Policy Choices under IFRS in UK and German Context - Essay Example

?Policy Choices under IFRS in UK and German Context After the mandatory adoption of IFRS by the public listed companies in 2005-06 especially in the Euro zone, the companies develop their financial statements in accordance with the guideline provided by the IFRS. IFRS, however, allows different policy choices for the companies to make. For example, in measuring the inventory, IFRS has provided a policy choice of measuring inventory amount on the basis of either FIFO method or on weighted average method. Similarly, some other choices have also been framed by IFRS to the companies, like they can value their property, plant and equipment either on cost model or revaluation model etc. Nobes (2006) studied this area of research and outlined 16 policy choices that are mostly available to the companies. The four choices have been eliminated from this analysis as some of them are industry specific and some of them are commonly used by every company no matter in which industry they operate. The rest of twelve policy choices do have some issues with them as some organizations do not disclose their policies at times. The most common examples are of “investment property” and “inventory” such that in relation to investment property, organizations do not disclose whether these investment properties are valued at cost or fair value, and in case of inventories, organizations at times do not disclose whether the inventories are valued at FIFO method or weighted average method. Other issue that may also arise is that organizations may not have any joint-ventures with other entities. In such cases organizations are unable to report their valuation whether they should be valued on proportionate basis or as per equity method. This particular report will analyze the 12 policy choices out of those 16 in the context of UK and Germany. As both the countries have the largest capital markets in the euro zone, therefore a comparison of these two countries will help in understanding as how the countries adopt different IFRS policy choices that are available to them. IFRS Policy Choices These policy choices are reproduced in the following: IFRS policy choices 1(a) income statement by function (b) by nature (c) neither 2 (a) inclusion of a line for EBIT or operating pro?t (b) no such line 3 (a) equity accounting results included in ‘operating’ (b) immediately after (c) after ?nance 4 (a) balance sheet shows assets = credits (b) showing net assets 5 (a) liquidity decreasing in balance sheet (cash at top) (b) liquidity increasing 6 (a) Statement of Changes in Equity, including dividends and share issues (b) SORIE, not including them 7 (a) direct operating cash ?ows (b) indirect 8 (a) dividends received shown as operating cash ?ow (b) as investing 9 (a) interest paid shown as operating cash ?ow (b) as ?nancing 10 (a) only cost for PPE (b) some fair value 11 (a) investment property at cost (b) at fair value 12 (a) some designation of ?nancial assets at fair value (b) none 13 (a) capitalisation of interest on construction (b) expensing 14 (a) FIFO for inventory cost (b) weighted average 15 (a) actuarial gains and losses to SORIE (b) to income in full (c) corridor 16 (a) proportional consolidation of some joint ventures (b) only equity method The following table reflects the 6 big corporations of UK which represents their policy choices of IFRS. Policy Changes GSK Astra Zeneca BAE British Airways Rolls Royce SAB Miller Total Percentage 1 (a) income statement by function 1 1 1 1 1 5 83.33% (b) by nature   1 1 16.67%   (c) Neither             0 0.00% 2 (a) inclusion of a line for EBIT or operating profit 1 1 1 1 1 1 6 100.00%   (b) no such line             0 0.00% 3 (a) equity accounting results of associates and joint ventures included in ‘operating’   1 1 16.67% (b) immediately after   0 0.00%   (c) after finance 1   1 1 1 1 5 83.33% 4 (a) balance sheet showing assets = credits   1 1 16.67%   (b) showing net assets 1 1 1   1 1 5 83.33% 5 (a) liquidity decreasing (cash at top)   0 0.00%   (b) liquidity increasing 1 1 1 1 1 1 6 100.00% 8 (a) dividends received shown as operating cash flow   1 1 2 33.33%   (b) Not 1 1 1 1     4 66.67% 9 (a) interest paid shown as operating cash flow   1 1 1 3 50.00%   (b) Not 1   1   1   3 50.00% 10 (a) only cost for property, plant and equipment 1 1 1 1 4 66.67%   (b) some fair value   1       1 2 33.33% 11 (a) investment property at cost   1 1 1 3 75.00%   (b) at fair value           1 1 25.00% 14 (a) FIFO for inventory cost 1 1 1 1 4 66.67%   (b) weighted average     1 1     2 33.33% 15 (a) actuarial gains and losses to Other comprehensive income 1 1 1 1 1 1 6 100.00% (b) to income in full   0 0.00%   (c) corridor method             0 0.00% 16 (a) proportionate consolidation of joint ventures   1 1 1 1 4 66.67%   (b) equity method 1 1         2 33.33% The following table reflects the 6 big corporations of German which represents their policy choices of IFRS.     Policy Changes Bayer Adidas BASF BMW Merck Volkswagen Total Percentage 1 (a) income statement by function 1 1 1 3 50.00% (b) by nature   0 0.00%   (c) Neither       1 1 1 3 50.00% 2 (a) inclusion of a line for EBIT or operating profit 1 1 1 1 1 1 6 100.00%   (b) no such line             0 0.00% 3 (a) equity accounting results of associates and joint ventures included in ‘operating’   0 0.00% (b) immediately after 1 1 1 1 4 66.67%   (c) after finance   1     1   2 33.33% 4 (a) balance sheet showing assets = credits 1 1 1 1 1 1 6 100.00%   (b) showing net assets             0 0.00% 5 (a) liquidity decreasing (cash at top)   1 1 2 33.33%   (b) liquidity increasing 1   1 1   1 4 66.67% 8 (a) dividends received shown as operating cash flow   1 1 16.67%   (b) Not 1 1   1 1 1 5 83.33% 9 (a) interest paid shown as operating cash flow 1 1 1 3 50.00%   (b) Not       1 1 1 3 50.00% 10 (a) only cost for property, plant and equipment 1 1 1 1 1 1 6 100.00%   (b) some fair value             0 0.00% 11 (a) investment property at cost   1 1 1 3 100.00%   (b) at fair value             0 0.00% 14 (a) FIFO for inventory cost   0 0.00%   (b) weighted average 1 1 1 1 1 1 6 100.00% 15 (a) actuarial gains and losses to Other comprehensive income 1 1 1 1 1 1 6 100.00% (b) to income in full   0 0.00%   (c) corridor method             0 0.00% 16 (a) proportionate consolidation of joint ventures 1 1 2 33.33%   (b) equity method   1   1 1 1 4 66.67% UK German     Policy Changes Total Percentage Total Percentage 1 (a) income statement by function 5 83.33% 3 50.00% (b) by nature 1 16.67% 0 0.00%   (c) Neither 0 0.00% 3 50.00% 2 (a) inclusion of a line for EBIT or operating profit 6 100.00% 6 100.00%   (b) no such line 0 0.00% 0 0.00% 3 (a) equity accounting results of associates and joint ventures included in ‘operating’ 1 16.67% 0 0.00% (b) immediately after 0 0.00% 4 66.67%   (c) after finance 5 83.33% 2 33.33% 4 (a) balance sheet showing assets = credits 1 16.67% 6 100.00%   (b) showing net assets 5 83.33% 0 0.00% 5 (a) liquidity decreasing (cash at top) 0 0.00% 2 33.33%   (b) liquidity increasing 6 100.00% 4 66.67% 8 (a) dividends received shown as operating cash flow 2 33.33% 1 16.67%   (b) Not 4 66.67% 5 83.33% 9 (a) interest paid shown as operating cash flow 3 50.00% 3 50.00%   (b) Not 3 50.00% 3 50.00% 10 (a) only cost for property, plant and equipment 4 66.67% 6 100.00%   (b) some fair value 2 33.33% 0 0.00% 11 (a) investment property at cost 3 75.00% 3 100.00%   (b) at fair value 1 25.00% 0 0.00% 14 (a) FIFO for inventory cost 4 66.67% 0 0.00%   (b) weighted average 2 33.33% 6 100.00% 15 (a) actuarial gains and losses to Other comprehensive income 6 100.00% 6 100.00% (b) to income in full 0 0.00% 0 0.00%   (c) corridor method 0 0.00% 0 0.00% 16 (a) proportionate consolidation of joint ventures 4 66.67% 2 33.33%   (b) equity method 2 33.33% 4 66.67% Comparison of Policy Choices among UK and Germany The above table shows a comparison between the policy choices of UK companies and the German companies. Every policy choice is analyzed between both the countries in a discursive manner as well in the following. Policy Choice 1 As per the first policy choice, it can be observed that around 83% of the UK companies prefer to formulate their income statement by function basis and 17% has chosen some other criteria. But in Germany, equal proportion of 50% can be observed between those who prepare income statement and by function and those who prepare on the basis of some random criteria. Surprisingly, no single entity formulated its financial statements on the basis of “nature”. Policy Choice 2 This policy allows the companies to insert the line of “operating profit” or “EBIT” in their income statements. The results show that every company of both UK and Germany has disclosed the operating profit on the face of its income statement. Policy Choice 3 The policy choice of equity accounting for joint ventures and associates has shown random results for both the countries such that in UK, only 1 company disclosed these results in its operating income, whereas no single German company disclosed it in operating profits. Most of the UK companies preferred to show these results after finance costs. However, the German companies were more interested in showing them immediately after the operating profits. Policy Choice 4 This policy shows the disclosure of overall presentation of balance sheet. The UK practice reflects that net assets based approach is more prevalent as compared to total assets, which is entirely followed by the German companies. Policy Choice 5 The placement of cash and cash equivalent in the balance sheet reflects whether the liquidity is on an increasing trend or on decreasing trend. The results show that liquidity position of every UK based company is on an increasing trend whereas similar trend is also found for German companies where 66% companies disclosed the similar pattern. Policy Choice 8 Whether dividend received should be disclosed in the operating cash flows or not, both UK and German countries selected not to show dividend received in the operating activities. Policy Choice 9 The amount of interest paid is to be a part of operating activity or not is reflected by this policy. Half of UK and German companies preferred to show the interest payments in the operating activities whereas the other half preferred to disclose them elsewhere in the cash flow statements. Policy Choice 10 Whether the property, plant and equipment should be valued at cost or fair value model, it can be noticed that every German company selected the cost model but in case of UK, around 66% of the companies preferred cost model. However, the rest of the companies used the fair value model for the measurement of their property, plant and equipment. Policy Choice 11 In relation to investment property, most of the companies do not disclose this policy. In UK perspective, only 4 companies out of 6 showed their policy relating to investment property. 75% of the companies preferred to keep them on cost model, and the rest preferred to measure them on fair value basis. For German companies, only 3 companies disclosed investment property policy and all of them selected cost model for their measurement. Policy Choice 14 For inventory valuation, most of the UK companies preferred to measure their inventories on the basis of FIFO method, however in German context, every company preferred to use weighted average method of valuing its inventories. Policy Choice 15 The policy pertaining to actuarial gains/losses to be included in the other comprehensive income, showed the similar results in both the countries such that every company included actuarial gain/loss in its comprehensive income and none of them selected any of the corridor method or the full income method. Policy Choice 16 The last policy relates to accounting method for the joint ventures whether to measure it using equity method or proportionate method. It can be observed that most of the UK companies (around 66%) preferred to use proportionate method for valuing the interest of joint ventures, whereas the equity method is mostly preferred by the German companies as 66% of the companies used this method. Comparison of Policy Choices for the periods 2005-06 and 2010-11 UK Germany     Policy Changes 2005/6 2010/11 2005/6 2010/11 1 (a) income statement by function 47.2% 83.33% 76.50% 50.00%   (b) by nature 13.9% 16.67% 23.50% 0.00%   (c) Neither 38.9% 0.00% 0.00% 50.00% 2 (a) inclusion of a line for EBIT or operating profit 97.2% 100.00% 100.00% 100.00%   (b) no such line 0.00% 0.00% 0.00% 3 (a) equity accounting results of associates and joint ventures included in ‘operating’ 24.5% 16.67% 18.80% 0.00%   (b) immediately after 32.1% 0.00% 62.50% 66.67%   (c) after finance 43.4% 83.33% 18.80% 33.33% 4 (a) balance sheet showing assets = credits 16.67% 100.00% 100.00%   (b) showing net assets 84.7% 83.33% 0.00% 0.00% 5 (a) liquidity decreasing (cash at top) 0.00% 15.00% 33.33%   (b) liquidity increasing 100% 100.00% 85.00% 66.67% 8 (a) dividends received shown as operating cash flow 36.70% 33.33% 66.70% 16.67%   (b) Not 66.67% 83.33% 9 (a) interest paid shown as operating cash flow 68.40% 50.00% 61.90% 50.00%   (b) Not 50.00% 50.00% 10 (a) only cost for property, plant and equipment 66.67% 100.00% 100.00%   (b) some fair value 12.20% 33.33% 0.00% 0.00% 11 (a) investment property at cost 75.00% 100.00% 100.00%   (b) at fair value 73.10% 25.00% 0.00% 0.00% 14 (a) FIFO for inventory cost 50% 66.67% 0.00% 0.00%   (b) weighted average 29.20% 33.33% 100.00% 100.00% 15 (a) actuarial gains and losses to Other comprehensive income 84.40% 100.00% 47.60% 100.00%   (b) to income in full 3.30% 0.00% 0.00% 0.00%   (c) corridor method 12.20% 0.00% 52.40% 0.00% 16 (a) proportionate consolidation of joint ventures 22.40% 66.67% 31.30% 33.33%   (b) equity method 33.33% 68.70% 66.67% From the above table its can be observed that there is a deviation in the first policy, as in the previous years companies used neither of income statements by nature or by function, but the recent practice revolves around income statements formulated by function. Policies 2 to 5 have remained more or less similar as compared to previous periods. Policy 8 is still the same for UK but is now changed for German companies. Policy 9 and 10 are still the same for both the companies in both the periods in terms of interest paid and valuation of Property, Plant and Equipment. Significant change can be observed in UK for policy 11 but it is same for Germany. Policy 14 shows the similar results in both the periods. Policy 15 has remained same for the UK in both the periods however they have shown the significant deviations in German context. Policy 16 has remained consistent for German companies but showed opposite outcomes in both the periods. Works Cited Ashbaugh, H. and Pincus, M., 2001. Domestic accounting standards, international accounting standards, and the predictability of earnings. Journal of Accounting Research, 39(3), pp. 417–434. Ball, R., 2001. Infrastructure requirements for an economically efficient system of public financial reporting and disclosure. Brookings-Wharton Papers on Financial Services: 127–169. Ball, R., 2006. International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and Business Research, International Accounting Forum, 5–27. Fields, T., Lys, T. and Vincent, L., 2001. Empirical research on accounting choice. Journal of Accounting and Economics, 31, pp. 255–307. Gassen, J. and Sellhorn, T., 2006. Applying IFRS in Germany – determinants and consequences. Betriebswirtschaftliche Forschung und Praxis, 58(4). Gonzalo, J.A. and Gallizo, J.L., 1992. European Financial Reporting: Spain. London: Routledge. Kvaal, Erlend and Nobes, Christopher., 2010. International differences in IFRS policy choice: a research note. Accounting and Business Research, 40(2), pp. 173–187. Leuz, C. and Verrecchia, R., 2000. The economic consequences of increased disclosure. 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