In recent years, the European Commission (EC) regarded harmonization as a vital element in order to meet the growing need for transparent corporate accounts and the need to compare financial statements thus streamlining the development and efficiency of European financial markets. The principle at the base of the harmonization process is convergence and transparent financial information at an international level. The EC wants to ensure financial statements are no longer merely true and fair pictures of a business’ economic position at a given date but are a financial information tool useful to those who make economic decisions. To achieve this goal, the European Union decided not to issue its own separate principles but rather to implement international standards that are already known and currently used by EU business standards published by the International Accounting Standards Board (IASB). (New standards will be issued by IASB called International Financial Reporting Standards or IFRS.) The European Union implemented IASB standards in order to rely on a consistent and coordinated body of accounting principles recognized worldwide.
International Accounting Standards (IAS), and IFRS in the future, were chosen as an alternative to the U.S. generally accepted accounting principles (GAAP). Although significantly different, they are both a comprehensive body of accounting principles whose main aim is to protect investors. The EU chose to adopt the IASB standards rather than GAAP because of the anticipated difficulties in applying U.S. principles in Europe. GAAP, in addition to specifically addressing the U.S. market, are also exceptionally detailed and analytical. Moreover, the IASB standards were endorsed by the International Organization of Securities Commissions (IOSCO), an organization that groups securities commissions of major world countries, and by the Basle Committee, the international organization of bodies in charge of banking supervision. IOSCO allows listing by companies that adopt international standards, with no need for reconciliation statements. The IASB is also working with the United States to obtain a listing of companies that prepare accounts by applying IAS. At the end of October 2002, the IASB formalized an understanding with the Financial Accounting Standards Board (FASB), the organization in charge of establishing U.S. accounting standards, where the two organizations worked together to remove mutual differences.
Convergence of the IASB and FASB is likely to involve mutual sacrifice in the name of an ambitious goal: worldwide consistency of financial statements and reporting. The convergence process between IAS and GAAP is evolving among politicians who discussed the issue at the TransAtlantic Business Dialogue meeting held in Ireland at the end of June 2004. At the meeting, the European Union and the United States committed to strengthening cooperation in order to provide investors with appropriate guarantees based on one set of accounting standards or on compatible systems.
Applying IAS in the European Union
The application of the IAS is regulated by EC Regulation No. 1606/02, approved in 2002. The EC regulation requires all EU companies listed on regulated markets to prepare consolidated financial statements in accordance with IAS by 2005 at the latest. An extension to 2007 is allowed in the case of companies that are already preparing accounts by applying internationally accepted accounting standards (such as GAAP), and companies with debt instruments (other than shares) traded solely on a regulated market of any member state.
The regulation includes the right for EU member countries to allow or require the adoption of international accounting standards by EU-listed companies, with reference to annual financial statements, and unlisted companies, with reference to annual and consolidated financial statements. The subsequent EC Regulation No. 1725/03 completed the previous EC Regulation No. 1606/02 and adopted all accounting standards issued by IASB (except for IAS 32 and IAS 39), which will need to be complied with when preparing annual and consolidated financial statements.
Employing IAS in Italy
The Italian legislator implemented EU regulations by introducing two measures. The first is EU Law No. 306, dated October 31, 2003. This law identifies the companies required to apply IAS. Italy exercised its right, as stated in the EU regulation, to allow unlisted companies to report by using IAS. The law also mentions listed companies, in drawing up their annual financial statements; companies issuing publicly traded financial instruments, in drawing up annual or consolidated financial statements; banks and financial intermediaries subjected to the supervision of the Bank of Italy, in drawing up their annual financial statements; and insurance companies in drawing up consolidated financial statements and annual financial statements. But, in the latter case, companies are subject to the law only if they are not listed and do not prepare consolidated accounts. Legislative Decree No. 394, dated December 30, 2003, amended clauses of the Italian Civil Code on information disclosed in the supplementary notes to accounts and in the report on the management. It now requires that supplementary notes to accounts contain information on the fair value of financial instruments.
Welcoming New Provisions Introduced by the IAS
New elements are going to be introduced for the preparation of companies’ annual and consolidated accounts by the upcoming adoption of international accounting standards. Their adoption will be a genuine revolution of general principles, specifically for companies with a continental structure that refers to the pivotal "prudence basis" of accounting aimed at preventing any dilution of the corporate capital and the distribution of fictitious profits. An essential difference between the previous European approach and the IASB’s is the purpose assigned to financial statements. According to the IASB, financial statements are the tool that enables investors to make economic decisions.
The substantial approach in the two cases is clearly different: On the one hand, the approach is essentially inspired by the prudence basis, which tends to highlight distributable income and available assets. On the other hand, attention is focused on the valuation of the performance achieved by the company, which is instrumental to making economic valuations. Under this framework, the concepts of capital and income are significantly different. The old European approach tended to identify capital with the concepts of ownership, risk and obligations undertaken toward third parties. The IASB’s approach tends to identify the capital with all the economic resources managed by the company. Based on the EU’s approach, income is "distributable income" and the rules for its determination are strictly connected to limiting the risk of distributing fictitious profits. Based on the IASB’s approach, income is "income earned" and may be influenced by unrealized revenue and proceeds, resulting from the use of current values for the valuation of the business.
A further essential element is the different way to represent operating results. In particular, while the Italian Civil Code merely mentions the reflection of assets and liabilities, the financial statement and the profit and loss account, the IASB standards refer to the statement of assets and liabilities, the profit and loss account and cash flows in the financial position. The dynamic reference to the financial aspect (cash flow) is an additional difference between the old European approach and the IASB’s approach. The IASB standards interpret the financial statements in terms of evolution (dynamically) and, albeit in accordance with the accrual basis of accounting, the operating result is seen as an indication of the future corporate performance. In this respect, the IASB standards are similar to the GAAP, which interpret financial statements in forward-looking terms to give investors the opportunity to appraise the ability to generate future profits and interpret possible investment-related risks, so as to place them in a position to make economic and financial decisions.
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