This report will provide a brief history and background on the process of harmonization in the European Union with regards to the 2 methods it employed: Directives and IFRS adoption. By providing a basis for which harmonization can be understood and why it is necessary, this report strives to elucidate the successes and failures of the methods. In particular, the issues that arose during the implementation of IFRS in the EU will be used to further demonstrate the need for harmonization, using specific standards as examples. The relationship between accounting harmonization and auditing will be debated with specific focus on the EC Green Paper on �Audit Policy: Lessons from the Crisis� as it points to on-going concerns in the attempt to achieve accounting harmonization.
2. History and Background of Accounting Harmonization
Definition
Harmonization is a process of increasing the compatibility of accounting practices by setting bounds to their degree of variation (Nobes & Parker, 2010). Essentially, harmonization allows countries to use different standards so long as they are not in conflict. This varies slightly from convergence, the goal of the IASB, which aims to develop high quality standards alongside national standard-setters to reduce international differences. The importance of this distinction highlights the differences in the harmonization efforts by both the EU and IASC/B.
The need for harmonization
Globalization has led to large companies looking to increase their sales and growth opportunities beyond national markets. To attract equity and debt financing to achieve these goals, many of these companies are looking to be listed on different stock exchanges. Additionally, investors are expanding their portfolios beyond national borders as global markets have created greater opportunities for investing.
As a result, the differences in the reporting practices of such companies is now of great importance as this has led to difficulties for those who prepare, consolidate, audit and interpret financial statements.
Two of the major obstacles to accounting harmonization are nationalism and the current size of the existing differences between countries. The EU has attempted to achieve harmonization by using Directives and Regulation through IFRS standards �as such, the efforts of the EU in creating a unified business environment as well as the adoption of IFRS in 2005 provide a relevant platform for understanding the harmonization process. This report seeks to convey this in section XXXXX below.
3. The Accounting Directives
The Directives are an attempt to harmonize reporting practices by requiring member nations to incorporate the directives into their national laws. The Fourth and Seventh Directives were aimed at accounting harmonization while the Eighth Directive was aimed at audit.
Fourth Council Directive � Annual accounts of companies with limited liability
�This Directive coordinates Member States� provisions concerning the presentation and content of annual accounts and annual reports, the valuation methods used and their publication in respect of all companies with limited liability (European Commission, 2009).�
The provisions of the Directive require public and private companies in all EU countries to include a balance sheet, profit and loss account, with a choice of 2 different layouts, as well as notes to the accounts as part of the annual accounts. It also provides the general principles by which items must be valued.
The earliest proposal for the Fourth Directive led to the first draft being developed in 1971 � the draft was heavily influenced by German law and as a result, the Directive prescribed conservative valuation rules, rigid formats and limited disclosure in the notes. By 1974, a year after accession to the EU, UK influence in the Directive became apparent with the introduction of the �true and fair view� concept; greater flexibility in the presentation formats and increased emphasis on disclosure in the notes.
The Directive was adopted by the EU in 1974 and has since been amended as many as 14 times in line with international developments. One major amendment was in 2001 when the Directive was further aligned with IASB standards by allowing the requirements of IAS 39 on the fair valuation of financial instruments to be employed. This was a substantial move as this had been a contentious issue and served the purpose of modernising European accounting rules - this will be discussed in more detail in subsequent sections. Another critical amendment came in 2003, when the Accounts Modernisation Directive was issued � it extended the use of fair values and further eliminated inconsistencies with IASB standards.
The most recent amendment in 2009 resulted in 2 developments; firstly, companies in member states with 10 or fewer employees were exempt from the requirements of the Directive. In addition, a consultation document was issued setting out a proposal for rearranging the Directives to improve its comprehension*.
Seventh Council Directive � Consolidated accounts of companies with limited liability
�This Seventh Company Law Directive coordinates national laws on consolidated (i.e. group) accounts Together with the Fourth Directive on the annual accounts of public limited liability companies, it belongs to the family of "accounting directives" that form the arsenal of Community legal acts governing company accounts (European Commission, 2009).�
This Directive was adopted in 1983 to improve international preparation and comparison of financial statements. It does so by prescribing the circumstances under which consolidated accounts must be prepared as well as the methods for preparation. According to the Directive, any company that legally controls another company is required to prepare consolidated accounts. The 1976 and 1978 drafts failed to clarify the concept of control for the purpose of consolidation. As such, the adopted Directive attempts to improve what is meant by the term �control�.
In countries where consolidation had been unheard of e.g. Portugal, Italy, Greece and Spain, the Directive signified a pronounced move towards modernisation. This was of great significance given that in 2005, the EU�s harmonization efforts in terms of group accounting finally converged with that of the IASB with the adoption of IFRSs by EU listed companies. As such, the Seventh Directive has now since been overtaken by IFRS standards.
4. Statutory Audit Directive
(Previously) Eighth Council Directive � Qualifications of persons responsible for carrying out the statutory audits of accounting documents
�This Directive aims to increase the credibility of financial reporting and to enhance the European Union�s (EU) protection against financial scandals by laying down rules harmonizing the procedures for statutory audits of annual accounts and consolidated accounts. It establishes, among other things, a requirement for external quality assurance, provisions on public supervision, the duties of statutory auditors and the application of international standards and the principles of independence applicable to statutory auditors. The Directive also provides a basis for cooperation between regulators in the EU and those in third countries� (European Commission, 2009).
The adopted Directive (1983) differs substantially from earlier drafts which would have had significant impact on the training patterns and scope of work of accountants in a number of countries, notably the UK. The Directive was introduced to determine which persons are allowed to carry out audits by prescribing qualification and educational requirements.
The need to modernize the Eighth Directive was recognized by the EC in the communication �Reinforcing the statutory audit in the EU�, published in 2003. It contained the strategy of the EC in coming years regarding audit matters such as public oversight and regulation at the EU level.
In response to Enron and other accounting scandals, the Directive was amended in 2006 � it focused on quality assurance by requiring the establishment of auditor oversight bodies, providing rules on professional integrity and independence, ensuring adherence to ISAs as endorsed by the EU in performing statutory audits, establishment of audit committees and the publication of transparency reports on audit firms.
In a bid to encourage the growth of alternative audit firms, further recommendations were released in 2008 with the objective of giving more responsibility to oversight bodies and to encourage member states to limit the civil liabilities of auditors (European Commission, 2008).
Following the financial crisis of 2007/8, the EC has deemed it necessary to amend the statutory audit directive through a proposal issued in November 2011 (European Commission, 2011). The amendments follow on from the EC Green Paper on �Audit Policy: Lessons from the Crisis� and tackles issues such as joint audits, provision of non-audit services, etc., which are discussed later on in this report.
Red boxes to go in appendix?
To go in summary?
EU attempts at harmonization through the use of Directives were not entirely successful and as such the EC chose instead to follow the convergence strategy of the IASB by adopting IFRS. The inadequacies of the Directives derived from the fact that they failed to cover many topics e.g. lease accounting, accounting changes, foreign currency translation etc., which IFRSs were better equipped to handle. Also, the Directives still allowed for a degree of choice within their prescriptions which meant that non-comparability was still an issue.
