The Use of International Accounting Standards in the European Union

Northwestern Journal of International Law & Business Volume 25 Issue 3 Spring Spring 2005 The seU of International Accounting Standards in the European Union Alexander Schaub Follow this and additional works at: http://scholarlycommons.law.northwestern.edu/njilb Part of the Accounting Law Commons, and the Comparative and Foreign Law Commons Recommended Citation Alexander Schaub, The sU e of International Accounting Standards in the European Union, 25 Nw. J. Int'l L. & Bus. 609 (2004-2005) This Symposium is brought to you for free and open access by Northwestern University School of Law Scholarly Commons. It has been accepted for inclusion in Northwestern Journal of International Law & Business by an authorized administrator of Northwestern University School of Law Scholarly Commons. The Use of International Accounting Standards in the European Union Dr. Alexander Schaub* 2005 is a watershed year for the application of International Accounting Standards (1ASs) in the European Union. From the first of January this year, all listed European companies must prepare their consolidated accounts using IASs or International Financial Reporting Standards (IFRSs).1 This requirement representsa quantum leap in the use of a single consistent set of accounting standardsfor capital markets in the European Union. I. THE BACKGROUND OF THE E.U. DECISION TO USE IASS A. Creation of Internal Market The E.U. treaty does not expressly provide for the harmonization of accounting standards as a Community objective. Rather, this objective has developed organically from the need to harmonize company law requirements for the creation of an internal market. Because of the substantial economic, social, welfare and political benefits, the E.U. treaty fixes as a common objective for Member States the * Dr. Alexander Schaub has been Director-General for the Internal Market and Services in the European Commission since September 2002. From 1995 to 2002, he was Director- General for Competition. During that period he was also Vice-President of the OECD Competition Committee. From 1990 to 1995 he was Deputy Director-General for Internal Market and Industrial Affairs and for Industry. From 1989 to 1995 he served as Director responsible for trade-related issues in the industrial sector and EC Special Representative for Textile Negotiations in the Uruguay Round. His career in the European Commission, which began in 1973, following two years with the Federal Ministry of Economics in Bonn, also includes service in the Cabinet of Commissioner Ralf Dahrendorf, as Deputy Head of Cabinet for Guido Brunner, Viscount Etienne Davignon and President Gaston Thorn, and as Head of Cabinet for Willy De Clercq. 1 International Accounting Standards (IASs) were adopted by the International Accounting Standards Board (IASB) in April 2001, when the IASB endorsed the body of IASs issued by its predecessor, the International Accounting Standards Committee (IASC). Accounting standards developed by the IASB are called International Financial Reporting Standards (IFRSs). Northwestern Journal of International Law & Business 25:609 (2005) creation of an internal market-an area allowing the free movement of goods, persons, services and capital. Two of the key principles to create this internal market are freedom of establishment and freedom to provide services, both on a cross-border basis. B. The Accounting Directives As business moves cross-border, companies need to be subject to comparable-but not necessarily completely identical-rules to provide equivalent protection for investors, shareholders and creditors. This leads to the need to develop and adopt common rules for financial reporting within the European Union through a series of Company Law Directives.2 The Fourth Company Law Directive provides for the preparation of audited annual accounts giving a "true and fair" view of a company's assets, liabilities, financial position and profit and loss. 3 This Directive, as amended, is still in force today and applies to the five million or so limited companies in the European Union. Two other Directives provide common rules for banks4 and insurance undertakings. 5 The Seventh Company Law Directive lays down common rules for the preparation of consolidated accounts.6 C. The Need for an International Approach While the Fourth and Seventh Directives lifted the quality of financial reporting and had the merit of preserving different national accounting traditions within the internal market, this often came at the cost of many options which hindered comparability. Furthermore, it was recognized that in relation to investors' needs, the Directives were capable of improvement in terms of addressing relevant issues and better reflecting economic reality. During the 1990's, efforts were made to address these weaknesses, but 2 Adopted under the terms of Article 44(2)g of the Treaty Establishing the European Community. TREATY ESTABLISHING THE EUROPEAN COMMUNiTY, Dec. 24, 2002, O.J. (C 325) 33, art. 44(2)g (2002), available at http://europa.eu.int/eur-lex/lex/en/treaties/dat/ 12002E/pdf/12002EEN.pdf. 3 Council Directive 78/660/EEC of 25 July 1978 on the Annual Accounts of Certain Types of Companies, 1978 O.J. (L 222) 11 [hereinafter Fourth Company Law Directive]. For reference, E.U. accounting legislation and other official documents can be found at the following Commission website: http://europa.eu.int/comm/intemalmarket/accounting/ officialdocs en.htm. 4 Council Directive 86/635/EEC of 8 December 1986 on the Annual Accounts and Consolidated Accounts of Banks and Other Financial Institutions, 1986 O.J. (L 372) 1. 5 Council Directive 91/674/EEC of 19 December 1991 on the Annual Accounts and Consolidated Accounts of Insurance Undertakings, 1991 O.J. (L 374) 7. 6 Council Directive 83/349/EEC of 13 June 1983 on Consolidated Accounts, 1983 O.J. (L 193) 1 [hereinafter Seventh Company Law Directive]. 610 The Use of InternationalAccounting Standards 25:609 (2005) for a variety of reasons, it was difficult to make further progress through Community legislation. For this reason, in 1995 the Commission adopted a Communication setting out a new strategy for accounting harmonization in the international market. The Communication identified that the most pressing need was the international vocation of European undertakings. The Communication recognized that the existing Directives as such were not suitable for the information needs of international capital markets and consequently large companies were increasingly being drawn to use U.S. Generally Accepted Accounting Practices (U.S. GAAP) in addition to their local Generally Accepted Accounting Practices (GAAP). This increased costs and sometimes resulted in confusion when comparisons were made to local GAAP.8 Furthermore, at a political level, the European Union had no influence on accounting standards adopted under U.S. GAAP, nor were the standards necessarily appropriate in an E.U. context. For these reasons, the Commission proposed that the European Union should place its full weight behind the international standards being developed by the International Accounting Standards Committee with the objective of establishing a set of standards that would be acceptable in capital markets world-wide. Given the needs of international companies and investors, priority was placed on consolidated accounts. D. The Financial Services Action Plan The implementation of this policy was given a new and decisive impetus by the development of the Financial Services Action Plan (FSAP).9 This was a regulatory reform package, composed of forty-two separate measures, with the objective of building a fully integrated European financial marketplace. The Plan was also a response to the growing importance of capital markets for corporate finance in the European Union. It was designed to allow E.U. companies and citizens to benefit fully from the advantages of the introduction of a common currency, the Euro. One of the main thrusts of the Plan was therefore to improve the quality of financial information in the European Union through a new reporting 7 Accounting Harmonisation: A New Strategy Vis-i-Vis International Harmonisation, COM(95)508 final at 2, available at http://europa.eu.int/conun/intemalmarket/accounting/ docs/com-95-508/com-95-508_en.pdf (last visited Mar. 31 2005). 8 When Daimler Benz listed on the New York Stock Exchange in 1999, the fact that its U.S. GAAP results showed a loss while its local GAAP revealed a profit became a cause c61+bre. 9 Press Release, European Commission, Financial Services: Commission Outlines Action Plan for Single Financial Market, (May 11, 1999), available at http://europa.eu.int/ rapid/pressReleasesAction.do?reference=IP/99/327&format=HTML&aged= 1&language=E N&guiLanguage=en. Northwestern Journal of International Law & Business 25:609 (2005) strategy. In March 2000, at the Lisbon Council, the Heads of State and Governments of the Member States decided that the FSAP should be implemented by 2005 at the latest. In June 2000, the Commission published a Communication proposing that all listed E.U. companies prepare their consolidated accounts in accordance with one single set of accounting standards, namely International Accounting Standards (1ASs).' ° Applying a common framework for financial reporting would bring about transparency and greater comparability between financial statements of companies operating on the same (European) capital market. This would contribute to greater market efficiency and, in turn, lead to a lower cost of capital for listed companies, thus providing a spur to investment, growth and employment. E. The IAS Regulation The Commission introduced its legislative proposal in February 2001. On June 7, 2002, after a single reading in the European Parliament, the Council of Ministers adopted the Commission's proposal for a Regulation on the application of IASs. 11 The key features of the IAS Regulation are described below. 1. Legal Instrument: A Regulation Rather than proceeding by way of a Directive (which is the traditional instrument used for the harmonization of company law, including accounting), the Commission decided to use another legal instrument available under the Treaty of Rome: a Regulation.

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