Interpretative communication concerning certain Articles of the fourth and seventh Council Directives on accounting
Date: 1998-01-20
Institutions: European Commission
Subjects: European accounting system, European standard, accounting, approximation of laws, consolidated account, standardised accounting system

20.1.98

EN

Official  Journal  of  the  European  Communities

C  16/5

INTERPRETATIVE  COMMUNICATION  CONCERNING  CERTAIN  ARTICLES  OF  THE
FOURTH  AND  SEVENTH  COUNCIL  DIRECTIVES  ON  ACCOUNTING

(98/C  16/04)

(Text  with  EEA  relevance)

1.(cid:217)INTRODUCTION

1.(cid:217)The  fourth  and  seventh  Council  Directives  are  the
main  harmonization  instruments  in  the  accounting
field  within  the  European  Union(cid:216)(˛).

2.(cid:217)In  the  present 

interpretative  communication,  the
Commission  comments  on  topics  where  authoritative
clarification  appears  to  be  required.  The  topics  have
been  chosen  taking  into  account  discussions  in  the
Contact  Committee  on  the  Accounting  Directives  as
well  as  discussions  at 
the  Accounting  Advisory
Forum.

The  views  expressed  in  this  Communication  do  not
necessarily  represent  the  views  of  the  Member  States
and  should  not,  in  themselves,  impose  any  obligation
on  them.  They  do  not  prejudge  the  interpretation
instance
that  the  Court  of  Justice,  as  the  final 
responsible 
and
interpreting 
secondary  legislation,  might  place  on  the  matters  at
issue.

the  Treaty 

for 

the  Member  States  and 

3.(cid:217)The  Contact  Committee  was  set  up  pursuant  to
Article  52  of  the  fourth  Directive  and  it  consists  of
representatives  of 
the
Commission.  An  important  function  of  the  Contact
Committee  is  to  facilitate  a  harmonized  application
regular
of 
meetings,  dealing 
in  particular  with  practical
problems  arising  in  connection  with  their  application.
in  1995  of  a  new  approach
The  adoption 

the  Accounting  Directives 

through 

(˛)(cid:217)Fourth  Council  Directive  78/660/EEC  of  25  July  1978  on
types  of  companies

the  annual  accounts  of  certain 
(OJ(cid:216)L(cid:216)222,  14.8.1978,  pp.  11  to  31).
Seventh  Council  Directive  83/349/EEC  of  13  June  1983  on
consolidated  accounts  (OJ  L(cid:216)193,  18.7.1983,  pp.  1  to  17).
In  the  banking  and  insurance  sectors  respectively  also  the
following  Directives  apply:
Council  Directive  86/635/EEC  of  8  December  1986  on  the
annual  accounts  and  consolidated  accounts  of  banks  and
other  financial  institutions  (OJ  L(cid:216)372,  31.12.1986,  pp.  1  to
17).
Council  Directive  91/674/EEC  of  19  December  1991  on  the
annual  accounts  and  consolidated  accounts  of 
insurance
undertakings  (OJ  L(cid:216)374,  31.12.1991,  pp.  7  to  31).

between 

international 

to  accounting(cid:216)(ˇ)  gave  a  fresh  impetus  to  this  aspect
of  the  Contact  Committee’s  work.  In  particular,  the
comparison 
accounting
standards  (IAS)  and  the  Accounting  Directives  made
for  the  Contact  Committee  by 
its  special  Task
Force(cid:216)(—),  and  the  continuing  work  on  avoiding
divergence  between  IAS  and  the  Directives  carried
out  in  the  Committee’s  Technical  Sub(cid:220)committee,
has  allowed  the  Contact  Committee  to  resolve  a
number  of 
long(cid:220)standing  differences  on  questions
relating  to  the  application  of  the  Directives.  The
Accounting  Advisory  Forum  is  a  consultative  body
which  the  Commission  set  up  in  1990.  It  is  composed
of  representatives  of  the  accounting  standard  setting
bodies  in  Member  States  and  of  European  organ(cid:220)
the  main  users  and
izations  which 
preparers  of  accounts.

represent 

the  Commission
On  environmental  accounting, 
intends  to  issue  further  guidance  through  a  recom(cid:220)
mendation.

2.(cid:217)(cid:216)(cid:217)(cid:216)(cid:217)THE  FOURTH  COUNCIL  DIRECTIVE  ON
THE  ANNUAL  ACCOUNTS  OF  CERTAIN
TYPES  OF  COMPANIES ((cid:209))

2.1. General  provisions

2.1.1. True  and  fair  view  (Article  2(cid:216)(3)  to  (5))

4.(cid:217)According  to  Article  2  (3)  of  the  Directive,  the
annual  accounts  shall  give  a  true  and  fair  view  of  the
company’s  assets,  liabilities,  financial  position  and
profit  or  loss.  In  addition,  Article  2  (4)  requires  that
information  must  be  given  where  the
additional 
the  Directive
application  of 

the  provisions 

in 

(ˇ)(cid:217)"Accounting  harmonization:  A  new  strategy  vis(cid:220){(cid:220)vis  inter(cid:220)
the

national 
communication 
Commission,  COM(95)  508,  November  1995.

harmonization’, 

from 

(—)(cid:217)"An  examination  of  the  conformity  between  the  international
the  European  Accounting
and 

accounting 
Directives’,  European  Commission,  1996.

standards 

((cid:209))(cid:217)When  the  term  "the  Directive’  is  used  in  this  part  it  refers  to
the  fourth  Directive,  unless  other  references  are  clearly
made.

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that  a  specific  provision  of 

is  not  sufficient  to  give  a  true  and  fair  view.  Article
the
2(cid:216)(5)  requires 
Directive  must  be  departed  from  where, 
in  ex(cid:220)
ceptional  cases,  application  of  that  provision  would
be  incompatible  with  the  obligation  to  give  a  true
and  fair  view.  Any  such  departure  must  be  disclosed
in  the  notes  to  the  accounts  together  with  an  expla(cid:220)
nation  of  the  reasons  for  it  and  a  statement  of  its
effect  on  the  assets,  liabilities,  financial  position  and
profit  or  loss.

5.(cid:217)The  true  and  fair  view  principle  must  be  applied  by
the  companies  themselves.  Only  where  additional
information  is  not  sufficient  to  give  a  true  and  fair
view  can  any  provision  of  the  Directive  be  departed
from.  Such  a  situation  will  only  occur  in  exceptional
cases.

6.(cid:217)As  stated 

in  the 

last  sentence  of  Article  2  (5),
Member  States  may  define  the  exceptional  cases  in
question  and  lay  down  the  relevant  special  rules.  In
the  interest  of  harmonization,  Member  States  may
however  not  use  the  last  sentence  of  Article  2  (5)  in
order  to  introduce  an  accounting  rule  of  a  general
the
nature  which 
Directive,  nor  can  they  use  this  sentence  to  create
additional 
accounting
treatments  which  are  not  in  conformity  with  the
Directive.

to  provisions  of 

is  contrary 

allowing 

options 

for 

2.2. General  provisions  concerning  the  layouts

2.2.1. Prohibition  of  setting(cid:220)off  (Article  7)

7.(cid:217)Article  7  of  the  Directive  prohibits  any  set(cid:220)off
between  asset  and  liability  items,  or  between  income
and  expenditure  items.

8.(cid:217)The  setting(cid:220)off  cases  referred  to  in  Article  7  should
not  be  confused  with  the  cases  where  a  legal  right
exists  to  set  off  claims  and  debts  by  virtue  of  the  law
or  of  a  contractual  arrangement.  An 
immediate
consequence  of  the  legal  right  to  set  off  is  that  only
the  remaining  amount  can  and  must  be  shown  in  the
accounts.

9.(cid:217)There  exist,  however,  complex  transactions  where
the  income  and  expenditure  involved  is,  from  an
economic  viewpoint,  without  importance  as  regards
the  final  outcome  of  the  transaction.  In  some  cases
the  true  and  fair  principle  would  require  that  only
the  final  result  of  a  complex  operation  be  shown,
although  every  case  must  be  judged  on  its  own
merits.

2.3. Balance  sheet

2.3.1. Capitalization  of  certain  intangible  fixed  assets

(Articles  9  and  10)

10.(cid:217)In  accordance  with  the  layout  of  the  balance  sheet,
the  heading  "Intangible  assets’  includes  concessions,
patents,  licences,  trade  marks  and  similar  rights  and
valuable
assets 
if 
consideration  or 
the
company  itself  and  capitalization  is  permitted  under
national  law.

they  were  created  by 

they  were 

acquired 

for 

if 

assets,  when 

11.(cid:217)It  follows  from  the  wording  of  the  Directive  that
valuable
these 
consideration,  must  be  capitalized.  Only  in  the  case
of  rights  and  assets  created  by  the  company  itself
does  the  Directive  permit  Member  States  to  decide
whether  or  not  they  should  be  capitalized.

acquired 

for 

2.3.2. Balance 

sheet 

items  concerning  undertakings
with  which  a  company  is  linked  by  virtue  of
participating  interests  (Articles  9,  10  and  11)

12.(cid:217)The  balance  sheet  layouts  require  that  claims  on  and
amounts  owed 
to  undertakings  with  which  a
company  is  linked  by  virtue  of  participating  interests
are  shown  separately.  A  participating 
is
defined  in  Article  17  as  meaning  rights  in  the  capital
of  other  undertakings,  whether  or  not  represented
by  certificates,  which,  by  creating  a  durable  link  with
those  undertakings,  are  intended  to  contribute  to  the
company’s  activities.

interest 

13.(cid:217)The  question  arises  whether  claims  on  and  amounts
owed  to  such  undertakings  should  be  shown  sepa(cid:220)
rately  only  by  the  company  which  held  the  partici(cid:220)
pating  interest  or  also  by  the  company  in  which  the
participating  interest  is  held.  The  expression  "linked
by  virtue  of  participating  interests’  in  Articles  9  and
10  of  the  Directive  suggests  that  the  broader  inter(cid:220)
pretation  was 
"creating  a
durable  link’  used  in  the  definition  of  participating
interest  applies  equally  to  the  company  holding  the
participating  interest  and  to  that  in  which  the  interest
is  held.

intended.  The  phrase 

14.(cid:217)Where 

the  company  holding 

the  participating
interest  and  the  company  in  which  the  interest  is
held  are  governed  by  the  law  of  different  Member
States  and  where  the  presumption  of  a  participatory
link  is  based  on  different  percentages,  the  question
whether  a  participating  interest  exists  is  decided  by
reference  to  the  law  of  the  Member  State  in  which
the  reporting  company  is  established.

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2.3.3. Subordinated  loans  in  the  balance  sheet  (Artic(cid:220)

les  9  and  10)

15.(cid:217)Subordinated  loans  are  loans  which,  in  the  event  of
liquidation  of  the  debtor  company,  are  repaid  after
all  other  creditors  have  been  satisfied  but  before
shareholders  receive  any  distribution.

16.(cid:217)The  balance  sheet  layouts  in  the  Directive  do  not
include  a  separate  heading  for  subordinated  loans.
Subordinated  loans  may  not  be  shown  under  "Capital
and  reserves’.  They  are  liabilities  which  must  be
shown  under  "Creditors’.  In  order  to  emphasize  the
specific  nature  of  these  loans,  it  may  be  appropriate
to  create  a  specific  balance  sheet  item  for  such  loans
and  to  give  further  details  in  the  notes  about  the
terms  and  interest  rates  of  these  loans.

2.3.4. Provisions  for  liabilities  and  charges  (Article  20)

17.(cid:217)Article  20  distinguishes  between 

two  categories
of  provisions.  The  provisions  referred  to  in  Article
20  (1)  cover  losses  or  debts,  the  nature  of  which  is
clearly  defined  and  which,  at  the  balance(cid:220)sheet  date,
are  either  likely  to  be  incurred  or  certain  to  be
incurred  but  uncertain  as  to  amount  or  as  to  the  date
on  which  they  will  arise.  In  addition  to  these
provisions,  Article  20  (2)  permits  Member  States  to
authorize  the  creation  of  a  further  category  of
intended  to  cover  charges
provisions.  These  are 
which  have  their  origin  in  the  financial  year  under
review  or  in  a  previous  financial  year.

18.(cid:217)Provisions  according  to  Article  20  (1)  cover  probable
losses  (arising  from  transactions  in  the  course  of
settlement)  and  probable  debts.  The  basic  approach
behind  these  provisions  is  that  a  relation  to  a  third
party  exists  (e.g.  supply  or  service  contract,  legal
proceedings,  etc.).  Provisions  which  meet 
these
conditions  must  be  formed  irrespective  of  the  profit
or  loss  for  the  financial  year  in  accordance  with  the
general  principle  laid  down  in  Article  31  (1)  (c)  (bb).
This  Article  requires  that  account  must  be  taken  of
all  foreseeable  liabilities  and  potential  losses  arising
in  the  course  of  the  financial  year  concerned  or  of  a
previous  one,  even  if  such  liabilities  or  losses  become
apparent  only  between  the  date  of  the  balance  sheet
and  the  date  on  which  it  is  drawn  up.

or  in  a  previous  financial  year,  the  nature  of  which  is
clearly  defined  and  which  at  the  balance  sheet  date
are  either  likely  to  be  incurred  or  certain  to  be
incurred  but  uncertain  as  to  amount  or  as  to  the  date
on  which  they  will  arise.  Although  there  is  no  obli(cid:220)
gation  to  a  third  party,  the  possibility  to  create  a
provision  in  this  case  gives  companies  the  oppor(cid:220)
tunity  to  calculate  the  profit  or  loss  for  the  period
more  precisely.  This  is  meant  to  cover,  for  example,
major  and  recurring  maintenance  costs  over  a
number  of  years  and  expenditure  on  major  repairs.

2.3.5. Provisions  for  environmental  liabilities  and  risks

(Article  20)

20.(cid:217)The  general  conditions 

in  Article  20  (1)  of  the
Directive  apply  also  to  provisions  for  environmental
risks  and 
liabilities.  Where  Member  States  have
implemented  the  option  contained  in  Article  20  (2),
it  is  also  applicable  to  environmental  charges.

21.(cid:217)Environmental  liabilities  or  risks,  which  result  from
past  transactions  or  events,  qualify  for  recognition  as
a  provision  in  the  balance  sheet,  if:

(a)(cid:217)the  company  has  a  legal  or  contractual  obli(cid:220)
gation  to  prevent,  reduce  or  repair  environ(cid:220)
mental  damage,  or

(b) the  company’s  management 

is  committed 

to
prevent,  reduce  or  repair  environmental  damage.
Such  commitment  would  exist,  for 
instance,
where  management  has  little  discretion  to  avoid
action  on  the  basis  of  statements  of  policy  or
intention, 
industry  practice  or  public  expec(cid:220)
tations  or  where  the  company’s  management  has
decided  to  prevent,  reduce  or  repair  environ(cid:220)
mental  damage  and  has  communicated 
this
decision  either  internally  to  another  company
organ  or  externally.

2.4.

Profit  and  loss  account

2.4.1. Definition  of  net  turnover  (Article  28)

19.(cid:217)Provisions  according  to  Article  20  (2),  however,  do
not  cover  provisions  for  losses  and  debts  but  only
provisions  for  charges.  These  are  expenses  which
have  their  origin  in  the  financial  year  under  review

22.(cid:217)In  accordance  with  Article  28  of  the  Directive,  the
net  turnover  comprises  the  amounts  derived  from  the
sale  of  products  and  the  provision  of  services  falling
within 
the  company’s  ordinary  activities,  after
deduction  of  sales  rebates  and  of  value(cid:220)added  tax
and  other  taxes  directly  linked  to  the  turnover.

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levied  and  reimbursed  at  each  stage 

23.(cid:217)The  expression  "other  taxes  directly  linked  to  the
turnover’  excludes  excise  duty.  Unlike  VAT,  which
is 
the
production  chain,  excise  duty  is  normally  paid  only
once  by  the  producer  when  the  product  first  leaves
the  factory.  The  most  logical  approach  is  therefore
to  regard  excise  duty  as  an  inseparable  part  of  the
price  of  the  product,  which  should  therefore  always
be  included  in  the  net  turnover.

in 

2.4.2. Extraordinary  items  (Article  29  (1))

24.(cid:217)Article  29  (1)  states  that  income  and  charges  that
arise  otherwise  than  in  the  course  of  the  company’s
ordinary  activities  must  be  shown  as  extraordinary
income  or  extraordinary  charges.

25.(cid:217)In  modern  accounting  practice  there 

is  a  trend
whereby  the  number  of  items  which  are  considered
as  extraordinary  is  decreasing.

26.(cid:217)The  definition  of  extraordinary 

in 

items 

the
Directive  does  not  preclude  that  income  and  charges
are  only  classified  as  extraordinary  in  rare  cases.
Different  factors,  such  as  the  size  and  the  activities
of  the  company,  need  to  be  taken  into  account  when
classifying  items.  The  classification  of  an  item  as
extraordinary  or  not  may  often  depend  on  the  size
of  the  enterprise:  the  larger  the  business,  the  more
often  certain  events  may  occur,  with  the  conse(cid:220)
quence  that  they  may  be  more  correctly  classified  as
ordinary  items.

2.4.3. Environmental  expenditure

to  deal  with 

27.(cid:217)Environmental  expenditure  is  not  explained  in  the
Directive.  Environmental  expenditure  may 
include
the  costs  of  steps  taken  by  an  undertaking  or  on  its
behalf  by  others  to  prevent,  reduce  or  repair  damage
to  the  environment  which  results  from  its  operating
activities,  or 
the  conservation  of
renewable  and  non(cid:220)renewable  resources.  These  costs
include,  inter  alia,  the  disposal  and  avoidance  of
waste,  the  protection  of  surface  and  groundwater,
preserving  or  improving  air  quality,  noise  reduction,
buildings,
the 
researching 
friendly
products,  raw  materials  or  production  processes,
etc.(cid:216)((cid:210)).

environmentally 

contamination 

for  more 

removal 

of 

in 

((cid:210))(cid:217)See  also 

"Paper  of 
issues 

the  Accounting  Advisory  Forum:
in  financial  reporting’,  (Document

Environmental 
XV/6004/94),  European  Commission  1995,  page  5.

28.(cid:217)Environmental  expenditure  should  in  most  cases  be
treated  as  ordinary  expenditure.  Consequently  it  is
normally  to  be  expensed  in  the  current  period,  i.e.
the  period  in  which  it  is  recognized.

2.5. Valuation  rules

2.5.1. Depreciation  of  fixed  assets  (Articles  31  (1)  (b),

33  (3)  and  35  (1)  (b))

29.(cid:217)The  purchase  price  of  any  fixed  asset  with  a  limited
useful  economic  life  must  be  depreciated  system(cid:220)
atically  over  its  useful  economic  life  (Article  35  (1)
(b)).

30.(cid:217)The  requirement  to  depreciate  applies  even  where
the  fair  value  of  a  building  is  equal  to  or  higher  than
the  book  value  or  where  the  estimated  remaining
useful  life  is  unlimited  or  at  any  rate  so  prolonged
that  annual  depreciation  would  be  insignificant.  The
Directive  requires  that  fixed  assets,  such  as  buildings
with  limited  useful  economic  lives  are  depreciated
over  their  useful  economic  lives.  Depreciation  serves
to  stagger  the  purchase  price  systematically  over  the
useful  life  of  the  building.

the  purchase  price 

31.(cid:217)The  application  of  a  valuation  method  which  is  not
based  on 
is  however  not
precluded.  The  application  of  such  a  method  may  be
authorized  within  the  meaning  of  Article  33.  Where
such  a  method  is  applied,  the  value  adjustments  must
be  calculated  each  year  on  the  basis  of  the  value
adopted  for  the  financial  year  in  question  (current
value)  (Article  33  (3)).

2.5.2. Split  depreciation 

in 

the  case  of 

revalued

buildings  (Articles  32  and  33  (3))

32.(cid:217)The  depreciation  charge  in  the  case  of  revalued
buildings  may  not  be  split  into  a  part  which  is  based
on  the  historical  cost  and  which  is  charged  to  the
profit  and  loss  account  and  another  part  which  is
based  on  the  revalued  amount  and  which  is  charged
directly  to  the  revaluation  reserve.

33.(cid:217)Article  33  (3)  allows  Member  States  to  permit  or  to
require  that  only  the  amount  of  the  depreciation
arising  as  a  result  of  the  application  of  the  general
rule  laid  down  in  Article  32  (purchase  price)  be  seen
under  the  relevant 
loss
account  and  that  the  difference  arising  as  a  result  of
the  valuation  method  adopted  under  Article  33  be
shown  separately  in  the  layouts.  This  provision  still
requires  the  depreciation  to  be  calculated  on  the

in  the  profit  and 

items 

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basis  of  the  value  adopted  for  the  financial  year  in
question.  It  merely  allows  Member  States  to  require
or  to  permit  the  purchase  price  element  of  the
depreciation  to  be  shown  under  the  relevant  items.
That  part  of  the  depreciation  charge  which  relates  to
the  revalued  amount  may  appear  separately  in  the
profit  and  loss  account  layout.

2.5.3. Determination 

of 
(Article  35  (1)  (b))

the  depreciable 

amount

2.5.5. Accounting  for  positive  differences  in  exchange

rates  (Article  31)

38.(cid:217)The  Directive  does  not  specifically  address 

the
problem  of  accounting  for  the  effects  of  changes  in
foreign  exchange  rates.  Article  43  (1)  requires  that
for  items  included  in  the  annual  accounts  which  are
or  were  originally  expressed  in  a  foreign  currency,
the  bases  of  conversion  used  to  express  them  in  local
currency  should  be  disclosed.

34.(cid:217)The  basis 

In 

for  depreciation,  or 

the  depreciable
amount,  is  indicated  in  Article  35  (1)  (b)  of  the
Directive  to  be  the  "purchase  price  or  production
cost’. 
the
accounting 
depreciable  amount  of  an  asset 
sometimes
determined  after  deducting  the  residual  value  of  the
asset.  Although  the  Directive  does  not  contain  a
specific  reference  to  residual  value,  the  use  of  a
residual  value  in  the  calculation  of  the  depreciable
amount  of  an  asset  is  not  contrary  to  the  Directive.

however, 
is 

practice, 

2.5.4. Accounting 
31  (1)  (c))

for 

long(cid:220)term 

contracts 

(Article

35.(cid:217)Long(cid:220)term  contracts  are  generally  understood  to
mean  contracts  which  relate  to  work  or  services
extending  over  a  period  of  more  than  one  year.
There  are  different  methods  to  account  for  this
situation.  One  method  is  to  take  the  profit  from  the
contract  into  account  only  after  final  completion  of
the  contract  (completed  contract  method).  Another
method  is  to  relate  the  profit  to  be  taken  into
account  to  the  proportion  of  the  contract  that  has
been  completed  at  the  end  of  the  financial  year
(percentage  of  completion  method).  Both  methods
are  allowed  under  the  Directive.

36.(cid:217)The  second  method  is  however  only  allowed  on
condition  that  the  prudence  principle  laid  down  in
Article  31  (1)  (c)  is  clearly  observed.  In  other  words,

39.(cid:217)The  question  of  how  to  account  for  translation
differences  in  exchange  rates  has  been  the  subject  of
a  long(cid:220)running  debate  in  Europe(cid:216)((cid:211)).  While  there  has
always  been  agreement  on  the  fact  that  negative
exchange  differences  should  be  charged  to  the  profit
and  loss  account  as  soon  as  they  arise,  doubts  have
existed  as  to  the  possibility  of  including  positive
differences  in  the  profit  and  loss  account.

in 
this 

40.(cid:217)Article  31  of  the  Directive  does  not  exclude  an  inter(cid:220)
pretation  whereby  positive  exchange  differences  may
loss  account.
the  profit  and 
be 
included 
Furthermore, 
both
possibility 
short(cid:220)term  and  long(cid:220)term  monetary  items.  Because
financial
of 
instruments,  it  would  indeed  be  arbitrary  to  operate
a  distinction  between  short(cid:220)term  and 
long(cid:220)term
monetary  items.

the  existence  of  very  sophisticated 

exists 

for 

2.5.6. Capitalization  of  borrowing 

costs 

(Article

35  (4))

41.(cid:217)Interest  on 

to 

capital  borrowed 

the
production  of  fixed  assets  may,  according  to  Article
35  (4),  be  included  in  the  production  costs  to  the
extent  that  it  relates  to  the  period  of  production.  The
term  "production’  in  Article  35  (4)  should  not  be
interpreted  too  narrowly.

finance 

(a)(cid:217)the  total  contract  income  must  be  known;

(b) it  must  be  possible  for  the  proportion  of  work

completed  to  be  calculated  accurately,  and

(c) the  work  on  the  contract  must  be  sufficiently

advanced.

Furthermore,  where  a  loss  is  anticipated  on  contract,
a  provision  must  be  set  up  for  the  entire  loss  as  soon
as  it  is  discovered.

42.(cid:217)Borrowing  costs  relating  to  the  construction  of  a
fixed  asset  may  equally  qualify  for  capitalization.  In
the  same  way,  borrowing  costs  relating  to  the
acquisition  of  a  fixed  asset  may  also  be  capitalized
provided  the  acquisition  does  not  result  in  an  asset
being  immediately  ready  for  use  or  sale.  Indeed,
capitalization  of  borrowing  costs  presupposes  that  a
substantial  period  of  time  is  needed  before  the  asset
is  ready  for  its  intended  use  or  sale.  As  far  as
acquisitions  are  concerned,  this  could  be  the  case
where  components  are  being  acquired  which  are
then  assembled.

37.(cid:217)Irrespective  of 

the  method  chosen,  appropriate
information  must  be  given 
in  the  notes  of  the
accounts  as  to  the  method  applied  in  accordance
with  Article  43  of  the  Directive.

((cid:211))(cid:217)See  for  example  "Paper  of  the  Accounting  Advisory  Forum:
Foreign  currency  translation’,  European  Commission,  Office
for  Official  Publications  of  the  European  Communities,
Luxembourg,  1995.

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2.5.7. Capitalization  of  environmental  expenditures

2.6.2. Environmental  information  (Articles  29,  42  and

(Article  15  (2))

43)

43.(cid:217)Where  environmental  expenditures  are  incurred  to
prevent  or  reduce  future  environmental  damage
damage  or  conserve  resources,  they  may  qualify  for
recognition  as  an  asset  if,  in  accordance  with  Article
15  (2)  of  the  Directive,  they  are  intended  for  use  on
a  continuing  basis  for  the  purpose  of  the  under(cid:220)
taking’s  activities  and 
in  addition  one  of  the
if 
following  criteria  is  met:

(a)(cid:217)the  costs  relate  to  anticipated  environmental
benefits  and  extend 
the
capacity,  or  improve  the  safety  or  efficiency  of
assets  owned  by  the  company,  or

increase 

life, 

the 

(b) the  costs 

reduce  or  prevent  environmental
contamination  that  is  likely  to  occur  as  a  result
of  future  operations.

2.5.8. Valuation  of  inventories  (Article  39  (1)  (b))

44.(cid:217)Article  39  (1)  (b)  states  that  current  assets  should  be
shown  at  the  lower  market  value  or,  in  particular
circumstances,  another  lower  value  to  be  attributed
to  them  at  the  balance  sheet  date.

45.(cid:217)Although  the  Directive  does  not  make  any  specific
reference  to  the  concept  of  net  realizable  value,  it
appears  difficult  to  imagine  any  practical  case  where
the  lower  value  to  be  attributed  to  inventories  at  the
balance  sheet  date  is  materially  different  from  the
net  realizable  value.  The  concept  of  net  realizable
value  is  therefore  compatible  with  the  Directive.

2.6. Notes  on  the  accounts

48.(cid:217)In  general  the  following  provisions  in  the  Directive
also  apply 
regarding
environmental  matters  that  ought  to  be  included  in
the  notes  on  the  accounts:

information 

financial 

to 

(a)(cid:217)Article  43  (1)  (1)  on  disclosure  of  valuation

methods  applied;

(b) Article  29  on  disclosure  of  extraordinary  items;

(c) Article  42  on  disclosure  and  details  of  provisions

included  under  "Other  provisions’;

(d) Article  43  (1)  (7)  on  disclosure  of  contingent
in
including  narrative 
the

liabilities, 
sufficient  detail,  so 
contingency  can  be  understood.

information 
the  nature  of 

that 

2.7. Annual  report

2.7.1. Environmental  information  (Article  46)

49.(cid:217)Based  on  Article  46, 

information
regarding  environmental  matters  could  usefully  be
given  in  the  annual  report:

the  following 

(a)(cid:217)where  environmental  issues  are  relevant  to  the
a
the

financial 
description  of 
the  respective 
undertaking’s  response  thereto;

the  undertaking, 
issues  and 

position  of 

(b) the  policy 

that  has  been  adopted  by 

the
enterprise  in  respect  of  environmental  protection
measures;

2.6.1. Possible  omission  of  certain  items  concerning
undertakings  in  which  participating  interests  are
held  (Article  43  (1)  (2)  and  45  (1)  (b))

(c) the  improvements  that  have  been  made  in  key

areas  of  environmental  protection;

46.(cid:217)According  to  Article  45  (1)  (b),  Member  States  may
allow  the  disclosures  prescribed  in  Article  43  (1)  (2)
concerning  undertakings 
the  company
holds,  either  directly  or  indirectly,  a  participating
interest  to  be  omitted  when  their  nature  is  such  that
they  would  be  seriously  prejudicial  to  "any  of  the
undertakings  to  which  Article  43  (1)  (2)  relates’.

in  which 

47.(cid:217)The  reference  to  "any  of  the  undertakings  to  which
Article  43  (1)  (2)  relates’  covers  not  only  those
undertakings  in  which  the  company  has  a  partici(cid:220)
pating  interest  but  also  the  holding  company  itself,
since  disclosure  can  be  prejudicial  in  both  cases.

(d) an  indication  of  government  incentives  related  to
such  as

environmental  protection  measures, 
grants  and  tax  concessions;

(e) the  extent  to  which  environmental  protection
measures,  resulting  from  changes  in  future  legal
requirements  that  have  already  been  enacted,  or
substantially  enacted,  into  law,  are  in  the  process
of  implementation;

(f) if  other  quantitative  or  qualitative  environmental
information  is  provided  in  a  separate  environ(cid:220)
mental  report,  a  reference  to  this  report.

20.1.98

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3.(cid:217)(cid:216)(cid:217)(cid:216)(cid:217)THE  SEVENTH  COUNCIL  DIRECTIVE  ON

CONSOLIDATED  ACCOUNTS ((cid:212))

3.1. Group  definition  and  scope  of  consolidation

3.1.1. Majority  of  voting  rights  in  another  undertaking

(Article  1  (1)  (a))

50.(cid:217)Article  1  (1)  (a)  of  the  Directive  requires  con(cid:220)
solidated  accounts  to  be  drawn  up  where  an  under(cid:220)
taking  holds  a  majority  of  the  voting  rights 
in
another  undertaking.  The  majority  of  the  voting
rights  does  not  necessarily  correspond  with  the
majority  of  the  share  capital.

these 

51.(cid:217)Where  the  undertaking  in  question  has  issued  shares
with  plural  voting  rights,  full  account  has  to  be  given
to 
shares  when  determining  whether  a
company  should  be  included  in  the  consolidation  or
not,  even  where  those  shares  do  not  represent  a
majority  of  the  capital.  The  same  principle  applies  to
non(cid:220)voting  shares,  i.e.  the  shares  held  by  the  under(cid:220)
taking  concerned  should  be  taken 
into  account
purely  on  the  basis  of  the  voting  rights  attached  to
them  and  irrespective  of  the  proportion  of  the  capital
they  represent.

52.(cid:217)For 

the 

the 

definition 

parent(cid:220)subsidiary
of 
relationship,  the  majority  of  voting  rights  should
always  be  taken  to  mean  a  simple  majority  of  all
voting  rights  in  a  company.  This  applies  even  if  the
law,  the  memorandum  or  the  articles  of  association
require  that  all  or  certain  decisions  in  a  company  can
be  taken  only  on  the  basis  of  a  qualified  majority.
The  parent(cid:220)subsidiary  relationship  is  not  affected  by
provisions  in  the  law,  or  the  memorandum  or  the
articles  of  association  which  limit  the  voting  power
of  a  shareholder  or  member  to  a  given  percentage  of
the  total  voting  rights  which  is  less  than  a  majority
of  all  the  voting  rights,  irrespective  of  the  size  of  his
shareholding  and  the  associated  voting  rights.

53.(cid:217)The  restrictions  referred  to  in  paragraph  52  must
however  be  seen  in  the  light  of  Article  13  (3)  (a)  (aa)
which  allows  an  undertaking  not  to  be  included  in
long(cid:220)term
consolidated 
restrictions  substantially  hinder  the  parent  under(cid:220)
taking  in  the  exercise  of  its  rights  over  the  assets  or
management  of  that  undertaking.

accounts  where 

severe 

54.(cid:217)Where  the  proportion  of  capital  and  the  proportion
of  voting  rights  held  differ  and  consolidation  has
the  majority
taken  place  on 

the  basis  of 

((cid:212))(cid:217)When  the  term  "the  Directive’  is  used  in  this  part  it  refers  to
the  seventh  Directive,  unless  other  references  are  clearly
made.

of  the  voting  rights,  the  notes  on  the  consolidated
accounts  must  include  information  concerning  the
basis  on  which  the  consolidation  has  been  carried
out,  i.e.  information  as  to  the  proportion  of  voting
rights  held  (Article  34  (2)  (a)).

3.1.2. Right  to  appoint  or  remove  a  majority  of  the
members  of  the  administrative,  management  or
supervisory  body  of  another  undertaking  (Article
1  (1)  (b))

55.(cid:217)Article  1  (1)  (b)  requires  consolidated  accounts  to  be
drawn  up  where  an  undertaking  has  the  right  to
appoint  a  majority  of  members  of  the  administrative,
management  or  supervisory  body  of  another  under(cid:220)
taking  (a  subsidiary  undertaking)  and  is  at  the  same
time  a  shareholder  in  or  member  of  that  under(cid:220)
taking.

56.(cid:217)In  principle 

this  provision  does  not  cover 

the  basis  of 
the  articles  of  association, 

the
situation  in  which  a  company  is  entitled,  in  respect
the
of  another  company  and  on 
memorandum  or 
to
appoint  a  minority  of  the  members  of  one  of  the
bodies  mentioned  and  that  minority  holds  a  majority
of  the  voting  rights  within  the  body  in  question.
Consolidation  is  only  required  where  the  right  exists
to  appoint  or  remove  a  majority  of  the  board
members.

3.1.3. Exclusion  of 

subsidiaries  with 

incompatible

activities  (Article  14  (1))

57.(cid:217)Article  14  (1)  of  the  Directive  states  that  an  under(cid:220)
taking  must  be  excluded  from  the  consolidated
accounts  when  its  inclusion  would  be  incompatible
with  the  requirement  to  show  a  true  and  fair  view.
Even  though  the  second  paragraph  restricts  the
scope  of  this  Article,  modern  accounting  practice
gives  this  kind  of  exclusion  an  even  more  restricted
role.

58.(cid:217)Since  the  adoption  of  the  Directive  a  development
has  taken  place  whereby  more  and  more  subsidiaries
have  been  included  in  the  consolidated  accounts,
regardless  of  the  nature  of  their  business  compared
with  that  of  the  parent  undertaking.  Preference  is
given  to  the 
in  the
consolidated  accounts  with  appropriate  information
(on  a  segmented  basis)  in  the  notes.  Article  14  (1)
should  be  read  in  the  light  of  this  development  and
exclusion  from  the  scope  of  the  consolidation  should
therefore  only  take  place  in  very  rare  circumstances
when  the  application  of  the  true  and  fair  view
principle  as  described  in  Article  16  (3)  so  requires.

inclusion  of  the  subsidiary 

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20.1.98

3.2.

Preparation  of  the  consolidated  accounts

3.2.1. Consolidated  balance  sheet  and  profit  and  loss

account  (Article  17)

59.(cid:217)According  to  Article  17  of  the  Directive,  the  layouts
of  the  consolidated  balance  sheet  and  profit  and  loss
account  are  governed  by  the  provisions  in  the  fourth
Directive  (Article  9  and  10  and  23  to  26).  However,
adjustments  resulting  from  the  particular  charac(cid:220)
teristics  of  consolidated  accounts  can  be  made.
Those  adjustments  involve,  firstly,  those  items  which
the  seventh  Directive  specifically  provides  for  to
supplement  those  of  the  fourth  Directive  and  which
follow  naturally  from 
the  consolidation  process.
Those  items  are  the  following:

-(cid:217)the  positive  or  negative  consolidation  difference

(Article  19  (1)  (c)),

-(cid:217)the  amount  of  capital  (Article  21)  and  profit  or
loss  (Article  23)  attributable  to  minority  share(cid:220)
holders,

-(cid:217)the  difference  between  the  book  value  of  a
interest  and 
the  amount  corre(cid:220)
participating 
sponding 
the  proportion  of  capital  and
to 
reserves  represented  by  that  participating  interest
in  the  case  of  application  of  the  equity  method
(Article  33  (2)  (a)  (b))  and  the  proportion  of  the
profit  or  loss  of  associated  undertakings  to  which
the  equity  method  has  been  applied  (Article  33
(6)).

60.(cid:217)Article  17  (2)  gives  Member  States  the  option  to
raw
omit 
the  classification  of 
in  progress,
materials  and  consumables,  work 
finished  goods  and  payments  on  account,  where

stocks  between 

expense 

there  are  special  circumstances  which  would  entail
undue 
detailed
information.  Stocks  may  therefore  be  clasified  in
accordance  with  the  purpose  most  frequently  used
during  the  financial  year.

providing 

such 

in 

3.2.2. Requirements  when  applying 

"international’

accounting  rules  (Articles  17  and  29)

61.(cid:217)If  an  undertaking  which  is  required  to  prepare  its
consolidated  accounts  in  conformity  with  the  seventh
Directive  wishes  to  satisfy  at  the  same  time  the
requirements  following  from  other  rules  such  as
International  Accounting  standards  (IAS)  or  US
generally  accepted  accounting  principles  (GAAP),
this 
the
to 
consolidated  accounts  remain  in  conformity  with  the
seventh  Directive.  This  is  particularly  relevant  for  the
layouts  of 
the  valuation
methods.

the  accounts  and 

is  only  possible 

the  extent 

that 

for 

The  consolidated  balance  sheet  and  profit  and  loss
account  must  be  drawn  up  in  accordance  with  the
requirements  of  the  Directive.  This  means  that  no
other  adjustments  to  the 
in  the  fourth
Directive  than  those  allowed  by  Article  4  of  this
Directive  can  be  made.

layouts 

As  far  as  the  valuation  rules  are  concerned,  Article
29  (2)  allows  Member  States  to  require  or  to  permit
the  use 
in  consolidated  accounts  of  valuation
methods  other  than  those  used  by  the  parent  under(cid:220)
taking  in  its  annual  accounts.  However,  these  other
valuation  methods  must  also  be  in  conformity  with
the  fourth  Directive.  No  valuation  methods  may  be
used  which  are  in  conflict  with  those  allowed  under
the  fourth  Directive.