Accounting (Basics) - Lecture 12
INTRODUCTION TO THE EUROPEAN ACCOUNTING, HARMONIZATION OF ACCOUNTING, DIRECTIVES OF THE EUROPEAN
UNION. US GAAP.

Content
nIntroduction to the European accounting
nHarmonization of accounting
nDirectives of the European union
nUS GAAP
2

Introduction to the European accounting
nIn most countries, it is not thought appropriate to regulate bookkeeping in any detail, although
there are generally requirements that orderly books should be kept so that auditors and tax
authorities could investigate them where this seems necessary to confirm the contents of financial
reports. nIn a few countries, such as Belgium and France, bookkeeping is regulated in detail, as is
noted below.
3

Introduction to the European accounting
nFinancial reporting could be regulated in a number of ways, including:
qlegislation, such as Companies Acts and Commercial Codes;
qother rules issued by departments of government (such as a Ministry of Finance) or by committees
operating under their control;
qrules from governmental regulators of stock exchanges;
qrules of stock exchanges;
qaccounting guidelines or standards issued by committees of the accountancy profession;
qaccounting guidelines or standards issued by independent private-sector bodies acting in the
public interest.
4

Introduction to the European accounting
nThe expression ‘accounting standard’ is used here to mean a document containing a series of
instructions on a particular topic of financial reporting (e.g. how to value inventories), where
the standard is written in the private (nongovernmental) sector and is intended to be obeyed in
full before an enterprise or an auditor can claim compliance with the system of rules of which the
standards form part. nFor financial reporting regulation, it is important to separate the creation
of rules from their enforcement.
5

Introduction to the European accounting
nFor example, in the United States most accounting rules are to be found in accounting standards
but the enforcement, for certain companies, comes from the stock exchange regulator.
6

Examples of regulation - Germany
nThe basic source of accounting rules in Germany is the Commercial Code (Handelsgesetzbuch,
abbreviated to HGB, and literally meaning the ‘commercial law book’). nThe HGB is amended from time
to time, most notably in 1985 as a result of implementation of EU Directives. nThe HGB covers all
types of enterprise in Germany, but limited companies have special rules and larger companies must
be audited. nBecause of the close links between tax and accounting in Germany, the rules of tax law
and the decisions of tax courts are also important for financial reporting.
7

Examples of regulation - Germany
nFor listed companies, there are some additional disclosure requirements in a special law.
nCompliance with the rules is the responsibility of the management of an enterprise.
nAuditors will check certain features of compliance.
nThe tax authorities will check matters of concern to them.
nHowever, the consolidated financial statements of groups are generally not relevant for tax, even
though parents and certain subsidiaries can sometimes be treated together for tax purposes.
8

Examples of regulation - Germany
nTherefore, there may not be a fully effective enforcement mechanism, particularly for consolidated
statements. nSince 1998 in Germany, consolidated statements of listed companies have been allowed
to depart from the normal requirements of the HGB if they follow ‘internationally recognized rules’
instead. nThere are other conditions, but US rules and International Standards are accepted. nA
number of large German companies take advantage of this permission, and it seems that there is no
mechanism of enforcing the strict use of these ‘foreign’ rules.
9

Examples of regulation - Germany
nAlso in 1998, a private-sector standard setter was established: the Deutsches Rechnungslegungs
Standards Committee (DRSC). nThe fact that the German for ‘standards committee’ is ‘Standards
Committee’ tells us that it is an imported concept. nThe DRSC can recommend to the Ministry of
Justice rules designed for listed companies in their consolidated statements.
10

Examples of regulation - France
nThe most detailed source of accounting instructions in France is the plan comptable general (PCG,
general accounting plan). nThe PCG is a large document within the control of a governmental
committee. nPart of the PCG is a chart of accounts that regulates how double entries should be
made; another part specifies the formats that financial statements should follow. nThe tax system
uses the output in PCG format, so that there is detailed enforcement.
11

Examples of regulation - France
nAn outline of the chart of accounts in the French PCG, as amended in 1999, nThe recording of each
type of transaction can be specified in great detail, so that it can be standardized throughout
France. nFrance also has a Civil Code and several Companies Acts.
nAll larger companies must be audited.
nFor listed companies, there is a stock exchange regulator that exercises some enforcement powers.
12

Examples of regulation – The United Kingdom
nThere have been Companies Acts in the UK since 1844, but the accounting content was not detailed
until the relevant EU Directives were implemented in the 1980s. nAll companies are covered, and
audits are required in all cases except small companies (‘small’ being defined). nThere are also
accounting standards, which are more detailed than the present Companies Act (of 1985) on many
issues. nThe standards were set by a committee of the accountancy profession until 1990 but are now
set by an independent private-sector body, the Accounting Standards Board.
13

Examples of regulation – The United Kingdom
nThe overriding requirement of the Companies Act is that financial statements must give a true and
fair view. nThis requirement is given more substance in the UK than elsewhere because the standard
setters make requirements that remove some of the options in law and sometimes even contradict the
detail of the law. nEnforcement of the rules is achieved because companies and auditors can be
taken to court (by the Financial Reporting Review Panel (FRRP), another private-sector body) for
‘defective accounts’, and legal opinion is that financial statements that break accounting
standards are likely to be defective.
14

Examples of regulation – The United States
nThere are no general Companies Acts or Codes in the United States, and so most companies have
little regulation and no audit requirement. nHowever, for listed companies there is the world’s
most active regulator: the Securities and Exchange
nCommission (SEC).
nThe SEC was founded in 1934 as a reaction to the free-for-all in accounting that contributed to
the Wall Street Crash of 1929. nThe SEC requires the use of ‘generally accepted accounting
principles ’(GAAP) and also requires an audit.
15

Examples of regulation – The United States
nThe SEC imposes serious penalties on auditors and companies that break the rules. nThe SEC makes
some of the content of GAAP but mostly chooses to rely upon the private sector to do this. Since
1973, the chosen body is the Financial Accounting Standards Board (FASB), which is a private-sector
body set up to act in the public interest. nThe FASB is independent but is influenced by the fact
that it could be overruled by the SEC.
16

Examples of regulation – some other countries
nMany other countries are similar to one or more of the above. nFor example, the Nordic countries
have Bookkeeping Acts and Companies Acts which have incorporated the EU Directives. nThey also have
various forms of accounting standards, set by committees involving representatives of various
bodies, such as the accountancy profession and stock exchanges.
17

Generally accepted accounting principles (GAAP)
nThe term ‘GAAP’ is of US origin but is commonly used to describe accounting requirements, and so
the term ‘Swedish GAAP’ might also be used, for example. nIn the United States, in the absence of
company law, the term first meant the practices of large and respected companies, as recommended by
textbooks and accepted by auditors. nBy the 1930s in the US, GAAP began to be codified, so that
there is now also written (or promulgated) GAAP including accounting standards. nThe SEC requires
companies registered with it to comply with GAAP.
n.
18

Generally accepted accounting principles (GAAP)
nIn other countries, ‘GAAP’ is generally an unofficial term with no exact meaning, although there
is a similar term, namely ‘good accounting practice’, in the laws of some countries, such as
Denmark. nFor example, if one sees the term ‘Swedish GAAP’ it presumably includes Swedish law,
Swedish accounting standards and the practices of respected companies and auditors.
19

Harmonization of accounting
nThere are major differences in the financial reporting practices of companies in different
countries. nThis leads to great complications for those preparing, consolidating, auditing and
interpreting published financial statements. nSince the preparation of internal financial
information often overlaps with the preparation of published information, the complications spread
further. nTo combat this, several organizations throughout the world are involved in attempts to
harmonize or standardize accounting.
20

Harmonization of accounting
n‘Harmonization’ is a process of increasing the compatibility of accounting practices by setting
bounds to their degree of variation. n‘Standardization’ appears to imply the imposition of a more
rigid and narrow set of rules. nHowever, within accounting these two words have almost become
technical terms, and one cannot rely upon the normal difference in their meanings.
21

Harmonization of accounting
nHarmonization is a word that tends to be associated with the supranational legislation promulgated
in the European Union, while standardization is a word often associated with the International
Accounting Standards Board.
nIn practice, the words are often used interchangeably.
nIt is necessary to distinguish between de jure harmonization (that of rules, standards, etc.) and
de facto harmonization (that of corporate financial reporting practices).
22

Harmonization of accounting
nFor any particular topic or set of countries, it is possible to have one of these two forms of
harmonization without the other. nFor example, countries or companies may ignore the harmonized
rules of standard setters or even lawmakers. nBy contrast, market forces persuade many companies in
France or Switzerland to produce English-language financial reports that approximately follow
Anglo-American practice.
23

Harmonization of accounting
nThe EU achieves its harmonizing objectives mainly through Directives (which must be incorporated
into the laws of member states) and Regulations (which have direct effect). nIn the 1970s and 1980s
attention was given to harmonizing national laws through Directives). nDuring the 1990s, the EU
began to take more notice of international standards, leading to a Regulation of 2002 requiring
IFRSs for the consolidated statements of listed companies.
24

Relevant EU Directives
nThe relevant body of law for accounting is company law, and the concern of this section will be
with the Directives on company law. These are listed on the slides below. nThe exact effects of any
Directive on a particular country will depend upon the laws passed by national legislatures. nFor
example, there are dozens of provisions in the Fourth Directive that begin with such expressions as
‘member states may require or permit companies to …’
25

Relevant EU Directives
nThe Fourth Directive covers public and private companies. nIts articles include those referring to
valuation rules, formats of published financial statements, and disclosure requirements. nIt does
not cover consolidation, which is left to the Seventh Directive. nThe Fourth Directive’s first
draft was published in 1971, before the United Kingdom, Ireland and Denmark (let alone the later
entrants) had joined the EU (or its predecessors).
26

Relevant EU Directives
nThis initial draft was heavily influenced by German company law, particularly the Aktiengesetz of
1965. nConsequently, for example, valuation rules were to be conservative, and formats were to be
prescribed in detail. nFinancial statements were to obey the provisions of the Directive. nThe UK,
Ireland and Denmark joined the then ‘common market’ in 1973.
27

Relevant EU Directives
nThe influence of Anglo-Saxon thinking was such that a much amended draft of the Fourth Directive
was issued in 1974.
nThis introduced the concept of the ‘true and fair view’.
nAnother change by 1974 was that some flexibility of presentation had been introduced. nThis
process continued and, by the promulgation of the finalized Directive, the ‘true and fair view’ was
established as a predominant principle in the preparation of financial statements (Article 2,
paragraphs 2–5).
28

Relevant EU Directives
nIn addition, the four basic principles (accruals, prudence, consistency and going concern) were
made clearer than they had been in the 1974 draft (Article 31). nMore rearrangement and
summarization of items in the financial statements was made possible (Article 4). nThere were also
calls for more notes in the 1974 draft than the 1971 draft, and more in the final Directive than in
the 1974 draft (Articles 43–46). nAnother concern of Anglo-Dutch accountants was with the effect of
taxation on Franco-German accounts.
29

Relevant EU Directives
nThe extra disclosures called for by the 1974 draft about the effect of taxation are included in
the final Directive (Articles 30 and 35). nThe fact that member states may permit or require a type
of inflation accounting is treated in more detail than in the 1974 draft (Article 33). nAs a
further accommodation of Anglo-Dutch opinion, a ‘Contact Committee’ of EU and national civil
servants is provided for.
30

Relevant EU Directives
nThis was intended to answer the criticism that the Directive gives rise to laws that are not
flexible to changing circumstances and attitudes. nThe Committee looks at practical problems
arising from the implementation of the Directive, and makes suggestions for amendments (Article
52). nFor over twenty years, the Fourth Directive was not changed in any substantial way. nHowever,
in 2001, it was amended to allow financial instruments to be valued at fair value with gains and
losses taken to income, as is required by the international standard (IAS 39).
31

Relevant EU Directives
nIn 2003, further amendments removed other incompatibilities with IFRSs. nThe Second Directive
concerns a number of matters connected with share capital and the differences between public and
private companies. nFor example, the Directive requires all member states to have separate legal
structures for public and private companies and to have separate names for the companies.
32

Relevant EU Directives
nAs noted in that chapter, a ‘public’ company in this context is one that is legally allowed to
have a market in its securities, although it does not need to have one. nFor example, many PLCs,
SAs or AGs are not listed. It is important to note that ‘public’ in this sense means neither listed
nor anything to do with government. nThe implementation of the Directive led to the creation of the
BV in the Netherlands and to the invention of the label ‘PLC’ in the United Kingdom.
33

Relevant EU Directives
nThe Seventh Directive concerns consolidated accounting. nThe Eighth Directive was watered down
from its original draft, which might have greatly affected the training patterns and scope of work
of accountants. nHowever, its main effect now is to decide on who is allowed to audit accounts in
certain countries. nNorway, although not a member of the EU, has also implemented the Directives
because it is required to do so as a member of the European Economic Area.
34

Directives on company law
nSecond
nDraft dates 1970, 1972
nDate adopted 1976
nTopic Separation of public companies, minimum capital, distributions
35

Directives on company law
nFourth
nDraft dates 1971, 1974
nDate adopted 1978
nTopic Formats and rules of accounting
36

Directives on company law
nSeventh
nDraft dates 1976, 1978
nDate adopted 1983
nTopic Consolidated accounting
37

Directives on company law
nEighth
nDraft dates 1978
nDate adopted 1984
nTopic Qualifications and work of auditors
38

The EU Regulation of 2002
nBy the early 1990s, it had become clear, even to the European Commission, that Directives were too
cumbersome and slow to achieve further useful harmonization. nThe Fourth Directive, agreed in 1978,
did not cover several topics and it had been too complicated to amend it often. nFurthermore,
global harmonization had become more relevant than regional harmonization.
39

The EU Regulation of 2002
nIt had also become clear that, for large European companies, voluntary harmonization might focus
on US rules over which the European Commission and other Europeans have no influence.
nConsequently, from the middle of the 1990s, the European Commission began to support the
increasingly important efforts of the International Accounting Standards Committee (later, the
IASB). nThe EU also had in mind the creation of powerful harmonized European financial markets.
40

The EU Regulation of 2002
nIn 2000, the Commission proposed the compulsory use of IFRSs for the consolidated statements of
listed companies for 2005 onwards. nThis was agreed by the European Parliament and the Council of
Ministers in 2002, in the form of a Regulation. nThis Regulation also allows member states to
extend the use of IFRSs compulsorily or optionally to unlisted companies and unconsolidated
statements. nFor any companies falling under the Regulation, the national laws and standards on
accounting are overridden. nFor other companies, the national rules (including the national
implementations of the Directives) are still in effect.
41

US GAAP
nGenerally Accepted Accounting Principles, also called GAAP or US GAAP, is the accounting standard
adopted by the U.S. Securities and Exchange Commission (SEC). nWhile the SEC has stated that it
intends to move from US GAAP to the International Financial Reporting Standards (IFRS), the latter
differ considerably from GAAP and progress has been slow and uncertain.
n
42

History of US GAAP
nAuditors took the leading role in developing GAAP for business enterprises. nAccounting standards
have historically been set by the American Institute of Certified Public Accountants (AICPA)
subject to Securities and Exchange Commission regulations. nThe AICPA first created the Committee
on Accounting Procedure in 1939 and replaced that with the Accounting Principles Board in 1959.
43

History of US GAAP
nIn 1973, the Accounting Principles Board was replaced by the Financial Accounting Standards Board
(FASB) under the supervision of the Financial Accounting Foundation with the Financial Accounting
Standards Advisory Council serving to advise and provide input on the accounting standards. nOther
organizations involved in determining United States accounting standards include the Governmental
Accounting Standards Board (GASB), formed in 1984; and the Federal Accounting Standards Advisory
Board (FASAB), formed in 1990.
44

History of US GAAP
nCirca 2008, the FASB issued the FASB Accounting Standards Codification, which reorganized the
thousands of US GAAP pronouncements into roughly 90 accounting topics. nIn 2008, the Securities and
Exchange Commission issued a preliminary "roadmap" that may lead the United States to abandon
Generally Accepted Accounting Principles in the future, and to join more than 100 countries around
the world instead in using the London-based International Financial Reporting Standards.
45

History of US GAAP
nAs of 2010, the convergence project was underway with the FASB meeting routinely with the IASB.
nThe SEC expressed their aim to fully adopt International Financial Reporting Standards in the U.S.
by 2014. nWith the convergence of the U.S. GAAP and the international IFRS accounting systems, as
the highest authority over International Financial Reporting Standards, the International
Accounting Standards Board is becoming more important in the United States.
n
46

Basic objectives of GAAP
nFinancial reporting should provide information that is:
qUseful to present to potential investors and creditors and other users in making rational
investment, credit, and other financial decisions
qHelpful to present to potential investors and creditors and other users in assessing the amounts,
timing, and uncertainty of prospective cash receipts about economic resources, the claims to those
resources, and the changes in them
qHelpful for making financial decisions
qHelpful in making long-term decisions
qHelpful in improving the performance of the business
qUseful in maintaining records
47

Basic concepts of GAAP
nTo achieve basic objectives and implement fundamental qualities GAAP has three basic assumptions,
four basic principles, and five basic constraints.
48

Basic concepts of GAAP - Assumptions
nBusiness Entity: The business is separate from its owners and other businesses.
qRevenue and expense should be kept separate from personal expense.
nMonetary Unit: A stable currency is the unit of record.
qThe FASB accepts the nominal value of the US Dollar as the monetary unit of record, unadjusted for
inflation.
nPeriodicity: The economic activities of an enterprise can be divided into artificial time periods.
49

Basic concepts of GAAP - Principles
nHistorical cost principle: Companies must account for and report the acquisition costs of assets
and liabilities rather than their fair market value.
qThis principle provides information that is reliable (removing the opportunity to provide
subjective and potentially biased market values), but not very relevant.
qThus there is a trend toward the use of fair values. Most debts and securities are now reported at
market values.
50

Basic concepts of GAAP - Principles
nRevenue recognition principle: Companies should record revenue when earned but not when received.
qThe flow of cash does not have any bearing on the recognition of revenue.
qThis is the essence of accrual basis accounting.
qConversely, however, losses must be recognized when their occurrence becomes probable, whether or
not it has actually occurred.
qThis comports with the constraint of conservatism, yet brings it into conflict with the constraint
of consistency, in that reflecting revenues/gains is inconsistent with the way in which losses are
reflected.
51

Basic concepts of GAAP - Principles
nMatching principle: Expenses have to be matched with revenues as long as it is reasonable to do
so.
qExpenses are recognized not when the work is performed, or when a product is produced, but when
the work or the product actually makes its contribution to revenue.
qOnly if no connection with revenue can be established, cost may be charged as expenses to the
current period (e.g. office salaries and other administrative expenses).
qThis principle allows greater evaluation of actual profitability and performance (shows how much
was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of
this principle.
52

Basic concepts of GAAP - Principles
nFull disclosure principle: The amount and kinds of information disclosed should be decided based
on trade-off analysis as a larger amount of information costs more to prepare and use.
qInformation disclosed should be enough to make a judgment while keeping costs reasonable.
Information is presented in the main body of financial statements, in the notes or as supplementary
information
53

Basic concepts of GAAP – Constraints
nObjectivity principle: the company financial statements provided by the accountants should be
based on objective evidence. nMateriality principle: the significance of an item should be
considered when it is reported. An item is considered significant when it would affect the decision
of a reasonable individual. nConsistency principle: It means that the company uses the same
accounting principles and methods from period to period.
54

Basic concepts of GAAP – Constraints
nConservatism principle: when choosing between two solutions, the one which has the less favorable
outcome is the solution which should be chosen nCost Constraint: The benefits of reporting
financial information should justify and be greater than the costs imposed on supplying it.
55

Precedence of GAAP-setting authorities
nIn the United States, GAAP derives, in order of importance, from:
qissuances from an authoritative body designated by the American Institute of Certified Public
Accountants(AICPA) Council (for example, the Financial Accounting Standards Board Statements, AICPA
Accounting Principles Board Opinions, and AICPA Accounting Research Bulletins);
qother AICPA issuances such as AICPA Industry Guides;
qindustry practice;
qinto para-accounting literature in the form of books and articles.
56