Audalia

Commercial and Accounting Reforms in Spain
08/10/2007

The time has come for the accounts departments of all companies in Spain – with the exception of the 300 companies that are listed on the Stock Exchange – to adapt to the new commercial and accounting rules.

With effect as from 1 January 2008, a new era will begin in Spanish companies. The Mercantile Reform Act 16/2007, published in July, has started the preparations for the race, which will culminate with the final approval of the Draft New General Accounting Plan, at the end of 2007, which will start to be applied in January 2008.

This entails a change of philosophy in Spanish commercial and accounting regulations, which on the one hand unifies, but unfortunately does not match the international accounting standards issued by the International Accounting Standard Board (IASB), which body has been based in the United Kingdom since 1973, and is composed of accounting and financial specialists from a variety of western countries.

The need for the new regulations has arisen for a number of reasons:
a) The unification of accounting standards required by a global economy, where decisions in one country affect other countries. By way of example, the recent financial crisis started by sub-prime mortgage loans in August 2007 in the United States has had repercussions in a number of European countries to a greater or lesser degree.
b) The response to the crisis of confidence in the capital markets caused by the financial scandals that arose at the beginning of the 21st century, such as the case of ENRON in the United States in 2002, followed soon after by the Parmalat case in Europe, amongst other additional cases.
c) The need for financial and accounting information to be used in business decision-making. For this reason, instead of the accounts being addressed to the company managers, at acquisition values, they should serve to assist INVESTORS and external economic agents in their decision-making.
d) As a result of the foregoing, the need for the economic background of transactions to be over and above the legal form by which the said transactions are clothed.

These regulations bring us closer to the Accounting Principles Generally Accepted in the United States (USGAAP), which although they are not exactly the same, they are very close to the IFRS. Furthermore, the possibility of also implementing the IFRS in the United States has started to be debated across the Atlantic. This supposed unification is still some years off.

In Spain, an effort has been made to summarize the approximately 3,000 pages of the various International Financial Information Rules into approximately 200 pages of the New General Accounting Plan. The aim of this article is to summarize in schematic form the main innovations that the vast majority of Spanish companies will be required to implement and apply, with all attendant consequences, as from New Year 2008.

The NGAP establishes, first of all, some new concepts with regard to assets, liabilities, and company net equity, and furthermore regulates some situations which were previously not regulated in the GAP, but which were being applied as they were Technical Auditing Rules or subsequent Decisions of the Spanish Accounts and Auditing Institute [ICAC], such as Subsequent Events occurring after the close of the financial year, or Business Combinations in the 1993 draft Decision on Mergers and Acquisitions which never saw the light of day but which we all apply as it reflects the IFRS rules.

All goods, rights, and other resources economically controlled by the company resulting from past events and from which it is expected to obtain profits or returns in the future are deemed to be assets. Therefore, fictitious assets which in Spain were deemed to be expenses and which were distributed over time, to be depreciated in up to five years, are no longer classed as assets under the new definition, and should be recorded directly in the company’s trading account. Therefore, even in a company that is up and running, it is not possible to adjust the costs of launching new products or geographical markets, with the corresponding impact on the company’s results.

All contractual duties arising from past events and for which, in order to be extinguished, the company expects to dispose of resources which may give rise to profits or economic returns in the future, shall be deemed to be liabilities. Therefore, interest on loans and accounts payables are liabilities, which had hitherto been accounted differently under the old GAP. In effect, liabilities are now the Current Value of the flow of future debts, discounted at a rate of i%, or cost of capital. Common sense, and our financial knowledge of the cost of capital, are what regulate the i% rate, and the establishment thereof is not insignificant when it comes to assessing the CV in transactions, especially where these are very long-term and for considerable sums. Fortunately the NGAP exempts us from calculating the CV for commitments of less than 12 months, which is furthermore also a matter of common sense.

Lastly, Net Equity is defined as the residual part of the assets of a company after liabilities have been deducted. Thus, with this simple definition, which we may say expresses the difference between Assets and Liabilities, the Net Equity of a company includes, as well as the capital and the traditional reserves, the Shareholders’ liabilities pending payment up, which was previously shown under Assets, the adjustments to reasonable value (market value) which arise in certain accounts, which now are not just allowed, but compulsory, and the Revenues Deferred over several financial years, which previously appeared under the limbo of long-term Liabilities Receivable and which were adjusted over various years.

From this definition of Net Equity we may see some new semantics but an old concept, that of REASONABLE VALUE. This is an old concept which nevertheless only appeared in the very intermittent Revaluation Laws for certain real-estate assets, which appeared every few years and allowed us a simple 3% or 4% revaluation with payment into reserves, without paying tax. Market value, translated from English as FAIR VALUE, is one of the fundamental pillars of the IFRS.

In Spain, in this initial adaptation to the IFRS, because I would venture to say there will be more in years to come, the legislator has not allowed for the possibility permitted in the IFRS of allowing the option that the company should value certain assets at their fair or reasonable value. Only certain financial investments, now known as “Portfolio available for sale” are to be compulsorily valued at their reasonable value.

Therefore it is not possible in Spain, for the time being, to record buildings for their market value, including those maintained as part of the assets for speculative purposes. Capital gains generated on investments classified by the company as Available for Sale must be recorded.

These capital gains are recorded in companies’ Net Equity, in account 13. But, by way of an additional innovation, those costs and revenues that are adjustments to the reasonable value, as well as the adjustments or errors from previous years, first pass through new accounts in new Groups 8 (costs) and 9 (revenues), which are recorded not in the trading account but in the Net Equity. It so happens that a new box appears in the annual accounts Report, entitled Statement of Variations in Net Equity, arising from movements in those accounts, which ought to leave a trace in the information on assets.

An additional consequence of the existence of these Groups 8 and 9, or if you prefer, of the direct regulation of the company’s Equity, without passing through the trading account, are the so-called temporary Differences, as opposed to time Differences, which semantic concept is new and important, consisting in determining those economic transactions that have no tax consequences, and which are recorded in the accounts in the new Groups 8 and 9 with effect on the Net Equity.

Special mention should be made of the treatment given to Goodwill, which as from 2008 will not be depreciated, although a deterioration test ought to be carried out, using financial models for the expectation of generating future revenues that the said goodwill is going to have at the close of each financial year. Furthermore, Cash Generation Units should be identified where possible, at different levels, which are the assets or groups of assets that generate revenues independently within the company. This matching of the Goodwill with these CGU will not be all that easy, just as the annual identification of future capacity to generate revenues that the Goodwill continues to have at the close of each year will not be easy.

The Spanish legislator diverges from the IFRS by establishing the need that although Goodwill is not depreciated, it is necessary to provide for a 5% per annum Reserve in the Company’s Equity from the post-tax profits, as a special precautionary measure, which is hard to explain when one considers that a deterioration test is already being applied. It is as if there was no confidence in the application of the deterioration test, which is a tricky question in some cases.

Lastly we should state that in the Mercantile Reform Act 16/2007 itself, there is a slight extension of the limits for the filing of individual abridged and consolidated accounts, and as from 2008 the following two out of three limits are applicable, during two consecutive financial years:

A) INDIVIDUAL ENTITIES
Total Balance Sheet: €2.85m
Net revenues: €5.7m
Employees: 50

B) CONSOLIDATION ENTITIES
Total Balance Sheet: €11.4m
Net revenues: €22.8m
Employees: 250

With these brief lines it has been our intention to summarize the most important innovations, without seeking to be exhaustive. What may be clearly seen is the training effort that companies need to make in order to start out on 1 January 2008 with this new philosophy which changes everything from the semantics to the GAP account numbers. The additional Provisions of the NGAP provide that in order to carry out the adaptation this should not be done retroactively, in contrast to the provisions of the IFRS, and so financial year 2007 is expressed under the GAP 1990 rules, and GAP 2007 is started, and so exceptionally the accounts will not be comparable.

In any event, it would be necessary to make an effort in 2008 for transactions to be properly recorded when and where appropriate. The co-operation of the company’s financial auditor is once again fundamental in order for this delicate adaptation to be performed with consensus. The role of the financial auditor, as a professional specializing in such a multidisciplinary subject, is of vital importance for the capital markets and the modernization of Spanish companies, with ever more interests in the international markets.

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