2.4 Development of mandatory financial reporting standards in Europe: the Fourth and Seventh Accounting Directives

Before Governmental involvement in the development of a mandatory set of uniform financial accounting standards, the accounting standards were developed by dedicated bodies and used in a voluntary market setting.1 Each country had developed its own accounting principles and had its national accounting practice which contributed to a very diverse global accounting practice, and therefore not easily comparable.2 France had in 1947, established the National Accounting Plan codifying company accounting established by the “Commission de Normalisation de la Comptabilité”, a Government body.34This Plan was updated in 1982 to implement the European Fourth Directive under the French National Accounting Council. In the Netherlands, the development of accounting standards were an initiative of the Royal Dutch Institute for Professional Accountants (NIvRA), which was established in 1967 as a public body, recognizing the accounting profession by law.56In 1969 an Advisory Committee (CAJ) was installed by the NIvRA, which was soon replaced in 1970 by the multi-stakeholder “Tripartite Overleg” (TO) (i.e. three parties: accountants, companies and trade unions) which was renamed in 1974 to its current name “Raad voor de jaarverslaggeving” (RJ), the Dutch Accounting Standards Board. The Dutch Accounting Standards Board is the Dutch accounting standard-setter. In the Netherlands, the accounting rules became embedded in Dutch company law in 1970, with the Act on Annual Accounts (Wet op de Jaarrekening van Ondernemingen – WJO). The Act on Annual Accounts was initially transposed to the Title 6 (later renumbered to Title 9) of Book 2 of the Dutch Civil Code.7 Before adopting the International Accounting Standards in 2001, the Dutch accounting standards were part of Book 2 of the Dutch Civil Code. The Dutch financial reporting regulation, part of the Dutch Civil Code, was complemented by the voluntary Dutch Accounting Standards issued by the “Raad voor de Jaarverslaggeving” (RJ) or in English, the Dutch Accounting Standards Board (DASB) which was largely initiated by the Royal Institute for Professional Accountants (NIvRA). The standards developed by the Dutch Accounting Standards Board (DASB) are not formal law and only provide guidance for the interpretation of the Dutch Law.89In the UK, the Institute of Chartered Accountants in England and Wales was the organization responsible for setting the UK accounting standards. Accounting of limited liability companies was regulated by the Companies Act 1985 (CA1985), amended later in 1989 to introduce the European Seventh Directive.10 In the US, the American Association of Public Accountants was formed in 1887, renamed in 1957 to American Institute of Certified Public Accountants, designation kept until today.11 The American Association of Public Accountants was responsible both for developing accounting standards and for representing the accounting profession in the US. According to Zeff (2003, pp. 192), before 1930 the US companies were not required to have their financial statements audited.12 Only later, with the Securities Act of 1933 and the Securities Exchange Act of 1934 (which created the Securities and Exchange Commission), financial statements were required to be audited by independent certified public accountants.

The need for harmonizing accounting legislation within the EU came from the need to “harmonize company law requirements for the creation of an internal market” rather than directly from the EU treaty (the creation of internal market was the essence of the original European Economic Community (EEC) treaty).13 The EU internal market with free movement of goods, persons, services and capital, allows and facilitates cross-border business. This business freedom led to increased international convergence of accounting standards to protect investors, shareholders and creditors.14 To harmonize the different national company laws already in place across the EU member states, since the 19th century, the EU developed two accounting Directives, the Fourth and Seventh accounting directives. These directives provide a harmonized basis for the preparation of the annual accounts of individual companies and groups of companies in the EU.1516 The Fourth Company Law Directive requires all limited liability companies to prepare annual accounts which must give a “true and fair” view of a company’s assets, liabilities, financial position, profit and loss.17 It coordinates the way that Member States present their annual accounts, defining its content, valuation methods, publication and audit of limited liability companies. As explained by the European Commission in a communication about accounting harmonization, it aims at achieving comparability of financial information rather than achieving standardization. The Seventh Company Law Directive regulates the preparation of consolidated accounts by the parent company.1819

In 1995, the European Commission recognized that although the quality and comparability of financial reporting in the Member States has improved, the current accounting directives were not responding to the growing need of information of international capital markets. The market has had more influence on national regulators and on companies than the Fourth and Seventh Directives of the European Commission.20

Large European companies seeking capital on the international capital markets were in competitive disadvantage as they were required to prepare a second set of accounts if they wanted to obtain a listing in the US.21 These companies were increasingly using the US-GAAP.22The European Commission also recognized that the accounts prepared in accordance with the EU accounting directives and national accounting legislation implementing the EU accounting requirements did not meet the demanding US accounting standards. Attempting to face these weaknesses and respond to the needs of the international capital markets, the European Commission set a new strategy for international harmonization of the EU accounting standards. At this point, these European Commission initiatives turned out to be very important for the further development of the European Company Law regulation, as explained below in section 5.