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ACCOUNTING IN

GERMANY

Lecture 6

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Accounting Regulation andEnforcement

Financial Reporting

Accounting Measurement

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Creditors protection is a fundamental concern of Germanaccounting as embodied in the Commercial Code.

Conservative balance sheet valuations are central tocreditor protection.

This creates a tendency to undervalue assets andovervalue liabilities.

Reserves are seen as protection against unforeseenrisks and possible insolvency.

These practices also result in a conservative income

amount that serves as the basis for dividends to owners. Thus, German accounting is designed to compute a

prudent income amount that leaves creditors unharmedafter distributions are made to owners.

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The German Institute, the Frankfurt Stock Exchange, Germantrade unions and accounting academics provided consultationin various processes of lawmaking that affected accountingand financial reporting.

The 1998 law on control and transparency (KonTraG)introduced the requirements for the Ministry of Justice torecognize a private national standard-setting body to servethe following objectives:

1. Develop recommendations for the application ofaccounting standards for consolidated financialstatements.

2.Advice the Ministry of Justice on new accountinglegislation.

3. Representation Germany in international accountingorganizations such as the IASB.

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The German Accounting Standards Committee(GASC) was founded in May 1998 recognized by theMinistry of Justice as the German standard-settingauthority.

The GASC responsible to develop accountingstandards for consolidated financial reporting andadvising the Ministry of Justice on the developmentof accounting legislation.

GASC is a private standard-setting body supported

by German companies and individual members. The GASC has 2 standing committees - German

Accounting Standards Board (GASB) andAccounting Interpretations Committee (AIC).

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GASB responsible for the preparation and adoptionof its pronouncements consists of accountingstandards, comments on accounting issues andworking papers.

The GASB is made up of seven independent expertswith a background in auditing, financial analysis,academia and industry.

Working Groups are established to examine and makerepresentatives on the issues before the board.

These working groups have representatives from tradeand industry and the auditing profession, a universityprofessor, and a financial analyst.

The standards issues by GASB must be approved andpublished by the Ministry of Justice.

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The new German accounting standard-setting system is broadlysimilar to the systems in the United Kingdom and the US, and tothe IASB.

However, GASB standards are authoritative recommendations

that only apply to consolidated financial statements. They do not restrict or alter German Commercial Code (HGB)

requirements.

The GASB was created to develop a set of German standardscompatible with international accounting standards.

Since its founding, the GASB has issued German Accounting

Standards (GAS) on issues such as the cash flow statement,segment reporting, deferred taxes and foreign currencytranslation.

In 2003, the GASB adopted a new strategy that aligned its workprogram with the IASBs effort to achieve a convergence ofglobal accounting standards.

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Accounting Interpretations Committee

(AIC) to promote international

convergence of interpretations of coreaccounting issues in close cooporation

with IASBs International Financial

Reporting Interpretations Committee

(IFRIC).

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The Financial Accounting Control Act (BilKoG) wasenacted in 2004 to improve compliance with Germanfinancial reporting requirements and IFRS by listedcompanies.

The law established a two-tiered enforcement system. The first-tier comprised of FREP and BaFin and the

Auditor Oversight Commission.

A private-sector body called the Financial ReportingEnforcement Panel (FREP) whose reviews suspectedirregular financial statements.

It also conducted random reviews of financial statements.

The FREP relies on companies to voluntarily correct anyproblems it finds.

The FREP refers matters that are not resolved to theFederal Financial Supervisory Authority (BaFin).

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BaFin is the public sector regulatory body thatoversees securities trading (stock exchanges)and the banking and insurance industries.

BaFin will then take authoritative action toresolve the issue.

BaFin refers questionable auditing to theWirtschaftsprufer (WP) or Certified Public

Accountants. All WPS are legally required to join the official

Chamber of Accountants.

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The Auditor Oversight Commission, which reports tothe Ministry of Economics and Labor, is responsible foroverseeing the Chamber of Accountants.

In 1985, Accounting Act extended the auditrequirement to many more companies.

As a result, a second-tier body of auditors was createdin the late 1980s.

They were known as sworn book examiners who

are allowed to audit small and medium-sizedcompanies.

German audit reports emphasized compliance withrequirements over the true and fair view.

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All companies either listed or not listed may useIFRS in preparing their consolidated financialstatements - 2005.

German accounting influenced by tax law. However, individual company financial statements

must follow German Commercial Code (HGB)requirements.

Presentation Disclosure Auditors report Consolidated Financial Statement

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German law specifies different accounting,auditing, and financial reporting requirementsdepending on company size rather than the

form of business organization. There are three size classes small, medium

and large defined in terms of balance sheettotals, annual sales totals, and numbers of

employees. Companies with publicly traded securities are

always classified as large.

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The law specifies the content and format of financial statementsas follows:

Balance sheet Income statement

Notes Management report Auditors report

Small companies are exempt from the audit requirement andmay prepare an abbreviated balance sheet.

Small and medium-sized companies may prepare abbreviatedincome statements have fewer disclosure requirements for theirnotes.

A cash flow statement and a statement of changes in ownersequity are required for consolidated financial statements but notindividual company statements.

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Disclosure

The notes section of the financial statements is usuallyextensive, especially for large companies.

Disclosure include the accounting principles used, the extent towhich results are effected by claiming tax benefits, unaccrued

pension obligations, sales by product line and geographicmarkets, unaccrued contingent liabilities and average number ofemployees.

The management report describes the financial position andbusiness developments during the year, importance post-balancesheet events, anticipated future developments, and research and

development activities. Publicly traded companies are required to provide additional

segment disclosures.

They must also provide abbreviated half-yearly financialstatements that are reviewed by an auditor and accompanied byan interim management report.

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Auditors report

Auditors report is considered as a private report andonly be submitted to companys managing board ofdirectors and supervisory board, and not to shareholders.

The report comments on the companys future prospectsand factors that may threaten its survival.

The auditors must describe and analyze items on thebalance sheet that have a material impact on thecompanys financial position.

The auditor also has to evaluate the consequences ofand pass judgment on all significant accounting choices.

This report can run several hundred pages for largeGerman companies.

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Consolidated Financial

Statement

Consolidated financial statements arerequired for enterprise underunifiedmanagement and with a majority of voting

rights, dominant influence by virtue of controlcontracts, or the right to appoint or remove amajority of the board of directors.

For the purpose of consolidation, allcompanies in the group must use identical

accounting and valuation principles. However, they need not be the same as those

used in individual company statements.

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Differences between German

GAAP and IFRS

Issue IFRS German GAAP

Business

combinations

IFRS3: must use

purchase method;

pooling of interest is

prohibited

Certain business combinations may be

accounted for as pooling of interests

even though an acquirer can be

identified.

Two forms of the purchase method are

permitted: the book-value method andthe revaluation method.

The equity method is used forassociates that are owned 20 percent ormore, but only in consolidated financial

statements.

Joint ventures may be accounted forusing eitherproportional consolidationor the equity method.

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Differences between German

GAAP and IFRS

Issue IFRS German GAAP

Goodwill on

consolidation

IFRS3: not

amortized, but tested

for impairment

annually (31 March2004)

Goodwill arising on consolidationcan be deducted immediatelyagainst equity oramortized

systematically over its useful life.The law mentions four years asthe regular amortization period.

Internally

generated

intangible assets

IAS38: internally

generated goodwill

can be recognisedas an asset under

certain conditions.

Internally generated intangible

assets, which are expected to

provide ongoing service to theenterprise must not be recognised.

Research and development costs

are expensed when incurred.

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Differences between German

GAAP and IFRS

Issue IFRS German GAAP

Foreign currency

translation

IAS21: foreign

currency monetary

item should be

reported using closing

rate.

Foreign currency monetary

balances are generally translated at

the worse of transaction and closing

rates so as to avoid the recognition

of gains on unsettled balances.

Leases IAS17: distinguish

between finance lease

and provide guidance

for classifying them.

Leases are normally classified

according to tax rules: therefore,

leases are seldom recognised as

finance leases.

Inventory valuation IAS2: requires

inventories to be stated

at the lower of cost and

NRV

Inventories can be stated at the lowest

of cost or replacement cost.

FIFO, LIFO and average method are

acceptable methods of determining

the closing value of the inventory.20

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Differences between German

GAAP and IFRS

Issue IFRS German GAAP

Construction

contract

IAS11: the stage of completion

of the contract activity at the

balance sheet date should be

used to recognised contractrevenue.

In general the completed

contract method is used

for the recognition of

revenue on constructioncontract and services.

Exclusion of

subsidiaries from

consolidation

IAS27: subsidiaries whose

activities are dissimilar to

those of its parent must be

consolidated.

Certain subsidiaries with

dissimilar activities

should be excluded from

consolidation.

Start-up-costs IAS38: start-up costs must be

charged to expenses when

incurred.

Start-up costs may be

capitalised and

amortised over 4 years.

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Most companies make provisions as large aspossible because legally booked expensesdirectly affect the determination of taxable

income. Provisions give German companies many

opportunities to manage income.

Portions give German companies many

opportunities to manage a mandated legalreserve and those resulting from the aboveprovisions.

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THE END