Business Management & Entrepreneurship Starter Seminars ...

Business Management &

Entrepreneurship

Starter Seminars

Introduction to Finance

November 2020

Marc GoldchsteinProf. dr. Marie-Laure Vandenhaute

Main source

Prof. Dr. Marie-Laure Vandenhaute

Faculty of Social Sciences & Solvay Business school

Department of Business – Accounting and Auditing

• Office: VUB, Pl.5.3.54

• Tel: +32 (2) 629.84.24

• Email: marie-laure.vandenhaute@vub.be

‛Edited and presented by Marc Goldchstein

3/11/2015 | pag. 2

Finance: why bother?

entrepreneurs need to understand the financial side of a company

‛entrepreneurs must master the basics of accounting‛what is a balance sheet, a profit and loss statement‛how are business transactions transated into accounting entries

‛entrepreneurs must be able to analyse the financial health of a company‛read and analyse a balance sheet, P&L statement‛entrepreneurs must be able to judge the financial viability of projects & companies‛companies fail when/because they are financially non-viable

‛entrepreneurs must understand the logic of professional investors‛how do they decide to invest, what are their expectations

Course Outline

I. Financial Accounting1. Role of Accounting

2. Legal Framework3. Understanding Financial Statements

4. Accrual Accounting

5. Selected Topics6. Financial Statement Analysis

II. Tax Basics

III. Management Accounting

IV. Investing in growth-oriented startups

3/11/2015 | pag. 5

Course Outline

I. Financial Accounting1. Role of Accounting 2. Legal Framework3. Understanding Financial Statements4. Accrual Accounting5. Selected Topics6. Financial Statement Analysis

II. Tax Basics

EventAccountant’s analysis and

recording

Financialstatements Users

Accounting - a process of identifying, recording,summarizing, and reporting economic information(transactions) to decision makers in the form offinancial statements

Definition

1. Role of AccountingLanguage of Business

Accounting information is useful to anyone who makes decisions that have economic results

= parties who are interested in the activities of the business because they’re affected by them (stakeholders / users)

• Investors / Shareholders want to know if a company is a good investment with adequate returns

• Creditors (banks/suppliers) want to know if they should extend credit, how much to extend, and for how long

• Clients want to know if they can rely on proper after sales service.

• Management wants to know if they perform well

• Others (e.g. employees, unions, competitors…)

• Government (tax authorities; national statistics)

1. Role of AccountingStakeholders

2 important accounting movements:

Anglo-Saxon Continental

Europe

https://www.lifepersona.com/what-are-the-anglo-saxon-countries

1. Role of AccountingAccounting traditions – Some history…

‛Anglo-Saxon

‛More equity-oriented

‛Neutral

‛(fair value)

Continental Europe

‛More debt-focused

‛and

‛Conservative

‛(historical price)

IAS/IFRSEuropean DirectivesNational GAAP (BE-GAAP, French GAAP, ...)

1. Role of AccountingThe Concept of Accounting Conservatism

Anglo-Saxon Continental

Europe

‛The major distinction between financial and management accounting is theusers of the information:

‛Financial Accounting focuses on the specific needs of decision makersexternal to the organization, such as stockholders, suppliers, banks, andgovernment agencies (summarized information) to help them assess the firm’sfinancial performance.

‛Management Accounting serves internal users, such as top executives,management, and administrators within organizations (detailed information) tohelp them operate the business.

3/11/2015 | pag. 13

Externally disseminated financial statements have to be drawn up by referenceto a set of accounting rules. These might be different depending on thejurisdiction.

1. Role of AccountingFinancial versus management accounting

‛Accounting: a process of identifying,recording, summarizing, andreporting economic information todecision makers in the form of financialstatements.

Auditing: a process of examiningtransactions and financial statements.

1. Role of AccountingAccounting versus Auditing

Stockholders

Board ofDirectors Auditor

Managers

• Corporate management is responsible for thepreparation of the financial statements. Theboard of directors, the link between ownersand managers, has the responsibility toensure that management acts in theinterests of the stockholders.

• Another way to solve the credibility problem isto introduce an honorable, expert third party.

ü The auditor examines the information thatmanagers use to prepare the financialstatements and provides assurancesabout the credibility of the statements(fair presentation and compliance withGAAP)

èunqualified opinionèqualified opinionèadverse opinion

ü These assurances should make theinvestors more comfortable about usingthe information to guide their investingactivity.

Appoint

1. Role of AccountingAccounting versus Auditing

3/11/2015 | pag. 16

Course Outline

I. Financial Accounting1. Role of Accounting 2. Legal Framework3. Understanding Financial Statements4. Accrual Accounting5. Generally Accepted Accounting Principles (GAAP)6. Selected Topics7. Financial Statement Analysis

II. Tax Basics

2. Legal FrameworkA new Code of Companies and Associations (CCA)

Companies Associations

Distribution of profits

https://justitie.belgium.be/nl/themas_en_dossiers/vennootschappen_verenigingen_en_stichtingen/vennootschappen/vennootschap_1

No distribution of profits

Limited liability Limited liabilityUnlimited liability Unlimited liability

2. Legal FrameworkA new Code of Companies and Associations

Limited liability

Minimum capital

More than one founder

Legal personality

socio-economic importance

All partersunilimited liable

2. Legal FrameworkSole proprietorship versus company

Sole proprietorship• Easy to set up

• The income of your business ispersonal income, which is taxedat the (high) progressive ratesin the personal income tax.

• No clear separation between theindividual’s personal assets andthe assets owned by thebusinessà Personal liability!

• Simple Accounting

The Company• A separate legal personality (except for

the ordinary partnership ‘maatschap’)

• More administrative and legalformalities and obligations

• Assets belonging to the company canbe separated and assets belonging tothe businesspersonsà further distinction between limitedand unlimited liability companies.

• Your company's income is taxedseparately in the corporate income taxand you can optimise your personalincome from the company.

• Mainly double-entry accounting

2. Legal Frameworkminimum legal capital requirements

§ Sole proprietorship : No minimum legal capital requirements

§ Limited liability company (BV/SRL):§ no minimum capital§ but:§ founders must provide enough financial means (capital, loans to conduct the

envisaged activities§ A detailed financial plan is required; its contents is laid down in the Code.

§ plan not publicly available, but can be consulted by the bankruptcy trustee in theevent that the BV/SRL becomes insolvent within three years of its incorporation

§ if the court finds that the founders clearly assembled insufficient meansfor normal operation of the BV/SRL for at least two years, the foundersmay be held liable for all or part of the uncovered liabilities.

§ Public limited liabilty company (NV/SA)§ The minimum subscribed share capital amounts to €61,500. At least one-fourth of the

total subscribed capital must be paid in upon incorporation, with a minimum of €61,500.

§ Shareholders are only responsible/liable up to their own contribution§ Must also have a financial plan

2. Legal FrameworkBelgian Accounting Law

§ According to the Code on Economic Law enterprises are required to have a bookkeeping system that corresponds with their size and nature.

§ Are now also subject to the accounting obligations:§ Any natural person carrying out a professional activity on a self-

employed basis in Belgium§ associations and foundations§ organisations without legal

§ Any ‘enterprise’ has to comply with the bookkeeping obligationsimposed by Belgian accounting law and to file its annual accountswith the Belgian National Bank§ some enterprises are exempt from this last obligation

§ Simplified accounting is allowed for small enterprises

§ Simple Accounting (Cash Accounting)

§ Purchases, Sales and Financial diary and an inventory – no standard form –Not to be deposited

§ Applies too Only possible in case turnover <0,5Mn, otherwise double-entry

accountingo Natural persons carrying out a professional activity on a self-employed

basis o VOF and CommVo Ordinary partnerships (Maatschappen)

§ Double Entry Accounting

§ Balance sheet, Income statement and Notes - standard form – To bedeposited and made public

o NV, BV, CV

§ Specific Accounting Rules

o a.o. associations, banks, insurance companies, hospitals,…

§ Financial Statements of entities with legal personality consist of three parts

1. Balance Sheet2. Income Statement3. Notes

§ The CCA provides standard models of the annual accounts.§ A distinction must be made between

§ kapitaalvennootschappen (capital companies) (NV)§ kapitaalloze vennootschappen (no-capital companies) (BV and CV)

§ For both types of companies, three standard models apply depending on the sizeof the company:

• Complete standard form for ‘large’ companies and listed companies (VOL)• Abbreviated standard form voor de ‘small’ companies (VKT)• Micro standard form for ‘micro’ undertakings (MIC)

• as from 1 January 2020 the filing of annual accounts in PDF format will beaccepted

https://www.nbb.be/nl/balanscentrale/opmaking/modellen-van-de-jaarrekening

Content & lay-out are fixedaccording to a standard format

3 De Belgische

With capital(kapitaalvennootschap)

Without capital(Kapitaalloze vennootschap)

Sole proprietorshipand very small

companies(1)

Micro companies (2)

Small Companies(3)

Large and quotedcompanies

• Sales < € 500,000• Natural persons

carrying out aprofessional activity ona self-employed basis

• VOF and CommV• Ordinary partnerships

(Maatschappen)

Companies other thanthose mentioned under(1) which, irrespective oftheir legal form, do notexceed more than one ofthe following thresholds:

-Sales: €700,000-Assets: €350,000-Employees: 10

Companies other than thosementioned under (2) which,irrespective of their legal form,do not exceed more than one ofthe following thresholds:

-Sales: €9,000,000-Assets: €4,500,000-Employees: 50

Companies other than those mentioned under (1), (2) and (3)

Cannot be a parent company or subsidiary

Limited liability: the liability of the owner is limited to itsinvestment. In case of financial trouble the owners’ personal

assets are not subject to the creditors’ grasp.

Unlimited liability: owner is personnally liable for all of the liabilities of the entity.

The overrun of more than one of the thresholds applicable tomicro-undertakings and small companies shall only have animpact on the corporate qualification if it occurs during aminimum of two consecutive financial years

Criteria are not calculated on a consolidated basis anymore. Only the parent company will have to do so

Soleproprietorship and

very small companies

Micro companies (2)

Small Companies(3)

Large and quotedcompanies

Simple Accounting/ Cash Accounting

Purchase-,Sales-, and Financial diary

Annual accounts: no standard form

Not to be deposited

Annual accounts: Micro-schedule (similar toabbreviated standardform but with limitednotes)

To be made public (except VOF and CommV)

Social balance sheet is no longer part of the annual accounts, but still have to be submit to the NBB

Annual accounts: Abbreviated standard form

Social balance sheet is no longer part of the annual accounts, but still have to be submit to the NBB

Annual accounts: Complete standard form

Social balance sheet is no longer part of the annual accounts, but still have to be submit to the NBB, as well as a director’s report

Double-Entry (Accrual) AccountingBalance sheet, Income statement and Notes

Source: NBB (2018)

Micro Schedule Accounts deposited

at the National bank of Belgium

AbbreviatedAnnual

Accounts deposited

at theNational bank of Belgium

Full AnnualAccounts deposited

Total Annual

Accounts deposited

174,000

226,000

23,000

423,000

(100%)

+/- 150 à 200 listedcompanies

Micro + Small companies: 95% of the compaines

20172. Legal FrameworkBelgium

2. Legal Frameworkwww.nbb.be

2. Legal Frameworkwww.nbb.be/balanscentrale

2. Legal FrameworkAnnual vs. Consolidated accounts

A Subsidiary

B Parent

Annual accounts

Consolidated accounts

Annual accounts

2. Legal Frameworkwww.data.be

2. Legal FrameworkInternational

+/- 150 listed companies in Belgium

‛Financial Accounting Standards Board (FASB) - responsible for establishingGAAP in the United Stateshttp://www.fasb.org

‛International Accounting Standards Board (IASB) - an organization that isdeveloping a common set of international accounting standards (IAS/IFRS) to beused throughout the worldhttp://www.iasb.orghttp://www.iasplus.com

‛All European quoted companies are obliged to issue their consolidatedfinancial statements in conformity with IAS/

IFRS is required for Listed (public) companies in more than 140 out of 166 worldwide jurisdictions

2. Legal FrameworkInternational

§ The statutory financial statements should be approved by theshareholders' meeting within 6 months after closing; and

§ filed at the Central Balance Sheet Office within 1 month after suchapproval.

§ ! Listed companies: 4 months after closing.

2. Legal FrameworkFiling of the financial statements

Research of Graydon 11-08-2009330.000 financial statements were deposited in 2008

Ø2/3 on timeØ1/3 too late

15.000 companies (5%) do not publish financial statements

2. Legal FrameworkFiling of the financial stataments

https://www.nbb.be/nl/balanscentrale/neerleggen/tarief/tarieven-voor-vennootschappen-2019

2. Legal FrameworkFiling of the financial stataments – Rates

in €

Micro Companies Small non-listedcompanies

Large and listedcompanies

Micro Standard Form Abbreviated Standard Form Complete Standard Form

No director’s report No director’s report Director’s report

No auditor No auditor Auditor

2. Legal FrameworkDocuments to be filed with the annual accounts

3/11/2015 | pag. 53

Course Outline

II. Tax Basics

3. Understanding financial statements

‛The primary questions about anorganization’s success that decisionmakers want to know are:

‛What is the financial picture of the organization on agiven day?

‛How well did the organization do during a given period?

3. Understanding financial statementsComponents of financial statements

‛Accountants answer these primary questionswith some basic financial statements:

‛Balance sheet: shows financial position on a given day.

‛Income statement: shows performance over a given period.

‛Notes/Annexes to the financial statements.

3. Understanding financial statementsThe Accounting Time Period

‛accounting time period• time period over which performance is measured

- At least once a year.- The most popular period: calendar year= 1/1-31/12- Alternative: a year that starts on a date other than December 31,

o usually at the low point in annual business activity.

‛Companies also prepare statements for interim periods, generallyon a half-yearly or quarterly basis.

3. Understanding financial statementsBalance sheet

‛The balance sheet provides a snapshot of an entity’s financial position at an instant in time.

Company XBalance Sheet

31 December 2013AssetsOwner’s Equity +

Liabilities

Long lived assetsLandEquipment

Current AssetsInventoryAccounts receivableCash

Total Assets

€ 16,2559,7556,500

€ 6,5652,3002,0402,225

€ 22,820

Owner’s equityCapital / Shareholder contributions

LiabilitiesLong-term DebtCurrent Liabilities

Accounts Payable Wages Payable

Total Liabilities & Owner’s Equity

€ 9,2559,255

€ 13,5655,800

3,7654,000

€ 22,820

In order of increasing liquidity In order of claim on assets

Account format

Resources of the firm (everything the firm owns)

Where is the money coming from?

Claims against the resources

Obligations (debts) of the business to outsiders (external)= first claim on the assets

Residual claim to assets (internal)

Assets always equal to Owner’s Equity + Liabilities

3/11/2015 | pag.

Balance Sheet31/12/X1

Assets Owner’s EquityLiabilities

Account format

Report format AssetsOwner’s Equity

Liabilities

3/11/2015 | pag. 61

3. Understanding financial statementsBelgian Standard Format

Assets

Company Formation expenses

Fixed assets Intangible assets Tangible fixed assets Financial fixed assets

Current assets Claims on more than a year Stocks and orders in progress Accounts receivable within one year Cash investments Liquid assets Deferred revenue

Total assets

Owner’s Equity + Liabilities

EquityCapitalRevaluation surpluses ReservesRetained earningsCapital grants

Provisions and deferred taxesProvisions for risks and costsDeferred taxes

DebtsDebts > 1 yearDebts ≤ 1 yearAccrued expenses

Total liabilities

‛= ‘Uitgestelde opbrengsten’ en ‘toe te rekenen kosten’ (a.k.a. overlopenderekeningen)

§ costs or revenues that you already have this year, but that are related to the next financial year

§ Deferred revenue represents a prepayment by its customers for goods or services that have yet to be delivered. It is an asset on the balance sheet

§ Example: Pre-paid subscriptions

§ Accrued expenses are expenses a company knows it must pay, but cannot account for because it has not yet been billed for them. It is a liability on the balance sheet

§ examples: Salaries; interest; rent; commission and royalties; utilities; taxes

§ purpose: to ensure that all costs and revenues of the company are always allocated to the correct financial year

DEFERRED REVENUE AND ACCRUED EXPENSES

14-11-2020 |

‛TOT HIER DEEL 2

3/11/2015 | pag. 64

3. Understanding financial statementsBelgian Standard Format

Activa

I. OprichtingskostenVaste activaII. Immateriële vaste activaIII. Materiële vaste activaIV. Financiële vaste activaVlottende activaV. Vorderingen op meer dan

één jaarVI. Voorraden en bestellingen in

uitvoeringVII. Vorderingen op ten hoogste

één jaarVIII. GeldbeleggingenIX. Liquide middelenX. Overlopende rekeningen/

Uitgestelde opbrengsten

Totaal der activa

PassivaEigen vermogenI. InbrengII. HerwaarderingsmeerwaardenII. ReservesIV. Overgedragen resultaatV. KapitaalsubsidiesVoorzieningen en uitgestelde belastingenVII A. Voorzieningen voor risico’s en

kostenVII B. Uitgestelde belastingenSchuldenVIII. Schulden > 1 jaarIX. Schulden ≤ 1 jaarX. Overlopende rekeningen/ toe

rekenen kosten

Totaal der passiva

NewCoBalance Sheet

Liabilities

Total Assets

€ 16,2559,7556,500

€ 6,5652,3002,0402,225

€ 22,820

€ 9,2559,255

€ 13,5655,800

3,7654,000

€ 22,820

3/11/2015 | pag.

3. Understanding financial statementsBalance Sheet

Balance sheet equation:

Assets = Liabilities + Owners’ Equityor

Assets – Liabilities = Owners’ Equity

The ‘balance sheet equation’ basis for double-entry accounting

= recording method whereby at least two accounts are always affectedby each transaction.

3/11/2015 | pag.

An account = a summary record of the changes in a particular asset, liability or owners’ equity.

3. Understanding financial statementsBalance Sheet

TRANSLATING THE START-UP OF A COMPANY IN ACCOUNTING TERMS

For the following transactions in Year 1, please post theirimpact on the balance sheet, the income statement and thecash flow statement.

1. Entrepreneur invests €1,000 of capital in Newco to start operations2. Bank lends Newco €1,000 to help fund operation3. Newco purchases €100 of Property, Plant, & Equipment necessary to begin production4. Newco buys €100 worth of inventory on credit5. Newco pays wages of €100 to employees6. Newco sells one-half of its inventory for €200 to customers on credit

Case Study – NewCo

NewCoBalance Sheet

Liabilities

Total Assets

€ 000

€ 0000

€ 00

NewCo Case StudyBalance sheet (Belgian Format)

NewCoBalance Sheet

Liabilities

Total Assets

€ 000

€ 1,00000

€ 1,000

€ 1,0001,000

€ 00

€ 1,000

NewCo Case StudyTransaction 1

Entrepreneur invests € 1,000.

Entrepreneur invests €1,000 of capital in Newco to start operations 2. Bank lends Newco €1,000 to help fund operation3. Newco purchases €100 of Property, Plant, & Equipment necessary to begin production4. Newco buys €100 worth of inventory on credit5. Newco pays wages of €100 to employees6. Newco sells one-half of its inventory for €200 to customers on credit

NewCoBalance Sheet

Liabilities

Total Assets

€ 000

€ 1,0001,000

2,0001,000

€ 1,000

€ 1,000€ 2,000

€ 2,000

Bank lends € 1,000.

€ 001,000

€ 1,000

€ 2,000€ 1,000

1. Entrepreneur invests €1,000 of capital in Newco to start operations 2. Bank lends Newco €1,000 to help fund operation3. Newco purchases €100 of Property, Plant, & Equipment necessary to begin production; pays cash4. Newco buys €100 worth of inventory on credit5. Newco pays wages of €100 to employees6. Newco sells one-half of its inventory for €200 to customers on credit

NewCoBalance Sheet

Liabilities

Total Assets

€ 1,0001,000

1,000€ 1,000

€ 2,000

€ 2,000 € 2,000

NewCo buys equipment worth €100, pays cash.

€ 0€ 100

€ 1,900

1. Entrepreneur invests €1,000 of capital in Newco to start operations 2. Bank lends Newco €1,000 to help fund operation3. Newco purchases €100 of Property, Plant, & Equipment necessary to begin production4. Newco buys €100 worth of inventory on credit5. Newco pays wages of €100 to employees6. Newco sells one-half of its inventory for €200 to customers on credit

NewCoBalance Sheet

Liabilities

Total Assets

€ 1,0001,000

1,000€ 1,000

€ 2,000 € 2,000

€ 100

€ 1,900

NewCo buys inventory worth € 100, pay on credit.

0100€ 2,000

€ 2,100 € 2,100

€ 1,100

‛What is the financial picture of the organization on agiven day?

3. Understanding financial statementsBalance sheet and income statement

‛The balance sheet provides a snapshot of an entity’s financial position at an instant in time.

‛The income statement provides a moving picture of events over a span of time and explains the changes that have taken place between balance sheet dates.

3/11/2015 | pag. 89

3. Understanding financial statementsBalance sheet and income statement

Balance sheet

31-12-2017

Balance sheet

31-12-2018

Balance sheet

31-12-2019

Incomestatement

3. Understanding financial statementsThe income statement (Anglo-Saxon format)

The income statement is used to show the revenues (sales) generatedand the expenses incurred over one financial year.

3/11/2015 | pag.

Revenue

Cost of goods Sold (COGS)

Cost of the inventory that a company sells

Operating expenses (Selling, General & Administrative expenses)

e.g. wages, rent, heating, telephone,…

Non-operating expenses e.g. interest expense

Net Income or Net Profit

à Costs are primarily divided according to function

DANIELS COMPANYIncome Statement

for the Year Ended December 31, 2015

Sales $98,600Expenses:

Cost of Goods Sold 30,500Wages expense 15,300Rent expense 12,000Utilities expense 6,500Depreciation expense 5,000

Total expenses 69,300Net Income $29,300

Single step income statement

3. Understanding financial statementsThe income statement: Single-step

Net sales- Cost of Goods Sold COGS (materials & direct labor cost)

= Gross Profit- Operating expenses (selling, general, and administrative)

= Operating income (EBIT)+/- Non-operating net income (= from non-core business)

= EBT (Earnings before taxes)- Taxes

= EAT (Earnings after taxes)Extraordinary items (net of taxes)

= Net income

Multiple step income statement

3. Understanding financial statementsThe income statement: Multiple-step

Balance Sheet 31/12/XX

Assets Owners’ equityCapital / Contributions

Retained earnings

3. Understanding financial statementsRetained earnings

Liabilities

3. Understanding financial statementsRetained earnings

‛Retained income = additional owners’ equity generated by income or profits

• Revenues increase owners’ equity.

• Expenses decrease owners’ equity.

→ The Retained income of the company can be described as the

- cumulative lifetime earnings less its cumulative lifetime losses and dividends.- cumulative lifetime revenues less its cumulative expenses

AssetsCurrentLong Lived

LiabilitiesCurrent

Long termOwners’ equityCapital / COntirbutionsRetained earnings

Cumulative revenues

Cumulative expenses

Balance Sheet1/1/X2

Assets Assets

Income statement 1/1/X2 – 31/12/X2

Revenues 1/1-31/12- Expenses 1/1-31/12

RE 1/1+ net income 1/1-31/12 – Dividends = RE 31/12

Owners’ equityCapital / ContributionsRE1/1

Liabilities

3. Understanding financial statementsRetained earnings: the link between the balance sheet and the income statement

Owners’ equityCapital / ContributionsRE31/12

Liabilities

3. Understanding financial statementsStatement of Owner’s equity (Statement of retained income)

Retained income, January 1, 2017 $108,600

Net income for the year 2017 29,300Total $137,900

Dividends declared 10,000

Retained income, January 1, 2018 $127,900

Although dividends decrease retained income, they are nottreated as expenses: dividends are not necessary for the generation of revenue, they are the result of the revenue generation process!

3. Understanding financial statementsA double test for any distribution to the shareholders in a BV

o New rules for the distribution of profits:

o The net assets test (nettoactieftest/ test d’actif net) : the distributionof net assets may not result in negative net assets for the company(asset – liabilities)

o The liquidity test (liquiditeitstest/test de liquidité): the distribution ofnet assets will not lead to the situation whereby the company would nolonger be able to pay the debts as they become due for a period of atleast twelve months.

3. Understanding financial statementsIncome Statement Ablynx Prepared in accordance with

International Financial Reporting Standards (IFRS)

3. Understanding financial statementsIncome Statement

Alarm bell procedure NV

Procedure must be followed when a company’s:

• net assets fall below½ of its share capitalà Board of Directors must convene a general shareholders’ meeting

within two months

à Board of Directors must compile a special report, to be submitted tothe general shareholders’ meeting, in which dissolution is proposed ora set of measures to redress company’s financial position

à Dissolution requires the approval of a 75% majority of those voting atthe general meeting)

à Non-compliance makes the directors liable

• net assets fall below¼ of its share capitalà the dissolution of the company requires only 25% approval

3. Understanding financial statementsIncome Statement

follows the same rules as those of the distribution to shareholders:

* The net assets test: the company has negative net assets (asset – liabilities)* The liquidity test: the company is no longer able to pay the debts as they become due in 12 months

à As soon as either of these two circumstances arises, Board of Directors must convene a general shareholders’ meeting

à BoD must compile a special report, to be submitted to thegeneral shareholders’ meeting, in which a set of measuresto redress company’s financial position

à Only the general meeting can decide to dissolve the company.

Alarm bell procedure BV

1. Venture Capital firm invests €1,000 of capital in Newco to start operations2. Bank lends Newco €1,000 to help fund operation3. Newco purchases €100 of Property, Plant, & Equipment necessary to begin production4. Newco buys €100 worth of inventory on credit5. Newco pays wages of € 100 to employees6. Newco sells one-half of its inventory for €200 to customers on credit

NewCoBalance Sheet

31 December 2013Assets Owner’s Equity + Liabilities

Total Assets

€ 1000

Owner’s equityCapitalRetained Earnings

€ 1,1001,000

Income Statement

Sales 0

Cost of Goods Sold 0

Gross Margin 0

(100)Selling, General, Admin

Operating Profit (100)

Interest Expense

Income Tax Expense

Net Income

Newco pays wages of €100 to employees

€ 2,000

€ 2,100

€ 1,000

€ 2,100

€ 1,900

€ 2,000

0(100)

€ 900

€ 2,000

1. Venture Capital firm invests €1,000 of capital in Newco to start operations2. Bank lends Newco € 1,000 to help fund operation3. Newco purchases € 100 of Property, Plant, & Equipment necessary to begin production4. Newco buys € 100 worth of inventory on credit5. Newco pays wages of € 100 to employees6. Newco sells one-half of its inventory for € 200 to customers on credit

NewCoBalance Sheet

Total Assets

€ 1000

€ 1,1001,000

Income Statement

Sales 200

Cost of Goods Sold 50

Gross Margin 150

Selling, General, Admin

Operating Profit 150

Interest Expense

Income Tax Expense

Net Income

€ 1,900

€ 2,000

€ 900

€ 2,000

Newco sells one half of its inventory for €200 to customers on credit

020010050

€ 2,050

€ 2,150

€ 1,050

€ 2,150

3/11/2015 | pag. 120

Course Outline

II. Tax Basics

4. Accrual AccountingAccrual Basis versus Cash Basis

The most common ways of measuring income are the accrualbasis and the cash basis.

* Cash basis: recognizes the impact of transactions only when cash is received or disbursed.

* Accrual basis: recognizes the impact of transactions for the time periods when revenues and expenses occur even if no cash changes hands.

4. Accrual AccountingRevenue recognition

‛Under the accrual basis revenues are recorded/recognised when:

‛Earned: goods are delivered or a service is performed

‛Realised: cash or a claim to cash (on credit) is received in exchange for goods or

services

For example:

Ø A sale on account is recorded as revenue when the goods are delivered even though the seller receives no cash at that moment.

Ø Magazine subscriptions are received in advance, but the revenue is not earned until the issues are delivered.

4. Accrual AccountingExpenses

‛Two types of expenses:

‛Product costs: cost of inventory linked directly with revenue earnedin the same period.

• Without sales there is no cost of goods sold or salescommissions.

‛Period costs: not directly linked with revenue, but with the timeperiod itself.

• Rent is paid even if no sales are made.

4. Accrual AccountingExpense recognition - Matching

‛Under the accrual basis:

‛Product costs are recorded in the same time period as the relatedrevenues are recognized (Matching).

• e.g. COGS is recorded in the same time period as the relatedsales. As long as the inventory is not yet sold, it remains anasset on the balance sheet.

‛Period costs are recorded in the time period in which they incur.• e.g. Rent for January can only be recorded as an expense in

January even if the payment has occurred already inDecember. In December the prepaid rent will be shown as anasset on the balance sheet.

‛An example of matching is depreciation.

Assets are used up over a period of time, so more and more of their original costs are transferred from asset accounts to expense accounts.

‛example: a car of 30.000 € ‛depreciated over 3 years = 10.000€ per year‛–> 10.000 € costs per year for 3 years

‛Depreciation - the systematic allocation of the acquisition cost of long-lived or fixed assets to the expense accounts of particular periods that benefit from the use of the assets

Under the cash basis, the cost of the asset would be expensed immediately when the asset would be paid for.126

4. Accrual AccountingMatching Principle

NewCoBalance Sheet

Total Assets

€ 1000

€ 1,1001,000

Income Statement

Cost of Goods Sold

Gross Margin

10Depreciation

Operating Profit -10

Interest Expense

Income Tax Expense

Net Income

€ 1,900

€ 2,000

€ 900

€ 2,000

NewCo Case Studydepreciation

Newco depreciates its equipment @ 10% per year

90 (110)

€ 890

€ 1,900 € 1,900

€ 90

4. Accrual AccountingAccrual Basis versus Cash Basis

‛The accrual basis is the current accountingstandard for the measurement of income.

• Presents a more complete summary of what happenedduring the year.

• Represents best economic reality.

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