Potential Benefits And Limitation Of Adopting The IFRS For Germany

Table of Content

List of Abbreviations

List of Diagrams

List of Figures

List of Tables

1. Introduction

2. SMEs in Germany
2.1 Classification
2.2 Current situation

3. Critical Impact Analysis
3.1 Key Aspects
3.1.1 Investor Communication
3.1.1.1 Home Country
3.1.1.2 Abroad
3.1.2 Operations and Internal Procedures
3.1.2.1 Corporate Governance
3.1.2.2 Internal Planning
3.2 Further Aspects
3.2.1 Financing
3.2.2 Financial Statement Preparation
3.2.3 Legislation
3.2.4 Accounting and Tax

4. Summary and Conclusions

5. Appendices

6. References

List of Abbreviations

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List of Diagrams

Diagram 1: Structure of accounting regulation in Germany

Diagram 2: Reasons for the international accounting problem

List of Figures

Figure 1: Formula Perecentage-of-Completion-Method

List of Tables

Table 1: Classification Scheme for SMEs used by the IfM Bonn

Table 2: Classification Scheme for SMEs after the EU

1. Introduction

The IFRS, developed by the International Accounting Standards Board (IASB, 2004-2013, p. XIII), is applied by a growing number of companies. It aims to harmonise financial reporting standards in order to provide a true and fair view of the company’s situation (Wiecek and Young, 2010, p. 3-5). Moreover, the IFRS for SMEs, containing clear simplifications compared to the full IFRS, is attractive to international SMEs by making available transparency, stability and the basis to overall compare international entities for companies’ stakeholders (IFRS Foundation and IASB, 2015; Stolowy and Lebas, 2006, p. 16; Alfredson, 2009, p. 3-4).

Therefore, the following report aims to analyse the opportunities, negative impacts and limitations of adopting IFRS for German SMEs. At first, a classification of SMEs in Germany is given and their current situation is demonstrated. The next passage critically analyses the impact of an introduction of IFRS for SMEs in Germany. The analysis includes investigating if the effect varies in different crucial business factors of SMEs as well as their company type. At last, the results are summarised and recommendations are given.

2. SMEs in Germany

2.1 Classification

In order to provide a base for the following impact analysis this chapter aims to present the current situation of SMEs. Firstly, it is necessary to give a classification of size- and legislative-requirements for SMEs in Germany.

The EU provides its member states with a recommendation of criteria to classify SMEs (table 2, appendices). Slightly deviating from this, as shown in table 2, the German Institute for SME-Research Bonn categorises in the framework of its researches (IfM Bonn, 2004, p. 3).

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Table 1: Classification Scheme for SMEs used by IfM Bonn (Own representation based on Institute for SME-Research Bonn (iFM Bonn), 2004, p. 3)

Moreover, there are different approaches to subdivide SMEs company type. One possibility, which is used in the following analysis, is to divide in:

1.) Subsidiaries of listed companies
2.) Companies with German and foreign business (intent to expand)
3.) Companies with purely German business

Currently, SME’s in Germany have to apply German accounting standards and can decide voluntarily to compile the IFRS for SMEs to provide further information to shareholders and stakeholders. The German accounting standards (German GAAP) are characterised by the early development of accounting principles back in the 17th, 18th, 19th century, which can still be found in the more modern German legislation (Walton et al., 1998). The overall structure of the German law is demonstrated in the diagram below.

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Diagram 1: Structure of accounting-regulation in Germany (Own representation based on Walton, Haller et al. (1998), p. 80)

In contrast to the international rather “soft” standards dominated by a standard-setting body, German accounting standards are mainly based on clear legislation. Most of the relevant accounting rules are unified in the third book of the HGB (German Commercial Code) (Walton et al., 1998), whereas complementing rules form the system of GoB (principles of proper accounting). However, in contrast to other GAAPs, the German GoB are non-codified rules and principles of e.g. financial reporting and bookkeeping, which have been developed in accounting practise.

2.2 Current situation

The German economy is strongly characterised by small and medium-sized enterprises (SMEs) (Kayser and Wallau, 2002, p. 111). Of about 3.7 million companies in Germany, more than 99% have been categorised as “German Mittelstand”, with a revenue of up to EURm 500 (European Commission, 2015; KfW SME Panel, 2015). Employing about 15.5 million people, this segment contributes around 52% of the total economic output. The success of German SMEs is among others due to the high number of family-owned and owner-managed firms as well as the governmental support (Federal Ministry of Economics and Technology, 2012).

Since the internationalisation of companies has been immense in the recent history, the need for international standards in order to provide transparency and comparability is given. Already Hopwood (1989) outlined in his book “International Pressures for Accounting Change”, that accounting has never been a topic which is only characterised by national aspects (Hopwood, 1989, p. 1-3). As demonstrated in diagram 2 (appendices) the country-specific environment leads to issues in an international perspective. Therefore international investors call for a reduction of the diversity of accounting practise (harmonisation) and moreover similar accounting practises (standardisation) (Roberts et al., 2005). As shown by Spiceland and Agrawal (1993) mentioning 304 academic accounting journals, there is a high amount of literature addressing international accounting issues. Therefore, the following chapter aims to deeply analyse the impact of an adoption of the IFRS on German SME’s.

3. Critical Impact Analysis

3.1 Key Aspects

3.1.1 Investor Communication

3.1.1.1 Home Country

Since there are a number of business factors, which should be considered analysing the implication of IFRS for SMEs in Germany, the following analysis sets the focus on investor communication and operations, whereas further selected factors are discussed less intense in the next chapter.

At first, the impact on access and communication to investors in Germany, which is the base for companies’ financing, is evaluated. Investors mostly look for transparent targets with a well-structured reporting. According to Barth et al. (2011) and Hung and Subramanyam (2004) IFRS shows a higher information quality than German GAAP, whereas Wang and Yu (2009) deny these findings. Even if a higher information quality is assumed, it remains doubtful if the adoption leads to an improvement of investor communication in the home country since the investors are familiar and mainly satisfied with their home accounting standards. Moreover German SME already show an easier access to capital than the EU average (IFRS Foundation, 2012) and it could be argued that the transition even keeps some national investors from investments due to the need to familiarise with the new, international standards.

These findings apply to subsidiaries of listed companies as well as companies with purely German or additional foreign business. Therefore, it could be argued that the IFRS for SMEs would mainly bring additional costs due to e.g. less compelling dividend barriers and a higher volatility, whereas advantages remain rather uncertain (Mansi et al., 2009).

3.1.1.2 Abroad

Apart from the influence in Germany, this section aims to assess the impact on foreign investor communication. Since accounting standards vary all over the world, the adoption of IFRS could help SMEs to harmonise them (Barth et al., 1999) and thus provide potential investors with the ability to compare them (Murphy, 2000; Yip and Young, 2012) and take them into consideration for potential investments (Ball, 2006, p. 11). As companies are expanding globally, business is getting more and more international. Therefore, the complexity of cross-border transactions with different sets of business and accounting regulation, for subsidiaries of listed companies as well as German SMEs with foreign business, is growing continuously. Both stakeholder and potential financial investors are interested in reliable and transparent information (Epstein and Mirza, 2004, p. 5-6) . Therefore, the introduction of IFRS for SMEs could bring an improvement in international investor communication for both subsidiaries of listed companies and German entities with foreign business (ACCA, 2011, p.38).

However, it remains doubtful if SMEs with purely German business would benefit of an introduction. Since the main investments in those entities are made by German investors and the companies are not interested in expansion, the access to foreign investors might not be that attractive, especially in respect of the additional efforts and costs (Litjens et al., 2012).

3.1.2 Operations and Internal Procedures

3.1.2.1 Corporate Governance

Besides the access to investors, the influence on various factors of the SMEs operations and internal processes should be considered.

Firstly, the adoption of IFRS for SMEs could bring further company transparency, which in general leads to an improvement of corporate governance. Managers have to act more in the interest of the shareholders and due to the increase loss recognition timeliness the agency costs between managers and shareholders could be reduced (Ball, 2006, p. 11) . Moreover, the necessity to report within the year could improve the communication, planning and acceptance in group-companies (“levelling the reporting field“).

On the other hand, the higher frequency and quality of reporting could mainly be associated with increasing expenses, especially for standalone German SMEs. Thus, it could be concluded that the benefits in terms of corporate governance vary on the size of the entities. The empirical study of Eierle and Haller (2009) on German SMEs confirms this assumption, that the suitability and therefore the benefits and limitations of IFRS for SMEs are dependent on the company’s size.

3.1.2.2 Internal Planning

Moreover, the internal planning of SMEs could be affected in various way by the adoption. Whereas more transparent accounting standard make forecasts less noisy, more accurate and value relevant, some authors argue that IFRS through the fair value approach makes earnings more informative, more volatile and thus harder to forecast (Ball, 2006, p. 12). Referring to a study on 80 non-U.S. companies (13 different countries) adopting IAS between 1990 and 1993, showing that the adoption of IAS leads to a decrease of the absolute value of analyst forecast errors due to increasing transparency (Ashbaugh and Pincus, 2001, p. 63) . Since the IFRS for SMEs brings a higher information quality and quantity (Cameran et al., 2014), a similar result could be expected from the introduction.

Nevertheless, a change of accounting standards leads to a change in operations and thus goes hand in hand with application difficulties. Since larger companies imply a higher number and wider range of stakeholders sophisticated financial reporting, according to Eierle and Haller (2009), the expenses and benefits significantly vary on the company’s size. Especially the low knowledge of IFRS in smaller entities leads to difficulties in understanding the real costs and benefits of an adoption and could be quite challenging for small entities (Masca, 2012). This coincides with the findings of Francis et al. (2008), that the benefits of an adoption of the standards significantly vary due to different country factors (e.g. location) as well as firm factors (e.g. financing, ownership situation, expected growth, export activity). At last it should be mentioned, that if an improvement of the companies’ operations could be achieved, the IFRS adoption constitutes a competitive advantage over other market players (Mahzan and Yan, 2014).

All in all it could be said that the number one issue of SMEs, the access to capital (IFRS Foundation, 2014, p. 12), is relevant to SMEs with international business and the intent to further expand and moreover could be improved by an adoption. However, for entities planning to stick with their pure business activity in Germany this possibility is rather marginal. The benefits for internal procedures are highly discussed and vary significantly dependent of the company’s ownership- and business-situation.

3.2 Further Aspects

3.2.1 Financing

Besides the impact on investor communication, internal procedures and operations, this chapter aims to discuss some further, chosen aspects.

According to (Beyersdorff, 2013) global accounting standards increase companies’ access to global capital, as discussed in chapter 3.1.1.2 and thus reduce their costs. Banks usually require very detailed information, even additional documents to financial statements in order to assess the companies. Therefore it could be argued that the IFRS, bringing a higher information quality could improve the companies financing situation (Sinnett and Mesa Graziano, 2006). On the other hand banks have their own evaluation approaches and are not interested in e.g. the fair value methods for assets of IFRS (Quagli and Paoloni, 2012).

In theory the higher information quality and transparency should reduce cost of equity (Ball, 2006, p. 11). But, although there are empirical studies on the correlation, it is difficult to quantity these findings (Botosan, 1997). Moreover, as empirically proved by an academic study on German companies adopting IFRS there is no evidence for a positive correlation of IFRS adoption and lower cost of equity capital (Daske, 2014, p. 42) .

3.2.2 Financial Statement Preparation

Whereas the German GAAP is a legislation with strict rules concerning the accounting obligations, the IFRS is a standard with a need for interpretation (Ahmed et al., 2013). Therefore, an introduction of IFRS for SMEs in Germany would come up with additional costs due to the higher complexity, transition-, reorganisation- and follow-up-costs, e.g. due to the need for training of employees and the review of old financial statements. Especially for SMEs that are subsidiaries of listed groups, the introduction could reduce costs due a harmonisation of consolidated accounting and a consistency of reporting with eased budgeting.

Nevertheless, although IFRS is applied, the comparability of IFRS is limited and some previously discussed international accounting differences could still remain after the introduction. (Nobes, 2006, p. 234).

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