Accountancy & Finance for Lawyers
Notes
Topic 1 – Financial Statements & Reporting
Standards; The Balance Sheet
Purpose of Financial Statements & Reporting Standards
Financial statements help provide 3 main information points about a firm:
o How much assets and liabilities does the firm have? (Balance sheet)
o How much does a firm earn? (Income statement / P&L statement)
o How much cash does a firm generate? (Cash flow statement)
They are useful to a wide range of users in making economic decisions
o Owners; managers; lenders; investors; customers; regulators; creditors;
employees; society
o Users need to be confident that the financial statements provide a true and fair
view of the particular company’s financial affairs
o That is why the content and presentation of the published financial statements
is regulated by a series of accounting standards (also by company law, and, for
listed companies, stock exchange requirements)
Two main accounting standards:
o International Financial Reporting Standards (IFRS)
All EU public companies
Principles-based
o Generally Accepted Accounting Principles (US GAAP)
United States
Rules-based
The Dutch case
o The Dutch GAAP refers to the whole body of authoritative accounting
literature in the Netherlands, including:
Book 2 Title 9 of the Dutch Civil Code
The Framework and the Guidelines on Annual Reporting from the
Dutch Accounting Standards Board (DASB)
Case law
European Directives
Introduction to the Balance Sheet statement
1. The Balance sheet statement
a. A ‘snap shot’ of a business at a point in time (usually at the end of an
accounting period)
b. Communicates what the business owns & owes
2. 3 main components:
a. Assets (e.g., cash, motor vehicles)
, b. Liabilities (e.g., bank loans)
c. Equity (e.g., investments in company / shares)
3. Fundamental accounting equation:
a. 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝐸𝑞𝑢𝑖𝑡𝑦
b. The balance sheet statement must always balance
c.
4. Equity as a statement of risk
a. All assets (left) are owned by either creditors or equity holders (right)
b. Claims of creditors are (1) fixed and (2) prior to the claims of equity holders
c.
d. Debt holders have first claim on organizations’ assets
Balance sheet components:
1. Assets – resources or anything of value
a. Current assets - on balance sheet for < 1 year (cash, inventory, receivables)
b. Non-current assets - on balance sheet > 1 year (buildings, trucks, land)
c. Tangible (building, machinery, vehicles)
d. Intangible assets (trademarks, licenses, patents)
2. Liabilities – any debt or other financial obligation owed
a. Current liabilities – need to be repaid in < 1 year (creditors, accounts payable)
b. Long term liabilities – repaid over > 1 year (long term loan)
3. Equity – the initial amount invested; net worth (Equity = Assets – Liabilities)
a. Book value of equity
b. Stockholder’s equity – paid in capital, preferred stock, common stock, treasury
stock (repurchased by the firm), retained earnings, dividends, unrealized gains
/ losses from investments
c. The accounting ‘books’ do not necessarily represent the current market value
or intrinsic values
How to read & prepare a balance sheet statement:
Balance sheet analysis
o What is the risk associated with this organization?
How are the firm’s assets invested?
, How much liquidity does the firm have to meet its obligations?
What is the size and value of the assets, liabilities, and equity (capital
structure)?
o Vertical vs. Horizontal analysis
Vertical slicing:
Horizontal slicing:
o Working capital = current assets – current liabilities
o How are assets financed?
Which is higher – equity or debt?
, Topic 2: The Income Statement & The Cash Flow
Statement
The Income Statement
1. Rationale of the income statement
a. Also called profit & loss accounts, or statement of earnings
b. States how much does a firm earn?
c. Tracks business activities and shows a profit or loss earned in a particular
accounting period
i. Records results over time; not just a snapshot
ii. Cf. balance sheet
d. Basic equation:
i. 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 = 𝑃𝑟𝑜𝑓𝑖𝑡
1. Profit not to be confused with pretax profit, operating income,
EBITDA
2. Example income statement (Figure 1):
a.
b. Starts with revenue, works its way down listing the costs down to the net profit,
i.e., the ‘bottom line’
c. 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 = 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
d. 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 − 𝐷𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛, 𝐴𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒, 𝑂𝑡ℎ𝑒𝑟 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡
e. 𝑂𝑝. 𝑃𝑟𝑜𝑓𝑖𝑡 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥
f. 𝑃𝑟𝑜𝑓𝑖𝑡 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥 − 𝑇𝑎𝑥𝑎𝑡𝑖𝑜𝑛 = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
3. Accrual accounting
a. Revenue is often shown on the income statement as soon as the sale is made, even
if the money has not yet been received from the customer
b. This means the revenue can be recognized before the cash is received – accrued
revenue
c. Vice versa, it could be that cash is receive, but the revenue is not recognized yet –
deferred revenue
d. This results in 2 types of accounting:
i. Cash accounting – tracks the actual cash received by the company
ii. Accrual accounting – tracks the actual cash received and IOUs
1. More complicated, but also better matches the revenue, expenses,
and P&L – matching principle
