Financial Accounting

Robert Nothhelfer

• Publisher: De Gruyter Oldenbourg
• Year: 2017
• ISBN:
  9783110521269
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Contabilidad financiera

Every German student of business administration needs to have a basic understanding of accounting according to German GAAP, and thanks to globalization many courses about German accounting are nowadays held in English to improve the language skills of the students.

In addition many foreign subsidiaries of German companies have to prepare their part of consolidated financial statements according to German GAAP. So far, these professionals can rely on German literature only.

The first part of the book offers a compact introduction to financial statements according to German GAAP, the second part comprises exercises on individual topics with solutions and case studies for in-depth and effective learning.

This introduction provides ideal support for German-speaking students taking Englishspeaking lectures in the field and is furthermore valuable for professionals looking for explanations when preparing the data for consolidated financial statements.

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• Includes exercises and case studies for practice
• Ideal textbook for students of German Universities attending English-speaking lectures in financial management
• Ideal introduction for professionals with a succinct explanation and additional support with a glossary and vocabulary

Part I:Financial statements according to German GAAP

1Introduction to accounting

Why is accounting necessary? Many students and professionals consider it boring, tedious, complex, or worse. So many laws and regulations, so many principles and methods – all sound similar, but are different. Why bother?

Imagine a businessman running a small business. He has no employees; he just works on his own. In a market economy, a business provides goods or services for other people, typically customers who pay for them. On the other hand, the businessman runs the business to provide a cash flow to cover his living expenses. When the businessman looks for new customers, an important question arises: What price should he charge for his goods or services? There are two perspectives on this question. The first is the marketing perspective and asks the question: How much are customers willing to pay? This is an important issue, but it is not the focus here. The other perspective is connected to the issue of how much does he need to charge to cover his business costs and to earn a decent living? Put another way: What living standard can he afford with this business?

The core intention of accounting is to answer these questions, to provide information about the financial performance of a business to its owners (or to management, if they are not the same). Other intentions have evolved over time.1

1.1Purpose of accounting

1.1.1The fundamental question and the fundamental equation

As mentioned earlier, the original purpose of accounting was to inform business owners about their financial performance. But what does financial performance mean? Financial performance means the value of the business that is available to the owner, which is usually money that can be spent by the owner, but it can also be in other forms of goods or rights.

But our businessman has more than just a bank account with a positive balance. Let us assume he provides consulting services for companies. For that he needs some equipment, so he buys some assets for example a computer, a mobile phone, and some software. He rents office space and buys some office furniture. Thus, he spends money and acquires other assets that have value. Perhaps one of his suppliers does not ask for cash payment but offers credit, which the businessman takes advantage of. Then he acquires some asset; he does not lose money (at least for now) but he does have a liability: He will eventually have to pay a certain amount of money to settle his purchase.

This leads to the following fundamental accounting equation:2

Net Assets = Assets − Liabilities.

The value that is available for the businessman are the net assets, that is all valuable items the business owns minus all obligations for future payments the business incurs. In accounting, net assets are also called (owner’s) equity:

Equity = Assets − Liabilities or Assets = Equity + Liabilities.

This fundamental equation gives the first important information to the owner of the business, and it must be satisfied all the time at a specific point in time; we return to this point later on.

Another important piece of information is change in equity. To analyse a change in equity, we need to look at a specific time period: At the beginning of this period there is a starting value, and at the end there is an ending value. If the ending value is higher than the starting value, equity increased; this is called profit because the value of the business increased. If the ending value is lower than the starting value, then equity decreased; this is called a loss.3

Example

The aforementioned businessman starts his business with €10,000 in cash. He purchases office equipment for a total of €6,000. Part of it, €4,000, he pays in cash; part of it, €2,000 he buys on credit. He provides services for €24,000, which is paid in cash, and has current expenses for rent and other items of €8,000, which he pays for in cash as well.

What is his financial position at the end of this period?

At the beginning, his equity stake in the business comes to €10,000.

Thus, we sum up his assets as follows (all figures in Euros):

Cash at the beginning	10,000
− purchases in cash	− 4,000
− current expenses	− 8,000
+ cash from services	24,000
= cash at end	22,000
+ purchased assets	6,000
= total assets	28,000

Applying the fundamental accounting equation

Equity = Assets − Liabilities = 28,000 − 2,000 = 26,000

we see that his equity (the value of his business) increased from €10,000 to €26,000, i.e. he made a profit of €16,000.

1.1.2Financial and managerial accounting

The original idea of accounting was to inform the owner of a business about the business’s financial situation. In 1494, Luca Pacioli, a Franciscan monk, made the first comprehensive presentation of double-entry bookkeeping. This is the method still used today in the vast majority of companies. In the following sixteenth and seventeenth centuries, it became common practice for businessmen to account for their transactions and to prepare financial statements, usually at the end of the year.4

The wider use and better understanding of accounting and, as a consequence, one’s own financial position allowed people to develop more complex business models: Selling and purchasing on credit, the use of different forms of credit and insurance and, in...