Financial Accounting Pre-Master

Financial Accounting
Pre-Master 2022
Michael.Epping@munich-business-school.de
This class in financial accounting
“Accounting is the language of business“
But you often see nothing else than … “Rules, rules, rules“
-> Unfortunately every language requires some grammar!
Aim of this class

Learn the rules (“grammar”), but a major focus is on applying these rules
preparing information accordingly (“speak”) and interpret the information
provided (“understand”).
Contents
1. Introduction to financial accounting

2. Basic financial statements and wrap-up bookkeeping
3. Non-current assets
1. Property, plant and equipment
2. Intangible assets
3. Financial assets
4. Current assets
1. Inventories
2. Receivables and current financial assets
5. Provisions and liabilities
6. Equity
7. Financial statement analysis
1. Capital structure analysis
2. Profitability analysis
1. The accounting discipline
Corporate Accounting
Management Accounting Financial Accounting

(internal) (external)
Planning,
Cost Accounting
Budgeting etc. “Record transactions to
provide information to
external parties”
1. The use of financial accounting information
Financial Accounting Information
Decision Making Stewardship
Accountability of management,
Decision useful information for
Determination of legal and
investors
contractual claims
“Future oriented: How will the
“Past oriented: How did the
company perform?”
company perform?”
1. Different addressees have differing information needs
Equity Investors
Lenders, Creditors
Government, Other Regulatory Bodies
Employees
Suppliers and other trade creditors
Customers
The Public
1. The international accounting landscape (overview)
Anglo-American influence
Continental European influence
1. Different philosophies
Continental European Accounting Anglo-American Accounting (e.g.

(e. g. Germany), United States, UK),
relatively strong tradition of debt relatively strong tradition of equity
financing through “house banks” financing through stock markets
Information
Protection of debt investors
True and fair view /
Prudence/conservatism
fair presentation
Capital protection by limiting Investment decision relevant

distributions to shareholders information (decision
usefulness)
Private standard setter as provider
Legislative as provider of GAAP*
of GAAP*
- Laws as GAAP
- Standards as GAAP
*Generally Accepted Accounting Principles

1. The international accounting landscape: Global accounting standards
• IFRSs (International Financial Reporting Standards) mandatory at least for consolidated

financial statements of capital market oriented companies in the European Union
(Regulation (EC) 1606/2002).
• IFRSs applied in more than 100 countries worldwide (partly in modified versions).
• Convergence of IFRS and US-GAAP – foreign issuers do not need 20F reconciliation
anymore.
• China and India are or are going to be IFRS countries.
Why do we strive for global accounting standards?

 Globalization of corporate activities creates global competition (also for capital) and
brings along increased activity on international capital markets. These developments
provide the rationale for globally comparable information!
Why are there still local accounting standards?
 IFRS are considered to be more complex and costly to implement. Local laws require
local accounting regulations, like in Germany EStG (for taxation) or AktG (for dividend
distributions).
A Common Set of Global Accounting Standards
The IASB works with national accounting standard setters to move toward global
convergence.
To date, nearly 100 countries have converged (require or allow IFRS) or are on the path
to convergence.
10
1. Regulatory developments in Germany
1998: KapAEG (“Kapitalaufnahmeerleichterungsgesetz “ / “Law to facilitate the raise of

capital”) allows capital market oriented companies to prepare their consolidated
financial statements according to US-GAAP or IFRS/IAS instead of local standards.
2004: Implementation of EU Regulation 1606/2002 through the BilReG
(“Bilanzrechtsreformgesetz” / “Accounting Law Reform Act”). IFRS are required for
consolidated financial statements of capital market oriented companies up from Jan 1st
2005.
2009: BilMoG (“Bilanzrechtsmodernisierungsgesetz” / “Accounting Law Modernization
Act”) is intended to increase the convergence of German GAAP (HGB) while maintaining
the format of the HGB.
2015: BilRUG (“Bilanzrichtlinie-Umsetzungsgesetz” / “Accounitng Directive
Implementation Act”) implements current EU Accounting Directives into German law
with major objectives such as the relief of small and medium sized entities from costly
regulations and the further harmonization of local regulations within the EU.
1. Current regulation in Germany
Capital market oriented Not capital market

companies oriented companies
Consolidated financial IFRS IFRS optional

statements (§ 315a HGB) (§ 315a HGB)
Separate (legal entity)

HGB HGB
financial statements
On the legal entity level and for not capital market oriented companies EU regulation
equipped its member states with the option to decide according to which GAAP the
companies have to report.
Financial Statements according to German GAAP are required for determining dividend
distributions to the shareholders of a company according to the German Stock
Corporation Law (AktG) as well as for the determination of income taxes according to the
respective tax regulations (EStG, GewStG, KStG) (“principle that tax accounting should be
based on commercial accounting”/ “Maßgeblichkeitsprinzip”).
1. Simplified overview: Components of a complete set of annual
financial statements according to German Commercial Code
Separate legal entity Separate legal Consolidated
Components of Financial
(Sole proprietorship, entity Financial Statements
Statements
commercial partnerships) (Corporations) (Corporations)
Balance Sheet (or Statement of
Financial Position)
✓ ✓ ✓
Income Statement ✓ ✓ ✓
Notes to the Financial
Statements
 ✓ ✓
Management commentary/
MD&A (“Lagebericht”)
 ✓ ✓

Statement of CashFlows  ✓
Statement of Changes in Equity   ✓
Segment Reporting   ✓
✓ Mandatory  Optional
1. Local accounting regulations in Germany: German Commercial Code
(“Handelsgesetzbuch”/ “HGB”) – Overview of regulations
Local accounting regulations in Germany are defined in the third book of German Commercial
Code (“Handelsgesetzbuch”/ “HGB”). Key subsections for the preparation of financial statements:
1.Section: General accounting regulations for all types of businesses which are required to
keep books and records according to §238 Sec. 1 HGB, i.e. business that have no separate
legal personality like a sole proprietorship or a commercial partnership (“e.K.”, “oHG”) as
well as businesses with a separate legal personality like corporations (“AG”, “GmbH”).
2.Section: Additional accounting regulations for corporations like for the management
commentary (§ 289 HGB), consolidated financial statements (§290 et seq. HGB) or for
auditing and publishing the financial statements (§316 et seq. HGB and § 325 et seq.,
respectively).
Sections 3 and 4 contain specific accounting regulations for cooperatives or financial
institutions.
Sections 5 and 6 set the regulatory framework for a private standard setting committee in
Germany (“Deutsches Rechnungslegungs Standards Committee”/ “DRSC”) which has an
advisory function for the legislative bodies as well as for the enforcement of the IFRS by the
German Financial Accounting enforcement body (“Deutsche Prüfstelle für
Rechnungslegung”/ “DPR”).
1. German Commercial Code (“Handelsgesetzbuch”/ HGB) – Key
requirements for annual financial statements (I)
Overall objective: “…provide a fair presentation of a company‘s financial position and

financial performance…“ (§ 264 Sec. 2 HGB)
A complete set of financial statements consists at least of a balance sheet and an income
statement for sole proprietorships and commercial partnerships (§ 242 Sec. 3 HGB).
For corporations a complete set of financial statements requires a balance sheet, an
income statement and notes to these statements. These statements have to be
supplemented by a management report (except for small corporations§264 Sec. 1 HGB).
Parent companies located in Germany have to prepare consolidated financial statements
(§ 297 Sec. 1 HGB):
▪ Consolidated financial statements aggregate the separate legal entity financial
statements of the companies forming the group (i.e. the parent company and its
subsidiaries). The consolidated financial statements of a group present the group of
legal entities as if they were one single economic entity.
▪ Next to the consolidated balance sheet, the consolidated income statement, the notes
to theses financial statements and a management commentary, the consolidated
financial statements of a group also require the preparation of a statement of cash
flows and a statement of changes in equity. Additionally, the preparation of segment
information is optional. (§ 297 Sec. 1 HGB).
requirements for annual financial statements (II)
Consolidated financial statements of capital market oriented companies have to be

prepared according to IFRS (§ 315a Sec. 1 HGB).
 Consolidated financial statements according to German Commercial Code have to
be prepared only by not capital market oriented companies located in Germany.
A capital market oriented company is a company that either has
▪ equity (e.g. “shares”) or
▪ debt (e.g. “bond”)
listed in a public market (or has applied for such a listing).
Any capital market oriented company has to present a complete set of annual financial
statements consisting of balance sheet, income statement, notes to financial
statements, statement of cash flows and statement of changes in equity.
 This rule applies to companies which are not a parent company and therefore do
not have to prepare consolidated financial statements.
 Same information shall be provided to all investors independent from whether the
capital market oriented company is a parent company or not.
requirements for annual financial statements (III)
For corporations thresholds exist which classify them into small, medium and large corporations
(§ 267 HGB): Criterion Total assets Revenue Employees
extra small ≤ EUR 350k ≤ EUR 700k ≤ 10
small ≤ EUR 6m ≤ EUR 12m ≤ 50
medium ≤ EUR 20m ≤ EUR 40m ≤ 250
large > EUR 20m > EUR 40m > 250
Classification depends on the fulfillment of two out of three criteria on two consecutive closing
dates. The classification determines the level of detail of the information to be reported by the
companies, e.g. more detailed structure of balance sheet or income statement (e.g.§266 Sec.
1, Sent. 3 HGB) or more extensive disclosures in the notes to financial statements (§288 HGB)
as well as auditing (§316 HGB) and publication requirements (e.g.§326 HGB).
Independent from their legal from, large companies have to prepare their financial statements
according to the requirements of a large corporation (e.g. large commercial partnerships) (§ 5
PublG/ “Publizitätsgesetz”/ “Company Disclosure Law”). Classification depends on the
fulfillment of two out of three criteria on two consecutive closing dates (§1 Sec. 1 PublG).
Criterion Total assets Revenue Employees
Large company > EUR 65m > EUR 130m > 5000
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
2. Balance sheet – Presentation
The balance sheet presents all current and non-current assets, equity, liabilities as well
as prepaid expenses and deferred income (§247 Sec. 1 HGB).
Aggregated presentation according to §266 Sec. 2 HGB:
Assets Equity and Liabilities
Non-current assets Equity
Intangible assets Subscribed capital
Property, plant and equipment Capital reserve
Financial assets Retained earnings
(Net income of current period/ pervious
Current assets periods’ unappropriated net income)
Inventories Provisions (e.g. for pensions, taxes or others)
Receivables and other assets Liabilities (e.g. liabilities to banks, trade
payables, advance payments received)
Securities Deferred income
Cash and cash equivalents Deferred tax liabilities
Prepaid expenses
Deferred tax assets
Asset resulting from offsetting
Total Total
2. Balance sheet – Recognition of assets and liabilities (I)
Recognition addresses the question “which items have to be presented on the balance
sheet”:
 All items that fulfill the definition of an asset or a liability have to be recognized.
Key characteristics of an asset for the recognition according to HGB:
▪Economic value („ability to generate benefits“)
▪Value is separately measurable and can be realized separately
Key characteristics of a liability for the recognition according to H GB:

▪ Existent or expected reduction of the net assets of a company that…
▪ … results from a legal or economic obligation of the company and whose…
▪ … value is separately measurable.
2. Balance sheet – Recognition of assets and liabilities (II)
Basic regulations for recognition are specified in §§ 246 – 251 HGB.

Those regulations embrace more explicit guidance that certain expenditures do not lead
to the recognition of an asset such as
▪ those for the foundation of a company,
▪ for raising equity or
▪ for the conclusion of insurance contracts (§248 Sec. 1 No. 1-3 HGB).
There are regulations explicitly prohibiting the recognition of certain assets like
internally developed brands, publishing titles or customer lists etc. (§248 Sec. 2 HGB).
Also for the liabilities side there is an explicit regulation that no other provisions than
those explicitly stated in the HGB are allowed to be recognized (§249 Sec. 2 HGB).
 Explicit regulations limit management discretion in preparing financial statements and

assure the objectivity of financial statements. This leads to a better comparability
between the financials of different companies.
2. Balance sheet – Measurement
Measurement addresses the question “at which value assets and liabilities are recognized on
the balance sheet”. The values have to be determined at first time recognition of the
respective assets and liabilities (“initial measurement”) and in subsequent periods
(“subsequent measurement”).
Basic regulations for measurement are specified in §252 – 256a HGB.
▪ Assumption for the measurement of assets and liabilities: “going concern” (§252 Sec. 1 No.
2 HGB).
▪ Assets and liabilities have to be measured separately on the level of the single assets or
liability (§252 Sec. 1 No. 3 HGB).
▪ Measurement of assets and liabilities has to be made in a prudent manner (“prudence
principle”), i.e. all anticipated risks and losses have to be recognized whereas gains are only
allowed to be recognized when they are realized (“imparity”) (§252 Sec. 1 No. 4 HGB).
▪ Assets are measured at acquisition or production costs reduced by depreciation or, if
required, impairments (§253 Sec. 1 HGB).
▪ Liabilities are measured at their maturity value (§253 Sec. 1 HGB).
▪ For measurement of provisions “a reasonable commercial assessment” has to be conducted
(§ 253 Sec. 1 HGB).
2. Income statement – Presentation
The income statement can be presented either according to the “nature of expense” or the
“cost of sales” method (§275 Sec. 1 HGB). Depending on which method is applied the
following (aggregated) presentation is prescribed in § 275 Sec. 2 HGB:
Nature of expense method Cost of sales method
Revenue Revenue
+ Increase/ - Decrease in finished goods inventories - Cost of sales
+ other own work capitalized Gross profit
Gross output Research and development expenses
Material expenses Selling expenses
Personnel expenses General administrative expenses
Depreciation Other operating income
Other operating income Other operating expenses
Other operating expenses Operating income (EBIT)
Operating income (EBIT) Income from investments
Income from investments Interest income
Interest income Interest expenses
Interest expenses Income before taxes (EBT)
Income before taxes (EBT) Income taxes
Income taxes Net income
Net income
2. Income statement – Nature of expense vs. Cost of sales method
Nature of expense method

▪ Presents the gross output revenue, change in (finished goods) inventories and other own
work capitalized) generated in a period and the corresponding expenses of the period
(irrespective of whether the output has been sold or not).
▪ The expenses are presented according to their nature (material expenses, personnel
expenses, depreciation).
▪ Advantage: Provides information on the nature of the costs required for running the
business. Disadvantage: No information on the costs incurred for certain activities like
production or research and development.
Cost of sales method
▪ Presents the revenue generated in a period and the corresponding expenses incurred for
the production as well as the expenses for other activities required for running the
business.
▪ The expenses are presented according to their function (production, research and
development, selling, administration).
▪ Advantage: Provides information on the costs of the activities required for running the
business. Disadvantage: No information on the nature of the costs incurred. More complex
and somewhat discretionary allocation of costs to functions is required.
2. Statement of cash flows: Overview
Information on the origin (cash inflows) and the use (cash outflows) of liquid funds regarding
− operating activities (collection of revenues, receivables, payment of payables)
− investing activities (investments in property, plant & equipment, intangibles)
− financing activities (dividend or interest payments, capital contributions)
 Information on the ability of a company to generate cash and the use of cash
Basic structure of a cash flow statement
Cash flows from operating activities

+/- Cash flows from investingactivities
+/- Cash flows from financing activities
= Change in liquid funds for the reporting period
+ Amount of liquid funds at the beginning of the period
= Amount of liquid funds at the end of the period
2. Statement of cash flows: Why cash flows?
Cash is required to fund the operations of a company.

Cash flow information…
▪ … is useful in assessing the ability of a company to generate cash and cash
equivalents.
▪ … is helpful to assess the operating performance of a company by examining the
relationship between profitability and cash flow.
▪ … enhances the comparability because it eliminates the effects of using different
accounting treatments for the same transactions and events.
▪ … enables users to develop models to assess and compare the present value of the
future cash flows of different companies.
 Assessmentof performance and cash management

 Elimination of accounting policy choices
 Valuation
2. Statement of cash flows: Preparation
Common approach for the preparation of the statement of cash flows:

▪ Cash flows from operating activities: Indirect method
▪ Cash flows from investing and financing activities: Direct method (report the actual
cash payments)
Basic principle for indirect calculation:

Apply a profit measure (net income or EBIT etc.) as starting point and adjust it for non-cash
income and expenses and cash flows not recognized in statement of income. Examples:
Depreciation, amortization and impairments, investments in non-current assets such as
property, plant and equipment, repayment of liabilities.
=> Reconciliation of measure of profitability (net income or EBIT) with measure of cash flow
General rule for preparing the statement of cash flows the indirect way:
“An increase (decrease) of an asset account over a period is subtracted (added) from (to)
net income to calculate cash flows.”
“An increase (decrease) of a liability or equity account over a period is added (subtracted) to
(from) net income to calculate cash flows.”
2. Statement of changes in equity
Presentation of the development of equity during the reporting period

Simplified illustration (for more detail see section 6 on equity)
Equity as of fiscal year beginning
+ Capital increases/ - Capital reductions
+ Net income of the period
- Dividend distributions
Equity as of fiscal year end

2. Wrap-up bookkeeping (I)
Double-entry accounting Normal Balance: Credit

Equity Accounts
Normal Balance: Debit
Debit (Dr) Credit (Cr)
Asset Accounts
- (decrease) + (increase)
+ (increase) - (decrease)
Liability Accounts
Expense/Loss Accounts - (decrease) + (increase)
+ (increase) - (decrease)
Income/Gain Accounts
- (decrease) + (increase)
2. Wrap-up bookkeeping (II)
Income statement (also Balance sheet Cash flow statement

profit and loss statement)
revenues assets cash inflow

./. expenses incl. cash and cash ./. cash outflow
equivalents
./. liabilities
= net income = equity = change in cash and cash

incl. net income equivalents
2. Wrap-Up Bookkeeping – Exercise: Basic financial statements (I)
Mike Smith the managing director of Mike Ltd. requires help to prepare the financial statements
of his company for the year 2017. Within 2017 the following transactions occurred:
1) Mike Ltd. generated revenues of 610,000 EUR. 30,000 EUR of these revenues are on credit.
2) All trade receivables as of fiscal year end 2016 have been collected in 2017.
3) Raw materials have been acquired for 330,000 EUR. 25,000 EUR of those have been bought
on credit.
4) For the production of finished goods inventories all raw materials purchased in 3) have been
consumed. Wages for the production of finished goods inventories amounted to 100,000 EUR
and have been paid in cash. Depreciation of the production facilities amounted to 20,000 EUR.
Overall, the production costs of finished goods inventories amounted to 450,000 EUR. The
book value of the finished goods inventories sold amounted to 440,000 EUR.
5) All outstanding trade payables as of fiscal year end 2016 have been paid in 2017.
6) Wages for the selling staff amounted to 50,000 EUR. Wages for the accounting staff
amounted to 40,000 EUR. All of them have been paid in cash in 2017.
7) Depreciation of the stores buildings amounted to 10,000 EUR. Depreciation of the
administration buildings amounted to 8,000 EUR. Further, Mike Ltd. invested 45,000 EUR in a
new store.
2. Wrap-Up Bookkeeping – Exercise: Basic financial statements (II)
8) For a long-term loan the company paid 1,500 EUR interest. Additionally, 5,000 EUR of the
loan have been repaid in 2017.
9) In 2017 Mike also found a new partner for Mike Ltd. This partner contributes 20,000 EUR of
equity in cash. The new partners decide to distribute total cash dividends of 18,000 EUR in
2017.
For simplification purposes taxes (value added tax, income taxes) can be ignored.
Below you find the Balance Sheet of Mike Ltd. as of fiscal year end 2016. Please record the
journal entries for the above listed transactions and prepare the balance sheet, the income
statement and the cash flow statement for the year 2017.
Assets As of fiscal year end 2016 Equity and Liabilities
Property, Plant and Equipment 110,000 Equity 114,000
Inventories 14,000 Long-term Loan 30,000
Trade Receivables 48,000 Trade Payables 38,000
Cash 10,000
Total 182,000 Total 182,000

Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
3.1 Property, plant and equipment: Introduction
Non-current assets are long-lived assets that help to produce goods or services to
generate revenue over multiple periods.
They are used in day-to-day operations and are not hold for resale or investment
purposes, i.e. they are not sold within the course of ordinary business activities.
Property, plant and equipment are tangible assets with physical substance. Items of
property, plant and equipment encompass:
▪ Land, land rights and buildings, including buildings on third-party land
▪ Technical equipment and machinery
▪ Other equipment, plant and office equipment
▪ Advanced payments made and construction in progress
Usually, non-current assets wear out over time. This effect is captured by the concept of
depreciation. An exemption is land and financial assets which regularly do not
depreciate in value over time.
3.1 Property, plant and equipment: Initial measurement (I)
Acquired property, plant and equipment is recognized on the balance sheet at

acquisition costs (§ 253 Sec. 1 HGB).
Acquisition costs are determined as follows (all values net of value added tax, § 255
Sec. 1 HGB):
+ Purchase price
+ Costs necessary to get the asset to the location and/ or into the condition for its
intended use (delivery or freight costs, installation and assembly costs)
- Price reductions like discounts, rebates etc.
= Acquisition costs
Incidental costs necessary to get the asset to the location or into the condition for its
intended use may not only arise through supply of services by third parties but also in
the company itself. Such company own incidental costs have to be capitalized as part of
the asset’s value.
3.1 Property, plant and equipment: Initial measurement (II)
Items of property, plant and equipment that are produced by the company itself have to
be recognized at production costs (§ 253 Sec. 1 HGB). Whereas acquisition costs can be
determined in a relative simple way based on invoices, production costs have to be
derived from the cost accounting systems of the company.
The composition of the production costs is defined in§255 Sec. 2 HGB:
Cost items and their consideration as a component of productioncosts

Direct Materials (raw materials consumed in the production process) 
Direct Labor (labor costs incurred for the production process) 
Manufacturing overhead (indirect materials, indirect labor, depreciation,
manufacturing related administrative costs) 
Development costs (§ 255 Sec. 2a HGB) 
Manufacturing related borrowing costs, e.g. interest (§ 255 Sec. 3 HGB) ◼
Non-manufacturing related administrative costs ◼
Selling costs 
Research costs 
=mandatory =prohibited ◼=optional
3.1 Property, plant and equipment: Overview subsequent measurement
Depreciable non-current Non-depreciable non-current

assets assets
Initial measurement/ Upper
Acquisition and production costs (§ 253 Sec. 1 HGB)
boundary for measurement
Regular depreciation over useful
Mandatory No regular depreciation
life (§ 253 Sec. 3 Sent. 1 HGB)
depreciation/
impairments Extraordinary depreciation (= impairment) for an expected
Subsequent permanent decrease in value (§ 253 Sec. 3 Sent. 5 HGB)
measurement
Reversal of
Mandatory reversal of depreciation/ impairments up to historical
depreciation/
amortized costs (§ 253 Sec. 5 HGB)
impairments
3.1 Property, plant and equipment: Depreciation (I)
Depreciation parameters
depreciable amount useful life of the asset depreciation method
cost • period of time over ▪ systematic method to

– residual value1 which an asset is allocate the
= depreciable amount expected to be used by depreciable amount
the entity. over the useful life.
• tax law provides ▪ reflecting the pattern
tables with prescribed in which the economic
useful life for certain benefits are expected
assets. This useful life to be consumed.
is usually applied for ▪ mainly linear
1) after the useful life of the German GAAP depreciation applied
asset, e.g. scrap value purposes. in practice.
3.1 Property, plant and equipment: Depreciation (II)
Carrying amount
Historical amortized cost (initial cost

less initially planned depreciation)
Cost at
initial
recognition Impairment/ reversal of impairment
recognized in the income statement
End of useful life
time
Impairment for an expected Mandatory reversal of impairment up
permanent decrease in value to historical amortized costs (§ 253
(§ 253 Sec. 3 Sent. 5 HGB) Sec. 5 HGB)
3.1 Property, plant and equipment: Costs for repairs, maintenance and
improvements
In addition to the initial investment companies incur ongoing costs associated with the
operation of property, plant and equipment.
For accounting purposes those costs are differentiated into repairs and maintenance on
the one hand and improvements on the other hand.
Repairs and maintenance …
▪ … maintain the asset’s future benefits. They include the repairs after breakdowns
or accidents or routine recurring costs such as oiling or cleaning.
▪ The costs for repairs and maintenance are expensed as incurred in the income
statement.
Improvements …
▪ … increase the asset’s future benefits by decreasing its operating costs or
increasing its rate of output or useful life.
▪ The costs for improvements are capitalized increasing the book value of the
respective asset and are then depreciated over the remaining economic useful life
of the asset.
3.1 Property, plant and equipment – Presentation in financial
statements
Corporations have to present their non-current assets in a summary of fixed assets

according to § 284 Sec. 3 HGB.
Example: Excerpt from Annual Financial Statements of Siemens AG 2017, p. 12.
Dr. Michael Ordosch, MBA

ACCT 200-1 © 2018, page 41
3.1 Property, plant and equipment: Exercise (I)
The Chemicals AG decides to expand its operations in the US. For this reason the company
acquired a new piece of land for 1,500,000 EUR in Dallas, Texas, in the beginning of 2015, where
it plans to install new production facilities. As part of these new facilities a new production line
to manufacture plastic components for the electronics industry is purchased for a price of
600,000 EUR at the beginning of 2016. Beyond the price, the company has to pay 30,000 EUR
for freight, 20,000 EUR for installation and assembly, and 5,000 EUR for other administrative
activities not directly attributable to the asset. The production line has a useful life of 5 years, is
depreciated applying the straight-line method and has a residual value of 0 EUR. All outlays for
the land and the production line are assumed to be paid in cash.
At the end of 2015 the market value of the land drops to 1,000,000 EUR.
In 2016 the markets recover. Therefore, the price of the land increases to 1,300,000 EUR.
In 2017 the markets continue to recover and the price of the land further increases to 1,600,000
EUR. In the same year also the value of the production line increases to 750,000 EUR from the
perspective of the Chemicals AG since a new operational area is located for it. It turns out that
the production line is not only useful for producing plastic components for electronics but also
for the automotive industry.
3.1 Property, plant and equipment: Exercise (II)
In 2019 rumors about a potential oil spring on the land emerge and therefore its price
further increases to 1,900,000 EUR. In the same year a severe operating error causes a fire
which destroys the production facilities completely.
At the beginning of 2020 the Chemical AG decides to sell the land for 2,000,000 EUR to an
utilities company which wants to exploit the expected oil spring.
All changes in value of the land and the production line can be considered to be permanent.
Please calculate the values of the land and the production line reported in the financial
statements of the Chemicals AG for the years 2015 until 2020 according to HGB and record
the respective journal entries.
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
3.2 Intangible assets: Introduction
Intangible assets are non-financial assets without physical substance. They are a key
value driver in the information economy. Key assets of many companies are not tangible
any more but intangible like know-how, technology, brand name etc.
Items of intangible assets encompass:
▪ Internally developed intellectual property rights and similar rights
▪ Acquired concessions, intellectual property rights and licenses for such rights
▪ Goodwill
▪ Advance payments for intangibles to be acquired
Intangible assets are one of the most challenging fields for accounting:
▪ They are hard to identify.
▪ They are hard to measure.
There are basically three scenarios that lead to a recognition of intangible assets on the
balance sheet:
▪ Separately purchased intangible assets
▪ Internally developed intangible assets
▪ Intangible assets acquired within a business combination
3.2 Intangible assets: Separately purchased intangible assets
Initial measurement:
Separately acquired intangible assets are measured at acquisition costs (see definition
of acquisition costs in section 3.1).
Through an acquisition from a third party the price paid represents an objective
measure of their value.
For subsequent measurement the same regulations as for property, plant and equipment
apply:
Regular depreciation over useful life (§ 253 Sec. 3 Sent. 1 HGB). For the determination
of the regular depreciation the depreciable amount, the expected useful life and the
depreciation method have to be determined (usually straight-line depreciation).
Extraordinary depreciation (= impairment) for an expected permanent decrease in value
(§ 253 Sec. 3 Sent. 5 HGB)
Mandatory reversal of depreciation/ impairments up to historical amortized costs (§
253 Sec. 5 HGB)
3.2 Intangible assets: Internally developed intangible assets (I)
For internally developed intangibles§248 Sec. 2 S. 1 HGB provides an option to

recognize those assets on the balance sheet, e.g. property rights like patents or legally
unprotected assets like internally developed software.
Certain internally developed intangibles, such as brands or customer lists, are explicitly
prohibited to be recognized as an asset on the balance sheet in§248 Sec. 2 Sent. 2
HGB. Reason: Costs for their development can not be assigned unambiguously to those
assets.
Requirement for the recognition of an internally developed asset:
It is highly probable that expenditures lead to an asset (i.e. it creates economic benefits,
its value is separately measureable and can be realized separately).
Costs for the “production” of internally developed intangible assets: Research and
Development costs defined in (§255 Sec. 2a HGB).
▪ Research: Original and planned investigation to gain new scientific or technical
knowledge.
▪ Development: Application of research findings to plan or design substantially
improved materials, devices, products or services.
3.2 Intangible assets: Internally developed intangible assets (II)
Accounting for research and development costs:

▪ Research costs: Have to be expensed as incurred since future economic benefits from
these activities are considered to be too uncertain (§ 255 Sec. 2a HGB).
▪ Development costs are the “production costs” of an internally developed intangible
asset (§ 255 Sec. 2a HGB). If it is highly probable that development costs lead to an
asset they are allowed to be recognized as an intangible asset.
Example: Costs for design and construction of a prototype before serial production or
internally developed software applications.
If research and development activities cannot be separated reliably from each other the
recognition of an asset is prohibited (§ 255 Sec. 2a HGB).
Before the BilMoG German GAAP with its traditional focus on prudence did not allow the
recognition of any internally developed intangibles (§ 248 Sec. 2 HGB old version) because
the economic benefits from those assets were considered to be too uncertain.
Concept of prudence/ capital preservation has still been preserved by dividend payment
constraint up to the value of net capitalized development costs (§ 268 Sec. 8 HGB).
3.2 Intangible assets: Exercise on internally developed intangible assets
The key project in the research and development department of the Bavaria Car Company is a
new self-driving electronic car. The personnel costs for the research and development team
working on the project amounted to EUR 1,000,000 EUR in total in the past fiscal year. The
team spends 30% of its time for basic research on issues like autonomous driving software or
battery technology. 70% of its time is spent for the construction of an actual prototype of a
self-driving electronic car.
For the construction of the prototype raw materials and supplies amounting to 80,000 EUR
have been consumed.
Depreciation of the research and development facilities amounted to 800,000 EUR in the past
fiscal year. 160,000 EUR of this depreciation can be allocated to the facilities where basic
research is conducted whereas 640,000 EUR relate to the facilities where the construction of
the prototype occurs.
The management of the company is convinced that the prototype will soon be ready for
serial production. Therefore it decides to capitalize the development costs incurred.
How have the costs described above to be recognized in the legal entity financial statements
according to HGB? Please record the corresponding journal entries.
3.2 Intangible assets: Intangible assets acquired within a business
combination (I)
A business combination is a transaction or event in which an acquirer obtains control of

one or more businesses.
How to obtain control?
▪ Share deal:
A obtains control over B by
acquiring the majority of B‘s
X% shares. Two separate legal
A B A B entities remain.
In its legal entity financial
statements A presents its share
in B as a financial instrument/
▪ Asset deal: investment.
A obtains control over B by acquiring all
A the assets and liabilities of B separately.
A B
One separate legal entity remains. A
B presents all acquired assets and liabilities
of B in its legal entity financial
statements.
combination (II)
Within the scope of an acquisition previously not recognized internally developed

intangibles of the acquiree turn into acquired ones from the perspective of the acquirer.
E.g. a brand that has been internally developed by the acquiree (and therefore has not
been recognized in the acquiree’s financial statements) turns into an acquired intangible
asset from the perspective of the acquirer. Therefore it has to be recognized in the
financial statements of the acquirer.
Goodwill
Purchase Price
Fair Value of not
Allocation (PPA)
(yet) recognized
Valuation of all
intangible assets
identifiable assets,
Purchase Price Step up to fair value Goodwill as non-
Book Value of net distributable
assets (= assets – Fair Value of disclosed difference
liabilities) net assets of the (residual amount).
recognized in acquiree
financial statements
of the acquiree.
combination (III)
Revalued/or newly identified assets and liabilities have to amortized over expected useful
life (e.g. customer lists over 10 years, patents until time of expiration etc.)
The difference between the acquired net assets (assets – liabilities) and the purchase price
paid for the acquired company is recognized as a separate non-current asset referred to as
„goodwill“ (§246 Sec. 1 Sent. 4 HGB).
This goodwill captures assets of the acquiree that cannot be identified separately such as
synergies from combining the companies, workforce, access to new markets etc.
The goodwill has to be amortized over expected useful life (§253 Sec. 3 HGB). If the useful
life can not be estimated reliably the goodwill has to be amortized over 10 years.
As for all other non-current assets an extraordinary depreciation (= impairment) for an
expected permanent decrease in value (§ 253 Sec. 3 Sent. 5 HGB) is required.
Reversal of depreciation/ impairments up to historical amortized costs is not allowed for
goodwill even if the reasons for the impairment cease to exist (§253 Sec. 5 HGB).
Annual Report BMW Group
3.2 Intangible assets: Exercise on intangible assets acquired within a
business combination
At the beginning of fiscal year X1 the internet dealer Z Sales acquires I-Sell which hosts online
auctions for a purchase price of 20 MU paid in cash in an asset deal.
Within the scope of the purchase price allocation it turns out that the fair value of the assets
reported in the financial statements of the I-Sell corporation amounts to 16 MU. The fair value of
the liabilities of I-Sell equals the book value reported.
I-Sell’s brand name valued with 2 MU and the software for the auction platform valued with 3 MU
have been identified as the major intangible assets which have been internally generated by I-Sell
and are therefore not recognized on the financial statements of I-Sell.
Below you find the financial statements of Z Sales and I-Sell before the transaction. Please
calculate the goodwill resulting from the transaction and prepare the financial statements of Z
Sales after the acquisition.
Z Sales I-Sell
Assets Equity and Liabilities Assets Equity and Liabilities
Assets 45 Equity 20 Assets 14 Equity 9
(incl. cash of 5) Liabilities 25 Liabilities 5
Total 45 Total 45 Total 14 Total 14
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
3.3 Non-current financial assets: Overview
Non-current financial assets encompass the following items:

▪ Shares in affiliated companies (§ 271 Sec. 2 HGB): Investments in subsidiaries over
which control is exercised, e.g. by holding the majority of the shares of the
respective company.
▪ Shares in investments (§ 271 Sec. 1 HGB): Investments held for the long-term to
support the operations of a company. E.g. investments in other companies with
mutual supply relationships or with joint research and development projects. An
“investment” is assumed when the share of ownership exceeds 20%.
▪ Securities: Long- term investments in equity instruments to generate an adequate
return. Neither held to support operations nor control can be exercised.
▪ Loans: Funds provided to other companies, usually in exchange for an interest (i.e.
investments in debt instruments). Presentation according to the degree of
relationship with borrower:
- Loans to affiliated companies
- Loans to investments
- Loans other (unrelated third) parties
3.3 Non-current financial assets: Recognition and measurement
Except for financial institutions (banks or insurance companies), there are no special
regulations for the accounting treatment of financial assets. Therefore, as a basic
principle, for non-current financial assets the same regulations as for the recognition and
measurement of all other non-current assets apply:
▪ Initial measurement at acquisition cost (i.e. initial investment + transaction costs)
which is also the upper boundary for subsequent measurement (§ 253 Sec. 1 HGB).
▪ As financial assets do not wear out over time, no regular depreciation is required.
▪ Optional extraordinary depreciation (= impairment) for an expected non-
permanent decrease in value for financial assets (§ 253 Sec. 3 Sent. 5 HGB).
▪ Extraordinary depreciation (= impairment) for an expected permanent decrease in
value (§ 253 Sec. 3 Sent. 5 HGB).
▪ Mandatory reversal of depreciation/ impairments up to acquisition costs (§ 253
Sec. 5 HGB).
Income from financial assets appears in the form of…
▪ … realized gains in value via a sale and dividends for equity instruments and
▪ … interest, debt discounts (disagio) or also gains in value via a sale for loans.
3.3 Example for presentation in the legal entity financial statements of
Siemens AG
3.3 Non-current financial assets: Exercise
Equity investments
In 2016 the Invest Company has acquired 1,000 shares of the Vola Corp. at a total Fair Value
of 100,000 EUR. For the purchase transaction costs amounting to 2,000 EUR have been
incurred. Through the purchase of these shares the Invest Company holds 2.5% of the total
voting rights of the Vola Corp. No other business relations with the Vola Corp. exist.
At the end of 2016 the total value of the shares drops significantly to 80,000 EUR. This
significant decrease in value is considered to be permanent. To compensate its investors for
this decrease in value Vola Corp. pays a dividend of 2.80 EUR per share in 2016. In 2017 the
securities recover a little bit and have a value of 90,000 EUR at the end of the year. The
dividend paid out for the year amounts to 2.90 EUR per share. Finally, in 2018 the shares
skyrocket to 120,000 EUR and a dividend of 3.00 EUR per share is paid out.
Under which category of financial assets has the investment to be presented in the legal
entity financial statements of the Invest Company according to HGB?
What book value is reported for the financial asset as of fiscal years end 2016, 2017 and
2018? Please record the journal entries required for each of the three years.
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
4.1 Inventories: Overview
Inventories are assets that are

▪ held for sale in the ordinary course of business,
▪ in the process of production for such sale; or
▪ in the form of materials or supplies to be consumed in the production process or in
the rendering of services.
Presentation of inventories on the balance sheet according to§266 Sec. 2 HGB:
▪ Raw materials and supplies
▪ Work in progress (“unfinished goods inventories”)
▪ Finished goods inventories and merchandise
▪ Advance payments made (for inventories)
Presentation of inventories in
legal entity financial statements 2017
of Siemens AG (p. 14):
4.1 Inventories: Initial measurement
Recognition at cost, i.e. either acquisition or production costs.

Acquisition costs are determined as follows (all values net of VAT, § 255 Sec. 1 HGB):
+ Purchase price
+ Costs necessary to get the asset to the location and/ or into the condition for its
intended use (delivery or freight costs, installation and assembly costs)
- Price reductions like discounts, rebates etc.
Acquisition costs
Production costs (§ 255 Sec. 2 HGB):
Cost items and their consideration as a component of production costs
Direct Materials (raw materials consumed in the production process) 
Direct Labor (labor costs incurred for the production process) 
Manufacturing overhead (indirect materials, indirect labor, depreciation,

manufacturing related administrative costs)
Development costs (§ 255 Sec. 2a HGB) 
Manufacturing related borrowing costs, e.g. interest (§ 255 Sec. 3 HGB) 
Non- manufacturing related administrative costs 
Selling costs 
Research costs 
=mandatory  =prohibited =optional ACCT 200-1 © 2018, page 60
4.1 Inventories: Subsequent measurement (I)
Strictly lower of (irrespective whether decrease in value is considered

to be permanent or only temporary) (§ 253 Sec. 4HGB)
Acquisition or production costs Net realizable value
The cost of inventories shall comprise all costs of Estimated selling price (for finished goods inventories)
purchase, costs of production and other costs incurred or purchase price (for work in progress and raw
in bringing the inventories to their present location materials) less the estimated costs necessary to make
and condition. the sale.
▪ Reversal of impairment: Maximal value is cost of purchase/production cost (§ 253 Sec. 1 HGB).
▪ No regular depreciation since inventories are current assets that are held only for a short period
and do not wear out due to their usage.
4.1 Inventories: Subsequent measurement (II)
In general cost of inventory items shall be recorded at individual costs.

This may be inappropriate for large numbers of interchangeable items (e.g. screws,
nails, fluids etc.). For this purpose cost flow assumptions are applied (§ 256 HGB, §
240 Sec. 4 HGB).
Allowed cost flow assumptions are:
▪ First in – first out (FIFO): The inventories that have been recognized first are
assumed to be consumed first.
▪ Last in – first out (LIFO): The inventories that have been recognized last are
assumed to be consumed first.
▪ Weighted average: After each recognition of new inventories a weighted average
cost per inventory item is calculated.
4.1 Inventories: Illustrative example on cost flow assumptions
Example: The Hammer Corp. is specialized on purchasing and selling nails. For the year 2017
the following transactions occurred:
March: Purchase of 4,000 nails @ 2.00 €
June: Purchase of 6,000 nails @ 2.50 €
July: Sale of 7,000 nails @ 2.90 €
September: Purchase of 5,000 nails @ 2.70 €
November: Sale of 6,000 nails @ 3.10 €
Beginning inventory of nails was 0.
Please calculate revenue, cost of sales, gross profit and ending inventory for the year 2017
applying the weighted average, FIFO and LIFO cost flow assumptions.
63
4.1 Inventories: Exercise
The Technology Corp. is a manufacturer of semiconductors. For the production of the company‘s
inventories of finished goods as of fiscal year end 2017 the following costs have been incurred:
a) The company has to prepare financial statements according

Monetary Units (MU) to German GAAP (HGB) for tax and dividend
Direct labor 50 measurement. To save taxes and dividend claims the
Direct materials 120 company wants to minimize its net income according HGB.
To minimize net income for the fiscal year 2017 what would
Indirect labor and materials 150 be the appropriate measurement of inventories as
Depreciation and maintenance of 180 of fiscal year end 2017 in the legal entity financial
production facilities statements.
Allocated development efforts 50 b) A major component in the manufacturing process of

semiconductors is silicium. The ending inventory of
Non-manufacturing related 35
silicium at acquisition cost is 200 MU as of fiscal year end
administrative costs
2017. However, due to a price decline the market value of
Selling costs 60 the silicium on hand amounts only to 180 MU. At which
value has the silicium to be recognized on the HGB balance
sheet at fiscal year end 2017? 180 , that leads to an
impairment loss of 20.
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
4.2 Receivables and current financial assets: Overview
Receivables: Claims from contracts with other parties for the payment of a defined
amount of money (or other assets) in exchange for goods or services delivered.
Receivables are presented according to the degree of relationship with the respective
debitor (§ 266 Sec. 2 HGB):
▪ Trade receivables
▪ Receivables from affilliated companies
▪ Receivables from investees
▪ Other assets
Other current financial assets encompass securities and cash and cash equivalents.
▪ Securities: Temporary investments of liquid funds such as shares, bonds or other
interest paying securities not intended to be held in the long-term.
▪ Cash and cash equivalents: Usually cash on hand and cash in banks (but also highly
liquid short term investments that could be turned into cash instantly and are not
subject to major fluctuations in value).
4.2 Receivables and other current financial assets: Recognition and
measurement
For the recognition of receivables it is of particular relevance that the netting of

receivables from a debtor with payables to the same debtor is regularly not allowed
(§246 Sec. 2 HGB).
Initial measurement of receivables is the invoiced amount, for securities the acquisition
costs (initial investment + transaction costs).
Also for receivables and other current financial assets the basic principle for subsequent
measurement of current assets applies (§253 Sec. 4 HGB):
▪ Both are measured strictly at the lower of acquisition costs (or invoiced amount) or
net realizable value, irrespective of whether decrease in value is considered to be
permanent or only temporary.
▪Reversal of impairment: Maximal value are acquisition costs (§253 Sec. 1 HGB). For
the measurement of receivables the risk that the customer does not settle the open
receivable has to be taken into account by an “allowance for uncollectible accounts“
(also called “bad debt allowance“).
A special regulation applies for the measurement of securities held for trading purposes
by financial institutions. Those have to be measured at fair value less a risk discount
even when this value exceeds the acquisition costs (§340e Sec. 3 HGB).
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
5. Provisions and liabilities: Overview
Recognition criteria for a liability according to HGB:

▪ Existent or expected reduction of the net assets of a company that…
▪ … results from a legal or economic obligation of the company and whose…
▪ … value is separately measureable.
Liabilities are obligations for which the timing and amount of the settlement is known as of
closing date of the respective fiscal period:
▪ The settlement of the obligation can be legally enforced.
▪ The value of be obligation is contractually defined.
▪ As of the closing date the liability is a reduction of the net assets of the company.
Provisions are liabilities of „uncertain timing and/ or amount“.
▪ Legal or economic obligation reducing the net assets of a company that is possible to occur.
▪ Value of the expected obligation can be measured reliably (reliable estimate possible).
Contingent liabilities (§ 251 HGB): Obligations that may arise depending on whether some
uncertain future event occurs (e.g. guarantees or other commitments). Their probability of
occurrence is rather remote, therefore they are not recognized on financial statements but
disclosed in the notes.
5. Provisions and liabilities: Selected liabilities
§ 266 Sec. 3 B. 1.-8. HGB lists the categories according to which liabilities have to be
presented on the balance sheet:
▪ Bonds: Company borrows money from an investor for a defined period of time at a
variable or fixed interest rate.
▪ Liabilities to banks: Liabilities arising from money borrowed from banks.
▪ Advance payments received on orders: Liability arising from prepayments of
customers that has to be fulfilled by delivering the promised goods or services.
▪ Trade payables: Obligations from invoices for goods or services that have been
delivered by suppliers but not yet settled by the reporting company.
▪ Liabilities to affiliated companies: Obligations of a parent company to its
subsidiaries.
▪ Liabilities to long-term investees: Obligations to investments held for the long-
term to support the operations of a company.
▪ Other liabilities.
Depending on company size and legal form information about the maturity of liabilities
is required (§268 Sec. 5 HGB,§285 No. 1 HGB).
5. Liabilities: Recognition and measurement
As a basic principle liabilities are recognized at settlement value, i.e. the amount that is
required to settle the liability (§ 253 Sec.1 Sent. 2 HGB).
Trade payables are adjusted by cash discounts or other types of rebates the company
draws on.
For the subsequent measurement of liabilities prudence and imparity principle prevail: A
reduction in settlement value is not allowed to be recognized on the balance sheet until
maturity.
A debt discount (disagio), i.e. if amount of money received < maturity value, is allowed
to be capitalized as a prepaid expense and amortized over life of the loan/bond (§250
Sec. 3 HGB).
5. Liabilities: Presentation at Siemens AG
Source: Annual Financial Statements of Siemens AG 2017, p. 18.

5. Liabilities: Exercise
To raise capital for its new training facilities Munich Football Club (MFC) arranges a loan with
a local bank. The bank offers a loan of 5,000,000 EUR over four years with a disagio/debt
discount of 100,000 EUR. The full amount of the loan (i.e. 5,000,000 EUR) is repaid in a
lump-sum payment upon maturity after four years. The annual interest on the principal is
1.5%.
MFC wants to postpone the expenses related to the loan as far as possible to future periods.
What options does the company have for the accounting treatment of the disagio/ debt
discount?
Under these circumstances how would you account for the liability the local financial
statements of MFC according to HGB? Please record the book value of the loan and its
impact on the income statement in each of the four years and record the corresponding
journal entries.
5. Provisions: Concept
Provisions are liabilities of „uncertain timing and/ or amount“.

▪ Legal or economic obligation reducing the net assets of a company that is possible to
occur.
▪ Value of the expected obligation can be measured reliably (reliable estimate is
possible).
Provisions are recognized to capture a possible reduction of the net assets of a company.
Further, they are recognized to assure a matching of costs and benefits from certain
transactions in the financial statements of a company. Example:
▪ A product is sold from which a possible warranty obligation is expected to arise
▪ The costs resulting from this transaction (= warranty costs) are recognized as an
expense through the recognition of a warranty provision in the same period when
the benefits from the transaction (= revenue from the sale) are recognized
 This approach assures a „matching of costs (warranty) and benefits (revenue)“ in
the financial statements of the company.
5. Provisions: Recognition and measurement
Provisions have to be recognized for liabilities of uncertain timing and/ or amount as

well as for anticipated losses from pending transactions (§249 Sec. 1 HGB).
Provisions can arise from legal obligations (e.g. tax obligations) or from economic
obligations (e.g. established industry practice to repair certain defects for free).
In addition to legal or economic obligations to third parties provisions can be recognized
under HGB for certain anticipated expenses like for maintenance completed within the
first three months of the following fiscal year (§249 Sec. 1 No. 1 HGB).
For the measurement of provisions “a reasonable commercial assessment” is required
(§ 253 Sec. 1 HGB). This assessment has to be made in accordance with the prudence
principle (§252 Sec. 1 No. 4 HGB). Key features of such an assessment:
▪ Reasonable estimates can be determined by the judgment of the management of
the company, supplemented by experience of similar transactions and, in some
cases, reports from independent experts.
▪ Possible methodologies for estimation: Expected value or most likely amount.
▪ For provisions with a remaining term of more than one year the provision must be
reported at present value (§ 253 Sec. 2 HGB). (Discount rates are provided by the
German Federal Bank).
5. Provisions: Common types of provisions
Litigation obligations: Pending or threatened litigation and actual or possible claims and
assessments (e.g. tax proceedings).
Warranty obligations: Warranty or product guarantee is a promise made by the seller to
compensate for deficiencies in quality or performance of a product.
Environmental obligations: Obligation for the retirement of long-lived assets (e.g. costs
associated with dismantling and removing an offshore drilling platform).
Onerous contract obligations: Unavoidable costs of meeting an obligation exceed the
expected benefits to be received (e.g. production costs turn out to exceed negotiated
prices).
Personnel related obligations: Obligations to employees or management, e.g. arising from
promised retirement benefits or severance payments in case of restructurings.
5. Provisions: The issue of decreasing interest rates in discounting
For discounting provisions to present value, the average market rates of the last seven years
corresponding to the remaining term of the provision have to be applied (except for retirement benefits)
(§ 252 Sec. 2 HGB). Those are published by the German Federal Bank. (Source:
https://www.bundesbank.de/Redaktion/DE/Downloads/Statistiken/Geld_und_Kapitalmaerkte/Zinssaetze_Renditen/abzinsungszinssaetze.
pdf? blob=publicationFile)
How did the development of interest rates influence the measurement of provisions over the last years?

ACCT 200-1 © 2018, page 77
5. Provisions: Accounting treatment at Siemens AG
Source: Annual Financial Statements of Siemens AG 2017, p. 7 and p.9.

5. Provisions: Exercise „Lawsuit“
In December 2017 “Sum-Sum” has been accused by its competitor “Creative Displays” of
infringing a major patent. “Sum-Sum” believes that it is possible that it will be sentenced to
pay compensation of 1,800 kEUR to “Creative Displays” for the patent infringement.
Due to the complexity of the case it is expected that the lawsuit will take several years.
Therefore the decision of the court and a related payment is most likely to occur at the end
of 2020.
The applicable discount rate amounts to 3%.
a) Please record the provision for the patent infringement case in the financial statements
of “Sum-Sum” according to HGB for the years 2017, 2018 and 2019 by calculating the
required provision.
b) At the end of 2020 Sum-sum is indeed sentenced to pay a compensation. However, the
required compensation is 1,900 kEUR. The payment is made immediately in 2020.
Please provide the journal entries for the accounting treatment of the provision in 2020.
5. Provisions: Exercise „Warranty“
In 2016 the notebook manufacturer Lemon Corp. sold 100,000 notebooks with a four year
warranty including the year 2020. Based on experience for 20% of the notebooks minor
defects occur resulting in repair costs of 40 EUR per notebook. For 5% of the notebooks
major defects occur resulting in repair costs of 200 EUR per notebook. Additionally, 1% of
the notebooks sold have to be replaced completely. Replacement costs amount to 300 EUR
per notebook.
On average, these warranty costs arise three years after the respective notebooks have been
sold. The applicable discount rate is 3%.
Surprisingly, no defects occur in 2017 and 2018. Then, in 2019 total warranty costs
associated with the sales from 2016 of 1,500,000 EUR have to be paid. In 2020 another
400,000 EUR of warranty costs associated with the sales from 2016 have to be paid.
Please record the provision for the notebook sales of 2016 for the fiscal years 2016 until
2020 when the warranty matures.
80
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
6. Equity: Overview
Equity is the “residual interest” in the assets of a company after deducting all its
liabilities.
It represents the funds invested by the owners of a company plus undistributed profits.
The presentation of equity depends on the legal form of the company.
▪ For businesses that have no separate legal personality like a sole proprietorship or
a commercial partnerships (“e.K.”, “oHG”):
There are no special regulations for the presentation of equity in the HGB financial
statements. It is common practice that there is an equity account for each owner
where the owner’s share of net income or loss, capital contributions as well
distributions/ withdrawals of capital to the respective owner are documented.
▪ For businesses with a separate legal personality:
There are detailed regulations for the presentation of equity (§272 HGB).
Primarily, because the liability of the owners is limited to the capital contributed.
Additionally, more transparency is required for corporations as those are more
likely to be subject to third party investment.
6. Equity: Components of equity in legal entity financial statements
Subscribed capital:
▪ Number of shares issued valued with their par or notional value.
▪ Regularly constant position, changes only in rare cases such as capital increases or
reductions.
Capital reserve: The excess of amounts paid-in by owners over the par or notional value.
Retained earnings: The corporations undistributed earnings accumulated in different
types of reserves.
▪ Legal reserves: Reserves that have to be build up according to stock corporation law
and that are only allowed to be released under certain conditions (§150 AktG).
▪ Statutory reserves: Reserves that have to be build up according to the articles of
incorporation of the company.
▪ Other reserves.
Treasury shares are the amount of own shares repurchased.
▪ Reasons why companies repurchase their own shares encompass the use of those
shares for employee compensation purposes, the reduction of supply of shares to
manage stock prices or to compensate shareholders.
83
6. Equity: Presentation at Siemens AG
Source: Annual Financial Statements of Siemens AG 2017, p. 15.

6. Equity: Exercise
As of the start of fiscal year 2017 the Core Capital Company had a balance in its equity
amounting to 2,800 kEUR. The composition of this equity as of fiscal year beginning was as
follows (all values in kEUR):
Subscribed capital 200
(200,000 shares x 1 EUR par value per share)
Capital reserve 800
Retained earnings 1,800
Total equity as of fiscal year 2017 beginning 2,800
Over the fiscal year 2017 the following transactions with an impact on equity occurred.
▪ The company increased its equity through a capital increase. It issued 10,000 shares for a
price of 20 EUR per share. The par value of a newly issued share amounted to 1 EUR .
▪ In the statement of income the company reported a net income amounting to 300 kEUR.
▪ A dividend of 0.40 EUR per share (including the 10,000 newly issued shares) has been paid.
Please record the journal entries for the above listed transactions and determine the value of the
components of equity of the Core Capital Company as of fiscal year end 2017.
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
7. Financial statement analysis: Overview
Potential for
Profitability Liquidity
future profits
Strategy analysis Financial statement analysis
Company analysis
7. Financial statement analysis: Basic principles
To analyze the financial statements of a company the respective measures of liquidity,

capital structure and profitability (e.g. operating income, operating margin) can basically
be considered in absolute or relative terms (so-called “ratios”).
Looking at a single performance measure on its own usually does not allow for meaningful
conclusions => Performance measures have to be analyzed in context with a comparison
(“benchmark”)
Possible benchmarks are:
▪ Company-internal targets
▪ Historical values of the company to be analyzed
▪ Values of competitors in the same industry
Absolute values vs. ratios: Usually the conclusions that can be drawn from absolute values
are limited because
▪ the size of a company itself in terms of assets or revenue changes over time, e.g. due
to acquisitions and divestments and
▪ different companies differ in size.
 Ratio analysis usually creates more meaningful results than just looking at absolute
numbers.
7. Financial statement analysis: Absolute values vs. ratios – Example
5,7% 5,8% 7,3% 6,94%

In 2016 Daimler generated a higher net profit than in 2015. Was Daimler indeed more
„profitable“ in 2016?
In 2016 Daimler generated a higher net profit than BMW but was Daimler indeed more
„profitable“ than BMW?
Sources: Daimler Annual Report 2016, p. 218; BMW Annual Report 2016, p. 112.
Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
7.1 Capital structure analysis: Introduction
Capital structure: “How does a company finance its operations by using different sources
of capital”
Common sources of capital:
▪Debt instruments like bonds, long-term loans or short-term debt (e.g. payables) and
▪equity such as funds from the issuance of shares or retained earnings.
Characteristics of debt financing:
▪ Brings along tax advantages since interest payments are tax-deductible.
▪ Does not dilute ownership.
▪Usually fixed rate of interest is “cheaper” than equity financing.
Characteristics of equity financing:
▪ No tax advantages as payments to shareholders are not tax-deductible.
▪ Represents a claim on the profit of a company according to the share of ownership.
▪ More expensive than debt since equity investors bear the entrepreneurial risk of a
company, i.e. they do not earn a fixed interest rate such as debt investors but
participate in profits as well as in losses.
7.1 Capital structure analysis: Ratios
Common ratios in capital structure analysis provide information about how a company
finances its operations as well as about its financial risks and liquidity needs.
Common ratios:
 Equity ratio = Equity / Total assets => “Share of assets financed by equity”
 Debt ratio = Debt / Total assets => “Share of assets financed by debt”
 Financial leverage = Debt / Equity => “How much debt is used relative to
equity to finance operations”
Companies have to balance the costs and benefits of equity and debt financing.
▪ Higher debt financing reduces the cost of capital (i.e. the “price” that has to be paid for
the provision of capital) and increases the return for the shareholders of the company.
▪ At the same time extensive debt financing increases the interest burden and can lead to
financial distress such as a shortage of cash to pay interest or a burden on profits in bad
years.
 There is no “optimal” capital structure, financing depends on multiple factors such as
industry membership or maturity of a company. (“Rule of thumb”: Financial leverage >
2 is considered to be relatively risky)
7.1 Capital structure analysis: Capital structure and cash flows
Key measure of cash flow: Free cash flow (”FCF“)
Cash flows from operating activities ▪ FCF > 0 indicates that a company has
generated sufficient cash from its operations
- Capital expenditures to fund investments in long-term assets.
Free cash flow ▪ FCF indicates the cash generated that is
available to debt and equity investors or to
fund growth initiatives, e.g. acquisitions.
Exemplary cash flow-based measures of financial risk (“coverage ratios”):

▪ Debt to cash flow ratio = Debt / Cash flows from operating activities
“How long would it take to repay debt if all cash flows generated from operating
activities were used to repay debt” EBIT/Interest Expenses
▪ Interest coverage ratio = Interest payments made / Cash flows from operating activities
“What share of cash flows generated by the operating activities of a company is
consumed by the interest payments that have to be made”
7.1 Capital structure analysis: Asset structure
Analyzing the asset structure of a company reveals whether the capital of the company is
rather tied up in non-current or current assets.
Common ratios:
▪ Non-current assets ratio = Non-current assets / Total assets
“How much capital of a company is tied up in non-current assets”
▪ Current assets ratio = Current assets / Total assets
“How much capital of a company is tied up in current assets”
The analysis of the asset structure allows the following conclusions about the financial risks
of a company:
▪ The higher the share of current assets the easier the company can convert those
assets into cash to react to changes in its operating environment and assure financial
stability.
▪ A higher share of non-current assets usually indicates a higher share of fixed costs.
High fixed costs limit the ability of a company to react to changes in its operating
environment. On the other hand, when capacities are exploited efficiently and output
is increased profits increase disproportionately (so-called “operating leverage”).
7.1 Capital structure analysis: Bringing together asset and capital
structure
A comparison of assets (use of funds) and equity and liabilities (source of funds) helps to
assess the ability of a company to pay its obligations.
Current ratio = Current assets / current liabilities
▪ “Measures the ability of a company to pay its current liabilities by liquidating current
assets”
▪ Rule of thumb: Current ratio < 1 => in the short-term there may be a shortage of
liquidity to settle short-term obligations. Too large current ratio (>3) potentially
indicates poor working capital management such as problems of turning receivables or
inventories into cash or just too much idle cash not invested.
▪ There are different variations of the current ratio such as the cash ratio (= cash /
current liabilities) or the quick ratio (= monetary current assets (like cash or receivables
but not inventories) / current liabilities).
“Golden rule of financing”: (Equity + long-term debt) / Non-current assets > 1
“Non-current assets should be funded by long-term capital. This avoids that capital is tied up
over the long-term in non-current assets but has to be repaid over the short-term.”
Limitations of ratios above: Only static perspective considering the balance sheet values and
not taking current period’s cash flows into account.
7.1 Capital structure analysis: Example – Mike Ltd.
Below you find the balance sheet of Mike Ltd. as of fiscal year end 2017. Based on this information please
calculate the following ratios to analyze the capital structure of Mike Ltd.:
Non-current assets ratio
Current ratio, quick ratio and cash ratio
„Golden rule of financing“ Financial
Based on these ratios how would you evaluate the risk of financial distress for Mike Ltd.?
Mike Ltd. - Balance Sheet FY 2017

Property, plant and equipment 117,000
Inventories 24,000
Receivables 30,000
Cash 55,500
Total Assets 226,500
Equity 176,500
Long-term loan 25,000
Payables 25,000
Total equity and liabilities 226,500

Contents

3. Financial assets
4. Current assets
1. Inventories
6. Equity
7.2 Profitability analysis: ”Turning revenue intoprofit”
Income statement – Cost of sales method Profitability analysis assesses a company’s ability to
Revenue generate profits from its operations. A key to
- Cost of sales
profitability is the ability to turn revenue into profit.
Gross profit margin = Gross profit / Revenue
Gross profit
“Production (and/ or procurement) costs incurred for
Research and development expenses every euro of revenue. Measures the efficiency of
Selling expenses production.”
General administrative expenses R&D, selling and general administrative expenses or
Other operating income material, personnel and depreciation expenses as a
percentage of revenue allow conclusions about the
Other operating expenses
relative importance of those expenses and accordingly
Operating income (EBIT) + Dep comparisons between companies of different size.
Income from investments Operating income (or EBIT) margin = Operating
Interest income income (or EBIT) / Revenue
Interest expenses “Measures the profitability of operating activities
Income before taxes (EBT) without the influence of financing/ capital structure
(interest) and taxation.”
Income taxes
Net income margin = Net income / Revenue
Net income
“Measures the overall profitability of a company
including the effect of financing/ capital structure
(interest) and taxation.”
7.2 Profitability analysis: Discussion of income statement-based
profitability ratios
Operating (or EBIT) margin: Why to isolate the effect of financing and taxation?
Interest is to some extent deductible for taxation purposes and hence reduces the tax burden.
Even given the same level of operating profitability different levels of debt between
companies may lead to different interest expenses. This results in differing tax expenses
between companies and therefore to a different net income margin.
Local tax regimes may provide different rules for the tax deduction of interest expenses.
 Factors limiting the comparability of net income margins: Different degree of operating
profitability, different degree of debt, different tax regimes.
EBITDA = Earnings before Interest Taxes Depreciation andAmortization

EBITDA margin = EBITDA / Revenue
Reasons for popularity of EBITDA
▪ Like EBIT, not distorted by financing and taxation, but also independent of management
depreciation policy, e.g. assumptions about useful life of assets or impairments
▪ Independent of capital intensity, i.e. firms with relatively more non-current assets tend
to have higher deprecation
▪ Serves as an approximation of cash flows
7.2 Profitability analysis: “Employing capital to generate profit”
Profitability analysis assesses a company’s ability to generate profits from its operations.
A key to profitability is the ability to employ assets efficiently to generate profits, i.e. to
generate a return on the capital invested.
Information on the capital invested can be drawn from the balance sheet.
Return on assets = Operating income (or EBIT) / Total Assets
▪ "How efficiently are total assets employed in the operations to generate profits"
▪ Variations on return on assets (or return on capital employed (“ROCE”)) apply
different measures of assets, e.g. they may consider only non-current assets
excluding working capital or only long-term capital (equity + long-term debt)
▪ Return on assets applies an entity perspective: How profitable are the operations of
the company?
Return on equity = Net income / Shareholder Equity
▪ "How efficiently is equity employed to generate a profit for the shareholders“
▪ Return on equity takes an equity perspective: What is the return of shareholders on
their investment?
7.2 Profitability analysis: Relationship between operating margin,
asset turnover and return on assets
Operating margin and return on assets are linked via asset turnover.
Asset turnover = Revenue / Average assets
"How efficiently are total assets employed to generate revenue”
The value driver tree below illustrates this relationship
Return on assets =
Operating income (or EBIT) / Average assets
Operating (or EBIT) margin = Asset turnover =

X
Operating income (or EBIT) / Revenue Revenue / Average assets
Management of profitability in income

Management of assets on balance sheet
statement
7.2 Profitability analysis: Key performance indicators at Siemens
Source: Siemens AG, Vision 2020: Clear strategy – Strong execution, JP Morgan European Capital Goods CEO Conference, June 16, 2017,
retrieved from: www.siemens.com/investorrelations.
7.2 Profitability analysis: Example – Mike Ltd.
Based on the information provided below please calculate the following ratios to analyze the
profitability of Mike Ltd.:
Gross profit, EBITDA (Depreciation in fiscal year 2017 was 38,000 EUR), operating income and
net income margin. Return on assets, return on long-term capital employed and return on
equity.
Based on this information, how would you evaluate the profitability of Mike Ltd.? When considering the
capital structure of Mike Ltd. what would be a lever to increase the return on equity of the company? What
is a potential pitfall when capital structure is designed with a unilateral focus on optimizing return on
equity?
Mike Ltd. - Balance Sheet FY 2017 FY 2016 Mike Ltd. - Income Statement FY 2017
Property, plant and equipment 117,000 110,000 Revenue 610,000
Inventories 24,000 14,000 Cost of sales -440,000
Receivables 30,000 48,000 Gross profit 170,000
Cash 55,500 10,000 Selling expenses -60,000
Total Assets 226,500 182,000 Administrative expenses -48,000
Operating Income (EBIT) 62,000
Equity 176,500 114,000 Interest Expense -1,500
Long-term loan 25,000 30,000 Net Income 60,500
Payables 25,000 38,000 Dr. Michael Ordosch, MBA
Total equity and liabilities 226,500 182,000200-1
ACCT © 2018, page 103
7.2 Wrap-up case financial statements analysis – Apple Inc.
For the analysis of the financial statements of Apple Inc. the 10-K annual report for FY 2017 - 2021 is
applied. This report can be retrieved from Apple investor relations under
https://www.annualreports.com/Company/apple-inc
Relevant excerpts from the report are:
•Consolidated statements of income,
•Consolidated balance sheets,
•Consolidated statements of cash flows, Profitability:
Based on the available data please analyze the development of the gross and operating margin for the
years 2017 – 2021. Further, please determine the return on capital employed for the same period
Capital structure and liquidity:
Please determine financial leverage and “golden rule of financing” for fiscal years 2016 - 2021. Further,
analyze the relationship of current assets to current liabilities. Finally, calculate free cash flow and debt
coverage ratio.

Financial Accounting Pre-Master

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Financial Accounting Pre-Master

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Financial Accounting

“Accounting is the language of business“

Aim of this class

1. Introduction to financial accounting

Management Accounting Financial Accounting

Financial Accounting Information

Decision Making Stewardship

Continental European Accounting Anglo-American Accounting (e.g.

Capital protection by limiting Investment decision relevant

*Generally Accepted Accounting Principles

• IFRSs (International Financial Reporting Standards) mandatory at least for consolidated

Why do we strive for global accounting standards?

1998: KapAEG (“Kapitalaufnahmeerleichterungsgesetz “ / “Law to facilitate the raise of

Capital market oriented Not capital market

Consolidated financial IFRS IFRS optional

Separate (legal entity)

Statement of Changes in Equity   ✓

Overall objective: “…provide a fair presentation of a company‘s financial position and

Consolidated financial statements of capital market oriented companies have to be

1. Introduction to financial accounting

Key characteristics of a liability for the recognition according to H GB:

Basic regulations for recognition are specified in §§ 246 – 251 HGB.

 Explicit regulations limit management discretion in preparing financial statements and

Nature of expense method

Basic structure of a cash flow statement

Cash flows from operating activities

Cash is required to fund the operations of a company.

 Assessmentof performance and cash management

Common approach for the preparation of the statement of cash flows:

Basic principle for indirect calculation:

Presentation of the development of equity during the reporting period

Equity as of fiscal year beginning

+ Capital increases/ - Capital reductions

+ Net income of the period

Equity as of fiscal year end

Double-entry accounting Normal Balance: Credit

Income statement (also Balance sheet Cash flow statement

revenues assets cash inflow

= net income = equity = change in cash and cash

Total 182,000 Total 182,000

1. Introduction to financial accounting

Acquired property, plant and equipment is recognized on the balance sheet at

Cost items and their consideration as a component of productioncosts

Depreciable non-current Non-depreciable non-current

depreciable amount useful life of the asset depreciation method

cost • period of time over ▪ systematic method to

Historical amortized cost (initial cost

End of useful life

Corporations have to present their non-current assets in a summary of fixed assets

Dr. Michael Ordosch, MBA

1. Introduction to financial accounting

For internally developed intangibles§248 Sec. 2 S. 1 HGB provides an option to

Accounting for research and development costs:

A business combination is a transaction or event in which an acquirer obtains control of

Within the scope of an acquisition previously not recognized internally developed

1. Introduction to financial accounting

Non-current financial assets encompass the following items:

1. Introduction to financial accounting

Inventories are assets that are

Recognition at cost, i.e. either acquisition or production costs.

Strictly lower of (irrespective whether decrease in value is considered

Acquisition or production costs Net realizable value

In general cost of inventory items shall be recorded at individual costs.

a) The company has to prepare financial statements according