Lecture 6

ACCOUNTING IN

GERMANY
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Issues to be discussed:
Accounting

Regulation and Enforcement Financial Reporting Accounting Measurement

Introduction

Creditors protection is a fundamental concern of German accounting as embodied in the Commercial Code. Conservative balance sheet valuations are central to creditor protection. This creates a tendency to undervalue assets and overvalue liabilities. Reserves are seen as protection against unforeseen risks and possible insolvency. These practices also result in a conservative income amount that serves as the basis for dividends to owners. Thus, German accounting is designed to compute a prudent income amount that leaves creditors unharmed after distributions are made to owners.

Accounting Regulation and Enforcement

The German Institute, the Frankfurt Stock Exchange, German trade unions and accounting academics provided consultation in various processes of lawmaking that affected accounting and financial reporting. The 1998 law on control and transparency (KonTraG) introduced the requirements for the Ministry of Justice to recognize a private national standard-setting body to serve the following objectives: 1. Develop recommendations for the application of accounting standards for consolidated financial statements. 2. Advice the Ministry of Justice on new accounting legislation. 3. Representation Germany in international accounting organizations such as the IASB.
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Accounting Regulation and Enforcement

The German Accounting Standards Committee (GASC) was founded in May 1998 recognized by the Ministry of Justice as the German standard-setting authority. The GASC responsible to develop accounting standards for consolidated financial reporting and advising the Ministry of Justice on the development of accounting legislation. GASC is a private standard-setting body supported by German companies and individual members. The GASC has 2 standing committees - German Accounting Standards Board (GASB) and Accounting Interpretations Committee (AIC).
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Accounting Regulation and Enforcement

GASB responsible for the preparation and adoption of its pronouncements consists of accounting standards, comments on accounting issues and working papers. The GASB is made up of seven independent experts with a background in auditing, financial analysis, academia and industry. Working Groups are established to examine and make representatives on the issues before the board. These working groups have representatives from trade and industry and the auditing profession, a university professor, and a financial analyst. The standards issues by GASB must be approved and published by the Ministry of Justice.
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Accounting Regulation and Enforcement

The new German accounting standard-setting system is broadly similar to the systems in the United Kingdom and the US, and to the IASB. However, GASB standards are authoritative recommendations that only apply to consolidated financial statements. They do not restrict or alter German Commercial Code (HGB) requirements. The GASB was created to develop a set of German standards compatible with international accounting standards. Since its founding, the GASB has issued German Accounting Standards (GAS) on issues such as the cash flow statement, segment reporting, deferred taxes and foreign currency translation. In 2003, the GASB adopted a new strategy that aligned its work program with the IASBs effort to achieve a convergence of global accounting standards.
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Accounting Regulation and Enforcement

Accounting Interpretations Committee (AIC) to promote international convergence of interpretations of core accounting issues in close cooporation with IASBs International Financial Reporting Interpretations Committee (IFRIC).

Accounting Regulation and Enforcement

The Financial Accounting Control Act (BilKoG) was enacted in 2004 to improve compliance with German financial reporting requirements and IFRS by listed companies. The law established a two-tiered enforcement system. The first-tier comprised of FREP and BaFin and the Auditor Oversight Commission. A private-sector body called the Financial Reporting Enforcement Panel (FREP) whose reviews suspected irregular financial statements. It also conducted random reviews of financial statements. The FREP relies on companies to voluntarily correct any problems it finds. The FREP refers matters that are not resolved to the Federal Financial Supervisory Authority (BaFin).
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Accounting Regulation and Enforcement

BaFin is the public sector regulatory body that oversees securities trading (stock exchanges) and the banking and insurance industries. BaFin will then take authoritative action to resolve the issue. BaFin refers questionable auditing to the Wirtschaftsprufer (WP) or Certified Public Accountants. All WPS are legally required to join the official Chamber of Accountants.
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Accounting Regulation and Enforcement

The Auditor Oversight Commission, which reports to the Ministry of Economics and Labor, is responsible for overseeing the Chamber of Accountants. In 1985, Accounting Act extended the audit requirement to many more companies. As a result, a second-tier body of auditors was created in the late 1980s. They were known as sworn book examiners who are allowed to audit small and medium-sized companies. German audit reports emphasized compliance with requirements over the true and fair view.
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Financial Reporting

All companies either listed or not listed may use IFRS in preparing their consolidated financial statements - 2005. German accounting influenced by tax law. However, individual company financial statements must follow German Commercial Code (HGB) requirements. Presentation Disclosure Auditors report Consolidated Financial Statement
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Presentation

German law specifies different accounting, auditing, and financial reporting requirements depending on company size rather than the form of business organization. There are three size classes small, medium and large defined in terms of balance sheet totals, annual sales totals, and numbers of employees. Companies with publicly traded securities are always classified as large.
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Presentation

The law specifies the content and format of financial statements as follows: Balance sheet Income statement Notes Management report Auditors report Small companies are exempt from the audit requirement and may prepare an abbreviated balance sheet. Small and medium-sized companies may prepare abbreviated income statements have fewer disclosure requirements for their notes. A cash flow statement and a statement of changes in owners equity are required for consolidated financial statements but not individual company statements.
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Disclosure

The notes section of the financial statements is usually extensive, especially for large companies. Disclosure include the accounting principles used, the extent to which results are effected by claiming tax benefits, unaccrued pension obligations, sales by product line and geographic markets, unaccrued contingent liabilities and average number of employees. The management report describes the financial position and business developments during the year, importance post-balance sheet events, anticipated future developments, and research and development activities. Publicly traded companies are required to provide additional segment disclosures. They must also provide abbreviated half-yearly financial statements that are reviewed by an auditor and accompanied by an interim management report.
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Auditors report

Auditors report is considered as a private report and only be submitted to companys managing board of directors and supervisory board, and not to shareholders. The report comments on the companys future prospects and factors that may threaten its survival. The auditors must describe and analyze items on the balance sheet that have a material impact on the companys financial position. The auditor also has to evaluate the consequences of and pass judgment on all significant accounting choices. This report can run several hundred pages for large German companies.
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Consolidated Financial Statement

Consolidated financial statements are required for enterprise under unified management and with a majority of voting rights, dominant influence by virtue of control contracts, or the right to appoint or remove a majority of the board of directors. For the purpose of consolidation, all companies in the group must use identical accounting and valuation principles. However, they need not be the same as those used in individual company statements.
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Differences between German GAAP and IFRS

Issue IFRS German GAAP

Business combinations

IFRS3: must use purchase method; pooling of interest is prohibited

Certain business combinations may be accounted for as pooling of interests even though an acquirer can be identified. Two forms of the purchase method are permitted: the book-value method and the revaluation method. The equity method is used for associates that are owned 20 percent or more, but only in consolidated financial statements. Joint ventures may be accounted for using either proportional consolidation or the equity method.
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Differences between German GAAP and IFRS

Issue
Goodwill on consolidation

IFRS

German GAAP Goodwill arising on consolidation IFRS3: not amortized, but tested can be deducted immediately against equity or amortized for impairment systematically over its useful life. annually (31 March The law mentions four years as 2004) the regular amortization period.
IAS38: internally generated goodwill can be recognised as an asset under certain conditions. Internally generated intangible assets, which are expected to provide ongoing service to the enterprise must not be recognised. Research and development costs are expensed when incurred.

Internally generated intangible assets

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Differences between German GAAP and IFRS

Issue Foreign currency translation IFRS IAS21: foreign currency monetary item should be reported using closing rate.
IAS17: distinguish between finance lease and provide guidance for classifying them. IAS2: requires inventories to be stated at the lower of cost and NRV

German GAAP Foreign currency monetary balances are generally translated at the worse of transaction and closing rates so as to avoid the recognition of gains on unsettled balances.
Leases are normally classified according to tax rules: therefore, leases are seldom recognised as finance leases. Inventories can be stated at the lowest of cost or replacement cost. FIFO, LIFO and average method are acceptable methods of determining the closing value of the inventory.
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Leases

Inventory valuation

Differences between German GAAP and IFRS

Issue
Construction contract

IFRS
IAS11: the stage of completion of the contract activity at the balance sheet date should be used to recognised contract revenue.

German GAAP
In general the completed contract method is used for the recognition of revenue on construction contract and services.

Exclusion of subsidiaries from consolidation

Start-up-costs

IAS27: subsidiaries whose activities are dissimilar to those of its parent must be consolidated.
IAS38: start-up costs must be charged to expenses when incurred.

Certain subsidiaries with dissimilar activities should be excluded from consolidation.

Start-up costs may be capitalised and amortised over 4 years.
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Accounting Measurement

Most companies make provisions as large as possible because legally booked expenses directly affect the determination of taxable income. Provisions give German companies many opportunities to manage income. Portions give German companies many opportunities to manage a mandated legal reserve and those resulting from the above provisions.
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THE END
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