Explanatory Memorandum to COM(2002)259 - Amendment of Council Directives 78/660/EEC, 83/349/EEC and 91/674/EEC on the annual and consolidated accounts of certain types of companies and insurance undertakings - Main contents
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| dossier | COM(2002)259 - Amendment of Council Directives 78/660/EEC, 83/349/EEC and 91/674/EEC on the annual and consolidated accounts of certain ... |
|---|---|
| source | COM(2002)259  |
| date | 28-05-2002 |
The 23-24 March 2000 Lisbon Council Conclusions stressed the need to accelerate completion of the internal market for financial services, set a deadline of 2005 to implement the Commission's Financial Services Action Plan and urged that steps be taken to enhance the comparability of financial statements prepared by EU companies whose securities are listed on a regulated market.
On 13 June 2000, the Commission adopted its Communication The EU's Financial Reporting Strategy: The Way Forward i. The Communication proposes that all EU listed companies should be required to prepare their consolidated accounts in accordance with a single set of accounting standards, namely International Accounting Standards (IAS), from 2005 at the latest. Adoption of uniform, high quality financial reporting rules in EU capital markets will enhance overall market efficiency, thereby reducing the cost of capital for companies.
On 17 July 2000, the ECOFIN Council welcomed the June 2000 Communication and emphasised in its conclusions that the comparability of the financial statements of EU listed undertakings, financial institutions and insurance undertakings is an essential aspect of the integration of the financial markets. ECOFIN also invited the Commission to present a proposal to introduce the new requirement and to establish an appropriate mechanism for recognising IAS.
On 13 February 2001, the Commission adopted a proposal for a Regulation of the European Parliament and of the Council on the application of international accounting standards i ('the IAS Regulation'). The proposal sets out the mechanism for recognising IAS in the EU - that they are considered vis-à-vis specified criteria and if considered suitable on the basis of those criteria they be adopted by the EU.
Most significantly, the proposal for a Regulation introduces the requirement that, from 2005 onwards, all EU listed companies prepare their consolidated financial statements in accordance with these adopted IAS. It also provides an option for Member States to permit or require the application of adopted IAS in the preparation of annual accounts and to permit or require the application of adopted IAS by unlisted companies.
A recent survey i of 700 EU listed companies reveals that 79% of Chief Financial Officers support the European Commission's recommendation that IAS should be mandatory for EU listed companies by 2005. Strategic business and financial considerations, ahead of accounting issues, are the most compelling reasons for considering the change to IAS. These include marketability, cross-border mergers and acquisitions, shareholder dialogue and finance raising.
Current EU accounting requirements are based primarily upon the following EU legislation (hereafter collectively referred to as the Accounting Directives):
* The Fourth Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies sets out the requirements in respect of the preparation of the annual accounts of companies i.
* The Seventh Council Directive 83/349/EEC of 13 June 1983 on consolidated accounts sets out the requirements in respect of the preparation of consolidated accounts i.
* Council Directive 86/635/EEC of 8 December 1986 on the annual accounts and consolidated accounts of banks and other financial institutions deals with those matters specific to such institutions i; and
* Directive 91/674/EEC of 19 December 1991 on the annual accounts and consolidated accounts of insurance undertakings sets out the specific requirements relevant to the preparation of accounts of such entities i.
The Accounting Directives will play an important role in the mechanism for adopting IAS under the proposed IAS Regulation. In addition, they will continue to be the basis of accounting legislation for entities which do not prepare their annual or consolidated accounts in accordance with adopted IAS further to the IAS Regulation. Finally, they deal with important matters which are outside the scope of the IAS Regulation (for example the requirement to obtain an audit and to prepare an annual report) and will continue to govern these areas.
The Accounting Directives have remained largely unchanged since their adoption as much as 23 years ago. In this time, accounting theory and accepted practice have developed significantly and continue to do so. Numerous studies have been prepared or received by the Commission which indicate that, in many respects, the Accounting Directives remain consistent with current accounting theory and practice. However, in certain limited areas, their requirements are incompatible with IAS which the EU will seek to adopt further to the IAS Regulation. This situation is unacceptable for two reasons:
Firstly, if the Accounting Directives are to play an important role in the mechanism for adopting IAS under the proposed IAS Regulation, they must reflect current accounting developments. In this respect, the Directives should be structured so as to accommodate and to be consistent with future incremental developments within IAS - it should not be necessary to consider amendment of the Directives each time a new IAS is proposed.
Secondly, there must be a level playing field between companies which apply IAS and those which do not. Such a position is necessary to enable also a smooth transition when companies seek a public listing.
The objectives of this proposal are therefore threefold:
To remove all existing conflicts between the Accounting Directives and IAS;
To ensure that optional accounting treatments currently available under IAS are available to EU companies which continue to have the Accounting Directives as the basis of their accounting legislation (ie those companies which do not prepare their annual or consolidated accounts in accordance with adopted IAS further to the IAS Regulation); and
To update the fundamental structure of the Accounting Directives so that they provide a framework for financial reporting that is both consistent with modern practice and flexible enough to allow for future developments in IAS.
The proposed changes will remove all inconsistencies between Directives 78/660/EEC, 83/349/EEC and 91/674/EEC and IAS in existence at 1 May 2002.
The Commission will present in due course consistent proposals in respect of Directive 86/635/EEC of 8 December 1986 concerning the annual accounts and consolidated accounts of banks and other financial institutions.
Contents
It is noted above that Lisbon Council set a deadline of 2005 for the implementation of the Commission's Financial Services Action Plan. The IAS Regulation and the modernisation of the Accounting Directives are each essential components of the Plan. In order to successfully meet this deadline, both components must be in place before 2005. Accordingly, it is extremely important to implement the proposed legislation as soon as possible.
Further to the objectives set out above, Article 1 makes those changes necessary to the Fourth Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies.
Paragraph 1 - It is common practice for certain additional statements to be provided in annual accounts, for example a cash flow statement. This revision expressly empowers Member States to permit or require such statements be included in annual accounts. See also similar amendment in respect of consolidated accounts in Article 2, paragraph 7.
Paragraph 2 - The accounting principle of substance over form - where the economic effect of a transaction or arrangement is considered in addition to its legal form - is already embodied in the Accounting Directives (for example, in determining the identity of subsidiary undertakings). This is consistent with the requirement that the annual (and consolidated) accounts shall give a true and fair view (Article 2(3)).
In addition to the recognition of these items is the manner of their disclosure within the prescriptive formats for the profit and loss account and balance sheet specified in the Directive. Under IAS certain transactions and arrangements must be disclosed in the profit and loss account and balance sheet within items which reflect the substance of the transaction or arrangement rather than its legal form. This revision expressly empowers Member States to permit or require that, in determining within which format item an amount should be included, regard may be had to substance as well as form.
Paragraphs 3 and 6 - The balance sheet formats set out in Articles 9 and 10 of the 4th Directive would not, in all circumstances, permit a balance sheet to be reported in accordance with the requirements of IAS. It is considered that the balance sheet disclosure requirements of IAS will provide comparable information and that, accordingly, it is appropriate to empower Member States to allow disclosure in this manner, as an alternative to the formats prescribed in Articles 9 and 10.
Paragraphs 4, 5, 7, 9 and 11 - IAS 37 Provisions, contingent liabilities and contingent assets sets out specific requirements as to which amounts should be recorded as provisions for liabilities. In the 4th Directive, Article 31 sets out certain basic rules as to the liabilities which must be taken into account in preparing the annual accounts and Article 20 expands on these principles, giving specific rules for provisions.
The provisions recorded under IAS are more specific than those under the 4th Directive. In particular, IAS restricts the amounts recorded to those obligations which exist at the balance sheet date. In addition to such amounts, the 4th Directive envisages also the provision of liabilities which are foreseeable. The proposal resolves this inconsistency in the case of companies applying IAS without necessarily changing the status quo for annual accounts and unlisted companies. This has been achieved by amending Article 31 to require the recognition of amounts consistent with IAS whilst allowing Member States to continue to permit or require those additional amounts currently envisaged by the Directive. In addition, certain minor changes to terminology and references have been proposed to facilitate the application of IAS 37.
Paragraph 8 - This revision relates to the presentation of the profit and loss account of the company, a statement which records income and expenditure of the company and whose purpose is to reflect its financial performance. Other gains and losses, for example those which arise on certain assets and which are considered to be unrealised, are currently reported directly in the reserves of the company, if they are recorded at all.
The profit and loss account formats set out in Articles 22 to 26 of the 4th Directive are compatible with the current requirements of IAS. However, the presentation of performance is current being reconsidered by accounting standard setters worldwide, including the International Accounting Standards Board. It is considered highly probable that at some point in the future the income and expenditure currently shown in the profit and loss account will be presented together with other gains and losses in a comprehensive statement of total performance for the period. Accordingly, the proposals provide in the Directive some flexibility such that its requirements will be compatible with these anticipated developments.
Paragraph 10 - IAS 38 Intangible assets permits the revaluation, in certain prescribed circumstances, of intangible fixed assets. The 4th Directive explicitly permits the revaluation of tangible fixed assets; it does not refer to the revaluation of intangible assets. The proposed revision amends Article 33(1)(c) so as to allow Member States to permit the revaluation of any fixed asset, including intangibles.
Paragraph 12 and 22 - In May 2001 a Directive (2001/65/EEC i) was adopted amending the 4th Directive so as to permit financial instruments to be recorded at their fair value and for the gains and losses which arise to be recorded in the profit and loss account. This was necessary in order to permit the application of IAS 39 Financial instruments: Recognition and measurement.
Other IASs require or permit the recognition of certain classes of asset at their fair value; notably IAS 40 Investment property and IAS 41 Agriculture. These standards contain detailed requirements concerning fair value and, in both cases, gains and losses resulting from recognition at fair value are required to be reported in the profit and loss account. The proposed revision, adding new Articles 42e and 42f, is necessary in order to permit the application of these standards. It is expected that a Member State permitting, and any company adopting, a policy of fair value should do so only in accordance with a recognised, generally accepted accounting system, such as that provided by adopted IAS.
The revision contains a general provision empowering Member States to permit such a treatment for any specified class or classes of asset. This is essential if the revision is to deal adequately with future developments.
To avoid confusion, the terminology in Article 60 of the Directive has been amended from market value to fair value.
Paragraphs 13, 21 and 23 - Reflect consequential changes to references.
Paragraph 14 - The 4th Directive currently includes a requirement for the preparation of an annual report giving at least a fair review of the development of the companys business and of its position'. The interpretation of this requirement has led to a wide variation of disclosures, ranging from those which help to provide an understanding of the annual accounts to mere boiler plate statements. Whilst no change is proposed to the underlying requirement for a fair review, it is desirable to promote greater consistency in the quality of these reviews and to give additional guidance on the information content expected of a fair review.
In proposing these amendments, consideration has been given to current best practice, in particular, the recent paper "Management's analysis of the business" produced by the European Accounting Study Group and to those disclosures anticipated under IAS. The inclusion of detailed provisions has been avoided in order that the requirements do not lead to boiler plate disclosures. This approach will allow additionally for future development in best practice.
Consistent with the Commission Recommendation of 30 May 2001 on the recognition, measurement and disclosure of environmental issues in the annual accounts and annual reports of companies (2001/453/EC) i, the provisions require that the information included shall not be restricted to the financial aspects of the company's business. It is expected that this will lead to an analysis of environmental, social and other aspects relevant to an understanding of the company's development and position.
Paragraph 15 - Further to the proposed changes to Article 51 of the 4th Directive, see paragraphs 17 and 18 below, the last sentence of Article 48 concerning the disclosure of certain elements of the report of the statutory auditor(s) has been deleted.
Paragraph 16 - This amends the provision of the 4th Directive which deals with the publication of, and references to, the audit report in those instances when extracts from the annual accounts are published. The requirements are amended slightly to reflect current practice, requiring additionally the disclosure of any matters to which the auditor has drawn attention without qualifying the audit report.
Paragraphs 17 and 18 - Standards on auditing, including the preparation and presentation of an audit report exist in each Member State. Unfortunately, the interpretation of these standards has not led to the expected degree of harmonisation - resulting in audit reports that differ across Member States. These differences, some of which are significant, reduce comparability and detract from the user's understanding of this vital element of financial reporting. The changes proposed in respect of the audit report reflect current best practice concerning the format and content of an audit report and will encourage greater harmonisation.
Paragraph 19 - This change updates the Directive further to the introduction of the Euro.
Paragraph 20 - The 4th Directive provides a limited number of exemptions, generally in respect of the obligation to make certain disclosures in the annual accounts, on the basis of the economic importance of the company. It is considered, consistent with the Commission's proposals in respect of the use of IAS by EU listed companies, that such exemptions should not be available to listed companies, regardless of their economic size. This is a reflection of the overriding economic importance that attaches to the public trading of a company's shares. Accordingly, this revision removes the availability of the exemptions in the case of such companies.
Further to the objectives set out above, Article 2 makes those changes necessary to the Seventh Council Directive 83/349/EEC of 13 June 1983 on consolidated accounts.
Paragraph 1 - Article 1 of the 7th Directive describes those undertakings which are considered to be subsidiary undertakings of a parent undertaking. The current provisions acknowledge that an undertaking may be controlled by the exercise of dominant influence (effective control), even in the absence of rights over a majority of the voting rights of the undertaking (ie a legal power of control). However, the current provisions do require a participating interest (as defined in Article 17 of the 4th Directive - broadly a minimum interest in the capital) to exist. Under IAS, an undertaking is a subsidiary undertaking if it is controlled by a parent, irrespective of the existence of an interest in the capital of the undertaking.
The issue has become more important in recent years with the development of legal structures (often referred to as Special Purpose Entities) designed to give the effect of a subsidiary undertaking without giving rise to a subsidiary undertaking under the existing requirements of Article 1. Accordingly, it is considered that the current requirement in the Directive for a participating interest to exist is no longer appropriate and it is therefore proposed to delete it. This brings the Directive into line with IAS requirements.
Paragraphs 2, 4(b), 5, 6, 9 and 10 - The 7th Directive currently requires the exclusion of an undertaking from the consolidated accounts of the parent if its activities are incompatible with those of the parent such that inclusion would fail to meet the requirement to give a true and fair view of the undertakings included therein taken as a whole.
It is now generally accepted that this is never the case. Regardless of the differing activities the appropriate accounting treatment is the inclusion of the undertaking together with suitable additional disclosure of its impact on the consolidated accounts. Accordingly, this requirement is now considered redundant and has been deleted. This brings the Directive into line with IAS requirements.
Consequential changes have been made to remove references to the deleted requirement.
Paragraphs 3(a), 4(c) and 13 - The 7th Directive provides a limited number of exemptions from its requirements, on the basis of the economic importance of the company. It is now considered, consistent with the Commission's proposals in respect of the use of IAS by EU listed companies, that such exemptions should not be available to listed companies, regardless of their economic size. This is a reflection of the overriding economic importance that attaches to the public trading of a company's shares. Accordingly, these revisions remove the availability of the exemptions in the case of such companies.
Paragraphs 3(b) and 4(a) - These delete defunct time-based provisions.
Paragraph 7 - It is common practice for certain additional statements to be provided in consolidated accounts, for example a cash flow statement. This revision expressly empowers Member States to permit or require such statements be included in consolidated accounts. See also similar amendment in respect of annual accounts in Article 1, paragraph 1.
Paragraph 8 - This makes a consequential change resulting from amendments to the 4th Directive above.
Paragraph 11 - These changes expand the guidance on the content of the consolidated annual report and are consistent with those in Article 1, paragraph 14 above. Where both an annual report and a consolidated annual report are required, it may be appropriate to present the analysis as a single document, the primary focus being upon those matters which are significant to the undertakings included in the consolidation taken as a whole.
Paragraph 12 - These changes relate to the requirements in respect of the audit report concerning the consolidated accounts. The changes are consistent with those set out in Article 1, paragraphs 17 and 18 above.
Further to the objectives set out above, Article 3 makes those changes necessary to make the Directive 91/674/EEC of 19 December 1991 on the annual accounts and consolidated accounts of insurance undertakings compatible with IAS.
Most of the changes proposed are consequential to those to the 4th Directive described above.
Additional changes are proposed in order to reflect amendments made in May 2001 by Directive 2001/65/EEC to the 4th, 7th Directives and to Directive 86/637/EEC. These changes relate to the use of fair value in the case of certain specific items further to IAS 39 Financial Instruments: Recognition and measurement.
No amendments are currently proposed to the prescribed formats for the balance sheet and profit and loss account of insurance undertakings. Any such changes will be considered and where necessary enacted, only when an International Financial Reporting Standard specifically concerning insurance accounting is published.
Paragraph 1 - The first sentence of Article 1 i of the Directive 91/674/EEC has been updated to refer to new and amended Articles in the 4th Directive as follows:
* A new reference to Article 51a has been added, consistent with the insertion of this Article 51 into the 4th Directive (see Article 1, paragraph 18);
* A new reference to Articles 42a-42f of the 4th Directive concerning fair value has been added;
* The reference to Article 43 of the 4th Directive has been amended to include also point 14 concerning certain fair value disclosures;
* A new reference to Article 61a of the 4th Directive concerning the revision of the fair value provisions after three years of use (or five years after the adoption of the Directive) has been added.
* Concerning the reference to Article 46, a specification to paragraphs 1 and 2 is added.
* A new reference to Article 50a is added for the sake of completeness.
* The reference to Article 54 has been removed, as this Article no longer exists.
In addition, a new second sentence has been added in relation to financial assets and liabilities. It contains a 'double override' provision which specifies that Articles 46 to 48, 51 and 53 of Directive 91/674/EEC shall not apply in respect to assets and liabilities that are valued in accordance with Section 7a of the 4th Directive. The paragraph establishes the hierarchy of rules in Directive 91/674/EEC and the 4th Directive concerning financial instruments and is consistent with the amendment to Directive 86/635/EEC introduced in May 2001 by Directive 2001/65/EEC.
In addition, Article 1 i has been revised to reflect consequential changes to references.
Paragraph 2 - This paragraph makes a consequential change in terminology.
Paragraph 3 - In order to facilitate full application of IAS 39, an amendment is included in Article 46 i to enable Member States to allow companies to use different valuation methods for different elements of an investment item denoted by an arabic numeral or shown as assets under C i on the balance sheet. An amendment to Article 46 i requires that, where such different methods are applied, the notes to the accounts include a description of the methods used and the amount so determined.
The provisions in these Articles deal with the adoption and administration of the proposed Directive.
As noted in section 1 above, the proposed amendments will remove all inconsistencies between Directives 78/660/EEC, 83/349/EEC and 91/674/EEC and IAS in existence at 1 May 2002.
This conclusion is supported by a review of the proposals performed by the European Financial Reporting Advisory Group (EFRAG).
In the development of the proposals, a number of accounting topics were considered carefully before concluding that no inconsistency or conflict exists. Where this was the case, no proposal for amendment is necessary and none has been made.
Solely for the avoidance of doubt, it is noted that the following three topics have been considered and it has been determined that no conflict arises with respect to:
* The recognition of actuarial gains and losses in accordance with the so-called corridor approach described in IAS 19 Employee Benefits.
* The correction of errors as either a prior period adjustment or as a current period item in accordance with IAS 8 Net profit or loss for the period, Fundamental errors and Changes in Accounting Policies.
* The application of reverse acquisition accounting in accordance with IAS 22 Business combinations - ie where, in a business combination, the owners of a company being acquired receive as consideration sufficient voting shares of the acquiring company so as to obtain control over the new combined entity. In applying reverse acquisition accounting, the company issuing the shares is deemed to have been acquired by the other enterprise; this means that, from an accounting (as opposed to a legal) perspective, the latter enterprise is deemed to be the acquirer, and therefore the purchase method of accounting is applied to the assets and liabilities of the enterprise issuing the shares.
These topics and the conclusions expressed have been discussed and agreed with EFRAG.