Question

The Volkswagen Group adopted International Accounting Standards (IAS, now International Financial Reporting, or IFRS) for its 2001 fiscal year. The following is taken from Volkswagen’s 2001 annual report. It discusses major differences between the German Commercial Code (HGB) and IAS as they apply to Volkswagen.

General:
In 2001 VOLKSWAGEN AG has for the first time published its consolidated financial statements in accordance with International Accounting Standards (IAS) and the interpretations of the Standing Interpretations Committee (SIC). All mandatory International Accounting Standards applicable to the financial year 2001 were complied with. The previous year’s figures are also based on those standards. IAS 12 (revised 2000) and IAS 39, in particular, were already complied with in the year 2000 consolidated financial statements. The financial statements thus give a true and fair view of the net assets, financial position and earning performance of the Volkswagen Group.

The consolidated financial statements were drawn up in Euros. Unless otherwise stated, all amounts are quoted in millions of Euros.
The income statement was produced in accordance with the internationally accepted cost of sales method.
Preparation of the consolidated financial statements in accordance with IAS requires assumptions regarding a number of line items that affect the amounts entered in the consolidated balance sheet and income statement as well as the disclosure of contingent assets and liabilities.
The conditions laid down in Section 292a of the German Commercial Code (HGB) for exemption from the obligation to draw up consolidated financial statements in accordance with German commercial law are met. Assessment of the said conditions is based on German Accounting Standard No. 1 (DSR 1) published by the German Accounting Standards Committee.

In order to ensure equivalence with consolidated financial statements produced in accordance with German commercial law, all disclosures and explanatory notes required by German commercial law beyond the scope of those required by IAS are published.

Transition to International Accounting Standards:
The accounting valuation and consolidation methods previously applied in the financial statements of VOLKSWAGEN AG as produced in accordance with the German Commercial Code have been amended in certain cases by the application of IAS.

Amended accounting, valuation and consolidation methods in accordance with the German Commercial Code:
• Tangible assets leased under finance leases are capitalized, and the corresponding liability is recognized under liabilities in the balance sheet, provided the risks and rewards of ownership are substantially attributable to the companies of the Volkswagen Group in accordance with IAS 17.
• As a finance lease lessor, leased assets are not capitalized, but the discounted leasing installments are shown as receivables.
• Movable tangible assets are depreciated using the straight-line method instead of the declining balance method; no half-year or multi-shift depreciation is used. Furthermore, useful lives are now based on commercial substance and no longer on tax law. Special depreciation for tax reasons is not permitted with IAS.
• Goodwill from capital consolidation resulting from acquisition of companies since 1995 is capitalized in accordance with IAS 22 and amortized over its respective useful life.
• In accordance with IAS 2, inventories must be valued at full cost. They were formerly capitalized only at direct cost within the Volkswagen Group.
• Provisions are only created where obligations to third parties exist.
• Differences from the translation of financial statements produced in foreign currencies are not recorded in the income statement.
• Mediumand long-term liabilities are entered in the balance sheet including capital take-up costs, applying the effective interest method.

Amended accounting, valuation and consolidation methods that differ from the German Commercial Code:
• In accordance with IAS 38, development costs are capitalized as intangible assets provided it is likely that the manufacture of the developed products will be of future economic benefit to the Volkswagen Group.
• Pension provisions are determined according to the Projected Unit Credit Method as set out in IAS 19, taking account of future salary and pension increases.
• Provisions for deferred maintenance may not be created.
• Mediumand long-term provisions are shown at their present value.
• Securities are recorded at their fair value, even if this exceeds cost, with the corresponding effect in the income statement.
• Deferred taxes are determined according to the balance sheet liability method. For losses carried forward deferred tax assets are recognized, provided it is likely that they will be usable.
• Derivative financial instruments are recognized at their fair value, even if it exceeds cost. Gains and losses arising from the valuation of financial instruments serving to hedge future cash flows are recognized by way of a special reserve in equity. The profit or loss from such contracts is not recorded in the income statement until the corresponding due date. In contrast, gains and losses arising from the valuation of derivative financial instruments used to hedge balance sheet items are recorded in the income statement immediately.
• Treasury shares are offset against capital and reserves.
• Receivables and payables denominated in foreign currencies are valued at the middle rate on the balance sheet date, and not according to the imparity principle.
• Minority interests of shareholders from outside the Group are shown separately from capital and reserves.

The adjustment of the accounting and valuation policies to International Accounting Standards with effect from January 1, 2000 was undertaken in accordance with SIC 8, with no entry in the income statement, as an allocation to or withdrawal from revenue reserves, as if the accounts had always been produced in accordance with IAS.

The reconciliation of the capital and reserves to IAS in shown in the following table:

	million Euros
Capital and reserves according to the German Commercial Code as at January 1, 2000	9,811.00
Capitalization of development costs	3,982.00
Amended useful lives and depreciation methods in respect of tangible and intangible assets	3,483.00
Capitalization of overheads in inventories	653.00
Different treatments of leasing contracts as lessor	1,962.00
Differing valuation of financial instruments	897.00
Effect of deferred taxes	-1,345.00
Elimination of special items	262.00
Amended valuation of pension and similar obligations	-633.00
Amended accounting treatment of provisions	2,022.00
Classification of minority interests not as part of equity	-197.00
Other changes	21.00
Capital and reserves according to IAS as at January 1, 2000	20,918.00
Source: Volkswagen AG Annual Report 2001, pp. 84–86.

Question:

What differences between the accounting requirements in the HGB and IAS are highlighted in Volkswagen’s disclosure? Are the German requirements consistent with your characterizations in requirement 1?

Answer 1

Transition from German Commercial Code to International Accounting Standards will ensure better reflection of financial position and performance of Volkswagen in the financial statements. The financial statements prepared in accordance with IAS and IFRS will help the users of the financial statements to assess the financial performance and position and compare these with other entities in the same industry to evaluate the financial position and performance of the company efficiently.

The fact that capital and other reserves of the company have increased from Euro 9,811m to Euro 20,918m under the financial statements prepared in accordance of IAS shows that there are significant difference between the German Commercial Code and IAS. Thus, the financial performance and position of the company have significantly modified subsequent to the use of IAS shows that the financial position of the company is significantly different than it was under the old system of German Commercial Code.