8 Glossary

Account Summary of similar transactions in a format with two columns; the left side is called the debit side, the right side the credit side.
Acquisition costs Measure for the initial measurement of acquired assets (§ 255 sect. 1). Acquisition costs are calculated as follows:
Purchase price or consideration
− Price reductions
+ Incidental acquisition costs
= Initial acquisition costs
+ Subsequent acquisition costs
= Total acquisition costs
All costs must be direct costs. No imputed costs are included. The acquisition process is completed when the asset is ready for operation.
Accruals Income and expense that have already occurred must be accrued independently of a payment. To do so, in the balance sheet, accrued liabilities and assets are recognized.
Amortization Depreciation of an intangible or financial asset. See depreciation.
Asset The abstract recognition criteria are:
– The asset must provide an economic benefit.
– The asset must be measurable separately from other assets.
– The asset must be separately marketable.
All three criteria must be fulfilled.
The specific recognition criteria are:
– Economic ownership: The reporting entity must own the asset economically, i.e. it must be able to use the asset and it must bear the majority of risks and opportunities of using the asset (including possible sales proceeds and changes in value).
– For proprietorships/partnerships: Distinction between assets of business and private assets of owner.
– Specific legal rules such as requirements, prohibitions or options for recognition.
Balance sheet Summary of all assets and liabilities at a specific point in time in a format that uses two columns; on the left side (the debit side) assets are reported, on the right side (the credit side) liabilities and equity. Total assets must always equal total equity and liabilities. For corporations, German GAAP prescribes a detailed structure of the balance sheet (§ 266).
Cash flow Change in cash and cash equivalents (or: liquid funds); a cash inflow increases cash and cash equivalents, whereas a cash outflow decreases them.
Cash flow statement Presentation of all cash flows in a certain format. According to DRS 21 structured in
– cash flow from operating activities,
– cash flow from investing activities and
– cash flow from financing activities.
A cash flow statement is mandatory for consolidated financial statements and for the individual financial statements of capital-market-oriented companies if they do not prepare consolidated financial statements.
Changes-in-equity statement Presentation of changes in equity in a specific format: The development from opening balance to closing balance must be presented for all line items of equity (DRS 22). The changes-in-equity statement is mandatory for consolidated financial statements.
Completed contract The only revenue recognition concept that is acceptable according to German GAAP; this means for a typical sale/purchase transaction:
– A contract exists,
– the goods have been supplied or delivered or the services have been rendered,
– the transfer of risks has occurred, in particular of the risk of accidental loss and
– any additional condition to request remuneration has been fulfilled.
Consolidated financial statements Groups that are controlled by a parent company must prepare consolidated financial statements presenting the group as if it were only one entity (§ 290). Small groups are excluded from this obligation (§ 293). Consolidated financial statements consist of (§ 297)
– a balance sheet,
– an income statement,
– notes,
– a changes-in-equity statement and
– a cash flow statement.
Consolidation procedures German GAAP provides three ways in which companies can be included the consolidated financial statements: Full consolidation for subsidiaries (that are controlled); this includes capital, liability, income consolidation and consolidation of intercompany profits; Proportional consolidation for joint ventures; At-equity consolidation for participations.
Consolidation scope The companies that are included in consolidated financial statements (parent company and subsidiaries).
Contingent liabilities Liabilities that represent a legal obligation but that are currently not probable. Contingent liabilities may not be recognized in the balance sheet but must be reported additionally (“below the balance sheet” (§ 251)); corporations may report them in notes (§ 268 sect. 8 and § 285 no. 27).
Credit/crediting The right column of an account or a balance sheet is the credit side. Doing an entry on the credit side is called crediting.
Current assets All assets that are not classified as non-current. Typically, current assets are short term (up to 1 year).
Debit/debiting The left column of an account or a balance sheet is the debit side. Doing an entry on the debit side is called debiting.
Deferrals Income and expense that will occur in a defined future time period, but that have been paid or invoiced already, must be recognized as deferred income or expense in the balance sheet (§ 250).
Depreciation Predictable loss of value of a tangible non-current asset. Because a non-current asset is typically used for several years (i.e. has a definite useful life), its loss of value is reflected by depreciation to the extent it is predictable. A depreciation is an expense but not a cash flow. Depreciation is mandatory under the Commercial Code but may only be based on acquisition or production costs (not on replacement costs or other imputed costs). The Commercial Code requires a depreciation schedule, i.e. a planned and systematic approach, but does not prescribe a specific depreciation method.
Equity Also called net assets
From an accounting perspective it is the residual of assets and liabilities. From a legal perspective it corresponds to the claims of the shareholders of the company.
Expense A decrease in net assets (or: equity) is called an expense; the recognition of expenses is independent of a past or future payment. Only imputed values that will never lead to a payment may not be included in expenses.
Financial statements The final result of accounting at the closing date are the financial statements. They consist of a balance sheet and income statement (§ 242). Corporations must add notes (§ 264 sect. 1). Groups must prepare consolidated financial statements (see there, §§ 290).
GAAP Generally Accepted Accounting Principles In this book, this refers to the underlying principles of accounting, most of which are codified by the Commercial Code, but some are best practice and common understanding. They can be divided into – principles of documentation (focusing on current bookkeeping) and – principles of accounting (focusing on financial statements). If the entirety of legal and other sources that constitute German accounting is referred to, the term German GAAP is used in this book.
German GAAP German generally accepted accounting principles include all laws and other sources that define the accounting for German companies. The central law is the Commercial Code, but there are many other sources such as other laws, court decisions, best practices and underlying principles.
Higher-of-cost-or-market-principle Application of the principle of prudence to the subsequent measurement of liabilities: Compare the initial settlement amount with the current fair value and take the higher one.
Impairment Decrease in value of an asset that exceeds the regular depreciation/amortization. Depending on the different variants of the lower-of-cost-or-market principle, impairments are mandatory, optional or prohibited.
Imparity principle Subprinciple of principle of prudence; states that expenses/losses must be recognized when they become probable, even if unrealized (§ 252 sect. 1 no. 4).
Income An increase in net assets (or: equity) is called income; the recognition of income is independent of a past or future payment. Only imputed values that will never lead to a payment may not be included in income.
Income statement Presentation of all income and expenses from a reporting period ending with the net result of the period. From an accounting perspective, the income statement is a subledger of equity, and therefore income is recognized as a credit entry, whereas an expense is recognized as a debit entry. Corporations must apply one of two specific formats: total-cost format or cost-of-sales format (§ 275).
Journal entry The specific form in which a transaction is recorded in the accounting is called a journal entry. It has at least one debit entry and at least one credit entry. A journal entry must always balance; otherwise, the fundamental accounting equation (assets = equity + liabilities) is violated.
Liability The abstract recognition criteria are as follows:
– There must be an obligation (legal or constructive).
– It must be an economic burden to fulfil the obligation and the fulfilment must be probable.
– The economic burden must be quantifiable.
All three criteria must be fulfilled.
The one who accepts the obligation must report the liability.
Liabilities comprise provisions (uncertain liabilities) and debt or payables (certain liabilities).
Lower-of-cost-or-market-principle Application of the principle of prudence to the subsequent measurement of assets: Compare the initial (amortized) acquisition or production costs with the current fair value and take the lower one (§ 253 sect. 3 and 4). Moderate lower-of-cost-or-market principle: must be applied for non-current assets. Only permanent decreases in value are a reason for an impairment. There is an impairment option for non-current financial assets in case of a temporary decrease in value (§ 253 sect. 3). Strict lower-of-cost-or-market principle: must be applied for current assets. Any decrease in value must be impaired (§ 253 sect. 4).
Management report Corporations must prepare a management report in addition to financial statements (§ 264). The management report must provide a verbal description of the business in general, the course of business in the reporting period, the current situation and expected future developments (§ 289; DRS 20).
Measurement If for a specific transaction it was decided to recognize an asset or liability, the next issue concerns measurement, i.e. at what value will the asset or liability be included in the financial statements. Initial measurement refers to the value of an asset or liability when it is included the first time in the balance sheet. Subsequent measurement refers to the value of an asset or liability at a subsequent closing date.
Non-current assets All assets that are intended to serve the business continuously (§ 247 sect. 2). Typically, non-current assets are long term (i.e. will be used more than 1 year).
Notes Corporations must add notes to the financial statements (§ 264). Their purpose is to
– make the interpretation of the financial statements easier,
– correct the financial statements if necessary,
– relieve the information burden in the balance sheet and income statement,
– furnish additional information not included in the balance sheet and income statement.
One-entity-theory Fundamental theory for the preparation of consolidated financial statements: The financial statements for the group that is consolidated must be prepared as if the group were a single legal entity (§ 297 sect. 3).
Presentation Deciding about the way in which specific information is given in the financial statements. Presentation is typically the last decision for a specific transaction (after recognition and measurement).
Present value Method for initial measurement of an annuity charge, i.e. an obligation to regularly pay a certain amount of money for a certain period of time. It is calculated by discounting future payments.
Principle of prudence Dominant principle of GAAP; states that all predictable risks and chances must be taken into account (§ 252 sect. 1 no. 4). Derived principles: realization principle and imparity principle.
Production costs Measure for initial measurement of produced assets (§ 255 sect. 2, 2a and 3). The production costs are calculated as follows:
Direct material costs
+ Direct manufacturing costs
+ Special direct manufacturing costs
+ Indirect material costs
+ Indirect manufacturing costs
+ Adequate part of depreciation/amortization
= Mandatory components of production costs
+ Adequate part of general administration
+ Adequate part of voluntary social benefits
+ Adequate part of voluntary pension scheme
+ Borrowing costs (only if directly related to production process)
= Maximum of production costs
The options can be used only in an identical way for commercial and tax purposes.
Any indirect costs must constitute an adequate part related to the specific production process, i.e. without impairment, idle time costs or extraordinary items.
Distribution costs, research costs or imputed costs may not be included.
Provisions Liabilities that are uncertain concerning the reason for the liability or the amount necessary to fulfil the obligation are called provisions.
If pending transactions become disadvantageous and will probably result in a loss, a provision for onerous contracts must be recognized.
A specific topic in German GAAP are the provisions for omitted maintenance and waste disposal that must be recognized under certain conditions.
Realization principle Subprinciple of principle of prudence; states that any income/gain can be recognized only when it is realized (§ 252 sect. 1 no. 4). Realization criteria follow the completed contract method (see there).
Recognition Including a transaction as an asset or liability in the balance sheet is called recognizing the transaction.
It is the first step in deciding about the accounting for a specific transaction. The subsequent steps are decisions about the measurement and presentation of the transaction.
Settlement amount Measure for initial measurement of liabilities. The amount that is required to fulfil the obligation.
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