Legalization of Transnational Accounting:
The Case of International Financial Reporting Standards
This Version:
Version 1.0
April 29, 2004
Jens Wüstemann
Chair and Institute for BA, Accounting and Auditing (Prof. Dr. Jens Wüstemann, M.S.G.)
University of Mannheim
A5, 6
68131 Mannheim
Germany
e-mail: wuestemann@bwl.uni-mannheim.de
Sonja Kierzek
Chair and Institute for BA, Accounting and Auditing (Prof. Dr. Jens Wüstemann, M.S.G.)
University of Mannheim
A5, 6
68131 Mannheim
Germany
e-mail: sonja_kierzek@yahoo.de
internet: www.bwl.uni-mannheim.de/wirtschaftspruefung
1
1. INTRODUCTION
The form of the process of rule making in the area of accounting depends on the national legal
system. In Common Law countries, private professional accountancy bodies are usually
responsible for the setting of professional accounting standards, whereas in Civil Law
countries predominantly national legislature, possibly in combination with jurisdiction,
develops legal accounting norms. Along with an increase of international economic
integration and the expanding globalization of capital markets, the need for one single set of
globally accepted accounting rules becomes apparent (e.g. Zeitler 1997). The existence of
globally accepted accounting rules would enable companies to offer listings at any foreign
stock exchanges with the same set of financial statements and facilitate the accounting in
international groups (van Helleman and Slomp 2002). For international investors uniform
accounting rules would provide worldwide comparable financial information allowing an
efficient choice of investment (van Helleman and Slomp 2002). Beside endeavours of the
United Nations Organisation (UNO) and the Organisation for Economic Cooperation and
Development (OECD), the worldwide harmonization of accounting is mainly driven by the
privately organized International Accounting Standard Board (IASB) promulgating
International Financial Reporting Standards (IFRS) (e.g. Achleitner 1995). In the European
Union, the harmonization of accounting regulation being part of Company Law was set off in
the 60s in order to create equal competitive conditions in view of the overall objective to
contribute to the establishment of a common market. While the European Commission
initially addressed itself to the task to make accounting rules and accordingly developed two
European Accounting Directives, the 4th Company Law Directive1 and the 7th Directive on
consolidated accounts2, in 2002 the Council approved a EU regulation that requires the use of
International Financial Reporting Standards (IFRS) in the consolidated accounts of all listed
companies in the European Union (‘IFRS Regulation’)3. Due to its private organization the
International Accounting Standards Board (IASB) does not have a direct law-creating
authority. Thus legal acts are necessary to implement the originally private accounting
standards IFRS in national frameworks. With regard to the size and international importance
1
See Fourth Council Directive 78/660/EEC of 25 July 1978 based on Article 54 (3) (g) of the Treaty on the
annual accounts of certain types of companies, Official Journal of the European Communities, L 222,
14/08/1978: 11-31.
2
See Seventh Council Directive 83/349/EEC of 13 June 1983 based on the Article 54 (3) (g) of the Treaty on
consolidated accounts, Official Journal of the European Communities, L 193, 18/07/1983: 1-17.
3
See Regulation (EC) No 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the
application of international accounting standards, Official Journal of the European Communities, L 243,
11/09/2002: 1-4.
2
of their capital markets, the United States and the European Union represent the key players
in the process of legalization of International Financial Reporting Standards (IFRS).
In consideration of the concept of legalization stated by Abbott et al. (2001), we define
legalization in relation to accounting rules. Whereas national accounting regulations should
already be highly legalized in developed countries, we expect to find a move to hard
accounting law in the field of transnational accounting. In the course of our essay we cover
the whole process of legalization, starting from the development of International Financial
Reporting Standards (IFRS) by the International Accounting Standards Board (IASB), their
implementation, considering the European Union as an example, and the securing of
compliance of accounting practice with the requirements of International Financial Reporting
Standards (IFRS) (‘enforcement’). Concerning accounting rule making we emphasize the
influence of the main actors, from whom the legalization of International Financial Reporting
Standards (IFRS) is basically depending, the European Union and the U.S. Securities and
Exchange Commission (SEC)/ the U.S. Financial Accounting Standards Board (FASB), on
the one hand, and the sponsoring parties of the International Accounting Standards Board
(IASB), mainly accountancy firms and multinational companies, on the other hand. The
implementation of International Financial Reporting Standards (IFRS) in the European Union
is conducted by a two-sided process. The required conformity of International Financial
Reporting Standards (IFRS) with Community Law, in particular with the main principles of
the EU Accounting Directives, should either be achieved by the rejection of opposing
International Financial Reporting Standards (IFRS), signalling the International Accounting
Standards Board (IASB) to review them, or by an amendment of the respective provisions of
the Accounting Directives towards International Financial Reporting Standards (IFRS).
Beside the presentation of the procedure as well as of the involved parties, we object to point
out the inadequate functioning of this mechanism as regards the creation of legal certainty in
the European Union by case studies on specific accounting issues. An essential part of the
process of legalization of International Financial Reporting Standards (IFRS) is a uniform
approach of enforcement in order to avoid deviant interpretations of International Financial
Reporting Standards (IFRS) and thereby transnationally inconsistent accounting practices. We
make clear that, as national enforcement institutions are embedded in specific national
financial and corporate governance systems as well as legal environments, a harmonization of
enforcement mechanisms and thus a uniform application of International Financial Reporting
Standards (IFRS) presents a long winded process.
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2. THE CONCEPT OF LEGALIZATION OF ACCOUNTING
In this first chapter we introduce our concept of legalization of accounting based on the
approach of Abbott et al. We conduct an examination of several national and international
accounting rules on the three relevant elements of legalization obligation, determination and
enforcement that shall represent the basis of this paper. In the following, the criteria will be
taken up again and applied to International Financial Reporting Standards in the respective
sections of this essay.
The element obligation reflects in how far preparers of financial statements are bound to the
application of a set of accounting rules. In the field of accounting regulation the degree of
obligation varies from the extreme of “legally binding” obligations, usually in the form of
legal norms stemming from legislature, such as statutes, up to professional standards, that are
applied on a voluntary basis. The authority to decide on the obligation of accounting rules is
dedicated to legislature for all companies having to keep books. Securities regulators might be
empowered to require specific accounting regulations for listed companies only. Beside the
determination of the required set of accounting rules, the respective authorities might also
grant companies the option to use other accounting rules alternatively. Obligation of
accounting rules is created in various forms. Accounting provisions codified in statues are
directly legally binding which is the case in most Civil Law countries. In the U.S., private
(professional) norms become binding via a provision with ‘substantial authoritative support’
by the U.S. Securities and Exchange Commission (SEC) being legally empowered to set
accounting regulation. Due to the rarity of international legislative bodies, transnational
accounting rules usually hold a low degree of obligation. Although the EU Accounting
Directives originate from an EU legislative act, they are only “quasi binding” to companies in
the EU as they require a transposition into national law to become effective. Because of its
private nature the International Accounting Standards Board (IASB) is not legitimized to
require the application of International Financial Reporting Standards (IFRS). Consequently
IFRS can only become compulsory if their use is proscribed by the respective national
authorities.
The element of determination generally defines the degree of limitation of the scope of
discretion that a rule leaves to the applicant (Wüstemann 1999 b). The relevant criteria of
determination relating to accounting are considered to comprise the level of detail of a rule
and the existence of explicit and implicit choices. Concerning the level of detail of accounting
rules the two extremes rule-based and principle-based accounting can be distinguished. Rule4
based accounting, such as the U.S. generally accepted accounting principles (U.S. GAAP), is
characterized by a multitude of detailed and relatively precise rules, aiming at the regulation
of the required accounting treatment for numerous situations (Schildbach 2003). An example
for principle-based accounting are German Generally Accepted Accounting Principles
(‘Grundsätze ordnungsmäßiger Buchführung’ – German GAAP). Rather general accounting
principles are codified in the German Commercial Code; a concretization of the fundamental
principles is conducted by jurisprudence (e.g. Duhr 2004). If only written rules are taken into
account, rule-based accounting approaches would obviously feature a higher level of detail
than principle-based accounting systems. However as legal accounting rules do not only
encompass statutes but also span non-codified accounting principles stemming from
jurisdiction (Rüdinger 2003), for an appraisal of the level of detail of an accounting system all
sources of accounting rules that are relevant for the preparation of financial statements should
be considered (Wüstemann 1999 a). Explicit choices allow two or more alternative accounting
methods for the same facts of a case (Siegel 1986). Implicit choices can emerge from
imprecise norms or the absence of rules, leaving the preparer the decision to choose an
appropriate accounting treatment. Another form of implicit choices is referred to
undetermined terms, being interpreted differently in individual cases, branches or countries.
For the judgement of the degree of determination the relevant criteria is not only the quantity
of options, but particularly whether they can be exerted arbitrarily (Rüdinger 2003).
Concerning the exertion of explicit as well as implicit choices, German GAAP bind the
preparer to the pursued objectives of financial statements (Moxter 1997). The EU Accounting
Directives illustrate that in the field of transnational accounting numerous explicit choices,
partly allowing keeping national accounting practices, are a premise for the acceptance of
transnational accounting rules. While the EU Accounting Directives set accounting rules for
corporations in Europe, International Financial Reporting Standards (IFRS) gear to be
globally applied by companies of all sizes and branches. Despite a continuous reduction IFRS
are still considered to contain a multitude of explicit options (e.g. Schildbach 2002). In
contrast to German GAAP, IFRS do not limit the exertion of explicit choices. From the fact
the exercise of implicit choices is bound to the requirement to choose an accounting treatment
that provides the best information for the user, depending on the personal judgement of the
preparer (IAS 8, par. 10), we assume that the preparer’s choice as regards implicit options is
virtually not limited.
Enforcement means that third parties such as courts, monitoring bodies and auditors ensure a
sound application of accounting rules by supervising compliance with the relevant set of
5
accounting rules, by initiating corrective actions and possible by sanctioning infringements.
By resolving disputes courts interpret and concretize accounting rules. As courts are usually at
least virtually bound to previous judgements they may contribute to the further development
of accounting rules. Accordingly a clear separation of rule making and enforcement as well as
of the two elements of our concept of legalization, determination and enforcement, is hardly
possible. Supervisory bodies being responsible for the enforcement of accounting rules do not
exist in every country. Depending on their form such institutions monitor financial statements
of predominantly listed companies, they may induce court orders in the case of violation of
accounting rules and possibly even have the authority to sanction breaches. The statutory
audit can virtually compel compliance of financial statements with the underlying set of
accounting rules or leastwise inform about infringements by qualifying or disclaiming the
audit opinion. The following three criteria, the existence of enforcement mechanisms, the
bindingness of their actions and the possibility of individuals to access such institutions,
should give information about the degree of enforcement. Enforcement institutions exist in all
developed countries; their respective form and weighting depends on the national financial
and corporate governance system. Court rulings are legally binding; the bindingness of
enforcement actions of supervisory bodies depends on its authoritative competences. National
courts are usually accessible by the public. Concerning supervisory bodies individuals
habitually have the possibility to announce violation of accounting rules. The statutory audit
is normally required for at least all listed companies. If the use of transnational accounting
rules is proscribed, such rules are enforced by the respective national enforcement
mechanism. However as enforcement mechanisms operate differently from country to
country, a consistent application of the relevant set of rules can only be ensured by a
centralized or at least transnationally harmonized enforcement.
In summary, we conclude from the presentation of our understanding of legalization of
accounting that on the national level the degree of obligation and enforcement should usually
be high. The determination of accounting rules is a complex issue. We find that it is not
clearly separable from enforcement. Rather imprecise written accounting rules might be
concretized into detail by legally binding enforcement actions of courts, such as Germany’s
Federal Tax Court (‘Bundesfinanzhof’) or securities regulators, e.g. the U.S. Securities and
Exchange Commission (SEC). In the following, we conduct a closer examination on the
legalization of transnational accounting rules on the basis of International Financial Reporting
Standards (IFRS).
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3. THE RELEVANT SET OF RULES
In this section we introduce the International Financial Reporting Standards (IFRS),
encompassing International Accounting Standards (IAS), International Financial Reporting
Standards (IFRS) and Interpretations developed by the International Financial Reporting
Interpretations Committee (IFRIC) as the relevant set of rules in our essay.4 In order to
provide the reader with a basis for further demonstrations and discussions concerning the
legalization of transnational accounting, we first of all present the purpose pursued by
financial statements prepared according to IFRS and the structure of the entire set of rules as
well as of the single standards. Under the special interest of the political dimension we
analyze the organization of the standard setting body, the International Accounting Standards
Board (IASB) and the international accounting standard setting process (‘due process’).
3.1. International Financial Reporting Standards (IFRS)
The scope of International Financial Reporting Standards (IFRS) comprises all general
purpose financial statements (Preface to IFRS, par. 10), i.e. individual and consolidated
accounts of any enterprise, regardless of its size or sector.5 The duty to keep books and to
prepare financial statements as well as the determination of the set of accounting rules that
should be applied is regulated by national legislation (Knorr and Ebbers 2001). Likewise the
requirement to prepare financial statements according to IFRS falls into the responsibility of
the particular national authorities.
Due to the dominance of Anglo-American membership in the International Accounting
Standards Board (IASB), International Financial Reporting Standards (IFRS) have always
been stamped by the Anglo-American accounting approach (e.g. Haller and Walton 2000).
Compared to the Continental European approach, being strongly orientated towards the
protection of creditors and having the main purpose to determine distributable and taxable
profits, the more investor-orientated6 IFRS have the sole function to provide information
about an enterprises’ financial situation, performance and cash flows being ‘useful to a wide
4
In April 2001,when the International Accounting Standards Board (IASB) took over the responsibility for the
setting of International Financial Reporting Standards (IFRS), it approved a resolution to adopt International
Accounting Standards (IAS) having been developed by its predecessor, the International Accounting Standards
Committee (IASC) and Interpretations originating from the Standard Interpretations Committee (SIC), the
predecessor of the International Financial Reporting Interpretations Committee (IFRIC).
5
In 2004 the IASB launched a project to develop an extra set of financial reporting standards for small and
medium size entities (SMEs). See Accounting Standards for Small and Medium-Sized Entities.
http://www.iasb.org/uploaded_files/documents/16_33_sme-ps.pdf (25.04.2004).
6
IFRS Framework par. 10 states that by orientating towards the needs of investors, the needs of all other users
(employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the
public) shall be deemed to be met in the same time.
7
range of users in making economic decisions’ (IAS 1, par. 7). Beside the prediction of future
cash flows and the appraisal of the profitability of an investment, the transmitted information
should also enable the user to assess the management’s performance (‘stewardship function’)
(IAS 1, par. 7).7 The profit is considered to be a measure of performance (IFRS Framework,
par. 69) and hence plays a central part in the provision of information under IFRS
(Wüstemann 2002). IFRS are not designed to determine distributable or taxable profits (e.g.
KPMG 1999). However, national legislation might determine to base these functions on IFRS
(Cairns 2002).
The basis for the preparation of financial statements according to International Financial
Reporting Standards (IFRS) is the Bound Volume ‘International Financial Reporting
Standards’, being annually edited by the International Accounting Standards Board (IASB).
The IFRS ‘accounting system’ mainly consists of two levels. The ‘Framework for the
Preparation and Presentation of Financial Statements’ defines the users, objectives,
underlying assumptions and qualitative characteristics of financial statements and sets general
definitions of the main balance sheet and income statement items, as well as criteria for their
recognition and measurement. Furthermore it serves as a conceptual basis for the development
and revision of IFRS by the IASB and for the interpretation of IFRS by preparers and auditors
(IFRS Framework, par. 1). The Framework itself does not present a standard, but stands apart
from IFRS (Cairns 2002). As it has not been established until 1989, the Framework is not
fully compatible with IFRS (Wollmert and Achleitner 2003). In the case of a conflict, the
requirements of IFRS prevail and consequently cannot be overridden by the Framework
(IFRS Framework, par. 2). On the other level, the currently 36 IFRSs, comprising 31 IASs8
and 5 IFRSs, rule the recognition, measurement, presentation and disclosure issues of
financial reporting. Due to the ‘case by case’ development of IFRS, neither the sequence of
the standards being determined by the date of issuance is based on a systematic approach, nor
the contents of IFRS is uniformly ruled. The standards deal with the accounting treatment of
balance sheet items (e.g. IAS 16 ‘Property, Plant and Equipment’, IAS 38 ‘Intangible
Assets’), instruments of financial reporting (e.g. IAS 7 ‘Cash Flow Statements’, IAS 14
‘Segment Reporting’), individual issues (e.g. IAS 21 ‘The Effects of Changes in Foreign
Exchange Rates’, IFRS 3 ‘Business Combinations’) and set rules for specific branches (e.g.
IAS 41 ‘Agriculture’). General principles being applicable to all financial reporting issues do
7
For details, see Mujkanovic (2002).
As some standards were cancelled or replaced during several revision projects, the standards are not
continuously numbered. IAS 3-6, 9, 13, 15, 22, 25 and 35 do not exist in the current set of standards.
8
8
not exist, but are specified in the standards. For example, historical costs are separately
defined for inventories (IAS 2, par. 10 and 11), plant, property and equipment (IAS 16, par.
15-22), intangible assets (IAS 38, par. 25-32) and financial instruments. All IFRS are coequal
and have to be applied ‘to result in financial statements that achieve a fair presentation’ (IAS
1, par. 13); in case of a disaccord between two standards, the newer one should prevail
(Achleitner and Behr 2003).
The constitution of an International Financial Reporting Standards (IFRS) generally follows a
uniform structure. A standard is preluded by the determination of its objective, scope and
definitions of the main terms used in the standard. The main standard text sets provisions,
principles and definitions to each item and elucidates them subsequently. Furthermore an
IFRS usually contains disclosure requirements, transitional provisions and determines the
effective date of the standard. Most IFRS are followed by non-binding appendices, illustrating
the application of the provisions with the help of examples. Some standards might allow two
methods of accounting. Even if companies can freely choose between alternative accounting
methods in consideration of the principle of consistency, the International Accounting
Standards Board (IASB) suggests a ‘benchmark treatment’ as a point of reference (Cairns
2002) and requires additional disclosure in the notes for the use of the ‘allowed alternative
treatment’.
Due to the ‘case by case’ development of beside the financial statements (IFRS), the set of
financial reporting rules cannot be regarded as a cohesive norm system (Wollmert and
Achleitner 2003). The responsibility for the interpretation of the standards is dedicated to the
International Financial Reporting Interpretations Committee (IFRIC), whose interpretations
are binding to all IFRS applicants. Is an issue not addressed by any IFRS or by the IFRIC, it is
left to the preparer to decide about appropriate accounting methods under consideration of the
basic principles set in the IFRS Framework (IAS 8, par. 10), IFRS regulating similar issues,
the definitions stated in the IFRS Framework (IAS 8, par. 11), and provisions of other
standard setters, accounting literature and accepted branch specific practices if they are not
opposing the overall IFRS policy (IAS 8, par. 12).
According to IAS 1, par. 8 all financial statements, independently from the company’s size or
branch, are composed of a balance sheet, an income statement, a statement of changes in
equity, a cash flow statement and notes. A segment reporting is only required for publicly
held companies (IAS 14, par. 3), earnings per share have to be published by companies whose
9
ordinary shares are publicly traded (IAS 33, par.1). The publication of a management report is
not mandated, but recommended (IAS 1, par. 9). Beside the financial statements companies
are free to release other financial information that does not come under the scope of IFRS
(IAS 1, par. 10).
3.2. The International Accounting Standards Board (IASB)
The predecessor of the International Accounting Standards Board (IASB), the International
Accounting Standards Committee (IASC) was founded in 1973 in London by a voluntary
joint together of professional accountancy bodies from North America, Europe and Asia. The
initiation to set up a privately organized international standard setter can be put down to Great
Britain's intention to build an opposition to the dominating highly legalized, state controlled
Continental European accounting approach in the harmonization process of European
accounting, when Great Britain’s entry into the European Economic Community (EEC) was
imminent (Hopwood 1994). While the International Accounting Standards Committee (IASC)
originally geared to develop broad international accounting principles, in order to confine
unsound accounting practices and thus to contribute to the improvement and harmonization of
financial reporting (Cairns 2002), its predecessor, the International Accounting Standards
Board (IASB) objects to develop a single set of global accounting standards, to promote their
uniform application and to converge national accounting standards and IFRS (IASC
Foundation Constitution, par. 2).
The International Accounting Standards Committee Foundation (IASCF), established in 2001
as a non-profit association in Delaware, is principally composed of a board of Trustees and
the International Accounting Standards Board (IASB). The 19 Trustees' major function lies in
the governance and fundraising of the IASC Foundation. The funds (£ 12.8 million in 2001)
are mainly provided by the beneficiaries of international accounting standards, i.e. companies
(65% in 2001) and auditing firms (30% in 2001)9. The standard setting body, the IASB has
the exclusive responsibility for all technical issues, including the determination of the
technical agenda, the preparation and issuance of exposure drafts and IFRS as well as the
approval of Interpretations originating from the International Financial Reporting
Interpretations Committee (IFRIC). Whereas the members of the board of Trustees represent a
diversity of geographical (mainly North America, Europe and Asia) and functional (auditors,
preparers, users and academics) backgrounds, the main selection criterion for the twelve full9
For the figures, see Bolton (2002). A list of all funding parties of the International Accounting Standards
Committee Foundation (IASCF) can be found in the respective annual report of the IASCF. www.iasb.org.
10
time and two part-time IASB members is their technical expertise, comprising both technical
competence and experience in international business. A balance of perspectives and
experiences should be guaranteed by functionally diverse backgrounds (≥ 5 auditors, ≥ 3
preparer, ≥ 3 user and ≥ 1 academic). In the same time a concentration of regional interests
within the Board should be avoided.10 Due to the International Accounting Standard Board's
objective to promote convergence of national accounting standards and IFRS, seven board
members serve as contact persons with national standard setters.
The strongly emphasized independence of the IASB in the standard setting process is
basically intended to be achieved by the separation of governance respectively funding and
technical matters. However as the Trustees select and appoint the IASB members, not only
the Trustees themselves but also the sponsoring parties may exert an indirect influence on the
IASB. As a reaction to the Exposure Draft No. 2 (ED 2) proposing the treatment of stock
options as expenses, U.S. companies were menacing to withdraw its funding from the IASB
(Accountancy Age 2003). Moreover the IASB is exposed to political lobbying from big
companies and organizations. One prominent example is the threat of Novartis, a major Swiss
pharmaceutical company, to switch from IFRS to U.S. GAAP in 2001, if the IASB would not
have followed the approach of the U.S. Financial Accounting Standards Board (FASB)
concerning goodwill accounting (Zeff 2002). Finally the IASB is subject to pressure from its
‘largest customer’, the European Union11 (Williams 2003) as well as the U.S. Securities and
Exchange Commission (SEC) having to decide about the admission of financial statements
prepared according to IFRS at the U.S. stock market.
3.3. Due Process of International Financial Reporting Standards (IFRS)
The expression ‘due process’ generally ‘describe(s) the steps taken to ensure that an
administrative matter is given the careful consideration needed to adequately protect the
interests of those involved’ (Miller 1998). With regard to the accounting standard setting
process the choice of this term reflects the International Accounting Standard Board's
intention to ensure the acceptance of International Financial Reporting Standards (IFRS) by a
democratization of the ‘due process’, i.e. users, all interested persons and organizations are
given the opportunity to participate in the development of IFRS via comments on the
published documents on each stage of the standard setting process. The objective to set high
10
See Recommendations on Shaping IASC For the Future. A Report of the IASC’s Strategy Working Party.
http://www.iasb.org/uploaded_files/documents/8_210_swp_rep.pdf (25.04.2004).
11
About 7,000 companies will be affected by the requirement of the IFRS Regulation. See e.g. Gannon (2002).
11
quality standards should be achieved by a set of procedures, consistently refining and
enhancing the documents on each stage (Flower and Ebbers 2002). After the admission of a
new topic, that can be put forward by organizations, individuals or the IASB staff, to the
IASB’s work agenda, the IASB usually publishes a discussion document describing preferred
and refused alternative accounting rules, followed by an exposure draft, a proposed IFRS, and
finally the promulgation of an IFRS (IFRS Preface, par. 18 and 19). The total cycle time of
the standard setting process depends on the project and varies from one year up to three or
more years. According to the International Accounting Standard Board's strategy to converge
International Financial Reporting Standards (IFRS) and national accounting standards, the
IASB pursues a close coordination with the rule making process of national standard setters.
4. THE PROCESS OF LEGALIZATION OF INTERNATIONAL FINANCIAL
REPORTING STANDARDS (IFRS)
In this section we present the mechanism that makes International Financial Reporting
Standards (IFRS) applicable in the legal environment of the European Union. The two-level
structure of the so called endorsement mechanism combining technical and political elements,
as well as the procedure of the adoption of an IFRS will be presented and further on examined
on its weaknesses. Moreover we analyse the implementation of IFRS by means of an EU
regulation in combination with an EU directive with regard to the objective of comparability
of financial statements in the European Union. Finally an overview is given on the worldwide
spread of IFRS.
4.1. European Union: Endorsement Mechanism
The integration of accounting rules that are established by a private third party into the
European Union’s legislative framework occurs for the first time with the approval of the
European Regulation requiring the application of International Financial Reporting Standards
(IFRS) in the group accounts of publicly traded EU companies (‘IFRS Regulation’). As it
would infringe Community Law to delegate the authority for the issuance of accounting rules,
being applied in the European Union, to an outside private standard setter, article 6, par. 2
IFRS Regulation requires the institution of an endorsement mechanism. This new EU
mechanism objects to provide the professional standards IFRS with the essential legislative
weight, making them applicable in the European legal environment. Furthermore it shall
advance the exchange of information and discussion about IFRS in the EU and their
understanding by all concerned groups (preamble 11 IFRS Regulation). The required
12
regulatory oversight on the EU level should be ensured by a two-tier structure consisting of a
regulatory and a technical level.
Based on article 6, par. 1 IFRS Regulation the Accounting Regulatory Committee (ARC) was
set up in 2002 as a comitology committee according to the EU specific comitology rules
relating to the exercise of implementing powers conferred from the Council to the
Commission12. The Accounting Regulatory Committee (ARC) is composed of representatives
of all EU Member States, mainly coming from national ministries, and chaired by the
European Commission. In the Council’s interest the Accounting Regulatory Committee
(ARC) represents the ‘interface of EU’s dual executive’ (Hix 1999), i.e. its function is to
control and assist the EU Commission in carrying out the endorsement of International
Financial Reporting Standards (IFRS). Additionally, the Accounting Regulatory Committee’s
power of veto on a Commission’s opinion about the adoption of an IFRS requiring a qualified
majority puts the Council into the position to have the final say in the endorsement decision
(Ballmann, Epstein, and O’Halloran 2002). For the EU Member States the Accounting
Regulatory Committee (ARC) serves as a mean to gain influence in the decision making
process on the EU level, compensating the growing shift of national authorities to EU bodies
(Wessels 1998). From a practical point of view, the inclusion of national civil servants
enhances the political legitimacy of IFRS and is supposed to facilitate their implementation in
the EU Member States (Eriksen and Fossum 2002).
The technical level of the endorsement mechanism is represented by the European Financial
Reporting Advisory Group (EFRAG) having been established in 2001.13 In contrast to the
Accounting Regulatory Committee (ARC), the European Financial Reporting Advisory
Group (EFRAG) is not an institutional EU committee. Instead, it was established by private
sector groups, ensuring that the Commission is provided with the necessary technical
expertise and that those parties that actually have to apply the endorsed IFRS, e.g. stock
exchanges, small and medium size entities (SME), financial analysts, accountancy professions
and national standard setters, is given the opportunity to influence the Commission’s
endorsement decision. Apart from providing the Commission with endorsement advices
concerning the adoption of an IFRS, it is the European Financial Reporting Advisory Group’s
role to proactively contribute to the International Accounting Standards Board’s work
12
See Council Decision of 28 June 1999 laying down the procedures for the exercise of implementing powers
conferred on the Commission (1999/468/EC), Official Journal of the European Communities, L 184,
17/07/1999: 23-26.
13
The need to create an accounting technical group emanates from preamble 10 IFRS Regulation.
13
(Fédération des Experts Comptables Européens 2001). Mainly through comments during the
standard setting process the European Financial Reporting Advisory Group (EFRAG) is
supposed to make sure that the European interests are regarded by the International
Accounting Standards Board (IASB) and to prevent conflicts of IFRS with European Law
from the outset (Fédération des Experts Comptables Européens 2001). Finally the European
Financial Reporting Advisory Group (EFRAG) shall initiate amendments of the EU
Accounting Directives to adjust them to IFRS if this is considered to be necessary (Fédération
des Experts Comptables Européens 2001).
Not later than two months after the promulgation of an International Financial Reporting
Standards (IFRS) by the International Accounting Standards Board (IASB), the European
Financial Reporting Advisory Group (EFRAG) is due to convey an advice about the adoption
or rejection of the standard at stake to the European Commission. By publishing a proposal
for public comment within its due process, the European Financial Reporting Advisory Group
(EFRAG) gives all interested parties the chance to contribute to its recommendation. Article
3, par. 2 IFRS Regulation sets three criteria that have to be considered in the assessment of an
IFRS. The application of an IFRS should not oppose the “true and fair view principle” stated
in article 2, par. 3 4th Company Law Directive, it should be conducive to the European public
good, and it should deliver a basis for users of financial statements in the EU to make sound
economic decisions by meeting the fundamental criteria of understandability, relevance,
reliability and comparability.14 On the basis of the European Financial Reporting Advisory
Group’s advice, the European Commission drafts a report including the proposal about the
adoption or rejection of an IFRS and an analysis about the standards’ conformity with
European Law and policy. The Accounting Regulatory Committee (ARC) on the second level
of the endorsement mechanism examines the report and submits its opinion on the proposal
back to the Commission within one month (par. 2 regulatory procedure)15. In the case of an
agreement with the Commission’s proposal, the Commission should take the necessary
measures for the adoption of the standard (par. 3 regulatory procedure). Is the Accounting
Regulatory Committee’s opinion opposing the proposal, or is it not conveying an opinion at
all within the schedule, the Commission submits a proposal to the Council or returns it to the
European Financial Reporting Advisory Group (EFRAG) to overwork it (par. 4 regulatory
procedure). Additionally the European Parliament, being empowered to intervene, if it
14
For a detailed discussion of the endorsement criteria, see van Hulle (2003).
The regulatory procedure represents article 5 of the Council Decision concerning the execution of
implementing powers delegated to the Commission.
15
14
considers that the Commission has exceeded its authority, has to be informed (par. 4
regulatory procedure). The Council should decide on the proposal with a qualified majority
within three months (par. 6 (1) regulatory procedure). If he affirms the Commission’s
proposal or does not take a decision within the schedule, the Commission should take the
required measures for the adoption of the IFRS (par. 6 (3) regulatory procedure). Does the
Council reject the proposal, the Commission shall repeat the endorsement procedure and bring
a modified proposition before the Council (par. 6 (2) regulatory procedure).
Although the introduction of the endorsement mechanism was predominantly appreciated, it
has to meet some criticism, too. Due to their composition, the Commission and the
Accounting Regulatory Committee (ARC) are regarded to be exposed to political pressure
from the EU Member States (House 2001). The rejection of IAS 32 and 39, both dealing with
the accounting of financial instruments, in the first endorsement process in 2003 serves as an
example. European banks, especially French banks and assurances, claimed that the
evaluation of derivatives on the fair (market) value instead of historical costs would lead to a
high volatility in their financial statements (Les Echos 2004). Even the French Prime Minister
Chirac expressed his concerns about the standards’ negative effects on financial stability
(Senoir 2004). Simultaneously the EU Commission is pushed by the U.S. Securities and
Exchange Commission (SEC) and the International Accounting Standards Board (IASB).
While the SEC warned the European Union, ‘not to water down’ IAS 39, as it would derogate
the aimed convergence between U.S. GAAP and IFRS (Evans 2004), the IASB’s Chairman
appealed to the Commission’s objective to avoid competitive disadvantages of EU companies
on the global capital market and considered the rejection of IAS 32 and 39 to be a
counteraction to the recognition of EU accounts at the U.S. stock market (Reynolds 2003).
The European Financial Reporting Advisory Group (EFRAG) is considered to face the
conflict of having to balance out its efforts to obtain acceptance within the International
Accounting Standards Board (IASB) on the one hand and the obligation towards the
Commission to ‘work against’ the IASB if the technical assessment of a standard results in a
negative opinion, on the other hand (House 2001). The fact that the European Financial
Reporting Advisory Group (EFRAG) recommended the adoption of all International Financial
Reporting Standards (IFRS), including IAS 32 and IAS 39,16 to the Commission and the
commitment that a rejection of an IFRS should only occur exceptionally ‘(t)he possibility of
16
See Endorsement of existing International Accounting Standards and related interpretations.
http://europa.eu.int/comm/internal_market/accounting/docs/ias/efrag-2002-06-endorsement-letter_en.pdf
(25.04.2004).
15
saying “no” to endorsement will be like using the atomic bomb’ (House 2001) might indicate
that the European Financial Reporting Advisory Group (EFRAG) prioritizes the need to
reinforce its relationship with the International Accounting Standards Board (IASB).
Combined with this problem the question is raised, whether the European Financial Reporting
Advisory Group (EFRAG), being established for the provision of technical accounting
expertise, can preserve its independence from political interferences17. Finally the first
conducted technical assessment of all existing IFRS in 2002 revealed that the heterogeneous
composition of the European Financial Reporting Advisory Group (EFRAG) renders the
agreement on ‘one European view’ expressed towards the IASB difficult. The intention of
minor represented organizations within the European Financial Reporting Advisory Group
(EFRAG), e.g. the industry, to directly address their opinions to the IASB, would split the
‘European view’ and consequently weaken the European Financial Reporting Advisory
Group’s influence within the IASB.
4.2. National Legislation: Implementation of the IFRS Regulation
Having chosen to harmonize accounting in the EU by means of Company Law Directives so
far, with the adoption of the IFRS Regulation in 2003 the European Commission used a legal
act of primary European Law. The overall intention of taking a regulation was to guarantee
that International Financial Reporting Standards (IFRS) are actually consistently applied by
all listed companies in their consolidated statements in the EU (par. 2 Proposal IFRS
Regulation)18. As a regulation is ‘binding in its entirety and directly applicable in all EU
Member States’ (article 249 EC Treaty19), the risk of a non-uniform transposition into
national law and transformation delays are reckoned being excluded (par. 2 Proposal IFRS
Regulation). Although the IFRS Regulation is directly effective in the EU, it leaves the EU
Member States the option to extend the requirement or to allow the voluntary use of IFRS
(article 5 IFRS Regulation). Consequently an additional act of law on the level of the Member
States to exercises the option is necessary. From the EU Member State’s proposals concerning
the exertions of the options in the IFRS Regulation20 we can conclude that the scope of
17
See Summary Record – Meeting of the Accounting Regulatory Committee of 21 November 2003.
http://europa.eu.int/comm/internal_market/accounting/docs/arc/20031121-summary-record_en.pdf
(25.04.2004).
18
See Proposal for a Regulation of the European Parliament and of the Council on the application of
international accounting standards, Official Journal of the European Communities, C 154 E, 29/05/2001: 285-99.
19
See Consolidated Version of the Treaty establishing the European Community, Official Journal of the
European Communities, C 325, 24/12/2002: 33-183.
20
See Table providing information on the intentions/decisions of Member States and EEA Countries concerning
the use of options in the IAS Regulation. http://europa.eu.int/comm/internal_market/accounting/docs/ias/iasuse-of-options_en.pdf (25.04.2004). And Table providing information on the intentions/decisions of Accession
16
International Financial Reporting Standards (IFRS) will not be uniform in the EU Member
States. Therefore equal competitive conditions for companies organized under the same legal
form and comparability and transparency of financial statements for users will only be
improved to a moderate extent. Supplementary to the IFRS Regulation, in 2003 the
Commission issued an Accounting Directive (‘Modernization Directive’)21, purposing to
modernize and update the 4th and 7th Company Law Directive towards the state of the art of
international accounting, IFRS respectively. Even though the intention to create a ‘level
playing field’ for EU companies using IFRS in their financial statements and those that still
prepare their accounts according to the provisions of the Accounting Directives (preamble 5
Modernization Directive) can be appreciated, the increase of the already supernumerous
options granted to the EU Member States in the 4th and 7th Company Law Directive lead to
new scope of discretion and opposes the desired improvement of comparability of financial
statements in the EU. Although the Commission claims that the Modernization Directive will
eliminate all discrepancies between the Accounting Directives and IFRS (preamble 15
Modernization Directive), we find that several conflicts remained and that since the approval
of the Modernization Directive, new discrepancies have already been emerging.22
According to the International Accounting Standard Board’s aim to become a global standard
setter, the scope of users of International Financial Reporting Standards (IFRS) is expanding
constantly23. Beside the mandatory use of IFRS from 2005 onwards for consolidated accounts
of listed corporations in the EU, the projected change-over to IFRS in Australia from 2005
and in New Zealand from 2007 on, there are numerous countries applying IFRS instead of
developing their own national standards and certain stock markets that require the preparation
of financial statements according to IFRS as a condition for listings. Due to the IASB’s
cooperation with the International Organisation of Securities Commissions (IOSCO), the
application of IFRS for cross-border listings is, with a few exceptions24, globally accepted.
Countries concerning the use of options in the IAS Regulation.
http://europa.eu.int/comm/internal_market/accounting/docs/ias/ias-use-of-options-accession_en.pdf
(25.04.2004).
21
See Directive 2003/51/EC of the European Parliament and of the Council of 18 June 2003 amending
Directives 78/660/EEC, 83/349/EEC, 86/635/EEC and 91/674/EEC on the annual and consolidated accounts of
certain types of companies, banks and other financial institutions and insurance undertakings, Official Journal of
the European Communities, L 178, 17/07/2003: 16-22.
22
See chapter 6.4.
23
For a list of the worldwide application of International Financial Reporting Standards (IFRS), see Gannon
(2003).
24
In 2003 IFRS were not accepted in Brazil, Canada, Chile, Israel, Mexico, New Zealand and Taiwan. The U.S.
SEC requires a reconciliation of the equity and the result to U.S. GAAP. For further details, see Wagenhofer
(2003).
17
5.
ENFORCEMENT
OF
INTERNATIONAL
FINANCIAL
REPORTING
STANDARDS (IFRS)
In the following section we introduce the issue of enforcement of accounting rules,
distinguishing between corporate governance and market related enforcement mechanisms.
On the national level of EU Member States we demonstrate the functioning of supervisory
bodies under the special interest of the influence of their enforcement actions on national
accounting practices concerning International Financial Reporting Standards (IFRS). The role
of court decisions with regard to the interpretation and application of IFRS will be examined
further on. On the level of the European Union we point out the need for a centrally organized
enforcement of IFRS as a precondition for their uniform application in all EU Member States.
Thereby we have a closer look at the harmonization efforts in the field of statutory audit and
national regulatory authorities. A special interest is dedicated to the role of the European
Court of Justice by means of an analysis of the impact of judgements on IFRS on the desired
worldwide consistent application of IFRS. The depiction of the enforcement of financial
reporting in the U.S. by the Securities and Exchange Commission (SEC) should reveal the
influence of the U.S. SEC on the interpretation of IFRS and the interdependencies between
European and U.S. enforcement mechanisms.
5.1. Enforcement: National Level
Enforcement means ‘the act of putting something such as a law into effect’ (Black 1990). In
the area of accounting enforcement is carried out via supervision of compliance of financial
reporting with the relevant set of accounting rules and by conducting adequate actions in case
of violations. With regard to the globalization of capital markets and the requirement for
comparable financial information, a uniform application of International Financial Reporting
Standards (IFRS) in all countries that allow or require the use of IFRS has to be ensured, i.e.
the creation of specific national or European IFRS accounting practices should be averted to
the greatest possible extend.
Enforcement is accomplished by the corporate governance system or market regulation (Leuz
and Wüstemann 2004). Enforcement via corporate governance comprises the proper
application of the relevant accounting regulations by the manager when preparing financial
statements (self-enforcement), the approval of financial statements by the shareholders or the
board of directors, depending on the national corporate governance system, a closer
examination by the supervisory board or an audit committee, and the statutory audit. The
main functions of the statutory audit in relation to enforcement are to effect compliance with
18
the underlying accounting rules by exercising control, and to underpin investors’ confidence
in financial reporting by giving an opinion on the compliance of accounting practices with
legal requirements (Gehring 2001).
Enforcement via market regulation encompasses the monitoring of financial reporting by a
regulatory authority and reactions of the press and the public. In market orientated financial
systems, being characterized by a dispersed share ownership, enforcement is mainly based on
market control by regulatory institutions. As the concrete organization and legal status of a
such a body depends on the national institutional framework and corporate governance
system, it highly varies between different countries. The Financial Reporting Review Panel
(FRRP) in the U.K., having been established by the Secretary of State for Trade and Industry
in 1991 represents an example for a privately organized regulatory body. The Financial
Reporting Review Panel (FRRP) is in charge of the monitoring of compliance of financial
statements of public and large private companies with the underlying accounting
requirements. It operates reactively, i.e. it investigates financial statements in the case of a
direct complaint, an ascertainment of defective accounts in audit reports or press releases
(Cooke, Choudhury and Olusequn Wallace 2001). In 2003 the Financial Reporting Review
Panel (FRRP) introduced the annual review of 300 accounts as a proactive element in its
enforcement strategy (Perry 2003). Characteristically for the Financial Reporting Review
Panel’s approach is that, if the assumed offences are proved, a solution is sought to be reached
by a voluntary remedial action of the company’s management25. Is the issuer not willing to
take the corrective actions demanded by the Financial Reporting Review Panel (FRRP), the
latter can pass the case to the Court in order to enforce its decision. The publication of press
statements about the questions at stake and the Financial Reporting Review Panel’s respective
decision should serve other companies as a basis for the preparation of financial statements
(Fédération des Experts Comptables Européens 2001). From this we can conclude that the
Financial Reporting Review Panel’s enforcement actions create some kind of an ‘indirectly
binding body of accounting case law’. An example for the effectiveness of press releases as a
market orientated enforcement mechanism is revealed by the drop down of Wiggins’s share
price by 19 % when the Financial Reporting Review Panel (FRRP) publicly warned Wiggins
to take legal action (Malvern 2001). Another organizational form of a regulator is the
independent public authority, the Stock Exchange Commission (‘Autorité des Marchés
Financiers’ - AMF) in France. In addition to the examination of financial statements initiated
25
See ‘How the FRRP works’. http://www.asb.org.uk/frrp/how/ (25.04.2004).
19
by advices about detective accounts, it works proactively, i.e. it reviews financial documents
on a sample basis. Moreover the French Stock Exchange Commission (AMF) is not only
empowered to investigate financial information, but also to issue regulations concerning the
requirement of information provided to investors and to monitor and sanction their noncompliance (Richard 2001). As the French Stock Exchange Commission (AMF) publishes
legally non binding recommendations with regard to accounting, in the field of accounting
regulation it can only enforce corrective actions by demanding for a high-court order or by
passing the case to a civil, criminal or administrative court.
In many countries a regulatory institution being responsible for the enforcement of accounting
rules does not exist. In Germany compliance with accounting regulations has been enforced
by the Board of Directors and statutory audit so far. Due to numerous corporate scandals
preparers and auditors were considered to be expected too much with the internationalization
of financial reporting (e.g. Hommelhoff and Mattheus 2004). Thus, the German government
drafted a law concerning the control of corporate financial statements (‘Bilanzkontrollgesetz –
BilKoG’) intending to establish a regulatory enforcement body being modelled on the British
Financial Reporting Review Panel (FRRP).
The final say about the application of International Financial Reporting Standards (IFRS) is
dedicated to courts, having the power to overrule decisions of any other enforcement body.
Like regulatory authority’s actions, court rulings bear the risk of creating national
interpretations of IFRS and thus might get in the way of a consistent application of IFRS on
the international level. When financial reporting is predominantly regulated by law, usually
only rather general accounting principles are codified in statutes. The entire system of
accounting principles and standards is built by the interpretation of the basic codified
accounting rules in law-suits (Leuz and Wüstemann 2004). As stated in chapter 2, in such
systems the process of accounting rule making and the enforcement of those rules by courts
cannot be clearly separated. To be able to judge, whether national court ruling might have a
significant impact on the transnationally consistent use of IFRS, a closer examination of the
occurrence probability of court orders in different systems might be adjuvant. Drawn from
past experiences in Germany, we believe that law-suits initiated by individuals, in particular
by investors, should rarely happen as long as IFRS are only required for financial statements
having the sole function of providing information. As court trials are expensive and longwinded, investors would rather sell their shares if they are not satisfied with a company’s
accounting practice (Watrin 2001). In the Netherlands a legally determined group of
20
interested parties can directly address a complaint about misleading financial statements to the
Enterprise Chamber (‘Ondernemingskamer’), a forum of the Court of Justice in Amsterdam.
The fact, that out of 50 decisions concerning complaints about financial statements from 1974
to 2001, only 10 % were taken in the last 10 years, can be regarded as an indicator for
decreasing interest in individual complaints in the domain of accounting26. Beside the little
frequency, these verdicts usually referred to very specific cases and therefore can hardly be
considered as having created generally accepted accounting principles (Klaassen 2001). As
we have seen above, oversight institutions operating under the form of a privately organized
review panel, like the Financial Reporting Review Panel (FRRP) in the U.K. are not legally
empowered to enforce corrective actions or to sanction non-compliance. Instead they might
enforce compliance by transmitting the respective cases to the Court. The fact that none of the
368 reviewed cases between 1989 and 1999 was brought to the Court27, the risk of the
development of a national interpretation body of IFRS in countries with privately organized
monitoring bodies appears to be marginal. The possibility to complain about criminal acts like
fraud of managers in the preparation of financial statements can be neglected, as it rarely
occurs. In France, our findings lead to a similar conclusion. Beside the infrequent
transmission of accounting cases to a court by the French Securities and Exchange
Commission (AMF), similar to British legislation aggrieved individuals can file a law-suit
against the company’s governing bodies if the provided information in the annual accounts is
misleading, i.e. if it does not present a ‘true and fair view’ (‘image fidèle’) of the company’s
situation (article 425, 437 and 460 French Commercial Law) or if fictive dividends were
distributed (article 347 French Commercial Law). Anyhow, only one court ruling concerning
the application of accounting regulations has been taken in the French jurisprudence so far
(Raffegeau, Dufils, Lopater and Arfaoui 2001). Due to the fact that independently from the
form of the regulatory body and the court system, court interpretations on the compliance of
financial statements with International Financial Reporting Standards (IFRS) should most
probably only be seldomly required, we can conclude that courts will not have a significant
impact on the enforcement of IFRS and consequently the risk of the creation of specific
national IFRS by courts rulings can be reduced to individual cases.
5.2. Enforcement: European Level
To improve comparability of financial statements in the European Union and to strengthen the
investors’ confidence in capital market information, the use of the same set of accounting
26
27
For the figures, see Fédération des Experts Comptables Européens (2001).
For the figures, see Cooke, Choudhury, and Olusequn Wallace (2001).
21
rules in all EU Member States is requisite, but does not constitute the only premise. In fact it
is essential to secure the EU wide uniform application of International Financial Reporting
Standards (IFRS). Hence, along with the introduction of IFRS in the European Union, the
IFRS Regulation requires the coordination of enforcement of IFRS on the European level
(preamble 16 IFRS Regulation). As significant differences in the corporate governance
system and the legal and economic environment in the Member States of the EU render the
establishment of a centralized European enforcement mechanism impossible (e.g. Fédération
des Experts Comptables Européens 2002), the securing of compliance with IFRS should
remain on the national level in the Member States’ authority (preamble 16 IFRS Regulation).
As the comparability of published financial statements depends inter alia on the quality of the
audit, a harmonization of audit regulations parallel to recent developments in the field of
accounting appears to be indispensable. Endeavours referring to the worldwide harmonization
of the statutory audit can principally be attributed to the International Federation of
Accountants (IFAC), under which more than 150 national accountancy bodies are privately
organized. A sub-committee of the International Federation of Accountants (IFAC), the
International Auditing and Assurance Standards Board (IAASB) issues International
Standards on Auditing (ISA) which should be implemented into national auditing regulations
and applied by all members of the International Federation of Accountants (IFAC). However,
in a statutory audit the International Standards on Auditing (ISA) are not legally binding; in
the case of a conflict they are superseded by opposing national auditing rules (Gehring 2001).
In the European Union, according to the 4th and 7th Company Law Directive, individual
respectively consolidated accounts of listed corporations have to be subject to an audit by at
least one person (article 51 4th Company Law Directive and article 37 7th Company Law
Directive). The required qualifications for persons performing statutory audits in the EU are
set in the 8th Company Law Directive28. Within the last years, the European Commission
issued recommendations relating to quality assurance standards for statutory audits29 and to
the independence of auditors30. The Commission justifies its conspicuous reservation as
regards the setting of legally binding rules with the argument, that minimum standards are
28
See Eighth Council Directive 84/253/EEC of 10 April 1984 based on Article 54 (3) (g) of the Treaty on the
approval of persons responsible for carrying out the statutory audits of accounting documents, Official Journal of
the European Communities, L 126, 12/05/1984: 20-26.
29
See Commission Recommendation of 15th November 2000 on the quality assurance for the statutory audit in
the European Union: minimum requirements (2001/256/EEC), Official Journal of the European Communities, L
091, 31/03/200: 91-97.
30
See Commission Recommendation of 16th May 2000 – Statutory Auditors’ Independence in the EU: A Set of
Fundamental Principles (2002/590/EEC), Official Journal of the European Communities, L 191, 19/07/2002: 2257.
22
‘the maximum level of harmonisation which could be supported by Member States at the
moment’31. Another explanation might be the Commission’s so far intention to achieve
harmonization in the area of auditing by a self-regulation of the accountancy profession.
Howsoever with the adoption of the IFRS Regulation in 2002, the Commission realized the
need for a legally based harmonization of auditing in Europe and therefore proposed a
modernization of the 8th Company Law Directive (‘Proposal Audit Directive’)32.
The
proposal broadens the scope of the legal basis of statutory audit in the European Union by
regulating almost all domains of the audit (Lanfermann 2004). In particular it stipulates
requirements concerning the conduct of an audit as well as the degree of public oversight and
external quality assurance (Explanatory Memorandum article 1, par. 2 Proposal Audit
Directive). Additionally, the Commission intends to require the International Standards on
Auditing (ISA) as the relevant set of auditing standards in the EU from 2005 on (article 26,
par. 1 Proposal Audit Directive) integrating them via an endorsement mechanism33 into the
legislative framework of the EU (article 26, par. 2 and article 49, par. 2 Proposal Audit
Directive). Even though the Commission’s intention to make the International Standards on
Auditing (ISA) applicable in the EU seems to resemble to the European harmonization of
accounting standards via International Financial Reporting Standards (IFRS), the
circumstances for an adoption of the International Standards on Auditing (ISA) are less
favourable. After having been recommended by the International Organisation of Securities
Commissions (IOSCO) in 1992, the International Standards on Auditing (ISA) were subject
to a ‘Codification Project’, setting off an opposition against the acceptance of the
International Standards on Auditing (ISA) by several members of the International
Organisation of Securities Commissions (IOSCO) and consequently invalidating the previous
recommendation. Moreover, some national audit systems comprise elements that are not
addressed in any International Standard on Auditing (ISA), e.g. the German and Austrian
auditor’s report. Specific national regulations are permitted to exist beside the International
Standards on Auditing (ISA) (article 26, par. 3 Proposal Audit Directive), only allowing a
minimum harmonization of the statutory audit in the EU.
While the establishment of a central European regulatory authority in the sense of a
31
Auditor independence - frequently asked questions.
http://europa.eu.int/rapid/start/cgi/guesten.ksh?p_action.gettxt=gt&doc=MEMO/02/96|0|RAPID&lg=EN&displ
ay= (25.04.2004).
32
See Proposal for a Directive of the European Parliament and of the Council on statutory audit of annual
accounts and consolidated accounts and amending Council Directives 78/660/EEC and 83/349/EEC (2004).
http://europa.eu.int/comm/internal_market/auditing/docs/com-2004-177/com2004-177_en.pdf (25.04.2004).
33
In contrast to the International Financial Reporting Standards (IFRS) endorsement mechanism the
International Standards on Auditing (ISA) endorsement mechanism will only consist of a political level.
23
‘European SEC’ would not be appropriate regarding the currently low degree of
harmonization in securities regulation in the European Union34, the responsibility for the
supervision of compliance of financial statements with International Financial Reporting
Standards (IFRS) remains in the hands of national regulatory authorities. Nonetheless there is
a call for convergence of enforcement mechanisms through collaboration between the
supervisory bodies of the EU Member States in order to foster market confidence, to avoid
regulatory arbitrage and to ensure consistent enforcement practice on the EU level (e.g.
Fédération des Experts Comptables Européens 2002). Based on the proposal of the
Committee of Wise Men35, in 2001 the European Commission established the Committee of
European Securities Regulators (CESR), consisting of securities experts representing national
public authorities36. With regard to the enforcement of International Financial Reporting
Standards (IFRS) it is the Committee of European Securities Regulators’s role to encourage
and administrate coordination between the national supervisory bodies by developing
common rules in the form of guidelines, recommendations and standards and by supervising
the regulatory practices in the EU Member States37. The Committee of European Securities
Regulators (CESR) has been issuing two standards concerning the enforcement of IFRS so
far. The national regulatory authorities are expected to stick to these rules even if they don not
have a legal status. CESR Standard No. 138 stipulates the necessity of coordination between
the national regulatory authorities in the EU. It requires the existence of a ‘competent
independent administrative authority’ in each EU Member State being responsible for the
enforcement of IFRS in financial statements of listed companies (principle 3 CESR Standard
No. l).39 As to the significantly varying forms of such authorities in the EU Member States,
CESR Standard No.1 only requires ‘consistency of the scope and reliability of those
enforcement systems’. Furthermore it sets a common definition of enforcement (principle 1
and 2 CESR Standard No. 1) and identifies appropriate enforcement methods (principle 11-15
CESR Standard No.1) and actions (principle 16-19 CESR Standard No.1). In CESR Standard
34
See Initial Report of the Committee of Wise Men on the Regulation of European Securities Markets.
http://europa.eu.int/comm/internal_market/en/finances/banks/report.pdf (25.04.2004).
35
See Final Report of the Committee of Wise Men on the Regulation of European Securities Markets (2001).
http://europa.eu.int/comm/internal_market/en/finances/general/lamfalussyen.pdf (25.04.2004).
36
See Commission Decision of 6 June 2001 establishing the Committee of European Securities Regulators
(2001/527/EC), Official Journal of the European Communities, L 191/43.
37
Charter of the Committee of European Securities Regulators. http://www.cesr-eu.org/ (25.04.2004).
38
See Standard No.1 on Financial Information: Enforcement of Standards on Financial Information in Europe.
http://www.cesr-eu.org/ (25.04.2004).
39
Up to now an institutional oversight body for financial statements has only been existing in about half of the
EU Member States. For further details, see Fédération des Experts Comptables Européens (2001).
24
No. 240, the Committee of European Securities Regulators (CESR) proposes measures to
achieve the required coordination of regulatory authorities in the EU. A convergence of the
national enforcers’ decisions on compliance with IFRS should be reached by the creation of a
database, containing all positive and negative decisions and being accessible to all members.
In the sense of a case law system, these precedents should be considered in future cases and
similar circumstances should result in similar decisions all over Europe. Additionally,
European Enforcers Coordination Sessions (EECS) should be organized on a regular basis,
giving the national regulatory authorities the chance to discuss previous enforcement
decisions and to exchange experiences. It is strongly emphasised, that the responsibility for
the interpretation of IFRS is strictly reserved to the International Financial Reporting
Interpretations Committee (IFRIC) and that neither on a national, nor on the EU level, an own
IFRS interpretation body should be built by the regulators.
Although a harmonization of enforcement by the creation of a ‘European case law system’
and the avoidance of a creation of Europe specific accounting practices of International
Financial Reporting Standards (IFRS) are desirable, their feasibility appears to be unrealistic.
Firstly, as the organizational form of the regulatory authority which does not even exist in all
EU Member States so far varies from privately organized review panels to governmental
administrative authorities, their enforcement decisions do not have the same legal status. It
would infringe national law if a public authority, taking legally binding actions, would be
bound to decisions of a foreign private organization. Thus, the Committee of European
Securities Regulators (CESR) eases its initially ambitious aims and states that previous
decisions to similar cases should only be regarded as a ‘source of information’ and ‘a useful
tool for the enforcers’ decision making process” (CESR Standard No. 2). It remains to be seen
in how far the regulatory bodies will actually put this system into practice and if this
cooperation mechanism will be able to achieve a harmonization of enforcement and in the end
ensure a consistent application of International Financial Reporting Standards (IFRS) in all
EU Member States. Secondly, it is highly questionable whether interpretation and
enforcement of accounting standards can clearly be separated (Kiefer 2003). The fact that, out
of economic efficiency reasons the International Financial Reporting Interpretations
Committee (IFRIC) only attends to issues that are widespread, relevant in practice and where
40
See Standard No.2 on Financial Information: Coordination of Enforcement Activities. http://www.cesr-eu.org/
(25.04.2004).
25
unsatisfactory or conflicting interpretations of an IFRS emerge or already exist41, reveals
several problems. The selection criteria set by the International Financial Reporting
Interpretations Committee (IFRIC) imply that only a fractional amount of cases will actually
be dealt with, especially problems relating to national particularities are not likely to be
attended (Tielmann 2001). Further on, as it is the IASC Foundation’s policy to consider the
interests of all involved and interested parties in the due process, the International Financial
Reporting Interpretations Committee’s interpretation setting process appears to be taking too
long to be able to quickly address urgent requests.
The European Court of Justice representing the highest level of jurisdiction in the European
Union might take part in the enforcement of International Financial Reporting Standards
(IFRS), too. To be able to judge if the involvement of the European Court of Justice will
effectively bear the risk of the creation of EU specific interpretations of IFRS, we examine the
likeliness of the occurrence of rulings of the European Court of Justice on the application of
IFRS under the same scheme as for national courts.
In general, according to the EU principle of subsidiarity, the interpretation of Community
Law is dedicated to the national courts of the Member States. In order to ensure the uniform
application of Community Law in all Member States, the European Court of Justice possesses
jurisdiction to give preliminary rules on the interpretation of Community Law (article 234 EC
Treaty). With the adoption by the European Commission, endorsed IFRS became part of the
Community Law (Schön 2003). Consequently, according to article 234 EC Treaty, national
courts can call the European Court of Justice for interpretation of questions concerning any
endorsed IFRS, if it considers that the European Court of Justice’s interpretation is necessary
for its final judgement. The possibility to appeal to the European Court of Justice is reserved
to national courts of the EU Member States; individuals cannot directly file a law-suit at the
European Court of Justice, when the application of Community Law is concerned. A first
indicator for our examination on the occurrence probability of rulings of the European Court
of Justice on IFRS might be the marginal amount of cases referring to the interpretation of EU
accounting rules under the 4th Company Law Directive and the absence of any judgements on
the 7th Company Law Directive so far. Moreover previous cases brought to the European
Court of Justice predominantly concerned accounting for tax or dividend distribution
41
See Template for submission of an International Financial Reporting Interpretations Committee (IFRIC)
Potential Agenda Item Request. http://www.iasb.org/uploaded_files/documents/8_20_IFRIC_issue_suggest.pdf
(25.04.2004).
26
purposes. As long as IFRS are only required for consolidated and individual accounts, having
the purpose of information only, an action by the European Court of Justice relating to the
interpretation of IFRS is highly unlikely. However it has to be considered that previous
rulings of the European Court of Justice referred to the interpretation of a directive,
representing indirect Community Law, being transposed into national legislation. This might
explain the reservation of national courts to call the European Court of Justice for
interpretation. In contrast, the IFRS Regulation is directly effective European Law implying
that national courts should appeal to the European Court of Justice in every case with a
material impact. From our findings concerning the frequency of national court decisions on
accounting issues, we can educe that the European Court of Justice should rarely be called,
especially as long as IFRS are only required for information purposes.
From a conceptual point of view the ‘systematics’ of the entire set of International Financial
Reporting Standards (IFRS) being stamped by the ‘case by case’ development, does not seem
to be designed for an interpretation by courts. Since its establishment in 1952, the European
Court of Justice has been developing an autonomous teleological approach of interpretation of
Community Law (Schön 1993). In contrast to that, the interpretation methods stated in IAS 8,
par. 10-12 reveal a rather inductive approach of interpretation of IFRS. Due to a different
approach of interpretation, the European Court of Justice might not only reach solutions that
does not fit to the logic of IFRS, it is also likely that its interpretations of International
Financial Reporting Standards (IFRS) are going to differ from accounting practices in other
non-European countries that require the application of IFRS.
5.3. Interdependencies with US-Enforcement
The U.S. Securities and Exchange Commission (SEC), having been established by the
Securities and Exchange Act in 1934, is in charge of the regulation of the U.S. securities
market. Being originally empowered for both, the establishment of accounting principles and
their enforcement, the SEC delegated the development of U.S. generally accepted accounting
principles (U.S. GAAP) to the privately organized Financial Accounting Standards Board
(FASB). Though, the SEC reserved its rarely used authority to set its own regulations,
displacing the Financial Accounting Standard Board’s principles, and further concretizes and
interprets U.S. GAAP in Financial Reporting Releases (FRR), gives assistance to the
preparation of financial statements through Staff Accounting Bulletins (SAB) and
supplements U.S. GAAP by its enforcement decisions published in Accounting and Auditing
Enforcement Releases (AAER). The SEC as a federal administrative agency takes the position
27
of a special court of lower instance for civil and criminal courts (Böckem 2000). The SEC
Enforcement Division is responsible for the review of all published documents of SEC
registrants and for investigations in the case of assumed violation of the U.S. capital market
regulation. Relating to the enforcement of accounting regulations, the SEC Enforcement
Division can either initiate an administrative proceeding and possibly sanction an
infringement of U.S. GAAP, when an issue cannot be agreed on between the SEC and the
company’s management during previous conversations, or submit the case to a judicial
authority for a civil injunctive proceeding or a penal proceeding (e.g. Kiefer 2003).42 The
legally binding court rulings can be considered as SEC case law (Martin 1989).
As the acceptance of International Financial Reporting Standards (IFRS) for cross-border
listings at the U.S. stock market without reconciliation to U.S. GAAP is foreseeable (e.g.
Kiefer 2003),43 the SEC, as the world-wide most powerful regulatory authority, will have a
major impact on the enforcement of IFRS. As the extensive enforcement powers grant the
SEC a strong influence on accounting practice in the U.S., either by legally binding court
decisions or by virtually obliging publications, the creation of a U.S. specific interpretation of
IFRS seems inevitable. This argument is supported by the much higher number of legal
procedures initiated and conducted by the SEC44 compared to the respective European
regulatory authorities. This might lead to the requirement for multinational companies, being
listed in the U.S., to have to adjust financial statements to the U.S. specific application of
IFRS. Consequently the advantage of one common set of accounting standards would be
derogated, due to transnationally different enforcement mechanisms.
6. DISCUSSION
After having demonstrated how International Financial Reporting Standards (IFRS) are
developed, implemented in national or European legislation and subsequently how a
transnationally consistent application of IFRS is sought to be ensured, in this last section we
discuss political, legal and technical problems referring to the legalization of IFRS. First of all
the restructuring of the International Accounting Standards Board and its dependency from
the U.S. Financial Accounting Standards Board (FASB) and the U.S. Securities and Exchange
42
The choice to delegate a case of infringement to a federal court or to enforce it internally depends on diverse
factors, such as the gravity of the infringement and the intended sanction. See Kiefer (2003).
43
In 2000 the SEC issued a Concept Release, in which it intends to examine, under which condition financial
statements of foreign companies prepared according to IFRS could be accepted for listings at the U.S. stock
market. http://www.sec.gov/rules/concept/34-42430.htm (25.04.2004). For the cases in which IFRS already have
an effect on U.S. companies, see Gannon (2002).
44
For figures see Kiefer (2003), p. 86.
28
Commission (SEC) will be pointed out as one of the major premise for a global acceptance of
IFRS. Thereafter, problems, arising from the integration of private norms into a national legal
framework will be discussed under the example of German and European group accounting.
Uncertainties emerging from the coordination of the IFRS due process and the EU
endorsement mechanism will be examined further on. An analysis of selected accounting
issues under British, German and French Law should reveal inconsistencies in the application
of IFRS owing to different national legal systems. With case studies on goodwill accounting
and dividend recognition we intend to highlight problems of the coexistence of original, such
as the EU Accounting Directives and the European Court of Justice’s jurisprudence, and
derived legal norms, like endorsed International Financial Reporting Standards, in the EU
legal environment.
6.1. Premises of the Legalization of International Financial Reporting Standards (IFRS)
In this section we show that the legalization of International Financial Reporting Standards
(IFRS) mainly represents a political issue. We point out the different influencing factors that
gave the impetus for the restructuring of the International Accounting Standards Board
(IASB) as well as the opposing political pressures that had to be balanced out by the IASB in
its reorganization phase. The role of the U.S. Financial Accounting Standards Board (FASB)
as the globally predominant national standard setter and its recently initiated collaboration
with the IASB will be examined in view of a convergence towards global accounting
standards.
6.1.1. The restructuring of the International Accounting Standards Board (IASB)
While the International Accounting Standards Board (IASB) does not have the authority to
commit companies to use International Financial Reporting Standards (IFRS), the worldwide
acceptance and application of IFRS depends on securities regulators, governments and
national standard setters. Hence the IASB seeks for legitimacy by collaborating with the
relevant parties. In the late nineties, several economic and political events occurred that
prompted the International Accounting Standards Committee (IASC) to review its strategy
and to adapt its structure to the changing environment. During the Asian business crisis
countries with dubious accounting techniques realized that they needed adequate accounting
standards enabling them to regain investors’ confidence and to attract new investors (Street
2002). Furthermore the International Accounting Standards Committee’s structure and its
inappropriate funding were strongly criticized by individual standard setters. As 13 out 16
29
members of the former Board were nominated by the International Federation of Accountants
(IFAC), and since the IASC was predominantly funded by its members (90% of the budget),
the accountancy profession had a major influence on the setting of International Accounting
Standards (IAS). Especially the G4+1 group, a voluntary joint together of the Anglo-Saxon
national standard setting boards of Australia, Canada, New Zealand, the UK and the US
started putting pressure on the IASC by emerging more and more towards an alternative
international accounting standards board (Accountancy 1999 a). Another important impact
came from the International Organisation of Securities Commissions (IOSCO) which was
supposed to end its review of International Accounting Standards (IAS) in 2000 and to
recommend to its members, national securities regulators, to accept financial statements
prepared according to International Accounting Standards (IAS) for cross-border listings of
multinational companies. The position of the U.S. Securities and Exchange Commission,
being the most powerful member of the International Organisation of Securities Commissions
(IOSCO), was of a major interest in the endorsement context as many non-U.S. companies
desired to offer listings at the U.S. capital market (Cairns 2002). Finally, the European
Commission was considering to require the use of IAS in the consolidated accounts of all
listed companies in the EU. The first proposal for the restructuring of the International
Accounting Standards Committee (IASC), the discussion document ‘Shaping IASC for the
future’ published in 1998 was met with a square refusal from all sides. The U.S. Securities
and Exchange Commission (SEC) and the U.S. Financial Accounting Standards Board
(FASB) called for a structure similar to the one of the FASB, i.e. for a reduction of board
members, the abolition of part-time membership and technical expertise as a selection
criterion for the board members (Accountancy 1999 b). The EU instead criticized the
organization of an international standard setter based on a national model (The CPA Journal
News 1999). To ensure the political legitimacy of the Board as well as a European
participation in the standard setting process, the EU called for a basement of the Board’s
constitution on geographical representation (Bury 1999). Furthermore the EU opposed a
concentration of power in a few full-time Board members as it was concerned about a
reinforcement of the already dominant position of Anglo-Saxon countries (Accountancy 1999
c). As the U.S. Financial Accounting Standards Board threatened that it would withdraw its
support from the International Accounting Standards Committee (IASC), if the restructuring
followed the interests of the European Union and due to the strong negotiation position of the
U.S. SEC, in 2000 the IASC reached an agreement on a structure in favour of the U.S.
notions. Above all, the success of the SEC is also put down to the key position of the former
30
SEC chairman David Ruder within the strategy working party, which enabled him to enforce
the U.S. interests (Cairns 2002). Although the European Union is constantly trying to gain
influence in the standard setting process45, the composition of the IASC Foundation’s bodies
and the International Accounting Standard Board’s current politics regarding the convergence
project with the FASB and the proposed amendments of the IASC Foundation’s
Constitution46 reveal that the FASB, respectively the U.S. SEC retain its dominant influence
on the IASB.
6.1.2. The Role of the U.S. Financial Accounting Standards Board (FASB)
The U.S. Financial Accounting Standards Board (FASB) also represents a privately organized
standard setting board, but in contrast to the International Accounting Standards Board
(IASB) it issues national professional accounting standards, the U.S. generally accepted
accounting principles (U.S. GAAP). An important role in the context of international
accounting is attributed to the FASB as the U.S. capital market does not only attract foreign
investors, likewise an increasing number of non-U.S. companies seek for listings at the New
York Stock Exchange. As the U.S. Securities and Exchange Commission (SEC) still requires
the use of U.S. GAAP even for cross-border listings or at least reconciliation from foreign
accounting rules to U.S. GAAP, multinational companies have to prepare an extra set of
financial statements according to U.S. GAAP to be able to raise capital in the U.S. To
disburden companies from preparing two different sets of accounts, German corporate law
allows listed companies to apply internationally accepted accounting standards, comprising
U.S. GAAP and IFRS, in their group accounts instead of using German GAAP (§ 292 a
German Commercial Code).47
Due to the fact that the legalization of International Financial Reporting Standards (IFRS)
largely depends on its acceptance in the U.S., collaboration with the Securities and Exchange
Commission (SEC) respectively with the U.S. Financial Accounting Standards Board (FASB)
is essential to the International Accounting Standards Board (IASB). The FASB has not only
served as a model for the organization of the IASC Foundation and in particular for the
45
Due to the current conflicts concerning the endorsement of IAS 32 and 39 Fritz Bolkenstein, member of the
EU Commission and responsible for the internal market, taxation and customs issues, called for an improvement
of the International Accounting Standard Board’s standard setting process and a reinforcement of the European
input. See Williams (2003).
46
For details concerning the IASC Foundation Constitution Review, see
www.iasb.org/uploaded_files/documents/8_137_2003-con-itc.pdf. (25.04.2004).
47
Whereas all publicly traded corporations in the EU have to use IFRS in their consolidated accounts from 2005
on, article 9 (b) IFRS Regulation permits those companies that are listed on a non-European stock exchange and
that apply internationally accepted accounting standards other than IFRS, not to switch to IFRS until 2007.
31
structure of the IASB and its due process, an orientation of the IASC/IASB towards the
FASB’s working agenda as well as the contents of U.S. GAAP is apparent. The recent
developments in goodwill accounting might serve as an illustration. Influenced by the
lobbying of U.S. enterprises that wanted to disburden their income statement of the onerous
charges for goodwill amortization (Moehrle and Reynolds-Moehrle 2001), with the issuance
of SFAS 141 “Business Combinations” and SFAS 142 “Goodwill and Other Intangible
Assets” in 2001, the FASB replaced goodwill amortization by an annual impairment tests.
The IASB that just had revised IAS 22 ‘Business Combinations’ and IAS 38 ‘Intangible
Assets’ in 1998 immediately followed the FASB’s ‘impairment-only approach’ with an
exposure draft (ED 3) in 2001 and the issuance of IFRS 3 ‘Business Combinations’ in 2004.
While the U.S. Financial Accounting Standards Board (FASB) traditionally refused any
outside collaboration in the field of financial reporting (Kostelitz 2002) and claimed that only
U.S. GAAP could be the basis for a convergence of global accounting standards, since the
U.S. corporate accounting scandals around Enron the supremacy of the rule-based U.S.
GAAP has been disputed (Investor Relations Business News 2002). As a consequence
International Financial Reporting Standards (IFRS) that are considered to be more principle
based48 got more hearing in the U.S. and have been increasingly discussed as an alternative to
U.S. GAAP (Investor Relations Business News 2002). The fact that the FASB appears to be
more open to international accounting standards can also be put down to the FASB’s new
chairman Bob Herzig, a former part-time member of the IASB, who achieved to get support
from the SEC and the U.S. government for a collaboration with the IASB (House 2003). In
2002 the IASB and the FASB concluded a memorandum of understanding ‘The Norwalk
Agreement’, with the objective to make a joint effort in order to bring about compatibility to
their sets of accounting standards by eliminating existing differences between IFRS and U.S.
GAAP and by coordinating their working agendas in the future.49 Although differences
between IFRS and U.S. GAAP should be removed by analyzing both standards at stake and
by agreeing on the better solution, it is seen most likely that in the majority of cases U.S.
GAAP will prevail over IFRS (Kostelitz 2002). The first real test that will reveal if the
objected convergence towards global accounting standards is operational is going to be the
regulation of the share-based payments issue. Due to immense lobbying mainly coming from
the business community and large auditing firms resulting in pressure from the U.S. Congress,
48
For a critical analysis of the principle orientation of IFRS, see Preißler (2002) and Schildbach (2003).
See Memorandum of Understanding – ‘The Norwalk Agreement’. http://www.fasb.org/news/memorandum.pdf
(25.04.2004).
49
32
the FASB failed to implement its proposal to record share based compensation as expenses in
1995. Instead the IASB reached an agreement on the disputed subject and issued IFRS 2
‘Share-based Payment’ in 2004. It remains to be seen if the IASB’s spadework will enable the
Financial Accounting Standards Board (FASB), that published an exposure draft on the sharebased payment topic only shortly after the International Accounting Standards Board’s
promulgation of IFRS 2, to enforce the issue this time.
6.2. Problems of Private Rule-Making
In this section we illustrate legal and technical problems that arise from the implementation of
privately developed rules by means of the dynamic reference (‘dynamische Verweisung’) in
German Law and via incorporation (‘Geltungsbefehl’) in the European Union. In our critical
analysis we centre the trade-off between the essential legal certainty on the one hand and the
desired avoidance of the creation of specific national or EU International Financial Reporting
Standards (IFRS) on the other hand.
It is a state’s duty to issue legal norms. However this does not exclude the possibility to
delegate rule making to private parties and to incorporate primary private norms into the legal
framework (Kirchhoff 1987). Private legal norms usually emerge from a two-stage process.
First of all private rules are developed by a private institution; thereafter the state provides
them with legal status, either via reference to or incorporation of the private rules (Kirchhoff
1987). In 1998 Germany opened its group accounting for IFRS and U.S. GAAP by means of a
dynamic reference. Since then German listed parent companies have been granted the option
to prepare their consolidated accounts according to IFRS or U.S. GAAP instead of German
GAAP (§ 292 a German Commercial Code). In this case IFRS and U.S. GAAP remain private
norms, only their wording becomes part of the national legal group accounting rules. The
methodology of the dynamic reference is highly criticized as it is referred to IFRS and U.S.
GAAP in their respective current form (Kirchhoff 2000). Hence changes in IFRS or U.S.
GAAP are automatically integrated into German Law resulting virtually in a delegation of the
authority to set legal norms to the non-legitimated International Accounting Standards Board
(IASB) and the U.S. Financial Accounting Standards Board (FASB) (Hommelhoff 1996). Not
only in Germany but also in other countries allowing or requiring the use of IFRS or U.S.
GAAP further problems are implicated with the reference to private rules. The development
of International Financial Reporting Standards (IFRS) on several stages in the due process
gives rise to confusion about the applicability of the different forms of drafts and standards.
Adler, Düring and Schmaltz (2003) generally exclude the possibility to refer to an exposure
33
draft if a topic is not regulated by any IFRS or Interpretation by the International Financial
Reporting Interpretations Committee (IFRIC), as exposure drafts are still likely to be changed
before the issuance of a final standard. In conformity with par. 22 Preface to IFRS stipulating
that IFRS remain effective until the due process of a new IFRS is completed, for standards
under revision Wollmert and Achleitner (2003) negate the application of exposure drafts as
well as issued but not yet effective IFRS, unless the International Accounting Standards
Board (IASB) explicitly encourages an earlier adoption as for example in the ‘Improvement
Project IASs’ having been completed in 2004. Finally the role of accounting literature should
be clarified. Due to the particularity of the IFRS due process a further development of the
standards by literature does not fit into the concept of IFRS (Achleitner 2003). Nevertheless
accounting comments and articles may serve as a guideline for unregulated topics if they are
conform to other IFRS, Interpretations by the International Financial Reporting Interpretations
Committee (IFRIC) or the Framework (IAS 8, par. 12).
Concerning the application of International Financial Reporting Standards (IFRS) in the
European Union, the EU Commission decided to incorporate IFRS into the EU legal
framework. Via the endorsement mechanism the standards are provided with legal status for
their use in the EU and consequently become Community Law. As IFRS do not become part
of the legal norms developed by the EU legislature, they are ranked below ‘original’ EU Law.
The conferment of legal status to private rules by means of incorporation poses several
problems, too. According to article 4 IFRS Regulation only those IFRS that have been
endorsed by the EU Commission are applicable in the European Union. Due to time delays
between the promulgation of a new or revised IFRS and the EU endorsement decision, it is
not clear which standards ought to be applied in the meantime and in the case of a rejection of
an IFRS by the Commission. For our further analysis of the required proceeding if a standard
has not yet been endorsed we distinguish three conceivable possibilities.
If a new IFRS relating to a so far unregulated topic is issued, the non-binding IFRS
Regulation Comment issued by the EU Commission in 200350 suggests that a standard that
has not yet been endorsed may serve as a guidance if it does not oppose other already
50
See Comments concerning certain Articles of the Regulation (EC) No 1606/2002 of the European Parliament
and of the Council of 19 July 2002 on the application of international accounting standards and the Fourth
Council Directive 78/660/EEC of 25 July 1978 and the Seventh Council Directive 83/349/EEC of 13 June 1983
on accounting. http://europa.eu.int/comm/internal_market/accounting/docs/ias/200311-comments/ias-200311comments_en.pdf (25.04.2004).
34
endorsed IFRS and if it is coherent with article 22 IAS 151 (article 2.1.3., par. 2 IFRS
Regulation Comment). We think that the relevant question is not whether a new standard is
consistent with other endorsed IFRS but rather if it is in conformity with ‘original’ EU Law,
i.e. the Accounting Directives and the European Court of Justice’s jurisprudence. The
proposed approach would grant the preparers of financial statements a wide scope of
discretion and would virtually delegate the endorsement decision from the EU Commission to
the preparers and auditors. Moreover the application of only certain paragraphs of an IFRS
would not just affect the legal certainty and the comparability of financial statements in the
EU, but is also likely to oppose the ‘fair presentation’ under IFRS52. Concerning the issuance
of a revised IFRS or a new IFRS that supersedes an already endorsed IFRS the case of
goodwill accounting under IFRS 3 “Business Combinations” that replaces IAS 22 exemplifies
our criticism stated above and will be further discussed in a later section. A further option is
the issuance of a revised IFRS or a new IFRS that supersedes an IFRS that has been rejected
by the EU Commission. The technically and particularly politically controversial matter of
IAS 32 ‘Financial Instruments: Disclosure and Presentation’ and IAS 39 ‘Financial
Instruments: Recognition and Measurement’ both having been refused by the European
Commission supports our reasoning that the decision about the applicability of an IFRS in the
EU should not be left to the preparers.
Concerning the rejection of an IFRS in the EU endorsement procedure, there are two
imaginable alternatives. For a rejection of a new IFRS that relates to a so far unregulated
issue, the IFRS Regulation Comment proposes to use the refused standard as a guideline
under the same conditions as for the not yet endorsed standards (article 2.1.3., par. 2 IFRS
Regulation Comment). Is an IFRS that revises or replaces an already endorsed standard
refused and is it conflicting with the endorsed standard, article 2.1.3., par. 3 IFRS Regulation
Comment recommends that companies should continue to fully apply the endorsed IFRS.
Whereas it does not appear to be appropriate to allow prepares to override the Commission’s
negative endorsement decision, we agree with the IFRS Regulation Comment on the
proceeding for rejected standards that conflict with EU Law.
Referring to the criticism stated above we rather think that only endorsed International
Financial Reporting Standards (IFRS) should be applied in the European Union. By
51
Within the currently completed ‘Improvement Project of IASs’ IAS 1 was changed. The corresponding
provisions can be found in IAS 8, par. 10-12 now.
52
Compliance with IFRS being a precondition for the achievement of a ‘fair presentation of the financial
performance, financial situation and cash flows of an entity’ requires compliance with all requirements of IFRS
(IAS 1, par. 13 and 14).
35
emphasizing the necessity of legal certainty of the application of IFRS in the EU, in return an
adverse effect on the comparability of EU financial statements with those of non-European
companies and the creation of EU specific IFRS has to be admitted. Additionally, the
confirmation in the notes that financial statements comply with all requirements of
International Financial Reporting Standards (IFRS) (IAS 1, par. 14) cannot be given by EU
companies, if they do not apply IFRS that have not yet been endorsed as well as IFRS that
were rejected in the endorsement mechanism. With regard to the audit opinion that should
state ‘whether the financial statements…are presented fairly, in all material respects’
according to the applied financial reporting framework (International Standard on Auditing
700, par. 17), from a logical point of view, for EU financial statements, compliance should
only be required with IFRS that have been endorsed by the EU Commission. From this we
draw that the endorsement mechanism might not only lead to EU specific International
Financial Reporting Standards (IFRS), it is also likely to reduce the global comparability of
the auditor’s report, even though the same auditing rules are applied.
6.3. Levels of Harmonization and National Legal Systems
In this section we show that even if the same accounting standards are applied on an
international level, different national accounting practices are likely to occur. Under
consideration of the German, French and British legal system we discuss the consequences of
the references to legal terms in IAS 18 ‘Revenue’ on national accounting treatments by means
of the accounting of sale of goods and real estate. The differing national interpretations of the
‘legal criterion’ concretizing the ‘identifiability’ of an intangible asset in IAS 38 and the
effects on the accounting practice will be illustrated on the basis of the different preconditions
for the emergence of a patent right in Germany and France .
IAS 18 ‘Revenue’ explicitly states in the appendix that depending on national legislations the
revenues resulting from the sale of goods might be recognized at variant times in different
countries. One of the criteria that determine the point in time of revenue recognition is the
transfer of the ‘significant risks and rewards of ownership of the goods’ to the buyer (IAS 18,
par. 14 a) which is supposed to usually coincide with the transfer of the legal title or the
possession of a good (IAS 18, par. 15). The abstraction principle (‘Abstraktionsprinzip’) in
German Law divides the act of sale into two main parts, the agreement that obliges the seller
to transfer the good and its legal title to the buyer and the buyer to pay the purchase price (§
433 German Civil Code) and the handing over of the good bringing about the transfer of the
legal title (§ 929 German Civil Code). The risks of ownership vest with the transfer of the
36
sold good (§ 446 German Civil Code). According to the consensus principle
(‘Konsensprinzip’) in French Law the legal title of a good is transferred with the agreement
on the sale (article 1583 French Civil Law). Consequently the risk of ownership is passed to
the buyer in the same time (Hübner and Constantinesco 2001). If the seller agrees to deliver
the sold goods to the buyer, under French Law the sales revenue has to be recognized with the
agreement on the sale whereas under German Law the revenue cannot be recorded before the
handing over at the buyer’s place53. Other deviant accounting treatments might occur from the
different understanding of the legal term ‘possession’. While German Law only conditions the
power and will of authority over a good (‘corpus and animus’), French Law additionally
requires the will to possess the good for oneself (Hübner and Constantinesco 2001).
Concerning real estate sales IAS 18, appendix par. 9 states that the sales revenue should
generally be recognized with the transfer of the legal title. In jurisdictions where the equitable
interest may be vested before the transfer of the legal title, the significant risks and rewards of
ownership are considered to have been passed to the buyer and thus revenue might have to be
recorded at that time. For the transfer of the legal title of reality, the German Civil Code
requires the conveyance of property (‘Auflassung’) and the registration of the change of legal
ownership in the cadastre (§ 873 and 925 German Civil Code). Under British Law with the
contract conclusion on the sale of real estate the buyer does not obtain the legal title, but an
equitable interest in the property and accordingly becomes the equitable owner (Heinrich and
Huber 2003). Compared to Germany where revenue cannot be recorded until the transfer of
the legal title, IAS 18 requires the revenue recognition already with the contract conclusion in
Great Britain, if the other criteria stated in IAS 18, par. 14 are met.
Another standard that refers to legal terms is IAS 38 ‘Intangible Assets’. The definition of an
intangible asset requires ‘identifiability’, which is met if an intangible asset ‘arises from
contractual or other legal rights, regardless of whether those rights are transferable or
separable from the entity or from other rights and obligations’ (IAS 38, par. 12 b). ‘Right’ in a
concrete sense can generally be defined as ‘a power, privilege, faculty, or demand, inherent in
one person and incident upon another’ (Black 1990). The Basis for Conclusion on IAS 38
Intangible Assets, BC10 implies that a ‘legal right’ is a right ‘conveyed legally by…statutes’.
Despite the existence of a generally accepted definition of a right in the legal sense, national
legislations might determine different requirements for the emergence of specific rights.
Under French Law a patent right, i.e. the exclusive right to exploit ones invention, already
53
For the revenue recognition in this particular case under German Law, see Lüdenbach (2003).
37
emerges with the submission for registration while German Law requires the assignation of
patent (Hauser 1984). Is a patent submitted for registration at the time of a business
combination but has not already been granted, in France the patent would be recognized
separately as an intangible asset, if the other criteria set in IAS 38 are met whereas in
Germany it would be included in the acquired goodwill. Different accounting treatments
concerning ‘contractual rights’ are likely to happen because of different preconditions for the
establishment of a contract. Under German and French Law a contract can be either bilateral,
i.e. both parties have a legal obligation e.g. a contract on sale of goods or unilateral, i.e. only
one party is obliged to do something, like in the case of a donation. Instead a contract under
British Law always requires a consideration for the establishment of a legally binding contract
(Heinrich and Huber 2003). Thus rights arising from unilateral contracts meet the ‘contractual
legal criterion’ in Germany and France but not in Great Britain.
6.4. Case Studies
After having discussed the political and legal aspects of the legalization of International
Financial Reporting Standards (IFRS) so far, in the following section a more technical
examination should highlight the conflicts that may arise from the implementation of
international accounting standards in a specific legislative framework, considering as example
the European Union. First of all we illustrate the complicacy of the coexistence of the
European Accounting Directives, representing ‘original EU Law’ developed by EU legislation
and IFRS, private norms being incorporated into EU Law, on the basis of goodwill
accounting. Following, the issue of dividend recognition will reveal the difficulty to
harmonize IFRS with previous as well as future judgements of the European Court of Justice.
From the results of the two case studies we highlight the weaknesses of the endorsement
mechanism and point out the particular role that is dedicated to the European Court of Justice
in this process.
6.4.1. Goodwill
As the European Accounting Directives, the 4th Company Law Directive and the 7th Company
Law Directive on consolidated accounts, continue to exist beside the IFRS Regulation,
conformity of endorsed IFRS with the Accounting Directives is required. After the
endorsement of all IFRS except IAS 32 and 39 and the promulgation of the Modernization
Directive in 2003 the EU Commission claimed that all conflicts between EU Law and IFRS
had been removed (preamble 15 Modernization Directive). In 2004 the International
38
Accounting Standards Board (IASB) issued IFRS 3 ‘Business Combinations’ superseding
IAS 22, which treats the accounting of goodwill resulting from business combinations. IAS
22, par. 44 prescribed that acquired goodwill should be systematically amortized over its
estimated useful life, that should normally not exceed 20 years (IAS 22, par. 49). Usually the
straight-line method of amortization should best reflect the reduction of the goodwill’s
capacity to generate future economic benefits (IAS 22, par. 45). Systematic amortization
presumes that the potential to contribute to the generation of future economic benefits
diminishes over time. Thus goodwill amortization allocates the ‘purchase cost’ of goodwill to
the periods in which it is wasted (BC139 b Basis for Conclusion on IFRS 3 ‘Business
Combinations’). Moreover systematic amortization avoids the prohibited recognition of
internally generated goodwill that replaces the diminishing acquired goodwill (BC139 b Basis
for Conclusion on IFRS 3 ‘Business Combinations’). The Accounting Directives follow the
same approach. Article 37, par. 2 in relation with article 34, par. 1a 4th Company Law
Directive and article 30, par. 1 7th Company Law Directive on consolidated accounts stipulate
to write off goodwill within a maximum time of five years, whereby Member States can allow
companies to systematically amortize goodwill over a longer period. The new standard on
goodwill accounting IFRS 3 abolishes goodwill amortization. Instead goodwill should be
annually tested on impairment (IFRS 3, par. 55) and depreciated if a loss in value is
recognized (IAS 36, par. 88). This proceeding having been introduced by the U.S. Financial
Accounting Standards Board (FASB) in 200154 is referred to as the ‘impairment-only
approach’ or ‘non-amortization approach’. The International Accounting Standards Board
(IASB) justifies the change by arguing that the useful life of goodwill and the pattern in which
goodwill diminishes cannot reliably be estimated (BC139 c Basis for Conclusion on IFRS 3
‘Business Combinations’). Hence a systematic amortization of goodwill is considered to be
arbitrary, not providing the user with useful information. As a conclusion the ‘impairmentonly approach’ is regarded to transmit more useful information than the systematic goodwill
amortization (BC140 Basis for Conclusion on IFRS 3 ‘Business Combinations’).
The analysis whether the new goodwill accounting under IFRS 3 is in accordance with the
Accounting Directives should be based on the endorsement criteria set in article 3, par. 2
IFRS Regulation. While a strict literal compliance with the Directives is not required, the
application of an IFRS should not oppose the ‘true and fair view principle’ in the
understanding of the Accounting Directives. Relevant for our examination should also be the
54
See SFAS 141 ‘Business Combinations’ and SFAS 142 ‘Goodwill and Other Intangible Assets’.
39
criterion that a standard has to provide reliable information. To be able to judge whether the
application of the ‘non-amortization approach’ leads to a ‘true and fair view’ we first of all
have to clarify the meaning of the this principle in the light of the Accounting Directives.
Article 2, par. 3 4th Company Law Directive states that ‘(t)he annual accounts shall give a true
and fair view of the company's assets, liabilities, financial position and profit or loss’.55 The
‘true and fair view principle’ is considered to serve as a basis for the interpretation of
individual provisions or the choice of an option (interpretation function) and might justify the
deviation from a provision if the application of a norm in a specific case does not result in a
true and fair view (override function) (e.g. Fresl 2000). As the concerned provisions of the
Accounting Directives clearly prescribe to write off goodwill, scope for interpretation does
only exist for the determination of the length of the amortization period which corresponds to
the useful life of goodwill, and the method of amortization. Accordingly an interpretation
legitimating the ‘impairment-only approach’ appears to be impossible. The fact that a
departure from a provision of the Accounting Directives should only occur in very
exceptional cases (e.g. Moxter 1979) a general non-amortization of goodwill cannot be
justified with the override function of the ‘true and fair view principle’. Since the procedure
of the impairment test opens up a wide range of discretionary powers to the preparers, the
reliability of the information provided by the ‘non-amortization-approach’ under IFRS 3 is
disputable (Wüstemann and Duhr 2003).56
German companies were faced with a similar problem when the U.S. Financial Accounting
Standards Board (FASB) promulgated SFAS 141 and 142, as the conformity of IFRS and
U.S. GAAP with the EU Accounting Directives is a premise for the preparation of
consolidated statements according to IFRS or U.S. GAAP instead of using German GAAP (§
292 a par. 2 no. 2 b German Commercial Code). In order to establish accordance of the new
goodwill accounting introduced by SFAS 141 and 142 in 2001 with the concerned provisions
in the Accounting Directives, the German Accounting Standards Committee (GASC) issued a
German Accounting Standard no. 1 a (GAS 1 a), which asserts that financial statements are
drawn up conformably with the EU Accounting Directives if goodwill is measured according
to the approach specified in SFAS 141 and 142 (GAS 1 a, par. 11). As IFRS 3 is also based
on the ‘impairment-only approach’, GAS 1 a, par. 11 is applicable to IFRS 3 too and
consequently confirms accordance of IFRS 3 with the EU Accounting Directives. This result
55
The ‘true and fair view principle’ for consolidated accounts is incorporated in the 7th Company Law Directive
on consolidated accounts in article 16, par. 2.
56
For the ‘impairment-only approach’ under U.S. GAAP, see Hommel (2001).
40
is achieved by a dynamic interpretation of the Accounting Directives adjusting them to the
status quo of international accounting standards. Van Hulle (1998) justifies this interpretation
method by a changed understanding of the authors of the directives since their development in
the 60s and 70s. As a change in the directive’s political accounting objectives from a mainly
Continental European perspective towards an Anglo-American view can only be proceeded
by a legislative act, the legitimacy of a dynamic interpretation of the Accounting Directives is
highly disputable (Schön 2000 and Zitzelsberger 1998). Moreover, the fact that the EU
Contact Committee asserted a congruence of goodwill accounting under the Accounting
Directives and IAS 22 in 200157 both requiring goodwill amortization, a change of the
understanding of the directive’s author can be denied58. From the results achieved in our
analysis we conclude that conformity of the new approach under IFRS 3 prohibiting goodwill
amortization with the Accounting Directives can hardly be justified. From the European
Financial Reporting Advisory Groups’s comment letter on the Exposure Draft 3 ‘Business
Combinations’, considering the impairment test to be ‘conceptually imperfect’ and demanding
for a systematic amortization of goodwill as a standard rule and only allowing the
‘impairment-only approach’ in the rare cases when goodwill has an indefinite life59, we
assume that the European Financial Reporting Advisory Group (EFRAG) failed to enforce the
European view in the due process of IFRS 3 and thus could not manage to avoid a conflict
with the Accounting Directives. The fact that the provisions concerning goodwill accounting
were not adjusted to the rules under IFRS 3 in the Modernization Directive, even though the
issuance of IFRS 3 with the proposed ‘impairment-only approach’ was already predictable,
can either mean that the EU Commission and the European Financial Reporting Advisory
Group (EFRAG) were not aware of the conflict or that they do believe that IFRS 3 is in
conformity with the Accounting Directives.
It remains to be seen if on the first level of the endorsement mechanism the European
Financial Reporting Advisory Group (EFRAG) will advise IFRS 3 for endorsement and if it
will propose an amendment to the Accounting Directives, although it refused the new
goodwill accounting in its comment letter. The endorsement decision by the Accounting
Regulatory Committee and the EU Commission might depend on the lobbying of big
companies who were the ones that pushed the ‘non-amortization approach’ in the U.S. In each
57
See Examination of the conformity between IAS 1 to IAS 41 and the European Accounting Directives, April
2001. http://europa.eu.int/comm/internal_market/accounting/docs/markt-2001-6926/6926_en.pdf (25.04.2004).
58
See Friedhoff, M. (2002). Stellungnahme zum E-DRS 1 a.
www.standardsetter.de/drsc/docs/comments/0001a/friedhoff.html (25.04.2004).
59
See ED 3 Final Comment Letter. www.efrag.org (25.04.2004).
41
case the decision will lead to an unsatisfactory solution. If IFRS 3 is accepted in the EU the
objective of the Modernization Directive to create a ‘level playing field’ for companies that
come under the IFRS Regulation and those that still apply the rules of the Accounting
Directives will not be achieved. If IFRS 3 is refused, EU companies will have to continue to
apply IAS 22. As a consequence EU specific IFRS would be created and the acceptance of
financial statements of EU companies for cross-border listings outside the European Union
would be jeopardized. The only possible solution would be an amendment to the Accounting
Directives. However, the process of the development of a proposal, the promulgation of a
directive and the transposition into national law by the Member States is very long-winded
and from a practical point of view cannot be conducted for every single change of an IFRS.
6.4.2. Dividend recognition
While in the case of goodwill accounting an International Financial Reporting Standard
(IFRS) was directly conflicting with provisions of the Accounting Directives, the regulation
of dividend recognition in IAS 18 seems to oppose EU accounting being determined by a
verdict of the European Court of Justice. As the Accounting Directives do not specifically
address the subject of dividend recognition, its accounting treatment has to be deduced from
the general principles set in the directives. According to article 234 EC Treaty, in 1994 the
German Federal Court of Justice (‘Bundesgerichtshof’) requested the European Court of
Justice to give a ruling on the time congruent recognition of dividends, i.e. the recognition of
a dividend from a subsidiary in the parent’s financial statements that has not yet been legally
asserted by a distribution decision at the balance sheet date.60 For the purpose of the
interpretation of the 4th Company Law Directive the European Court of Justice declared the
‘true and fair view principle’ to be the primary objective of the directive, being concretized in
this case by the realization principle (‘only profits made at the balance sheet date may be
included’ article 31, par. 1 c aa), the accrual principle (‘account must be taken of income and
charges relating to the financial year, irrespective of the date of receipt or payment of such
income or charges’ article 31, par. 1 d) and the principle that ‘account must be taken of all
foreseeable liabilities and potential losses arising in the course of the financial year…,even if
such liabilities or potential losses become apparent only between the date of the balance sheet
and the date on which it is drawn up’ (article 31, par. 1 c bb). For the particular case that a
parent company is the only shareholder of its subsidiary and that the financial statements of
the subsidiary giving a ‘true and fair view’ and showing that profits are appropriated to the
60
See Bundesgerichtshof (1996). Beschluß vom 21.7.1994 – II ZR 82/93, Betriebs-Berater, 49: 1673-75.
42
parent company, are adopted by the general assembly before the completion of the parent
company’s audit, the European Court of Justice decided that the time congruent recognition of
a dividend was not opposing the realization principle laid down in article 31, par. 1 c aa of the
4th Company Law Directive.61
According to the ‘case by case’ approach of International Financial Reporting Standards
(IFRS), a general principle ruling the recognition of revenues does not exist (Wüstemann
2004). The main criteria for revenue recognition set in IAS 18 ‘Revenue’ are supplemented by
specific regulations for revenues resulting from constructions contracts (IAS 11), leases (IAS
17) and changes in the fair value of financial instruments (IAS 39). IAS 18, par. 30 c
explicitly links the recognition of dividends to the establishment of a shareholder’s right to
receive payment. From national legislations and IAS 10, par. 1162 we can deduce that this
right ordinarily arises from the general assembly’s declaration to distribute dividends. This
highly legalized approach is combined with the more economical criteria that in addition to
the legal certainty, the flow of the dividend should be probable and reliably measurable (IAS
18, par. 29). This implies that the declaration of dividend distribution is considered to be the
earliest date at which the receipt of the dividend can be regarded as probable (Cairns 2002).
In German accounting literature the regulation of dividend recognition under IAS 18 is
regarded not to oppose the European Court of Justice’s verdict allowing a time congruent
recognition of dividends.63 This result that interprets IAS 18, par. 30 against its wording is
justified by the assumed predominance of the ‘substance over form principle’ under IFRS and
inconsistencies with other less objectified rules for revenue recognition (Ordelheide and
Böckem 2002).
Beside the fact that the predominance of the ‘substance over form principle’ which is only
explicitly mentioned in the non-binding IFRS Framework (Framework, par. 35) is disputable,
the wording in IAS 18, par. 30 does not leave wide scope for interpretation. From the
existence of a specific provision for the recognition of dividends we conclude that the
International Accounting Standards Board (IASB) intended to set a “stricter” criterion for this
particular type of revenue. The deletion of the option to recognize a liability for dividends that
61
See Judgment of the Court (Fifth Chamber) of 27 June 1996. Waltraud Tomberger v Gebrüder von der
Wettern GmbH. Reference for a preliminary ruling: Bundesgerichtshof - Germany. Directive 78/660/EEC Annual accounts - Balance sheet - Date at which profit is made. Case C-234/94, European Court reports 1996: I03133.
62
IAS 10, par. 11 represents the corresponding provision for the recognition of liabilities. It stipulates that ‘(i)f
dividends…are proposed or declared after the balance sheet date, an enterprise should not recognise…’.
63
See Ordelheide and Böckem (2002), Grau (2002) and Institut der Wirtschaftsprüfer (1999).
43
are proposed or declared between the balance sheet date and the date the financial statements
are drawn up (IAS 10, Introduction b respectively IAS 10, par. 11) resulting from the revision
of IAS 10 ‘Events after the balance sheet date’ in 1999 supports this argument.
Despite the indications of a conflict of IAS 18 and EU Law concerning the recognition of
dividends, IAS 18 was unconfinedly endorsed by the European Commission in 2003. We
think that the suitability of the appraisal criteria set in article 3, par. 2 IFRS Regulation for the
endorsement mechanism as well as the functioning of the endorsement mechanism are
debatable.
The ‘true and fair view principle’64 and the ‘criteria of understandability,
relevance, reliability and comparability’ do simultaneously represent principles of the EU
Accounting Directives and of IAS 1, respectively the IFRS Framework. As the EU does not
forbear from examining IFRS on these criteria before they become applicable in the EU and
as the Commission refused the adoption of IAS 32 and 39, both being developed on the basis
of the IFRS Framework, the principles stated in article 3, par. 2 IFRS Regulation appear to
have a different meaning under IFRS compared to the EU Accounting Directives. The link of
the probability of the flow of dividends to their legal emergence in IAS 18 might serve as an
illustration for the different weighting of the criteria ‘relevance’ and ‘reliability’ under IFRS
(Grau 2002). We argue that the endorsement criteria seem to be defined in a too broad sense
so that in the end the decision on the adoption of IFRS in the EU is reduced to political issues.
Concerning the endorsement mechanism itself, we are wondering whether the technical part
of the mechanism, the European Financial Reporting Advisory Group (EFRAG) in its current
form is actually able to acceptably accomplish its task to push the European view at the
International Accounting Standards Board (IASB). To our mind, the European Financial
Reporting Advisory Group (EFRAG) should have requested a clarification of the dividend
recognition issue by the IASB and the International Financial Reporting Interpretations
Committee (IFRIC) as a premise for the adoption of IAS 18 by the European Union. It
remains to be seen whether the current IASB project on revenues, aiming at the development
of a general approach for revenue recognition, will be able to eliminate the stated conflict. In
the meanwhile companies in the EU will have to proceed according to the ruling of the
European Court of Justice, being superior to IFRS in the EU norm hierarchy (Schön 2004). A
further problem might be raised if the European Court of Justice had to decide on a similar
case with regard to the IFRS Regulation. As IAS 18 was considered to be in conformity with
the endorsement criteria stipulated in article 2, par. 3 IFRS Regulation and as the European
64
IAS 1, par. 13-15 is referring to the principle of ‘fair presentation’.
44
Court of Justice is likely to base its jurisprudence on the same principles, the European Court
of Justice would have to arrive at the same conclusion as in the ‘Tomberger Verdict’ and thus
interpret IAS 18, par. 30 against its wording, but in conformity with original Community
Law. From this result we imply that the European Court of Justice virtually represents the
third level of the endorsement mechanism, bringing about the required legal certainty of
financial reporting in the European Union.
7. CONCLUSION
This essay analyses the legalization of transnational accounting rules in the case of
International Financial Reporting Standards (IFRS). Starting from the International
Accounting Standards Board’s major objective to develop globally accepted accounting
standards, we discuss the main premises for a worldwide legalization of IFRS and the related
conflicts. The suitability of IFRS for a heterogeneous group of applicants is sought to be
reached by the professionally and geographically mixed composition of the bodies of the
International Accounting Standards Committee Foundation (IASCF), by the consideration of
the applicant’s interests in the ‘democratized’ due process of IFRS and the granting of various
implicit and explicit choices of accounting treatments in the standards. As the privately
organized International Accounting Standards Board (IASB) is not empowered to require
compliance with International Financial Reporting Standards (IFRS), the use of IFRS depends
on governments and stock market commissions. We point out that the International
Accounting Standards Board (IASB) is exposed to opposing political pressure from the main
actors, the European Union, requiring the application of IFRS in the group accounts of all
listed companies in the EU from 2005 on, and the U.S. Securities and Exchange Commission
(SEC) having to decide about the admission of financial statements prepared according to
IFRS at the U.S. stock market. The other conflict that has to be balanced out by the
International Accounting Standards Board (IASB) is compatibility of International Financial
Reporting Standards (IFRS) with the EU accounting principles as a precondition for the
applicability of IFRS in the EU, and conformity of IFRS with U.S. GAAP in reference to the
convergence project with the U.S. Financial Accounting Standards Board (FASB) initiated in
2002. We ascertain that the U.S. Securities and Exchange Commission (SEC) respectively the
U.S. Financial Accounting Standards Board (FASB) retain a dominant influence on the
International Accounting Standards Board (IASB) as the European Union, having to face
internally conflicting interests due to economic and cultural differences among the EU
Member States, is not able to form a strong opposition. Furthermore the EU itself depends on
45
the SEC as an increasing number of EU companies seek for listings at the U.S. capital market.
Another consequence of the private organization of the International Accounting Standards
Board (IASB) is that the funds are mainly provided by the beneficiaries of International
Financial Reporting Standards (IFRS). We find that even after the restructuring of the
organization of the International Accounting Standards Committee Foundation (IASCF), the
International Accounting Standards Board (IASB) is still subject to lobbying from its
applicants respectively sponsors. Due to the private character of International Financial
Reporting Standards (IFRS) the integration of IFRS into a national or the European legal
framework poses problems on several levels. We reveal cases in which despite the adoption of
IFRS via the EU endorsement mechanism, legal uncertainty about the application of IFRS
remains. We assume that only endorsed International Financial Reporting Standards (IFRS)
should be applied in the EU, even if a new standard has already been issued and become
effective. From the demonstration of differences in IFRS goodwill accounting and the EU
Accounting Directives as well as the recognition of dividends under the endorsed IAS 18 and
European accounting practice being concretized by a verdict of the European Court of Justice,
we highlight the weaknesses of the endorsement mechanism. We imply that ‘primary’
European accounting rules stemming from European legislation and jurisprudence should
always prevail over International Financial Reporting Standards (IFRS). We conclude that it
will be the European Court of Justice’s role to repair inadequate functioning of the EU
endorsement mechanism and therefore to restore legal certainty concerning the application of
Community Law in the domain of accounting. Finally we show that to ensure a uniform
application of International Financial Reporting Standards (IFRS) a harmonization of national
legal systems as well as of enforcement mechanisms such as the statutory audit and
enforcement actions of regulatory bodies is required. Court decisions that are likely to create
specific national IFRS accounting practices should only rarely occur in the European Union.
However as the function of financial statements is likely to be extended from the sole purpose
to provide information to the determination of distributable and taxable profits in the future, a
transnational coordination of court rulings might become necessary.
In summary, we conclude that despite a continuous convergence of national legal, financial
and economic systems, remaining crucial differences still seem to impede a transnationally
uniform application of one set of globally accepted accounting standards. Although a
worldwide increasing adoption of International Financial Reporting Standards (IFRS) can be
noticed, the institution of the endorsement mechanism in the European Union reveals that
there is only a restricted readiness to delegate the power of rule making in accounting to
46
outsiders. The acceptance of IFRS in the European Union by means of the IFRS Regulation
on the one hand, and the insistence on the requirement of conformity of International
Financial Reporting Standards (IFRS) with Community Law, on the other hand, is a
contradictory move, advancing and thwarting the worldwide harmonization of accounting in
the same time. If the creation of an EU specific body of IFRS shall be avoided in the long
term, the European Union will have to abandon the endorsement mechanism and in return
should concentrate on an enforcement of its position within the International Financial
Accounting Standards Board (IASB).
47
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