A comparison and contrast of German and international financial reporting issues. Fair Value Accouting - current issues and possible solutions

Contents

List of abbreviations

Table of figures

I. Introduction

II. Fair value accounting according to German law ..
A. Objectives and basic principles...
B. Concepts of valuation..
1. Valuation bases as to commercial code..
2. Valuation bases as to tax law..

III. Fair value accounting according to IFRS..
A. Objectives and basic principles
B. Concepts of valuation..
1. General survey of valuation bases..
2. Definition and determination of fair value..
3. Fundamental ideas for a fair value measurement
4. Impetus for a fair value measurement.
a) IAS 16..
b) IAS 39..
c) IAS 40..

IV. Comparison and contrasts of fair value accounting concepts..

V. Conclusions and perspectives

References.

List of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

Table of figures Page

Figure 1: Functions of annual financial reporting.

Figure 2: General valuation principles as to commercial code..

Figure 3: Valuation bases as to IFRS.

Figure 4: Measurement as to IAS 16..

Figure 5: Accounting of equity securities...

Figure 6: Measurement of fixed available-for-sale securities.

Figure 7: Possible and current solutions of income determination.

I. Introduction

Huge changes arose in the world of economy during the last decade. Due to globalisation and competition for scarce capital¹a heightened discussion regarding different national accounting policies emerged. There has been an intensive controversy between continental-European and Anglo-American based accountancy. All companies listed on a stock exchange in the EU are obliged to present their group accounts in accordance with IAS/IFRS²from 2005 on. One crucial aspect of IRFS focuses on the increasing tendency to recognise a fair value which implies a departure from historical cost-based financial statement to a rather market value-based one.

Subsequently, this paper introduces and compares the current valuation bases of the German commercial/tax law and IRFS. Because of the increasing importance of IFRS the major point reflects this consideration. Finally, contrasts will be emphasised and opportunities for a complete takeover of an advanced fair value accounting to German accountancy will be examined. For this reason a reference to the general objectives and principles both of the accountancies is inevitable and will be introduced in either case.

II. Fair value accounting according to German law

A. Objectives and basic principles

“A particular characteristic of German accounting is the conservative reckoning of profit in individual accounts, intended to guard against a too rosy view of net assets or net wealth.”³Thereby the objective is to protect creditors’ interests which have strong impact on German law. That is evident when analysing the functions of annual financial reporting.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1: Functions of annual financial reporting

Source: own presentation in accordance with Coenenberg, A., Jahresabschluss und -analyse (2003), p. 19

Although profit measurement and regulation of profit distribution first of all determine the claims of information-orientated shareholders likewise owners, managers and tax authorities, protection of the creditors’ contractual income is still taken into consideration. Thus, the nominal guaranteed capital is maintained.⁴That is mostly to see in the large impact of the prudence principle which focuses more on the interests of creditors by understating of profits than delivering reliable information for shareholders.⁵

A further particularity of German accounting is the close relationship between commercial and tax accounting which are based on the authoritative principle.⁶Therefore, decisions made in commercial accounting immensely influence tax accounting, unless mandatory rules of taxation require other valuation bases.

B. Concepts of valuation

1. Valuation bases as to commercial code

Owing to the current balance sheet conception income determination by the ‘single net worth comparison’ (Einzelvermögensvergleich)⁷two main questions arise. As soon as the question about recognition of a balance sheet item is affirmed, its measurement has to be settled. The reply plays a huge role for the net worth and results, since it affects the balance sheet result directly. Nevertheless, lots of problems derive from the measurement, because it often depends on the objectives of the valuer.⁸General valuation principles are codified in §§ 252-256 HGB for business organisations of all types and supplemented by special provisions in §§ 279-283 HGB for limited companies. The following figure shall give an overview:

Abbildung in dieser Leseprobe nicht enthalten

Figure 2: General valuation principles as to commercial code

Source: own presentation in accordance with Ballwieser, W., Germany Individual Accounts, in: Ordelheide, Dieter/KPMG, Transnational Accounting, Basingstoke and New York (1995), p. 1477

The paramount principle is the prudence principle and his specifications, namely the principles of realisation⁹and imparity, which require a further explanation. Thus, the other principles will not be discussed in this paper.

As mentioned above, German law is governed by the protection of creditors. Hence, the realisation principle permits only the recognition of realised profits. Unrealised - but realisable - profits must not be recognised as long as they are not realised.¹⁰On the contrast, the imparity principle requires that additionally to realised losses unrealised losses, which are likely to incur up to the balance sheet date, have to be anticipated.¹¹ With this distinction in mind evidence of a fair value accounting should be furnished now.¹²Corresponding to § 253 I no. 1 HGB acquisition or production costs less depreciation are the upper bounds of assets. This historical cost concept forms the basis for the advance of first measurement that is the determination of primary valuation bases for purposes of inter-subjective verification. At the date of acquisition/production they correspond to a fair value accounting. Subsequent to initial recognition, further measurement employs a fair value only in isolated cases. A good example is to see in § 253 I no. 2 HGB where pension obligations for which a consideration can no longer be expected must be stated at their present value. But even on the asset side a fair value approach is evident, e.g. when separate value units are formed for foreign currency businesses and financial innovations.¹³Moreover, the imparity principle recognises lower fair values due to the lower of cost or market principle. Its prudent thoughts are responsible for the advance of the further measurement, namely the determination of the secondary valuation bases at the balance sheet date. Thus, fixed assets have to be written down to the lower fair value where it is anticipated that the decline is permanent (§ 253 II no. 3 HGB). In event of a temporary decline, however, the exceptional depreciations are optional. This rule is known as the ‘weaker lower value principle’ (gemildertes Niederstwertprinzip).¹⁴Unlike fixed assets, depreciations of current assets to the lower fair value derived from a stock market or general market price are always necessary (§ 252 III no. 1 HGB). It does not matter whether the decline seems to be temporary or permanent. In absence of a stock market or general market price and in cases of historical costs exceeding the fair value of the assets at the balance sheet date a write-down to the fair value has to be undertaken (§ 252 III no. 2 HGB). The rule is called the ‘strict lower value principle’ (strenges Niederstwertprinzip).

Although overstated write-downs or omitted write-ups form hidden reserves, the German commercial code does not forbid them,¹⁵even if the reasons do no longer exist.

Valuation bases as to tax law

As stated earlier, the accounting principles according to the commercial code prevail for tax purposes due to the authoritative principle (§ 5 I no. 1 EStG). For instance, the commercial code permits valuation solely for tax purposes.¹⁶Referring to § 6 I no. 1 EStG the tax accounting also employs historical costs. Nevertheless, the recognition of a ‘part-of-the-whole value’ (Teilwert) is possible. The EStG defines it as the amount that the purchaser of the whole enterprise would have to pay for the individual item as one part of the overall price considering the going concern principle. The assumption is that the market value of the business equals the sum of all the part-of-the-whole values. Theoretically, the part-of-the-whole value would be part of the ‘discounted cash flow’ (Ertragswert) of a whole enterprise¹⁷and, therefore, is in conformity with a fair value. In practise, this would happen solely with some degree of arbitrariness and beyond that it infringes the objective of an equal and uniform taxation.¹⁸

Dealing with these problems tax jurisprudence has developed the ‘presumed part-of-the- whole value’ (Teilwertvermutung) which is relevant as long as it is not refuted by the taxpayer. This presumption mirrors the original acquisition or production costs for non- depreciable assets and the amortised costs for depreciable fixed assets. Regarding current assets the replacement costs respectively the stock market or general market price is relevant.¹⁹

A reason for refuting the presumed part-of-the-whole value could be a fall in replacement costs. In this event a write-down to the lower part-of-the-whole value is indispensable. Here the relationship with a lower fair value in commercial accounts becomes distinctive.

depreciable fixed assets are acquisition or production costs less depreciation (§ 280 I HGB).

Another fair value approach is raised in the Valuation Law (Bewertungsgesetz) which affects to taxes on earnings likewise municipal trade tax on earnings and taxes on capital likewise real property tax or inheritance and gift tax. § 9 I BewG provides a fair market value (gemeiner Wert), unless a different measurement is specifically prescribed. Usually it is ascertained by a price from the selling market²⁰which would be achieved in ordinary businesses. In absence of such a representative market it has to be estimated according to comparable selling prices.²¹§§ 11-16 BewG can be interpreted as specifications of a fair market value. For instance, listed securities or debt register claims have to be measured at their current values.

Moreover, a fair value approach can be seen in transaction taxes, because they usually refer to market prices.

III. Fair Value Accounting according to IFRS

A. Objectives and basic principles

In difference to German law the IFRS involves lots of separate accounting standards. This principle of case law is derived from the Anglo-Saxon legal tradition. Referring to IASB Framework § 12 financial reporting should “provide information […] that is useful to a wide range of users in making economic decisions.” This decision usefulness principle particularly focuses on information-orientated shareholders and therefore states an enormous contrast to the German creditors’ protection. That is to see in the prudence principle which does not remark a paramount, qualitative characteristic to accountancy. Instead, it is solely one aspect of reliability which forms a primary quality for the decision usefulness principle.²²Additionally, the prudence principle does not legitimate the creation of hidden reserves because of worsened and not reliable financial statements (IASB, FW, § 37). Rather, financial reporting should give a true and fair view of the financial position and performance of an enterprise (IASB, FW, § 46).

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¹c.f. Bruns, H-G., Der Gang an die New York Stock Exchange - das Beispiel der Daimler-Benz AG (WPK- Mitteilungen, Sonderheft 1997), p. 32

²In the following IFRS refers to IAS/IFRS.

³ Ballwieser, W., Germany Individual Accounts, in: Ordelheide, Dieter/ KPMG (ed.), Transnational Accounting, Basingstoke and New York (1995), p. 1401

⁴c.f. Moxter, A., Bilanzlehre I (1984), p. 93

⁵c.f. Ballwieser, W., Germany Individual Accounts, in: Ordelheide, Dieter/KPMG, Transnational Accounting, Basingstoke and New York (1995), p. 1401

⁶c.f. Federmann, R., Bilanzierung nach Handelsrecht und Steuerrecht (2000), p. 182 ff.

⁷c.f. Sigloch, J., Rechnungslegung (2003), p. 32

⁸ c.f. Wöhe, G., Bilanzierung und Bilanzpolitk (1997), p. 337 f.

⁹ The realisation principle is interpreted here in broad terms and implies the matching of expenses.

¹⁰c.f. Baetge, J., Kirsch, H-J., Thiele, S., Bilanzen (2002), p. 164

¹¹c.f. Baetge, J., Kirsch, H-J., Thiele, S., Bilanzen (2002), p. 168

¹² Unlike IFRS the HGB does not define a fair value as valuation base explicitly. However, it is translated as ‘beizulegender Zeitwert’ which serves exclusively as downward adjustment.

¹³Wiedmann, H., Fair Value in der internationalen Rechnungslegung, in: Internationale Wirtschafts- prüfung, Festschrift für Hans Havermann (1995), p. 806

¹⁴In the case of temporary decline limited companies can only apply the option to long-term financial assets (§ 279 I no. 2 HGB).

¹⁵Thus, sole traders and partnerships have broad opportunities to form hidden reserves regarding both § 253 IV HGB where “depreciations within the parameters of sound business judgement are allowed” and § 253 V HGB where “a lower valuation may be maintained, even if the reasons for it no longer apply”. However, limited companies are required to write up, whereby the upper limit of

¹⁶According to § 254 HGB sole traders or partnerships can maintain a lower valuation by depreciations for tax reasons; with the enactment of Tax Relief Act 1999/2000/2002 limited companies are obliged to reinstate original values when the asset has recovered in value. However, a transitional provision permits the recognition of the recovered amount (§ 281 I no. 1 HGB).

¹⁷c.f. Wöhe, G., Bilanzierung und Bewertung (1997), p. 409

¹⁸c.f. Schneider, D., Steuerbilanzen (1978), p. 154

¹⁹ c.f. Coenenberg, A-G., Jahresabschluss und Jahresabschlussanalyse (2003), p. 111

²⁰c.f. Wöhe, G., Bilanzierung und Bilanzpolitik (1997), p. 408

²¹c.f. Rose, G., Die Substanzsteuern (1997), p. 31

²² c.f. Schierenbeck H., Grundzüge der Betriebswirtschaftslehre (2003), p. 528