2. The double entry accountingTOREMEMBER
Asset accounts
D
Increase Decrease
Liability accounts
Decrease Increase
Charges Revenus
P & L Account
3. The concept of a balance sheetExercise1
What I HAVE What I OWE
4. Exercise1
What I HAVE What I OWE
House
Car
Furniture
Equipment
Savings
“Petty” Cash
Mortgage
Car loan
Equipment loan
Invoices
Overdraft
The concept of a balance sheet
5. Exercise1
What I HAVE What I OWE
House 100
Car 10
Furniture 30
Equipment 20
Savings 10
Petty Cash 5
Adding up 175
Mortgage 65
Car loan 5
Equipment loan 10
Invoices 5
Overdraft 10
Adding up 95
The concept of a balance sheet
6. Exercise1
What I HAVE What I OWE
House 100
Car 10
Furniture 30
Equipment 20
Savings 10
Petty Cash 5
Total 175
Net worth 80
Mortgage 65
Car loan 5
Equipment loan 10
Invoices 5
Overdraft 10
Total 175
The concept of a balance sheet
7. Exercise1 The concept of a balance sheet
Assets =Liabilities +Net Worth (Equity)
What about income and expenses?
8. Revenues (Income) 1000
- Mortgage loan repayment 300
- Car expenses 50
- Heating, electricity,… 100
- Various expenses 100
- Taxes and Soc. Sec. 400
Revenuesandexpenses
Net income / Savings 50
Where did the money go?
9. The charges to the P & L
Net Result
TheP&LAccount
Other
operational
income
Gross
margin
Added
Value
Gross ops
profit
Profit before
taxes
Goods
& services
Personnel
-expense
Other ops
expenses
Amortisa
tion
EBIT
Financial
expenses
Taxes
Result of
Operations
Financial
Income &
exceptional
Gross
Profit
Other
income
10. P & L N-1 EURO N
Turnover (1)
Purchased goods
- Inventory
= Cost of goods sold (2)
Gross margin (3)=(1)-(2)
+ Other business related income
= Income from operations (4)
- Goods and services (5)
= Added Value (6)=(4)-(5)
- Personnel expense
- Other operational expenses
= Gross operating income
+ Financial revenues
+ Exceptional results
= Gross total revenue (EBITDA)
- Amort., provisions, depreciations
= EBIT
- Financial expenses
- Taxes
= NET PROFIT
ExceptionalExceptional
OperationsOperations
InvestmentsInvestments
FinancingFinancing
Key elements of a P & LTheP&LAccount
12. The balance sheet of a bank
ASSETS LIABILITIES
Differentbalancesheets
What the bank HAS What the bank OWES
13. Example :
The opening balance sheet of a company
Assets Liabilities
Short term asset Net worth
The methodology of double entry accounting
Doubleentry
21. Barca BARCA Trial Balance
Cash Capital Equipment Supplier Equipment
Sales Stock Supplier Stock Customers
Fees Operations Cost of goods sold Depreciation
Income Taxes Due to Tax Aut. Dividends Due to Shareholders
22. Barca BARCA Trial Balance
Cash Capital Equipment Supplier Equipment
Sales
50,000
156,000
25,000
77,000
48,000
22,000
2,000
Trial balance = 339,600
206,000 174,000
32,000
50,000 25,000 25,000 25,0006,250
18,750
Stock Supplier Stock Customers
Fees Operations Cost of goods sold Depreciation
Income Taxes Due to Tax Aut. Dividends Due to Shareholders
240,000 95,000 80,000 95,00077,000 156,000240,000
48,000 22,000 80,000 6,250
27,600 27,600 6,000 4,000
15,000 18,000 84,000
25. Barca
P & L account (Income statement)
Revenue
Cost of materials
Salaries
Other operating cost
EBITDA
Depreciation
Op. income EBIT
Tax
Net income before div.
26. Barca
P & L account (Income statement) – rounded figures
Revenue 240,000
Cost of materials -80,000 (95-15)
Salaries -48,000
Other operating cost -22,000
EBITDA 90,000
Depreciation -6,250 (25% 25)
Op. income EBIT 83,750
Tax -27,600 (33% EBIT)
Net income before div. 56,150
Net income after div. 50,150
27. Barca
Cash flow
Payments from clients
Cost of goods sold
Salaries
Other op. expenses
Cash flow from ops
Cash flow for investments
Available cash flow
disponibleCapital increase
Dividends
Cash flow from financing
Cash flow
28. Barca
Cash flow
Payments from clients 156,000 (65%240)
Purchase goods -77,000 (95-18)
Salaries -48,000
Other op. expenses -22,000
Cash flow from ops 9,000
Cash flow for investments -25,000
Available cash flow
disponible
-16,000
Capital injection 50,000
Dividends -2,000
Cash flow from financing 48,000
Cash flow 32,000
30. Barca
Balance (rounded figures )
Fixed assets 18,750
Inventory 15,000
Receivables 84,000
Cash 32,000
Total assets 149,750
Capital 50,000
Ret. Earn. 50,150
Net worth 100,150
Tax due 27,600
Payables 18,000
Div. due 4,000
Liabilities 49,600
N.W. &
Liabilities
towards
third parties
149,750
31. Cost of goods sold
Beginning inventory 4,000
Plus Purchases 7,400
Equals : Good available for sale 11,400
Less : Ending inventory 2,000
Cost of goods sold 9.400
Ending inventory
Beginning inventory
Available
For sale
11,400
Pur-
Chases
7,400
Cost of
goods
Sold
9,400
4,000
2,000
Notas del editor
The following slides are an illustration of what was stated in relation to the EVALUATION OF ASSETS and the impact on the NET WORTH
This is quite a remarkable slide
It shows the P & L statement in a different manner
Look at all this hard work and what is finally left over after taxes
FOR OUR DEALER LESS THAN 1% OF HIS TURNOVER IS LEFT FOR HIM
Now we should really company to what is left over with his initial investment
The return on investment for our car dealer is about 12 to 15 %, in other words it is still worth being a car dealer
Below 7% he better puts his money to fruition somewhere else and enjoy himself rather than working as hard as he is doing
As you can see the Income statement also called the Profit & Loss Account is structured in 4 parts to show income and charges as a result of
Operations
Exceptional items (for instance head quarters have been sold)
The results (positive or negative) of the investments made by the company
The financial cost and taxes
The purpose to structure a P & L that way is to make comparison possible and show if the money is coming from operations or anything else
As you can see the P & L has its own vocabulary
Turnover – cost of goods sold = GROS MARGIN
GROS MARGIN + OTHER BUSINESS RELATED INCOME = INCOME FROM OPERATIONS
INCOME FROM OPERATIONS – GOODS AND SERVICES = ADDED VALUE
ADDED VALUE – PERSONNEL EXPENSE & OTHER OPERATIONAL EXPENSES = GROS OPERATION INCOME
GROS OPERATING INCOME +/- EXCEPTIONAL ITEMS = EBITDA (Earnings before interest and taxes and before depreciation and amortisation)
EBITDA – AMORTISATION & DEPRECIATIONS & PROVISIONS = EBIT (Earnings before interest and taxes)
EBIT – INTEREST AND TAXES = NET PROFIT
You have to get used to both the terminology and the lay-out
Participants should be in a position to put on paper the basics of a balance sheet of a bank
I WOULD SUGGEST ANOTHER EXERCISE HERE ON DEBITS AND CREDITS
THEY FOLLOW THE SAME CONVENTION AS EARLIER BUT A BANKER THINKS DIFFERENTLY THAN HIS CUSTOMER DUE TO THE FACT THAT WHAT REPRESENTS AN ASSET FOR A CUSTOMER IS A LIABILITY FOR A BANK
When a person puts money in his or her account that person increases his or her assets held at the bank
That same transaction for the bank means that the indebtedness from the bank towards the customer increases
The bank will consider that the money of the customer is a liability
When a liability account increases we talk about a CREDIT
Therefore the banker will say to the customer that the account has been credited
When a bank pays by means of the account a telephone bill, this means that the LIABILITY TOWARDS THE CUSTOMER DERCREASES this means a DEBIT
The bank does not think differently than the customer it is just that what the customer puts on his balance sheet as an asset is put on the banker’s balance sheet as a liability and the other way around
When a customer borrows money from the bank this borrowed money is a liability for the customer and an asset for the bank!
When a bank extends a loan this means an asset account that is increased thus a DEBIT and for instance a CREDIT to the treasury account
The key accounts of the balance sheet of a bank are shown on the next slide
Their source is the CSSF and the figures are aggregated figures for the Luxembourg banking system
Source www.cssf.lu
THIS IS THE WAY IT IS DONE
WHEN A ASSET ITEM INCREASES IT MEANS A DEBIT
Say you get a 500 bill that you have to put into your « petty cash » (cash on hand – it is always an asset item in opposition to treasury which is a broader concept and can be either positive or negative) – this would mean an accounting entry which would start as
DEBIT PETTY CASH 500
CREDIT…..500
What you HAVE is an ASSET and when it INCREASES we talk about a DEBIT
What we OWE is a LIABILITY and when it INCREASES we talk about a CREDIT
Debits and credits are conventions and allow for the double entry concept and for the balance of a balance sheet
Example : My telephone bill of 150 comes in – this means that I have A LIABILITY which INCREASES this means that the accounting entry will be
DEBIT ……150
CREDIT ELECTRICITY SUPPLIER 150
We will see later what we credit and debit and how
As stated there is often a confusion due to the bank terminology whereby the bank considers that your asset is its liability
So when YOUR MONEY IN YOUR BANK ACCOUNT INCREASES IT MEANS AN INCREASE OF THE LIABILITY OF THE BANK TOWARDS YOURSELF AND THEREFORE THE BANK TALKS ABOUT THE FACT THAT YOUR EXTRA MONEY MEANS FOR THEM A CREDIT TO YOUR ACCOUNT HELD WITH THEM
But let us forget about banks for now and think like an entrepreneur or a private citizen
Summary
When an asset account increases the convention is that we DEBIT
Wen a liability account increases the convention is that we CREDIT
IN fact, the only thing you need to remember is the first sentence and the fact it is the opposite for the liability accounts
It is therefore essential to know if an account is a asset or liability account
We have general agreed standards for that like in Belgium we habe a Belgian Accounting Plan or a GAAP general accepted accounting practice and each account has a specific number
For instance the 1… accounts are for equity and reserves,; the 6 ….. Accounts are for charges and the 7….. For revenues and so on
The balance sheet of the EIB is based on the IFRS schedule or the International Financial Reporting Standards
Those standards gain universal acceptance and even the USA is leaning towards the use of these standards
It is not an academic issue as the companies quoted on various stock exchanges have to publish their balance sheet according to different schedules which represent quite an expense
The need for a universal lay out and structure is quite obvious
The first accounting entry for a new company would be (not taking into account expenses, notary cost)
DEBIT PETTY CASH or BANK ACCOUNT100
CREDIT EQUITY or DUE TO SHAREHOLDERS100
It balances and we have a debit and a credit
You will notice that you always need the two (a debit AND a credit) and that it is ESSENTIAL to ask yourself if you deal with an ASSET ACCOUNT or a LIABILITY ACCOUNT which is increasing or decreasing
Let us look at a few examples and after that we will have an exercise or two to get it into the fingers
This slide explains BEFORE the example and the exercise that it is a CONVENTION FOR THE REVENUE ACCOUNT OR ALSO CALLED THE PROFIT AND LOSS ACCOUNT TO DEBIT FOR A CHARGE
CREDIT FOR A REVENUE
Example – the payment of a telephone bill would be considered as a charge and would mean a DEBIT to the P&L Account
Example – the payment by a customer you invoiced would be considered as an income and would mean a CREDIT to the P&L Account
Let us have a look at the statement first
The turnover or total sales of the company jumped from 14.104 to 14.690
The gross margin is the difference between goods sold and the cost of goods sold (+/- the inventory level: a decrease in inventory equals an increase in cost of goods sold (convention)
The cost of goods sold for N equals 12.573+141 or in total 12.714 (this way of calculating is conventional but confusing for the participants)
The gross margin went from 1887 to 1976 or in percentage slightly better from 13.38% of T/O to 13.45% (improvements are always small steps!)
Other operation income is all the income generated by the business but which is not core business: car rental for instance
Added value is more an economic concept than an accounting concept: it is the difference between Income from operations less goods and services (electricity bill, water, software)
As shown personnel expense is a different category because of the impact on the operations
Added value less personnel expense less other (unusual operating expenses) provides the gross operating income
PARTICIPANTS SHOULD RETAIN 496 THIS IS IN FACT WHAT THE COMPANY HAS MADE AND WHAT CAN BE USED TO REPAY FOR INSTANCE LONG TERM DEBT
Subsequently we record the amortisation which recognises loss in value of the long term assets and decrease by same token the base upon which the company is going to pay taxes on company income!
This brings us to the EBIT which is a MUCH USED benchmark for comparing companies between each other
Indeed the taxation may be very different from one country to another and taking the net amount might provide a wrong picture on the efficiency and financing strategy of the company
Participants will notice that so much effort and work only results into a NET PROFIT of less than 1% of T/O
However, this figure should be compared with the investment done by the company rather than the T/O
This would make us compare 137 versus the net worth or 673 which is about 20% which is much better than stocks and bonds
From this picture it can also be noticed that with the money made other operating expenses, financial expenses, taxes have been paid and also dividends
The latter can not be seen from the statement
WE WOULD HAVE TO LOOK AT THE NOTES TO SEE THAT
Say we put 100 on the table to start a NEW COMPANY without taking into account notary expenses and other expenses we would have 100 as an asset of the newly founded company and 100 as a liability towards the shareholders
The asset total would be 100 and the liability total would be 100
In other words the asset of the company is 100% financed by the shareholders
A share is a portion of the capital
Say we would be 10 shareholders of the new company with an incorporated capital of 100 it would mean that each shareholder would hold 1/10 or 10
As soon as the company starts his life the assets and the liabilities will vary and the net worth (the difference between the assets and the liabilities) will move upwards or downwards
Say we put 100 on the table to start a NEW COMPANY without taking into account notary expenses and other expenses we would have 100 as an asset of the newly founded company and 100 as a liability towards the shareholders
The asset total would be 100 and the liability total would be 100
In other words the asset of the company is 100% financed by the shareholders
A share is a portion of the capital
Say we would be 10 shareholders of the new company with an incorporated capital of 100 it would mean that each shareholder would hold 1/10 or 10
As soon as the company starts his life the assets and the liabilities will vary and the net worth (the difference between the assets and the liabilities) will move upwards or downwards
Say we put 100 on the table to start a NEW COMPANY without taking into account notary expenses and other expenses we would have 100 as an asset of the newly founded company and 100 as a liability towards the shareholders
The asset total would be 100 and the liability total would be 100
In other words the asset of the company is 100% financed by the shareholders
A share is a portion of the capital
Say we would be 10 shareholders of the new company with an incorporated capital of 100 it would mean that each shareholder would hold 1/10 or 10
As soon as the company starts his life the assets and the liabilities will vary and the net worth (the difference between the assets and the liabilities) will move upwards or downwards
Say we put 100 on the table to start a NEW COMPANY without taking into account notary expenses and other expenses we would have 100 as an asset of the newly founded company and 100 as a liability towards the shareholders
The asset total would be 100 and the liability total would be 100
In other words the asset of the company is 100% financed by the shareholders
A share is a portion of the capital
Say we would be 10 shareholders of the new company with an incorporated capital of 100 it would mean that each shareholder would hold 1/10 or 10
As soon as the company starts his life the assets and the liabilities will vary and the net worth (the difference between the assets and the liabilities) will move upwards or downwards
Say we put 100 on the table to start a NEW COMPANY without taking into account notary expenses and other expenses we would have 100 as an asset of the newly founded company and 100 as a liability towards the shareholders
The asset total would be 100 and the liability total would be 100
In other words the asset of the company is 100% financed by the shareholders
A share is a portion of the capital
Say we would be 10 shareholders of the new company with an incorporated capital of 100 it would mean that each shareholder would hold 1/10 or 10
As soon as the company starts his life the assets and the liabilities will vary and the net worth (the difference between the assets and the liabilities) will move upwards or downwards
Say we put 100 on the table to start a NEW COMPANY without taking into account notary expenses and other expenses we would have 100 as an asset of the newly founded company and 100 as a liability towards the shareholders
The asset total would be 100 and the liability total would be 100
In other words the asset of the company is 100% financed by the shareholders
A share is a portion of the capital
Say we would be 10 shareholders of the new company with an incorporated capital of 100 it would mean that each shareholder would hold 1/10 or 10
As soon as the company starts his life the assets and the liabilities will vary and the net worth (the difference between the assets and the liabilities) will move upwards or downwards