07/11/2022

ACCOUNTING, CONTROLLING AND AUDITING: LECTURE II

Introduction to Financial Statements

i. Balance sheet
 Goal of Financial statements  companies serve the information need of different
stakeholders 
 Balance sheet = statement of financial position  it shows the financial status of a company
and actual earnings of a company in its income statement as corresponding revenues and
expenses are recorded in the same period
 Components of the balance sheet: assets (use of capital) and liabilities and equity (sources
of capital)
 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑒𝑞𝑢𝑖𝑡𝑦  𝐸𝑞𝑢𝑖𝑡𝑦 = 𝑎𝑠𝑠𝑒𝑡𝑠 – 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

 Current assets or liabilities  less than one year (assets

turned into cash or used within one year and for liabilities they
are due within one year)
 Non-current assets and liabilities  long-term positions
 “Capitalizing” an asset = it is recognized on the balance
sheet
1) Historic approach
Valuation
Initial valuation Subsequent valuation
Acquisition cost or cost Depreciation Impairment
of conversion
 Current costs  Historic costs (depreciate a non-current asset in subsequent
= the calculation under periods)
the fair value approach
 Objective: correcting income,  Objective: follow/map a
compensation for use (decrease sudden market
in value) change/distribution (shock)
 No “true” remaining value of an  One-time value adjustment
asset (only decrease in value)
 Planned, systematic, over several  Increase up to the original
years value is sometimes possible

2) Fair value approach (for very specific assets)  under IFRS a company can also revalue
non-current assets at their fair value and then depreciate and assets can be valued upwards
 Fair value  often higher than the historical costs
Valuation
Initial valuation Subsequent valuation
Acquisition cost (= buy Depreciation: Impairment
something) or cost of  Planned regularly shocks in continuo 
conversion ( = produce  systematic over multiple market changes  lowering
something from ourself) periods the value even more

 Current costs  current costs (market value, re-production value)

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Valentina Serratore Bachelor BWL 07/11/2022

ii. Income statement

  success or failure of a company’s operations over a given period of time.
 = Profit & loss statement  the accrual basis of accounting as opposed to the cash basis of
accounting  Accrual accounting matches revenues with expenses
 To present information in their income statement, companies can choose between two
different methods:
1) Cost of goods sold method
2) Total cost method.
1) Cost of goods sold:
𝑆𝑎𝑙𝑒 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 − 𝐶𝑂𝐺𝑆 = 𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖 − 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑎𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑜𝑡ℎ𝑒𝑟 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 = 𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇 +/−𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑟𝑒𝑠𝑢𝑙𝑡 = 𝐸𝐵𝑇
𝐸𝐵𝑇 − 𝑡𝑎𝑥𝑒𝑠
= 𝑝𝑟𝑜𝑓𝑖𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑖𝑛𝑐𝑜𝑚𝑒 𝑎𝑡𝑡𝑟𝑖𝑏𝑢𝑡𝑎𝑏𝑙𝑒 𝑡𝑜 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝑜𝑡 𝑒ℎ 𝑝𝑎𝑟𝑒𝑛𝑡 𝑎𝑛𝑑 𝑚𝑖𝑛𝑜𝑟𝑖𝑡𝑦 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡)


“COGS” = all of the expenses a company incurs that directly relate to the product a company
is selling.
Importance of the income statement:
 Company: if performance is improving and business is growing.
 Investors: if this company is a promising company to invest in.
 Employees: the overall profit of a company can directly affects year-end bonuses and raises.

iii. Cash flow statement

 Cash flow statement analyses:
1) From which sources the company has received cash and for what it has been spent.
2) The company has enough cash to pay its bills
3) How liquid it is?
 Profit ≠ more cash
 The cash flow statement is divided into three parts:
1. The cash flow from operating activities
2. The cash flow from investing activities
3. The cash flow from financing activities
1) Cash flow from operating activities:

 provides information on the progress of the core business  sales activities of the company
(e.g., purchasing, production, sales)
 shows the internal financing strength of the company
 Indirect method
 most common method among companies
 takes an earnings figure from the income statement and incorporates the changes
which do not affect cash
 Direct method
2) The cash flow from investing activities:

 provide information regarding the use of resources for future earnings potential.
3) The cash flow from financing activities:
 to financially balance out deficits from the operating and investing activities.
 Reflection of long-term financial debt and equity.

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Leases
 Relevant for accounting purposes  legal ownership of rented objects is not acquired, BUT
rental agreements can result in economic ownership  all opportunities and also all risks are
transferred to the lessee.
 = a contract that convey the right to use an asset for a period of time in exchange for
compensation
 Accounting for leases  the principle of "substance over form" must often be considered in
accounting.
 Advantages to leasing instead of purchasing: lower initial financial burden, temporary
increase in capacity, more flexible and have the last models with highest quality
Impact on statements:

 Lessor  the asset disappears from the balance sheet  provide information for assessing
the economic situation.
 Lessee:
1) Assets side  shows all those essential assets that are necessary for his or her business
2) Liabilities side  main obligations should be identifiable, and a lease agreement does
indeed commit the lessee to make future payments. (= leasing payments)
3) Cash Flow  leasing fee  cash out
 Two types of leasing agreements:
Operating leasing Finance leasing (Financial purchase)
(classical rental
agreement)
Short-term Long-term
Payments are only small Payments are large part of total value
part of total value
Risks and rewards Risks and rewards transferred to lessee
remain with lessor
Lessee: rental expenses Lessee: become the new owner  principle of "substance over form"
but no items in the  asset in the BS and liability = cash value of future payments to
balance sheet. which the lessee has committed himself
Lessor: Leased asset is Lessor: the leased asset disappears  receivable at present value of
an asset in the lessor's the future lease payments + notes in the case of a lease (the extent to
balance sheet. which assets have been leased and the resulting liabilities
 Sector that often use lease: airline, retailers and services and utilities companies
 Problems with old standard IAS 17:
- No whole picture for the investors
- Assets and liabilities missing for lessee
 IFRS: all leases appear on BS, reporting a right of use asset and lease liability and lease expense
is composed of depreciation charge and an interest expense

Impairment
 "impairment" = "extraordinary depreciation" of an asset.
 = the recognition of an unexpected loss in value of an asset.
must be recognized in full in the period in which it occurs.
 Mainly used in the context of non-current assets, i.e., intangible
assets, tangible assets and financial assets.
 Exceptional losses in value of current assets  value
adjustments or write-downs.  regularly calculated
When an impairment loss should be recognized?
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 Asset’s criterion the existence of a future economic benefit  If the value falls below the
originally expected value  impairment
 A company must always monitor its environment to calculate the need for unscheduled
impairments if necessary.
 Intangible assets with an indefinite useful life (goodwill) subjected to a documented review at
least once a year to determine whether an impairment loss needs to be recorded
 To determine an impairment requirement  sum of the expected future inflows of benefits
from an asset are compared with the carrying amount of this asset:
1) future cash flows > current carrying amount  no impairment
2) future cash flows < current carrying amount of the asset  impairment
Impairment test:

 Complex
 Management chooses the economically better alternative  the scenario with the higher
inflow of benefits
 Predicting the inflows over several years basically corresponds to a company valuation. 
Companies tend to present themselves better than the situation actually is  triggering event
 The more assets included in a cash-generating unit, the sooner negative and positive
developments in the individual values can be offset against each other, so that an impairment
may be prevented.
 An impairment test is usually triggered by changes in the technical, economic or legal
environment.
Acquisition of intangible assets
1) Intangible assets purchased in situation other than business combination  fair value
2) Intangible assets developed internally  expenses; under IFRS: expenditures on R&D
3) Intangible assets acquired in a business combination  fair value if identifiable and if there
is acquisition price exceeds  goodwill

Pensions
Employee Pensions: employer to employee contributions made to fund future retirement
Impact on statements:
1) Defined contribution pension commitment (DCP):
 Obligation of a company  make a certain contribution to its employees' pension
scheme (exception of some information in the notes)  limited obligation
 Monthly payments  fixed contributions  an insurance company or a pension fund.
 Pension fund  responsible for the employee's future retirement benefits.
 Pensions are protected even if company goes bankrupt
2) Defined benefit pension commitment (DBP):
 Company promises the employee a pension at a certain level (for example
half of the previous salary until the end of the employee's life)
 Company  not obliged to make certain contributions BUT obliged to
provide certain benefits.
 Obligation of the company towards current and past employees
 the actuarial and investment risk is placed on the entity
How to calculate provisions:
1. Estimate total pension payments (life expectancy, the age at which they retire, wage
development)

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2. Estimate yearly provisions (remaining worktime and interest development)

SWITZERLAND:

 Employers have established a pension fund which is a

separate legal entity separate from the company
 Funds receive regular payments from the company,
which are held as financial assets on the assets side.
 If the pension fund has higher obligations than it has
assets, this is known as “underfunding”.
 If the fund has higher assets than liabilities, then there
is an excess cover, which is known as “overfunding”.
 Liquidity for future pension payments in Switzerland is
usually handled by external pension fund
 Notes on pension obligations can be quite extensive.

Financial Instruments
 = any contractual rights or obligations that involve an exchange of cash and give rise to
exchange of liquid assets
 agreement between two or more parties stating that means of payment are to flow between
the parties
Different types of financial instruments:

 Loans and Bonds: right to a given share of equity of the entity invested in
 Stock purchase/Shares: ownership amounts traded on the stock exchange
 Derivative positions/assets (options, futures and swaps)
 Trade or other Receivables/payables
 Financial assets
 Short-term investment
Impact on statements:
IFRS OR
- Fair value OCI (through equity) - Amortized cost (you recognize the profit
- Fair value IS after you sell it)  acquisition cost
IFRS and US-GAAP tend to show market values.

 Financial instrument should normally always be viewed from two sides:

1) Recipient of the means of payment  gives money
2) Sender of the payment  has a liability
 a financial instrument must not only be a trade
receivable, to the debtor, but it also has to be a trade
liability, from a creditor
 ≠ different from liquid assets such as cash  financial
instruments give rise to the right to exchange these
liquid assets
 a long-term fixed-term deposit account are financial
instruments

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Different ways of valuing financial instruments:

1) Financial assets:
Initial measurement Subsequent measurement
 = the measurement at the time a financial  = the measurement at the end of the
instrument is recognized on the balance accounting periods following the acquisition.
sheet  monthly, quarterly or annually in the financial
 Acquisition cost = the value paid  at Fair statements.
Value

2) Financial liabilities:
Initial measurement Subsequent measurement
At Fair value = value of the Amortized cost: FVTPL:
consideration received when the Most financial liabilities are Derivates and liabilities
liability was incurred measured at amortized cost accounted for under the
using the effective interest fair value option
method

Income Taxes
 Interplay between accounting and tax law
 Income taxes = money owed to the government based on profits earned by a company
 Impact on statements: BS and IS
How accounting affect taxes?

 Accounting  determine the actual tax burden

 Book-tax conformity means: commercial BS = tax BS

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 But not apply without restriction: OR - Principle of prudence = low profits  low tax burden
 The tax legislator abandoned the principle of book-tax conformity: established its own rules
for determining profits  higher profit

 Tax law follows the ability-to-pay principle = those with the most resources should pay the
most taxes
 Deferred taxes can arise from OR vs IFRS financial reporting on, for example:
depreciation/impairment, inventory and valuations
Two types of taxes:
1) Current taxes:
 result from the determination of taxable income in accordance with local tax law.
 To way to pay current taxes:
1. Paid immediately through advance payments during the year
2. Provision  the entity shall recognize a provision for the corresponding amount at
year-end
 Recorded in the annual financial statements (IS) as tax expense (regardless of whether
it is in accordance with OR, IFRS or Swiss GAAP FER) ↑
1) Deferred taxes:
 No book-tax conformity  result determined in the accounting ≠ the result obtained
after the determination of taxable profit
 It happened when a company does not prepare its accounts in accordance with the
OR, but has to prepare consolidated financial statements in accordance with IFRS,
Swiss GAAP FER or US-GAAP.
 Completely different profit in the income statement and a completely different value of
assets in the balance sheet than in the tax statements.
 Recognition of deferred taxes has time differences between the tax and commercial
balance sheet valuation:
1) Permanent: financial accounting and tax accounting do not recognize the same
rule, difference will not balance out over time  no depreciation and/or tax-free/not
tax deductible
2) Temporary: the tax difference will balance out over time = creates a tax liability or
assets  if there is a depreciation and it will balance out the BS
 Different types of deferred taxes:
1) Deferred tax liabilities = future tax burden arising on sale is placed on the liabilities
side like a provision.
- Taxable income (OR) < Financial reporting income / profit (IFRS)
- IFRS financial statements  the actual taxes are too low to provide a true
and fair view.
2) Deferred tax assets
- Taxable income (OR) > Financial reporting income / profit (IFRS)
- Current taxes are higher than they would be on the basis of the IFRS
financial statements.
- From an IFRS pov  the company has a future, latent claim for repayment
against the tax authorities.
How do taxes affect accounting?

 Measurement of deferred taxes at expected future tax rate

 Tax rate: expected to apply when the temporary difference reverses = tax rate applicable at
the time when the deferred tax becomes an actual tax.

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