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Financial statements
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The annual financial statements in their various forms are an important means of providing information, building trust and protecting the company.

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Definition: what are the annual accounts?

The annual financial statements are the financial conclusion of a commercial business year. Bookkeeping and annual financial statements were invented as early as the 15th century to prove the economic performance of merchants. Anyone who demonstrably adhered to the strict rules and had a healthy balance sheet could be trusted and given a payment term or credit. Basically nothing has changed to this day.

Annual financial statements: addressees with different expectations

Annual financial statements are therefore an important source of information for the company, not just for business partners. They serve to inform and control the owners or shareholders about what is happening over a set period of time. Financing partners, especially banks, already have a legal mandate to request and audit the annual financial statements; in addition, the obligation to submit them is agreed in all common credit agreements.

Last but not least, the tax authorities require the annual financial statements. Recently, this has to be done in electronic form and according to the officially prescribed structure within the framework of the so-called taxonomy for efficient control and comparisons with other taxpayers.

The interests of these recipients are rarely identical. You want to look as good as possible to banks or potential investors and show your taxable income as low as possible to the tax office. Both are permissible and possible at the same time.

Annual financial statements analysis and assessment

The different interests of the addressees hardly allow us to create a uniform financial statement and thus serve every information interest. The annual financial statements have the function of creating trust in the company's economic and fiscal environment.

Based on uniform (always national) rules, a true and fair picture of the asset, financial and earnings situation should be presented at the end of each financial year. For internationally active companies, the problem is that the annual financial statements have to be prepared according to local rules at the national level. This means that the degrees are not comparable with each other. However, in order to analyze and assess annual financial statements, decision-makers need to look at the whole, which must be prepared in a coherent manner according to a uniform standard or recipe.

Choice of fiscal year

While the balance sheet shows the assets and their financing as of the reporting date, the income statement shows the economic result of the financial year for a specific period. It is by no means the case that a financial year generally begins on January 1st and ends on December 31st. It is also possible to choose an economic or fiscal year that differs from the calendar year. This right to choose always exists when setting up a company, although the decision does not have to be made at the time of founding. The decisive date for the end of the first financial year is the date at which the annual financial statements are actually prepared.

The financial year or financial year can therefore also cover the period from September 1st of one year to August 31st of the following year. The choice made is binding for subsequent years. However, in Germany and some other countries you can change to the calendar year without the consent of the tax authorities and thereby achieve financially interesting effects.

For purely tax purposes, the result generated throughout the entire financial year is treated as if it had been achieved on the last day of the financial year. In the above example, the result of the 2020/2021 financial year, which covers the period from September 1, 2020 to August 31, 2021, would be taxed in full in 2021. This would allow profits from the period before the Corona crisis to be offset against losses suffered afterwards, thus saving taxes.

Save costs with tax advisors and auditors

For internationally active companies, a uniform choice of financial year that applies to all companies can also save costs for tax advisors and auditors. If you have a branch in a country where the tax year differs from the calendar year, for example Great Britain or Japan, the British or Japanese company would have to prepare additional annual financial statements for the consolidated financial statements for the parent company's balance sheet date.

Of course, this applies the other way around if the German company belongs to a Japanese group. It should therefore generally be considered to align the financial year of all subsidiaries with that of the parent company.

Trade balance - internationally different standards

Practically every country has its own rules, not even the EU agrees. One and the same company can report a profit under the German HGB standard, but a loss under the international standard IFRS - and vice versa. This is a problem for internationally active companies. Because the viewer's perspective usually follows his or her home standards.

German entrepreneurs tend to interpret balance sheets that appear similar all over the world as HGB balance sheets. Accordingly, they will draw their conclusions and make decisions. However, if the annual financial statements are based on the US standard US Gaap or the Chinese standard CAS, the interpretation and the decision based on it are most likely wrong.

Interpretation of the annual financial statements

Being able to read annual financial statements does not mean being able to interpret and understand them correctly. In international business, it is therefore necessary to convert the annual financial statements prepared in accordance with foreign law, the so-called commercial balance 1 (HB1), to the standard of the investor or the parent company (HB2), in order to provide those responsible and financing partners with a reliable basis.

If there is an obligation to consolidate the annual financial statements or group accounting under national law, the commercial balance sheet must be reconciled to the parent company's standard for legal reasons.

Consolidation - Consolidated Financial Statements

According to almost all legal systems, in the case of multi-member companies, the parent company must therefore prepare, in addition to the national individual financial statements, consolidated annual financial statements or consolidated financial statements under commercial law in accordance with the law of the country in which the parent company is domiciled under commercial law.

The circumstances must be presented as if it were a single company. The business transactions between each other are therefore neutralized and receivables and liabilities within the group are offset against each other.

However, under tax law, no summarized annual financial statements have to be prepared. This is because each country taxes the income of the companies based there in isolation, adjusted for the income allocated or exempted under the respective double taxation agreements. Profits in this country are not offset against losses from other countries.

But the result shown in the respective tax balance sheet is not always what is ultimately taxed. The income in the tax balance sheet is adjusted outside the balance sheet if, for example, the transfer prices for deliveries and services with affiliated companies do not correspond to a fictitious arm's length comparison.

Preparation for the statutory audit by the auditor

The annual financial statements may be subject to a separate obligation to be audited by an independent auditor in accordance with national law. While in some countries, such as China, the obligation to audit also applies to small companies, Germany essentially only has the obligation to audit for corporations of certain size classes.

The obligation exists separately for the national individual financial statements in addition to the obligation to audit the consolidated financial statements. This means that the size characteristics for the individual financial statements may not be met and they therefore do not require an audit, while the consolidated financial statements still require an audit. However, if the inclusion of subsidiaries results in the consolidated financial statements being placed in a different size category, then all subordinate companies must also be audited.

A problem arises with group audits in that the auditor is not legally allowed to simply rely on the certificates of foreign auditors. He must personally convince himself of the accuracy of the foreign qualification. This becomes difficult if the local accounting and the local annual financial statements including the audit report are only prepared in Cyrillic, Japanese or Chinese characters.

Accounting software

We have therefore developed software that we use to create accounting in China and Russia according to local law and in local script. At the same time, we present the respective business transaction in accordance with the German Commercial Code (HGB) or in the parent company's standard and therefore in their language. This is referred to as the creation of HB2.

In preparation for the consolidated financial statements, all customers booked abroad are mapped in HB2 to the parent company's chart of accounts. This means that the entire accounting and annual financial statements of the foreign company can be transferred and imported into the parent company's system, e.g. DATEV or SAP. This means that the group auditor also has the opportunity to understand each individual business transaction. In addition, the extended obligations to cooperate in foreign matters required by tax law are fulfilled. Above all, the company's consultants and their decision-makers have a reliable basis for assessing the overall situation as well as the comparability of the national individual financial statements.

Tax balance - deliberately exceeding requirements

All states use commercial profit determination and base the merchants' income tax on the profit determined in the annual financial statements. In order to steer their business behavior in the politically desired direction, corresponding steering laws are integrated into practically all tax laws in the world. Every country and every government has its own ideas about which direction to take. Because of the large number of control measures, the tax balance in all countries has increasingly moved away from the local, commercial balance sheet. Apart from micro-enterprises and some exceptions, it is necessary to prepare a separate tax balance sheet derived from the commercial balance sheet.

In Germany and many other countries, the financial administration has upgraded digitally. The tax balances must be prepared according to specified templates and submitted electronically. No explanations are provided for individual items on the balance sheet or income statement. This makes the work of the tax administration easier, but also protects it from knowledge that it does not want to have, so that it can later go further in the audit. In the classic annual financial statements in paper form you could report on the financial year.

Everything written in the annual financial statements was considered known to the tax office. It didn't matter whether the tax officer read it or not. If, in this way, facts that were assumed to be known were later assessed differently by the tax authorities, they could not rely on supposedly “new facts” and change the decision.

For the safety of our customers, we advise that, in addition to the electronic balance sheet, we also send the tax office a paper version with extensive explanations, which is sometimes interpreted there as imposition.

Commercial law versus tax law

Unlike commercial law, there is no obligation for consolidation or group accounting in tax law. This means that companies rarely have a global view in terms of tax accounting. Instruments and rules are available that, from an international perspective, lead to a fair and optimal overall tax result for the company. It is therefore in the interest of companies to pursue a global tax strategy and tax planning.

Primary goal is one comprehensive tax strategy It should not be just to keep an eye on and reduce taxes in one country, but to achieve global tax security. Across all countries, only what you have earned in total should be taxed.

 

Publicity - the public handling of the annual financial statements

In many countries, the authorities publish the tax returns and annual financial statements of all companies on the Internet. In Germany it's different. Here only the corporations are obliged to file their annual financial statements under commercial law with the Federal Gazette, and only in a very shortened version. This public counter is mainly used by credit agencies, which in turn analyze the financial statements and trade with the data. In addition, people and companies with a credible interest can view the annual financial statements stored there. Therefore, the attitude of disclosing only the minimum amount of information and reducing disclosure to the minimum has become widespread.

Some other companies, but especially all listed companies, banks and insurance companies, see comprehensive reporting as an effective means of public relations and even the recruitment of qualified specialists. Anyone who presents themselves well creates trust, which brings us back to why annual financial statements were invented in the first place.

Jürgen Bächle
Jurgen Bachle

has been working as an independent tax consultant and expert in international tax law since 1989 and has been a member of the board of the German Association of Tax Consultants Baden-Württemberg, DSTVBW, for over 20 years.

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