96 € Kotulla/Biethahn/Helms/Morich 154 Input VAT E&D 39 Trading goods Debit (+) Credit (‐) 500 500 16 Trade payables Debit (‐) Credit (+) 550 154 Input VAT 50 Debit (+) Credit (‐) University of Applied Sciences Europe 50 Financial Accounting Bonus Journal entries when considering a bonus (Sale) • Sale of trading goods (net amount 10,000 €) on account • Afterwards granting a 5% bonus Assets Debit 14 Trade receivables € Credit € 11,000 85 Sales of goods 174 VAT 97 Kotulla/Biethahn/Helms/Morich 10,000 E&D 14 Trade receivables Debit (+) Credit (‐) 85 Sales of goods Debit (‐) Credit (+) 10,000 11,000 174 VAT Debit (‐) 1,000 Credit (+) 1,000 University of Applied Sciences Europe Financial Accounting Bonus Journal entries when considering a bonus (Sale) • Sale of trading goods (net amount 10,000 €) on account • Afterwards granting a 5% bonus Assets Debit 88 Rev. reversals 174 VAT € Credit € 500 14 Trade receivables 50 E&D 14 Trade receivables Debit (+) Credit (‐) 550 550 88 Rev. reversals Debit (‐) 500 174 VAT Debit (‐) If already paid: Credit (+) Credit (+) 50 10/11 Cash/Bank or 16/17 Trade or other payables 98 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Cash discount Example: 2% Cash discount after a purchase (10% VAT) Purchase price [€] Raw material (net amount) VAT Raw material (gross amount) Booking entry for the billing D 30 Raw material D 154 Input VAT Cr 16 Trade payables 99 Discount [%] Discount [€] Adjusted purchase price [€] 10,000 € 2% 200 € 9,800 € 1,000 € 2% 20 € 980 € 11,000 € 2% 220 € 10,780 € Booking entry for the payment D 16 Trade payables Cr 11 Bank Cr 30 Raw material Cr 154 Input VAT € 10,000 € 1,000 € 11,000 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe € 11,000 €10,780 € 200 € 20 Financial Accounting Cash discount Example: 2% Cash discount after a sale (10% VAT) Selling price [€] Trading goods (net amount) VAT Trading goods (gross amount) Booking entry for the billing D 14 Trade receivables Cr 85 Sales of merchandise Cr 174 Payables from VAT 100 Kotulla/Biethahn/Helms/Morich Discount [%] Discount [€] Adjusted selling price [€] 10,000 € 2% 200 € 9,800 € 1,000 € 2% 20 € 980 € 11,000 € 2% 220 € 10,780 € € 11,000 € 10,000 € 1,000 Booking entry for the payment D 11 Bank D 88 Revenue reversals D 174 Payables from VAT Cr 14 Trade receivables University of Applied Sciences Europe € 10,780 € 200 € 20 € 11,000 Financial Accounting Cash discount Journal entries when considering a cash discount (Purchase) • Purchase of trading goods (net amount 20,000 €) on account • Getting a 5% cash discount if paid within 10 days (cash) Assets Debit 39 Trading goods 154 Input VAT 101 € Credit € 20,000 16 Trade payables 22,000 E&D 39 Trading goods Debit (+) Credit (‐) 16 Trade payables Debit (‐) Credit (+) 22,000 20,000 154 Input VAT Debit (+) 2,000 Credit (‐) 2,000 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Cash discount Journal entries when considering a cash discount (Purchase) • Purchase of trading goods (net amount 20,000 €) on account • Getting a 5% cash discount if paid within 10 days (cash) Assets Debit 16 Trade payables € Credit € 22,000 10 Cash Debit (+) Credit (‐) Debit (‐) 20,900 22,000 Credit (+) 39 Trading goods 154 Input VAT Kotulla/Biethahn/Helms/Morich 16 Trade payables 10 Cash 20,900 39 Trading goods 102 E&D 1,000 100 Debit (+) Credit (‐) 1,000 154 Input VAT Debit (+) Credit (‐) 100 University of Applied Sciences Europe Financial Accounting Cash discount Journal entries when considering a cash discount (Sale) • Sale of trading goods (net amount 10,000 €) on account • Granting a 5% cash discount if paid within 10 days (bank transfer) Assets Debit 14 Trade receivables € Credit € 11,000 85 Sales of goods 174 VAT 103 Kotulla/Biethahn/Helms/Morich 10,000 E&D 14 Trade receivables Debit (+) Credit (‐) 85 Sales of goods Debit (‐) Credit (+) 10,000 11,000 174 VAT Debit (‐) 1,000 Credit (+) 1,000 University of Applied Sciences Europe Financial Accounting Cash discount Journal entries when considering a cash discount (Sale) • Sale of trading goods (net amount 10,000 €) on account • Granting a 5% cash discount if paid within 10 days (bank transfer) Assets Debit 11 Bank 104 € Credit € 10,450 14 Trade receivables 88 Rev. reversals 500 174 VAT 50 Kotulla/Biethahn/Helms/Morich 11,000 E&D 88 Rev. reversals 11 Bank Debit (+) Credit (‐) Credit (+) 500 10,450 14 Trade receivables Debit (+) Debit (‐) 174 VAT Credit (‐) Debit (‐) 11,000 50 University of Applied Sciences Europe Credit (+) Financial Accounting Exercise Example 5: Booking discounts Post the journal entries. (10% VAT) 1. Purchase of raw materials on account, net amount 15,000 €. 2. Sales of trading goods on account, net amount 20,000 €. 3. You pay the bill of No. 1, cash discount 2% by bank transfer. 4. When delivering the goods of No. 2, you pay freight charge of 200 € net in cash. 5. You get a sales bonus on purchased (and paid) raw material of € 1,800 gross. The bonus will be paid within 30 days. 6. A customer pays an amount of € 23,520 by bank transfer, settling trade payables after considering 2% cash discount 105 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 7 Questions for self‐review • What are reasons for price reductions and how do you account for them (selling side and buying side)? • Please give examples of selling expenses as well as of incidental acquisition expenses. • What is the difference between a cash discount, a sales discount, and a bonus? • What are the journal entries when getting or granting a cash discount? 106 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 8th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • Social security in Germany • Personal income tax in Germany • Payroll accounting 107 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Social security in Germany German Social Security System • Statutory insurance system – Provides financial protection against the major life risks – Basic principles: • Principle of compulsory insurance – Mandatory insurances for all employees, except certain groups of people, because they are not intended to be covered by some insurances (e.g. civil servants, soldiers, persons who reached their regular retirement age) – Voluntary opting out in certain cases (e.g., private health insurance) • Principle of financing through contributions – Financed through contributions paid by employees and employers – Contribution rates are based on the wage or salary of the employee • Principle of solidarity • Principle of self‐government 108 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Social security in Germany The five branches of social insurance • Statutory insurances – Unemployment insurance (“Arbeitslosenversicherung”: AV) – Pension insurance (“Rentenversicherung”: RV) – Health insurance (“Krankenversicherung”: KV) – Accident insurance (“Unfallversicherung”: UV) – Long‐term care insurance (“Pflegeversicherung”: PV) 109 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Social security in Germany Unemployment insurance • Purpose – Insures employees’ livelihood in case of unemployment • Contribution – Rate is set at 3.0 % of the contribution assessment basis (employee's gross wage or salary [“assessable income”]), • Employer and employee each pay one half (1.5 % each) • Up to a certain contribution assessment ceiling (as of 2019: federal states (west) € 6,350 per month / federal states (east) € 5,700 per month) • Organization – Federal Employment Agency (“Bundesagentur für Arbeit”) 110 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Social security in Germany Pension insurance • Purpose – Insures members in old age as well as in case of reduced earning capacity, and insures, upon an employees' death, his/her survivors as well • Contribution – Rate is set at 18.7 % of the assessable gross wage or salary • Employer and employee each pay one half (9.35 % each) • Same assessment ceiling as for the unemployment insurance • Organization – German Pension Insurance (“Deutsche Rentenversicherung”) 111 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Social security in Germany Health insurance • Purpose – Supports maintenance and restoration of good health and eases the financial consequences of illness • Contribution – Rate is set at 14.6 % of the assessable gross wage or salary • Employer pays 7.3 % and employee pays 7.3 % (plus supplement) • Up to a certain contribution assessment ceiling (as of 2019: € 4,800 per month) – Individual risk‐based rate in case of voluntary private health insurance (option for those who earn more than € 4,800) • Organization – Six types of health insurance funds: AOK, vdek, BKK, IKK, LKK, Knappschaft 112 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Social security in Germany Long‐term care insurance • Purpose – Provides financial support for those dependent on care and assistance from others • Contribution – Rate is set at 2.55 % of the assessable gross wage or salary • Employer and employee each pay one half (except in Saxony) • Same assessment ceiling as for health insurance • Childless people, if their minimum age is 23 and their year of birth is after 1939, pay an additional premium of 0.25 % – Individual risk‐based rate in case of voluntary private insurance • Organization – Long‐term care insurance under the umbrella of health insurance 113 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Social security in Germany Accident insurance • Purpose – Helps an employee regain his earning ability after a work‐related accident • Contribution – Contribution rates are determined based on expenditures in prior years: • In contrast to health, long‐term care, pension and unemployment insurance, accident insurance is contribution‐free for those insured; the costs for insurance coverage are borne by employers (depending on the occupational risk) • Organisation – Deutsche Gesetzliche Unfallversicherung (DGUV) – Landwirtschaftliche Berufsgenossenschaft 114 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Personal income tax in Germany Wages tax • Legal background: Einkommensteuergesetz (EStG) • Employee subject to wages tax – – – Pay‐as‐you‐earn principle, withholding tax (based on monthly salary), Sec. 38 EStG “Monthly estimate” of personal income tax: Allowable against yearly income tax (i.e. considered like a tax prepayment) Different wage tax classes (I to VI) depending on family status etc. • Tax base (example for 2019): Gross salary 12 * € 2,500 = € 30,000 Blanket deduction for income‐related expenses (Sec. 9a EStG) ‐ € 1,000 Provisional lump sum ‐ € 4,653 Blanket allowance for special expenses (Sec. 10, 10a, 10b, 10c EStG) ‐ € 36 Estimated taxable income basis for wage tax € 24,311 – – 115 Applicable tax rate calculated under the principles for personal income tax (calculation see next slide) Result: Wage tax on a yearly basis: € 3,758 (€ 313.16 a month); here: 15.5 % Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Personal income tax in Germany Progressive personal income tax • Calculation acc. to Sec. 32a EStG for 2019 Taxable income Formula Key Up to € 8,652 0 € 8,653 to € 13,669 (993.62 • y + 1,400) • y y=(taxable income – € 8,652)/10,000 € 13,670 to € 53,665 (225.40 • z + 2,397) • z + 952.48 z=(taxable income – € 13,669)/10,000 € 53,666 to € 254,446 0.42 • x – 8,394.14 x=taxable income More than € 254,446 0.45 • x – 16,027.52 x=taxable income – Also consider splitting for married couples 116 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Personal income tax in Germany Church taxes and solidarity surcharge • Church tax – Contribution to a religious community – Rate is 8 % or 9 % of the income/wage tax (relevant assessment basis), depending on the place of residence – Considered as part of the wage tax procedure on a monthly basis (as well as via the income tax declaration on a yearly basis) • Solidarity surcharge – Introduced to finance the Gulf War 1991, later the reunification of Germany: Solidaritätszuschlaggesetz (SolzG) 1995 – Levied from all taxpayers on personal tax (also corporation tax) – Surcharge is currently 5.5 % of the income/wage tax (relevant assessment basis) – Considered as part of the wage tax procedure on a monthly basis (as well as via the income tax declaration on a yearly basis) 117 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Illustrative example Monthly gross salary € 2.500, unmarried, no children, wage tax class 1, born 1991, protestant, living in Berlin Employee • Health insurance 14.60 % (+1.10%) 210.00 € • LT care insurance 2.55 % (+0.25%) 38.13 € • Pension insurance 18.70 % 233.75 € • Unemployment insurance 3.00 % 37.50 € Social security charges 519.38 € 1,980.62 € Subtotal • Wage income tax • Church tax • Solidarity surcharge Total tax and charges Net salary: 118 Kotulla/Biethahn/Helms/Morich 12.5264 % 9.00 % 5.50 % Employer 182.50 € 31.88 € 233.75 € 37.50 € 485.63 € 313.16 € 28.18 € 17.22 € 877.94 € 1,622.06 € University of Applied Sciences Europe Financial Accounting Payroll accounting Payment procedure • Social security contributions – Employers submit these contributions as an overall social insurance contribution (including the share of the employee) to the health insurance fund (collection office); exception: UV (direct payment to the UV carrier); the collection offices then forward the contributions designated for other insurances to the responsible authorities • Wage/Income taxes, church tax, solidarity surcharge – Employee is subject to wage tax, church tax and solidarity surcharge – However, employer has to calculate, deduct from the monthly salary and pay these taxes to the responsible tax authority 119 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Payroll accounting Which accounts are basically affected? Balance sheet accounts (Cr) Expenditure accounts (D) Net salary Gross salary 43 Personnel expenses 10 Cash or 11 Bank (Payment to employee) Income taxes Employee‘s social insurances share 17 Other payables 44 Social security and similar costs 120 Kotulla/Biethahn/Helms/Morich Employer‘s social insurances share University of Applied Sciences Europe Financial Accounting Exercise Example 6: Payroll accounting Post the journal entries. 1. Salary payments by bank transfer: Gross salaries € 33,000, income wage taxes € 4,500, church taxes € 400. Social security: employee’s and employer’s share € 6,000 each. 2. Salary payments in cash: gross salaries € 22,000, income wage taxes € 3,000, church taxes € 250. Social security: employee’s and employer’s share € 4,000 each. 3. Payment of social security contributions to the collection office on the 10th of the following month by bank transfer. 121 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 8 Questions for self‐review • Which social security insurances do exist? • How are social security charges considered when accounting for payrolls? • How do you calculate church taxes? • What is the solidarity surcharge? • Which social security insurances are paid solely by the employer‘s side? 122 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 9th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 123 Initial and subsequent measurement of fixed assets Nature and extent of purchase‐ and production cost Accounting for amortization of fixed assets Depreciation methods Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Introduction to fixed assets Starting point • Fixed assets = property, plant and specific equipment: – Items that are held • for use in the production or supply of goods or services, • for rental to others, or • for administrative purposes; and – are expected to be used during more than one period – i.e. not transformed, machined or sold during the production process • Keep them in the balance sheet unchanged? – Similar question for intangible assets (software, license) 124 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Introduction to fixed assets Structure of this session • Initial measurement – Acquisition of fixed assets • Purchase costs – Production of fixed assets • Production costs • Subsequent measurement – Allocation of cost over time: Amortization – Depreciation methods? 125 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Initial measurement Purchase costs are… Purchase costs comprise the expenditures incurred in order to acquire an asset and bring it to working condition to the extent that they can be allocated to the specific asset. Purchase price reductions shall be deducted. … also includes incidental expenses Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management including import duties and non‐refundable purchase taxes. … and subsequent purchase costs Expenses incurred after the commissioning of the asset for a substantial improvement or change in its use purpose. Do not consider regular maintenance costs (incurred as expense instead). 126 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Initial measurement Determine purchase costs • Example: Purchase of machinery, € 100,000 net. Transportation cost € 1,000, transportation insurance € 500. Two weeks later, an IT interface is delivered (purchase price € 1,000 net) to control the machine. • How do you initially measure the machinery at its acquisition date? 127 Type of cost Explanation Purchase price 100,000 € • Deducting trade discounts e.g. cash discounts, bonuses: € 0 • Directly attributable costs Incidental expenses for transportation: € 1,500 • Subsequent costs Terminal necessary for the machine to be capable of operating in the manner intended: € 1,000 = Total purchase costs € 102,500 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Subsequent measurement Amortization of fixed assets Depreciation (scheduled) • Purchase‐ or production cost of fixed assets with finite useful lives shall be reduced by depreciation Predictable, regular development Impairment (unscheduled) • Write down to the lower of cost or market value if impairment is expected to be permanent Unforeseeable extraordinary events Any amortization of an asset reduces its carrying amount and therefore represents an economic outflow of resources. Considered as expense in the profit & loss statement. 128 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Subsequent measurement Regular depreciation charge • The depreciation (tangible) or amortization (intangible) schedule shall allocate the purchase‐ or production cost over the financial years in which the asset is expected to be used. Start when it is available for use Depreciable amount total costs Useful life defined in terms of the asset’s expected utility expected usage (by reference to capacity or physical output) expected physical wear and tear technical or commercial obsolescence legal limits Account for the depreciation charge on expense account: 23 Depreciation (Debit entry) Counterpart is a reduced carrying amount of the fixed asset (Account No. 00 – 05) 129 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Subsequent measurement Depreciation methods • A depreciation method reflects the pattern in which the asset’s future economic benefits are expected to be consumed by the entity Depreciation method Description Formula Straight line depreciation Same depreciation is charged over the entire useful life. Depreciation expense = (depreciable amount) / useful Life Reducing balance depreciation Depreciation expense decreases at a constant rate as the life of an asset progresses. Depreciation expense = (residual depreciable amount) x Rate % Sum of the year' digits depreciation Depreciation charge declines by a constant amount as the life of the asset progresses. Depreciation expense = [(un‐depreciated useful life + 1) / sum of the years' digits] x depreciable amount Units of production method Depreciation charge varies each period in proportion to the change in level of activity. Depreciation expense = (value of work certified as complete / total expected production or usage) x depreciable amount Depreciable amount = purchase‐ or production cost – residual value when the asset is sold at the end of the useful life 130 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Subsequent measurement Illustrative Example • Illustration based on the following information: – Cost of fixed asset: € 100,000 (Residual value = 0) – Useful life: 4 Years – Total machine hours: 20,000 – Rate of depreciation: 40% (for calculating depreciation using reducing balance method) 131 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Exercise Example 7: Amortization of fixed assets Post the journal entries! (10% VAT) 1. Purchase of a car by bank transfer, given the following information: • Purchase price: Gross amount € 132,000 • Date of purchase: January 1, 2019 • Useful life of the car: 5 years Prepare a depreciation schedule on a yearly basis, including the depreciation charge and carrying amount of the car at the end of the years 2019 to 2023. Then post the journal entries for the amortization process until 2023. Consider two different options of depreciation methods: 2. Straight line 3. Sum of the years’ digits method 132 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 9 Questions for self‐review • Please explain the basic concept of amortization. • What is the difference between depreciation and impairment of fixed assets? • What depreciation methods do you know and what are their differences in economic substance? • Which depreciation method do you think an entity will prefer a) to short‐time minimize taxable profits b) to short‐time maximize distributable profits to shareholders? • Does the carrying amount of a regularly depreciated fixed asset necessarily reflect its fair value? What might be reasons for or against this assumption? 133 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 10th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • Impairment of trade receivables • Considering VAT adjustments • Taking into account later settlements of impaired receivables 134 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Impairment of receivables 1 Base Case: Journal entries for the initial sale • • • • Sale of trading goods (net amount 10,000 €) on account (credit term 30 days) No doubt about the collectability in the future Date of sale: October 20, 2019 Seller expects the customer to pay the bill during the granted credit term Debit € Credit € Assets E&D 14 Trade receivables 14 Trade receivables 11,000 85 Sales of goods 10,000 Debit (+) Credit (‐) 85 Sales of goods Debit (‐) 10,000 11,000 174 Payables from VAT Credit (+) 1,000 174 VAT Debit (‐) Credit (+) 1,000 135 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Impairment of receivables 2 Level 1: Journal entries for a doubtful account receivable • • • • Doubts about the future collectability of the trade receivables E.g. customer has not paid the bill within the credit term and has liquidity problems Reporting date: December 31, 2019 Separating these doubtful accounts from the other trade receivable, just for presentation reasons, no measurement adjustments yet Debit € Credit € Assets E&D 14 Trade receivables 14a Doubtful debts 11,000 14 Trade receivables 11,000 Debit (+) Credit (‐) 11,000 14a Doubtful debts Debit (+) Credit (‐) 11,000 136 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Impairment of receivables 3 Level 2: Journal entries for a very doubtful account receivable • • • • • Serious doubts about the future collectability of the trade receivables E.g. arranging a settlement out of court with the customer that he will pay 10% only Reporting date: December 31, 2019 Impairment of the doubtful accounts to the amount envisaged in the arrangement No VAT adjustments yet Debit € Credit € Assets E&D 14a Doubtful debts 48 Imputed costs 9,000 14a Doubtful debts 9,000 Debit (+) Credit (‐) 9,000 48 Imputed costs Debit (‐) Credit (+) 9,000 Loss in the P&L! 137 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Considering VAT adjustments Adjustments to VAT • VAT constitutes a liability towards the tax authorities. It is based on the taxable amount, i.e. the consideration receivable from the customer. • Doubts about the collectability of this considerations are not sufficient to declare a reduced taxable amount towards the tax authorities. – Liabilities from VAT remain unchanged and impairments of the trade receivable are based on its net amount. • A VAT adjustment is only accepted by tax authorities, if it is virtually certain that a certain portion or all of the taxable amount is no longer collectable. 138 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Considering VAT adjustments Adjustments to VAT • Alternative: The customer’s insolvency proceedings have started (in this case, 100% initial write‐down). • Future adjustment to the taxable amount and the liable VAT might be necessary if the initial assessment of the envisaged collectable share needs to be changed (e.g. the entity gets a share of its outstanding receivables as part of the later insolvency procedures) 139 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Impairment of receivables 4 Level 3: Journal entries for an uncollectable account receivable • • • • • 100% Assurance about the uncollectability of 90% of the trade receivables Customer pays 10% in December 2019 as envisaged in the settlement arrangement Reporting date: December 31, 2019 Write‐off of the uncollectable accounts in the amount lost due to the arrangement Adjusting the liable VAT Debit € Credit € Assets E&D 174 VAT 11 Bank 11 Bank 174 Payables from VAT 1,100 14a Doubtful debts 900 2,000 Debit (+) Credit (‐) Debit (‐) Credit (+) 900 1,100 14a Doubtful debts Debit (+) Credit (‐) 2,000 140 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Impairment of receivables Summarizing the examples 1 Trade receivables / gross amount: € 11,000 Trade receivables, net amount: € 10,000 2 141 VAT € 1,000 Trade receivables get doubtful / gross amount: € 11,000 3 90 % impairment Based on the net amount of € 10,000 (i.e. € 9,000) VAT € 1,000 4 Customer pays the remaining 10 % as envisaged / gross amount: € 1,100 VAT reduction of € 900 Liable for VAT of € 100 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Settlements of impaired receivables Excursus: Journal entries for a changed uncollectable receivable (–) • • • • • Surprise: Changed uncollectability of 95% of the trade receivables Customer pays 5% in January 2020 which is even less than envisaged in the arrangement Reporting date: December 31, 2020 Write‐off of an additional uncollectable amount of 5% Adjusting the liable VAT and considering an operating expense from other accounting periods Debit € Credit € Assets 11 Bank 142 550 14a Doubtful debts 174 Payables from VAT 950 26 Oper. Exp. other periods 500 Kotulla/Biethahn/Helms/Morich 2,000 E&D 174 VAT 11 Bank Debit (+) Credit (‐) Debit (‐) Credit (+) 550 950 14a Doubtful debts 26 OpEx. oth. period Debit (+) Credit (‐) 2,000 University of Applied Sciences Europe Debit (‐) Loss in the P&L! Credit (+) 500 Financial Accounting Settlements of impaired receivables Excursus: Journal entries for a changed uncollectable receivable (+) • • • • • Surprise: Changed uncollectability of 85% of the trade receivables Customer pays 15% in January 2020 which is more than envisaged in the arrangement Reporting date: December 31, 2020 Reversal of a uncollectable amount of 5% Adjusting the liable VAT and considering an operating income from other accounting periods Debit € Credit € Assets 11 Bank 174 Payables from VAT 1,650 14a Doubtful debts 2,000 850 26 Oper. inc. other periods 500 E&D 174 VAT 11 Bank Debit (+) Credit (‐) Credit (+) 850 1,650 14a Doubtful debts Debit (+) Debit (‐) Credit (‐) Gain in the P&L! 26 OpIn. oth. period Debit (‐) Credit (+) 2,000 143 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe 500 Financial Accounting Exercise Example 8: Doubtful debt and VAT Post the transactions in T‐accounts and prepare the journal entries (10% VAT) for 2019 and 2020. 1. Sales of trading goods as of November 15, 2019 on account to customer Miller, net amount € 100,000. 2. As of November 31, 2019, Miller faces some liquidity problems. 3. As of December 31, 2019, you arrange a settlement out of court with the customer that he will pay 50% only. 4. Case 1: As of January 31, 2020, Miller pays 50% by bank transfer as envisaged in the settlement arrangement. 5. Case 2: As of January 31, 2020, Miller pays only 10%, i.e. less than envisaged. 6. Case 3: As of January 31, 2020, Miller pays only 80%, i.e. more than envisaged. 144 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 10 Questions for self‐review • Are impairments relevant for current assets? In which cases? Why? • Please describe how to account for trade receivables which become doubtful, need to be impaired and are settled to a certain extent in the future? • What do you need to consider regarding VAT in the context of impairment of trade receivables? 145 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 11th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • • • • 146 Introducing provisions Recognition‐ and measurement principles Accounting for provisions Use, change and reversal of provisions Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Introduction to provisions Provisions ... • … are a specific type of debt – separate chapter on the debt side of the balance sheet • … are present obligations of the entity – of uncertain timing or amount – arising from past events – the settlement of which is expected to result in a financial outflow from the entity • Purpose: To account for the true and fair financial performance of the entity for the reporting period 147 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Introduction to provisions Types of provisions acc. to Sec. 249 HGB • Provisions for 1. uncertain obligations 2. expected losses from executory contracts 3. expenses for deferred maintenance 4. expenses for deferred land restoration 5. warranty expenditures • Under German GAAP, provisions may not be recognized for other reasons 148 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Recognition 1. Provisions for uncertain obligations • Recognition criteria – “Certain” probability that the future outflow will occur – Obligation towards a third party – Reliable estimate of the obligation – Based on an event before the end of the reporting period 149 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Recognition 2. Provisions for expected losses from executory contracts • Executory contract = contract in which the rights and obligations of both parties have not yet been fulfilled • Recognition criteria – Present obligation under a contract… • in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it • Alternatively: The unavoidable costs can be the cost of exiting from the contract (if these costs are lower) 150 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Recognition 3. – 5. Other types of provisions 3. Provisions for deferred maintenance expenses – if deferred from the financial year to the first three months of the following year 4. Provisions for deferred land restoration – if deferred from the financial year to the following year 5. Provisions for warranty expenses – incurred with or without a contractual obligation 151 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Measurement Measurement of provisions acc. to Sec. 253 HGB • Core principle – Provisions are recognized at the settlement amount dictated by prudent business judgement in accordance with the prudence principle • Long‐term provisions – Provisions with a maturity of more than one year shall be discounted using an appropriate market interest rate (under German GAAP, this is a seven‐year average interest rate) • Pensions – Specific measurement principles apply to provisions for post‐employment obligations or similar long‐term obligations (e.g., specific mathematical procedures for risk capture) 152 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Use, change and reversal of provisions • Initial recognition of a provision The initial recognition of a provision shall be considered in the expenditure account reflecting the type of expenses that are expected to occur in future periods from the obligation Assets Equity & Debt 4… Expenditure Debit (‐) Credit (+) X 08 Provisions Debit (‐) Credit (+) X • Subsequent changes or use a. A provision shall be used only for expenditures for which the provision was originally recognized. b. Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. c. If it is no longer probable that an outflow of resources embodying economic benefits will be required for settlement, the provision shall be reversed. 153 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Journal entries Provision for income taxes Please post the journal entry for 2019. • December 15, 2019: For the current period you expect to pay an additional trade income tax of € 3,000 in the course of 2020 • Mandatory recognition of a provision for uncertain obligations from income taxes: 154 Year Debit 2019 46 Income taxes Kotulla/Biethahn/Helms/Morich Amount Credit € 3,000 08 Provisions University of Applied Sciences Europe Amount € 3,000 Financial Accounting Journal entries Provision for income taxes Please post the journal entry for 2020. • January 15, 2020: The additional trade income tax of € 3,000 is paid in the amount as previously estimated • Use of the provision for uncertain obligations from income taxes for expenditures for which the provision was originally recognized: 155 Year Debit 2019 46 Income taxes € 3,000 08 Provisions € 3,000 2020 08 Provisions € 3,000 11 Bank € 3,000 Kotulla/Biethahn/Helms/Morich Amount Credit University of Applied Sciences Europe Amount Financial Accounting Journal entries Provision for income taxes Please post the journal entry for 2020. • January 15, 2020: An additional trade income tax of € 3,500 is paid in an amount higher than previously estimated • Use of the provision for uncertain obligations from income taxes for expenditures for which the provision was originally recognized, but actual expenditure are higher than expected! 156 Year Debit 2019 46 Income taxes € 3,000 08 Provisions € 3,000 2020 08 Provisions 26 Operating expense for other accounting period € 3,000 11 Bank € 500 € 3,500 Kotulla/Biethahn/Helms/Morich Amount Credit University of Applied Sciences Europe Amount Financial Accounting Journal entries Provision for income taxes Please post the journal entry for 2020. • January 15, 2020: An additional trade income tax of € 2,500 is paid in an amount lower than previously estimated • Use of the provision for uncertain obligations from income taxes for expenditures for which the provision was originally recognized, but actual expenditure are lower than expected! 157 Year Debit 2019 46 Income taxes € 3,000 08 Provisions € 3,000 2020 08 Provisions € 3,000 11 Bank 26 Operating income for other accounting period € 2,500 € 500 Kotulla/Biethahn/Helms/Morich Amount Credit Amount University of Applied Sciences Europe Financial Accounting Exercise Example 9: Provisions Post the 2019/2020 journal entries for the following transactions. 1. Receiving an official letter on December 15, 2019 to pay property tax of € 700 for 2019 within the next four weeks. 2. Provisions for pensions increase by € 13,500. 3. Recognizing a provision with regard to a court case, best estimate amounting to € 60,000 as of December 31, 2019. 4. As of January 15, 2020 the actual final costs of that court case add up to € 65,000, paid by bank transfer. 5. As of January 15, 2020 the trade income tax supplementary payment is set to € 3,000. Last year‘s estimate as reflected in the corresponding tax provision amounted to € 4,000. 158 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Wrap‐up of Lesson 11 Questions for self‐review • What is the difference between provisions and reserves? • What types of provisions do we distinguish under German GAAP? In which (sub‐)chapters of the balance sheet are they presented? • How do you account for the use, the change and the reversal of provisions? 159 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Agenda 12th Lesson 1 Fundamentals about accounting 2 Inventory and balance sheet as the starting point of bookkeeping 3 Breakdown of the balance sheet into accounts 4 Accounting for core business transactions 5 Relation of financial and management accounting Topics today • Link between financial accounting and management accounting 160 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Financial accounting vs. management accounting Structuring the income‐ and expenditure accounts Income/Expense Operating Actual period Ordinary Non‐operating Other periods Extraordinary Income/Revenue Expense/Costs Acc. No. 8 … Acc. No. 4 … Nonoperating and similar income and expense Acc. No. 25 Acc. No. 26 Acc. No. 20‐24 Management accounting 161 Kotulla/Biethahn/Helms/Morich University of Applied Sciences Europe Financial Accounting Joint industrial standard chart of accounts Class 0: Fixed assets and long-term debt and equity 00 Land and buildings 01 Plant 02 Factory equipment 03 Office equipment 04 Other fixed assets 05 Other long-term assets 06 Long-term debt / Bank loans 07 Equity 08 Provisions 09 Deferred Income&Expense Class 1: Working Capital 10 Cash 11 Bank accounts 12 Notes receivable, cheques 13 Securities 14 Trade receivables 14a Doubtful debts 15 Other receivables 154 Receivables from input VAT 16 Trade payables 17 Other payables 174 Payables from VAT 18 Notes payable 19 Private accounts Class 2: Nonoperating and similar income and expense 20 Non-operating income and expense 21 Gains and losses from land and buildings 23 Depreciation 24 Interest income and expense 25 Operating extraordinary income and expense 26 Operating income and expense for other accounting periods 27 Allocation of operating costs for other accounting periods 28 Allocation of imputed costs Class 3: Inventories 30 Raw material 33 Consumables 34 Supplies 38 Purchased goods inventories 39 Merchandise inventories Class 4: Cost elements 40 Cost of raw material 41 Cost of consumables and supplies 42 Energy, fuel and similar costs 43 Personnel expenses (Wages and salaries) 44 Social security and similar costs 45 Maintenance and purchased services 46 Taxes, levies, fees, insurances and similar contributions 47 Rental, office, marketing and similar overhead costs 48 Imputed costs 49 Special direct costs Class 5: Cost Center empty Class 6: Cost Center empty Class 7: Finished goods inventories and work in progress 78 Work in progress 79 Finished goods Class 8: Revenues 83 Sales of goods and services 85 Sales of merchandise 86 Sales from secondary business 87 Other own work capitalised 88 Write downs, discounts, revenue reversals 89 Increase or decrease in finished goods inventories and work in progress Class 9: Closing accounts 98 P&L accounts 980 Result from ordinary activities 985 Allocated results 988 Profit distribution 989 Profit and loss account 99 Balance sheet accounts 998 Opening balance account 999 Closing balance account
