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The new accounting standards in the Czech Republic, Hungary, and Poland vis-à-vis international accounting standards and European Union directives
The New Accounting Standards in the Czech Republic, Hungary, and Poland Vis-Wis International Accounting Standards and European Union Directives
Eva Jermakowicz Dolores F. Rinke
The objective of this study is to describe the new accounting regulations promulgated in three countries in Eastern and Central Europe: the Czech Republic, Hungary, and Poland. The description and examination focuses on selected accounting standards related to asset valuation and financial reporting. The article also compares specific valuation and financial reporting issues in these countries with the standards recommended by the International Accounting Standards Committee (IASC) and the directives of the European Union (EU). This comparison will help to assess the degree of harmonization between the accounting standards of the selected countries and those of the International Accounting Standards Committee and the directives of the ELI.
The transition of the post-communist countries of Central and Eastern Europe (CEE) from centrally planned economies to market economies has created the need for new accounting practices in that area of the world. In the past, accounting in these countries served as the means for central planners to collect data necessary for decision making and to measure performance against budgets. In a market economy, it is essential that the participants have access to impartial Eva Jemakowicz l Department of Accounting and Business Law, University of Southern Indiana, Evansville, IN 47712. E-mail: [email protected] Dolores F. Rinke l Department of Management, Purdue University Calumet, Hammond, IN 46323. E-mail: [email protected] Journal of International Accounting & Taxation, 5(1):73-87 All rights of reproduction Copyright 0 1996 by JAI Press, Inc.
ISSN: 1061-9518 in any form reserved.
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information derived primarily from accounting records. Both privatized enterprises and interested third parties have placed new demands on the accounting profession in CEE countries. The growth of private enterprise creates the need for reliable and accurate financial information. New managers need detailed management data for decision making. Shareholders need information for investment decisions. Potential foreign and domestic investors need to make informed choices and comparisons between enterprises. Creditors need to establish the credit worthiness of enterprises because trading balances and loans will no longer be guaranteed by the state. Moreover, governments want to measure the performance of state enterprises on a commercial basis, and the requirements of the taxation authorities will grow. In part, internal pressures for change have come from the desires of most CEE governments to join the European Union (EU), requiring the introduction of laws and regulations which expedite the process of harmonization. The external pressures for change arise from the need to attract foreign loans and investment guarantees. Here, the World Bank and the International Monetary Fund (IMF) play key roles in sponsoring changes. The purpose of this study is to describe the new accounting regulations promulgated in three Central and Eastern European countries: the Czech Republic, Hungary, and Poland. The description and examination focus on those accounting standards related to valuation of assets, income determination, and financial statement presentation. This article also examines and compares specific valuation and reporting issues of these new standards with the standards recommended by the International Accounting Standards Committee (IASC) and the directives of the European Union. This comparison could be used to determine the level of compliance or degree of harmonization of the accounting standards of these countries with more generally accepted standards so the feasibility of entry into the EU can be assessed. These three countries were selected for study because they are the CEE countries which are the most advanced in privatization of their economies and which show the highest level of direct foreign investments (World Investment Report 1994). Additionally, all these countries received the status of associate members to the European Union and are seeking full membership in the EU by the year 2000 (EU, Articles 68-70, 1994).
ACCOUNTINGPRINCIPLESANDCONCEPTUALFRAMEWORKS INTHECZECHREPUBLIC,HUNGARYANDPOLAND Accounting principles in the Czech Republic are established by decrees issued by the Ministry of Finance, the Commercial Code, and the 1992 Accounting Act. The new Czech accounting regulations (Zukonya Reguluce v
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Accountinku) were put forth in the form of a decree by the Ministry of Finance in the Czech Republic on December 12, 1991. A new legislative act, which became effective January 1, 1993, introduced a single set of accounting regulations for state and private companies which complied with the Fourth EU Directive. This act applies to all enterprises subject to income taxes. The reporting period is a calendar year. The annual reports prepared by Czech entities must contain a balance sheet, an income statement, and notes to the financial statements prepared in conformity with the book of accounts provided by the Ministry of Finance. In Hungary, the accounting principles, as well as the form and content of financial statements and related matters, are established in the Accounting Act, Law XVIII of 1991 (AZ zifSza’mviteli Tiinhzy), which was passed by Parliament on May 14, 1991. This act will be augmented and interpreted by the National Accounting Committee established by the Ministry of Finance, which is expected to carry the main burden of Hungarian accounting development. All Hungarian companies and other business entities are required to keep proper accounting records in accordance with the provisions of the Accounting Act. These provisions are general in the sense that they give individual entities wide discretion in designing and implementing their own accounting systems, but they are specific in regard to the minimum standards of internal control and documentation that must be achieved. The Hungarian annual report, prepared on a calendar year basis, consists of the balance sheet, the income statement, the notes, and the business report. The business report presents the financial statement analysis, all the significant events taking place after the end of the reporting period, data pertaining to the acquisition of the company’s own shares (treasury shares), and information on research and experimental development. In Poland, the new Act on Accounting (I/stuwa o Rachunkowosci), which was enacted by Parliament on September 19, 1994, and became effective January 1, 1995, applies to all enterprises-including banks, insurance companies, and health and welfare organizations both social and political-which are subject to Polish income taxes. The Act applies to all entities regardless of legal form or ownership if annual turnover (revenues) exceeds 400,000 ECU (European Currency Unit). The reporting period is a calendar year. The purpose of this Act was to introduce full compliance of existing standards with EU regulations including Directives IV and VII, Directive SW635 on financial statements of banks and other financial institutions, and Directive 91/ 674 on financial statements of insurance companies. The introduction of full compliance was a commitment Poland made while receiving the status of associate member with the EU (Articles 68-70 [Lisiecka-Zajac 19941 of the EU on the associate membership of the Republic of Poland with the EU). The general preamble to the Act states that new accounting standards should also comply with international standards if they do not contradict the EU directives and if their application
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is possible in the actual stage of Poland’s economic development. The Act was also intended to establish uniform accounting principles for all entities, to increase the social status of the accounting profession, and to create premises for future synchronization of accounting principles with income tax regulations (LisieckaZajac 1994). The Polish annual report includes the balance sheet, the income statement, the notes, and the business repolt. All corporations, in addition, are required to present a statement of cash flows. The most important accounting principles to be applied during the preparation of the annual report include accrual basis, going concern, conservatism, consistency, comparability, and materiality.
The process of harmonization of financial accounting standards within the European Union has been influenced by international accounting standards issued by the.Intemational Accounting Standards Committee (IASC) and EU directives. The Intemat~onal Accounting Standards Committee has, since its inception in 1973, attempted to reduce cross national differences in financial reporting practice. As of January X995, the IASC, with representatives from professional accountancy bodies in almost 80 countries, had issued 3 1 international accounting standards (IASs) and 49 exposure drafts (EDs). Despite the volunt~ nature of the IASC’s standards, there has been continuous international support for its work, The real catalyst behind the IASC’s move to substantially upgrade its standards is the International Organization of Securities Commissions (IOSCO). The IOSCO made a tacit agreement with the IASC that if IASC standards developed sufficiently, the IOSCQ would recommend to its member securities commissions that foreign financial statements complying with IASC standards be accepted for listing purposes (Fabler and Tori 1993). Since 1985, the EU has issued a number of directives for company law harmonization. These directives are a set of legislative instruments intended to provide guidance in the format and content of financial statements and the nature of the audit, among other policies and procedures. They are legally binding. Upon their adoption, the member states must transform the rules of the legal framework into national law within a specified period of time, usually three years. In this respect, the directives differ from the standards issued by the IASC, which have no real authority. The influence of the EU, however, reaches the intemational level via its impact on multinational enterprises operating within its area and through the active participation of the member countries in international accounting organizations. The EU accounts for almost one quarter of total world trade. In January 1995, with the entry of four very wealthy nations-Austria, Finland, Norway, and
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Sweden-the EU’s population increased to 372 million and its gross domestic product (GDP) to $6.3 trillion (Barnard 1994). The harmonization of financial accounting within the EU has been the main concern of two directives from the Council of Ministers: the Fourth Directive on the annual accounts of companies, which adopted the “true and fair’ view criterion for preparation and presentation of financial statements (July 1978); and the Seventh Directive on consolidated accounts (June 1983). The Seventh Directive’s overriding objective is that the consolidated accounts present a true and fair view of the assets, liabilities, financial position, and profit or loss of the consolidated entity. Both directives have been implemented in the national laws of all EU member countries.
COMPARATIVEANALYSIS OFSELECTEDVALUATION ANDFINANCIALREPORTINGSTANDARDS The international standards issued by the IASC and the EU directives are used as a reference point for comparing the selected valuation and reporting requirements of the Czech Republic, Hungary, and Poland. Table 1 presents differences in valuation and financial reporting standards among the selected CEE countries, the EU directives, and the IASC standards. In the case of inventories, the IASC standards (E32) advocate that FIFO and weighted average cost should be benchmark treatments, LIFO should be an allowed alternative, and the base stock method should be eliminated. The Fourth Directive of the EU requires member countries to apply actual cost, FIFO, LIFO, Weighted Average, or a similar cost method. In the Czech Republic and Hungary, permissible cost flows are FIFO and Weighted Average cost. Polish companies may also apply LIFO. The IASC standards and EC directives, as well as the standards in the three analyzed CEE countries, require inventories to be valued at the lower of cost or market (LCM). In the past in the Czech Republic, Hungary, and Poland, ambiguities existed concerning the valuation of self-manufacturing inventory-that is, inventory costs did not include manufacturing overhead. The IASC standards as well as the EU directives recommend that accounts receivable should be valued at net realizable value, the net amount expected to be received in cash. Important changes introduced by new accounting laws in the three countries include new rules on valuation of receivables and fixed assets. In the past, accounting regulations in these countries did not anticipate the possibility of otherwise solvent entities defaulting on their obligations. Bad debt reserves could be set up only in the case of balances due from entities placed into liquidation or bankruptcy. New accounting standards introduced in these countries moved toward reporting receivables at net realizable value.
Bad debt reserves se1 up only for balances past due 6 months or more. Depreciation plan based on asset usage. Straight-Line, or accelerated methods
Provision for uncollectible accounts is included in liability section of Balance Sheet Depreciation may be compiled by StraightLine, Declining-Balance method, or by usage. Lower of cost or market is required.
Provision for uncollectible accounts is recommended.
Rates for accounting depreciation are based on time, utilization period, or output.
Lower of cost or market is required.
Cost method is required.
Valuation of accounts receivable
Depreciation methods
Valuation of marketable securities
Accounting for longterminvestments
_
Cost method is recommended.
Inventory costs may be established either on FIFO, LIFO, or Weighted Average basis.
Permissible cost flows are FIFO and Weighted Average Cost.
Permissible cost flows are FIFO and Weighted Average Cost.
Inventory costing methods
Cost method is recommended.
Lower of cost or market is required.
Reporting period is calendar year.
Poland
Reporting period is calendar year.
Hungary
Companies required to make their accounts on calendar year basis.
Czech Republic
Accounting periods
Item
Cost method is preferred, but equity method may be used.
Market value or lower of cost or market is recommended.
Straight-Line depreciation, but Declining Balance or Units of Output are also permissible.
In keeping with the concept of prudence, receivables should be reduced to reflect net realizable value.
Fourth Directive permits use of FIFO, LIFO, actual cost, average cost, and others with no preferences.
Fiscal year other than calendar year permitted.
EU Directives
TABLE 1 Differences in Valuation and Financial Reporting Standards
ED40 proposes the equity method.
IAS recommends market value or lower of cost or market.
IAS4, IA%, IAS 16, and ED 43; straightLine depreciation, but other methods are allowed.
IASC recommends that receivables be shown at net realizable value.
ED32 recommends FIFO or Weighted Average Cost. LIFO is an allowed alternative. Base LIFO is eliminated.
Fiscal year other than calendar year permitted.
Revised IASS considers research expenditure as period expenses. Development expenditures are capitalized if certain conditions are met.
IAS 17 recommends that substance over form should be considered in recording leases. ED33 pending revision of IAS 12 on deferred taxes.
Fourth Directive makes a distinction between expenditures for research and those for development. Research costs should be expensed and costs of development project recorded as an asset. Preference is substance over form in recording leases.
The difference between accounting income and taxable income should be disclosed.
Costs of research written off as incurred. Costs of development may be capitalized and amortized over a maximum period of 5 years. No clear distinction is made between capital and operating leases for accounting purposes. Deferred taxes are recorded using tax rate which is valid for subsequent accounting period.
Costs of research written off as incurred. Costs of development may be capitalized and amortized over a maximum period of 5 years.
No clear distinction is made between capital and operating leases for accounting purposes. Deferred taxes are not reported on the Balance Sheet.
R&D costs related to successful projects may be capitalized. Amortization period should be less than 5 years.
No clear distinction is made between capital and operating leases for accounting purposes.
Deferred taxes are recorded using tax rate which is valid for subsequent accounting period.
Research and development (R&D) expenditures
Accounting for leases
Accounting for deferred taxes
(Continued)
E32 states goodwill must be recognized as an asset and amortized against revenues over a period not to exceed 5 years.
Purchased goodwill written off within a maximum period of 5 years (against revenues or equity).
Goodwill recognized only if acquired from third parties and then amortized over period not to exceed 5 years.
Goodwill recognized only if acquired from third parties and then written off over a period of 5 to 15 years.
Goodwill recognized only if acquired from third parties and then written off in 5 years.
Accounting for goodwill
IAS states that intercompany sales/ profits are to be eliminated. Recommended.
Seventh Directive requires elimination of intercompany sales/ profits. Not required.
Elimination of intercompany sales/ profits required. Not required. Financial statements cover 2 consecutive years.
Intercompany sales/ profits required to be eliminated. Not required. Law on Accounting requires comparative financial statements.
Czech law requires elimination of intercompany sales/ profits.
Not required.
Financial statements cover 2 consecutive years.
Elimination of intercompany sales/ profits upon consolidation
Disclosure of earnings per share
Presentation of comparative financial statements
Fourth Directive requires comparative financial statements.
Recommended.
E32 requires the purchase method for acquisitions and the pooling of interests method for uniting of interests.
Directive the purchase to account for combinations.
Seventh requires method business
Purchase method for all business combinations.
Purchase method for all business combinations.
Purchase method required to account for all business combinations.
Accounting for business combinations
IAS and IAS state that consolidated accounts should be provided.
Consolidated accounts are required by Seventh Directive.
Required if a company holds 50% of the equity or controlling interest.
Required if a company holds 50% of the equity or controlling interest.
Consolidated accounts required for 20% ownership interest.
Consolidated accounts
Revised IAS uses the concept of cash, or cash equivalent items as funds.
Fourth Directive does noI include the requirement of presenting a Statemenl of Changes in Financial Position.
Required.
Not required.
IASC
Czech law does not require Statement of Cash Flows.
EU Directives
Statement of cash flows
Poland
Czech Republic
Item
Hungary
TABLE 1 Continued
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Czech accounting regulations state that receivables should be reported at their nominal values. Losses from permanent impairment of the values which are known on the last day of the accounting period should reduce the nominal values of receivables. In Hungary, accounts receivable and other monetary current assets (except marketable securities) are shown at their face value. Receivables are presented at gross with an amount deducted for general turnover tax (charged on receivables) under the current assets section of the balance sheet. Provisions for uncollectible accounts are made in an amount which includes all anticipated losses and collection costs and are included in the liabilities section of the balance sheet. In Poland, receivables are reported at nominal values, and bad debt reserves are set up for accounts past due six months or more. The Act, therefore, gives the right to apply the principle of prudence in deciding on the realizable value of receivables to the entrepreneur. The IASC’S E32 and the Fourth Directive of the EU require the historical cost principle be used to value purchased property, plant, and equipment (PPE). Straight-line depreciation methods are recommended, but other methods, including accelerated depreciation, are allowed. All three CEE countries require the historical cost principle to be used. In the past, fixed assets were depreciated in accordance with rates specified in the official tables prescribed for tax purposes. In the Czech Republic, Hungary, and Poland, there has been a tradition of preparing financial statements in accordance with tax regulations. The new accounting regulations concerning depreciation of fixed assets constitute an important break with the past in these countries. A clear distinction is made between depreciation for accounting purposes and for tax purposes. For accounting purposes, the depreciation plan must be based on asset usage. Straight-line methods are recommended, but other methods, including accelerated depreciation, are also permissible. IAS classifies investments in marketable securities into short term and permanent. According to IAS25, short-term investments should be valued at market price or at the lower of cost or market (if listed on the securities markets). The IASC’s Exposure Draft 40 identifies three types of financial instruments depending on the firms’ purposes: financing and investment, hedging, and operating. ED40 proposes the use of fair market value for financial assets arising from operating activities. For financial assets held for investment purposes, the acquisition cost is recommended, but the use of fair market value is permitted. Any resulting difference in valuation between reporting dates is to be included in the income statement. ED40 also proposes the equity method to account for investments in which the investor has significant influence over the investee company. The Fourth EU Directive states that holdings in affiliated undertakings are to be valued at cost. The equity method is permitted provided that: (1) the use of the equity method is disclosed in the notes, (2) the differences between the cost and equity in the underlying net assets at the date of acquisition is shown separately in
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the balance sheet or notes, (3) the equity in the annual profit or loss is shown separately, and (4) the excess of the equity in the annual profit or loss over the dividends received is classified in a nondistributable reserve. Accounting principles in the Czech Republic, Hungary, and Poland require investments in marketable securities to be valued at the lower of cost or market (LCM). The cost method is recommended although the equity method is allowed. In accounting for goodwill, IAS permits either (1) recording goodwill as an asset with amortization against revenue over its useful life, or (2) immediate write-off against the company’s equity. The IASC’s E32 proposals are more restrictive in that goodwill must be recognized as an asset and must be amortized against revenues over a period not to exceed five years. The Fourth Directive of the EU is consistent with the IASC proposal and states that purchased goodwill is to be written off within a maximum period of five years. Member states may permit a longer period, provided that it does not exceed the useful economic life of the goodwill. The most controversial approach is the immediate write-off approach. Accordingly, goodwill is written off against equity with no charges made against current earnings. This approach is permitted in several European countries, including France, Germany, Italy, Switzerland, and the United Kingdom. Czech accounting regulations include only two statements related to intungible assets. Intangible assets acquired should be valued at historical costs while self-produced intangibles are reported at the lower of costs incurred or replacement value. Intangible assets should be amortized over a period not to exceed five years. In the past, intangible assets were not recorded at all (Dolezal 1992). In Hungary and Poland, goodwill is to be capitalized and amortized on a straight-line basis over a period of five years. The IASC states that research expenditures are considered period expenses, whereas development expenditures are capitalized if certain conditions are metif the company can prove there is a market for the products to which the development spending related, and the costs can be recovered. The EU Directive makes a distinction between expenditures for “research” and expenditures for “development.” Research costs should be expensed and the cost of development projects may be recorded as an asset and systematically amortized to expenses in current and future periods. The law in the Czech Republic does not make a distinction between research and development, but it does state that only research and development costs related to successful projects may be recorded as an intangible asset. In Hungary and Poland, costs of research must be written off as incurred, but the cost of developing a specific product may be capitalized and written off over a maximum of five years. The international standards (IAS 17) and EC directives recommend accounting for leases on the basis of their economic substance and not on the basis of their
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legal form. A lease may be in substance a simple rental agreement, called an operating lease, or it may be substantially the same as a purchase transaction, called a capital lease. Classification criteria have been established to distinguish operating leases from capital leases. In the Czech Republic, Hungary, and Poland, all lease transactions are to be accounted for as operating leases per the Ministry of Finance regulations. Accounting procedures, therefore, follow the legal ownership of the leased asset. No clear distinction is made between operating and capital leases for accounting purposes. Standards for deferred taxes and accounting for tax consequences of temporary differences between accounting income and taxable income, are still pending final approval by the IASC. The Fourth EU Directive requires disclosure of the difference between the tax charge reflected in the accounts and taxes actually paid. In the Czech Republic and Hungary, the Law on Accounting does not use the concept of “latent” taxes; therefore, deferred taxes are not shown on the balance sheet. Both tax payable and tax expense directly mirror the amounts calculated on the tax returns. The extent to which the tax charge is significantly affected by timing differences and the anticipated effects of recovery must be disclosed in the notes, however. New accounting regulations introduced in Poland permit recognition of the deferred tax liability or asset on the balance sheet which is calculated using the tax rate valid in subsequent accounting periods, but the new regulations do not provide clear standards of accounting for deferred taxes. Concerning the statement of cash flows, the IASC in its Revised IAS (formerly ED36) states that the entity must present a statement of changes in financial position as part of its annual financial statements. The IASC uses the concept of cash, or cash and cash equivalent items, as funds. This statement should report the periodic flow of funds classified into operating, investing, and financing activities. The EU directives do not require either a statement of cash flows or a statement of changes in financial position. The financial reporting requirements in the Czech Republic and Hungary do not require or recommend the presentation of a statement of cash flows. Such a statement would be very useful during the privatization of state companies. Taking into consideration that there is a limited number of companies listed on new stock exchanges, business valuation methods based on market multiples (i.e., price earning ratio) are of limited use. The most highly recommended business valuation methods for privatization purposes in each of these countries include discounted cash flows techniques. The Act on Accounting enacted in Poland introduced a requirement that all corporations prepare a statement of cash flows. The recommended method to prepare cash flows from operating activities is the indirect method because of its simplicity. In IAS and IAS (1989), the IASC states that worldwide consolidated accounts should be provided and should include all subsidiaries. Exceptions can
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be made provided they are justified and accounted for by the equity method. The IASC’s ED32 requires the purchase method to account for acquisitions and the pooling of interest method for uniting of interests. Consolidated accounts are covered in the Seventh Directive of the EU, which requires worldwide consolidations (Article 3), the use of the “fair value” approach when accounting for assets purchased through acquisition, the equity treatment of associated corporations, and segmental disclosure for line of business and geographical area. The “true and fair” view (Article 16) and uniform formats (Article 17) are also required. In 1983, an agreement was reached concerning the definition of a “group.” After contrasting the effective management control and share ownership criteria based on German law with the U.K. approach based on share ownership and control, a compromise was reached. Control criteria other than ownership can be applied by member countries on an optional basis (Radebaugh and Gray 1993,218). The Seventh Directive requires the purchase method to be used to account for business combinations. The new accounting laws promulgated in the three CEE countries require preparation of consolidated financial statements for all investments with controlling interests. This requirement is important since some privatized companies operate as holding companies. In conformity with the Seventh EU Directive, the accepted method of accounting for all business combinations is the purchase method. Elimination of intercompany sales and profits is required. Financial disclosure requirements were minimal in the past in all analyzed CEE countries, leaving the users of these statements to make assumptions when evaluating performance of an enterprise. Earnings per share, as well as disclosure of contingent liabilities, such as warranties or legal settlements, were not required. The new accounting laws do not introduce the requirement to present earnings per share in the financial statements. The annual reports in these three CEE countries should present comparative financial statements for two consecutive years.
SUMMARY
AND CONCLUSIONS
Accounting principles in the Czech Republic, Hungary, and Poland are in a state of transition. The reporting systems in these countries were not swept aside by new legislation. Instead, new regulations considered more appropriate to an emerging market economy have been superimposed upon the existing systems. Although the standard-setting bodies of these countries were confronted with choosing from sometimes conflicting accounting standards, they appear to have taken views consistent with those of the IASC and EU. The new accounting laws promulgated in the Czech Republic, Hungry, and Poland represent an important advance toward compliance with the EU directives.
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Although these countries are not members of the EU, they are parties to the European Accord of 1991, which foresees eventual full membership in the EU. In 1994, all three countries received associate status in the EU, and they should achieve full membership around the year 2000. Accession to full membership means a firm commitment by these countries to comply with the directives as reflected in many of the recently enacted legal reforms. These three countries have taken the requirements of the relevant EU directives into account or have fully implemented them when enacting accounting legislation (Price Waterhouse 1993). Adoption of the EU directives by the analyzed CEE countries constitutes an important step toward harmonization of accounting standards in the former Eastern bloc. It is also a very important step in improving the feasibility of entry into the EU. Despite the recent changes, revisions are still required in all three CEE countries to be in full compliance with both the EU directives and the IASC standards. Clear standards of accounting for long-term liabilities must be established (i.e., bonds, leases, deferred taxes) since there was no tradition of accounting for interest under the old system. More precise principles of accounting for the stockholders’ equity and consolidation accounting are also needed. The full disclosure principle should also be implemented. Each country’s accounting regulations make attempts to have the preparation of financial statements depart from conformity with tax regulations (i.e., depreciation accounting). Future attempts at harmonization should allow consolidated accounts to be prepared in conformity with the objectives of financial reporting rather than with the different objectives of tax law. Since consolidated statements are not used for tax purposes, these statements would be more informative and of better use in financial markets if prepared in conformity with accounting standards. Individual company financial statements, subject to taxes, could reflect valuation methods for tax purposes. In the Czech Republic, the Act on Accounting is very general and will need additional revisions (Cramer 1993). There are several areas in the Act which are unclear. Both the Act on Accounting and the Chart of Accounts are silent on the details of areas such as recording work in progress on long term contracts and the precise meaning of prudence. In order to comply with the Seventh Directive of the EU, the Czech Republic must establish more detailed guidelines for the preparation of consolidated financial statements. Requirements for financial disclosure should be increased and the presentation of the statement of cash flows must be required if the Czech Republic is to comply with the international accounting standards. Although Hungary was the first of these three CEE countries to issue revised accounting regulations, several issues, including valuation of assets and liabilities, need to be addressed. To comply fully with EU directives, Hungary must establish more detailed rules for the valuation of intangible assets. A clear distinction
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should also be made in accounting for funds provided by owners and creditors. According to current law, additional contributions from owners to satisfy losses are treated as liabilities as opposed to contributed capital (DRT International 1992). In order to comply with international standards, the reporting of the statement of cash flows must be required. The Act on Accounting enacted recently in Poland appears to be the most developed of the three countries. Important changes introduced by this new law include the new rules on valuation of assets. A big attempt was made to increase the disclosure of financial information. The amount of information each business entity will have to disclose in the notes to the financial statement will increase significantly. The new Polish accounting law provides new standards on consolidation accounting and a requirement to prepare a statement of cash flows. The question that arises is whether eventual harmonization within the EU will conflict with international harmonization. The EU is committed to internal harmonization as part of its common market policy, which applies to all sizes and types of enterprise. A recent study by the Federation des Experts Comptables Europeans (FEE) demonstrates that current IASC standards are, with minor exceptions (e.g., the statement of cash flows, the pooling of interest method of accounting for business combinations), consistent with the EU directives, and it recommends that IASC standards should therefore qualify as equivalent (Thorell and Whittington 1994). Compliance does not provide for issues which are not presently covered by the directives. New accounting standards introduced in Czech Republic, Hungary, and Poland implement the EU directives and also go beyond these directives, making attempts to conform to international standards (i.e., the requirement to prepare the statement of cash flows in Poland). Accounting laws in these countries aim to comply with international standards to the extent possible during the transition period to a market economy (Lisiecka-Zajac, 1994). There is the possibility that conflicts between EU direcpftives and IASC standards may arise in the future as a consequence of the IASC taking a more restrictive attitude toward alternative accounting methods. It is recommended that future research be conducted as these anticipated changes occur in the CEE countries to determine whether the new standards comply with those issued by the IASC.
REFERENCES Barnard, Bruce. 1994. EU enlarges. Europe: Magazine of the European Comrnuni~ 33S(April): ss LSS2. Cramer, John. 1993. Privatization in Czechoslovakia and the EC. European Business and Economic Development (part 4, January): I.
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Czechoslovakia, Ministry of Finance. 1991. Act on Accounting (Zakonya Regulate v Accountinku). Prague: Federal Finance Ministry. Dolezal, J. 1992. Czechoslovakia. In The Europenn Accounting Guide, eds. D. Alexander and S. Archer, 42-46. London: Academic Press. DRT International (DRT). 1992. Hungary: International Tax and Business Guide. New York: Author. Hungary, Ministry of Finance. 1991. Act on Accounting (AZ uf Szamviteli Torveny): Budapest: Author. International Accounting Standards Committee (IASC). 1989. Exposure Draft 32: Comparability of Financial Statements. London: International Accounting Standards Committee. London: Author. Lisiecka-Zajac, B. 1994. Ogolna Charakterystyka Ustawy o Rachunkowosci [Act on Accounting, General Characteristics]. In Rachunkowosc. Zeszyt Specialhy [Journal ofAccounting. Special Issue], 35-38. Warsaw, Poland: Association of Accountants in Poland. Pahler, A.J., and J.E. Mori. 1994. Advanced Accounting-Concepts and Practice. The Dryden Press: Harcourt Brace College Publishers. Poland, Ministry of Finance. 1994. Act on Accounting (Ustawa o Rachunkowosci). Warsaw: Author. Price Waterhouse. 1993. Doing Business in Hungary. New York: Price Waterhouse World Film, Ltd. Radebaugh, Lee H., and Sidney J. Gray. 1993. International Accounting and Multinational Enterprises. 3rd edition. New York: John Wiley & Sons. Seal, W., P. Suchar, and I. Zelenka. 1994. The rise of a profession. Paper presented to the 17th Congress of the European Accounting Association, Venice, Italy, April. Thorell, P., and G. Whittington. 1994. The harmonization of accounting within the EU-Problems, perspectives and strategies. The European Accounting Review 3(2): 60-64. World Investment Report. 1994. Transnutionul Corporations, Employment and the Workplace. New York: United Nations Economic and Social Council, Commission on Transnational Corporations.
Eva Jermakowicz Dolores F. Rinke
The objective of this study is to describe the new accounting regulations promulgated in three countries in Eastern and Central Europe: the Czech Republic, Hungary, and Poland. The description and examination focuses on selected accounting standards related to asset valuation and financial reporting. The article also compares specific valuation and financial reporting issues in these countries with the standards recommended by the International Accounting Standards Committee (IASC) and the directives of the European Union (EU). This comparison will help to assess the degree of harmonization between the accounting standards of the selected countries and those of the International Accounting Standards Committee and the directives of the ELI.
The transition of the post-communist countries of Central and Eastern Europe (CEE) from centrally planned economies to market economies has created the need for new accounting practices in that area of the world. In the past, accounting in these countries served as the means for central planners to collect data necessary for decision making and to measure performance against budgets. In a market economy, it is essential that the participants have access to impartial Eva Jemakowicz l Department of Accounting and Business Law, University of Southern Indiana, Evansville, IN 47712. E-mail: [email protected] Dolores F. Rinke l Department of Management, Purdue University Calumet, Hammond, IN 46323. E-mail: [email protected] Journal of International Accounting & Taxation, 5(1):73-87 All rights of reproduction Copyright 0 1996 by JAI Press, Inc.
ISSN: 1061-9518 in any form reserved.
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information derived primarily from accounting records. Both privatized enterprises and interested third parties have placed new demands on the accounting profession in CEE countries. The growth of private enterprise creates the need for reliable and accurate financial information. New managers need detailed management data for decision making. Shareholders need information for investment decisions. Potential foreign and domestic investors need to make informed choices and comparisons between enterprises. Creditors need to establish the credit worthiness of enterprises because trading balances and loans will no longer be guaranteed by the state. Moreover, governments want to measure the performance of state enterprises on a commercial basis, and the requirements of the taxation authorities will grow. In part, internal pressures for change have come from the desires of most CEE governments to join the European Union (EU), requiring the introduction of laws and regulations which expedite the process of harmonization. The external pressures for change arise from the need to attract foreign loans and investment guarantees. Here, the World Bank and the International Monetary Fund (IMF) play key roles in sponsoring changes. The purpose of this study is to describe the new accounting regulations promulgated in three Central and Eastern European countries: the Czech Republic, Hungary, and Poland. The description and examination focus on those accounting standards related to valuation of assets, income determination, and financial statement presentation. This article also examines and compares specific valuation and reporting issues of these new standards with the standards recommended by the International Accounting Standards Committee (IASC) and the directives of the European Union. This comparison could be used to determine the level of compliance or degree of harmonization of the accounting standards of these countries with more generally accepted standards so the feasibility of entry into the EU can be assessed. These three countries were selected for study because they are the CEE countries which are the most advanced in privatization of their economies and which show the highest level of direct foreign investments (World Investment Report 1994). Additionally, all these countries received the status of associate members to the European Union and are seeking full membership in the EU by the year 2000 (EU, Articles 68-70, 1994).
ACCOUNTINGPRINCIPLESANDCONCEPTUALFRAMEWORKS INTHECZECHREPUBLIC,HUNGARYANDPOLAND Accounting principles in the Czech Republic are established by decrees issued by the Ministry of Finance, the Commercial Code, and the 1992 Accounting Act. The new Czech accounting regulations (Zukonya Reguluce v
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Accountinku) were put forth in the form of a decree by the Ministry of Finance in the Czech Republic on December 12, 1991. A new legislative act, which became effective January 1, 1993, introduced a single set of accounting regulations for state and private companies which complied with the Fourth EU Directive. This act applies to all enterprises subject to income taxes. The reporting period is a calendar year. The annual reports prepared by Czech entities must contain a balance sheet, an income statement, and notes to the financial statements prepared in conformity with the book of accounts provided by the Ministry of Finance. In Hungary, the accounting principles, as well as the form and content of financial statements and related matters, are established in the Accounting Act, Law XVIII of 1991 (AZ zifSza’mviteli Tiinhzy), which was passed by Parliament on May 14, 1991. This act will be augmented and interpreted by the National Accounting Committee established by the Ministry of Finance, which is expected to carry the main burden of Hungarian accounting development. All Hungarian companies and other business entities are required to keep proper accounting records in accordance with the provisions of the Accounting Act. These provisions are general in the sense that they give individual entities wide discretion in designing and implementing their own accounting systems, but they are specific in regard to the minimum standards of internal control and documentation that must be achieved. The Hungarian annual report, prepared on a calendar year basis, consists of the balance sheet, the income statement, the notes, and the business report. The business report presents the financial statement analysis, all the significant events taking place after the end of the reporting period, data pertaining to the acquisition of the company’s own shares (treasury shares), and information on research and experimental development. In Poland, the new Act on Accounting (I/stuwa o Rachunkowosci), which was enacted by Parliament on September 19, 1994, and became effective January 1, 1995, applies to all enterprises-including banks, insurance companies, and health and welfare organizations both social and political-which are subject to Polish income taxes. The Act applies to all entities regardless of legal form or ownership if annual turnover (revenues) exceeds 400,000 ECU (European Currency Unit). The reporting period is a calendar year. The purpose of this Act was to introduce full compliance of existing standards with EU regulations including Directives IV and VII, Directive SW635 on financial statements of banks and other financial institutions, and Directive 91/ 674 on financial statements of insurance companies. The introduction of full compliance was a commitment Poland made while receiving the status of associate member with the EU (Articles 68-70 [Lisiecka-Zajac 19941 of the EU on the associate membership of the Republic of Poland with the EU). The general preamble to the Act states that new accounting standards should also comply with international standards if they do not contradict the EU directives and if their application
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is possible in the actual stage of Poland’s economic development. The Act was also intended to establish uniform accounting principles for all entities, to increase the social status of the accounting profession, and to create premises for future synchronization of accounting principles with income tax regulations (LisieckaZajac 1994). The Polish annual report includes the balance sheet, the income statement, the notes, and the business repolt. All corporations, in addition, are required to present a statement of cash flows. The most important accounting principles to be applied during the preparation of the annual report include accrual basis, going concern, conservatism, consistency, comparability, and materiality.
The process of harmonization of financial accounting standards within the European Union has been influenced by international accounting standards issued by the.Intemational Accounting Standards Committee (IASC) and EU directives. The Intemat~onal Accounting Standards Committee has, since its inception in 1973, attempted to reduce cross national differences in financial reporting practice. As of January X995, the IASC, with representatives from professional accountancy bodies in almost 80 countries, had issued 3 1 international accounting standards (IASs) and 49 exposure drafts (EDs). Despite the volunt~ nature of the IASC’s standards, there has been continuous international support for its work, The real catalyst behind the IASC’s move to substantially upgrade its standards is the International Organization of Securities Commissions (IOSCO). The IOSCO made a tacit agreement with the IASC that if IASC standards developed sufficiently, the IOSCQ would recommend to its member securities commissions that foreign financial statements complying with IASC standards be accepted for listing purposes (Fabler and Tori 1993). Since 1985, the EU has issued a number of directives for company law harmonization. These directives are a set of legislative instruments intended to provide guidance in the format and content of financial statements and the nature of the audit, among other policies and procedures. They are legally binding. Upon their adoption, the member states must transform the rules of the legal framework into national law within a specified period of time, usually three years. In this respect, the directives differ from the standards issued by the IASC, which have no real authority. The influence of the EU, however, reaches the intemational level via its impact on multinational enterprises operating within its area and through the active participation of the member countries in international accounting organizations. The EU accounts for almost one quarter of total world trade. In January 1995, with the entry of four very wealthy nations-Austria, Finland, Norway, and
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Sweden-the EU’s population increased to 372 million and its gross domestic product (GDP) to $6.3 trillion (Barnard 1994). The harmonization of financial accounting within the EU has been the main concern of two directives from the Council of Ministers: the Fourth Directive on the annual accounts of companies, which adopted the “true and fair’ view criterion for preparation and presentation of financial statements (July 1978); and the Seventh Directive on consolidated accounts (June 1983). The Seventh Directive’s overriding objective is that the consolidated accounts present a true and fair view of the assets, liabilities, financial position, and profit or loss of the consolidated entity. Both directives have been implemented in the national laws of all EU member countries.
COMPARATIVEANALYSIS OFSELECTEDVALUATION ANDFINANCIALREPORTINGSTANDARDS The international standards issued by the IASC and the EU directives are used as a reference point for comparing the selected valuation and reporting requirements of the Czech Republic, Hungary, and Poland. Table 1 presents differences in valuation and financial reporting standards among the selected CEE countries, the EU directives, and the IASC standards. In the case of inventories, the IASC standards (E32) advocate that FIFO and weighted average cost should be benchmark treatments, LIFO should be an allowed alternative, and the base stock method should be eliminated. The Fourth Directive of the EU requires member countries to apply actual cost, FIFO, LIFO, Weighted Average, or a similar cost method. In the Czech Republic and Hungary, permissible cost flows are FIFO and Weighted Average cost. Polish companies may also apply LIFO. The IASC standards and EC directives, as well as the standards in the three analyzed CEE countries, require inventories to be valued at the lower of cost or market (LCM). In the past in the Czech Republic, Hungary, and Poland, ambiguities existed concerning the valuation of self-manufacturing inventory-that is, inventory costs did not include manufacturing overhead. The IASC standards as well as the EU directives recommend that accounts receivable should be valued at net realizable value, the net amount expected to be received in cash. Important changes introduced by new accounting laws in the three countries include new rules on valuation of receivables and fixed assets. In the past, accounting regulations in these countries did not anticipate the possibility of otherwise solvent entities defaulting on their obligations. Bad debt reserves could be set up only in the case of balances due from entities placed into liquidation or bankruptcy. New accounting standards introduced in these countries moved toward reporting receivables at net realizable value.
Bad debt reserves se1 up only for balances past due 6 months or more. Depreciation plan based on asset usage. Straight-Line, or accelerated methods
Provision for uncollectible accounts is included in liability section of Balance Sheet Depreciation may be compiled by StraightLine, Declining-Balance method, or by usage. Lower of cost or market is required.
Provision for uncollectible accounts is recommended.
Rates for accounting depreciation are based on time, utilization period, or output.
Lower of cost or market is required.
Cost method is required.
Valuation of accounts receivable
Depreciation methods
Valuation of marketable securities
Accounting for longterminvestments
_
Cost method is recommended.
Inventory costs may be established either on FIFO, LIFO, or Weighted Average basis.
Permissible cost flows are FIFO and Weighted Average Cost.
Permissible cost flows are FIFO and Weighted Average Cost.
Inventory costing methods
Cost method is recommended.
Lower of cost or market is required.
Reporting period is calendar year.
Poland
Reporting period is calendar year.
Hungary
Companies required to make their accounts on calendar year basis.
Czech Republic
Accounting periods
Item
Cost method is preferred, but equity method may be used.
Market value or lower of cost or market is recommended.
Straight-Line depreciation, but Declining Balance or Units of Output are also permissible.
In keeping with the concept of prudence, receivables should be reduced to reflect net realizable value.
Fourth Directive permits use of FIFO, LIFO, actual cost, average cost, and others with no preferences.
Fiscal year other than calendar year permitted.
EU Directives
TABLE 1 Differences in Valuation and Financial Reporting Standards
ED40 proposes the equity method.
IAS recommends market value or lower of cost or market.
IAS4, IA%, IAS 16, and ED 43; straightLine depreciation, but other methods are allowed.
IASC recommends that receivables be shown at net realizable value.
ED32 recommends FIFO or Weighted Average Cost. LIFO is an allowed alternative. Base LIFO is eliminated.
Fiscal year other than calendar year permitted.
Revised IASS considers research expenditure as period expenses. Development expenditures are capitalized if certain conditions are met.
IAS 17 recommends that substance over form should be considered in recording leases. ED33 pending revision of IAS 12 on deferred taxes.
Fourth Directive makes a distinction between expenditures for research and those for development. Research costs should be expensed and costs of development project recorded as an asset. Preference is substance over form in recording leases.
The difference between accounting income and taxable income should be disclosed.
Costs of research written off as incurred. Costs of development may be capitalized and amortized over a maximum period of 5 years. No clear distinction is made between capital and operating leases for accounting purposes. Deferred taxes are recorded using tax rate which is valid for subsequent accounting period.
Costs of research written off as incurred. Costs of development may be capitalized and amortized over a maximum period of 5 years.
No clear distinction is made between capital and operating leases for accounting purposes. Deferred taxes are not reported on the Balance Sheet.
R&D costs related to successful projects may be capitalized. Amortization period should be less than 5 years.
No clear distinction is made between capital and operating leases for accounting purposes.
Deferred taxes are recorded using tax rate which is valid for subsequent accounting period.
Research and development (R&D) expenditures
Accounting for leases
Accounting for deferred taxes
(Continued)
E32 states goodwill must be recognized as an asset and amortized against revenues over a period not to exceed 5 years.
Purchased goodwill written off within a maximum period of 5 years (against revenues or equity).
Goodwill recognized only if acquired from third parties and then amortized over period not to exceed 5 years.
Goodwill recognized only if acquired from third parties and then written off over a period of 5 to 15 years.
Goodwill recognized only if acquired from third parties and then written off in 5 years.
Accounting for goodwill
IAS states that intercompany sales/ profits are to be eliminated. Recommended.
Seventh Directive requires elimination of intercompany sales/ profits. Not required.
Elimination of intercompany sales/ profits required. Not required. Financial statements cover 2 consecutive years.
Intercompany sales/ profits required to be eliminated. Not required. Law on Accounting requires comparative financial statements.
Czech law requires elimination of intercompany sales/ profits.
Not required.
Financial statements cover 2 consecutive years.
Elimination of intercompany sales/ profits upon consolidation
Disclosure of earnings per share
Presentation of comparative financial statements
Fourth Directive requires comparative financial statements.
Recommended.
E32 requires the purchase method for acquisitions and the pooling of interests method for uniting of interests.
Directive the purchase to account for combinations.
Seventh requires method business
Purchase method for all business combinations.
Purchase method for all business combinations.
Purchase method required to account for all business combinations.
Accounting for business combinations
IAS and IAS state that consolidated accounts should be provided.
Consolidated accounts are required by Seventh Directive.
Required if a company holds 50% of the equity or controlling interest.
Required if a company holds 50% of the equity or controlling interest.
Consolidated accounts required for 20% ownership interest.
Consolidated accounts
Revised IAS uses the concept of cash, or cash equivalent items as funds.
Fourth Directive does noI include the requirement of presenting a Statemenl of Changes in Financial Position.
Required.
Not required.
IASC
Czech law does not require Statement of Cash Flows.
EU Directives
Statement of cash flows
Poland
Czech Republic
Item
Hungary
TABLE 1 Continued
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Czech accounting regulations state that receivables should be reported at their nominal values. Losses from permanent impairment of the values which are known on the last day of the accounting period should reduce the nominal values of receivables. In Hungary, accounts receivable and other monetary current assets (except marketable securities) are shown at their face value. Receivables are presented at gross with an amount deducted for general turnover tax (charged on receivables) under the current assets section of the balance sheet. Provisions for uncollectible accounts are made in an amount which includes all anticipated losses and collection costs and are included in the liabilities section of the balance sheet. In Poland, receivables are reported at nominal values, and bad debt reserves are set up for accounts past due six months or more. The Act, therefore, gives the right to apply the principle of prudence in deciding on the realizable value of receivables to the entrepreneur. The IASC’S E32 and the Fourth Directive of the EU require the historical cost principle be used to value purchased property, plant, and equipment (PPE). Straight-line depreciation methods are recommended, but other methods, including accelerated depreciation, are allowed. All three CEE countries require the historical cost principle to be used. In the past, fixed assets were depreciated in accordance with rates specified in the official tables prescribed for tax purposes. In the Czech Republic, Hungary, and Poland, there has been a tradition of preparing financial statements in accordance with tax regulations. The new accounting regulations concerning depreciation of fixed assets constitute an important break with the past in these countries. A clear distinction is made between depreciation for accounting purposes and for tax purposes. For accounting purposes, the depreciation plan must be based on asset usage. Straight-line methods are recommended, but other methods, including accelerated depreciation, are also permissible. IAS classifies investments in marketable securities into short term and permanent. According to IAS25, short-term investments should be valued at market price or at the lower of cost or market (if listed on the securities markets). The IASC’s Exposure Draft 40 identifies three types of financial instruments depending on the firms’ purposes: financing and investment, hedging, and operating. ED40 proposes the use of fair market value for financial assets arising from operating activities. For financial assets held for investment purposes, the acquisition cost is recommended, but the use of fair market value is permitted. Any resulting difference in valuation between reporting dates is to be included in the income statement. ED40 also proposes the equity method to account for investments in which the investor has significant influence over the investee company. The Fourth EU Directive states that holdings in affiliated undertakings are to be valued at cost. The equity method is permitted provided that: (1) the use of the equity method is disclosed in the notes, (2) the differences between the cost and equity in the underlying net assets at the date of acquisition is shown separately in
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the balance sheet or notes, (3) the equity in the annual profit or loss is shown separately, and (4) the excess of the equity in the annual profit or loss over the dividends received is classified in a nondistributable reserve. Accounting principles in the Czech Republic, Hungary, and Poland require investments in marketable securities to be valued at the lower of cost or market (LCM). The cost method is recommended although the equity method is allowed. In accounting for goodwill, IAS permits either (1) recording goodwill as an asset with amortization against revenue over its useful life, or (2) immediate write-off against the company’s equity. The IASC’s E32 proposals are more restrictive in that goodwill must be recognized as an asset and must be amortized against revenues over a period not to exceed five years. The Fourth Directive of the EU is consistent with the IASC proposal and states that purchased goodwill is to be written off within a maximum period of five years. Member states may permit a longer period, provided that it does not exceed the useful economic life of the goodwill. The most controversial approach is the immediate write-off approach. Accordingly, goodwill is written off against equity with no charges made against current earnings. This approach is permitted in several European countries, including France, Germany, Italy, Switzerland, and the United Kingdom. Czech accounting regulations include only two statements related to intungible assets. Intangible assets acquired should be valued at historical costs while self-produced intangibles are reported at the lower of costs incurred or replacement value. Intangible assets should be amortized over a period not to exceed five years. In the past, intangible assets were not recorded at all (Dolezal 1992). In Hungary and Poland, goodwill is to be capitalized and amortized on a straight-line basis over a period of five years. The IASC states that research expenditures are considered period expenses, whereas development expenditures are capitalized if certain conditions are metif the company can prove there is a market for the products to which the development spending related, and the costs can be recovered. The EU Directive makes a distinction between expenditures for “research” and expenditures for “development.” Research costs should be expensed and the cost of development projects may be recorded as an asset and systematically amortized to expenses in current and future periods. The law in the Czech Republic does not make a distinction between research and development, but it does state that only research and development costs related to successful projects may be recorded as an intangible asset. In Hungary and Poland, costs of research must be written off as incurred, but the cost of developing a specific product may be capitalized and written off over a maximum of five years. The international standards (IAS 17) and EC directives recommend accounting for leases on the basis of their economic substance and not on the basis of their
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legal form. A lease may be in substance a simple rental agreement, called an operating lease, or it may be substantially the same as a purchase transaction, called a capital lease. Classification criteria have been established to distinguish operating leases from capital leases. In the Czech Republic, Hungary, and Poland, all lease transactions are to be accounted for as operating leases per the Ministry of Finance regulations. Accounting procedures, therefore, follow the legal ownership of the leased asset. No clear distinction is made between operating and capital leases for accounting purposes. Standards for deferred taxes and accounting for tax consequences of temporary differences between accounting income and taxable income, are still pending final approval by the IASC. The Fourth EU Directive requires disclosure of the difference between the tax charge reflected in the accounts and taxes actually paid. In the Czech Republic and Hungary, the Law on Accounting does not use the concept of “latent” taxes; therefore, deferred taxes are not shown on the balance sheet. Both tax payable and tax expense directly mirror the amounts calculated on the tax returns. The extent to which the tax charge is significantly affected by timing differences and the anticipated effects of recovery must be disclosed in the notes, however. New accounting regulations introduced in Poland permit recognition of the deferred tax liability or asset on the balance sheet which is calculated using the tax rate valid in subsequent accounting periods, but the new regulations do not provide clear standards of accounting for deferred taxes. Concerning the statement of cash flows, the IASC in its Revised IAS (formerly ED36) states that the entity must present a statement of changes in financial position as part of its annual financial statements. The IASC uses the concept of cash, or cash and cash equivalent items, as funds. This statement should report the periodic flow of funds classified into operating, investing, and financing activities. The EU directives do not require either a statement of cash flows or a statement of changes in financial position. The financial reporting requirements in the Czech Republic and Hungary do not require or recommend the presentation of a statement of cash flows. Such a statement would be very useful during the privatization of state companies. Taking into consideration that there is a limited number of companies listed on new stock exchanges, business valuation methods based on market multiples (i.e., price earning ratio) are of limited use. The most highly recommended business valuation methods for privatization purposes in each of these countries include discounted cash flows techniques. The Act on Accounting enacted in Poland introduced a requirement that all corporations prepare a statement of cash flows. The recommended method to prepare cash flows from operating activities is the indirect method because of its simplicity. In IAS and IAS (1989), the IASC states that worldwide consolidated accounts should be provided and should include all subsidiaries. Exceptions can
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be made provided they are justified and accounted for by the equity method. The IASC’s ED32 requires the purchase method to account for acquisitions and the pooling of interest method for uniting of interests. Consolidated accounts are covered in the Seventh Directive of the EU, which requires worldwide consolidations (Article 3), the use of the “fair value” approach when accounting for assets purchased through acquisition, the equity treatment of associated corporations, and segmental disclosure for line of business and geographical area. The “true and fair” view (Article 16) and uniform formats (Article 17) are also required. In 1983, an agreement was reached concerning the definition of a “group.” After contrasting the effective management control and share ownership criteria based on German law with the U.K. approach based on share ownership and control, a compromise was reached. Control criteria other than ownership can be applied by member countries on an optional basis (Radebaugh and Gray 1993,218). The Seventh Directive requires the purchase method to be used to account for business combinations. The new accounting laws promulgated in the three CEE countries require preparation of consolidated financial statements for all investments with controlling interests. This requirement is important since some privatized companies operate as holding companies. In conformity with the Seventh EU Directive, the accepted method of accounting for all business combinations is the purchase method. Elimination of intercompany sales and profits is required. Financial disclosure requirements were minimal in the past in all analyzed CEE countries, leaving the users of these statements to make assumptions when evaluating performance of an enterprise. Earnings per share, as well as disclosure of contingent liabilities, such as warranties or legal settlements, were not required. The new accounting laws do not introduce the requirement to present earnings per share in the financial statements. The annual reports in these three CEE countries should present comparative financial statements for two consecutive years.
SUMMARY
AND CONCLUSIONS
Accounting principles in the Czech Republic, Hungary, and Poland are in a state of transition. The reporting systems in these countries were not swept aside by new legislation. Instead, new regulations considered more appropriate to an emerging market economy have been superimposed upon the existing systems. Although the standard-setting bodies of these countries were confronted with choosing from sometimes conflicting accounting standards, they appear to have taken views consistent with those of the IASC and EU. The new accounting laws promulgated in the Czech Republic, Hungry, and Poland represent an important advance toward compliance with the EU directives.
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Although these countries are not members of the EU, they are parties to the European Accord of 1991, which foresees eventual full membership in the EU. In 1994, all three countries received associate status in the EU, and they should achieve full membership around the year 2000. Accession to full membership means a firm commitment by these countries to comply with the directives as reflected in many of the recently enacted legal reforms. These three countries have taken the requirements of the relevant EU directives into account or have fully implemented them when enacting accounting legislation (Price Waterhouse 1993). Adoption of the EU directives by the analyzed CEE countries constitutes an important step toward harmonization of accounting standards in the former Eastern bloc. It is also a very important step in improving the feasibility of entry into the EU. Despite the recent changes, revisions are still required in all three CEE countries to be in full compliance with both the EU directives and the IASC standards. Clear standards of accounting for long-term liabilities must be established (i.e., bonds, leases, deferred taxes) since there was no tradition of accounting for interest under the old system. More precise principles of accounting for the stockholders’ equity and consolidation accounting are also needed. The full disclosure principle should also be implemented. Each country’s accounting regulations make attempts to have the preparation of financial statements depart from conformity with tax regulations (i.e., depreciation accounting). Future attempts at harmonization should allow consolidated accounts to be prepared in conformity with the objectives of financial reporting rather than with the different objectives of tax law. Since consolidated statements are not used for tax purposes, these statements would be more informative and of better use in financial markets if prepared in conformity with accounting standards. Individual company financial statements, subject to taxes, could reflect valuation methods for tax purposes. In the Czech Republic, the Act on Accounting is very general and will need additional revisions (Cramer 1993). There are several areas in the Act which are unclear. Both the Act on Accounting and the Chart of Accounts are silent on the details of areas such as recording work in progress on long term contracts and the precise meaning of prudence. In order to comply with the Seventh Directive of the EU, the Czech Republic must establish more detailed guidelines for the preparation of consolidated financial statements. Requirements for financial disclosure should be increased and the presentation of the statement of cash flows must be required if the Czech Republic is to comply with the international accounting standards. Although Hungary was the first of these three CEE countries to issue revised accounting regulations, several issues, including valuation of assets and liabilities, need to be addressed. To comply fully with EU directives, Hungary must establish more detailed rules for the valuation of intangible assets. A clear distinction
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should also be made in accounting for funds provided by owners and creditors. According to current law, additional contributions from owners to satisfy losses are treated as liabilities as opposed to contributed capital (DRT International 1992). In order to comply with international standards, the reporting of the statement of cash flows must be required. The Act on Accounting enacted recently in Poland appears to be the most developed of the three countries. Important changes introduced by this new law include the new rules on valuation of assets. A big attempt was made to increase the disclosure of financial information. The amount of information each business entity will have to disclose in the notes to the financial statement will increase significantly. The new Polish accounting law provides new standards on consolidation accounting and a requirement to prepare a statement of cash flows. The question that arises is whether eventual harmonization within the EU will conflict with international harmonization. The EU is committed to internal harmonization as part of its common market policy, which applies to all sizes and types of enterprise. A recent study by the Federation des Experts Comptables Europeans (FEE) demonstrates that current IASC standards are, with minor exceptions (e.g., the statement of cash flows, the pooling of interest method of accounting for business combinations), consistent with the EU directives, and it recommends that IASC standards should therefore qualify as equivalent (Thorell and Whittington 1994). Compliance does not provide for issues which are not presently covered by the directives. New accounting standards introduced in Czech Republic, Hungary, and Poland implement the EU directives and also go beyond these directives, making attempts to conform to international standards (i.e., the requirement to prepare the statement of cash flows in Poland). Accounting laws in these countries aim to comply with international standards to the extent possible during the transition period to a market economy (Lisiecka-Zajac, 1994). There is the possibility that conflicts between EU direcpftives and IASC standards may arise in the future as a consequence of the IASC taking a more restrictive attitude toward alternative accounting methods. It is recommended that future research be conducted as these anticipated changes occur in the CEE countries to determine whether the new standards comply with those issued by the IASC.
REFERENCES Barnard, Bruce. 1994. EU enlarges. Europe: Magazine of the European Comrnuni~ 33S(April): ss LSS2. Cramer, John. 1993. Privatization in Czechoslovakia and the EC. European Business and Economic Development (part 4, January): I.
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