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Implementing the EU Implementing the EU acquisacquis

in accounting and auditingin accounting and auditing

World Bank REPARIS conferenceWorld Bank REPARIS conference

Vienna 25Vienna 25--26 March 200926 March 2009

Ulf LinderUlf Linder

Deputy Head of Unit Deputy Head of Unit -- AccountingAccounting

European CommissionEuropean Commission

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Agenda

Part 1: The acquis in financial reporting:

background and general comments on

the implementation

Part 2: Auditing

Part 3: Accounting

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Part 1Part 1

IMPLEMENTING EU ACQUIS IMPLEMENTING EU ACQUIS

FOR FOR

THE SINGLE MARKETTHE SINGLE MARKET

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EU Treaty of Rome

• EU Treaty Objectives:– To promote economic and social progress and

– a high level of employment ……

– In particular through creation of Internal Market….

• Internal Market : Area where goods, persons, services and capital can move freely

• Achieve through:– freedom of establishment cross-border and

– freedom to provide services cross-border.

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Internal MarketInternal Market

Area without internal frontiers in Area without internal frontiers in

which the free movement of goods, which the free movement of goods,

persons, services and capital is persons, services and capital is

ensured in accordance with the ensured in accordance with the

provisions of the Treatyprovisions of the Treaty

(Treaty EU, art. 7A)(Treaty EU, art. 7A)

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Need Company Law harmonisation

• As business moves cross-border need

comparable rules

(not necessarily identical rules)

• To protect investors, shareholders, and

creditors in companies

• Leads to company law harmonisation for

• Harmonised financial reporting in the EU

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The road to an acquis in accounting

and auditing

1978

44thth Dir. Dir.

Annual Annual

AccountsAccounts

77thth Dir. Dir.

ConsolidationConsolidation

88thth Dir. AuditDir. Audit

Banks Dir.Banks Dir.

1111thth Dir.Dir.

BranchesBranches

Insurance Dir.Insurance Dir.

IAS Reg.IAS Reg.

Prospectus Prospectus

Dir.Dir.

Transparency Dir.Transparency Dir.

New Audit Dir.New Audit Dir.

Equivalence Equivalence

mechanismmechanism

19831984

19861989

19912002

20032004

20062007

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Legal Mechanisms

• Regulations directly applicable

• Directives must be implemented into national

law

• Decisions of Commission / infringement

procedures

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Part 2Part 2

STATUTORY AUDITSTATUTORY AUDIT

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The Audit Directive in a nutshell

• Directive 2006/43/EC

• Adoption: 17 May 2006

• Transposition by Member States into national law: 29 June 2008

• Comprehensive, principles based Directive

• Minimum harmonisation

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Audit Directive - Key points

1. Approval, ownership and registration of

statutory auditors and audit firms

2. International Standards on Auditing (ISA)

3. Ethics and Independence

4. Public oversight and quality assurance

5. Specific requirements for the audit of

Public Interest Entities

6. Internal control and audit committees

7. International dimension

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1) Approval, ownership and registration

of statutory auditors and audit firms

• Education, training, good repute

• Mutual recognition of statutory auditors between

Member States

• Liberalized ownership and management

requirements for audit firms approved in the EU

• Enhanced public registration of auditors

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2) International standards on auditing

and audit report

• Option for the EU to adopt ISA, but no target

date

• If adopted, mandatory for all statutory audits

• IAASB Clarity Project

• Responsibility of group auditor

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3) Ethics and Independence

• Professional ethics and secrecy

• Independence: documentation of threats and

safeguards, no contingency fees, provision of

additional services

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4) Public oversight and quality

assurance

• Public Oversight

– Governed by a majority of non-practitioners

– Cooperation of Public Oversight bodies and

regulatory arrangements between Member

States

– Home country control principle

• Quality Assurance (every 6 or 3 years)

• Sanctions

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5) Specific requirements in relation to

Public Interest Entities

• Transparency report by audit firm

• Internal control and audit committee

• Rotation

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6) Internal control and audit

committees (1)

• Recital 24:

– Audit committees and an effective internal control

system help to minimise financial, operational and compliance risks, and enhance the quality of

financial reporting.

• Scope: all risks

– Member States may determine that the functions

assigned to the audit committee may be performed

by the administrative or supervisory body as a

whole.

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6) Internal control and audit

committees (2)

• Setting up an audit committee (Article 41):– Structure/composition: options for Member States,

exemptions possible• At least one member independent, with competence in

accounting and/or auditing

• Body performing equivalent functions to an audit committee

– Role : monitor• financial reporting process

• effectiveness of the company’s internal control, internal audit where applicable, and risk management systems

• statutory audit of the annual and consolidated accounts

• independence of the auditor

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6) Internal control and audit

committees (3)

• Role of the auditor (article 41§4)

– report to the audit committee on key matters

arising from the statutory audit, and in

particular on “material weaknesses” in

internal control in relation to the financial

reporting process.

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7) International dimension

• Registration and oversight of auditors from third

countries

– Derogation if equivalence and reciprocity

• Cooperation between Member States and third

countries

• Access to audit working papers

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ISA update

• The Commission may adopt ISAs for the

application in the EU

• Study on the cost & benefits

• Public consultation scheduled for late spring.

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Implementation of the Statutory Audit

Directive

• 15 Member States have fully transposed the

Directive into the national law

• 11 Member States expect to transpose by June

2009

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Part 3Part 3

FINANCIAL REPORTING FINANCIAL REPORTING

IN THE EUIN THE EU

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Structure: Accounting presentation

• The Accounting Directives - overview

• International accounting convergence –

IAS Regulation

• SME accounting developments in the EU

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Accounting Directives

• Fourth Company Law Directive – (78/660/EEC)• Audited annual accounts

• “True and fair “ view of company’s assets, liabilities, financial position, profit and loss

• Seventh Company Law Directive – (83/349/EEC)

• Consolidated accounts

• Eleventh Directive – (89/666/EEC) – NOT TREATED IN DETAIL Disclosure requirements of branches

• Sector-specific Directives for banking (86/635/EEC) and insurance (91/674/EEC) –NOT COVERED TODAY

• Several modernisations/updates of the Directives

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Accounting Directive are…

• difficult to transpose into law – but much more complicated to make work in practice

• full of sensitive political compromises (tendency to avoid reopening issues…)

• reflect accounting thinking at the time they were written

• at a crossroad… (I come back to this later on)

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• Good: - high basic level of accounting,

- respected national traditions

• Less Good : - many options,

- comparability / consistency

- difficult

- rules not suitable for

international companies in

global capital markets

Accounting Directives

+-

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ANNUAL ACCOUNTSANNUAL ACCOUNTS

4th Directive (1978)4th Directive (1978)

with subsequent amendments etc.with subsequent amendments etc.

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4th Directive – starting point

• One of the world’s most successful accounting

texts!

• Combines ”Anglo-Saxon” and continental

accounting traditions

• Preparations started in 1960’s,

redirection when the UK joined 1973

• Difficult negotiations – many options

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4th Dir. – Scope, ”True and Fair”

• ”The annual accounts shall comprise a balance

sheet, the profit and loss account and notes to

the accounts.”

• ”The annual accounts shall give a true and fair

view…”

– If not: additional information or non-

application of rules (”override”)

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4th Dir. - Layouts

• Standardised formats with possibility for

additions

• 2 possible layouts for P&L, 4 for balance sheet -

best practice from the time

• Further options in 2003/51: allow for ”current –

non-current balance sheet” and ”performance

statement”

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4th Dir. - Valuation rules

• Historical cost (purchase cost or production

cost)

• Inflation accounting, replacement values?

• Market value (Banks’ Accounts Directive)

• Current value (Insurance Accounts Directive)

• Fair value – included through 2001/65

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4th Dir. – Annual report, Auditing and

publication

• Contents of annual report (extended through

2001/65 and 2003/51)

• Disclosures (May 2006 amendments

off-balance sheet transactions,

internal control structures etc.)

• Publication of accounts (still controversial…)

• Auditing requirement

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CONSOLIDATED CONSOLIDATED

ACCOUNTSACCOUNTS

7th Directive (1983)7th Directive (1983)with subsequent amendments etc. with subsequent amendments etc.

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7th Dir. – main rules

• When consolidated accounts must be

established (legal versus control approach)

• True and fair approach

• Layouts and valuation – as in 4th Directive

• Uniform valuation methods in the group

• Consolidation techniques

• Participating interest (4th Dir.) vs. associated

undertaking (7th Dir.)

• Publication, auditing, cf. 4th Directive.

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INTERNATIONAL ACCOUNTING INTERNATIONAL ACCOUNTING

CONVERGENCECONVERGENCE

International Accounting International Accounting Standards Standards

International Financial Reporting International Financial Reporting StandardsStandards

IAS Regulation (2002)IAS Regulation (2002)applied from 2005 applied from 2005

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The IAS Regulation (EC/1606/2002)

• Regulation – directly applicable in all Member

States

• No need for national rules transposing EU law

• Less time consuming, no national variations

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Scope of the IAS Regulation

• Requirement: EU companies listed in the EU to

use endorsed IAS for consolidated accounts

• Non-EU issuers outside the scope

• Optional extension of the scope:

– unlisted companies

– individual accounts

– e.g. banks and insurance companies

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Endorsement - objectives

• Political and legal endorsement of IAS into EU

law

• Pro-active device for the shaping of future

standards

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Endorsement - infrastructure

• EFRAG (European Financial Reporting Advisory

Group)

• SARG (Standards Advisory Review Group)

• EU Accounting Regulatory Committee

• Commission

• European Parliament

• Council

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Endorsement criteria

• IAS not contrary to the "true and fair view"

principle of the 4th and 7th Accounting

Directives

• IAS must be conducive to the European public

good (competitiveness and convergence)

• IAS meet the criteria of understandability,

relevance, reliability and comparability

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Endorsement of existing IAS

• All existing IAS, except some hedging

provisions in IAS 39 have been endorsed

• Adopted IAS published in full in all official

languages of the Community in the Official

Journal

• Consolidation project

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Fitting IAS/IFRS into the existing legal

framework (1)

• Company Law Directives

– 4th, 7th Directives on accounting

– 2nd Directive on profit distribution

• The IAS Regulation ”overrides” the Directives

for companies in its scope

– MS can extend the scope of regulation

– If MS use IFRS to inspire national law for

other companies, these must be in line with

the Directives

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Fitting IAS/IFRS into the existing legal

framework (2)

• Even if a MS requires IFRS by all companies,

the Directives must be implemented

– Provisions not included in IFRS – only those?

– Part of a legal framework

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SME ACCOUNTINGSME ACCOUNTING

DEVELOPMENTSDEVELOPMENTS

IN THE EUIN THE EU

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Company categories

Source: 4th Company Law Directive and Micro proposal

≤ 250≤ 50≤ 10Average number of

employees during

the financial year

≤ € 35 000 000≤ € 8 800 000≤ € 1 000 000Net turnover

≤ € 17 500 000≤ € 4 400 000≤ € 500 000balance sheet total

MediumSmallMicroCategory

Threshold

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Action Plan

� Fast Track changes currently negotiated

� Option to exemption micro entities from the

Accounting Directives

� Launch of the revision of the Accounting

Directives

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Fast track changes

� Option to omit “formation expenses” disclosure

for medium size companies

� Alignment of consolidation rules to IFRS:

Parent companies with only immaterial

subsidiaries are exempted from consolidation

requirement

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Micro entities - definition

Companies that do not exceed two of three

criteria:

� Balance sheet total of €0.5m

� Net turnover of €1m

� Average employment of ten

Can be exempted from the scope of the Fourth

Directive on Accounting

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Micro entities - Impact

� Around 5.4m companies in the EU

� Estimated administrative burden of €6.3bn (Bookkeeping costs not included)

� Enable one stop shop reporting

� Even playing field with the US

� Minimal impact on cross border trade(only 7% active internationally)

� Voluntary application possible

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Revision of the Directives - Reasons

� Outdated directives

� Patchy updates

� Too burdensome for SME

� Impact of IAS Regulation

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Revision of the Directives - Goals

� Modernisation

� Simplification

� Clarification

Guided by “think small first” principle

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Revision of the Directives - Scope

Source: CSES study "Evaluation of Thresholds for Micro-Entities" (2008), Ramboll "Study on administrative costs of the EU Company Law Acquis" (

2007), Ramboll Management. 2005. Report on impacts of raised thresholds defining SMEs, own calculations

100%0.1%1%3%21%75%

7,158,2097,60896,562206,4191,477,8825,369,738

TotalListedLargeMediumSmallMicro

Estimated number of companies by segment

� Around 1.8m companies in core scope

Possibility

to exemptIFRSCORE

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Revision – road map

� Public consultation: 26 Feb - 30 Apr 2009

� Meetings with stakeholders and MS: 12 Jun ‘09

� Legal proposal and Impact Assessment:

Autumn 2009

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Consultation paper - contents

� Basic principles – qualitative characteristics

� Structure – "bottom-up" approach

� Member State options

� Definition and number of company categories

� Elements of annual accounts

� Publication requirements – electronic filing

� Layout requirements

� Notes to the accounts

� Valuation issues

� Creating one Accounting Directive – terms and technical language

� The future role of the Accounting Directives - Outlook

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Basic principles

� Separate section with principles� True and fair view (with override)� Going concern� Consistency� No off-setting� Separate valuation� Purchasing price� Continuity� Clarity� Comparability� Equivalent information

� No major changes just clear presentation

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Structure – "bottom-up”

Large

Medium

Small

Basic rules for small companies

Rules for medium-sized companies built

on rules for small companies

Rules for large companies built on rules

for medium and small companies

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Member State options

� Investigate the reasons for lack of utilisation of

all options

� Measures to simplify options

� Bottom up – “opt-in” replaces “opt-out”

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Publication requirements

Note: � Means mandatory requirement

���MS option to

exempt

Audit

accounts

��MS option to

publish abridged information

MS option to publish abridged

information

Publish

accounts

����Prepare

accounts

ListedLargeMediumSmall

(incl. micros)

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Elements of annual accounts

Note: � Means mandatory requirement* IAS Regulation 1606/2002

�−−−Cash flow analysis

��Can be

exemptedCan be

exempted

Consolidated

accounts

���Can be

exemptedAudit report

���Can be

exemptedAnnual report

����Profit and loss

account

��� certain

possibilities for abridged format

� possibility

for abridged format

Balance sheet

Listed*LargeMediumSmall

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Layout requirements

� Should it be prescribed?

� Key figures only (Small):� Tangible Assets� Inventory� Accounts receivable and other debtors� Cash� Capital and Reserves� Provisions� Liabilities,� Net turnover� Cost of sales� Interest� Tax,� Profit or loss for the year

� Extraordinary items?

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� Streamlining and simplification for all companies

� Key figures only (for Small)?� Valuation methods,

� Subsidiaries

� Financial commitments not on balance sheet

� Material off balance sheet arrangements

� Related parties transactions

� Average employment

� Management remuneration

� Credits and other commitments to management

� Fees for audit, assurance, tax advisory, non-audit services

Notes to the accounts

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Valuation issues

� Lighter regime for Small

� More harmonized for others

� More principle based

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Terms and technical language

� Merging 4th and 7th Directive

� Streamlined and modernised terminology

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The future role of the Directives

IFRS/Directive

Directive What

about IFRS PE?

Directive What

about IFRS PE?

DirectiveDirective (optional)

Future

framework

IFRS/Directive

DirectiveDirectiveDirectiveDirectiveCurrent

accounting framework

ListedLargeMediumSmallMicro

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Contact

Ulf LinderDeputy Head of Unit

Financial Reporting

℡℡℡℡ (32-2) 299 22 76���� (32-2) 292 17 49

� ulf.linder@ec.europa.eu

� http://ec.europa.eu/internal_market/accounting/index_en.htm

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