Questions and Answers:
“Mock Examination”
Chapter I: Financial Analysis
1. Information Needs of Investors
Q1 Which role play earnings in financial accounting? How are they defined and what is their purpose?
Financial Reporting – Questions and Answers Page 1
Q2 What, in accounting, is profit and what are dividends?
| Profit is x an income distributable to the owner in a market production process (business). x i.e. the share of income formation the owner is able to keep in the income distribution process. Dividends are x the amount actually distributed to the shareholders x i.e. the share of income formation the owner gets in the income distribution process. The difference between profit and dividends are the earnings retained in the company (e.g. for future investments. |
Q3 What are the purposes of determining a company’s earnings?
| There are two general purposes: x 1. Allocation » Dividend distributions (Getting the company’s fair amount of dividends or legal min/max) » Income taxation (Getting the company’s income tax base) x 2. Evaluation » Information (Getting the company’s value) » Motivation (Creating performance measures and incentives for management) |
Q4 Which approaches to measure the value of a company can be distinguished?
| There are two approaches to measure the value of a company: x 1. Substance evaluation approach: Company value is the sum of all assets on balance, e.g. » Net asset value approach » Liquidation value approach x 2. Total evaluation approach: Company value is the result of the ability of the company to earn sustainable financial surpluses combining and utilizing all assets on and off balance, e.g. » Absolute valuation (intrinsic) » Relative valuation (extrinsic) |
Q5 What are the differences between the two categories of total valuation models?
| x Absolute valuation models » Absolute valuation models attempt to find the intrinsic or “true” value of an investment based only on fundamentals. » Looking at fundamentals simply mean you would only focus on such things as dividends, cash flow and growth rate for a single company, and not worry about any other companies. » Valuation models that fall into this category include the dividend discount model, discounted cash flow model, residual income models and asset-based models. x Relative valuation models » Relative valuation models operate by comparing the company in question to other similar companies. » These methods generally involve calculating multiples or ratios, such as the price-toearnings multiple, and comparing them to the multiples of other comparable firms. » Generally, this type of valuation is a lot easier and quicker to do than the absolute valuation methods, which is why many investors and analysts start their analysis with this method. |
Q6 What are key differences between debt and equity investments?
| Key differences are represented in the following points: | ||||
| Basis for Debt Comparison | Equity | |||
| Meaning | Funds owed by the company towards another party | Funds raised by the company by issuing shares | ||
| What is it? | Loan funds | Own funds | ||
| Reflects | Obligation | Ownership | ||
| Term | Comparatively short term | Long term | ||
| Status of holders | Lenders | Proprietors | ||
| Risk | Less | High | ||
| Types | Term loan, debentures, bonds etc. | Shares and stocks | ||
| Return | Interest | Dividend | ||
| Nature of return | Fixed and regular | Variable and irregular | ||
| Collateral | Essential to secure loans, but funds can be raised otherwise also. | Not required | ||
2. Decision-Useful Accounting
Q1 What to we mean by ‘earnings quality’ and ‘decision-useful’ accounting?
| We want reported earnings to accurately represent current operating performance and to aid in accurately forecasting future operating performance. (Dogma of decision usefulness: Information value for the investor’s decision making process) x Therefore, high quality reported earnings amounts for a particular period should: » represent the underlying economics of the business; and » be both persistent and predictable (the metric should be stable over time). The two fundamental qualities of decision-useful financial accounting are x Relevance: The metric is timely and has predictive power; it can confirm or reject prior predictions and has value when making new predictions. x Reliability: The metric is verifiable, free from error or bias and accurately represents the transaction. |
Q2 How do cash and accrual accounting compare with respect to relevance and reliability? Which one is more decision-useful?
| The following chart shows how cash and accrual accounting compare with respect to relevance and reliability: | ||||
| Relevance Reliability | ||||
| Cash Accounting | Low, due to instability of earnings measurement | High, because deals with completed transactions | ||
| Accrual Accounting | High, due to periodicity | Low, because it relies on management’s expectations | ||
| Accrual accounting is persistent over time and thus has more predictive power about future periods’ earnings. |
Q3 What is meant by the idea of ‘periodicity’ in accrual accounting and which principles does it cover?
Periodicity states that each transaction should be assigned to a given period and split accordingly if it covers several periods. x Realisation principle: Recognise revenues in the period in which they were actually earned!
x Matching principle: Match the related expenses to the earned revenue!
Q4 What is meant by ‘flexibility’ in accounting and which types can be distinguished from the perspective of the management?
| Unintended vs. intended flexibility: x Management judgement » One company’s reported earnings are not of the same exact quality as another’s because each management team uses its own judgment when recording business transactions. » Hopefully, management uses its judgment in a manner that reflects the stated principles and qualities of accrual accounting, but even with honest efforts to forecast the future, management will not always produce accurate accrual estimates, such as when business conditions change and what were thought to be very low-probability events occur more frequently than predicted. x Earnings management and window dressing » Unfortunately, management may not be so principled and can intentionally bias accrual estimates within accounting principles in order to meet performance targets. They can do this by knowingly under- or overestimating accrual amounts in a variety of different areas at the start of the transaction. » In addition, management can maintain accrual accounts based on old assumptions, even though they should adjust them to more accurately reflect new events and conditions. |
Q5 Please name and describe three balance sheet items where management has high/low accounting flexibility!
| Degree of management discretion when applying accounting rules: | ||||
| Accrual Item Management Flexibility | Degree | |||
| Current Accruals | ||||
| Inventory | Influence the allocation of overhead between inventory and COGS and estimating the value of inventory | High | ||
| Accounts Receivable | Estimating product returns and the portion that is uncollectible | High | ||
| Accounts Payable | These are financial obligations that can be measured reliably | Low | ||
| Other Current Liabilities | These are financial obligations that can be measured reliably | Low | ||
| Non-Current Accruals | ||||
| PP&E and Goodwill | Estimating the residual value of assets and choice of depreciation schedule | High | ||
| Investments – Other | Investments in marketable securities can be measured reliably, but the value of long-term receivables may not be | Middle | ||
| Pension Liabilities | Estimating returns on plan assets, discount rate on liabilities and growth in wages and healthcare costs | High | ||
| Long-Term Debt | These are financial obligations that can be measured reliably | Low | ||
Q6 Please name and describe three possible reasons for accounting manipulation!
| Areas in which manipulating business accounts might benefit management to the detriment of report users: | ||
| Debt Covenants Financial Market Reasons Management Compensation Tax Reasons Regulatory Reasons Competitive Reasons | Firms that are close to violating contractual agreements have incentive to reduce the probability of covenant violation, specifically where they are required to maintain prespecified interest coverage and liquidity ratios. | |
| Management may want to present data to influence stock or bond prices in the near term for a merger/acquisition or options that it wants to exercise. | ||
| Bonus compensation may be tied to performance targets. | ||
| Some accounting policies must be used in shareholder reporting if the company wants to use it for tax reporting. For example, firms are required to use LIFO inventory accounting for this purpose. | ||
| Management may want to present favorable data for antitrust review, tariff considerations or due to concerns regarding an “excess-profit tax.” | ||
| Management may want to present data to influence labor negations or to discourage new business competitors. | ||
Q7 What does the abbreviation ‘GAAP’ stand for? What are their typical elements and sources? What are their purposes?
| Generally Accepted Accounting Principles (GAAP) are a common set of accounting principles, standards and procedures that companies must follow when they compile their financial statements. (However: Often no legally defined term!) x Elements: Usually consist of pervasive principles and qualitative characteristics (framework) plus detailed standards x Sources: Legislation, best practice, academics, auditors x Purpose: » GAAP improve the clarity of the communication of financial information. » GAAP is meant to ensure a minimum level of consistency in a company’s financial statements, which makes it easier for investors to analyse and extract useful information. | ||
| » GAAP also facilitates the cross comparison of financial information across different companies. |
Q8 Can you think about some general limitations accounting standards may have with regard to a company valuation?
| Limits on a company’s equity valuation based on financial information from accounting standards: x On the substance value: Accounted equity (net assets) is (only) the residual of assets and liabilities. » What about hidden reserves? » Equity does not necessarily represent the shareholder value! x On the total value: Financial accounting is based on historic data (“status quo”). » Might fail to predict cash flow! » How to faithfully consider growing, shrinking or changing businesses? |
3. Company Valuation and Performance Measures
Q1 Please describe in detail the two areas of conceptual problems with Dividend Discount Models (DDM) in general and the Gordon Growth Model (GGM) in particular!
| The first area of conceptual problems with the DDM and GGM arises from the discount rate: x What should be “expected”? A sticking point with the DDM is that no one really knows for certain the appropriate expected rate of return to use. It’s not always wise simply to use the long-term interest rate because the appropriateness of this can change. x The presumption of a steady and perpetual growth rate less than the cost of capital may not be reasonable. » No fancy DDM model is able to solve the problem of high-growth stocks. If the company’s dividend growth rate exceeds the expected return rate, you cannot calculate a value because you get a negative denominator in the formula. x The stock price resulting from the model is hyper-sensitive to the growth rate chosen. The second area of conceptual problems with the DDM and GGM arises from two issues with the cash flow projection: x Issue 1: Dividend projection from FtE » Why does the FtE differ from dividends (in the short term)? Remember: FtE represents the generated cash flow which is allocatable to its owners, but not the actual distribution to the equity investors! » Distribution depends on the dividend policy. Most companies will retain a certain amount of the FtE as a reserve! x Issue 2: FtE projection from actual cash flows » Why may this year’s cash flows differ from a recurring FtE? Remember: Cash flows of the current period to not necessarily represent a long-term average of FtE! » Non-recurring transactions like investing and financing activities might affect actual cash flows which are not representative for the coming years. (“Garbage in, garbage out”) |
Q2 In 2019, Company X had a cash flow to equity (FtE) of € 1.000, no investing or financing activities took place. Considering that operating expense of X in 2019 included regular depreciation of € 400, and X has a policy to only pay out 2/3 of its profits, please determine the equity value of X as of 2020 from the 3 earnings measures FtE, profit and dividends. Use the presumptions of a GGM with a growth rate of 3% p.a. and an expected return on equity of 7% p.a. How would you evaluate the appropriateness of these three calculated values?
| Three ways on different GGM bases of X from current year‘s financials: x Based on flow to equity: » ܧ= ி௧ாబכ(ଵା) = € ଵ. כ (ଵା,ଷ) = € 25.750 ಶି ,ି,ଷ » Valuation is too high, actual FtE does not consider reinvesting effects. x Based on profit: » ܧ= బכ(ଵା) = € כ (ଵା,ଷ) = € 15.450 ಶି ,ି,ଷ » Valuation is appropriate (within the limits of GGM). x Based on dividends: » ܧ= ௗబכ(ଵା) = € ସ כ (ଵା,ଷ) = € 10.300 ಶି ,ି,ଷ » Valuation is too low, actual dividend policy does not consider long-term effects from retained earnings. |
Q3 In 2019, Company Y accounted a profit of € 1.000k and a book value of its net assets of € 5.000k. Its number of issued shares amounts to 4.000.000. Its share price on the market at the end of the year amounts to € 5. Please describe and calculate the core investment ratios used for relative valuation models of Y for the financial year 2019. Assume a year-over-year growth rate of its earnings of 8%. Y has paid total dividends of € 200k in the course of the year.
| The following investment ratios of Y for the financial year 2019 can be calculated from the fact pattern: x Earnings per Share (EPS): » Bringing earnings for the total company to the value of a single share: » ܧܲܵ = ்௧ ா௦ = € ଵ. = 0,25 €/ݎ݄ܽݏ݁ ்௧ ே. ௌ௦ ସ. x Price Earnings (P/E) ratio: » P/E ratio can be thought of as how long a stock will take to pay back your investment P if there is no change in the business (like „amortisation period of current share price“): » = = ହ € = 20 ா ாௌ ,ଶହ €/௦ x Price-to-Book (P/B) ratio: » P/B ratio represents the value of the company if it is torn up and sold today. The book value usually includes equipment, buildings, land and anything else that can be sold, including stock holdings and bonds. » = (ெ௧ ) = ସ. ௦ כ ହ € = 4 ௨ € ହ. x Price-to-Earnings-Growth (PEG) ratio: » The PEG ratio is calculated by taking the P/E ratio of a company and dividing it by the year-over-year growth rate of its earnings. The lower the value of your PEG ratio, the better the deal you’re getting for the stock’s future estimated earnings. ು » PEG = ಶ = ଶ = 2,5 ଼Ψ x Dividend yield: » The dividend yield shows how much of a payday you’re getting for your money by dividing the stock’s annual dividend by the stock’s price. You can think of that percentage as the interest on your money, with the additional chance at growth through the appreciation of the stock. » ݕ݈݅݁݀ = ௩ௗௗ௦ = € ଶ = 0,01 (ͳΨ) (ெ௧ ) ସ. ௦ כ ହ € |
Q4 Company Z is presenting the following financial statements:
Balance sheet as of 31 December 2019:
| Total Assets | k€ | Total Equity + Liabilities | k€ |
| Fixed assets | Equity | ||
| PPE | 1.500 | Capital | 100 |
| Retained Earnings | 600 | ||
| Current assets | P/L (Income) | 500 | |
| Inventories | 700 | ||
| Trade receivables | 400 | Long-term liabilities | |
| Cash | 200 | Loan | 500 |
| Provisions | 300 | ||
| Short-term liabilities Trade payables | 800 | ||
| 2.800 | 2.800 |
Income statement for the Year 2019:
| k€ | |
| Revenues | 2.500 |
| Cost of goods sold | -1.000 |
| Gross profit | 1.500 |
| General administration | -500 |
| Selling expenses | -200 |
| Operating profit | 800 |
| Financial result | -100 |
| Income taxes | -200 |
| Profit | 500 |
Please calculate the performance ratios with regard to Z’s profitability, liquidity, activity and financial risk position!
| 1. Measuring profitability: Primary objective of a profit seeking company to make a profit to be able to provide a return to any investors and be able to grow the business by re-investment x Return on capital employed (ROCE) = Operating profit ÷ (non-current liabilities + total equity) [%] » € 800k ÷ (€ 500k + € 300k + € 100k + € 600k + € 500k) = 40% x Return on sales (ROS) = operating profit ÷ revenue [%] » € 800k ÷ € 2.500k = 32% x Gross margin (GM) = gross profit ÷ revenue [%] » € 1.500k ÷ € 2.500k = 60% |
| 2. Measuring liquidity: Used to give an indication of a company’s ability to manage and meet short term financial obligations x Current ratio = Current assets ÷ Current liabilities [%] » (€ 700k + € 400k + € 200k) ÷ € 800k = 1,625 x Acid test / Quick ratio = (Current assets – inventory) ÷ Current liabilities [%] » (€ 400k + € 200k) ÷ € 800k = 0,75 x A ratio in excess of 1 is desirable but the expected ratio varies depending on the type of industry. Equally a high ratio could indicate that any surplus cash is not being made efficient use of. 3. Measuring activity: Look at how well a business manages to convert statement of financial position items into cash x Asset turnover = Revenue ÷ Capital employed » € 2.500k ÷ (€ 500k + € 300k + € 100k + € 600k + € 500k) = 1,25 x Inventory days = inventory ÷ cost of sales × 365 days » € 700k ÷ € 1.000k × 365 days = 255,5 days x Receivable days = receivables ÷ credit sales × 365 days » € 400k ÷ € 2.500k × 365 days = 58,4 days x Payable days = payables ÷ credit purchases × 365 days » € 800k ÷ (€ 1.000k + € 500k + € 200k) × 365 days = 171,8 days 4. Measuring financial risk: Gearing indicates how well a business will be able to meet its longterm debts (Leverage) x Capital gearing I = non-current liabilities (debt) ÷ ordinary shareholders funds (equity) [%] » (€ 500k + € 300k) ÷ (€ 100k + € 600k + € 500k) = 66,67% x Capital gearing II = non-current liabilities (debt) ÷ (non-current liabilities + ordinary shareholders funds (debt + equity)) [%] » (€ 500k + € 300k) ÷ (€ 500k + € 300k + € 100k + € 600k + € 500k) = 40% x Interest cover = Operating profit ÷ Finance cost » € 800k ÷ € 100k = 8 |
Q5 What is benchmarking? Name and describe which types or levels of benchmarking can be derived from financial accounting data!
| Benchmarking is the establishment, through data gathering, of targets and comparators x Permits relative levels of performance (and particular areas of underperformance) to be identified. x The adoption of identified best practices should improve performance. Types and levels of benchmarking; mainly defined by whom an organisation chooses to measure itself against: | ||
| x Internal benchmarking » Other units or departments in the same organisation are used as the benchmark. x Competitive benchmarking » The most successful competitors are used as the benchmark. x Functional benchmarking » Comparisons are made with a similar function in other organisations that are not direct competitors. x Strategic benchmarking » Form of competitive benchmarking aimed at reaching decisions for strategic action and organisational change. |
Chapter II: Financial Reporting
1. Legal Framework of Financial Reports in the EU
Q1 Please briefly describe the general reporting requirements under the EU Accounting Directive:
- Which type of entities are in the scope of the Directive?
- What are their core reporting elements?
- Do you think the provisions lead to uniform accounting in the EU?
| Core observations from reporting requirements under the EU Accounting Directive: x 1. Scope (Chapter 1): » Undertakings listed in Annex I; and in Annex II, where all of the members of the undertaking in fact have limited liability (Corporation) [Art. 1]. » Categories of undertakings and groups by size [Art. 3]: Simplifications and exemptions for micro, small and medium-sized undertakings. x 2. Reporting elements (Chapter 2 to 5): » Annual financial statements comprising the balance sheet (BS), the profit and loss account (PL) and the notes to the financial statements [Art. 4]. » Contents of the management report [Art. 19]; including a non-financial [Art. 19a] and a corporate governance statement [Art. 20]. x 3. Reporting provisions (Chapter 2 to 4) | ||
| » Pro uniformity: BS and PL shall be prescribed based on layouts in Annexes III to VI [Art. 10 & 13]. » Con uniformity: General financial accounting principles with a lot of alternatives and options and minimum disclosure requirements [Art 6 to 18]. |
Please briefly describe the general reporting requirements under the EU Transparency Directive:
- Which type of entities are in the scope of the Directive?
- What are the periodic reporting requirements?
- Which accounting framework(s) do apply?
| Core observations from reporting requirements under the EU Transparency Directive: x 1. Scope (Chapter I): » Issuers whose securities are already admitted to trading on a regulated market situated or operating within a Member State [Art. 1] » No categories of undertakings and groups by size(!) x 2. Periodic information (Chapter II): » Annual financial report comprising [Art. 4] Audited financial statements (cf. Accounting Directive) Management report (cf. Accounting Directive) Responsibility statement by management » Half-yearly financial reports [Art. 5] x 3. Applicable accounting frameworks: » In case of separate accounts: drawn up in accordance with national law (Local GAAP) » In case of consolidated accounts: drawn up in accordance with Regulation (EC) No 1606/2002 (IFRS): No alternative, no simplifications or exemptions |
2. Statutory Financial Statements
Q1 Please name and briefly describe the four dimensions of regulating financial reporting.
| The four dimensions of regulating financial statements are: x 1. Preparation » Define the nature, extent and content of financial statements an entity has to prepare via accounting standards. x 2. Audit » Require an external quality assurance by an auditor whether the statutory provisions and the supplementary provisions of the shareholder agreement or the articles of association have been complied with and to assure that misstatements and violations of the provisions that materially affect are detected if professional diligence is exercised. x 3. Publication » File and publish the (audited) financial statements with a registration agency (e.g. Electronic Federal Gazette in Germany). x 4. Enforcement » Review and supervision of financial statements after publication by an independent enforcement panel (usually for listed companies only). In case of an error detection, company has the requirement to publish that error. |
Being in the legal form of a corporation is the relevant prerequisite for an entity to fall under the advanced accounting legislation starting from Sec. 264 (part 2 of the 3rd book) under German Commercial Code. Please name and describe any three distinguishing features between a corporation and a partnership.
| General (non tax/accounting) considerations of a corporation vs. partnership: | ||||
| Corporation Partnership | ||||
| Life | A corporation continues until dissolved by law (unless a statute limits the time). | For the term specified in the partnership agreement: death of a partner may dissolve it earlier. | ||
| Entity | Has entity separate from its stockholder. A corporation can sue and be sued, hold and deal in property. | Has (in some jurisdiction) no separate entity from the partners. | ||
| Liability | A stockholder has no individual liability; only his capital contribution is involved (exception: some state laws subject bank stockholders to double liability). Shareholders may be liable if the “corporate veil” is pierced. | General partners are individually liable for all partnership obligations: limited partners are usually liable only up to the amount of their capital contributions. | ||
| Changing Ownership | Stock can ordinarily be sold or otherwise transferred at will. | Change in interests may create a new partnership. Arrangements are necessary to end liability of ex-members. | ||
| Raising Capital | A corporation raises capital by sale of new stock or bonds or other securities. | Only by loan, or by new membership, or contributions of present members, or by remaking the firm. | ||
| Making Policy | Corporate authority is centered in its board of directors, acting by majority agreement. | Unanimous agreement of partners usually required, involves problems of personality. | ||
| Credit | As separate entity, a corporation has credit possibility apart from stockholders: in close corporation. stock is available as collateral. | Depends on standing of individual partners; partnership interests usually can’t be pledged. | ||
| Management | Stockholders are not responsible: managers are employed. | By partners; they are responsible (except silent partners). | ||
| Flexibility | A corporation is limited to the powers (express and implied) in its charter from the state; may be subjected to judicial consideration. | Partners have leeway in their actions except to the extent limited by the Partnership agreement (occasionally by law). | ||
3. Financial Statements of German Corporations
Q1 A German corporation (GmbH) was founded in 2015. Over the years, the following size criteria apply:
Year Total assets Sales Employees [Mio. €] [Mio. €] [࢚]
| 2015 | 0.1 | 3.0 | 5 |
| 2016 | 7.5 | 11.0 | 30 |
| 2017 | 5.0 | 13.5 | 60 |
| 2018 | 23.0 | 23.0 | 280 |
| 2019 | 10.0 | 50.0 | 100 |
On 1 May 2019 the entity changed its legal form to a stock corporation and applies for admission to trading of securities on a regulated market.
Determine the size of the entity acc. to HGB for every year from 2015 to 2019.
| Classification changes only apply if they are exceeded or fallen short of in two successive financial years: Year Total assets [Mio. €] Sales [Mio. €] Employees [࢚] Classification 2015 0.1 ч0,35 micro 0,7 < 3.0 ч12 small 5 ч10 micro 2014 micro (first year) = micro 2016 6 < 7.5 чϮϬ medium 0,7 < 11.0 ч12 small 30 чϱϬ small 2015 small + 2014 micro = micro 2017 0,35 < 5.0 чϲ small 12 < 13.5 чϰϬ medium 50 < 60 ч 250 medium 2016 medium + 2015 small = small 2018 23.0 > 20 large 12 < 23.0 чϰϬ medium 280 > 250 large 2017 large + 2016 medium = medium 2019 6 < 10.0 чϮϬ medium 50.0 > 40 large 50 < 100 ч 250 medium 2018 medium + 2017 large |
What are the size-dependent preparation requirements for a micro / small / medium / large corporation in Germany with regard to the format of the financial statements (balance sheet, income statement and notes) and of the management report?
| The following table summarises the size-dependent preparation requirements for a German corporation: | ||||||
| Micro Small Medium Large | ||||||
| § 267a | § 267 (1) | § 267 (2) | § 267 (3) | |||
| Balance sheet | Condensed § 266 (1), 4 | Condensed § 266 (1), 3 | Yes § 266 (2+3) | Yes § 266 (2+3) | ||
| Income statement | Specific § 275 (5) | Combine items § 276 | Combine items § 276 | Yes § 275 (2+3) | ||
| Notes | No § 264 (1), 5 | Yes § 264 (1) reliefs § 288 (1) | Yes § 264 (1) reliefs 288 (2) | Yes § 264 (1) | ||
| Management report | No § 264 (1), 4 | No § 264 (1), 4 | Yes § 264 (1) | Yes § 264 (1) | ||
4. Consolidated Financial Statements
Q1 Please describe the idea of consolidated financial statements by explaining the idea of a single econonomic entity approach.
| Consolidated financial statements the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity x They must present fairly the group’s financial position, financial performance and cash flows. x They are prepared by combining the financial statements of the group entities. x They should generally incorporate all of the information contained in the individual financial statements of the entities included in the consolidation. |
Q2 What are the core characteristics and differences between separate and consolidated financial statements?
| Separate and consolidated financial statements have different perspectives and objectives: x Single Entity (Separate financial statements): » Focussing on legal entity performance » Capital maintenance and distribution (legal approach) » Tax basis x Group (Consolidated financial statements): » Reporting the operating result of a business group » Showing combined financial condition (management approach) » Group not subject to tax |
Q3 Please describe the procedure for consolidation.
| Consolidation describes the process as the parent and its subsidiaries being combined by | ||
| x aggregation of financial statements of group entities as consolidated financial statements; x using uniform accounting policies for similar transactions and by adding together like items of assets, liabilities, equity, income and expenses; and x eliminating in full intragroup transactions. |
Q4 What are the legal sources for group accounting standards in Germany?
| The three legal sources for group accounting standards in Germany are: x German Commercial Code, 3. Book, 2. Part, 2. Subpart acc. §§ 290 to 315d HGB x German Group Accounting Standards (GAS) developed by the German Accounting Standards Board (Deutsches Rechnungslegungs Standards Committee – DRSC) acc. § 342 HGB x For listed groups: International Financial Reporting Standards acc. § 315e HGB |
5. International Financial Reporting Standards
Q1 Why does the global financial community need International Financial Reporting Standards?
The motivation and purpose for a global set of accounting standards like IFRS is, that Generally Accepted Accounting Principles (GAAP) derived on national or regional levels are not sufficient for a global financial reporting language for two reasons:
x 1st Matter: Comparability
» There is divergence in country practice in implementing accounting principles. So what about benchmarking with foreign companies?
x 2st Matter: Purpose and Quality
» Local GAAPs do not fit the purpose for investor communication as they are often focusing on legal aspects rather than on decision usefulness for investment decisions.
Q2 What are differences in objective and purpose Between IFRS and German GAAP?
Q3 When and for which types of financial statements are corporations in Germany obliged to apply IFRS as accounting standard?
Legal requirements to prepare statutory financial statements under IFRS:
x Consolidated financial statements:
» Mandatory use of IFRS, if parent company is traded in a regulated market, § 315e (1) HGB or in the process of being listed on such market, § 315e (2) HGB.
» Optional for all other groups, § 315e (3) HGB, i.e. relief from local GAAP group accounting is possible.
x Separate financial statements:
» No mandatory application of IFRS at all.
» Optional use of IFRS for publication purposes only, § 325 (2a) HGB, not for preparation(!),
i.e. no relief from local GAAP accounting possible.
Please consider the necessary endorsement of IFRSs in the EU (=applicable version):
x Endorsement = Publication of a standard in the EU Official Journal to become effective.
» Application Regulation (EC) No 1606/2002 set IFRSs as the international accounting standards to be used in the context of the Transparency Directive.
» Adoption Regulation(s) (EC) No 1126/2008 is continously amended to reflect changes in the IFRS as published by the IASB.
