IFRS Adoption in Germany Banks: An Analysis from Deutsche Bank - Research Paper Example

IFRS adoption in Germany Banks: An Analysis from Deutsche Bank Table of Contents Chapter Introduction, objectives and methodology 3 1.1 Introduction 3 1.2 Problem statement 4 1.3 Research objectives 4 1.4 Research questions 4 1.5 Methodologies 5 Gaps in research 5 Research method 5 Research approach 6 Research design 6 Chapter 2 Literature review 6 2.1 Background study of IFRS 6 2.2 Conceptual framework 8 2.3 IFRS in the EU and in German banking sector 9 Chapter 3 Data presentation 10 Chapter 4 Data analysis and discussion on the Empirical Findings 12 4.1 Impact of IFRS on Deutsche Bank’s financial performance 12 4.2 IFRS in German banks 13 4.3 Challenges for DB during transition 14 Chapter 5 Conclusion and recommendation 15 Reference list 17 Chapter 1 Introduction, objectives and methodology 1.1 Introduction International financial reporting in the recent times has been accepted by many nations of the world as a standard for preparing financial statements and their reporting (Horton, Serafeim and Serafeim, 2013). Shifting from local accounting regulations to the IFRS (International Financial Reporting Standards) is seen to be one of the largest changes in the history of reporting standards (Sudarsanam and Broadhurst, 2012). The phenomenon of change has also been analyzed widely by many financial regulators and experts. Most of the analysis conducted upon the subject matter has remained positive and it is seen that the adoption of IFRS has significantly facilitated the regulation of activities in the capital markets. The sources of such positive influence are seen to remain highly unclear. It is seen that IFRS implementation has become essential in the present globalised business environment so that a common accounting and financial language can be established. The harmonization of accounting policies facilitates easy comparability and leads to better interpretation of financial results on the global platform. The IFRS policies were particularly developed so as to reduce the number of fraudulent activities which take place as a result of differences in the accounting policies of different nations. Also the implementation a common accounting framework facilitates consolidation of financial statements of firms which operate in a number of nations (Levitt, 1998). The adoption of IFRS in German banking firms has been gaining momentum in the recent times. In the current paper the potential impacts of the adoption of IFRS in German banking sector with special reference to the Deutsch Bank. The paper vividly analyses the manner in which the IFRS policies have impacted the financial reporting quality and its impacts upon the firm’s financial policies. The paper will also vividly analyse the manner in which the IFRS policies impact the management decisions in respect of financial resources and the challenges in respect of transitions from one accounting framework to the other. The literature review in the current paper has been conducted on the basis of analyzing IFRS policies, their particular advantages and shortcomings and the manner in which they have been adapted in the European Union (EU) (Horton, Serafeim and Serafeim, 2013). 1.2 Problem statement The IFRS is rapidly being adopted in many organizations around the world. The current paper focuses upon the issue of mandatory adoption of IFRS and how the same impacts financial reporting and preparation of financial statements. 1.3 Research objectives Achieving a uniform standard in maintenance books of accounts and preparation of financial statements are an essential aspect in the present day global economy. As business concerns belonging from different nations continuously interact with each other, the need for developing common regulatory framework becomes essential. The IFRS has been implemented to fulfil such objectives. Over the last decade, the IFRS is seen to be rapidly adopted by many nations of the world. It facilitates the manner in which financial statements are compared. The framework also regulates the manner in which financial statements meet the requirements of auditing establishing common rules for all companies. Through the implementation of the IFRS, it becomes easier for companies to compete in the financial markets of other nations. It also facilitates consolidating the financial statements of different firms together. The current paper focuses upon understanding the importance of IFRS in the banking sector of Germany with particular reference with the Deutsch Bank. The paper incorporates analysing how the implementation of IFRS impacted the financial reporting and statements of the company. 1.4 Research questions Based upon the nature and the objectives of study, the following research questions have been framed. 1) Why has Germany implemented mandatory IFRS accounting standard for bank industry and in particularly, for Deutsch Bank? 2) What are the impacts of IFRS implementation have over Deutsch Bank’s financial statements and its reporting to stakeholders? 3) How does Deutsch Bank manage the challenges and transition from implementing IFRS over Germany GAAP? 1.5 Methodologies Gaps in research The current paper analyses the impact of mandatory implementation of IFRS in the German banking sector, in context of the Deutsch Bank. The IFRS was mainly implemented in the banks of Germany so as to enhance the quality of reporting to stakeholders. Whether a firm’s reporting quality and the manner in which their financial statements are presented have significantly improved due to the adoption of IFRS is a matter of individual judgement. Some may associate reporting quality with the manner in which information is presented while others may associate it with whether the system facilitates enhancing profitability. It is also considered to be difficult to understand the manner in which IFRS implementation impacts reporting by analysing only a company’s financial statements. However, to fulfil the needs of the current paper, the financial statements of Deutsch Bank from before and after implementation of the IFRS have been considered. Additionally a number of publications and scholarly articles have been analysed to gain information regarding the impact of IFRS. Research method The current research is based upon the secondary data collection technique. Secondary data refers to the information obtained from sources such as journals, books and web publications. Since the current paper focuses upon gaining information regarding the impacts of IFRS in German banking system and particularly in the Deutsch Bank, obtaining primary data is beyond scope. Hence the objectives of the paper have been fulfilled through the procurement of primary data. The data required for the current paper has been obtained from different journals, websites and books which contain relevant materials in respect of IFRS implementation in Germany. In order to gain information regarding the manner in which the implementation of IFRS has impacted Deutsch Bank, the company’s financial statements have been utilized. The purpose of the current paper is to identify whether the implementation of IFRS has impacted the financial performance of Deutsch Bank. To gain relevant information regarding the subject matter, financial statements were deemed to be the suitable source. Information regarding the financial performance of the company was taken from the annual reports of the company, from before and after implementation of the IFRS. The procured data has been analysed both qualitatively and quantitatively (Kumar and Phrommathed, 2005). Research approach The researcher has undertaken the deductive approach in the current paper. This method facilitates the researcher to frame the research questions and objectives based upon existing knowledge and theories. The deductive approach does not lead to the formation of new ideas; instead it facilitates applying existing theories to different situations and analyzing their potential outcome. Based on the outcomes of analysis, suitable recommendations and conclusions are framed either justifying the existing ideas or negating the same. The deductive approach is widely utilized in analyzing different phenomenon’s associated with business (Kumar and Phrommathed, 2005). Research design In the current research, firstly the researcher undertakes studying relevant literature relating to the subject matter of IFRS. This facilitates understanding the concept of IFRS vividly. Accordingly required data is collected from Deutsch Bank’s annual report. The information is then presented in the paper in a summarized manner. On the basis of the information collected, analysis has been carried out regarding the manner in which IFRS has impacted the reporting and presentation of financial results of Deutsch Bank. It is also analysed why IFRS is deemed to be important and the motives behind its implementation in the banking sector of Germany. Finally, appropriate conclusions and recommendations have been developed (Kumar and Phrommathed, 2005). Chapter 2 Literature review 2.1 Background study of IFRS The IFRS was designed with the motive of establishing a common global language of accounting. As international business becomes more widespread and commercial interact occurs on a global platform, it becomes essential to follow similar accounting policies so as to facilitate easy comparability and sharing of information. The growing rate of international business and the increasing participation of companies in the markets of different nations necessitate the development of similar accounting patterns. The IFRS is seen to rapidly replace the accounting policies existing in many nations (Horton, Serafeim and Serafeim, 2013). The IFRS facilitates maintenance of books of accounts and preparation of financial statements in a similar manner across different firms belonging from diverse nations. This makes it easier for international investors and stakeholders to interpret financial results. As per the research conducted by Gassen and Sellhorn (2006) one of the most essential reason behind the establishment of the IFRS is to facilitate the development of a single type of accounting policy so that financial results can be easily be compared. It is seen to be difficult to compare financial results of different firms if they follow different accounting patterns (Ball, 2006). This poses difficulties for investors and financial regulators to judge the soundness existing in the business. The IFRS is yet to gain acceptance in the U.S. International firms having their activities in the U.S are therefore are required to prepare their financial statements using two different systems, one using the IFRS and the other using the U.S GAAP (Generally Accepted Accounting Principles). The IFRS has gained rapid popularity in the current decade due to its high flexibility. The IFRS is fundamentally principle based rather than being rule based. This makes the provision under the IFRS easy to understand and adopt. A principle based accounting system facilitates valuation based on justifiable reasons. As a result there exists many ways to reach a particular financial treatment. As a result firms can easily use IFRS regulations in a manner which suits their business needs (Christensen, Hail and Leuz, 2013). According to Barth, Landsman and Lang (2008) although the IFRS has been accepted and appreciated by many nations, it has significant disadvantages as well. The system provides a high flexibility to stakeholders allowing them to use the data which they wish. As a result financial statements may be prepared in a manner in which firms display only the information which they wish to disclose (Jeanjean and Stolowy, 2008). Firms many at times are seen to manipulate the manner in which they present financial results through inflating profits or showing declined loss of revenues. The system is also used for hiding many financial issues existing within an organization leading to fraud. For instance, making alterations in the manner in which inventory is calculated may lead to inflating profits. Although the IFRS regulations specifically state that the rules or changes incorporated in the preparation of financial statements must be accompanied with justifiable reasons, it is often observed that firms may invent reasons so that they can convince financial authorities and stakeholders regarding the technique used by them. In order to prevent such manipulation, it is essential that the IFRS gets established in a stricter manner. Another significant barrier seen to arise in respect of the IFRS adoption is that it’s a costly affair. Shifting from existing accounting policies to the IFRS required providing training, bringing in new financial experts and consultants. Many small firms are not able to bear the costs of shifting to the IFRS system of accounting due to lack of financial resources. Large firms however find it much simpler to incorporate IFRS policies. The IFRS principles are considered to be much simpler to incorporate than the GAAP regulations. The IFRS regulations have facilitated putting investors and professional experts in the same level. New investors are able to interpret the system in the same manner as finance professionals. Experts also argue that the IFRS facilitates more correct and timely preparation of the financial statements. The system presents financial information in a concise manner eliminating all unwanted information (Ashbaugh and Pincus, 2001). 2.2 Conceptual framework On the basis on the above discussed aspects, a conceptual framework has been developed in respect of the impact of the adoption of IFRS. 2.3 IFRS in the EU and in German banking sector The IFRS was established initially for regulating the financial activities of the European Union (EU). However the system gained rapid acceptance in other nations as well. The IFRS is many at times called by its initial name IAS (International Accounting Standards). In the year 2002, nations of the EU had agreed that the IFRS would be required to be mandatorily be followed by the companies which are listed. In order for the system to be used in the EU, the standards were required to be endorsed by the ARC (Accounting Regulatory Committee). The committee has been formed by incorporating government representative from each of the EU nations (Deutsch Bank, 2007a). The ARC is advised in respect of its decisions by the European Financial Reporting Advisory Group, who is essentially a group of financial experts. This makes the IFRS differ in the manner in which it is adopted in the EU than anywhere else. Many regulations of the IFRS such as the IAS 39 were not accepted by the ARC (Pwc, 2010). Such regulations and sections were amended so that they prevent any type of fraudulent activities. The International Accounting Standards Board (IASB) is seen to work closely with the EU for implementing reforms in the IFRS systems. In Germany, France and Spain, the IAS allows the use of local GAAP in the case of banks which are not listed. Banks which are listed require following IFRS regulations mandatorily for presentation of financial statements (Nobes and Parker, 2008). However in the U.K listed and unlisted companies are required to follow IFRS. It was seen that German banks were more prepared to accept and implement the IFRS than French and Italian banks and financial institutions. In the case of tax reporting, the IFRS is seen to gain greater acceptance than GAAP. Although there not many differences in both the systems in case of reporting for tax but due to the ease of presentation and lower complexity, IFRS is seen to be more acceptable. Banks in Germany which voluntarily adapted IFRS system had been driven by factors such as higher degree of disclosure and standardization of information as compared to the local GAAP. While participating in market transactions it is seen that German banks prefer the use of IFRS principles to achieve transparency. As per the studies conducted by Levitt (1998), the adoption of IFRS has seen to have lesser impact upon the size, capital and profitability of banking firms. The significance of adopting such a technique is more internal in nature as it facilitates easy disclosure of information. Another major driver of rapid IFRS adoption in Germany is to develop competitive advantages. In many firms it was seen that following the U.S GAAP and the local GAAP had led towards increasing reported expenses, lowering the profits. For such firms adopting the IFRS presented them with greater market opportunities. Geographical distribution of a firms operation is also considered to be a key driver for the adoption of local GAAP. On the other hand it was seen that SEC (Stock Exchange Certificate) filling requirements for firms which were listed in the U.S were required to follow the U.S GAAP mandatorily. A number of banks in Germany are seen to adopt local GAAP as they are seen to be more rule based and strict ensuring greater fairness in financial statements (Zeghal and Mhedhbi, 2006). Local GAAP in Germany is more adequately established as they are more principle based than IFRS. Taxation and legal dividend policies follow German GAAP regulations and therefore it is seen that for fulfilling government needs, IFRS regulations are less acceptable. However the strict regulations and greater expense recognition are likely to reduce the level of earnings under the German GAAP than IFRS (La Porta, et al., 2001). However it must be kept in mind that the IFRS regulations were set keeping in mind the broader characteristics of business and their interactions with other businesses, while German GAAP is more concentrated upon fulfilling the national needs. As a result banking institutions which consider making their activities widespread are more likely to adopt the IFRS. It is seen that local GAAP adaptation exists only for providing information required for government tax and other legal formatives. The analysis in respect of the adaptation of IFRS and the difference of its impact with the nations own accounting policies is subject matter which has not been vividly been analyzed. While in many financial firms, IFRS reporting standards are seen to be more productive; in others it is observed that the local GAAP is a more favourable option (Ball, Kothari and Robin, 2000). The choice largely depends upon the span of activities and the special reporting requirements. However it can be stated that the growing popularity of IFRS and its potential benefits are likely to influence many firms in Germany to adopt the same in the coming years (Daske and Gebhardt, 2006). Chapter 3 Data presentation Deutsche Bank (DB) is a stock company which has been organized under the laws of the Federal Republic of Germany (Deutsch Bank, 2007b). The company has been seen to follow the U.S GAAP until the year 2006. From the year 2007, the company prepares its consolidated financial statements on the basis of IFRS as per the regulations imposed by the EU. The SEC accepts the financial statements with reconciliation on the basis of the U.S GAAP. The U.S GAAP figures correspond to the information DB has applied all IFRS regulations applicable for its activities while preparing the financial statements. The company prepares its statements on the basis of the following assumptions: 1) Retrospective method was not used for adjusting business combinations. 2) While carrying out U.S GAAP, premises were valued at deemed cost. 3) Unrecognized actuarial losses and gains in pension schemes were reflected as retained earnings. 4) Translation differences were reclassified as retained earnings. 5) With effect from January 2004, the de-recognition rules of IAS39 were applicable. 6) Share based payment system (IFRS 2) was adopted with effect from November 2002. Figure: Important financial highlights of the company during five years of post and pre implementation of IFRS Post IFRS Pre IFRS (YTL 000) 2007 2006 2005 2004 2003 Cash and Central Bank 15,720 47,645 1,203 188 2,481 Securities Held for Trading (Net) 363,601 680,943 680,943 298,662 22,389 Banks 22,588 3,472 41,736 13,428 83,558 Tangible Assets (Net) 8,959 4,312 3,965 2,295 2,172 Intangible Assets (Net) 143,595 163 - - - Shareholders’ Equity 338,180 192,669 147,385 125,117 103,216 Net Operating Profit/(Loss) 51,321 54,111 36,069 81,871 81,244 Net Operating Profit/Loss After Taxes 40,511 45,286 24,759 44,349 47,873 Net Profit (Loss) 40,511 45,286 24,767 44,349 47,949 Total Assets 743,975 877,376 300,867 365,101 222,780 Total Liabilities 743,975 877,376 300,867 365,101 222,780 Source: (Deutsch Bank, 2007b: Deutsch Bank, 2011) It was also observed that EPS (Earnings per share) was negatively impacted (almost by -0.35%) post implementation of the IFRS at DB. The pre tax return on average active equity was higher by 2.4% under the IFRS than the U.S GAAP. Chapter 4 Data analysis and discussion on the Empirical Findings 4.1 Impact of IFRS on Deutsche Bank’s financial performance On the basis of the information collected from the financial statements of DB, post and pre implementation of the IFRS, it can be stated the critical areas of impact are equity, total assets and the net reported income of the company (Soderstrom and Sun, 2007). The equity investments of the company were seen to positively raise post implementation of the IFRS. Net profits and total assets however had shown a slight fall after the implementation of the IFRS. This is likely due to the increased flexibility and regulation over expenses brought into the accounting framework due to the implementation of IFRS (Jermakowicz and Hayes, 2011). The prime aim of mandatory implementation of the IFRS upon DB was to enhance stakeholder reporting. Through reporting activities it was expected that the company could better meet the need of information dissemination. This goal is seen to be successfully met as the investments in shareholding of the company have potentially increased. The company’s securities held for trading had considerably declined as they were utilized for raising capital as compared with the period prior to implementation of IFRS. Overall the financial regulation internal financial reporting quality had significantly improved. Stakeholders had also provided significant acceptance to the new financial system implemented in the organization. The firm’s financial resources were seen to be presented in a more concise and clear manner than it was prior to the implementation of IFRS (Hilton and Johnstone, 2012). Managers and senior executives of the company state that to the implementation of the IFRS financial information could be presented in a manner such that greater investments could be attracted. Since DB is essentially a stock based company providing timely and clear information in respect of their financial activities was deemed essential. The IFRS regulation had been implemented so that better reporting of financial activities could be achieved (Kager, Schanz and Niemann, 2011). 4.2 IFRS in German banks The main motive behind the implementation of the IFRS in German banks and particularly in DB was to implement greater consistency in the reporting of activities. When financial reports were developed based on greater consistency it was seen that stakeholders could interpret the information in a more feasible manner. DB’s investors and stakeholders had previously raised concerns regarding the reporting activities of the company (Adhikari, Betancourt and Alshameri, 2014). The weak internal monitoring and perceived losses of finance had encouraged managers and financial regulators to undertake stringent measures which could regulate financial assets and operations of the company. Post conversion of the accounting system of DB into IFRS, it was possible for the company to compare the results of their performance at an international level. Another significant advantage gained by the company was that it’s trading in the foreign stock markets had risen, attracting many foreign investors to invest in the company’s equity holdings. Stakeholders and financial regulators had perceived that considering the company’s financial position before the implementation of IFRS, liquidity was a big issue (Van Tendeloo and Vanstraelen, 2005). IFRS had led the organization towards achieving greater market liquidity. DB was also able to secure investment flow in respect of foreign mutual funds. Private debts levels were seen to become more favourable. After shifting to the IFRS system, managerial decisions were seen to become efficient in respect of utilization of fund. DB was also successful at reducing the volatility of their earnings and equity. With the help of various regulatory committees, DB has remained successful at implementing the IFRS within the company which justifies their operations. Since DB was one of the firms upon whom IFRS was imposed mandatorily, the company has shown signs of intelligent market investments, which prior to adopting the IFRS were seen to lack (Nichols, Street and Cereola, 2012). The adoption of IFRS in the DB had considerably impacted the company’s shareholders equity value. An additional 205 entities were consolidated under the financial system of the company post adoption of the IFRS. In case of loan products, the company was seen to acquire lesser private loan from private clients. Borrowing based financial conditions had also become more liberal (Haller and Eierle, 2004). As a consequence of implementing IFRS, DB had selected to implement the fair value system of asset valuation selectively so that a balance in respect of volatility in accounting can be maintained. Due to the adoption of the fair value system the company was not required to show impairment of assets under the head provisions for credit and losses, further easing the accounting system. Post adoption of the IFRS system it was seen that the company’s asymmetry between different grade loans could be depicted more clearly and effects of the same in the financial statements were also reflected. Since fair value system was adopted, the firm’s portfolio management could be done based on proper risk evaluation (Acharya and Schnabl, 2010). Post adoption of the IFRS, a number of assets was reclassified for sale. IFRS also provided the company with suitable opportunities of buying investments without settlement. The investments made by the company in cooperative banks were recognized in the statements effectively. Also the freedom of using different models for stock valuation and in estimation of the values of underlying assets of many stocks provided adequate liberty and enhanced the company’s value in the stock markets (Nobes, 2006). 4.3 Challenges for DB during transition The prime challenge faced during the implementation of the IFRS in DB was relating to costs. The administrators of the company had initially disagreed to adopt IFRS as the company would be required to change their financial recording systems significantly and bring in new skilled employees. Another significant disadvantage was that the company had to undertake reconciliation of their statements in order to match the same with the U.S GAAP requirements so as to fulfil the SEC reporting needs (Gebhardt and Novotny‐Farkas, 2011). Harmonizing the IFRS system with the U.S GAAP was challenging for the management. Since the decision of implementing IFRS in DB was taken long back, the company management had adequate time to make budgetary and training related arrangements. The company had entered into the transition phase much earlier and therefore found it easy to implement IFRS (Agostino, Drago and Silipo, 2011). The slow and planned sequence had reduced much challenges associated with the implementation of the IFRS regulations. The prolonged time invested by DB so as to implement IFRS had increased the company’s expenses. It was also observed that post implementation of the IFRS the company’s net revenues had declined, although positive results were attained in respect of the share capital enhancement. The decline in revenue was largely due to the transition of statements from the U.S and local GAAP to the IFRS (Gebhardt and Novotny‐Farkas, 2011). Chapter 5 Conclusion and recommendation Whether IFRS adoption leads to better management of financial resources depends upon the firm’s nature of activities and their span of operations. International financial institutions are seen to benefit potentially from the implementation of IFRS. The last decade had witnessed a global revolution in the financial sector. Development of IFRS was necessitated as business transactions started becoming more and more global. Although IFRS has facilitated developing a common financial language, it is considered to be less strict and provides scope of manipulation. It is generally seen that in the first year of adoption of IFRS, a decline in revenues is common (Ernst & Young, 2006). Many firms such as the DB who had adopted IFRS mandatorily eventually began to earn high profits. Moreover when DB was seen to use the U.S GAAP, the comparability of its financial statements with the local GAAP was difficult. The weak conditions existing in the EU’s market conditions were seen to become extremely volatile and risk embedded due to the weak economic condition and the debt related crisis. This is also considered to be a potential reason behind the shifting of many banking firms from the U.S GAAP to the IFRS system. Comparing the early and late adopters of IFRS, it can be stated that the advantages of adopting IFRS takes time to surface in the financial system of a company (Liao, Sellhorn and Skaife, 2012). DB has remained successful at increasing its revenues considerably post adoption of the IFRS in the subsequent years. Financial regulators claim that IFRS reduces the home biasness. This means that post adoption of IFRS companies attain the ability of comparing the results of their operations with other firms, who hail from other nations. Alongside of the IFRS adoption, it becomes easier for the companies to attract foreign investments in their equity. However it is seen that the aspect of comparability of statements made following the IFRS regulations are questioned by many. Different companies may adopt the regulations in different ways. This may cause differentiation and hamper comparability. Moreover, it can also be stated that in the absence of the direct control of IASB to regulate the manner in which IFRS rules are incorporated in German Banks cause difficulties in regulatory activities. It becomes adequately easy for many banking firms to display only the information which they deem to be essential in the financial statement. Considering the adoption of IFRS in the DB, it can be stated that the system was successfully implemented in the organization. The company was able to manage its financial resources well and enhance their reporting quality. Financial regulatory authorities had foreseen that implementation of an international system of accounting was required to prevent major impact of the economic crisis. Considering such a situation IFRS adoption was mandatorily implemented in a number of banks. The system was largely implemented for those banks which traded in the stock exchanges of other nations as well. Implementing IFRS system was seen to benefit these companies more widely. Adopting the IFRS in the financial framework of DB was not an easy task; the company had to incur prolonged costs of training and acquisition of new skills so the system could be implemented in the company efficiently. A significant amount of difficulty was also faced by the firm during consolidation of financial statements with the requirements of the SEC. Adoption of IFRS in many German banks also resulted in loss of time as it was seen to be a time consuming system as compared to local GAAP (Hau and Thum, 2009). It was also seen that IFRS recognizes revenue more smoothly and spread over larger span of time than losses. Losses are recognized in larger quantities and during the period in which they form. 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