Accounting
1. Subject-matter and functions
The law of accounting is regarded as a ‘centrepiece of European company law’ (Stefan Grundmann). Its body of rules certainly ranks among the most comprehensively and intensively harmonized areas of private law; from a functional perspective, these rules play a key role for disclosure and transparency—and thus also for the information model, a characteristic feature of European company law.
As opposed to cost accounting for internal purposes, accounting serves to document business transactions for external purposes, in particular for the commercial and tax balance sheet. Currently, however, the European accounting rules apply only for commercial accounting, mainly for reasons of legislative competence. Yet commercial and tax accounting are not entirely unrelated. The latter may even be based on the former. Such relevance of commercial accounting for tax purposes—known as Maßgeblichkeit (authoritativeness) in Germany—is a question of national (tax) law. Given that national law, which makes autonomous reference to harmonized rules, may well have to be interpreted in accordance with the respective European standard (quasi-richtlinienkonforme Auslegung), European accounting rules can indeed affect national rules on tax accounting. Independently, the European Commission recently proposed (optional) rules for a common consolidated tax base (COM (2011) 121/4). These rules would apply directly to tax accounting. As matters currently stand, these rules, in turn, do not explicitly refer to the applicable rules on commercial accounting.
The business results as shown in commercial accounting not only serve as a potential yardstick for tax purposes, but also as a basis for the determination and distribution of profits. It can also be a limit on the amount of possible distributions. This so-called ‘point of reference function’ of accounting, however, again largely depends on national (company) law. The information function, on the other hand, is truly embodied in European accounting law for all (limited) companies. This role is of essential importance from a functional perspective: annual and consolidated accounts (auditor) should, above all, give a correct view of the present economic situation of the company or group, with a view to the future.
Yet the key functional question concerns the basic orientation, namely which party’s information demands are primarily to be served by the accounts. Given that evaluation issues are at stake, accounting simply cannot give a completely objective, true and overall picture. The question of whether liabilities, for example, should be valued at the nominal, effectively secured or already liquidated amount is likely to be answered differently by typically risk-averse creditors as opposed to investors, who focus primarily on potential profits. Traditionally, Member States have shown a preference for diametrically opposed perspectives. Whereas accounting rules in the United Kingdom are based on the principle of ‘true and fair view’ and therefore primarily aim at the investor perspective, the so-called ‘principle of prudence’ has been paramount on the Continent; it takes creditors’ interests into account. European law tries to strike a balance: even though the Fourth Directive stipulates the principle of ‘true and fair view’ as a general and apparently overriding provision, many of its specific rules are rather an expression of a principle of prudence. Moreover, the directive provides various possibilities for deviation. These options are generally granted to Member States who may, however, often pass them on to companies. The answer to the basic question—which party’s information demands are primarily to be served by accounts—therefore largely depends on these choices. A more obvious orientation towards investor information, on the other hand, can be found in the uniform accounting rules of the International Financial Reporting Standards (IFRS). At the EU level, these rules are now mandatory (only) for publicly traded groups of companies.
2. Body of rules and trends in legal development
Accounting has always been a key element of European company law harmonization. Indeed, the Disclosure Directive of 1968 (First Company Law Dir 68/151, now replaced by Dir 2009/101) may be regarded as the starting point, as it stated in Art 2(1)(f) the obligation for all limited liability companies to draft and disclose a balance sheet and a profit-and-loss account. Since their reform in 2003, these rules have required, moreover, a comprehensive disclosure of annual accounts. On the other hand, the substantial harmonization of accounting rules has been the subject of preparatory work and first legislative drafts that reach back as early as 1965. At the time these drafts were exclusively inspired by continental accounting principles. The accession of the United Kingdom required fundamental modifications. This change in perspective is embodied in both centrepieces of European accounting law, namely the Directives on Annual Accounts (Fourth Company Law Dir 78/660) and on Consolidated Accounts (Seventh Company Law Dir 83/349), adopted in 1978 and 1983 respectively. Both directives apply exclusively to limited liability companies, but cover all types of such company (PLC, private limited company, partnership limited by shares). A specific directive adopted in 1990 extends the scope of application further to partnerships that do not have any natural persons among their personally liable members (so-called limited liability company & Co). As of 1 January 2005, these directives have been fundamentally amended in order to adjust them to the IFRS rules, or at least to enable accounts that comply with both regimes.
The IFRS Regulation (Reg 1606/2002) as such was adopted in 2002. The legislation is regarded as an answer to the growing pre-eminence of the US Generally Accepted Accounting Principles (US GAAP), which also apply for European companies if listed on US securities markets. Given that the EU accounting directives in force did not have any prospect of worldwide adoption, and given that, on the other hand, allowing European companies to draw up their accounts exclusively in accordance with US GAAP was not an option, the regulation is based on accounting rules of a private standard setter. The IFRS are drawn up by the International Accounting Standards Board (IASB), a private body consisting of members from professional circles and supervisory authorities. These rules are similarly based on the Anglo-American, investor-oriented accounting philosophy. As a consequence of the financial turmoil, it is unclear whether these rules have a real chance of being accepted on a global basis; many expect a (tentative) convergence of IFRS and US GAAP at least in the long term. The IFRS Regulation, in turn, confines itself to stating general conditions for the application of the IFRS and to establishing certain, very general criteria that the IFRS need to comply with in the long term.
Finally, the European rules on material aspects of accounting are supplemented by the Statutory Audits Directive, which had originally been adopted in 1984 as the Eighth Company Law Directive (Dir 84/253), but was substantially revised in 2006 (Dir 2006/43, auditor).
3. Accounting elements and principles
The annual accounts represent the main component of accounting, according to both the Annual Accounts Directive and IFRS (and US GAAP). Annual accounts, in turn, consist of the balance sheet, ie a statement of the financial position of the company at the end of the financial year, showing assets and liabilities; the profit-and-loss account, ie the development of income and expenses over the past financial year; and the notes. The balance sheet and profit-and-loss account complement each other by providing information on stock value and flow figures, respectively. Ultimately, they need to be consistent because the difference between income and expense equals the increase or decrease of assets and liabilities. Whereas these two instruments provide quantitative business information, the notes contain additional and explanatory verbalized details. In particular, the exercise of various valuation options needs to be explained in order to avoid a misleading interpretation of the accounts.
These three-part annual accounts (in the strict sense) are supplemented by additional information. On that point, the requirements of the Annual Accounts Directive and the IFRS are in fact different in form. The directive calls for an annual report, aimed at supplementing the backward-looking accounts with more timely and forward-looking, verbalized information. The IFRS, on the other hand, require a cash flow statement, a statement of all changes in equity and a (business and geographical) segments report.
With respect to the balance sheet, the IFRS only set minimum requirements, whereas the Annual Accounts Directive fixes the layout in most respects. Member States may choose between two different forms which, however, only differ with respect to the format, not with respect to the order of the entries. The asset side is subdivided into fixed assets (intangible, tangible and financial assets), current assets (stocks, amounts due, financial investments, cash at hand and in bank) and other entries (mainly prepayments and accrued income), whereas the liability side comprises equity (subscribed capital, additional paid-in capital (agio), retained earnings, including profits and losses brought forward, and the profit or loss of the current financial year), provisions for liabilities and charges, amounts owed, as well as accruals and deferred income.
For any single entry, the core accounting questions need to be answered: is an entry possible at all (on the asset or on the liability side), at what time (accounting period) and at what amount (valuation)? The Annual Accounts Directive provides many options. However, these options are subject to general principles regarding valuation (going concern, realization, prudent accounting), but also accounting principles in general (true and fair view), which, in turn, restrict the choice. Entry and valuation will often ultimately depend on the accounting philosophy—cautious or realistic. The fact that the directive does not adopt an unambiguous position gives rise to many disputes. At least as regards its Tomberger judgment, the ECJ has left the decision largely to Member States (ECJ Case C-234/94 – Tomberger [1996] ECR I-3133). Apart from these substantively important principles, the directive also stipulates some rather formal, largely undisputed accounting principles (clarity and transparency, consistency, sufficient exactitude and precision). Their purpose is to contribute to the legibility and comprehensibility of the information given. By contrast, the much reduced role of companies’ option rights in the IFRS is striking, and as a uniform set of standards it contains no options for Member States in any event. On the other hand, the IFRS allow or require revaluation much more often (with potential impacts on consistency).
4. Consolidated accounts and special regimes
The Directive on Consolidated Accounts contains special rules for companies forming part of a corporate group. One single accounting document is, in general, sufficient, namely the consolidated accounts of the holding company. However, the (imaginary) individual accounts cannot simply be added as they may be based on different regimes and contain, above all, many transactions and holdings within the same group. The Directive on Consolidated Accounts is therefore based on the general rules for annual accounts, but provides specific adaptations for group accounting. Moreover, it defines the scope of application (on the basis of the control concept) and specifies this scope in cases where the group to be consolidated contains several different types of company.
The accounting rules of the IFRS have already been mentioned several times, including their material deviations from the Directive on Annual Accounts. According to the IFRS Regulation, these rules (not the Directives on Annual and Consolidated Accounts) are mandatory for parent companies if at least one company in the group has issued securities on a regulated market. Moreover, the IFRS Regulation allows Member States to prescribe or at least allow IFRS accounting also for independent companies and for corporate groups that are not publicly traded. In that case, companies may be exempted from the application of the Directives on Annual and Consolidated Accounts.
Finally, special regimes apply for banks and insurance companies. The reason is that confidentiality plays a particularly significant role in both sectors, so that disclosure obligations, namely with respect to hidden reserves, need to be modified accordingly. Moreover, sector-specific features require modification with respect to various entries, namely, of course, with respect to financial instruments.
5. Auditing and disclosure
In order to provide procedural safeguards for the reliability of accounting information, EU law imposes the obligation to have a professional audit of the annual accounts. In addition, the Statutory Audits Directive states requirements for professional education and independence of auditors.
Whereas the annual accounts generally need to be published, national law can confine itself to imposing a simple duty to deposit the annual report and to make a public indication as to where it can be obtained. Some relaxations apply for private limited companies of small size. In order to facilitate verification of the reliability of information, extensive and particularly far-reaching disclosure obligations apply to the auditors’ report.
Literature
Sidney Gray, Adolf Coenenberg and Paul Gordon, International Group Accounting: Issues in European Harmonization (2nd edn, 1993); Jens Ekkenga, Anlegerschutz, Rechnungslegung und Kapitalmarkt (1998); Peter Hommelhoff, ‘Europäisches Bilanzrecht im Aufbruch’ (1998) 62 RabelsZ 381; Karel van Hulle, ‘Die Reform des Europäischen Bilanzrechts’ [2000] ZGR 537; Michael Asche, Europäisches Bilanzrecht und nationales Gesellschaftsrecht (2007); Stefan Grundmann and Florian Möslein, European Company Law: Organization, Finance and Capital Markets (2007); Paul Rodgers, International Accounting Standards (2007); Christopher Nobes and Robert Parker, Comparative International Accounting (11th edn, 2010); Wolfgang Schön, Ulrich Schreiber and Christoph Sprengel (eds), A Common Consolidated Corporate Tax Base for Europe: Eine einheitliche Körperschaftsteuerbemessungsgrundlage für Europa (2008).
