The grAde -INTERNATIONAL ACCOUNTING Systems assignment

Differences between EU IFRS and IASB Standards pg. 7

Differences between IFRS and Italian accounting requirements pg. 8

Filing and submitting financial statements pg. 8

Requirements for non-listed companies pg. 8

Taxation in Italy pg. 9

Banking industry in Italy pg. 10

Italy referendum vote 2016 pg. 11

Future of accounting for SMEs in Italy pg. 11

Appendix A pg. 13

References pg. 17

Official standard setter in Italy

The official standard setter in Italy is The Italian Accounting Committee (OIC). Formed in 2001, the OIC was created due to the need for appropriate national standard setters. To fulfill their objectives of having transparency, independence, accountability, and impartiality, the OIC’s governance consists of a Board of Founders, a Supervisory Board, an Executive Board, and a Board of Auditors. The Executive Board, whose members are appointed by the Supervisory Board, is responsible for issuing the national accounting standards Organismo Italiano di Contabilità (n.d.).

Italian stock exchange

Borsa Italiana, founded in 1997, is currently responsible for the Italian stock exchange. However, it was not always that way. Italy established a holding company, IRI, in 1933 to assist some major banks and firms that were hit hard by the 1929 financial crisis. By the end of the 1980s, there were state holdings for nearly all economic activity. In 1991, more than one third of the top fifty firms were completely state-owned. This led to many state-owned entities contributing more than the European average with regards to value added, employment, and fixed capital formation. State-owned banks accounted for more than 70% of total loans and deposits. However, the financial performance of these entities was often very weak when compared to private organizations, because they were forced to support investment, and hire people to reduce the unemployment rate, and they had strong political interference (Bortolotti, 2005).

During the early 1990s, state-owned entities were involved in corruption, and large scandals. At the same time, Italy was facing the “most acute political crisis of the post-war period”. In 1993, as a requirement to join the European Monetary Union, Italy decided to become privatized. While the government was still a significant shareholder in some privatized firms, the number of state-owned entities decreased dramatically, and Italy raised approximately US$108 billion in proceeds from the privatization process within a decade (Bortolotti, 2005).

Borsa Italina is regulated by The Commissione Nazionale per la Societa’e la Borsa (CONSOB). Activities performed by CONSOB, as stated by The Commissione Nazionale per la Societa’e la Borsa (n.d.) include:

· Supervising management companies of regulated markets

· Regulates services and investment activities performed by intermediaries

· Check data and information provided by companies listed on the exchange

· Handles illegal conduct

· Works with other national or international regulatory bodies

Since October 1, 2007, Borsa Italiana is part of the London Stock Exchange Group (Borsa Italiana, 2016, November 18).

History of accounting in Italy

The earliest known evidence of double entry bookkeeping comes from a banker in Florence, Italy, and dates back to 1211. The first book that described double entry bookkeeping was written in 1458, by Benedetto Cotrugli. His book, along with other hand written manuscripts circulated the Italian city states in the 15th century. Cotrugli’s book was published in 1573, but it was not the first published book that describes double entry accounting (Canham Rogers Chartered Accountants, n.d.).

Luca Pacioli, known as the “father” of modern accounting, was the first to successfully publish this information, which was published in his 1494 manuscript. The implementation of the double entry system has been one of the few great advances in accounting technique. Pacioli has been celebrated for his work, yet he takes no credit in in the creation of the double entry system, as he believed it had existed in Northern Italy for approximately two centuries or more (Mills, 2011).

While there has not been a lot of work done to determine why the double entry-accounting system emerged, or how it spread from Italy to the rest of Europe, Geofrey Mills (2011) concludes that regional economic development and the technology of moveable type printing were likely responsible for the increase in use of double entry accounting. Mills states that double entry bookkeeping was implemented by large merchants, and was specific to the economy and culture of Northern Italy. The economy of Northern Italy increased rapidly after 1100 due to an increase in population, and economic opportunities provided by the Crusades. Printing has helped contribute to the spread of the double entry system because it allowed more people to become educated on the topic. In Northern Italy, the printing centres were in Venice, Florence, and Genoa, which are the areas where double entry accounting was being developed (Mills, 2011).

Italian reporting environment before IFRS

Before the implementation of IFRS, Italy had its own reporting environment and there were accounting requirements that companies were required to follow. Below is a summary of Italian reporting environment before the implementation of IFRS, according to Dunne et. Al. (2008):

Source: Dunne et. Al., 2008

Accounting is typically very regulated in a civil law system, and these regulations are usually included in national laws, which significantly contribute to the financial reporting process. Before the implementation of IFRS, the accounting standards in Italy were not mandatory for companies to use – they had an integrative and interpretive function with the national laws. Creditors are the main users of the financial statements in Italy because the majority of financing for businesses comes from banks (Dunne et. Al., 2008). Ninety-nine percent of all business in the European Union are small and medium entities (European Commission, 2017), which is why they’re financed through banks and not investors.

The prudence concept says to be very cautious when calculating estimates to include in the financial statements, and it is something to consider when developing accounting policies. While the prudence concept requires financial statement preparers to exercise caution, it is not justification for an understatement of assets or overstatement of liabilities. If there is no uncertainty, the prudence concept is not required, and it should not be used as a reason for accounting irregularities (Kwok, 2005, p.30).

Accounts and records

In the Italian accounting system, all supporting documentation must be kept for 10 years (European Document Retention Guide, 2014) The directors are responsible for creating the balance sheet, the income statement and the notes to the financial statements (Corporate Governance Committee of the Italian Stock Exchange, 2014). These statements are prepared using Euros, and must reflect the true value of the assets, liabilities, financial conditions and profits or losses of the company in the current financial. Each item must be evaluated on a prudent basis. (Circular No. 262, n.d.).

The notes to the financial statements describe the criteria for project evaluation. The notes must provide a detailed description of the items specified in the accounts and must state any changes in the number of items in an account, and the reason for the change. It must indicate the average number of employees, the number and value of the shares of the company, the financing of its members, any leasing information, and the important information (Circular No. 262, n.d).

Influences on Italy’s accounting system

As we know, double entry bookkeeping was created in Italy. There are several factors that contributed to the creation of double entry bookkeeping, such as math techniques, using coins/money as a form of exchange, introduction of paper, banking system developments, and a variety of economic conditions which needed proper recording for transactions (Libina, 2005).

In Italy, conservatism and secrecy are recognized as important values when conducting business activity. For many accounting professionals, their main task is to reduce taxable income for their clients, therefore, the taxation system in place in Italy has an influence on their accounting system (Haller et. Al., 2003).

The legal system in Italy also influences accounting practices. In 1865, there was a Civil Code requirement that stated dividends could only be drawn from “actually realized profits”, and there were no rules regarding accounting principles or statements, even though this was the first year that companies were required to file financial statements with commercial courts. The 1882 Commercial Code stated that accounts should show the financial information of a company with straightforwardness and truth. The 1942 Civil Code replaced previous codes, and said that accounts should reflect a company’s financial position and results with clarity and precision. It also set a minimum requirement for the content found on a balance sheet, but not the income statement (Haller et. Al., 2003).

In 1974, a new law was set which established the format and minimum content required for the income statement, and also set the requirement for interim results to be published by listed companies. This is also the year CONSOB, the regulator of Borsa Italiana, the Italian stock exchange, was formed (Haller et. Al., 2003).

Implementation of IFRS

The European Union (EU) began using IFRS in 2005. The requirements adopted by Italy are noted below:

Source: Deloitte IAS Plus, n.d.

The International Accounting Standards Committee (IASC) was a main contributor to the harmonisation process. The IASC works with accountancy bodies in different countries to find a common set of accounting rules, which are known as International Accounting Standards (IAS). Having a common set of accounting rules would open the doors for more investors to gain interest in a company, because they would have a better understanding of their financial statements, and financial performance (Dunne et. Al., 2008).

When Italy switched to IFRS, there was a large increase in the amount of IFRS-related disclosures provided by companies, the financial statements saw a shift from a creditor focus to shareholder focus, and information systems had to be changed (Carini et. Al., n.d.).

Controversy with the implementation of IFRS

Dunne et al. (2008) tell us that some standards caused controversy in the European Union (EU) when implemented, such as:

· IAS 39 Financial Instruments Recognition and Measurement – this standard requires companies to account for and disclose all financial instruments, use hedge accounting restrictions, and/or recognize derivatives on the balance sheet.

· IAS 19 Employee Benefits – this standard was an issue due to its complexity and potential impact on the income statement.

· IFRS 2 Share-based Payments – 90% of companies in the EU had to make charges to the income statement when they had not disclosed this information before.

· IFRS 5 Non-current Assets Held for Sale and Discontinued Operations – this standard represented the second biggest increase in new disclosure information.

It should be noted that standards causing large financial issues were different from those that caused large disclosure issues. The standards that had the biggest issues related to disclosure include financial instruments, pensions, goodwill, share-based payments, deferred taxation, impairment, dividends, intangibles and business combinations (Dunne et. Al., 2008).

Differences between EU IFRS and IASB Standards

With regards to foreign companies whose securities trade on the public market, the EU has adopted standards equivalent to IFRS issued by the International Accounting Standards Board (IASB), or Canadian Generally Accepted Accounting Principles (GAAP). There were limited changes to IFRS adopted by the EU, when compared to the IFRS standards issued by the IASB. One change was a temporary ‘carve-out’ applied to International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement (IFRS Foundation, 2016).

The European Commission carved-out two items because they thought the provisions were not appropriate for the adoption of IFRS at the time, and needed to be reviewed further. The first carve out was the full fair value option. Companies are not permitted to determine the fair value of their own debt under Fourth Company Law Directive (Directive 78/660/EEC), therefore this was carved-out when IFRS was adopted. The second carve out, of certain hedging accounting provisions, was brought on because it would significantly affect many European banks. By limiting cash flow hedges, or fair value hedges, there would need to be extreme changes to risk management practises, which would be very costly for banks (European Commission, 2004). The carve-out of the full fair value option was removed in 2005, however, the carve out for hedge accounting has not been removed yet (Ernst & Young, 2015).

Differences between IFRS and Italian accounting requirements

Cortesi et. Al. (2009) lay out some of the key differences for financial statement items between IFRS and the Italian accounting requirements in place before the implementation of IFRS. The first item to discuss it tangible assets. Under IFRS, the first evaluation is based on the cost of the item purchased less accumulated depreciation and impairment losses. With IFRS, tangible assets can be reassessed to determine their fair value. Under Italian GAAP, no reassessments are allowed unless specified by a specific by-law. The first evaluation is the same – based on cost of purchase less accumulate depreciation or impairment losses (Cortesi et. Al., 2009).

The second key difference is with leased assets. Under IFRS, we can have a financial or operating lease for accounting purposes. Financial leases are accounted for as capitalization, and operating leases show up as an expense on the income statement. Under Italian GAAP, operating leases are applied for accounting purposes. Italian GAAP requires additional notes for the effects on equity, net income, and cash flow (Cortesi et. Al., 2009).

Intangible assets are the next difference to discuss. Under IFRS, intangible assets are recorded if they have a future economic benefit. The assets must be amortized over the useful life of the asset. With Italian GAAP, the following costs are capitalized: setting up costs, installation & expansion, research & development, and advertising. These costs are also amortized over their useful live, which is typically within five years (Cortesi et. Al., 2009).

Filing and submitting financial statements

Once the financial statements have been prepared, the annual general meeting must be held within 120 days to approve the statements. In some cases, this can be extended to 180 days (Association of Chartered Certified Accountants, 2009).

The financial statements must be submitted to the enterprise registration within one month after approval. The fiscal year can not exceed 12 months and companies typically finish their fiscal year on December 31 or June 30 (KPMG, 2016).

Requirements for non-listed companies

Not all companies in Italy follow IFRS. There are other accounting requirements for small and medium entities(SMEs) to follow. The following chart, provided by the European Commission (2017, February 6), can be helpful in determining whether the size of the company is medium, small, or micro:

It is important to understand the accounting requirements for SMEs because they employ 78% of the workforce in the Italian economy (Carini et. Al., n.d.). The accounting requirements for SMEs are outlined in Appendix A. Please note that these requirements are as of January 31, 2013. For this chart, type I companies consist of general partnerships, or limited partnerships, and type II companies consist of sole proprietorships (Ernst & Young, 2015).

Taxation in Italy

In Italy, individuals are responsible for the following taxes, according to PwC (2017):

· National income tax

· Regional income tax

· Municipal income tax

Individuals who are residents of Italy for tax purposes are responsible to report their worldwide income, and individuals who are not residents of Italy for tax purposes are responsible to report their income earned in Italy. Italy has a progressive tax rate, meaning the amount of taxes to be paid will increase with an increase in income. National income tax rates are as notes below:

Source: Pwc (2017)

Beginning in 2011, and up to December 31, 2016, Italy introduced a solidarity tax of 3% for those who earned a gross income over EUR 300,000 (PwC, 2017).

Personal income taxes have long been an important source of revenue for Italy. The percentage of revenue raised by taxation raised from 8.3% to 9.6%. The tax burden was constraining economic growth, and it was thought to be too high. In 2003, the personal income tax reform in Italy had a goal to reduce this tax burden. The tax rates varied significantly before the tax reform, they were between 10% and 51%, and there were seven income brackets. Italy had a variety of income brackets to remain progressive (Centre for Tax Policy and Administration, n.d.). The chart below, provided by the Centre for Tax Policy and Administration (n.d.), shows the differences of the income tax brackets between the years 1995 and 2005:

The focus of the reform was to reduce statutory tax rates - revenue raised from personal income taxes was reduced by 11.4 million euro. The first step in the tax reform saw a shift from tax credits, to a tax allowance (income that will not be taxed). The basic allowance was 3,000 euros. The second stage of the reform changed the number of tax brackets to four, and dependent tax credits were changed to tax allowances. This tax reform has reduced the tax burden for large families who are in the middle-income bracket, and families with low income (Centre for Tax Policy and Administration, n.d.).

The corporate tax reform had a goal to reduce the tax burden on companies, as well as simplify their corporate taxation system. Italy wanted their tax system to be more similar to other tax systems in the European Union, as it could attract more foreign investment. The corporate tax reform saw the corporate tax rate drop from 36% in 2002 to 33% in 2004. The reform also provided a system for capital gains exemption, and the method used to eliminate double taxation of dividends was replaced with a (partial) exemption method, which allowed company level profits to be taxed (Centre for Tax Policy and Administration, n.d.).

One key component to this tax reform was that companies who belonged to the same group could consolidate their taxes. This means they would be able to offset their profits and losses, which would require them to pay less income tax as a whole. This reform also saw a participation-exemption regime, which allowed inter-corporate capital gains to be exempt from taxation, and dividends become exempt from taxation. These rules were put in place to avoid double taxation (Centre for Tax Policy and Administration, n.d.).

Banking industry in Italy

Banks in Italy are struggling due to bad debts – approximately €360 billion of loans will likely never be repaid. This bad debt represents more than 18% of the country’s total lending. In comparison, bad loans represent 1.5% of Britain’s total lending (Smith, 2016). There has been financial difficult in the EU since 2008. In July 2011, the bond markets in Italy took a turn due to the sovereign debt crisis. By August, Jean-Claude Trichet, President of the European Central Bank, and Mario Draghi, Bank of Italy Governor, wrote a letter to Silvio Berlusconi, the Prime Minister of Italy at the time, stating that “immediate and bold” measures needed to be taken to promote growth of the markets (Jones, 2012).

Hoping to boost profits by the end of this decade UniCredit, Italy’s largest bank aimed to raise €13 billion though the country’s biggest share rights issue (Euronews, 2016). In addition to the large issue of shares, 11% of the workforce would lose jobs throughout Europe, and 1,000 banks in Italy would close. Without new capital, the bank would need to reduce its loan capacity and have more job cuts (The Guardian, 2016). When UniCredit first issued the new shares in February 2017, their shares fell 6.9%. The day after the issue, the shares were up .5% (Euronews, 2016).

Still awaiting regulatory approval, two struggling regional banks in Italy are considering a €5 billion bailout. The two banks, Veneto Banca and Banca Popolare di Vicenza, are considering being taken over by a government sponsored rescue fund, Atlante (Sanderson, 2017). Before the banks can be rescued by the Italian government, junior bondholders will need to take a financial hit, based on EU rules (The Guardian, 2016).

Banks do not want to acknowledge the loss involved with these bad loans, therefore they do not want to write them off (The Economist, 2015). While there is no loss recognized on the income statement because a bad debt expense would have been accounted for in prior years, there is still a loss in accounts receivable.

Italy referendum vote 2016

In December 2016, Italians voted in a historic referendum. This was proposed by Prime Minister Matteo Renzi, who threatened to resign if Italians voted against his reform. One key component to his proposal was to change the decision-making process for the Italian government. He wanted this changed because both houses of the Italian parliament currently hold the same powers and legislative functions. Renzi proposed that the Chamber of Deputies would be completely involved in passing laws. The Senate, however would represent local authorities, and still have some legislative power in areas like constitutional reform, and ratification of EU treaties. The second key change to Renzi’s proposal was that the state would have more power than it currently does, and local authorities would have less power (Genito, 2016). After two thirds of voters voted against his referendum, Renzi stepped down from his position of Prime Minister 90 minutes after polls closed (Culbertson et. Al., 2016). Paolo Gentiloni, Renzi’s processor Prime Minister, has an immediate priority to protect the banks in Italy (Reynolds, 2016).

Future of accounting for SMEs in Italy

While IFRS for SMEs is currently not an option for small and medium entities in Italy, it could be something for the Italian Accounting Committee to consider. After conducting a study of medium sized entities that either voluntarily adopted or did not adopt IFRS, Carini et. Al. (2001) believes that IFRS for SMEs should be voluntary, but not many companies will voluntarily adopt the full IFRS. This is due to the fact that full IFRS is very complex, and unnecessary for many SMEs in Italy, because many are owner-operated. Basile et. Al. (2016) discuss IFRS for SMEs, which is a Standard that aims to meet the needs and capabilities of small and medium sized entities. Compared to the full IFRS, this standard is much less complex in several ways, as noted below (IFRS, n.d.):

· Irrelevant topics, such as earnings per share are omitted

· There are simplified principles for recognising and measuring assets, liabilities, income, and expenses

· Approximately 90% less disclosures are required

· The standard is written in language that is easy to translate, and clear

· Revisions limited to once every three years

It is important to note the differences between Italian GAAP and IFRS for SMEs. The legal system is the first difference that is important to note. The civil law system, used by Italian GAAP, has strong political influence because national accounting standards are established and enforced by governments. This leads us to the second difference between these two models, which is the nature and origin of regulatory bodies. The International Accounting Standards Board (IASB) is responsible for setting international standards, which would include IFRS for SMEs. The OIC, mentioned at the beginning of this paper, is the official standard setter for Italian GAAP. The users of annual reports differ as well. The Italian framework states that creditors are the main users of financial statements, however, IFRS for SMEs states the objective of the financial statements for SMEs is to provide information about the entity that can be used by a wide range of users without being tailored to their specific needs. These models also differ on the basis of accounting. The Italian model focuses on prudence, in order to protect creditors, and IFRS for SMEs uses an accrual basis. The final consideration when determining differences between IFRS for SMEs and Italian GAAP is tax regulation. Tax regulation has a large impact on the Italian framework since the government is highly involved in setting the national accounting standards under this model. Owner-managers of SMEs often only prepare financial statements for tax reasons, and they recognize the objectives of general purpose financial reporting are different from the objectives of reporting taxable income (Basile et. Al, 2016).

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