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Today the Federal Cabinet adopted the Bill for an Act to Modernise Accounting Law ("Bilanzrechtsmodernisierungsgesetz - BilMoG"). This legislation ensures that the proven, inexpensive and straightforward accounting law of the Commercial Code will be retained in future and strengthened for competition with international accounting standards. The annual financial statement drawn up under commercial law remains the basis for distributing profits and for calculating profits for tax purposes.

Federal Minister of Justice Brigitte Zypries said "Enterprises in Germany need modern and efficient accounting rules, as provided by the BilMoG. We are enhancing the qualitative validity of annual financial statements drawn up under commercial law and, by taking this step, we are also taking away the pressure to use international accounting standards, which particularly affects medium-sized enterprises in Germany. In the end result, the accounting law of the Commercial Code will continue to offer a fully adequate alternative to international accounting standards without entailing their disadvantages - high levels of complexity, time-consuming processes and high costs. Enhancing qualitative validity also means improved future exposure of the economic risks of so-called special purpose entities". Zypries went on to say that "The centrepiece of the reform also consists in deregulation and cost reduction, particularly for small and medium-sized enterprises (SMEs). So the economy will see an end to avoidable costs amounting to more than 1 billion euro; this way we can set free forces of innovation and investment".

Here are the most important individual points in the Bill:

1. Deregulation

The Bill exempts enterprises from avoidable balance sheet operations. Sole merchants conducting only a small business operation, are made exempt from the commercial law duty to keep accounts and records. For share capital companies like the Public Limited Company (PuLC) and the Private Limited Company (PrLC) there is also provision for accounting exemptions and relief. All in all, by virtue of these measures, an annual cost reduction of about Euro 1.3 billion is to be reckoned with in respect of the total costs of keeping accounts and records, of drawing up, auditing, and disclosing the financial statement.

We are concerned here with the following specific measures:

• Sole merchants who do not cross certain thresholds (Euro 500,000 turnover and Euro 50,000 profit per financial year) are exempted from the obligation to keep accounts and records in accordance with the provisions of commercial law. This provision will give these SMEs relief in the dimension of roughly Euro 1 billion.
• Existing thresholds creating different categories of enterprise size and thus determining which obligations to provide information are to apply to a particular enterprise shall be raised: thresholds for the balance sheet total and for turnover revenue, in section 267 of the Commercial Code (ComC), shall be increased by 20%. This means that a larger number of enterprises than before will be able to enjoy the relief already afforded to small and medium-sized share capital companies. Such enterprises will, in future, have fewer accounting obligations under commercial law. Depending on whether a share capital company is to be classified as small, medium-sized, or large, it has to fulfil more or less far-reaching duties to provide information. Small share capital companies do not need, for instance, to have their annual financial statement checked by an auditor, and they have to disclose only their balance sheet, but not the profit and loss account. Medium-sized share capital companies can dispense with some of the specific information that has to be provided by large share capital companies, and they are allowed to combine balance sheet items. For the enterprises concerned, this can lead to a saving in the dimension of about Euro 300 million.
• • In future, share capital companies are to be classified as "small" where they do not have a balance sheet total of more than approximately Euro 4.8 million (hitherto about Euro 4 million), turnover revenue of more than approximately Euro 9.8 million (hitherto about Euro 8 million), or more than 50 employees on annual average. A share capital company must fulfil at least two of these criteria to be classified as "small".
  • In future, share capital companies are to be classified as "medium-sized" where they do not have a balance sheet total of more than approximately Euro 19.2 million (hitherto about Euro 16 million), turnover revenue of more than Euro 38.5 million (hitherto about Euro 32 million), or more than 250 employees on annual average.

2. Improving the qualitative validity of financial statements under the Commercial Code

The modernised ComC accounting law is the answer to the International Financial Reporting Standards (IFRS), published by the International Accounting Standards Board (IASB). The IFRS are geared to suit capital market oriented enterprises; in other words, they also serve information needs of financial analysts, professional investors and other participants in the capital markets.

By far the majority of those German enterprises that are required by law to keep accounts and records do not take part in the capital market at all. For this reason, there is no justification for committing all the enterprises that are required to keep accounts and records to the cost-intensive and highly complex IFRS. Also the draft, recently published by the IASB, of a standard "IFRS for Small and Medium-Sized Entities" is not a feasible alternative for drawing up an informative annual financial statement. Practitioners in Germany have strongly criticised this draft because its application - compared with ComC accounting law - would still be much too complicated and costly.

The Act to Modernise Accounting Law therefore takes a different approach: it has developed the tried and tested accounting law of the Commercial Code into a body of rules that is on a par with international accounting standards but much cheaper and easier to handle in practice. In particular, the Commercial Code balance sheet remains the basis for calculating taxable profits and dividends. This makes it possible, especially for small and medium-sized enterprises, to draw up just one calculation - the so-called "uniform balance sheet" - which forms the basis for all stated purposes.

The qualitative validity of the annual financial statement made under commercial law will be improved by the following measures:

• Internally generated intangible fixed assets
  In future, internally generated intangible assets forming part of fixed assets, such as, for instance, patents or know-how, are to be marked in the Commercial Code balance sheet. This is important, above all, for innovative enterprises involved in intensive research and development - for instance in the chemical or the pharmaceutical industry or in the automobile industry together with their ancillary (supplier) industries. So-called "start-up" enterprises, too, where they are small and medium-sized, are particularly going to reap the benefit of this provision. In future they, too, will be able to point to their developments - show their potential - in their financial report. This means that enterprises can expand their shareholder equity base and improve their capacity to acquire more capital at low cost on the market. In tax terms, the expenses incurred remain deductible; they are also not available for profit distribution. This promotes Germany's competitiveness as a business location for innovative enterprises.

Examples:
(1) A large proportion of the costs arising in the pharmaceutical industry is attributable to research and development of new drugs. In future, where it becomes apparent, for instance from clinical studies, that a particular drug is going to be licensed for sale, the costs of developing that drug are to be entered on the assets side of the balance sheet as the costs of producing a self-constructed asset forming part of fixed assets, e.g. a patent or just know-how, and not, as in the past, as effective expenditure. This means that the enterprise's profit and loss account will not be burdened and the balance sheet profit will be higher.
(2) A start-up enterprise, concerned for instance with the development of software, must enter the costs of developing the software as software production costs for self-constructed intangible assets, forming part of fixed assets, and not, as in the past, as effective expenditure.

• Valuation of financial instruments at fair value
  So far as they are acquired for trading purposes, financial instruments like shares, debt securities, units held in funds, and derivatives, will in future be assessed for all enterprises at their fair market value on the closing date for the balance sheet. This simplifies and unifies commercial law accounting, is internationally customary and will now also be established in the accounting law of the Commercial Code. This means a strengthening of the qualitative validity of the annual financial statement with reference to profits and losses that are realisable at any time; however, profits that have not yet been realised will, on principle, be subject to a bar on distribution. With regard to credit institutions, the scope of application of the fair value assessment will be widened in an appropriate fashion and will cover all financial instruments in the trading portfolio.

Example: A bank buys 10 shares at a price of Euro 100 per share. These shares were acquired with the goal of making a profit on sale and can be sold again on any stock exchange trading day. On the closing date for the balance sheet these shares are priced at Euro 120 per share. Since the shares are to be given their fair market value, they are to be marked with a total of Euro 1,200 (10 shares x Euro 120) in the balance sheet. The resulting profit for the bank is Euro 200. On the basis of the acquisition costs principle - which has been in force to date - the shares would have had to be marked with the acquisition costs amounting to Euro 1,000 (10 shares x Euro 100). The market profit of Euro 200 was not to be entered as a collected sum so long as it had not been realised through sale of the shares.

• Change in the valuation of provisions
  An enterprise's provisions for future obligations will be assessed more realistically in future. In the course of public discussion, the way in which provisions are currently handled under accounting law has repeatedly been identified as a weak point in commercial law accounting. Particularly with regard to provisions for post-employment benefits so the argument went it was not possible nowadays, in commercial law accounting, to infer the true burden affecting an enterprise because, by common consensus, valuations are considered to have been too low. So, in respect of the valuation of provisions, future developments (salary / wage, price and personnel developments) are going to be taken into greater account than in the past. Moreover, provisions are to be discounted in future. Hence the more future-oriented measurement of provisions will particularly affect post-employment benefits. The reform will lead to an increase in the valuation of provisions, at least in the case of post-employment benefits. However, this is imperative if we want to have a provisions valuation that reflects reality. In order to cushion the effects, the Bill makes it possible for provisions to be accumulated over a period of several years. The tax provisions remain unchanged on this point, so that there will be no shortfall in tax revenues.

Example: An enterprise's real estate is contaminated with chemicals. The authorities instruct the enterprise to eliminate the contaminated site as soon as the enterprise stops business operations. This is to be reckoned with in five years' time. On the balance sheet closing date the costs of employing an excavator amount to Euro 100 per hour. It is to be assumed that an excavator hour will cost Euro 120 in five years' time. Under the present legal position - abiding by the closing date principle - the sum that has to be taken here for accrual valuation is Euro 100 per hour; however, in future, that sum will be Euro 120 in the example given, because account has to be taken of future developments.

• Abolition of accounting options no longer reflecting current circumstances
  In addition to the above, Commercial Code accounting law will be relieved of the "ballast" of past years. Accounting options which no longer reflect current circumstances once enjoyed by enterprises but now presenting an obstacle to the provision of informative and, in particular, comparable annual financial statements - have been made subject to restriction or have been repealed. This applies, for instance, to the option - which also does not enjoy recognition for tax purposes - of building up reserves to help cover one's own future expenditure on repairs, renovations and the like.

Example: At ten-year intervals, an enterprise renovates the administrative and works buildings in its ownership. The sum of money required for carrying out these renovations is collected by the enterprise over a period of ten years in an accrual fund to cover future expenditure (in German: "Aufwandsrückstellung") without agreements having already been entered into with third parties regarding the carrying out of such renovations; such provisions are not recognised for tax deduction purposes. In future this sort of accrual fund, with no tax recognition, can no longer be accumulated.

• Transparency of special purpose entities
  The Bill also contains proposals for more information and transparency in the balance sheet handling of special purpose entities. The financial situation of the special purpose entity and the economic risk undertaken by the group are to become more visible from the group's own annual consolidated financial statement. On the one hand, enterprises must in future be included in the consolidated financial statement where they are under the unified management of a parent enterprise. Until now inclusion has depended on whether the parent enterprise has a holding in the special purpose entity based on partnership and company law. Furthermore, in their consolidated statement notes, enterprises are required to report on the type, purpose and financial effects of business transactions that do not appear on the balance sheet so far as this is necessary for an assessment of their financial position. This implements a requirement under EU law. In addition, enterprises are required in future to set out the considerations underlying their risk assessment with regard to contingent liabilities. Here it is not sufficient merely to inform financial statement users about the sum total of existing contingent liabilities and about the underlying risks, whilst leaving them in the dark regarding the enterprise's assessment of eventual materialisation of these liabilities.
  
• Further amendments resulting from EU legal requirements
  Other EU legal requirements, especially those concerning the enterprise management report as well as the establishment of an audit committee, will be implemented "one to one" in German law - i.e. with minimum strain on the enterprises themselves. Here is an example: capital market oriented enterprises that already have a supervisory body do not have to set up an audit committee in any situation where the latter's functions are being performed by the supervisory body itself. Enterprises are also not made subject to requirements for establishing an internal risk management system. The decision on whether to set up such a system and on the type and extent thereof falls within the responsibilities borne by the management bodies of an enterprise.

3. Time schedule

The Bill for an Act to Modernise Accounting Law will be tabled before the Federal Council at the beginning of July for its initial passage through that Chamber and will then be debated by the Federal Parliament immediately after the summer recess. From the present perspective, most of the new provisions are to be applied for the first time to the financial years beginning in the calendar year 2009. The relief granted, particularly through threshold increases, might already be claimed in part in respect of the 2008 financial year.

Glossary:

• Fixed assets: part of property, i.e. shown on the assets side of the balance sheet. Fixed assets are the property that is intended to serve the purpose of maintaining constant business operations. They include, for instance, the buildings and machines used for production by an enterprise that produces goods.
• Balance sheet: report of a merchant's property (assets side of the balance sheet) and of liabilities with shareholder equity (liabilities side of the balance sheet) at the end of a financial year.
• Derivatives: classificatory term denoting financial products such as options, swaps or forwards regarding, for instance, the purchase or sale of securities on a predetermined future date.
• Shareholder equity: assets - liabilities = shareholder equity (net assets or worth).
• Contingent liabilities: possible legal recourse, on a contractual basis, to a merchant, which, when viewed from the perspective of the closing date for the annual financial statement, is actually not to be reckoned with.
• Financial instruments: Contractual obligations directly or indirectly focused on the exchange of means of payment (shares, debt securities, derivatives).
• Forwards: contract requiring the purchase or sale of securities etc. at a predetermined price on a predetermined future date.
• Profit and loss account: report of expenditure and revenue during the financial year.
• Trading portfolio: trading portfolio financial instruments are the financial instruments of credit institutions that are not part of either the liquidity reserve or the asset pool.
• International accounting standards: used here as a synonym for the International Financial Reporting Standards (IFRS). Within the EU the IFRS are mandatory for capital market oriented enterprises required to draw up a group consolidated financial statement.
• International Accounting Standards Board (IASB): institution set up under private law, with its headquarters in London, drawing up the IFRS. The objective of the IASB is to achieve enforcement of the IFRS as accounting standards with uniform application throughout the world.
• Annual financial statement: umbrella term covering the balance sheet, the profit and loss account and, in the case of share capital companies, the notes supplemental to, and forming part of, the financial statement.
• Capital market oriented enterprise: enterprises that have issued shares or debt securities for dealing on a regulated market.
• Regulated market: market segment on the German stock exchanges.
• Options: (optional) right to purchase a security at a predetermined price.
• Swaps: business transaction concerning the exchange of one cash flow stream against another (for example: exchanging a fixed rate of interest for a floating rate).
• Special purpose entity: independent legal entity (mostly a legal person or a foundation). The linking of an enterprise to a special purpose entity is regularly structured in such a manner that the special purpose entity does not need to be included (consolidated) in the group financial statement. With a special purpose entity there are various "purposes" that can be pursued. Usually a special purpose entity serves the purpose of shifting assets and debts, thus "liberating the balance sheet", as in the case, for instance, of leasing companies. By shifting away assets and debts the enterprise concerned moves into the position where it can shorten its balance sheet. This generally leads to an improvement in a balance sheet's ratios. Indeed, going beyond this, risks can be concealed from the financial statement users.