Role of EU in Int. Accounting

THE ROLE OF EUROPEAN UNION IN THE INTERNATIONAL ACCOUNTING

CONVERGENCE PROCESS. RESEARCH REPORT

Group “1”: Frans Raida #43577776

Irina Sorkina #43708056

Siyu Liang #44654650

Yaroslav Rezchikov #43489621

ACCG835 International Accounting

Dr. Charles Koh

Macquarie University in Sydney

May 22, 2015

THE ROLE OF EUROPEAN UNION IN INT. ACCOUNTING ii

CONTENTS

1. Abstract ............................................................................................. 3

Yaroslav Rezchikov

2. Introduction....................................................................................... 4

Yaroslav Rezchikov

The Background of Adoption IFRS in Europe................................................ 4

3. Institutions......................................................................................... 5

Frans Raida

European Financial Reporting Advisory Group (EFRAG) ............................ 5

The Economic and Financial Affairs Council (ECOFIN) ............................. 6

International Accounting Standards Board (IASB) ........................................ 6

European Accounting Association (EAA) ....................................................... 6

European Commission (EC)............................................................................. 7

4. Formal Procedures ........................................................................... 7

Frans Raida

5. The Fourth and Seventh Directives ................................................ 8

Irina Sorkina

6. Examples of Harmonization & Transition in Europe .................10

Siyu Liang

Germany .......................................................................................................... 10

The United Kingdom ....................................................................................... 11

7. Conclusion ......................................................................................12

Yaroslav Rezchikov

8. Reference list ..................................................................................13

THE ROLE OF EUROPEAN UNION IN INT. ACCOUNTING 3

Abstract

(by Yaroslav Rezchikov)

This study examines the role played by the European Union (EU) as a supranational

union representing 28 member states with regard to its legislative enactments and interaction

with financial institutions in International Accounting.

Briefly, the adoption of IFRS was a great milestone towards European harmonization

of financial reporting, which gave an impulse to many disputes at a state level. The

contribution of our Research is that in a summary it demonstrates the vital role of EU in

International Accounting formation from different ways.

Keywords: comparative international accounting, the European Union integration,

IFRS adoption, accounting quality, convergence/harmonization of Accounting Standards


Introduction (by Yaroslav Rezchikov)

The background of Adoption IFRS in Europe

The foundation of EU can be dated to 1957 year, when, for the augmentation of

general welfare, six European countries decided to eliminate trade barriers and establish the

common European Economic Community (EEC). From that moment began the convergence

of European states, which also required the harmonisation of Accounting Standards.

At the same time, due to social and cultural differences (for instance, local GAAP of

Anglo-Dutch society made from the points of investors in mind and based on shared

principles, while in France, Germany, and Italy Accounting Standards were made from the

taxation purpose with explicit prescriptive rules), this process took a long time. The scandals

with Enron and MCI WorldCom in 2001-2002 uncovered the weaknesses of US GAAP (as

long as it is possible to follow the rules, but not their spirit) and determined the demand for a

new based on shared principles system.

Remarkable to add, that after successful arrangement in EU, the Financial Accounting

Standards Board (FASB) and International Accounting Standards Board (IASB) made a

Norwalk Agreement in September 2002 for elimination of differences between US GAAP

and IFRS in the medium term. It was a pivotal point of changing the US GAAP, because the

world shifted to IFRS`s side. Thus, for example, in late February 2005 (after compulsory

embedding from January 1 of the same year in EU member states), 41 countries around the

world had decided to require the use of IFRS (such Anglo-Saxon “heavyweights” as

Australia, New Zealand and South Africa can be highlighted among them).


The remainder of this paper is organised in the following way. Section 3 sets out the

formal procedures and Section 4 reviews the relevant unique institutional settings and

describes their roles in applying IFRS in Europe. Section 5 discusses the Fourth and Seventh

Directives and presents the effect of accounting standards’ harmonisation for cultural, social

and economic systems of EU`s countries. Section 6 illustrates the examples of IFRS`s

standardising implementation process and analyses it`s effect for accounting efficiency in

Germany and the UK. Finally, a brief conclusion with overriding points of the report is

provided in Section 7. There were also mentioned the limitations of this study and given the

ideas of how the results of report can be extended.

Institutions

(by Frans Raida)

European Financial Reporting Advisory Group (EFRAG)

EFRAG is an institute providing the technical advice of accounting issues to the EC

(European Commission) and giving input to IFRS. It was established in 2001, June and

started operations in 2001, September. EFRAG is a private organization formed in

compatibility with law of Belgium and some members which known as ‘EFRAG Member’

Stakeholders of Europe such as FEE, EBF, ASBG, EACB, AFAA, etc. and National

organizations such as DASB-Netherlands, DRSC/ASCG- Germany and etc., which interested

in developing IFRS and contributing to the efficiency of capital markets (EFRAG, 2015b).

Their aim are ensuring that the views of Europe on the financial report development are

obviously attached or articulated in the process of international standard-setting . Currently,

the President of EFRAG is Roger Marshall, who also is a member of Board and the

Accounting Committee’s Chairman of the Financial Reporting Council of the United

Kingdom (EFRAG, 2015a).


The Economic and Financial Affairs Council (ECOFIN)

The Economic and Financial Affairs Council, which usually known as the Ecofin

Council is one of the oldest institutions in the European Union and is structured of the

economics and finance ministers of 28 EU member states, including Budget Ministers.

ECOFIN has responsible in the policy of economic, taxation issues, financial markets and

movements of capital, and economic relations abroad of EU. They also prepare the budget of

EU annually and involved in legal, practical aspects of the Euro currency. Specifically,

ECOFIN has a role in making recommendations namely, rules of mark to market valuation

and reclassification for financial instruments (European Council, 2015).

International Accounting Standards Board (IASB)

The IASB is an independent, private sector body that develops and approves the

standard setting of the IFRS Foundation. The IASB was established in 2001 in order to

replace the International Accounting Standards Committee. Their roles are under the IFRS

Foundation Constitution, which they are responsible for all technical issues of the IFRS

Foundation namely (Deloitte Global Services Limited, 2015; IASB, 2015):

Full policy in creating and developing the technical agenda, complied to the

particular requirements of consultation with the public and Trustees.

The preparation, promoting of IFRS (beside interpretations), and drafts of

exposure, followed by the due process stipulated in the Constitution.

Approve and issue the interpretations developed by the Interpretations

Committee of IFRS.

European Accounting Association (EAA)

EAA is a non-profit association, which was established in 1977 and has had a major

impact on the accounting research community throughout Europe. EAA aims to provide a


link between accounting scholars and researchers in wide European community and provide a

platform for spreading the research of European accounting and improving research to ensure

the development of accounting including the skills of teaching. Beside, EAA also has mission

in developing relations with all professional and research associations, which correlated with

accounting, included concern in political decision making with European or International

authorities (EAA, 2015).

European Commission (EC)

EC is European Union’s executive body which was established to represent the

common interest in Europe and has responsibility in proposing legislation, upholding the

treaties of EU, decision in implementation and managing business of the EU.

Formal Procedures

(by Frans Raida)

The institutions of Europe play a great role to make sure that IFRS are applied with

consistent degree of principles accounting standards context. There are couples of procedures

that were required to be followed in IFRS Foundation. The adoption should be done by

enactment of Regulation (EC) no 1606/2002 of parliament of Europe and of the Council of

19 July 2002 on the application of International Accounting Standards.

Then, the Regulation of Accounting sets up a process for IFRS endorsement for EU.

After adopting, the IFRS, which was existing at that moment, were endorsed. New and

amended Standards and Interpretations are individually subject to the process of it

endorsement. After the standard (/it`s amendment) has introduced by the IASB, EC requests

EFRAG for an advice and the study effects on the pronouncement under consideration for

endorsement. During these, EFRAG will hold some meeting with interest groups and issues


the advice which concern in meeting the criteria/standards or endorsement for using in the

EU to EC. Further, the EC can prepare the draft of regulation of endorsement, which will be

adopted after the vote of ARC, opinions of the European Parliament and the EU Council.

Subsequently, it becomes effective when the Regulation is introduced in the Official Journal

of the European Union. If there is any translation in the IFRS, according to the agreement of

copyright waiver with the Directorate-General for Translation of the EC, the Commission

will take care of the official languages translation based on their process.

The Fourth and Seventh Directives

(by Irina Sorkina)

Speaking about harmonization within the European Union, we cannot omission main

directives. No doubt, EU attempted to harmonize company law and accounting through two

main instruments: Directives, which must be incorporated into the laws of member states; and

Regulations, which become law throughout the EU without the need to pass through national

legislatures (Nobes & Parker, 2008). European Commission has developed a list of

regulations since the beginning of harmonization process in 1967. At that time, Elmendorf

Report was created as an answer of EU commission request. Nowadays, it is known as a

fourth Directive, which is the part of the main body of financial reporting requirements for

limited liability companies in the EU. Fourth Council Directive was published 24 July 1978

and involves a set of restrictions on the annual accounts of certain types of companies. It is

based on a German law, as all first principles of European Union. However, the entry of the

UK in 1973 brought Anglo-Saxon ideas to the Union. Other countries have not had much

effect on it. Another important part is Seventh Council Directive published on 13 June 1983

focusing on consolidated accounts. The Fourth and Seventh Directives are repealed and


replaced by the new Accounting Directive 2013/34/EU , which entered into force on 20 July

2013 (Zervaki, 2014).

According to Christopher Nobes in his book Comparative International accounting,

the exact effects of any Directive on a particular country will depend upon the laws passed by

national legislatures. For instance, fourth Directive begins with such expressions as ‘member

states may require or permit companies to…’ This flexibility makes it difficult to measure

the impact of directives on European Union and its parts. Divided into three main groups

issues could be analysed easier. First group include the social factor related matters, second

and third political and cultural factor related respectively. Harmonization of accounting

standards is a crucial step to the EU and International Globalization. To evaluate an outcome

of it on the social factor such problems as Lack of Professional Accountancy bodies in some

developing countries, extent, and degree of professional education and training systems for

accountants should be solved. Moreover, literacy rate is important in the process of

globalization. Difference in the status of Accountancy Professions of countries form a general

level of social attitude toward industry, business and government. Geographical distance

makes it difficult to manage changes in many countries in the same time. The changing of

attitude towards accounting profession and the increased demand for this major is one of the

answers how harmonization changing society. Political and legal factors can varies from

country to country and relate to such issues, as quality and effectiveness of legal system,

correlation between legal system and traditions of the country, degree of control towards

companies and firms, level of political maturity in the country, different approach to the

creation of legal standards, political form of the country. In addition, level of nationalism,

intervention by OECD, UN, EC, and enforcement cases in the country. Members of the

European Union reserves the substantial sovereignty. Governments are trying to work in

cooperation with each other, not interfering in the affairs of neighbours. While globalization


is gaining the force, some countries still stand partly out of the union, such as England.

Despite, that most of the standards represent the experiences and circumstances of the

pioneering countries and the difficulties in the translation, European countries are moving

towards open-minded society. Cultural and racial barrios not interfere with the occupational

choice. Professional groups and unions are working on these problems. With a great support

of the government and media, public are willing to accept all kind of people on all levels of

business and government. Adaptation of the accounting standards played a significant role in

the cultural intervention of the European citizens.

Examples of Harmonization & Transition in Europe

(by Siyu Liang)

In this part some examples of standardizing and different effect for European

countries will be listed. Prior research generally shows that different European country

complying with different accounting standards has different accounting quality.

Daske&Gebhardt figure that IFRS/US GAAP adopted firms have higher standardized scores

and ranking than domestic GAAP adopted firms (Gallery, 2006). There are two countries

will be discussed, which are German and United Kingdom.

Germany

According to the German Commercial Code, Germany always pay high attention on

supporting the interest of firms’ creditors. As a result, German firms is heavily taxed

(Salewski, 2013). This fiscal policy deduct firms’ profit significantly, and investors have very

lower confident. In that time zone, there are so many arguments for Germany GAAP, and two

of international professors, Leuz and Verrecchia (2000), outlined main arguments for

Germany GAAP in several sectors: too much discretion are allowed by Germany GAAP,

especially with large hidden reserves; Germany GAAP has heavy taxation; Germany GAAP


has insufficient financial information to meet the demand of investors’ analysts. Too much

discretion leads to higher level of power distance, which encourages gray conduction. Heavy

taxation leads to lower investor confidence and insufficient information for investors may

lead to lower investment. These all factors illustrate that Germany GAAP lower Germany

efficiency. However, after “IAS Regulation” in 2002 (Regulation (EC) NO.1606/2002). The

European companies are required to prepare their consolidated financial statement in

accordance with IFRS, if they are willing to trading on a regulated market in EU. Several

accounting frame work are changed in this revolution, especially in some accounting frame

works, such as Historical cost or fair value, Fair presentation over-rice, First-time adoption of

accounting frameworks. Compare to Germany GAAP, historical cost method is not a main

method, but a primary method. And IFRS allows firm to re-evaluate their intangible assets,

such as property, plant and equipment, which compares to no revaluations are allowed in

Germany GAAP. For fair presentation over-ride, Germany GAAP requires additional

disclosures in the notes if financial statements not showing a true or fair value, which

compares to IFRS has an independent entities. Finally, for the first-time adoption of

accounting frameworks, Germany GAAP has no specific guidance, and IFRS encourages all

adjustments arising in first time (PricewaterhouseCoopers LLP, 2010). These comparisons

shows German has more effective accounting systems after complying with IFRS.

The United Kingdom

Before UK adopted the IFRS on 1 January 2005, UK firms comply with UK GAAP.

According to Samarasekera’s research, accounting quality in UK firms improved after

adoption of IFRS. Samarasekera has observed 493 firms and collect their data from 2000 to

mid-2009. In addition, eight measurements have been used to measure accounting quality.

Based on Samarasekeras’ report, for disclosure requirement, there is no sufficient evidence to

support that greater disclosure requirement required by IFRS improved accounting quality;


Greater use of fair value required by IFRS has a higher accounting quality, because of

reducing management towards earning target; improvement in supervise activities and

institutional oversight system foreign countries required by IFRS also increased accounting

quality, which is supported by smoothing measures, managing towards earnings targets

(Salewski, 2013). All evidence above shows that UK has a big improvement on accounting

quality after adopting IFRS on 2005.

In conclusion, in this part Germany and UK are two examples, which showed IFRS

adoption can increase European countries’ accounting quality. That means firms under IFRS

adoption have higher efficiency than firms under domestic GAAP.

Conclusion

(by Yaroslav Rezchikov)

This study briefly from different point of views investigates the crucial role of EU in

formation and promotion of International Accounting Standards. Overall, it can be said that

the results of this Report coincide with global shifting towards common standards in

accounting and in the near future this tendency with EU as a multilateral institution at the

head of it will continue.

Future researches can concentrate on limitations and extend this study by, for

instance, investigating the effect of transformation of communist accounting in a command

economies and adaptation of EU`s Accounting Standards in East European countries. Other

countries, which did not benefit from the Accounting efficiency, also can be considered.


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