3Financial statements according to Commercial Code
3.1Balance sheet
First the legal structure of the balance sheet is explained; then the different balance sheet items are explained in detail focusing on recognition, measurement and presentation.
3.1.1Structure
For proprietorships and partnerships, the Commercial Code prescribes only a very basic structure (§ 247):
Tab. 3.1: Basic structure of a balance sheet (§ 247).
| Debit | Balance sheet | Credit | |
| Non-current assets | Equity | ||
| Current assets | Liabilities | ||
| Deferred expenses | Deferred income | ||
Further detailing to fulfil the GAAP, in particular the principle of clarity and transparency, is up to the judgement of the reporting unit. Once a structure has been decided upon, it should be kept constant (principle of formal comparability).85
For corporations, § 266 prescribes a detailed structure.
For the debit side see Table 3.2.86
For the credit side see Table 3.3.87
The asset side is structured according to the common current/non-current distinction. Within the current and non-current assets, a further detailing is done according to the kind of asset. Advance payments are shown depending on what is paid for in advance, meaning each category of non-current items has a separate category of payments made in advance.
The credit side singles out equity and then according to differences in certainty provisions and debt, i.e. the current/non-current distinction is not used here, but this
Tab. 3.2: Debit side according to § 266 sect. 2.
| A. | Non-current assets | ||
| I. | Intangible assets | ||
| 1. | Internally generated commercial property rights and similar rights and assets | ||
| 2. | Concessions, commercial property rights and similar assets as well as licenses of such rights and similar assets, acquired against remuneration | ||
| 3. | Goodwill | ||
| 4. | Payments made in advance | ||
| II. | Tangible assets | ||
| 1. | Land, rights similar to land and buildings including buildings on third-party land | ||
| 2. | Technical facilities and machines | ||
| 3. | Other facilities and office equipment | ||
| 4. | Payments made in advance and assets under construction | ||
| III. | Financial assets | ||
| 1. | Shares in affiliated companies | ||
| 2. | Loans to affiliated companies | ||
| 3. | Participations | ||
| 4. | Loans to companies in which a participation exists | ||
| 5. | Non-current securities | ||
| 6. | Other non-current financial assets | ||
| B. | Current assets | ||
| I. | Inventories | ||
| 1. | Raw materials and other materials | ||
| 2. | Unfinished goods and services | ||
| 3. | Finished goods and merchandise | ||
| 4. | Payments made in advance | ||
| II. | Receivables and other assets | ||
| 1. | Trade receivables | ||
| 2. | Receivables from affiliated companies | ||
| 3. | Receivables from companies in which a participation exists | ||
| 4. | Other assets | ||
| III. | Securities | ||
| 1. | Shares in affiliated companies | ||
| 2. | Other securities | ||
| IV. | Cash, positive deposits at central bank or other banks, cheques | ||
| C. | Deferred expenses | ||
| D. | Deferred tax assets | ||
| E. | Asset surplus from netting | ||
Tab. 3.3: Credit side according to § 266 sect. 3.
| A. | Equity | ||
| I. | Subscribed capital | ||
| II. | Capital reserves | ||
| III. | Revenue reserves | ||
| 1. | Legal reserves | ||
| 2. | Reserves for shares of a controlling entity | ||
| 3. | Statutory reserves | ||
| 4. | Other revenue reserves | ||
| IV. | Profit/loss carry forward | ||
| V. | Net profit/loss of year | ||
| B. | Provisions | ||
| 1. | Provisions for pensions and similar obligations | ||
| 2. | Tax provisions | ||
| 3. | Other provisions | ||
| C. | Debt | ||
| 1. | Bonds, thereof convertible | ||
| 2. | Bank debt | ||
| 3. | Received advance payments for orders | ||
| 4. | Trade payables | ||
| 5. | Payables from bills of exchange | ||
| 6. | Payables to affiliated companies | ||
| 7. | Payables to companies in which a participation exists | ||
| 8. | Other payables, thereof tax payables and social security payables | ||
| D. | Deferred income | ||
| E. | Deferred tax liabilities | ||
information must be given in the notes. Further detailing is again based on the kind of liability.
For the application of this structure the following is to be considered:88
–This structure must be applied in this way. Small corporations can neglect items with Arabic numerals (§ 266 sect. 1).
–In the balance sheet, the figures of the current year and of the previous year must be reported. If previous year information is not comparable or was adjusted, this needs to be explained in the notes (§ 265 sect. 2).
–If an asset or a liability cannot be attributed unambiguously to one item, it is attributed to one item with reference to the other relevant items or with an explanation in the notes (§ 265 sect. 3).
–A further detailing of the structure is possible when the given structure is respected. Additional items and subtotals can be added if the content is not covered by existing items (§ 265 sect. 5).
– tructure and naming of the items with Arabic numerals can be changed if this improves clarity and transparency because of the particularities of the corporation (§ 265 sect. 6).
–Items with Arabic numerals may be aggregated if the amounts are not material for a true and fair view or if clarity and transparency are improved by doing so; in the latter case detailed information must be given in the notes (§ 265 sect. 7).
–Blank lines, i.e. items with a zero value in the current and the preceeding period, can be neglected (§ 265 sect. 8).
–Once a structure and naming is decided, it must be kept according to the principle of formal comparability (see earlier, § 265 sect. 1).
Further readings
IDW RS HFA 39 “Vorjahreszahlen im handelsrechtlichen Jahresabschluss” – Previous year’s figures in the financial statements according to the Commercial Code.
Important differences to IFRS
The IFRS define in IAS 1.54 and 1.60 minimum requirements, usually using the current/non-current distinction. Further detailing depends on the judgement of the reporting entity and should be based on the underlying principles. Thus, the IFRS are more flexible than the Commercial Code.
3.1.2Recognition prohibitions
§ 248 sect. 1 specifies several explicit recognition prohibitions. Not to be recognized as assets are
–expenses incurred for the founding of a company, such as consulting fees, notary and registration fees, expenses for a formation audit, fees for publication or travel expenses of the founders;
–expenses incurred for the procurement of equity, for example expenses for issuing shares, consulting fees or an initial public offering;
–expenses for concluding an insurance contract, such as broker fees.89
These transactions always result in expenses of the period.
Important differences to IFRS
Expenses related to the procurement of equity are deducted from the capital reserves (IAS 32.37).
3.1.3Non-current assets
3.1.3.1Classification non-current–current
An asset is classified as non-current if it is intended to serve a business continuously (§ 247 sect. 2). There are objective indicators of this, such as the function of the asset (in relation to the business of the company) and useful life. On the other hand, the classification depends on the way the asset will be used in the business process, meaning it depends on the (subjective) judgement of management:90
–If the asset is to be sold to customers, it is current;
–If the asset will be used multiple times in business operations, it is typically non-current;
–A long-term production process does not require classifying the product as non-current if the intention is to sell the product after completion;
–Any asset that is not classified as non-current is current.
Examples
Tab. 3.4: Examples of the classification non-current–current.
| Software | If acquired or produced/developed for the purpose of selling it to customers: →current assets (inventory) |
| If acquired or produced/developed to be used within the company continuously →non-current assets (intangible assets) | |
| Land | If acquired to be sold (e.g. real estate development) →current assets (inventory) |
| If acquired to be used for example as the basis for a production or administration building →non-current assets (tangible assets) | |
| Traded shares | If acquired to be sold again to realize a trading gain →current assets (current securities) |
| If acquired to establish a permanent relationship with the issuing company or to control the issuing company →non-current assets (participations or shares in affiliated companies) |
3.1.3.2Subsequent measurement
These rules are relevant for all non-current assets. In the subsequent chapters only specifics for the different items will be explained.
3.1.3.2.1Depreciation/amortization
Because a non-current asset serves a company continuously, the decrease in its value should be reflected over the periods of usage according to the accrual principle. This is done by a depreciation or an amortization.91
§ 253 sect. 3 states that for non-current assets that have a definite useful life, the initial acquisition or production costs must be distributed over the useful life in a planned manner. This implies:92
–The useful life is definite, i.e. foreseeably limited. In consequence, there is no depreciation for assets with an unlimited or indefinite useful life such as land.
–The useful life is the time period for which the asset can be presumably used in an economically effective way, meaningwhat’s important is the economic life, not the technical life. An asset’s useful life ends if it brings no additional economic benefits when used (even if it is technically possible). Typically, the economic life is shorter than the technical life because of technical progress, obsolescence, changed market conditions or other factors.
–The initial acquisition or production costs must be distributed, meaning no more than the initial acquisition or production cost may be distributed. Higher replacement costs may not be recognized. If the asset is already completely depreciated but is still used (i.e. the useful life was estimated to be too short), there is no further depreciation.
–Costs must be distributed in a planned manner, i.e. a specific method must be used and this plan must be set up at the beginning.
–Depreciation is an expense (a reduction of net assets) but not an expenditure or cash outflow, because nothing is paid. The cash flow occurred in the past by paying the initial acquisition or production costs; depreciation is the expense effect of a prior payment. This distinction is important for the preparation of the cash flow statement (Chapter 3.4).
Basis for depreciation
The initial acquisition or production costs serve as the basis for depreciation. A residual value, i.e. sales proceeds at the end minus any costs for decommissioning or selling, must be recognized if it is substantial and can be estimated reliably; only rough guesses may not be deducted owing to the imparity principle.93 Subsequent acquisition or production costs increase the basis at the point in time when they are incurred, meaning the depreciation schedule must be changed prospectively (not retrospectively).94
Useful life
The useful life of an asset must be estimated based on the information available; this means a certain range is possible.
For tax purposes specific depreciation tables must be used. These tables attach to nearly all possible assets a specific useful life that must be used for tax purposes; a shorter useful life may be used only if there are good reasons for doing so.95
Because useful life is an estimate, changes may occur during the actual usage of the asset. If substantial changes in the estimates are necessary, the depreciation schedule must be revised from the point in time in which the estimates are changed (prospectively, not retrospectively). The estimates of the useful life should be reviewed regularly.96
Start and end of depreciation
In general, depreciation starts with the end of acquisition or the end of production, meaning when the asset is ready for operation. It ends with the end of usage. Thus, the first and eventually the last years are depreciated on a pro rata basis. The common simplification is to start with the complete month in which the asset is ready for operation and to end with the complete month in which the asset is no longer used.97
Depreciation methods
The distribution of the initial acquisition or production costs must be done in a planned manner, meaning a specific method must be used. The Commercial Code does not require a specific method, but it must fulfil the GAAP, in particular it should reflect real decreases in value. The most common methods are as follows:98
–Linear (straight line)
Acquisition or production costs are distributed equally over the useful life; this method assumes a continuous usage pattern. The annual depreciation is calculated as follows:
This implies a constant rate of depreciation, meaning a certain percentage of the initial value is depreciated in each year.
–Declining balance (degressive)
A certain percentage is applied here as well, not to the initial value, but to the remaining book value. As the remaining book value decreases, depreciation decreases. This implies that the loss of value is higher at the beginning than at the end.
Because a certain percentage is applied to the remaining book value, the remaining book value would never reach zero. This would not comply with the legal requirement that the initial acquisition or production costs must be distributed over the useful life, i.e. the remaining value should be zero at the end. Therefore, when using the declining balance method, you necessarily switch to the linear method when the linear depreciation over the remaining useful life becomes higher than the corresponding depreciation according to the declining balance method.99
This is not considered a change in the measurement methods because it is planned from the beginning this way and it is necessary to fulfil the legal goal. The declining balance method is currently not acceptable for tax purposes.
–Performance oriented/units of activity
If the performance of an asset can be measured precisely, for example the mileage of a car or the flight hours of a plane, and if the total performance can be estimated, these values can be used as the basis for performance-oriented depreciation. Depending on the effective use of the asset, the depreciation rate will change each year:
This depreciation rate is applied to the initial acquisition or production costs.
–Progressive
This means that the depreciation amounts increase from year to year. In most cases, this will not be compliant with the GAAP; it is not acceptable for tax purposes.
IDW RH HFA 1.015 “Zulässigkeit degressiver Abschreibungen in der Handelsbilanz vor dem Hintergrund der jüngsten Rechtsänderungen” – Acceptability of depreciation according to the declining balance method in financial statements according to the Commercial Code with regard to the latest legal changes.
IDW RH HFA 1.1016 “Handelsrechtliche Zulässigkeit einer komponentenweisen planmäßigen Abschreibung von Sachanlagen” – Acceptability of depreciation for components for tangible assets according to the Commercial Code.
Important differences to IFRS
According to IAS 16.51, the remaining useful life of an asset must be reviewed regularly, at least annually (no formal rule exists in the Commercial Code).
A residual value of tangible assets must reduce the depreciation basis if it is material – the reliability of estimates is not a reason to exclude a residual value (IAS 16.6 and 16.53). For intangible assets regularly a residual value of zero is assumed (IAS 38.100).
3.1.3.2.2Impairment and reversal of impairment
Whereas depreciation/amortization reflects the regular decrease in value of an asset, an impairment reflects an additional, unscheduled decrease in value.
Non-current assets must be impaired to the lower fair value if this decrease in value is foreseeably permanent. This means, in consequence, that temporary decreases in value are not a reason for an impairment. This is the so-called moderate lower-of-cost-or-market principle.
The fair value can be a market value if a procurement market exists (i.e. a replacement value). This refers to the acquisition costs of a comparable asset less necessary depreciation. If a replacement value is not available, a reproduction value can be used, i.e. the production costs if this asset were produced again. For non-current assets, a focus on the sales market is usually not acceptable because such assets are intended to serve the business continuously. A present value might be used if no other values are available.100
A common understanding of a permanent decrease in value for a depreciable asset is that the value at the closing date after impairment is for a substantial part of the useful life or the next 5 years lower than the future remaining book values without impairment. Put differently, if the impairment is caught up within 5 years by regular depreciation, the decrease in value is not considered permanent.101
Based on the principle of individual measurement, the need for impairment must usually be judged for each asset separately (unless simplifications can be used).
Like depreciation, an impairment is an expense, but not an expenditure or a cash flow. Typical reasons for an impairment may be, for example,
–substantial damage, destruction or loss of an asset;
–permanent decrease in the procurement market price or technical or economic obsolescence;
–substantial shifts in demand for products that lead to closure or continuous underutilization of facilities;
–for financial assets: substantial decrease in the market price (if listed) or earnings rate.
If the reasons for an impairment are no longer valid, the impairment must be reversed to the new fair value of the asset. In case of a non-depreciable asset, the maximum level is the initial acquisition or production costs. In the case of a depreciable asset, the maximum level of the reversal is the remaining book value that would have resulted without impairment.102
Presentation
Corporations must report impairments for non-current assets as a separate line item in the income statement or in notes (§ 277 sect. 3).
Important differences to German tax law
German tax law uses a different logic:103
–There is no requirement for an impairment in the case of a permanent decrease in value, but it is an option.
–The remaining book value is compared with the so-called partial value. The partial value is the fictitious value an acquirer of the whole company would be willing to pay for the specific asset as part of the whole. There are several assumptions about how this approach can be measured in real life.
–A permanent decrease in the value of a depreciable asset is assumed if the values at the closing date (after impairment) will be at least 50% of the remaining useful life below the remaining book values without impairment.
Because of these differences, the accounting for impairments will often be different in the commercial balance sheet and in the tax balance sheet and may result in deferred taxes.
Impairments of assets are specified in IAS 36 (with exceptions). It uses a different and more detailed concept than the Commercial Code:
–Impairments must be assessed on the basis of cash-generating units to which cash inflows can be attributed.
–The recoverable amount of a cash-generating unit is the higher value of its fair value (according to IFRS 13) less costs of disposal and the value in use. The value in use is the present value of the future cash in- and outflows of the cash-generating unit.
–An impairment must be recognized if the recoverable amount is less than the book value of the cash-generating unit. There is no distinction between a temporary and a permanent decrease in value.
–An impairment test must be conducted at least annually. It is a 2-step-approach: first, indicators are checked whether or not an impairment is probable; then, the recoverable amount is calculated. Apart from goodwill and intangible assets with indefinite useful life, the recoverable amount has to be calculated only if there are indications for an impairment.
–If the need for an impairment no longer exists, it must be reversed.
3.1.3.3Presentation
Corporations must prepare in the notes for all non-current assets a development from the opening balance to the closing balance split into development of total acquisition and production costs and accumulated depreciation, amortization and impairment (§ 284 sect. 3). This needs to be prepared for all the different items according to § 266 (see Table 3.5).104
In addition, it must reported whether and to what extent interest on borrowings has been included in the production costs.105
3.1.3.4Intangible assets
Intangible assets are assets without physical presence and that are not financial assets, i.e. they do not entail a claim to financial means. Typically, they are intellectual or commercial property rights, for example patents, software, licenses, brands.
Intangible assets must be subdivided into three categories, which will be explained separately: acquired intangible assets, self-produced intangible assets and goodwill.
Tab. 3.5: Development of non-current assets.
| Content | Line | |
| Total acquisition or production costs at beginning of reporting period | 1 | |
| + | Additions to acquisition or production costs during period | 2 |
| − | Disposals from acquisition or production costs during period | 3 |
| ± | Reclassifications of acquisition or production costs during period | 4 |
| = | Total acquisition or production costs at end of reporting period | 5 = 1 + 2 − 3 ± 4 |
| Accumulated depreciation, amortization and impairment at beginning of reporting period | 6 | |
| + | Depreciation, amortization and impairment of the period | 7 |
| − | Reversal of depreciation, amortization and impairment of the period | 8 |
| + | Changes of accumulated depreciation, amortization and impairment in context of additions (without 7) | 9 |
| − | Changes of accumulated depreciation, amortization and impairment in context of disposals | 10 |
| ± | Changes of accumulated depreciation, amortization and impairment in the context of reclassifications | 11 |
| = | Accumulated depreciation, amortization and impairment at end of reporting period | 12 = 6 + 7 − 8 − 10 ± 11 |
| Book value at beginning (opening balance) | 1 − 6 | |
| Book value at end (closing balance) | 5 − 12 |
Acquired intangible assets
Recognition
Acquired intangible assets are recognized as any other asset if they fulfil the recognition criteria.106
Initial and subsequent measurement
Acquired intangible assets are measured at acquisition costs and amortized/impaired as any other asset.
Presentation
No additional requirements.
Important differences to German tax law
See earlier remarks for all non-current assets.
IAS 38 allows the use of a revaluation model for measurement as alternative to the cost model, i.e. assets are regularly revalued to their fair value and amortized on that basis; this is only possible if an active market exists for the intangible asset (IAS 38.75–87). If the useful life of an asset cannot be estimated, meaning it has an indefinite useful life, it is not amortized (but only impaired if necessary; IAS 38.107 and 108). See the earlier remarks for all non-current assets.
Further readings
IDW RS HFA 11 “Bilanzierung entgeltlich erworbener Software beim Anwender” – Accounting for acquired software by the user.
Internally generated intangible assets
Recognition
Specific internally generated intangible assets are prohibited from recognition (§ 248 sect. 2): Internally generated brands, mastheads, publishing titles, customer lists and similar items.107
For all other internally generated, non-current, intangible assets there exists a recognition option, meaning these assets can be recognized but need not be (§ 248 sect. 2). If this option is used, a profit distribution restriction exists (§ 268 sect. 8): The difference between the book value of the recognized asset and the corresponding deferred tax liability must be kept in the revenue reserves and may not be distributed as profit to shareholders.108
Initial measurement
If the aforementioned option is used, assets must be recognized with their production costs. Because these are non-current assets, production costs consist only of development costs (and the fair part of general administration and voluntary social security). Research costs are prohibited from recognition (see earlier, Chapter 2.4.2.2).109 If research and development costs cannot be distinguished clearly, recognition is prohibited.
If – under rare circumstances – the useful life of a internally generated intangible asset cannot be estimated reliably, a useful life of 10 years must be assumed (§ 253 sect. 3 sent. 3).
Presentation
Corporations must furnish the following information in the notes:
–If the recognition option is used, the total amount of research and development costs and the part recognized as intangible assets (§ 285 no. 22).
–If the recognition option is used, the amount of revenue reserves that cannot be distributed as profit (§ 285 no. 28).
Important differences to German tax law
A recognition of internally generated intangible assets is prohibited in general, i.e. there is no recognition option. Therefore, the use of the option results always in a deferred tax liability.
Important differences to IFRS
According to IAS 38, internally generated intangible assets must be recognized (i.e. mandatory recognition, not optional) if certain recognition criteria are fulfilled (IAS 38.57). Research costs cannot be recognized. As in the Commercial Code, a recognition prohibition exists for brands, mastheads, publishing titles, customer lists and similar items (IAS 38.63). See the earlier comments on acquired intangible assets and for all non-current assets.
Goodwill
Recognition
Acquired goodwill is defined as the difference between the consideration for an acquired business and the net assets at time value. According to § 246 sect. 1 sent. 4, an acquired goodwill is treated as an asset with a definite useful life and therefore must be recognized. This has three implications: first, goodwill is not an asset, but only treated as one; goodwill does not fulfil the criterion of separate marketability because it cannot be sold separately from the business. Second, the generic goodwill, i.e. internally generated goodwill, of a company cannot be recognized. Third, goodwill is amortized.110
Goodwill can arise in individual and consolidated financial statements depending on the form of the acquisition transaction. If a business is acquired in an asset deal, i.e. by acquiring all relevant assets and liabilities but not a specific legal entity, the goodwill arises in the individual financial statements. If a business is acquired in a share deal, i.e. the majority of shares of the legal entity that comprises the business is acquired, the goodwill arises in the consolidated financial statements (Chapter 4).
Initial measurement
Goodwill is measured as follows:
| Acquisition costs of the business: | |
| Purchase price or other form of consideration including all incidental | |
| acquisition costs | |
| − | Net assets at time value, which are |
| acquired assets at time value less acquired liabilities at time value | |
| = | Acquired goodwill |
It is important that net assets must be measured at time value, not at book value, i.e. any hidden reserves or hidden burdens must be uncovered; this process is called purchase price allocation. It includes not only a new measurement of the already recognized assets and liabilities but also the recognition of as yet unrecognized assets or liabilities.
Example
A company may have developed its own brand and therefore not be allowed to recognize this brand as an intangible asset. If the business of this company is acquired in an asset deal and the acquirer attributes value to this brand, he must recognize it, because for him it is an acquired brand (which must be recognized) and not an internally generated brand (which is not allowed to be recognized).
Subsequent measurement
Because goodwill is treated as an asset with a definite useful life, the useful life must be estimated and the goodwill is amortized over it. If – under rare circumstances – the useful life of goodwill cannot be estimated reliably, a useful life of 10 years must be assumed (§ 253 sect. 3 sent. 3 and 4).
In addition, goodwill must be impaired if its value decreases permanently (see earlier). The Commercial Code does not specify a method of testing goodwill impairment. If goodwill has been impaired, the impairment will not be reversed, even if the reasons for the impairment are no longer valid (§ 253 sect. 5 sent. 2).111
Corporations must describe for each occurrence of goodwill the useful life used for amortization (§ 285 no. 13).
Important differences to German tax law
Acquired goodwill must be amortized over 15 years independently of the useful life estimated for the commercial balance sheet (§ 7 sect. 1 sent. 3 EStG).
Important differences to IFRS
According to IFRS 3 and IAS 36, goodwill is not amortized, only impaired (impairment-only approach). The goodwill must be allocated to a cash-generating unit and is tested together with the cash-generating unit for impairment (IAS 36.80–99).
3.1.3.5Tangible assets
Tangible assets are assets that have a physical presence, for example buildings, machines and vehicles.
Recognition
Tangible assets are recognized as any other asset if they fulfil the recognition criteria.
Initial measurement and subsequent measurement
Tangible assets are measured at acquisition or production costs and depreciated/impaired as any other asset.
Constant-value approach
As a simplification, tangible assets and raw materials can be recognized and measured using the constant-value approach (§ 240 sect. 3)112
–if the total value of the assets is not material compared to total assets; a rule of thumb is that all constant values should not exceed 5% of total assets;
–if the amount, value and composition of the assets fluctuate only slightly; this excludes, for example, assets with high market price fluctuations;
–if the used assets are replaced regularly.
If all three criteria are fulfilled, the assets can be recognized at a constant amount and value. They do not need to be included in annual stock taking. Any additions to these assets, i.e. replacement of used assets, are directly recognized as expenses. Typically, after 3 years a physical stock taking is necessary. If this stock taking results in a higher or lower value, the value needs to be adjusted. Common practice is that an increase in value is only recognized if it is material (typically an increase of 10% or more), whereas decreases in value are recognized always owing to the prudence principle.
Example
A typical example of the use of the constant-value approach is the cutlery or tableware of a restaurant: Often, the value will be immaterial. Typically, the available amount, value and composition do not fluctuate: There is a fixed number of seats available and for each seat a defined amount of cutlery and tableware is necessary. The composition is constant, i.e. a missing knife cannot be replaced by an additional spoon or fork. Missing items will be replaced regularly because they are needed.
If all this is true, the cutlery and tableware can be recognized using a constant value, meaning there is no depreciation, but all replaced items are directly expensed.
Low value goods
For non-current assets there are no further simplifications included in the Commercial Code (apart from group measurement and constant value approach; see above). German tax law specifies the approach for low-value goods, which is typically applied for the commercial balance sheet as well (§ 6 sect. 2 and 2a EStG).113
Low-value goods are defined as moveable assets that are tangible and non-current and whose value is not more than €1,000 net.
The following simplifications exist:
Direct expense
The asset is directly expensed, that is, it is not recognized as an asset. The kind of expense depends on the kind of asset or the context of the acquisition (it is not depreciation; see subsequent discussion).
The asset is recognized as a non-current asset, but then depreciated completely in the first year (i.e. a useful life of one year is assumed). A register must be kept that explains which assets were recognized and completely depreciated (this can be the usual asset ledger, but it can be a simplified register as well).
Aggregated asset
All assets of this category are aggregated together. Aggregated assets are no longer recognized and measured individually; this means that they are depreciated for 5 years independently of the individual useful life and that any subsequent changes (e.g. destruction, disposal) are not recognized. A register must be kept that explains which assets were recognized and aggregated (see above).
The method of simplification can be chosen freely for each of the three categories of assets but must be applied uniformly for all assets of that category.
Presentation
No additional requirements
Important differences to German tax law
See earlier remarks for all non-current assets.
Important differences to IFRS
IAS 16 requires including the future costs of dismantling, disposal and site restoration in the acquisition cost of an asset (IAS 16.16); the corresponding entry is a provision that will be used when the costs are incurred.
IAS 16 allows the use of the cost model a revaluation model for measurement as alternative to the cost model, i.e. assets are regularly revalued to their fair value (revaluation model) and depreciated on that basis (IAS 16.31–42).
IFRS requires the component approach, meaning substantial parts of an asset that have a different useful life are depreciated separately according to that useful life (IAS 16.43–47).
Real estate held as a financial investment, so-called investment property, must be accounted for according to IAS 40. For subsequent measurement, the company can choose between the cost model and the fair value model, but independently of other tangible assets (IAS 40.32A–33).
See the earlier remarks on all non-current assets.
3.1.3.6Financial assets
Financial assets are assets that represent claims on financial means or are a part of the equity of another company.
§ 271 defines participations and affiliated companies:
–A participation consists of shares of another company with the intention of establishing a continuous connection with this company. This is assumed if the acquired shares comprise at least 20% of the total share capital of the company i.e. the acquirer has substantial influence, but no control.114
–Affiliated companies are companies that are included as parent company or subsidiary in the same consolidated financial statements. This means, typically, that the companies are controlled by the same parent company or that one company controls the others.115
Recognition
Financial assets are recognized as any other asset if they fulfil the recognition criteria.
Initial measurement
Financial assets are measured at acquisition cost.
Subsequent measurement
§ 253 sect. 3 sent. 6 provides an additional impairment option for financial assets: Financial assets not only must be impaired in the case of a permanent decrease in value but can also be impaired in the case of only temporary decreases in value.116
Presentation
If the option for an additional impairment is not used, a corporation needs to report the following items in notes (§ 285 no. 18):117
–the book value and the fair value of financial assets and
–the reason for not impairing the assets, including arguments as to why the decrease in value is considered temporary.
A list of companies that classify as participations must be included in the notes; this list must include the name and location of the company, portion of capital of the participation, total equity and profit for the last year for which financial statements are available (§ 285 no. 11).118
Further readings
IDW RS HFA 8 “Zweifelsfragen in der Bilanzierung von asset backed securities-Gestaltungen und ähnlichen Transaktionen” – Specific questions about the accounting for transactions with asset backed securities and similar transactions.
IDW RS HFA 10 “Anwendung der Grundsätze des IDW S 1 bei der Bewertung von Beteiligungen und sonstigen Unternehmensanteilen für die Zwecke eines handelsrechtlichen Jahresabschlusses” – Application of company valuation principles according to IDW S 1 for the measurement of participations and other shares for the accounting according to the Commercial Code.
IDW RS HFA 18 “Bilanzierung von Anteilen and Personenhandelsgesellschaften im handelsrechtlichen Jahresabschluss” – Accounting for shares in partnerships according to the Commercial Code.
IDW RS HFA 22 “Zur einheitlichen oder getrennten handelsrechtlichen Bilanzierung strukturierter Finanzinstrumente” – Aggregated or separated accounting for structured financial instruments according to the Commercial Code.
IDW RH HFA 1.1014 “Umwidmung und Bewertung von Forderungen und Wertpapieren nach HGB” – Reclassification and measurement of receivables and securities according to the Commercial Code.
Important differences to German tax law
See earlier remarks for all non-current assets.
3.1.4Excursus: accounting for financial instruments according to IFRS
The current standards for the accounting of financial instruments are IAS 32 “Financial Instruments: Presentation” and IAS 39 “Financial Instruments: Recognition and Measurement”. The approach is highly complex. In addition, IFRS 7 “Financial Instruments: Disclosures” requires extensive information in the notes.
To simplify the accounting, IFRS 9 “Financial Instruments” was adopted and supersedes IAS 39. It must be applied to fiscal years beginning on or after 1 January 2018 (IFRS 9.7.1.1).
The IFRS do not follow the current/non-current distinction for assets and liabilities but require an additional classification that must be used for all financial assets and liabilities.
IAS 32.11 defines a financial instrument as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity”. It further details this as follows:119
Tab. 3.8: Financial assets and liabilities according to IAS 32.
| Financial assets are | Financial liabilities are |
| –Cash | |
| –An equity instrument of another entity | |
| –A contractual right: | –a contractual obligation: |
| a) to receive cash or another financial asset from another entity; or | a) to deliver cash or another financial asset to another entity; or |
| b) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; | b) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; |
| –A contract that will or may be settled by the reception of the entity’s own equity instruments, including further definitions that are beyond the scope of this discussion. | –a contract that will or may be settled by the delivery of the entity’s own equity instruments, including further definitions that that are beyond the scope of this discussion. |
Financial assets and liabilities must be recognized and measured according to IAS 39, unless their recognition and measurement are accounted for according to another standard (IAS 39.2). IAS 39 requires a further categorization:
Financial assets must be
–categorized as loans and receivable,
–heldtomaturity,
–availableforsaleor
–be measured at fair value through profit and loss.
Financial liabilities must be
–measured at fair value through profit and loss or
–other financial liabilities.
The initial categorization can be changed only in very limited cases.120
Depending on the classification, financial assets and liabilities are measured differently. In a simplified overview:
The fair value must be determined according to IFRS 13.
Amortized cost refers to the acquisition costs minus any repayments and accumulated amortization of agios or disagios; the amortization of agios or disagios must be calculated using the effective interest method (IAS 39.9).
Other comprehensive income (OCI) is an equity category that is used for changes in the value of assets or liabilities that should not affect the income statement.
New regulation IFRS 9122
IFRS 9 requires only a categorization in three categories on which the subsequent measurement is based (IFRS 9.4.1 and 2). The categorization depends on the business model used for the financial instrument and the characteristics of the cash flows of the financial instrument.
For financial assets:
–at amortized costs
–if the goal of the business model is to hold the asset and realize the cash flows and
–if the cash flows are contractually fixed and include only interest payments and repayments of the principal;
–at fair value through OCI
–if the goal of the business model is to hold the asset or to sell it,
–if the cash flows are contractually fixed and include only interest payments and repayments of the principal;
–at fair value through profit and loss
–inallothercases.
Financial liabilities are categorized as “at amortized costs” unless they are held for trading.123
A reclassification is possible only if the business model used changes.
For the impairment of financial assets, a new three-step approach is used: the expected credit loss model. The amount of an impairment depends on the expected credit losses (IFRS 9.5.5).124
3.1.5Current assets
Any asset that is not non-current is current (§ 247 sect. 2).
The current assets consist of inventories, accounts receivable and securities, as well as cash and cash equivalents. Whereas inventories are often tangible assets, all the others are financial assets of different kinds.
This chapter explains the general approach for subsequent measurement. Specifics on financial instruments and hedge accounting are highlighted in Chapter 3.1.5.3 or in Chapter 3.1.10.3.
Subsequent measurement
Because current assets do not continuously serve the business, i.e. they are used only once for operations, they are not depreciated or amortized. However, they must be impaired, if necessary.
For all current assets, the strict lower-of-cost-or-market principle must be applied (§ 253 sect. 4): The initial value (acquisition or production cost) must be compared with a market price at the closing date; if a market price is not available, a fair value is used. The lower value of the two must be recognized (based on the principle of prudence).125
In contrast to non-current assets, this must also be applied for only temporary decreases in value (that is why it is called strict lower-of-cost-or-market principle).
If the reason for an impairment is no longer valid, the impairment must be reversed (§ 253 sect. 5).
The value from which fair value is derived depends on the kind of current asset:126
Important differences to German tax law
See the remarks on non-current assets. Under tax law, there is an impairment option only for permanent decreases in value. This will often result in differences between the commercial balance sheet and the tax balance sheet because the strict lower-of-cost-or-market principle requires impairment also for only temporary decreases in value.
Important differences to IFRS
The remarks on the impairment of assets according to IAS 36 apply as well to current assets (see above) if they are not inventories, financial assets or assets resulting from contracts with customers (IFRS 15).
3.1.5.1Inventories
Recognition
For inventories the general principles of recognition of assets must be used (see Chapter 2.4.1).
Because inventories are often owned only a short time and may be moved from one location to another, the question of economic ownership is very important. Typical issues that arise are the following:
–Transfer of risks: Depending on the terms of trade (e.g. as the international standard Incoterms), the reporting entity can be liable for goods that have not reached its premises. If for example goods are to be delivered under the condition “free on board” (fob), the purchaser is responsible for the goods and bears the risk of loss or destruction, when the goods cross the railing of the ship on which they are loaded, even if the goods are far away.
–Economic ownership: Even if the goods are physically on the premises of the reporting entity, they may not be recognized in the balance sheet, for example if they are used on commission or a similar arrangement, i.e. the reporting entity does not own the inventories economically.
Initial measurement
As for all assets, the measurement basis is acquisition costs (if purchased) or production costs (if produced). Thus, for proprietary products the definition of production costs and the use of the available options is a central topic of accounting policy (see Chapter 2.4.2.2).
Because inventories are often purchased or produced frequently or in large quantities, the principle of individual measurement is applicable only after exerting considerable effort. Imagine a box containing 5,000 identical screws that were delivered at different times and prices – it would be very costly to keep track of the value of each specific screw. To keep the accounting cost effective, several simplifications are possible:
–Constant-value approach: for raw materials and similar supplies a constant-value approach can be used (§ 240 sect. 3); this is the same approach as for tangible non-current assets and requires the same conditions (see Chapter 3.1.3.5).
–Group measurement: This can be used for similar inventories; similar means similar in kind or similar in use or function (§ 240 sect. 4). If applicable, the inventories are measured using the periodic weighted average or with the moving average:127
–Periodic average: One average value is calculated for the complete reporting period, that is
This average price is used to measure the inventories and the cost of goods sold.
–Moving average: Basically, the same calculation is done, but after each addition a new average is calculated and used until the next addition.
–Cost formulas: For similar items of inventories, cost formulas can be used (§ 256); cost formulas assume a certain usage pattern, that is, the real usage pattern can be different or is not known (as long as the GAAP are respected):128
–Last in, first out (LIFO): It is assumed that the goods acquired/produced last are used/sold first; this implies that the goods in stock at the closing date are assumed to be the oldest or the oldest prices are used to measure the closing amount. In times of inflation this typically results in certain hidden reserves because the newer and higher prices are used to measure the cost of goods sold, whereas the older and lower prices are used to measure the stock.
–First in, first out (FIFO): It is assumed that the goods acquired/produced first are used/sold first; this implies that the goods on stock at closing date are assumed to be the newest or the newest prices are used to measure the closing amount.
Subsequent measurement
As for all current assets, the strict lower-of-cost-or-market principle must be applied at each closing date (see above).
Presentation
If the previously described simplifications are used and market prices exist for these goods, corporations must report the total difference for each group of goods measured using these methods between the latest market price before closing date and the initial measurement in the notes, if this difference is material (§ 284 sect. 2 no. 3).
Important differences to German tax law
LIFO is applicable for tax purposes if the real sequence of consumption does not contradict LIFO. FIFO is applicable for tax purposes only if it is the actual sequence of consumption, meaning it cannot be used as a simplification (§ 6 sect. 1 no. 2a EStG).
Important differences to IFRS
The applicable standard is IAS 2 “Inventories”. Important differences exist
–with regard to the initial measurement: LIFO is not applicable according to IAS 2.25;
–with regard to subsequent measurement: Inventories are measured with their net realizable value at the closing date if that is below the initial acquisition or production costs (IAS 2.34). The net realizable value is strictly sales market oriented (even for materials), i.e. price decreases on a procurement market are not directly relevant for an impairment but may be an indicator of decreasing sales prices; in consequence, materials are not impaired (even if the procurement prices have decreased) as long as the finished products can be sold above the production costs (IAS 2.28–33).
3.1.5.2Accounts receivable
Recognition
Accounts receivable are recognized as any other asset if they fulfil the recognition criteria. For any receivable, but in particular for trade receivables, the revenue recognition criteria must be fulfilled (completed contract method; Chapter 2.3.3.3.1).
Initial measurement
Accounts receivable are measured at their nominal value (acquisition cost).
Subsequent measurement
The principle of individual measurement and the lower-of-cost-or-market principle must be applied here as well. There is no specific legally required approach. In combination with the requirements of German tax law, this leads to a three-step approach as common practice:
1.Specific valuation allowance
(a) Complete loss of a receivable
(b) Partial loss of a receivable
2.General valuation allowance
In detail:129
1.Specific valuation allowance
Based on the principle of individual measurement, any risks known for specific receivables are taken into account. Because market prices for receivables are usually not observable, the collectible amount must be estimated.
(a)Complete loss of a receivable
If a receivable is completely lost, it is derecognized and the VAT can be corrected (§ 17 sect. 2 UStG).
(b)Partial loss of a receivable
If a receivable is not lost completely, a correction of the VAT is not possible, i.e. only the net values may be corrected to the extent the receivable is expected to be uncollectible.
2.General valuation allowance
Apart from specific risks, i.e. knowledge about risks for specific receivables, typically a general risk exists, i.e. a certain percentage of receivables will become uncollectible even if at the closing date no specific risks were known. This general risk is reflected by a general valuation allowance. As in case 1.b. the VAT may not be corrected. The net values of all receivables for which no specific valuation allowanceswere recognized serve as the basis for the general valuation allowance130; the formula is as follows:
| Net value of all receivables | |
| − | Net value of receivables with specific valuation allowance |
| = | Net value of receivables with no specific valuation allowance |
| × | Percentage of general valuation allowance |
| = | General valuation allowance |
The percentage is an estimate of the risks of these receivables; typically it is based on past experience.
Presentation
If receivables have a remaining term of more than 1 year, this must be reported per balance sheet item in the balance sheet or in the notes (§ 268 sect. 4).131
Further readings
IDW RS HFA 8 “Zweifelsfragen in der Bilanzierung von asset backed securities-Gestaltungen und ähnlichen Transaktionen” – Specific questions about the accounting for transactions with asset-backed securities and similar transactions.
IDW RS HFA 22 “Zur einheitlichen oder getrennten handelsrechtlichen Bilanzierung strukturierter Finanzinstrumente” – Aggregated or separated accounting for structured financial instruments according to the Commercial Code.
IDW RH HFA 1.1014 “Umwidmung und Bewertung von Forderungen und Wertpapieren nach HGB” – Reclassification and measurement of receivables and securities according to the Commercial Code.
Important differences to German tax law and IFRS
See earlier remarks on impairment and financial assets.
3.1.5.3Securities and cash/cash equivalents
Securities are financial assets that are in a specific form that allows for trading on stock exchanges (independently of whether or not they are traded).
Cash is the legal currency of the corresponding country; most amounts will not be held in cash on hand but in positive bank accounts. Cash equivalents are financial assets that can be converted to cash in the short term and at very little risk.
Recognition
Securities and cash/cash equivalents are recognized when they fulfil the general criteria for recognition.
Initial and subsequent measurement
Securities are measured initially by their acquisition costs, cash by its nominal value. For subsequent measurement the general rules for impairments must be applied.
Presentation
There are no specific requirements.
Important differences to German tax law and IFRS
See earlier remarks on impairment and financial assets.