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Anglo-American Accounting Biases in the Rush towards Convergence: The Case of Germany

Eva Heidhues & Chris Patel

Department of Accounting and Finance

School of Economic and Financial Studies,

Macquarie University, Australia

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Abstract

This paper evaluates the development of accounting in Germany from its early beginning in the 14th

century and shows how a distinct continental European accounting model has evolved. The focus

is on establishing that there are strong Anglo-American biases in describing continental European

accounting models and in particular Germany’s accounting model. This discussion of Anglo-

American biases employs Gray’s (1988) theoretical framework of accounting values. An

examination of Germany’s historical, economic, political, cultural and legal factors establishes how

the conservative and legalistic approaches have dominated German accounting. Historical

developments from the 14th to the 21st century are analysed to highlight relationships between

different periods as well as the significance of international influences. While the first accounting

records of trading houses were mainly written for internal purposes or as evidence against third

parties, the objective of accounting changed with the introduction of the first legal accounting

regulations (Prussian Civil Code of 1794; Preußisches Allgemeines Landrecht and General

German Commercial Code of 1861; Allgemeines Deutsches Handelsgesetzbuch, ADHGB). These

regulations exhibit a progression towards including external requirements to the formerly only

internally orientated accounting approach. The analysis further highlights that the civil and

commercial codes mark the first step towards an ongoing consideration of creditor protection and

are the first stages of the close interrelation between the German state and the accounting

profession. Particular political, economic and social changes during World War I and II are

examined as well as more general influences such as the role of bank financing, taxation,

European Union requirements and the current focus on convergence. Finally, this paper evaluates

not only the approach of conservatism such as creditor protection and legalism in the German

accounting tradition, but also provides insight into some of the current problems facing the

accounting profession. In the light of ongoing convergence and the current introduction of IAS/IFRS

in 2005 for capital market orientated companies in Germany, the paper provides a deeper insight

into the emerging accounting challenges of the 21st century. Applying Gray’s (1988) theoretical

framework of accounting values, we reveal the presence of strong Anglo-American biases.

Importantly, the conflict between the Anglo-American accounting model and the German focus on

legalistic approaches is highlighted as well as the potential problems associated with convergence.

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Introduction Over the last decade, international harmonization and convergence of accounting standards

have greatly influenced accounting practices all over the world. Recently, the convergence

process with the development and adoption of International Financial Reporting Standards

(IFRS) as national standards has become the focus of governments, professionals and

researchers. For example, the European Union and Australia adopted IFRS in 2005 and a

recent survey by Deliotte Touche Tohmatsu (2007) reported that seventy-nine countries have

adopted or intend to adopt IFRS for all their domestic listed companies. The growing number of

countries implementing IFRS, their experiences and emerging challenges have further raised

researchers’ attention (Schneider et al. 1997; Niskanen et al. 2000; Ashbaugh and Pincus 2001;

Stolowy et al. 2001; Camfferman and Cooke 2002; Ashbaugh and Warfield 2003; Kinnunen and

Koskela 2003; Othman and Zeghal 2006; Ding et al. 2007; Haverals 2007; Lopes and

Rodrigues 2007; Tyrrall et al. 2007; Van der Meulen et al. 2007). However, these studies have

concentrated on the development and application of specific accounting standards and

practices and/or cross-national and cross-cultural issues concerning adaptation, implementation

and evaluation of IFRS. Moreover, an increasing number of studies have been devoted to

classifications of accounting models and categorization of accounting standards, principles and

values (Nair and Frank 1980; Gray 1988; Perera and Mathews 1990; Salter and Doupnik 1992;

Doupnik and Salter 1993; D'Arcy 2000, 2001; Patel 2003, 2007; Chanchani and Willett 2004;

Doupnik and Richter 2004; Kamla et al. 2006). However, almost no study has critically

examined the historical development of accounting practices and issues related to convergence

in its socio-economic context, and importantly no study has rigorously examined Anglo-

American biases embedded in this rush towards convergence of accounting standards.

The purpose of this paper is to critically analyse and evaluate the assumptions by International

Accounting Standards Board (IASB) concerning the objectivity of accounting values embedded

in IFRS and the assumed superiority of IFRS’s conceptual principles, which often appears to be

an inherent and indisputable feature of IFRS (International Accounting Standards Committee

Foundation 2005). We argue that the assumed conceptual superiority of IFRS reflects strong

Anglo-American biases and in particular we question the assumption that the Anglo-American

accounting model is superior to other accounting paradigms such as the continental European

accounting model. The paper evaluates historical development of German accounting practices

to show how a distinct continental European accounting model has evolved. The focus is on

establishing that there are strong Anglo-American biases in describing continental European

accounting models. While basing this analysis and discussion on Gray’s (1988) theoretical

framework of accounting values, we will critically evaluate Gray’s (1988) model. As such, we

apply Gray’s (1988) theoretical framework considering its limitations. Indeed, this study follows

the objective to show the subjectivity of Gray’s (1998) model and its biased application.

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The remainder of this paper is organised as follows. The first section introduces Gray’s (1988)

theoretical framework of accounting values and critically evaluates its widespread usage in

accounting research and education. Importantly, Gray’s (1988) framework shows the existence

of biases. A critique of Gray’s (1988) theoretical framework enables us to demonstrate that the

current evaluation of accounting models with respect to differences in accounting values is often

highly subjective. Despite these major criticisms, the perpetuation of Gray’s (1988) framework in

research and education and its role in further driving accounting biases towards the continental

European accounting model led to the application of Gray’s (1988) theoretical framework in our

analysis. In particular, the objective in using Gray’s (1988) theoretical framework relates to its

widespread usage and resulting knowledge of Gray’s (1988) accounting values by accounting

researchers and other interested readers.

The second section evaluates the historical evolution of accounting in Germany with particular

reference to its historical, political, economic, cultural and legal features as well as other

influences such as the role of bank financing, taxation, European Union requirements and the

current focus on convergence. This contextual analysis reveals the rationale of Germany’s

conservative and legalistic accounting practices, which constitute a distinct continental

European accounting model. Importantly, our historical analysis will relate Germany’s

accounting practices to Gray’s (1988) accounting values to reveal distinct features of Germany’s

accounting model.

We use Gray’s (1988) theoretical framework of international accounting values to show

significant differences between Anglo-American and continental European Accounting

approaches and emerging challenges in the convergence process. Implicit judgements, the

existing unequal balance of power, non-consideration of historical development processes and

other contextual factors all clearly show the presence of Anglo-American biases towards the

continental European Accounting model. Such biased evaluations of accounting models often

reinforce the belief in the so-called superiority of Anglo-American accounting perspectives

compared to the continental European accounting model.

The paper concludes with a discussion of the major findings, which confirm the introductory

assumption of Anglo-American biases in the convergence process. The conceptual differences

between accounting models but also the assumption of a subjective superiority of the Anglo-

American approach and IFRS is likely to raise serious problems. Therefore we will evaluate

current issues, but also analyse consequences and emerging challenges related to the ongoing

biased convergence process.

Gray’s theoretical framework: Accounting values & Anglo-American biases The focus of this paper is on establishing that an Anglo-American bias exists towards

continental European accounting models. Both, the evaluation and development of Germany’s

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specific accounting model and in particular the discussion of Anglo-American biases towards

Germany’s accounting model will employ Gray’s (1988) theoretical framework of accounting

values. The application of Gray’s (1988) model in this discussion results from three reasons.

First, the theoretical framework relates to the major differences of national accounting models

and thus provides a useful evaluation tool. Second, we argue that Gray’s (1988) theoretical

framework contains inherent biases, which reinforce the perception that the Anglo-American

accounting model is superior to the continental European Accounting model. Third, Gray’s

(1988) model has been extensively used in accounting research and major textbooks and has

been very influential in the development of international accounting literature since 1988. As

such, a high number of readers will be familiar with the terminology and its categorizations,

which facilitates to a better understanding of the discussion about biases. The next section

provides a brief insight into Gray’s (1988) framework and its major criticisms.

Gray’s theoretical framework of accounting values Based on Hofstede’s four-dimensional cultural framework (Hofstede 1980), Gray (1988) argued

that societal values influence accounting values, which in turn influence accounting systems. In

this sense shared societal values within a country will influence the nature and structure of

national accounting systems. To show this influence of culture on accounting systems, Gray

(1988) developed a theoretical framework of four accounting values:

Professionalism vs. Statutory control: “a preference for the exercise of individual professional

judgement and the maintenance of professional self-regulation as opposed to compliance with

prescriptive legal requirements and statutory control” (Gray, 1988, p.8)

Uniformity vs. Flexibility: “a preference for the enforcement of uniform accounting practices

between companies and the consistent use of such practices over time as opposed to flexibility

consistent with the perceived circumstances of individual companies” (Gray, 1988, p.8)

Conservatism vs. Optimism: “preference for a cautious approach to measurement so as to cope

with the uncertainty of future events as opposed to a more optimistic, laissez-faire, risk-taking

approach” (Gray, 1988, p.8)

Transparency vs. Secrecy: “preference for confidentiality and the restriction of disclosure of

information about the business only to those who are closely involved with its management and

financing as opposed to a more transparent, open and publicly accountable approach” (Gray,

1988, p.8)

Gray (1988) argues that accounting values could be used in categorizing national accounting

models. Specifically, Gray (1988) proposes that there is a relationship between

‘professionalism/uniformity’, the authority of an accounting systems and its enforcement.

Furthermore, he argues that conservatism is the most relevant accounting value influencing

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measurement practices, while secrecy is the most relevant accounting value in influencing

disclosure of information.1

The influence of Gray’s (1988) theoretical framework has grown significantly and his theoretical

framework has dominated international accounting research and accounting education. The

former becomes clear in the significant number of studies that invoke Gray’s (1988) theoretical

framework (Eddie 1990; Meek and Saudagaran 1990; Gray and Vint 1995; Salter and

Niswander 1995; Sudarwan and Fogarty 1996; Zarzeski 1996; Williams and Tower 1998;

MacArthur 1999a; Jaggi and Low 2000; Mathews and Reynolds 2001; Schultz and Lopez 2001;

Chan et al. 2003; Chanchani and Willett 2004; Doupnik and Richter 2004; Askary 2006;

MacArthur 2006; Marrero and Brinker Jr 2007; Hope 2003). While some researchers

acknowledge limitations (Doupnik & Tsakumis, 2004), most researchers have not questioned

the validity and reliability of Gray’s framework.

Furthermore, Gray’s (1988) theoretical framework has been taken for granted and students all

over the world rely on published textbooks which incorporate Gray’s (1988) framework. We find

Gray’s hypothesis and terminology in a number of international accounting textbooks, where it is

often regarded as path breaking and only few mention the lack of confirmation (Choi and

Mueller 1992; Radebaugh and Gray 1993, 1997, 2002; Riahi-Belkaoui 1994; Mathews and

Perera 1996; Roberts et al. 1998, 2002, 2005; Choi et al. 1999, 2002; Gernon and Meek 2001;

Gray et al. 2001). As such, accounting students all over the world are fed a heavy dose of

Gray’s (1988) theoretical framework.

Moreover, Gray’s (1988) accounting values are frequently called upon to show the superiority of

Anglo-American accounting model over other accounting models such as continental European

accounting models. Specifically, the Anglo-American accounting model is described in positive

terms such as ‘professionalism’, ‘optimism’, ‘transparency’ and ‘flexibility’. In contrast, the

continental European accounting model is described using values of ‘statutory control’,

‘conservatism’, ‘secrecy’ and ‘uniformity’. As such, these differences between Anglo-American

and continental European accounting models provide a useful framework to examine biases in

the way these accounting models are portrayed. The next section provides additional criticisms

of Gray’s (1988) theoretical framework.

1 Gray (1988) relates the accounting values back to Hofstede’s (1980) societal dimensions arguing that accounting

value dimensions are derived from societal values. Thus, Gray (1988) hypothesizes a relationship between Hoftstede’s cultural dimensions and accounting values as expressed in his four propositions. The higher a country ranks in terms of individualism and the lower it ranks in terms of uncertainty avoidance and power distance the more likely it is to rank highly in terms of professionalism. The higher a country ranks in terms of uncertainty avoidance and power distance and the lower it ranks in terms of individualism the more likely it is to rank highly in terms of uniformity. The higher a country ranks in terms of uncertainty avoidance and the lower it ranks in terms of individualism and masculinity the more likely it is to rank highly in terms of conservatism. The higher a country ranks in terms of uncertainty avoidance and power distance and the lower it ranks in terms of individualism and masculinity the more likely it is to rank highly in terms of secrecy.

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Criticism of Gray’s model of accounting values Despite the wide acceptance of Gray’s (1988) model of accounting values, researchers appear

to have ignored its major criticisms. Recall that Gray (1988) completely develops his theoretical

framework based on Hofstede’s (1980a) cultural dimensions of ‘individualism’, ‘power distance’,

‘uncertainty avoidance’ and ‘masculinity’. However, Gray (1988) fails to take into account

significant criticisms of Hofstede’s (1980a) framework. Gray (1988) provides a simplistic

explanation regarding the validity of Hofstede’s cultural dimensions by arguing that “if Hofstede

has correctly identified Individualism, Power Distance, Uncertainty Avoidance, and Masculinity

as significant cultural value dimensions then it should be possible to establish their relationship

to accounting values”. This lack of critical analysis significantly limits the validity of Gray’s

framework. For example, Baskerville (2003) argues that ‘Hofstede never studied culture’. The

concept of national culture is highly simplistic and fails to take into account significant within-

country differences and ignores important aspects such as legal, social, political and economic

influences on culture. This shortcoming has been recognized in a growing body of literature

which relates to national diversity (Bhagat 1979; Archer 1989; Alexander and Seidmann 1990;

Smelser 1992; Bock 1999; Harrison and McKinnon 1999; McSweeney 2002; Doupnik and

Tsakumis 2004; Baskerville-Morley 2005). Note that criticisms refer to the validity of Hofstede’s

dimensions in the 21st century (Holden 2002; Patel 2004). Hoftstede collected his data around

mid 1970s and researchers often assume that these outdated data are still applicable in the 21st

century.

Despite the significant number of criticisms, Hofstede’s work has been applied extensively in

international accounting and accountability research (Soeters and Schreuder 1988; Harrison

1992; Sudarwan and Fogarty 1996; Kachelmeier and Shehata 1997; MacArthur 1999b; Chow et

al. 2002; Chan et al. 2003; HassabElnaby and Mosebach 2005; Smith and Hume 2005;

Doupnik and Riccio 2006). Baskerville (2003, p. 11) concludes that “the use of Hofstede's

indices of cultural dimensions appeared to give cross-cultural studies in accounting stature and

scientific legitimacy, and respectability within accounting research”. As such, researchers

applying Hofstede’s (1980a) model should examine and address its intrinsic problems. Gray

(1988) fails to do this. Consequently, Gray’s (1988) theoretical framework is criticized for

excessive simplicity and its focus on excessive uniformity in describing national accounting

values and national accounting systems. Moreover, questions are raised about the validity of

Gray’s (1988) theoretical framework (Doupnik and Tsakumis 2004).

Importantly, we argue that Gray’s (1988) theoretical framework itself is subjective and assumes

the superiority of the Anglo-American accounting model. The accounting values are subjective

and we question Gray’s (1988) advocacy of the superiority of Anglo-American accounting

models and principles. This subjectivity becomes clear when evaluating Gray’s (1988)

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terminology, which contains judgemental connotations.2 For example, ‘Professionalism vs.

Statutory Control’ is defined “as preference for the exercise of individual professional judgement

and the maintenance of professional self-regulation as opposed to compliance with prescriptive

legal requirements and statutory control” (Gray, 1988, p.8). Gray (1988) argues that

professionalism is related to the judgements of accountants as professionals whereas statutory

control refers to the role of accountants, who are primarily concerned with the implementation of

prescriptive and detailed legal requirements. Gray’s (1988) choice of language is open to

criticisms. The terms ‘professionalism’, ‘exercise of professional judgement’ and ‘maintenance

of professional self-regulation’ have positive connotations. In contrast, the terms ‘statutory

control’ and ‘compliance with prescriptive legal requirements’ imply simple bookkeeping-related

tasks and, importantly, imply a lack of professionalism. Gray further implies that accountants

applying the Anglo-American model are well educated professionals and in contrast that

accountants in the continental European accounting are inferior in terms of ‘professionalism’.

Therefore, we argue that Gray’s dimension of ‘professionalism vs. statutory control’ establish

strong biases against continental European accountants and the continental European

accounting model. We also argue that Gray’s (1988) other three accounting values ‘secrecy vs.

transparency’, ‘uniformity vs. flexibility’ and ‘conservatism vs. optimism’ have similar

judgemental biases. Concepts such as ‘transparency’, ‘optimism’ and ‘flexibility’ are used to

describe positive Anglo-American accounting models and in contrast concepts such as

‘secrecy’, ‘conservatism’ and ‘uniformity‘ are applied to continental European accounting

models.

These criticisms are further reinforced because Gray (1988) violates the fundamental principle

of cultural relativity, which advocates that all cultures are equally important and that neutrality

should be applied in its evaluation (Boas 1948; Kottak 2000).3 In this respect, Gray’s

development of four accounting values perhaps reflects his own cultural bias and ethnocentrism

(defined as the tendency to belief that one's own cultural tradition is superior to all others)

(Roberts 1995). Note that anthropology and ethnology literature suggest that a certain degree of

ethnocentricity is often inevitable, but does not limit cultural studies as long as it is adequately

addressed (Bennett 1966; Hammersley 1992; Bennett 1998; Kottak 2000).

Gray’s (1988) model is largely applied in categorizing differences between national accounting

models, and in particular between the Anglo-American and the continental European accounting

2 Connotation is understood in line with the definition of Cohen and Nagel (1934), who define connotation

or intention as the attributes or characteristics that define the object. In the case of the Philosopher Plato such attributes and characteristics would include lover of wisdom, intelligent etc.

3 The principle of cultural relativism goes back to Franz Boas and his research in the beginning of the 20th century. Although he did not name the principle, it became an axiomatic in his research. Boas’ students popularized the cultural relativism, which is until today a key methodological concept accepted and applied in the discipline of anthropology.

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model (Choi et al. 2002; Radebaugh and Gray 2002). These categorizations become more

important in relation to the ongoing debate about convergence of accounting standards by

adopting IFRS as national or regional standards (Flower 1997; Zeff 1998). The following section

will provide an analysis of the development of German accounting practices with particular

reference to the accounting values introduced by Gray’s (1988) framework.

Development of accounting practices in Germany: A contextual analysis The focus of this section is on establishing how the specific German accounting model has

developed from its early beginnings in the 14th century to the current move towards

convergence. This historical evolution of accounting in Germany is evaluated with particular

reference to historical, political, economic, cultural and legal features as well as other influences

such as the role of bank financing, taxation, European Union requirements and the current

focus on convergence. The analysis reveals the rationale of Germany’s conservative and

legalistic accounting practices, which constitute a distinct continental European accounting

model. Importantly, our historical analysis will relate Germany’s accounting practices to Gray’s

(1988) accounting values to reveal distinct features of Germany’s accounting model.

Accounting practices in Germany: Bookkeeping in the 14th, 15th & 16th century We have selected some business records of the 14th, 15th and 16th century to provide insight into

the beginning of German accounting and show the growing sophistication and development of

particular German accounting records, which constitute the early beginning of the distinct

continental European accounting model. Our analysis suggests that creditor protection by

providing evidence against third parties in court as well as the advantageous potential of

recording and controlling transactions were probably the main reasons for the appearance of

these records (Hirsch 1858; Penndorf 1913; Eikenberg 1976).

Some of the existing business records of trading houses of the 14th century reveal the beginning

of accounting in Germany. According to Penndorf4 (1913) the earliest accounting records date

back to the Hanseatic trade in the 14th century5 and show a very elementary form of

bookkeeping and an application of informal techniques to record credit transactions (Mollwo

1901; Penndorf 1913). The oldest rudimentary accounting records of this period were owned by

the wholesale trader Wittenborg and usually contained the name of debtors, a description of the

underlying transactions, the outstanding balance and dates of payment (Penndorf 1913). More

sophisticated accounting techniques were found in the book of Tölner’s trading company. This

4 Penndorf’s (1913) text on the history of accounting in Germany provides an in-depth analysis of early

German accounting records. 5 Hanseatic trade refers to trade of the ‘Hanse’ (Hanseatic league), a merchants’ alliance to safeguard

trade and commercial privileges from the middle of the twelfth to the middle of the seventeenth century. Membership was first open to all merchants trading overseas but was later confined to specific towns. In particular northern German merchants from Saxony and Westphalia were members of this league (Freiherrn von Poelnitz, 1953; Lloyd, 1991).

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encompassed also a complete calculation of revenues, expenses and outstanding debits, which

were needed when a partner left the trading company and demanded his share (Koppmann

1885; Penndorf 1913). Greater sophistication and structure are revealed in the accounting

records of the 15th and 16th century. A trade book of Gdansk provides evidence of accounts for

regular customers, a more structured accounting system with opposing entries and also the

exclusion of private content. Another example are the trade records of Starck, which contain a

clear division into separate columns of the creation of the transaction on the one side and its

payment on the other (Penndorf 1913).

Furthermore, some accounting records from southern Germany clearly reveal the growing

importance of accounting as a mean of control (Penndorf 1913; Weitnauer 1931; Ehrenberg

1963a). This is demonstrated by the books of the Runtinger and Fugger merchant families

(Penndorf 1913; Eikenberg 1976). Importing and exporting from and to far away places such as

Italy, Netherlands, Bohemia, Russia and Poland, Runtinger employed a number of trade

assistants and commission merchants, who had to provide accounting records to the head

office in Regensburg. In this way Runtinger was able to organise and control trade without being

involved in travelling to far away places (Penndorf 1913; Eikenberg 1976). The Fugger, a rich

merchant family, which held at its zenith approximately 10% of total capital in the Holy Roman

Empire of German Nations used a factoring system, which consisted of branches in different

cities each under the control of an assigned factor (Ehrenberg 1963a; Ogger 1978; Denzel

2002). As a result of the underdeveloped communication networks of the time, the factors of

these branches had extensive responsibility and power. Although they engaged in trade

independently, they were required to send periodic reports to the main office, where all

accounts were collected and controlled by the main accountant Matthäus Schwarz (Penndorf

1913; Ehrenberg 1963a).

The accounting records of Fugger also reveal the early establishment of a certain degree of

‘secrecy’, an idea that would come to shape later Germany’s accounting principles. The closure

of all accounts was usually contained in the merchants’ secret book, which had to be clearly

distinguished from other records. This was written by and restricted to the master of the

business and contained details of the profit or loss, commercial terms, interest rates and wages

(Penndorf 1913; Weitnauer 1931). In terms of Gray’s (1988) theoretical framework of

accounting values, this reveals Germany’s early tendency for ‘secrecy’ in contrast to

‘transparency’.

In addition to recording and controlling transactions, records from various towns provide insight

into the function of accounting records as evidence in court proceedings (Leffson 1980).

Gdansk’s town records suggest that their main function was authenticity as evidence in court

(Hirsch 1858). Importantly, the sufficiency of the accounting records such as the records of the

Fugger permitted their usage as evidence against third parties in legal proceedings (Penndorf

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1913; Ehrenberg 1963b). These records highlight the historical importance of early creditor

protection, which would evolve to be one of the main German accounting principles.

The evolution of German accounting law The 17th century marks the beginning of commercial legislation affecting accounting

requirements in a number of countries in Europe and the U.K. Early German commercial law

such as the ‘Preußisches Allgemeines Landrecht’ (ALR - Prussian Civil Code) 6 of 1794 was

greatly influenced by the French Ordonnance de Commerce of 1673 (Renton 1910;

Hattenhauer 1970; Barth 1953; Clark 1998). The ‘ALR’ can be seen as the first step towards

development of strong legal requirements in the German accounting model. In terms of Gray’s

(1988) framework of accounting values, this reveals the beginnings of a tendency of ‘statutory

control’ as opposed to ‘professionalism’.

The ‘ALR’ (Prussian Civil Code) essentially had two accounting functions. First, this required

merchants to organize and record transactions and was intended to reinforce the importance of

orderly bookkeeping to enable control of trading activities. Second, the requirements

emphasized the importance of creditor protection. The legal intention was to ensure that

merchants had proof of their orderly business management, which could be used as evidence in

court. While the ‘ALR’ did not enforce periodic drawing of balance sheets or taking of inventory,

bookkeeping requirements could be deduced from the penal provisions in case of bankruptcy.

Merchants who did not keep orderly records and did not draw a balance sheet could be

prosecuted as negligent bankrupts (ALR §1468), while accounting records that were legally

compliant could be used to prove agreed prices and terms (ALR §§ 573 & 568). As such, the

‘ALR’ is seen by Moxter (1976) as the first step towards legal introduction of creditor protection

(Schmidt-Busemann 1977).

In addition, the early beginnings of ‘conservatism’ as a German accounting value is maybe

revealed in the valuation requirements of the ‘ALR’ (Prussian Civil Code), which exhibited the

first signs of the principle of prudence. The ‘ALR’ did not state any specific regulations except in

case of business partnerships. Value of assets was recorded at historical cost. If the value of

assets had decreased, it was recorded to the lower price. Moreover, machines were recorded at

depreciated value. Finally, receivables had to be recorded with the likelihood of collection, which

meant that debits had to be recorded with a proportional deduction or had to be written off in the

worst case (ALR §§ 644-646).

The enactment of the ‘Allgemeines Deutsches Handelsgesetzbuch’ (ADHGB - General German

commercial code) in 1861 further reveals the influence of the social, political, legal and

6 Other German states tried to enact commercial codifications such as the Kingdom of Würtemberg. However, these endeavours did not enhance the development of commercial law in the German jurisdiction, wherefore a more detailed analysis of these shall be excluded (Schmidt-Busemann, 1977)

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economic environment on accounting law. Importantly, our study shows that the ‘ADHGB’s’

intention to harmonize German accounting law within its territories has some similarities to the

convergence process in the European Union (EU). The need for unification of commercial

legislation accelerated with industrialisation and commercial and political liberalisation. The

growing scale of economic activity7 in the German confederation8 experienced difficulties

because of the complex situation with different civil laws and commercial regulations in

Germany’s autonomous territories (Schmidt-Busemann 1977; Baums 1982; John 1989). As a

result, the German national assembly convened the Nuremberg commission to formulate a

unifying commercial law, which led to the ‘ADHGB’ (General German Commercial Code) in

1861, the first German movement towards unified accounting (Schmidt-Busemann 1977;

Schröer 1993). Importantly, the ‘ADHGB’ was the result of a discussion on best practices, which

may be a less biased approach than the current experiences with the introduction of IFRS.9

The enactment of the ‘ADHGB’ (General German Commercial Code) provides insight on how

the legislators tried to balance the need for protection of creditors and the public while

respecting merchants’ freedom and privacy at the same time (Gareis and Fuchsberger 1891;

Schmidt-Busemann 1977). This challenge was met by requiring the keeping of accounting

records, while giving merchants certain choices about the form and content of these records

(ADHGB §§28 & 29). The legislators’ objective of balancing private and public interests also

becomes clear in the enforcement of the ‘ADHGB’ as merchants were only penalised when they

had failed to keep orderly records (Schmidt-Busemann 1977). This balancing of interests

reveals an important feature of ‘statutory control’, namely the German legislators’ aim to

maintain legitimacy of legal requirements by respecting diverse interests. Despite the indirect

enforcement creditor protection was again a central feature of the ‘ADHGB’ (ADHGB, §§ 28 &

29).

A further analysis of the Nuremberg committee’s discussions provides interesting insights that

reveal the importance of national adaptation of accounting requirements. For example, a debate

arose related to the appropriateness of the French Codes to German States and German law.

7 Although industrialisation began only in the 1840/1850 in Germany, it took then place at accelerated

speed (Wehler 1973, Engelsing 1976). The following examples may exhibit this point. Performance of steam engines rose from 20000 PS to 200,000 PS, while only 178,000 PS were used in France in 1860. In the Ruhr production of coal more than doubled between 1850 and 1860, production of pig iron even increased twelve fold. The number of miners grew from 13,000 in 1850 to 50,000 in 1870

8 The German confederation (1815-1866) and later the North German Confederation (1867-1871) were relatively loose political federation of the single German territorial states, which led on the 18th January of 1871 to the foundation of the second German Reich (Fulbrook 1997).

9 This historical analysis which enables us to revisit and re-evaluate the past could contribute to a better understanding of the ongoing convergence process and provide future implications (Philipps Carsen and K.D. Carsen 1989, Kieser 1994, Griffin 1995, Busse von Colbe, W. 1996, Bedeian, 1998). This requires the appreciation of the past as an eclectic tool which we can use to understand and interpret the current context. It seems, however, that this historical understanding has not received adequate attention in the ongoing development to convergence.

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While the Nuremberg commission appreciated the merit of the French Code de Commerce, it

argued that the French legislation was the result of the mistrustful French system of police and

paternalism. Consequently, the pre-emptive and fearful measures that forced merchants to

keep accounting records would be unsuitable in the more liberal German understanding (Lutz

1858-63; Krieger 1957).

Creditor protection and the importance of secrecy at the end of the 19th century The importance of creditor protection in German accounting is revealed in the German

legislator’s enactment of the third ‘Aktienrechtsnovelle’ (corporation law novella) in 1884. The

early years of the 1870s witnessed strong capital expansion fostered in part by abolishing the

need for government approval in founding stock corporations (Gallhofer and Haslam 1991;

Quick 2005). Moreover, the public supported the increase in company formations as a number

of stock corporations promised significant dividends. However, some companies could only

generate the profits required to pay these dividends by engaging in creative accounting

practices and earnings management techniques, which led to financial collapses of a number of

important corporations. With the amount of investments lost by investors growing to an

extraordinary sum, German legislators were forced to react (Schmidt-Busemann 1977;

Gallhofer and Haslam 1991; Merkt 2001; Eierle 2004). The enacted ‘Aktienrechtsnovelle’

required assets to be valued by applying the principle of the lower of cost and market and to

only show profits when realised (Koch 1957).10 As such, ‘Aktienrechtsnovelle’ clearly revealed

the legislators’ intention to secure creditor protection (Merker et al. 1965). Related to Gray’s

(1988) theoretical framework of accounting values this shows Germany’s preference for

conservatism, defined as ‘a cautious approach to measurement’ (Gray, 1988, p.8), as opposed

to ‘optimism’.

While the 1884 ‘Aktienrechtsnovelle’ (stock corporation novella) was enacted in response to

developments in the corporate and economic environment, it digressed from earlier trends of

accounting requirements, which pursued a tradition of ‘secrecy’. As a result, the

‘Aktienrechtsnovelle’ was amended in 1887 to reinforce confidentiality and ‘secrecy’ (Barth

1953; Gallhofer and Haslam 1991). The tendency of ‘secrecy’ regarding disclosure in the public

realm was further reinforced by the dominant role of banks providers of capital. Banks

dominated stock exchanges, had extensive ownership in companies, were represented on

supervisory boards and later established their own audit firms, giving them access to inside

information and further embedded ‘secrecy’ and ‘conservatism’ in the German accounting

system (van Dien 1929; Quick 2005). This domination of German industries by banks and the

10 An earlier stock corporation law novella was enacted in 1870. The establishment of supervisory boards,

regulations to impede excessive dividend distribution and further disclosure requirements did however not successfully enhance creditor protection Graves, O.F., G.W. Dean, and F.L. Clarke (1989), Schmalenbach’s dynamic accounting and price-level adjustments : an economic consequences explanation New York: Garland Publishing..

12

consequent emphasis on ‘secrecy’ and ‘conservatism’ as accounting values are still major

features of the current German accounting system (Baker and Quick 1998).

The ‘Aktienrechtsnovelle’ (stock corporation novella) and subsequent legislation were positively

supported by all major parties involved, revealing the broadly based acceptance of creditor

protection, ‘conservatism’, ‘secrecy’ and confidentiality as important principles in German

accounting law. Both banks as the main financiers of the time, and the government saw

advantages in the legislation as a mean of restricting excessive capital distribution (Gallhofer

and Haslam 1991). In addition, management supported creation of ‘Stille Reserven’ (quiet

reserves) accounting to ensure a smooth and regular dividend policy (Klausing 1931). The term

‘Stille Reserven’ (quiet reserves) may imply an unethical accounting practice, however, in the

German context ‘Stille Reserven’ had a positive connotation in the language and were rather an

expected practice linked to confidentiality and privacy (Gallhofer and Haslam 1991). ‘Stille

Reserven’ were further encouraged and created by legal rules that specified the application of

the ‘Niederstwertprinzip’ (historic cost principle) and vague depreciation policies that created

‘Stille Reserven’ for depreciation. These legal regulations reveal that accounting law

emphasized underestimation and ‘conservatism’ and thus further embedded these as important

features of the German accounting system (Klausing 1931; Dietzen 1937; Gallhofer and Haslam

1991). This growing orientation towards ‘secrecy’ and ‘conservatism’ was also accepted by the

general public, because of the phenomenal success of the German economy. Furthermore,

public support of state policies was ensured by Germany’s social stability, which was driven by

state policies that were regarded as legitimate and moral such as the establishment of early

welfare programmes (Baehring 1985; Gallhofer and Haslam 1991). Consequently, the

establishment of ‘secrecy’ and ‘conservatism’ as important accounting principles was in

consistence with the expectations of important stakeholders and thus further embedded these in

the German accounting model. In relation to Gray’s (1988) theoretical framework these reveal

the rationales for a preference of ‘secrecy’ and ‘conservatism’ as principle accounting values in

Germany.

The enactment of the German Commercial Code (HGB) The driving forces of the public interest in accounting requirements were the protection of

economic efficiency and functional capability in Germany’s growing economy (Schmidt-

Busemann 1977; Goren and Forrester 1979; John 1989; Gallhofer and Haslam 1991).

Consistent with this intention, in January 1900 the legislators’ enacted the ‘Handelsgesetzbuch’

(HGB - German commercial law) to replace the ‘ADHGB’ (General German Commercial Code).

However, this was not so much a reform of the existing law as it was a necessary classification

and adaptation of requirements necessitated by the enactment of the new ‘Bürgerliches

13

Gesetzbuch’ (BGB - German Civil Code) (Staub 1900; Barth 1953).11 Consequently, the ‘HGB’

adopted the accounting requirements of the earlier ‘ADGHB’ with only minor modifications that

reflected necessary adaptations to ensure compliance with the commercial environment (Hahn

1899).

The main purpose of the ‘HGB’ (German commercial code) remained accountability in the

interest of both the merchant and other stakeholders taking part in the merchant’s financial

business engagement. This strongly embedded the principle of creditor protection in German

accounting requirements (Ballerstedt 1965; Leffson 1976; Moxter 1976; Schmidt-Busemann

1977). The accounting regulations ensured that documentation and recording relevant

information became important features of German accounting requirements (Moxter 1976;

Schmidt-Busemann 1977). This did, however, only involve merchants’ self-information and not

necessarily the right of information by third parties. Third parties only had a right to this

information in the case of bankruptcy (Schmidt-Busemann 1977). This underlines the German

preference for restriction of disclosure, which relates to Gray’s (1988) accounting value of

‘secrecy’ as opposed to ‘transparency’.

Important feature of the ‘HGB’ (German commercial code) was the merchant’s obligation to

keep books consistent with the ‘Grundsätze ordnungsgemäßer Buchführung’ (principles of

orderly accounting) (HGB, §38), which evolved to be the general principle of all requirements

stated in the ‘HGB’ (Barth 1953; Leffson 1976). These ‘Grundsätze ordnungsgemäßer

Buchführung’ were applied to all merchants, revealing a standardization of accounting

regulations and reflecting the legislators’ intention of protecting all stakeholders linked with an

entity’s activities. In this regard the German legislation tends towards Gray’s (1988) accounting

value of ‘uniformity’ as opposed to ‘flexibility’. However, the protection of all stakeholders by the

legislation of the HGB was enhanced by providing supplementary regulations for various

categories of businesses, legal forms, size and macroeconomic significance. Often subsequent

legislation and changes of the ‘HGB’ arose because of necessities due to changes and

developments in the commercial, political, legal and social environment (Barth 1953).12

It is significant that the term ‘Grundsätze ordnungsgemäßer Buchführung’ (principles of orderly

accounting) was not defined, highlighting the implicit flexibility in German accounting law. This

lack of definition has generated debate regarding the applications of accounting rules (Schmidt-

Busemann 1977). In essence, the ‘Grundsätze ordnungsgemäßer Buchführung’ embedded the

importance of judgements, which relied on ethics and moral behaviour in interpreting and

applying German accounting standards (Litthauer 1898; Spannhorst 1973; Leffson 1980). For

11 The HGB was enacted on May, 10 1897 but become effective on the 1st of January 1900. 12 This is consistent with Miller et al’s (1991) argument that history of accounting could be advanced by

“examining the work of historians in the fields other than accounting, and assessing the extent to which they enable new questions to be posed or existing research agendas to be refined or modified.”

14

example with respect to valuation of assets, specific rules were only assigned to stock

corporations in 1884, whereas all other businesses had to apply judgement in consistence with

the ‘Grundsätze ordnungsgemäßer Buchführung’ (Barth 1953; Kruse 1970; Schmidt-Busemann

1977; Eierle 2004). The importance of interpretation and judgement in the application of

German accounting requirements raised the relevance of commentaries and juridical decisions

in applying German accounting law, which became an essential feature of German accounting

requirements (Staub 1900). The enactment of the ‘HGB’ shows strong tendency for legal

accounting requirements, which would suggest a categorization consistent with Gray’s (1988)

accounting value of ‘statutory control’. However, the specific German context has to be taken

into account, which reveals that the simplicity in Gray’s (1988) model is maybe not able to

adequately depict the German context.

Importantly, the ‘HGB’s’ (German commercial code) intentions and its main principles, such as

creditor protection and ‘Grundsätze ordnungsgemäßer Buchführung’ (principles of orderly

accounting) are still valid today as the ‘HGB’, although modified in certain parts, builds the basis

of German accounting law and has to be observed by all merchants (HGB, §238). In relation to

Gray’s (1998) model of accounting values, this further reveals a tendency for ‘statutory control’

instead of exercising ‘professional judgement’. The objective of the next section is to provide an

insight into the importance of taxation and quiet reserves.

The role of taxation and secret reserves One of the major features of the German accounting system is the close relationship between

accounting requirements and taxation requirements. Indeed, taxation requirements have been

responsible for the development of the continental European accounting model (Schneider

1998). The early beginnings of this relation date back to the ‘Aktienrechtsnovelle’ (stock

corporation novella) of 1884 and in particular the ‘Preußisches Einkommenssteuergesetz’

(Prussian income tax law) of 1891. The ‘Preußisches Einkommenssteuergesetz’ established the

‘Maßgeblichkeitsprinzip’ (congruence principle), which was enacted for all nations in the

German Reich with the income tax act of 1920. The ‘Maßgeblichkeitsprinzip’ declared that

calculation of taxable income had to be based on commercial accounting figures, which resulted

in the preparation of one set of financial statements by the majority of entities (Eierle 2004).

Despite some modifications of tax laws the ‘Maßgeblichkeitsprinzip’ was maintained and is still

part of the current income tax regulations (EstG §5(1)) (Eierle 2004). The early development of

the ‘Maßgeblichkeitsprinzip’ was related to the initiative of merchants, who previously had to

prepare separate financial statements for taxation and accounting purposes. Furthermore, the

enactment of the ‘Maßgeblichkeitsprinzip’ was influenced by government’s growing reliance on

revenue from taxation during the First World War (Barth 1953; Pohl 1983; Eierle 2004).

15

The establishment of the ‘Maßgeblichkeitsprinzip’ had a major impact on German accounting

requirements by enhancing the implementation of commercial requirements and implementing a

system of unified accounting requirements. For example, the ‘Grundsätze ordnungsgemäßer

Buchführung’ (principles of orderly accounting) did not require small merchants to engage in

bookkeeping. However, the establishment of ‘Maßgeblichkeitsprinzip’ required all entities to

prepare financial statements for taxation purposes (Barth 1953; Eierle 2004). Furthermore, the

‘Maßgeblichkeitsprinzip’ enhanced the development of uniform commercial accounting

requirements in the ‘HGB’ (German commercial code) as taxation required consistent treatment

of transactions in similar situations. This led to the enactment of general taxation accounting

requirements independent of an entities’ legal form, which were taken as a model for unified

commercial accounting requirements set out in the ‘HGB’. For example, the rise of inflation

during the early 1920s led to a revision and the enactment of the ‘Niederstwertprinzip’ (historic

cost approach) for all businesses subject to taxation. Although legislators had consciously

opposed a general enactment of the ‘Niederstwertprinzip’ in 1897 in the ‘HGB’, they now

required it for all merchants because of taxation law requirements. Consequently, the

codification in taxation laws extended the legal application of the ‘Niederstwertprinzip’ from

stock corporations to all entities (Barth 1953; Kruse 1970; Pohl 1983; Eierle 2004). This

revealed the growing tendency towards ‘uniformity’ in relation to Gray’s (1988) accounting

values. The next section shows how ‘secrecy’ was reinforced in the beginning of the 20th

century.

In particular during the First World War, industries and government reinforced a tendency

towards ‘secrecy’ in the German accounting system. A number of large German companies

engaged in businesses related to war and were able to gain massive profits. However, this was

in sharp contrast to the experience of the German public that endured sacrifices, food shortage,

poverty and resulting consequences of the war (Abelshauser et al. 1985; Bessel 1993;

Gebhardt and Mommsen 2002). Industry and government were aware that disclosure of huge

profits to the public could lead to disapproval of state policies with the potential of raising

enormous tensions. Hiding the enormous profits as ‘Stille Reserven’ (quiet reserves) provided a

simple solution and caused the government to further promote this secretive accounting

practice (Gallhofer and Haslam 1991; Bessel 1993). Entities’ positive attitude towards ‘Stille

Reserven’ was enhanced further by the possibility of reducing tax liabilities and dividend

distributions to shareholders (Hoffmann 1920). ‘Stille Reserven’ could also be used to offset

pressure from shareholders, who expressed higher dividend expectations because of the

suspension of stock markets in wartime (Gallhofer and Haslam 1991).

While the ongoing understatement of profits rose tensions between corporate management and

shareholders, who complained about accounting practices and the quality of disclosure, the

criticism did not focus for long on accounting as its role and significance marginalised in light of

16

an analysis of the wider capitalist society (Gallhofer and Haslam 1991). Importantly, despite the

questionable application of ‘Stille Reserven’ (quiet reserves) during wartime, they were

maintained as a major feature of the German accounting system and were even further

embedded as a traditional custom. ‘Stille Reserven’ accounting was debated again in 1926, but

the appointed commission decided against changing accounting requirements. Moreover, the

commission did not object to the general idea of ‘Stille Reserven’ but questioned the

exaggerated discussion about misuse of ‘Stille Reserven’ (Barth 1953). This clearly reveals the

strong positive perception of ‘Stille Reserven’ accounting and how deeply it was embedded in

the German accounting system. The understatement of profits through ‘Stille Reserven’ also

reveals the importance of ‘conservatism’ in the German accounting system. As such, our

analysis reveals that Gray’s (1988) accounting values of ‘secrecy’ and ‘conservatism’ became

deeply embedded in the Germany accounting model.

Related to the growing importance of ‘conservatism’ were the German inflation experiences,

which had a strong influence on public perception of the objectives of German accounting

requirements. In the early twenties of the 20th century Germany experienced hyperinflation with

devastating economic consequences (Ferguson 1997). This experience strongly influenced the

public perception of monetary values and consequently accounting requirements, which was

further reinforced by the inflationary situation after the Second World War. Indeed, inflation and

its consequences are still a major concern to the German public which still fears it more than

most other economic disadvantages (Schildbach 1990; Busse von Colbe 1996). This fear of

inflation and consequent losses has driven an understanding that accounting should prevent the

so-called “inflation bacillus” entering the economy. Thus, since the currency reform of 1948

German commercial law has specified its accounting rules in conformance with the

‘Niederstwertprinzip’ (historic cost approach) (Busse von Colbe 1996), which emphasizes the

conservative tendency in the German accounting system. As such, Gray’s (1988) accounting

value of ‘conservatism’, defined as “a cautious approach to measurement” (Gray, 1988, p.8) is

an important feature of the German accounting model.

Development of stock corporation law until the stock corporation act of 1937 The enactment of the ‘Aktienrechts(not)verordnung’ 1931 (stock corporation emergency decree)

and the ‘Aktiengesetz’ (stock corporation law) of 1931 were the result of two different influences,

namely the major economic crisis in Germany during the late 1920s and early 1930s and a

growing international influence on German accounting law. As a consequence, these

enactments departed slightly from the earlier German tradition on ‘secrecy’, but still embedded

creditor protection as the main principle of German accounting requirements.

When the economic crisis reached a height with major financial collapses the

‘Aktienrechts(not)verordnung (stock corporation emergency decree) was enacted as an

17

emergency decree because of the serious economic conditions in 1931 (Leffson 1976; Eierle

2005). As a consequence, the enactment included extensive modifications with regard to

financial accounting and reporting (Barth 1953; Eierle 2004). Accounting regulations concerning

the valuation and recognition of assets and liabilities in annual financial statements were

specified but still followed the traditional principle of creditor protection. For example, the

legislation enforced the strict ‘Niederstwertprinzip’ (principle of the lower of cost and market) for

current assets and prohibited the recognition of start-up costs as assets (Eierle 2004).

The growing interest in international equity and the perception that not only shareholders but

also the general public would have a legitimate interest in accounting information led to

modifications in the content of financial reports and auditing requirements (Barth 1953; Eierle

2004). With the objective of attracting of foreign investors and equity financing, the German

legislators gave consideration to the adoption of Anglo-American principles and perspectives

(Markus 1997; Walker 2000; Eierle 2005). As such, annual reports had to include explanatory

comments, display major variations from earlier periods and introduce certain sub-

categorizations in the balance sheet and profit and loss statement (Eierle 2004). In the case of

the balance sheet one major function of the new requirements was to ensure a clear

presentation of an entities’ liquidity (Barth 1953). Furthermore, the ‘Aktienrechts(not)verordnung’

of 1931 (stock corporation emergency decree) codified explicit auditing requirements for stock

corporations and associations limited by shares. As such, the legislator reacted to pressure

from foreign investors that frequently requested reports by independent auditors. Moreover,

spectacular bankruptcies and business failures had resulted in a questioning of the supervisory

boards to effectively monitor balance sheets (Barth 1953; Eierle 2004). Audit requirements were

further enhanced by the ‘Aktiengesetz’ of 1937 (stock corporation law) which effectively

introduced compulsory audits by enacting that former annual reports without external audit were

void by law (Barth 1953; Doupnik and Perera 2007). Importantly, these changes clearly depart

from the earlier focus on ‘secrecy’ in the German accounting tradition and reveal the early

beginnings of an adjustment process to implement international investors’ requirements.

Despite some criticism the ‘Aktiengesetz’ of 1937 (stock corporation law) maintained the

prevailing valuation rules (Eierle 2004). While a change from the ‘Niederstwertprinzip’ (historic

cost approach) to the market value was encouraged, the legislators decided against it. The

preference for the existing law was related to the desire of a consistent and solid development

of the German economy and it was felt that this would not be achieved by having asset

valuations change on a daily basis (Barth 1953). Importantly, this decision reveals the relation

between national interest and ‘conservatism’ as an accounting requirement and an accounting

value, which is of major importance in German accounting law.

The enactment of the ‘Gesetz über die Prüfung von Jahresabschlüssen’ (audit of annual reports

law) in 1937 reveals the perpetuation of the importance of ‘secrecy’ in German accounting

18

requirements. The minister of justice was authorised to extend the scope of the requirement for

compulsory audits of annual reports to ‘Gesellschaften mit beschränkter Haftung’ (GmbH -

limited liability companies). However, the compulsory audit requirements were only extended to

credit institutions (Eierle 2004). This is of particular importance as the minister’s decision meant

that the majority of German businesses did not have to audit their annual accounts.

State planning system in the 1930s In the 1930s until 1945 Germany experienced a phase of standardized accountancy as a result

of state economic planning under the Nazi regime. The legislator introduced one official

industrial chart of accounts that was compulsory for all industrial enterprises. The chart was

based on a systematic order developed by Schmalenbach (1927). Although the introduction of

this system to the German industry was an instrument of German state economic planning, it

was embraced by other nations as well. In particular France and Spain were inspired by the

Schmalenbach system and introduced similar regulations (Busse von Colbe 1996; Küpper and

Mattessich 2005). Importantly, this introduction of similar regulations by France and Spain

provides some evidence of similarities in the accounting practices of continental European

countries. In relation to Gray (1988), this further embedded the accounting value of ‘uniformity’

in the German accounting model.

Aktienrechtsreform (Stock corporations act) of 1965 An important milestone in the history of German stock corporation law was the

‘Aktienrechtsreform’ of 1965. This enactment reveals insights into the adaptive nature of

German accounting requirements, while still being consistent with a strong focus on creditor

protection (Leffson 1987).

One aspect of the ‘Aktienrechtsreform’ (stock corporations act) concerned ‘Stille Reserven’

(quiet reserves), which had been debated over the previous decades. In general, the legislator

still followed a conservative approach with the ‘Niederstwertprinzip’ (historic cost approach),

strict Niederstwertprinzip (principle of the lower of cost and market) and ‘Realisationsprinzip’

(realisation principle) to ensure creditor protection and capital maintenance. Nevertheless, the

legislator tried to restrict conscious overvaluation of liabilities and undervaluation of assets,

which were often used to conceal profits and subsequently capital distribution to shareholders

(AktG, Art.133-155). Importantly, the practice of creating ‘Stille Reserven’ (quiet reserves) was

not questioned in general. In fact the legislator argued again that ‘Stille Reserven’ established

under accounting law were an appropriate element of reasonable commercial risk anticipation

(Eierle 2004, 2005). This clearly underlines the importance of ‘conservatism’ in German

accounting law and suggest a classification consistent with Gray’s (1988) accounting values of

‘secrecy’ and ‘conservatism’, which he defines as “a preference for a cautious approach of to

measurement so as to cope with the uncertainty of future events” (Gray, 1988, p.8).

19

While ‘secrecy’ was an important German accounting value, creditor protection and the interest

of the general public in accounting information restricted the tendency of Gray’s (1988)

accounting value ‘secrecy’ in German accounting law with the enactment of the

‘Publizitätsgesetz’ (disclosure law) of 1969. Already in 1930 the legislators had argued in that

the general public had a legitimate interest in information about stock corporations’ financial

results (Eierle 2004). This debate was reinforced by a number of large corporate collapses such

as of the Krupp group in 1966. Suppliers, customers, and employees were not aware of the

company’s risky situation as the publication of financial reports was not yet required (Busse von

Colbe 1996). The ‘Publizitätsgesetz’ changed this by requiring large unincorporated groups and

firms13 to disclose their financial reports and draw up consolidated statements independent of

their legal form (Busse von Colbe 1996; Eierle 2004).

European integration and harmonization European accounting harmonization (defined as reducing differences in accounting standards

over time) and convergence (defined as the adoption of IFRS by the IASB as national

standards) have became major issues since the mid 1970s and remain controversial. The

creation of the European Economic Community (EEC) in 1957 followed the objective to

establish a common market without obstacles to free movement of capital, labour, goods and

services (European Community 1957; Willis 1978). The objective of accounting harmonization

was achieved by enacting a number of European directives. Importantly, these harmonization

efforts reflected a compromise between Anglo-Saxon and continental European accounting

traditions (Neihus 1972; Nobes 1980; Eierle 2004). While the fourth and seventh European

directives laid the foundation for harmonization of accounting regulations within the EEC, the

fundamental differences between Anglo-Saxon accounting model and continental European

accounting created difficulties as they seemed to be insurmountable. Harmonization in the EEC

was achieved mainly through political compromise, which however harmed its main objective,

namely comparability of accounting information (Eierle 2004).

In Germany the implementation of the European directives was attained by the enactment of the

‘Bilanzrichtliniengesetz’ (accounting directives act) of 1985, which the German legislators used

as an opportunity for reforming the ‘HGB’ (German commercial code) (Eierle 2004; Eierle 2005).

This reform restructured the ‘HGB’ to its current form, which requires uniform accounting

standards for all entities (HGB, §§238-264). As a result of adopting the fourth and seventh

European directives, the revised ‘HGB’ imposed additional accounting standards for stock

corporations, associations limited by shares and limited liability companies (Haller, 2003; Eierle,

2005). Importantly, the ‘HGB’ still contains the ‘Grundsätze ordnungsgemäßer Buchführung’

13 The categorization of large groups and firms focused on three key figures: Employees exceeding 5,000; balance sheet total exceeding DM 125 million; sales exceeding DM 250 million. A group or firm was considered large when it fulfilled at least two criteria on three subsequent balance sheet dates (PublG, 1969, § 1).

20

(principles of orderly accounting) as a general principle applicable to all entities. The

Grundsätze ordnungsgemäßer Buchführung are strongly related to creditor protection and

subsequently the principle of prudence. These are revealed in the ‘Realisationsprinzip’

(realisation principle) (which requires that profits have to be realised at recording date to be

included in financial statements; HGB, §252, para.4, no.1), the ‘Imparitätsprinzip’ (recognition of

loss principle) (which requires recognition of anticipated losses but only realised profits; HGB,

§252, para.4, no.1) and also the ‘Niederstwertprinzip’ (historic cost principle) (which requires

that asset values are recorded at historic cost less depreciation; HGB, §253, para.1). Moreover,

the value of current assets has to be recorded at the lower of depreciated historic cost and

market value, which is known as the strict ‘Niederstwertprinzip’ (principle of the lower of cost

and market) (HGB, §253, para.2). This reveals that Germany’s accounting model strongly

relates to Gray’s (1988) accounting value of ‘conservatism’.

The fourth European directive referred only to companies limited by shares, however, the

‘Bilanzrichtlinienreform’ (accounting directives act) was used to impose the measurement and

recognition principles to all enterprises independent of their legal form. The rationale was

Germany’s intention to retain the close relationship between financial reporting and income

taxation as established by the ‘Maßgeblichkeitsprinzip’ (congruence principle). As such,

Germany followed a conservative approach in implementing European directives with the

objective of only fulfilling minimum requirements (Eierle 2004, 2005). Germany’s intention to

preserve the status quo is also reflected in the implementation of the ‘true and fair view’

principle, which was only enacted for stock corporations and not for all entities. Importantly, the

legislators did not implement the ‘true and fair view’ principle as an overriding principle, but

under the consideration of the ‘Grundsätze ordnungsmäßiger Buchführung’ (principles of orderly

accounting). Consequently, stock corporations still have to interpret accounting regulations in

accordance with the ‘Grundsätze ordnungsmäßiger Buchführung’, which supports the

application of the creditor protection and the principle of prudence (Eierle 2004).

The enactment of the ‘Bilanzrichtlinienreform’ (accounting directives act) reveals the importance

of maintaining ‘secrecy’ as a specific German accounting value for SMEs. The

‘Bilanzrichtlinienreform’ introduced major changes to ‘GmbHs’ (limited liability companies)

because of requirements regarding financial reports, consolidated reports and auditing.

However, SMEs that often rely on the legal form ‘GmbH’ and are still regarded as the

‘backbone’ of the German economy (Kayser and Wallau 2006; Bundesministerium für

Wirtschaft und Technologie 2007) were relieved of these requirements by extensive exceptions

based on size (Beisse 2001).

Recall that adoption of national accounting laws with the European directives was only achieved

with difficulty. Indeed controversies arose about the adequacy of European directives as a basis

for harmonization of standards and principles, especially as some member nations expressed a

21

preference for a wider consideration of international endeavours. As a result, the European

Commission decided in 1990 to follow the invitation of the International Accounting Standards

Committee (IASC), to become a member of its consultative group, and acquire observer status

on the board. Note that in the early 1990s the IASC advocated that international accounting

standards would apply to multinational companies aiming for listing on stock exchanges. The

European Commission was aware that attainment of this goal would significantly improve

access to international equity markets (Haller 2002; Weißenberger et al. 2004). The next

section discusses issues leading to convergence of accounting standards in the European

Union and Germany in particular.

Internationalisation and the move towards convergence with the introduction of IFRS Internationalisation of German firms with growing trade links and capital needs had a major

influence on German accounting practices and German accounting. The debate about

international accounting practices was fuelled by the increased capital needs of German

companies, who pushed towards international capital markets that require relevant, reliable and

comparable accounting information (Kurylko 1994; Liener 1995). With the case of the former

Daimler Benz AG, the discussion about improving access to international equity markets

became a political issue in Germany (Europäische Kommission 1995). Daimler-Benz’s listing on

the New York Stock Exchange in 1993 required the preparation of financial reports consistent

with U.S. GAAP, which turned a profit of 625 Mio DM disclosed in accordance with German

standards into a loss of 1,839 Mio DM under U.S. GAAP (Liener 1995, von Keitz, 2005) This

huge disparity harmed the credibility of German accounting principles in the international

community and increased industry pressure on the German legislator (Böcking 2001; Kirsch

and Scheele 2004; Pellens et al. 2004). As a result, the ‘Kapitalaufnahmeerleichterungsgesetz’

(alleviation law regarding raising of capital) was enacted in 1988 to improve the competitiveness

of German companies (Deutscher Bundestag 1998; Delvaille et al. 2005). This allowed groups

headed by companies with listed shares (such as stock corporations) to prepare consolidated

statements according to internationally accepted accounting standards, namely IAS or U.S.

GAAP (Eierle 2005).

The application of the ‘Kapitalaufnahmeerleichterungsgesetz’ (alleviation law regarding raising

of capital) was confined to consolidated reports as individual entity reports had to be consistent

with German accounting principles because of their purpose to determine dividend and taxation

payments (Deutscher Bundestag 1998). However, the option to prepare consolidated reports in

conformity with U.S. GAAP or IAS introduced Anglo-American principles into German

accounting. These principles differ significantly from Germany’s accounting model that focuses

on creditor protection and the principle of prudence. Indeed, the Anglo-American standards

focus on providing shareholder information with the ‘substance over form’ approach that

requires extensive use of professional judgements (Leuz 2000; Busse von Colbe et al. 2003;

22

Fischer et al. 2004). In relation to Gray’s (1988) theoretical framework, this reveals opposing

preferences for accounting values. While Germany shows a tendency for ‘statutory control’ and

‘conservatism’, the Anglo-American approach is described by ‘professionalism’ and ‘optimism’.

International standards and influences had a growing influence on German accounting practices

as reflected in the ‘Gesetz zur Kontrolle und Transparenz im Unternehmensbereich’ (KonTraG -

Governance Act) of 1998. This adapted German accounting law to international standards in

two areas. First, the improvement of financial reporting and governance was ensured by

requiring an inclusion of cash flow statements and segment reports in consolidated reports of

parent companies with listed shares (KonTraG, §297 HGB) (Deutsches Rechnungslegungs

Standards Committee 2007). Second, provision was made for the formation of a private sector

standard setting body who could, inter alia represent Germany in international standard setting

bodies (KonTraG, §342 HGB). The German Accounting Standards Committee, the German

standardization committee, was founded shortly after the decree (Eierle 2005). The objective

was to ensure flexibility and timely adaptation of international accepted accounting principles

that followed an Anglo-American orientation (Council Directive 1990).

Noteworthy is also the ‘Kapitalgesellschaften und Co.-Richtliniengesetz’ (KapCoRiLiG -

Qualifying partnerships act) of 2000 (Deutscher Bundestag 2000). This extended the option to

prepare consolidated financial reports consistent with either U.S. GAAP or IAS to all entities

(KapCoRiLiG, HGB §292a) (Brinkmann 2006) and applied the stock corporations’ accounting

regulations to qualifying partnerships as required by European Council directive of 1990

effective from January 1993 (Bömelburg 1999; Ernst 2000; Eierle 2005). The apparent time lag

between European requirement and national enforcement in Germany reveals the legislators’

intention to protect the principle of ‘secrecy’ that has been of major importance since the

beginning of bookkeeping in Germany. In Germany qualifying partnerships are a common legal

form of SMEs, which the German legislators did not want to burden with additional

requirements. Specifically, the directive’s disclosure and filing requirements were seen as an

invasion of privacy which would conflict with the German idea of a merchant’s freedom and

privacy. The perceived conflict has created problems since the enactment of the

‘Bilanzrichtliniengesetz’ (accounting directives act) of 1985, which gave rise to a situation where

a number of companies refused to file their accounts with the commercial register, believing that

their privacy would be extensively harmed if they did (Bömelburg 1999; Ernst 2000; Fischer et

al. 2004).

A focal step towards international convergence was the immediately effective so-called

European IAS regulation, which required capital-market orientated companies to prepare

consolidated financial reports consistent with IAS/IFRS (European Parliament and Council

2002). This obligation became effective for reports of financial years beginning on or after the 1st

of January 2005. The EU provision included an option for member countries to postpone the

23

enactment to the 1st of January 2007 for entities providing only debt instruments. The objectives

of this European regulation were to improve the efficient and cost-effective functioning of capital

markets and also enhance the protection of investors and maintenance of confidence in the

financial markets. In addition, member states were free to opt for a wider implementation

allowing or requiring both capital market orientated and non-capital market orientated

companies to prepare individual financial statements consistent with IAS/IFRS (Brinkmann

2006).

In relation to the implementation of international accounting standards by the European IAS

regulation, Germany enacted the ‘Bilanzkontrollgesetz’ (Financial Reporting Control Act)

(Deutscher Bundestag 2004b) and the ‘Bilanzrechtsformgesetz’ (Accounting Law Reform Act) in

2004 (Deutscher Bundestag 2004a). These increased the differentiation between publicly

traded and non-publicly traded entities and between individual and consolidated reports The

German legislators allowed entities providing debt instruments to postpone the changeover for

two years, while non-capital market orientated companies were allowed to prepare their

consolidated financial statements in conformity with IAS/IFRS (Brinkmann 2006). However,

individual financial statements still need to be consistent with the German accounting principles

of the ‘HGB’ (German commercial code) because of their role in the calculation of dividend

payments and income tax (Herzig 2000; Kahle 2002; Eierle 2005). In contrast to the UK, the

German legislator refused to accept statements consistent with IAS/IFRS for calculating taxable

profits as this would transfer its legislative tax authority to a private standard setting body (Eierle

2005; Herzig 2005; Brinkmann 2006). On the other side, adjustments of national law to

internationally accepted accounting principles have reduced differences between consolidated

reports consistent with ‘HGB’ (German commercial code) and consolidated reports prepared

according to IAS/IFRS. For example, more comprehensive disclosure notes and the inclusion of

cash flow statements and statement of changes in equity in the set of consolidated financial

statements highlight the adaptation of the ‘HGB’ to IFRS (HGB, §297). Furthermore, this

reveals the differences in accounting values as categorized by Gray (1988). The next section

will provide a critical discussion of the application of IFRS in the German context and

importantly show Anglo-American biases towards the German accounting model.

Anglo-American biases towards the continental European accounting model The focus of this section is on establishing that an Anglo-American bias exists towards the

German accounting model. Recall that we will employ Gray’s (1988) model of accounting values

as a framework of this discussion. Gray’s (1988) model is largely applied in categorizing

differences between national accounting models, and in particular between the Anglo-American

and the continental European accounting model. These categorizations become more important

in relation to the ongoing debate about convergence of accounting standards by adopting IFRS

as national or regional standards (Flower 1997; Zeff 1998). Specifically, IFRS reflect the

24

principles applied in the Anglo-American accounting model (Haller and Walton 2003). Recall

that our criticisms of Gray’s (1988) framework have already demonstrated that Gray’s

framework implicitly favours this approach. In addition, we will use Gray’s (1988) accounting

values to analyse Anglo-American biases against the German accounting model as a specific

continental European accounting model. Importantly, we question the assumption of IFRS as

world’s best practice.

Professionalism vs. statutory control Gray’s accounting values suggest that IFRS reflect ‘professionalism’ and the continental

European accounting model is largely based on ‘statutory control’. IFRS as world’s best practice

implies that ‘a preference for the exercise of individual professional judgement and the

maintenance of professional self-regulation’ (Gray 1988) is superior and in contrast continental

European model is inferior, because it requires ‘compliance with prescriptive legal requirements

and statutory control’ (Gray 1988; von Keitz 2005). Our evaluation of Germany’s historical

development of accounting shows that Germany’s accounting model is largely based on

‘statutory control’ with extensive legislation in the ‘HGB’ (German commercial code) (Choi et al.

2002; Doupnik and Perera 2007). The accounting requirements of the ‘HGB’ include options

regarding, for example specific recognition of acquisition and production costs (§255, Para 2)

and recognition and valuation of assets (§240, Para 3) and as such require professional

judgement. However, the ‘HGB’ requires judgements to a significantly lesser degree and does

not require the ‘substance over form’ approach. As such the application of IFRS is likely to

create problems for German accountants, who are trained in extant German accounting

requirements. Professional judgement comes with experience and as such the learning curve

may be steep. Professionals and accounting educators may not appreciate the choices and

judgements required by IFRS and may have difficulty in understanding their complexity (Haller

2002b; Larson and Street 2004; Baetge 2005; Jermakowicz and Gornik-Tomaszewski 2006).

For example, a study of consolidated reports of 100 German companies between 2001 and

2003 revealed that a number of regulations have been inconsistently applied (von Keitz 2005).

Although this may be partly because of explicit options stated in the IFRS, others are related to

the wide discretionary authority of accountants (Küting et al. 2001, von Keitz 2005). This harms

the comparability of financial reports, which is one of the major objectives of IFRS (Lüdenbach

and Hoffman 2004).

Consistent with the IFRS framework, IFRS are assumed to be superior in presenting a “true and

fair view” (IASB, 2007, F45) that provides “useful decision-making information for a wide range

of users” (IASB, 2007, F12) because of principles such as the “accrual principle” (IASB, 2007, F

22), the related “realization principle” (IASB, 2007, F 83; F 92) and the importance of applying

the “substance over form approach” (IASB, 2007, F 35). The presentation of a ‘true and fair

view’ is related to a number of discretionary decisions regarding profit recognition and

25

valuations of assets and liabilities. For example, IAS 11 (construction contracts) and IAS 39

(Financial instruments) allow the recognition of unrealised profits (Küting 2004). Furthermore,

IFRS applies uncertainty expressions such as ‘probable’ (IAS 37 - provisions) and ‘measured

reliably’ (IAS 38.21(b)). Consequently, accountants have wide discretionary authority in the

application of IFRS standards (Wagenhofer 2003; Lüdenbach and Hoffman 2004; Brinkmann

2006). This discretionary authority is reinforced by some imprecise and unspecified

terminologies as ‘identifiability’ and ‘control’ (Baetge 2005; DGRV 2005). Besides possibilities

for earnings management questions have been raised regarding reliability of financial reports,

which may be reinforced by cross-cultural differences in interpretation of uncertainty

expressions (Menn 2002; Moxter 2002; Doupnik and Richter 2004; Brinkmann 2006;

Jermakowicz and Gornik-Tomaszewski 2006). However, the IFRS framework identifies reliability

as a precondition of providing useful decision-making information (IASB, 2007, F31).

Consequently, the objective of IFRS to provide decision-relevant information to investors may

be restricted (Herzig 2005). The Anglo-American accounting system with extensive reliance on

professional judgement and significant discretionary decisions often fails the test of reliability. In

contrast, our historical analysis showed that Germany’s accounting system contains less

unspecified terminology and uncertainty expressions and therefore there is a greater focus on

reliability. Moreover, it is important that German accountants are required to exercise their

professional judgement in accordance with the ‘Grundsätze ordnungsmäßiger Buchführung’

(principles of orderly accounting) and the principle of prudence and subsequently also with the

‘Niederstwertprinzip’ (historical cost approach), ‘Realisationsprinzip’ (realization principle) and

‘Imparitätsprinzip’ (recognition of loss principle). German financial reports are thus less

influenced by discretionary decisions and therefore result in higher reliability. We therefore

argue that the Anglo-American accounting model is not superior to the continental European

Accounting model in terms of reliability.

The convergence process with the biased understanding of IFRS as a best practice approach

(IASB, 2006) is based on professional regulation by the IASB in contrast to other forms of

regulation, which rely on greater government control. However, strong controversies exist about

the legitimacy and international representativeness of the IASB. A number of German

accounting researchers argue that accounting requires legitimised legal regulation because of

the significant importance of accounting information to national economies and the general

public. Thus, serious concerns arise about the legitimacy of the IASB, which is a private

standard setting authority (Budde 1998; Hommelhoff and Schwab 1998; Beisse 1999; Kirchhof

2000; Schmidt 2002). These concerns reflect the tradition of continental European countries

that are typically regulated by code law, which also applies to financial regulating (Ballwieser

2001). Legitimacy of IASB decisions could be questioned because final decisions rest only in

the hands of the board without further democratic control. Moreover, the European parliament

26

(2007) has raised concerns regarding legitimacy because of a lack of transparency regarding

the board’s mandate and working plans (DGRV 2005; Europäisches Parlament 2007).

Moreover, representativeness and objectivity of the IASB remain a controversial issue. Major

concern is the structure of the IASB, whose board members are selected by the trustees of the

International Accounting Standards Committee Foundation (IASCF). Consistent with IASCF

constitution, the board members are chosen in relation to their professional competence and

practical experience (IASCF constitution, 19). Consequently, the majority of ISAB members are

accounting professionals. The IASCF constitution requires integrity and objectivity as qualifying

criteria for membership in the IASB. However, controversies exist regarding their objectivity.

Moreover, objectivity and independence is questioned because of a dominance of members

with an Anglo-American background (Baetge 2005; Europäisches Parlament 2007). Serious

concerns have also been raised regarding the role of a biased standard setting process

(Schmidt, 2002). Although biased decisions because of the influence of significant interest

groups are not restricted to private standard setting bodies, the European parliament has raised

concerns regarding the influence of interest groups on development of accounting standards

and the lack of accountability in private standard setting processes (Europäisches Parlament,

2007). In contrast, our historical analysis of Germany shows that there is greater neutrality and

greater accountability in development of accounting standards because of the legislators’

objective to take into account and balance diverse interests and also because of the importance

of ‘statutory control’ in Germany’s context. We therefore argue that this excessive reliance on

professional self-regulation and excessive politics in the standard setting process may not be

superior to other forms of regulation. We further argue that the Anglo-American dominance of

the IASB and its questionable objectivity and independence may result in Anglo-American

biases in the standard setting process.

Optimism vs. conservatism Our analysis shows that accounting in Germany reflects a cautious approach to measurement

and creditor protection. This is opposed to the more ‘optimistic’, ‘laissez-faire’, ‘risk-taking’

Anglo-American approach, which has been advocated as a best practice. We argue that this

shows Anglo-American bias, which fails to take into account Germany’s accounting tradition that

focuses on institutionalised creditor protection. While the IASB claims to provide useful

decision-making information for a wide range of users (IASB, 2007, F12), it is important to note

that IFRS are largely equity investor-orientated and fail to provide information for other users of

financial reports (IASB, 2007, F10). The informational interest of lenders and suppliers and

trade creditors may deviate significantly from the informational interest of investors.

Consequently, the application of IFRS neglects the heterogeneous information interest of users

of financial report (Brinkmann 2006). Furthermore, the IASB claims to protect creditor interest by

providing useful information, while Germany’s accounting model focuses on institutionalised

27

creditor protection (Kahle 2003; Pfitzer and Kahre 2004). Consequently, the superiority of the

more ‘optimistic, laissez-faire, risk-taking’ Anglo-American approach is with regard to creditor

protection restricted and thus reveals an Anglo-American bias against the German accounting

model.

A related challenge relates to determination of dividend distribution. In Germany, dividend

distributions are based on individual financial statements that have to be prepared according to

the ‘HGB’ (German commercial code). However, Brinkmann (2006) argues that consolidated

statements influence the determination of dividend distribution. The ‘HGB’ requires

determination of profits in consistency with the principle of prudence, ‘Realisationsprinzip’

(realisation principle) and Imparitätsprinzip (recognition of loss principle). However, these are

restricted by application of IFRS standards. For example, recognition of provisions (IAS 37.14;

IAS37.15) opposes the principle of prudence because of the application of uncertainty

expression. IAS 37.16 states “where it is more likely than not that a present obligation exists at

the balance sheet date, the enterprise recognises a provision.” The probability expression ‘more

likely than not’ is regularly interpret as a probability of more than 50% (Pellens, 2004;

Brinkmann, 2006). Thus, there is a high probability that expected obligations will not be

recognised. Moreover, while the objective of capital maintenance requires prudent

determination of dividend distribution, the standards should also restrict excessive reduction of

profit distribution. This requires clear and distinct regulations that restrict subjective

discretionary authority for asset and liability recognition and valuation. Recall that IFRS are

restricted in fulfilling this objective and thus may disqualify financial statements fro determining

profits available for distribution (von Keitz 2005, Brinkmann 2006). With regard to the influence

of consolidated statements on the dividend determination, Brinkmann (2006) argues that the

preparation of consolidated financial statements consistent with IFRS is controversial in terms of

German accounting principles. We thus argue that Anglo-American biases exist as accounting

requirements may not be superior in regard to fulfilling the requirements of the specific German

accounting environment.

Our second concern arises when considering an extended application of IFRS for individual

financial reports in Germany. The application of the more ‘optimistic, laissez-faire, risk-taking’

Anglo-American approach would oppose Germany’s longstanding accounting principles of

creditor protection and prudence. These German principles developed because of Germany’s

specific legal, economic, social and political environment and thus reflect the needs and

interests of German stakeholders, namely business entities, government, creditors and the

general public. Internationalisation and resulting market pressures have changed the economic

environment over the last decade and have resulted in changes to German accounting

legislations with the introduction of IFRS for consolidated reports (Haller and Eierle 2004).

However, a full implementation of IFRS would raise serious issues because of their inadequacy

28

to adapt to the needs of all German stakeholders. This has generated rigorous debate in

Germany regarding the appropriateness of IFRS for small and medium sized entities (SMEs)

(Hüttche 2002; Deutscher Industrie- und Handelskammertag and PricewaterhouseCoopers

2005; Buchholz 2006; Schürmann 2006; Grass 2007). Specifically, a significant number of

German SMEs have criticised the ‘optimistic, laissez-faire, risk-taking’ elements in the Anglo-

American approach that often results in the recognition of unrealised profits. This may become

a serious problem if creditors and owners demand increased profit distributions based on these

inflated profit figures (Arbeitskreis Bilanzrecht der Hochschullehrer Rechtswissenschaft 2002;

Schürmann 2006). This discussion clearly shows that there is no one superior accounting

model. Importantly, accounting as the official language of the business is deeply embedded in a

national, legal, social, political and economic environment and we further argue that historical

development of accounting in a country cannot be ignored.

Transparency vs. secrecy Our analysis indicates that Germany has a strong preference for confidentiality, ‘secrecy’ and

the restriction of financial disclosure to those that are closely involved with the management of

the business. IFRS are argued to be more transparent with greater public accountability. Our

historical analysis shows that ‘secrecy’ in terms of disclosure of financial information is deeply

embedded in the German accounting model for a number of reasons such as owners’ privacy

and the important role of bank financing. Indeed, the importance of ‘secrecy’ in the German

accounting model is still a major accounting feature and has resulted in rigorous discussions

about implementing IFRS for SMEs (Deutscher Industrie- und Handelskammertag and

PricewaterhouseCoopers 2005; Kuhn and Stehle 2006; Schürmann 2006; Europäisches

Parlament 2007). SMEs in Germany fear that they may experience negative consequences if

sensitive financial information were disclosed in accordance with IFRS (Kuhn and Stehle 2006).

Note that our historical analysis reveals that protection of SMEs has been a major objective

because of their significant importance in Germany’s economy. We argue that the so-called

superiority of the ‘transparency’ value which is embedded in the Anglo-American approach and

IFRS has to be evaluated in national context. A strong investor orientation in IFRS and

subsequently in the ‘transparency’ value as largely applicable to SMEs in Germany is

questionable.

Flexibility vs. uniformity In this paper we have argued that in Germany’s focus on uniform commercial accounting

requirements results from a close relationship of taxation law and commercial laws on

accounting established by the ‘Maßgeblichkeitsprinzip’ (congruency principle). As such, one

enactment, namely the ‘HGB’ (Germany’s commercial code) sets accounting standards for all

German entities, thereby reinforcing comparability of financial reports. In contrast Anglo-

29

American accounting models provide a greater focus on flexibility with the aim of ensuring

greater inter-company comparability by taking into account their specific circumstances and

context (Nobes und Parker, 1995). It is important to note that the use of IFRS, which focuses on

flexibility, may restrict comparability of financial reports. Specifically, inter-company

comparability may be reduced by the significant number of choices regarding profit recognition

and valuations of assets and liabilities. For example, IAS 38 (intangible assets) requires

recognition of development cost if certain criteria are met. However, these criteria are subject to

interpretation and have often resulted in significant differences in recognition ratios (recognised

development cost / total research and development cost) between companies (Baetge, 2005).

Furthermore, we argue that comparability will be further reduced when IFRS are applicable to

all entities. As such, adaptation of IFRS to all entities may damage Germany’s traditional

relationship between taxation law and accounting law. The principle aim of IFRS is to provide

useful information largely to investors is not consistent with the objective of Germany’s taxation

legislators (Herzig 2000; Kahle 2002; Brinkmann 2006).

Conclusions This paper has examined the historical development of accounting practices and issues related

to convergence in the socio-economic context of Germany to show how the specific German

accounting model has developed. The evolution of German accounting and in particular the

discussion about Anglo-American biases towards continental European accounting in the rush

towards convergence has been related to Gray’s (1988) theoretical framework of accounting

values. While revealing major criticisms of Gray’s (1988) theoretical framework and its

application in categorizing accounting models, its widespread acceptance in accounting

research and education have brought forward arguments for an application of Gray’s (1988)

framework in this study. As such, we have applied Gray’s (1988) theoretical framework

considering its limitations. Indeed, this study followed the objective to show the subjectivity of

Gray’s (1998) model and its biased application.

Our critical analysis of Gray’s (1988) theoretical framework suggests that his model can be

criticised for excessive simplicity and its focus on uniformity in describing national accounting

values and national accounting systems. Furthermore, we have questioned Gray’s (1988)

advocacy of the superiority of the Anglo-American accounting models and principles. We have

argued that Gray’s accounting values are subjective because of judgemental definitions and a

lack of cultural relativity, which further embeds biases against the continental European

accounting model. Importantly, our analysis has shown that Gray’s framework has dominated

international accounting research and accounting education despite the number of criticisms

and inherent subjectivity that favours the Anglo-American accounting model. As such, we have

argued that Gray’s (1988) model and its classifications are used to show the superiority of

30

Anglo-American accounting models over other accounting models such as the continental

European accounting model.

Our historical analysis has revealed that Germany’s accounting model follows a legalistic

approach with strong ‘statutory control’. This focus on legalism and ‘statutory control’ has

increased with the development of accounting practices in Germany because of changes in the

political, economic, cultural and legal environment that required adaptations and enhancements

of German accounting law. Thus, the legalistic approach is deeply embedded in Germany’s

accounting model. Moreover, our analysis has revealed that the German legislators’ objective

has been to take into account and protect the interests of diverse stakeholders, namely

business entities, government, creditors and the general public. Importantly, this approach of

balancing diverse interests has increased the legitimacy of German accounting regulations.

Furthermore, our analysis has shown that Germany’s accounting model focuses strongly on

creditor protection and a preference for a cautious approach to measurement of assets,

liabilities and profits since the early beginnings of bookkeeping when accounting records

provided evidence in court. This focus on creditor protection is still deeply embedded in

Germany’s accounting laws, which follow the principle of prudence with the ‘Realisationsprinzip’

(realisation principle), the Imparitätsprinzip (recognition of loss principle), and also the

‘Niederstwertprinzip’ (historic cost principle) and strict ‘Niederstwertprinzip’ (principle of the

lower of cost and market). Moreover, we have shown that accounting in Germany prefers a

significant degree of ‘secrecy’ in relation to the disclosure of information about businesses. This

is closely related to the historical development of Germany’s economy that focused traditionally

on bank rather than equity finance and as well as the legislators’ objective of protecting SMEs

which play a dominant role in Germany’s economy. However, we have also shown that

Germany’s accounting model has adapted to extended disclosure requirements for stock

corporations because of European harmonization and international convergence endeavours. In

this regard our historical analysis has revealed that German legislators’ objective is to balance

and to protect diverse interests. As such, investors’ requirements and internationalisation have

resulted in extended disclosure for stock corporations under IFRS, while the traditional

preference of a certain degree of ‘secrecy’ is maintained for SMEs and their disclosure

requirements in accordance with the ‘HGB’. Finally, the historical analysis has shown that a

preference for uniform accounting practices has developed in Germany because of the close

relationship between accounting information and taxation related to the introduction of the

‘Maßgeblichkeitsprinzip’ (congruency principle). Related to Gray’s (1988) framework of

accounting values, our historical analysis has thus revealed that Germany’s accounting model

can be categorized as showing ‘statutory control’, ‘conservatism’, ‘secrecy’ and ‘uniformity’ in

contrast to the Anglo-American model that is related to ‘professionalism’, ‘optimism’,

‘transparency’ and ‘flexibility’.

31

The application of Gray’s (1988) theoretical framework of accounting values to analyse Anglo-

American biases against the continental European accounting model and German accounting

model has revealed that strong Anglo-American biases exist. As such, we have questioned the

assumption of IFRS as world’s best practice. Specifically, we have shown that these biases

result largely because historical, political, economic, cultural and legal factors are largely

ignored in understanding the relationship between accounting and its context. The adoption of

IFRS as official standards for consolidated accounts have further compound issues, challenges

and Anglo-American biases. Our analysis reveals that IFRS requirements such as the

‘substance over form’ approach and the presentation of a ‘true and fair view’ with the extensive

use of professional judgement and discretionary decisions because of uncertainty expressions

and imprecise terminology restrict comparability and reliability of financial reports. As such, we

have questioned the superiority of the Anglo-American accounting model over the German

accounting model in terms of reliability. Moreover, our analysis has revealed that significant

controversies exist regarding the legitimacy, international representativeness and transparency

of the private standard setting body IASB. Further concerns have been raised regarding the

objectivity of IASB’s members and the influence of interest groups on the development of

accounting standards. In contrast, our analysis of Germany has shown that there is greater

neutrality and greater accountability in development of accounting standards. As such, we have

argued that the excessive reliance on professional self-regulation and excessive politics in the

standard setting process may compromise the so-called superiority of IFRS as ‘best’ practice.

Issues also emerge regarding the different measurement approaches. Our analysis has shown

that accounting in Germany reflects a cautious approach to measurement and creditor

protection, which is opposed to the more ‘optimistic’, ‘laissez-faire’, ‘risk-taking’ Anglo-American

approach. We have argued that the superiority of the more ‘optimistic, laissez-faire, risk-taking’

Anglo-American approach is restricted with regard to creditor protection and the objective of

capital maintenance and thus does may not fulfil all stakeholders’ requirements in the specific

German accounting context.

In conclusion, this paper has shown that Anglo-American biases in the current move towards

convergence of accounting standards have already resulted in a number of issues and

challenges. We further provide evidence that an extended adoption of IFRS is likely to reinforce

existing challenges and importantly could lead to additional challenges because of inherent

biases. In this context the controversial debate about extending IFRS to SMEs is of major

importance. Our analysis has revealed serious concerns because of the questionable

appropriateness of IFRS for SMEs that fear negative consequences if forced to disclose

sensitive information and apply the more ‘optimistic’, ‘laissez-faire’, ‘risk-taking’ Anglo-American

approach, which could result in inflated profit figures. This discussion clearly reveals that there

is no one superior accounting model. Importantly, accounting as the official language of the

32

business is deeply embedded in a national, legal, social, political and economic environment

and the historical development of accounting in a country cannot be ignored.

Consequently, we have argued that the assumed conceptional superiority of IFRS in the current

rush towards convergence of accounting standards is highly controversial. Moreover, we find

that Anglo-American biases towards continental European accounting models and towards the

German accounting are deeply embedded in international accounting research and accounting

education. Indeed, the ongoing process of convergence is largely dominated by Anglo-

American perceptions of best practice which do not take into account a nation’s specific

historical, political, economic, cultural and legal context. Moreover, we have revealed that the

challenges to convergence are profound and may not be tackled in a short period of time as

they relate to deeply embedded accounting values.

Our study suggests that objective evaluations of accounting models in their national context are

of significant importance in the current move towards convergence. Indeed, if IFRS are

supposed to be a best practice approach, the standards should be derived mutually from an

objective evaluation of practices in consideration of contextual factors and not simply be a

reflection of Anglo-American accounting values. We have revealed that the current convergence

process is already experiencing challenges and issues because of Anglo-American biases.

Thus, we argue that it is of significant importance to address these issues and biases to be able

to discuss an international ‘best’ practice objectively in particular related to the discussion about

an extended adoption of IFRS for all entities and individual reports. This call for objectivity in the

discussion and adoption of IFRS also requires that objectivity is preserved and established in

accounting education and international accounting research.

33

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