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National GAAP

20. Sep 2012
1

Good day,

In our company, we are dealing with a very difficult situation. On the one hand, section § 19 paragraph 9 of the Czech Accounting Act, states that we have to account under IFRS. On the other hand, Instruction D - 295 says:

“According to § 23 paragraph 2 point. a) Act No. 586/1992 Coll. on Income Tax, as amended (hereinafter the "Law on Income Tax"), to determine the income tax base is based on operating results, and always without influence IAS. A taxpayer who prepares financial statements under IAS for the purposes of the Income Tax Act applies to determine the results of its operations by special legislation, namely Law on Accounting and Decree that the Act provided:

“Decree No. 500/2002 Coll., Which implements certain provisions of the Act on accounting for entities that are businesses accounting using double-entry accounting, as amended ...

“It follows that a taxpayer referred to in the provisions of § 19 paragraph 9 of the accounts during the year accounted for in accordance with the Act on Accounting under IAS for tax purposes, however, must identify and report profit before tax for line 10 tax return for income tax according to Czech accounting standards.”

Of course, the advice you often hear is that this can be done by, during the period, accounting under IFRS and the end of the period making adjustments to accounts to match the Czech accounting regulations.

Our advisor proposes to do this by taking the closing balances of the accounts pursuant to IFRS and bridging them to balances that would have been if Czech legislation was used.

However, the question arose. How to prove that these bridges provide the right answer when, the transactions are never recorded as per Czech regulations?

Submitted by Mladek on Thu, 09/20/2012 - 07:06

Hate to say it, but your advisor is an idiot.

But you already know that.  Simply asking the question implies you already know the answer (nevertheless, it's always nice to get confirmation).

Since Czech accounting standards and IFRS are incompatible on a fundamental level, there is no way to prove that any adjustment to an IFRS account yields an identical result to what would have been if the transactions comprising that account had originally been recorded as per Czech National Standards (and vice versa).

In fact, since IFRS prescribes no chart of accounts, and since an account structure consistent with IFRS would likely by vastly different from the one prescribed by Czech regulation, there is not even any direct account-to-account correlation.

For example, there are no IFRS equivalents to “011 Start-up costs”, “122-Semi-finished goods" or "641-Revenue from sale of intangible and tangible assets" just as there would be no Czech equivalents to “Deferred interest on receivables”, “Excessive spoilage” "wages paid to manufacturing employees".  In fact, even “Changes in inventory” (an item that would show up on an IFRS nature of expense income statement) cannot have an separate IFRS account, since booking to such an account would be inconsistent with IAS 2.

Then, even when two similar accounts (say "licenses" and "software") are used, Czech standards and IFRS have different measurement requirements.

Even a simple task like reconciling interest expense would involve finding and adjusting all the instances where it must be capitalized under IFRS and cannot be under Czech standards.

And these difficulties pale in comparison to those caused by differing revenue / expense recognition principles.   Since Czech standards recognize revenue / expense on the basis of transfer of ownership / the letter of the contact, they generally produce different results than IFRS’s, which recognizes revenue / expends on the basis of transfer of risks and rewards of ownership.

This can lead to significant differences in income even if all that were recorded were plain vanilla purchases and sales (especially at year end).  When one starts dealing with multiple-act services, multiple deliverables, construction contracts or other challenging situations, making supportable adjustments becomes more challenging.  And these differences become practically insurmountable if a company decides to produce a function of expense, IFRS income statement.

Just for fun, you can go through these two comparisons (from PwC in Cz and Eng, and from E&Y in Cz).  Neither of them is particularly exhaustive, but at least you’ll get an idea (item by item) of what you’re up against.


But, back to your question.

There is no way to prove that any conversion, bridge or adjustment is accurate except by re-booking all the transactions (that originally were booked as per IFRS) again, as per Czech National Standards.

If the results are the same, evidently the adjustments were accurate.  If not, then not.

But one way or the other, if worse comes to worse, there is absolutely no way to avoid booking every transaction twice.

The only difference is, if it is done to begin with, one does not have to go back (maybe years) and re-open all the events and transactions, re-examine all the documents and re-do all the work already done.

On the other hand, if one never gets audited for tax compliance, or sued for tax non-compliance, one can go on, happily making adjustments, until, one day, one does get audited and/or sued.  Then one has to demonstrate to the taxing authority / prove to the judge that one’s bridges really did lead to full compliance with Czech tax legislation.

Good luck!

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