______________________________________________
NEITHER TRUE NOR FAIR?
-
THE CASE OF HIDDEN RESERVES IN SWEDISH AND GERMAN
ACCOUNTING
____________________________________________________________
Jörgen Dahlgren, School of Management, Linköping University, Sweden
and
Sven-Arne Nilsson, School of Economics and Management, Lund University, Sweden
Corresponding author:
Jörgen Dahlgren, School of Management, Linköping university, SE-581 83 LINKÖPING,
SWEDEN
[email protected], phone: +46 13 28 15 57, fax: +46 13 28 18 73
2
„Ohne historisches Fundament bleibt alles Können
unvollkommen und das Urteil über die Erscheinungen der
Gegenwart unsicher und unreif.“1
1
Penndorf 1966
3
Contents
1. Introduction ..........................................................................................................................4
2. Purpose .................................................................................................................................5
3. The Concept of Hidden Reserves.........................................................................................6
4. Theoretical perspectives .......................................................................................................7
5. The Swedish Case.................................................................................................................8
6. The German Case...............................................................................................................11
The period 1794 – 1897, until HGB 1897.........................................................................11
Commercial legislation.....................................................................................................11
Fiscal legislation ...............................................................................................................12
The period 1898-1937, until the Companies Act 1937 ....................................................13
Commercial legislation.....................................................................................................13
Fiscal legislation ...............................................................................................................15
The period 1938 – 1984......................................................................................................16
Commercial legislation.....................................................................................................16
Fiscal legislation ...............................................................................................................17
The period 1985 –...............................................................................................................17
Fiscal legislation ...............................................................................................................18
7. Contrastive analysis............................................................................................................19
A Parallel perspective.......................................................................................................19
A Stakeholder perspective ................................................................................................21
Selected list of references:......................................................................................................24
4
1. Introduction2
"The most unusual feature of Swedish accounting practice is the presence of
untaxed reserves.“(Choi and Mueller 1984)
The phenomenon described in the quotation, the untaxed reserves, has constantly been a
source of confusion for foreigners trying to understand Swedish accounting. During more
than two decades now, all reserves have been disclosed publicly, and this has therefore
prompted an attempt to understand their meaning and role. However, since the untaxed
reserves, referred to in the quotation above, were originally hidden, one has to focus an
understanding and analysis on the process whereby hidden reserves were created.
As far the taxation aspect is concerned, if business income is taxed at all—and if financial
accounting is at hand—the relationship between accounting and taxation can take various
forms. The taxation can be unrelated to the accounting income, i. e. the taxable income is
calculated according to a set of specific rules for income measurement or asset and liability
valuation. The creation of hidden reserves in financial accounting does not in this case
influence the computation of taxable income.
Taxation can further be linked to the accounting income, which means that the business
income to be taxed is determined by the accounting rules for income measurement, or for
asset and liability valuation. Then, if the accounting rules permit the creation of hidden
reserves, these appropriations of profit are tax-deductible, and the reserves are untaxed as
well. Another type of link exists if rules in the fiscal legislation require a certain valuation in
the financial reporting, which can result in reserves also being untaxed. This is known as
reversed linkage.3
The distinction between hidden and open reserves, combined with the distinction between
taxed and untaxed reserves, gives rise to the following matrix:
Taxed reserves
Untaxed reserves
Hidden reserves
A1
A2
Open reserves
B1
B2
Reserves in inventories in Sweden can be used as an example. In the beginning of the 19th
century, companies did not create any kind of reserves in inventories, i. e. the companies were
outside the matrix. In the next stage, up until 1928, such reserves were hidden but taxed (A 1).
Through the fiscal reform of 1928, they became untaxed (A 2). (Through the fiscal reform of
1955, the untaxed proportion became restricted.) Through the accounting reform of 1976,
they had to be disclosed openly (B 2). With the fiscal reform of 1991, untaxed reserves in
inventories were abolished. It remained possible to create open but taxed reserves in
inventories (B 1), even if it was never practised. Finally, through the accounting reform that
was promulgated in 1997, open reserves in inventories were abolished in principle as well.
Thus Swedish companies are again outside the matrix.
2
3
We particularly acknowledge the very helpful comments from Prof W. Ballwieser and Prof.
A. Haller
In German accounting this is known as the reversed authoritative principle
(Umkehrmaßgeblichkeit)
5
Nowadays, with a marked over-riding focus on the importance of relevant accounting
information for investors and creditors, hidden reserves seem even more in need of an
explanation than was experienced by Choi & Mueller in regard to untaxed reserves.
“The SEC regards transparency, comparability, and full and fair disclosure
as indispensable to financial reporting.” (Zeff 1998)
“Wird Informationsverfälschung nicht verhindert, so reagiert der
Kapitalmarkt mit Misstrauen.“ (Siegel et al 1999)
Given such a perspective, derived from the conception of an efficient market and its
requirements, it seems today almost incomprehensible that less than “full” information might
be efficient.
Furthermore, with the present focus on harmonisation within the EU and the cross-Atlantic
debate on standard issues (cf Zeff op. cit.), it is also interesting to put the question of hidden
reserves in a comparative, cross-national perspective and see whether practice and argued
logic has been the same in different countries.
2. Purpose
In a paper from 1996 (Dahlgren and Nilsson 1996), we described the extent to which hidden
reserves had been used for inventories and/or machinery and equipment in Swedish financial
accounting during a period from the end of the 19th century up until the 1990’s. We also tried
to trace the reasons behind the creation, regulation and cessation of hidden reserves. The
focus was on hidden reserves since we believe that one needs first to understand hidden
reserves because what appeared as untaxed reserves were actually hidden reserves made open.
Finally, we attempted to describe the relationship between hidden and untaxed reserves.
Despite the importance and interest in hidden and untaxed reserves in Swedish accounting, no
previous studies had been undertaken. It had generally been presumed that companies in their
accounting had intentionally created large hidden reserves.
The purpose of this paper is to extend the analysis to include a description and analysis of the
corresponding development of hidden reserves in German accounting and the extent to which
these were untaxed. The reason for expanding the analysis is that it makes possible a
contrastive analysis, which, comparing and analysing similarities and differences, provides a
deeper understanding of hidden and untaxed reserves in Swedish accounting because:
-
German accounting has historically always been the main source of influence for
Swedish accounting
Germany has always been regarded as the fatherland of hidden reserves
As a final purpose, the analysis gives us a possibility to reflect on what drives accounting
change and, in an international perspective, why accounting norms and practice differ
between different countries even if they share a common tradition.
The paper starts with a short description of two relevant perspectives that are used in it: the
international accounting perspective and the stakeholder approach. After an attempt to nail
down the concept of hidden reserves as it is used in this paper, we present a summary of our
findings in the 1996 study (the Swedish case). In the following chapter (the German case), the
development in Germany is then described, structured in four periods and each period
6
containing a description of both the commercial and fiscal legislation. The periods chosen are
based on major changes in legal regulations. We are fully aware that an argument can be
made for choosing another logic behind the period structure e.g. related to changes in the
society at large. At present we do, however, lack any empirical data that would permit such an
alternative. Consequently we have to assume that major changes in legal requirements also
reflect important changes in the society at large.
The paper concludes with a contrastive analysis and conclusions. In both the German and the
Swedish case, our discussion comprises only entities with limited liability (Sw. AB, Ge. AG).4
3. The Concept of Hidden Reserves
Although reserves in accounting can be of different kinds and created for various reasons,
most of them are shown publicly in one way or another. Such is the case for reserves for
particular purpose e.g. contingent liabilities or for reserves that are created as a consequence
of legal requirements.
In this paper we are interested in the history of hidden reserves, which means that the reserve,
at least the amount of it, is not known to people outside the company (and sometimes not even
within the company). It is important to remember that such reserves are not only created to
deliberately conceal true values, but are also a normal consequence of applying valuation on
the basis of historic cost. Since most assets are globally valued in this way and the difference
between the historic cost value and any concept of current value is not known, hidden
reserves are part and parcel of conventional accounting. In this sense hidden reserves are as
much part of US accounting as of European accounting.
In other instances hidden reserves is the result of difficulties of ex ante estimating the value of
assets or liabilities. This is e.g. true in many cases of contingent liabilities, but also of course
when it comes to valuing assets that are subject to depreciation. True values can at best be
computed in hindsight.
Our treatise of hidden reserves is, however, limited to cases where a lower value of an asset is
deliberately and systematically chosen in favour of a value based on conventional accounting
principles. Thus, the value chosen is not a product of applying conservatism, and the decrease
in value is therefore not linked to any assumed real reduction in either market or use value.
Rosendorff (1917) describes how entire factories were valued at 1 mark in Germany and how
management in some cases reduced the profit through depreciation charges computed to give
a suitable reported profit5.
A consequence of the nature of these reserves, as not corresponding to decreases in real value,
is that they can be said to consist of undistributed and, sometimes, untaxed profits, something
that may or may not be contrary to the interest of the shareholders or the government.
4
5
We do not specifically include the German GmBH in the description and analysis. It is,
however, our understanding that the description of the development for AGs in principle
also applies to GmBHs.
“Während sie in früheren Jahren ihre Effekten- und Konsortialkonto erzielten Gewinne auf
Gewinn- und Verlustkonto auswies, verwendet sie dieselben jetzt vorweg zu
Abschreibungen, ohne die Höhe dieser Gewinne bekanntzugeben.“ (Rosendorff, p. 7)
7
4. Theoretical perspectives
As we pointed out in the beginning, today it might be difficult to understand why hidden
reserves were at the time not only allowed but also advocated. In order to analyse the logic
behind such an argument, we use a stakeholder approach. According to this approach, social
structures and norms are formed in a process of interplay between different groups
(stakeholders) with different interests and claims. A stakeholder is, as the name suggests, an
individual or a group that has something at stake in a certain issue (Guba and Lincoln 1989).
The configuration of stakeholders must therefore be identified for each issue.
In our case, the issue is accounting information. Although we can identify several groups with
an interest in accounting information6, in order to understand the phenomenon of hidden
reserves we have for our analysis identified only the three most important groups: present and
potential shareholders, company management and the government. The interests of the three
groups are:
•
•
•
Shareholders:
Company management:
Government:
Dividends and growth of stock value
Self-financing and freedom to act
Taxation and economic policy
These interests have been and are often in conflict with each other i. e. the government’s
claim for taxes goes against both the shareholders’ claim for dividends and management’s
interest to finance growth internally. The creation of hidden reserves is mainly in the interest
of the management and sometimes in the interest of the shareholders. Owing to the dual
position of the government, these reserves can also be to its advantage for a government with
an interest in company strength if the hidden reserves make companies more viable and less
vulnerable.
With an accelerating internationalisation of business, understanding accounting in other
countries becomes evidently of growing importance both for accountants in companies that
have holdings abroad and/or a traded on stock exchanges in other countries, and for
international investors. Within the EU, the ambition to harmonise accounting adds further
force to this process.
Although the basic ideas in financial accounting seems to have spread from Italy after the 15th
century, only a casual study is needed to reveal evident differences in the accounting of today.
The harmonisation process has met with some difficult obstacles that are based on culture,
tradition and legal structures7. Even if the ambition may not be to standardise accounting
world-wide, the global perspective of business makes it necessary to understand these
differences, something that is the subject area for comparative international accounting.
Our ambition in this paper is not to develop the comparative accounting theory but instead to
use it as a background in our analysis. According to Carnegie & Napier (Carnegie and Napier
2000), cross-national accounting studies could be carried out in one of the following ways:
•
6
7
“Synchronic” comparisons: Such a study involves a comparison between different
countries at a given point of time.
Cf The Corporate Report (1975) and The Stamp Report (1980)
Cf “Current trends seem to indicate that there is little chance of ever achieving
international harmonization” (Riahi-Belkaoui 2000)
8
•
•
Parallel studies of accounting development: Here the focus is on the development of
accounting across a given time-period.
“Diffusion” studies: These studies entail the trailing of accounting ideas from one
country to another.
In relation to these approaches, our study contains elements of both the parallel approach and
the diffusion approach. We try to describe the development of the hidden reserves both in
Germany and Sweden over a period from the 19th century to today; and, given the fact that
Swedish accounting has been heavily influenced by German accounting, we also try to link
the development in Sweden with Germany.
“International accounting aims to site local accounting practices of today
within a comparative framework across space, while country histories of
accounting attempt the same process across time. A synthesis across both
dimensions will enrich the perspectives not only of students of the
contemporary scene but also of historians.” (Tosh 1991)
5. The Swedish Case
It is a widespread opinion that unrestricted hidden and untaxed reserves have been common in
Swedish accounting. As far as we can establish, this has only been the case during a limited
time period from the beginning of the 1930’s to the middle of the 1950’s.8
In the early days, no generally accepted principle for the valuation of assets, particularly
inventories and machinery and equipment, seems to have existed. Very often exit values were
used for inventories; and depreciation, although it existed early in some companies, was not
widely practised until the beginning of the 20th century. The reason for this was that in most
companies, the owners and the management were the same group. There was therefore no
point in valuing assets for tactical reasons, and the management of a company could choose
whatever value it considered proper. No requirement to publish the accounts existed.
Gårdlund (1947) did not find any evidence of that accounts were prepared “backwards“.
Furthermore, the taxation was not linked to accounting, so no reason existed to use valuation
techniques for avoiding or deferring taxes.
The next period, from 1928 to 1955, is marked with the creation of large hidden and untaxed
reserves in Swedish accounting. The main reason for this can be traced to the government’s
interest in two aspects:
1.
The government takes an interest in the functioning of the capital market. In the
Companies Act of 1910, there is a concern for the information given by the companies to
potential investors and creditors. The act required that financial information should be
made public and included rules to prevent companies from overvaluing their assets, but
not from undervaluing them.
The link established between accounting and taxation in 1928 can also be regarded as a
sort of systemic measure, standardising the way taxable income was to be computed, and
therefore securing equal treatment of businesses, regardless of local government
jurisdiction.
8
Dahlgren,J and Nilsson,S-A, "The Rise and Fall of Hidden Reserves in Swedish
Accounting," (Lund, Institute of Economic Research, 1996),
9
2.
The second aspect originates more from an economic-political view. From the beginning
of the 1930’s, Sweden had a social-democratic government. From that government’s
perspective, measures that could counter the risk of mass employment, experienced both
in Sweden and abroad, were sought after. It was thought that the financially stronger a
company was, the more likely it would be that it could resist occasional losses and the
fluctuations in business cycles. In order to create strong companies, cash drain, both as
dividends and as taxes, had to be prevented. It was therefore accepted that companies
placed as low a value as 1 krona on their assets, something that of course created large
untaxed reserves. Given the weak requirements on disclosure of financial information at
the time, they were also hidden.
It can thus be seen that the intentions of companies' management and of the state interacted
during this period to produce financial information, which was not useful for the analysis of
profitability or financial position. For management, the requirements from 1910 to publish a
balance sheet certainly made it tactically interesting, from a control perspective, to conceal
the true strength of the company. The state, on the other hand, did not show any additional
interest in questions of disclosure apart from making the balance sheet public.
One may well ask why shareholders did not demand a greater openness. There are a number
of probable causes for this but, lacking more definite knowledge, they may only be put
forward as possibilities. One such cause is tradition. In the early days, ownership and
management often went hand in hand. When ownership slowly spread to new groups, there
was a tradition from the dominant owners not to disclose more information than necessary
about the company. Furthermore new owners seem to have accepted that, as long as the
company paid dividends over and above the owners’ requirements, no detailed information
was given. When the hidden reserves also became tax deductible, this in itself produced a
number of effects, which were to benefit the shareholders more than high dividends. The
untaxed reserves made it possible for the companies to postpone taxes on profit more or less
indefinitely, which had two effects:
-
It helped companies finance their expansion by letting cash stay in the company instead
of being paid out as taxes (and for that matter as dividends).
-
It provided the companies with funding at zero rate of interest.
These effects were profitable from both a management and a shareholder perspective and led,
ceteris paribus, to a growth in the value of the company.
After the Second World War, Swedish companies made very large profits. The hidden and
untaxed reserves made it possible to reinvest these profits directly. From the shareholders’
perspective this made sense, since the tax law caused dividends to be taxed twice—first as
profit in the company and secondly as income for the shareholder. On the other hand, the
capital gain from the sale of shares was free of tax, if the shares had been held for more than 5
years. So if profits then weren’t paid out as dividends, the value of the shares was likely to
rise, producing a profit that could be, realised tax-free. The use of untaxed reserves postponed
or avoided taxation both of the company and its owners.
The last period, from 1955 onwards, has seen an increasing openness. This openness benefits
first of all the stockmarket, which has been an increasingly more important source of capital
than previously, both in Sweden and abroad.
10
The development towards increased openness has, however, at least among the large
companies, to a certain degree been voluntary. In the previous period, state and management
action worked together to conceal the true value of a company’s assets. At the end of the
1940’s and the beginning of the 1950’s, the state gradually changed its position. A political
study initiated in 1947 concluded that companies fulfilled a vital function in society, and an
increased openness regarding for example financial information was therefore necessary. The
extent of untaxed reserves was then restricted in 1955 since they were thought to produce
effects that were counter-productive to the government’s economic policy. The large
companies, which were used to working closely with the political sphere, registered the
message and adapted accordingly. For these companies, the requirement in the Accounting
Act of 1976, to include untaxed reserves as items in the balance sheet, was a confirmation of
practice.
Through a tax reform in 1991, untaxed (and open) reserves in inventories were abolished, but
the possibility of untaxed reserves in machinery and equipment remained. However, the EC
directives on accounting were introduced in 1997, through a new Annual Accounts Act. The
previous rules, giving the highest value for an asset, were then replaced by rules that
determine which value an asset shall be reported at in the balance sheet. (This marked the end
for untaxed reserves in machinery and equipment.)
In a historical perspective it might be worth noting that the conceptual meaning of ”book
value” in Sweden has changed during the last century. In the era of hidden reserves, the
meaning of ”book value” was simply the value on the balance sheet (the acquisition value less
any depreciation or write-down). When Swedish financial accounting went through a
transition to open, but untaxed, reserves depreciation could be split between depreciation
based on estimated service life (avskrivning enligt plan) and excess depreciation (avskrivning
utöver plan).
In the wake of the Accounting Act 1976, it was discussed whether it for a single year would
be possible to reduce the amount of accumulated excess depreciation in a way that the
reduction would exceed the year’s depreciation based on service life. The conclusion was at
the time that the meaning of ”book value” was the acquisition value less all accumulated
depreciation. Consequently, a reduction could not exceed the depreciation the same year.9
The Annual Accounts Act 1995 states ”fixed assets with limited economic lives shall be
written off systematically over these lives”. Thus, the accounting legislation does not any
longer define the highest value of assets, but it sets out the valuation rules to be used:
”Depreciation shall be done systematically over the service life”. This means that the
accumulated excess depreciation does not have an effect on the book value. Book value is
then consequently defined differently today then 25 years ago.
The Swedish treatment of reserves for machinery and equipment can now be summarised
using the matrix on page 3. During the 19th century companies did not create any reserves in
such assets, i. e. the companies were outside the matrix. In the next stage, up until 1938, such
reserves were hidden but taxed (A 1). Through a fiscal reform of 1938, they became untaxed
(A 2). (Through the fiscal reform of 1955, the untaxed proportion became restricted.)
Through the accounting reform of 1976, they did not have to be disclosed openly; but, at least
for the larger companies, accounting practice was to disclose them (B 2). With the fiscal
reform of 1991, untaxed reserves in machinery and equipment were unchanged. Thus, it
9
See FAR: Nr 3. Materiella anläggningstillgångar, 5., until the version in FARs
Samlingsvolym 1999.
11
remained possible to create open and untaxed reserves in them (B 2). Finally, through the
accounting reform that was promulgated in 1997, deferred taxation through accelerated
depreciation of machinery and equipment is not part of the book value of the assets and
therefore not regarded as reserves in machinery and equipment. Thus Swedish companies are
again outside the matrix.
Although it has no relation to asset values, a section for untaxed reserves is, however, still
included in the formats for the balance sheet and the income statement. The most unusual
feature of Swedish accounting practice, according to Choi and Mueller, therefore still remains
in the financial statements of Swedish companies.
6. The German Case
The description of the German development has been into four periods. Each period is
demarcated by changes in the commercial legislation. Within each period, the developments
of both the commercial and the fiscal legislation are described.
The period 1794 – 1897, until HGB 1897
Commercial legislation
The first German regulations in financial accounting, which where included in Preußisches
Allgemeines Landrecht introduced in 1794, built heavily on the French Ordonnance de
Commerce. The gist of the regulations was an obligation to carry books and certain optional
valuation rules, the latter a predecessor to today's rules with valuations based on acquisition
value. The rule for valuation of current assets was the lower of cost or market and fixed assets
were to be depreciated. 10
The common German commercial code (Allgemeines Deutsches Handelsgesetzbuch, AHGB),
which was introduced in 1861, followed mainly the French Code de Commerce and can be
seen as the starting point for German legislation on financial accounting. It contained rules
that required inventory and balance sheet for each financial year, and also rules for valuation
(beizulegener Wert)11. Already before the development of the AHGB, there were, however,
those who considered wirklicher Wert (real value) as meaning gemeiner Wert (sales value) or
Zeitwert (current value). The intentions behind the AHGB were not to prescribe any specific
valuation rule but only to prevent over-valuation. Despite this, the new regulations were more
and more considered as a decree to use sales value, called wahrer Wert (true value).
10
11
Ӥ 644: Sind in dem Kontrakte keine besonderen Abreden getroffen, so werden bei
Aufnahme des Inventariums die zum Handlungsvermögen gehörenden Vorräte an
Materialen und Waren nur zu dem Preise, wofür sie angeschafft sind, und wenn der
gangbare Wert zur Zeit der Inventur niedriger ist, nur zu diesem niedrigeren Preise
angesetzt.
§645: Von solchen Materialien und Waren, deren Wert durch das Liegen im lager
vermindert wird, ingleichen von den Gerätschaften, welche sich durch den Gebrauch
abnutzen, muß außerdem noch verhältnismässiger Abzug gemacht werden.“(Barth
1953:279)
”Artikel 31: Bei der Aufnahme des Inventars und der Bilanz sind sämtliche
Vermögensstücke und Forderungen nach dem Werte einzusetzen, welcher ihnen zur Zeit
der Aufnahme beizulegen ist. […]” (Barth 1953:281)
12
The AHGB applied to every businessman but not to limited companies (Aktiengesellschaft,
AG), since the rules within the concession system, whereby each proposed limited company
was reviewed before receiving a concession, were thought to provide sufficient control.
Following a reform in 1870, limited companies were for the first time subjected to uniform
laws in entire Germany. These rules were included in the AHGB. Detailed rules on valuation
were, however, not included something which, together with a received practice of valuation
based on real (current) value, led to almost fatal consequences in the sense that overvalued
assets promoted an expansion which in many cases was followed by bankruptcies.
The first attack on this valuation approach came from those parts of industry that mainly used
fixed assets. Together with the disappointing experiences from using sales value, the result
was that, in Aktiennovelle 1884, the acquisition value was declared to be the highest value,
not only for fixed assets, but also for current assets12. Herman Veit Simon (1886) made after
the introduction of the act an attempt to present a theoretical justification for a valuation
based on acquisition value. He maintained that the cost of acquisition was applicable to every
type of business and explained depreciation in terms of allocation of the acquisition cost over
time.
In the 1884 act, rules with the purpose of protecting the creditor were included, but the act
was mainly a codification of established practice after Gründerjahre. Schneider (Schneider
1995:133) points out that with the 1884 act, almost all of the financial accounting principles
relating to the measurement of income were established. He mentions as examples the
recognition of intangible assets only in cases where they could be sold separately and the
recognition of expected losses.
Most of the accounting regulations in the Companies Act of 1884 and in the GmbH Act of
1892 were transferred to the new commercial code of 1897 that, in turn, remained with
amendments in force until 1985. The 1897 act was the first where reference was made to
Grundsätze ordnungsmäßiger Buchführung (Ballwieser 2000)
Fiscal legislation
Although commercial accounts have very earlier played a part in taxation of e.g. property, and
undervaluation consequently was to be expected, it was not until the 19th century that a closer
link was established between accounting and taxation. At the beginning of the 19th century,
taxation was, however, in the hands of the Länder, which meant that principles varied
between different parts of Germany. Prussia introduced a tax law in 1851
(Einkommensteuergesetz, EStG)13, where income was based on comparison between cash
receipts and expenditures (Pfaff and Schröer 1996). Income was estimated by the tax
authorities since a system with self declaration was not in operation at that time. Accounting
”This innovation….owes its adoption to the increasing pace of industrialization, acute
demand for capital and some disastrous experiences with overvaluation of
assets”(Ballwieser 2000)
13 Business income can be taxed in three different ways in Germany: Einkommensteuer and
Körperschaftsteuer is the tax paid to the state and das Land and Gewerbesteuer to local
government. A business where at least one physical person has unlimited liability is
subject to Einkommensteuergesetz, whereas limited companies and all other legal juridical
persons without any personal liability are subject to Körperschaftsteuer. All companies are
subject to Gewerbesteuergesetz. The definition of taxable income is by and large the same
and the different tax laws do not affect our subject.
12
13
rules were here not per se involved in the computation of tax, but the tax payer was allowed
to use accounting books as evidence in cases of appeal.
At the basis for the computation of taxable income was “die Quellentheorie” which held that
taxable income was: “… die Summe der Tauschgüter, die einer ohne Schmälerung seines
Stammvermögens in gewisser Zeit verzehren darf.“ (Barth 1955:95)
Changes (increases) in the value of fixed assets were, according to “die Quellentheorie”, not
considered taxable. Taxable income was also computed using an average based on several
years (three years in the case of the 1851 EStG in Prussia). Since taxable income was based
on current assets, the creation of reserves, hidden or otherwise, in fixed assets were not of
interest from a fiscal point of view.
During the last part of the century, the authoritativeness principle (das
Maßgeblichkeitsprinzip) gradually evolved. Saxony and Bremen passed laws in 1874, which
determined that taxable income should be computed based on financial accounts. Prussia
followed suit in 1891 (Ballwieser 2000). At the beginning the principle appeared in two
versions, one where separate tax accounts were prepared, the other version where
“commercial accounts were the basis for calculating taxable profit” (Pfaff and Schröer op.
cit.). In Prussia, the authoritativeness principle meant that accounting rules replaced the
previous cash-based principles hitherto used in taxation. Further, “Die Quellentheorie” was
replaced by “die Reinvermögenszugangstheorie” which held that: “… Einkommen ist alles
das, über das im Laufe des Zeitabschnittes verfügt werden konnte.“ (Barth op. cit.:97) 14
These changes were facilitated by the fact that although die Aktienrechtsnovelle of 1884 did
not allow “die alte Einnahmen- und Ausgabenrechnung” (the old receipt and expenditure
basis), it prescribed acquisition value or production value as the highest value for assets.
Since the prudence principle was also accepted, tax authorities assumed and warned against
that taxable income consequently would be understated. The use of accounting as the basis for
taxation certainly meant that hidden and untaxed reserves could be created.
The period 1898-1937, until the Companies Act 1937
Commercial legislation
Within the above-mentioned framework, an orderly development of the balance sheet
continued until the outbreak of the First World War. A considerable change took place during
and after the war, especially during the hyper-inflationary years. The topic most intensely
discussed was Bilanzwahrheit. Those who were against hidden reserves maintained that a true
balance sheet must not include such reserves. A commission for burning problems within
company law, established at the Deutsche Juristentag 1926, came in their analysis of balance
sheet problems to the conclusion that hidden reserves were the crucial point. If such reserves
were thought to be necessary, it followed that the balance sheet only to a limited extent could
provide insights into the wealth of the company. Even so, the majority of the commission
agreed that the formation of hidden reserves should not be restricted. The conclusive reason
14
The difference between Quellentheorie and Reinvermögenstheorie can be described in the
following way: “Für die Reinvermögenstheorie ist …..vor allem auch die Wertänderung
am ruhenden Vermögen Einkommen oder Minuseinkommen. Für die Quellentheorie hat
eine Wertänderung der Quellen nichts mit dem Einkommen zu tun.“ (Schmidt)
14
for this was that it was impossible to form hidden reserves without sooner or later having to
distribute them as dividends. Even the member of the commission who opposed hidden
reserves admitted that a ban was feasible only if the right of the shareholders' meeting to
distribute profits or reserves was substantially restricted. On the whole, the commission
considered it very difficult to establish the point where the conservative valuation ended and
where the hidden reserves began, and it considered the constant remarks on the misuse of
hidden reserves exaggerated.
The Justice Department published a draft to a new Companies Act in 1930. One idea was that
the company was not only of interest to the shareholder but also to the general society. The
prototypes for increased openness were the laws in the USA and Great Britain. The
information given to the shareholders should not only comply with the law but also be in
correspondence with a conscientious and faithful accounting. The question of a change in
valuation principles was also brought up, but it did not result in any proposal for new
valuation principles. Neither did the draft include any attempt to prescribe richtige
Wertansätze (true values) that was the concept within the tax law.
No theoretical reason was given for the proposed valuation approach. In a short remark it was
noted that fixed assets should henceforth be valued at acquisition or production cost less
depreciation, and that current assets should be valued at the lower of cost or market.
Depreciation should correspond to the amount that was allocated to the period in question,
using an orderly allocation over the service life. In this context, a reference was made to the
tax law and a possible future adjustment to this law.
Regarding valuation, the proposal was limited to an extension of existing law. The regulations
were primarily based on what was considered an appropriate attempt to prevent dividends
from over-valuations of assets, so that the paid-in capital was maintained. The changes were
considered to focus a correct measurement of income at the expense of a true balance sheet.
After numerous suggestions had been put forward, the entire process resulted in regulations
known as Die kleine Aktienrechtsreform in 1931. This reform did little to restrict the
formation of reserves. If assets were capitalized, they could be entered at very low values.
Spoerer (1998) gives the follwing example from 1934:
Assets
Fixed assets
Current assets
Balance sheet total
Liabilities
7 Subscribed capital
9,445,384 Legal reserve
Revenue reserves
Provisions
Other liabilities
Net income for the year
9,445,391
5,000,000
1,060,938
805,261
320,267
1,007,368
1,252,557
9,445,391
Table 1: The disclosed balance sheet of P. Beiersdorf AG, Hamburg, 31 december 1934
(quoted in Spoerer 1998.)
In 1934 the government decided to limited dividends to 6%. Dividends in excess of this were
to be paid into a blocked account. Most firms and shareholders restricted their dividends
accordingly.
15
The Akademie für Deutsches Recht formed a committee for company law, and the work of
this committee led to the Companies Act of 1937. Despite many attacks on the valuation
rules, they remained unchanged. The committee energetically opposed all economictheoretical proposals for change, among them Fritz Schmidt's organic approach to the balance
sheet.
Through the Companies Act of 1937, the balance sheet had for the time being found its form.
The principles of valuation had more or less been taken over from the regulation in 1931 and
the draft from 1930. These principles had again and again been under attack from e.g.
Schmidt and Schmalenbach. The lawmaker had, however, decided to reject these ideas. It
therefore meant that management was given the right to create reserves without any
restriction.
Fiscal legislation
The authoritativeness principle was to acquire the status of generally accepted principle in
entire Germany with the EStG15 of 1920 and the EStG of 1925. The EStG of 1920 stated that
principles of proper bookkeeping had to be applied. It also established, however, that tax rules
sometimes were to have priority over accounting rules. Tax accounts were more and more
seen as separate from commercial accounts, and taxable profit would be a measure of the
basic economic ability of the taxpayer. Tax accounts were to establish “real profit” instead of
the low profit that resulted from the application of the prudence principle.
In the EStG of 1925, further tax accounting rules were introduced. Valuation should be based
on acquisition cost or market value. The fiscal rules acted as a restriction on commercial
accounting, and deliberate undervaluation below fair market value, and the concomitant
creation of hidden reserves, was not seen as being acceptable for tax purposes:
“Deliberate undervaluations in the commercial accounts i.e. below fair
market value was not seen as being acceptable for tax purposes and were
viewed as too pessimistic.”(Pfaff and Schröer 1996)
The EStG of 1934 attempted to align taxable and commercial profit. On the one hand, a
company should not be required to show a higher profit for tax purposes than for commercial
purposes, thus options exercised in the accounts had to be taken to the tax accounts as well.
On the other hand, it should not be allowed to show a lower profit. The value of an asset
should be based on acquisition cost or a possible lower value used in the commercial
accounts. (Pfaff and Schröer op. cit.).
However, in 1934 the Nazis did not want capital to be allocated on a purely economic basis
and therefore in the EStG of 1934 introduced changes which would facilitate self-financing.
One such method was that an immediate write-off for acquired machinery with a service life
of less than 5 years was made permissible (Spoerer 1998).
15
Einkommensteuergesetz
16
The period 1938 – 1984
Commercial legislation
The valuation rules in the act of 1937 were limited to prescribing the highest value that was
allowed for fixed assets and current assets. This act did not, however, contain any explicit
rules defining a lowest acceptable value for assets. Such a value had to be deduced from the
GoB (Grundsätze ordnungsmäßiger Buchführung). The practical importance of this was
insignificant, since the problem of whether a too low a value had been used should be judged
in terms of unwarranted conservatism. The highest value was determined as to protect the
creditors; the rules should limit the amount that could be distributed to owners as dividends.
From a juridical point of view, the formation of hidden reserves seems to have been accepted:
”… doch gehen die Stellungsnehmen der meisten juristischen Autoren der neueren
Zeit … .im Ergebnis dahin, daß zum mindestens die Aktivposten nahezu beliebig
unter den gesetzlichen Höchstwerten angesetzt werden können.“ (Pohmer 1953)
In 1959, a governmental draft for a new companies act disagreed for the first time with the
existing tradition. It was considered that the shareholders' legitimate claim for dividends was
unduly restricted through the formation and liquidation of reserves without control. Such
reserves could be detrimental to the possibilities of gaining insight into a company's financial
position, something that could be bad for shareholders as well as for the entire economy.
The rules for valuation, in accordance with the rules for the distribution of profit, are, together
with the regulations for company groups, considered to be the most important new features in
the Companies Act of 1965. One important purpose was to restrain management’s discretion
to create hidden reserves (Ballwieser 2000). The reason for this was an intention to clearly
manifest the position of the shareholder, namely that of the company's economic owner. In
this way the new act, for the first time in German history of company law, served the interest
of creditors as well as that of owners (the creditor's position having been established already
in 1884). The valuation rules requiring a specific valuation approach and defined methods of
depreciation and valuation would preclude conditional valuation, particularly an uncontrolled
formation and liquidation of hidden reserves—something that would improve the
informational content of annual reports. Furthermore, the regulations were to make it possible
to make comparisons between two consecutive annual reports and to guarantee that nobody
could infringe upon the shareholders' rights to the profits of the company.
The valuation rules in the new act permitted alternative valuation approaches e.g. for
inventories. According to the principle of method specificity, each possible valuation
approach was tied to specific valuation or depreciation methods. Within this framework, the
choice of method was, however, left to the management according to the principle of freedom
of method. Consequently, the value to be used did in many cases not directly emerge from the
act, but from the chosen valuation rules within the framework of the act. This left
considerable degrees of freedom. The new feature of the law was that henceforth it was not
allowed to use values below the valuation categories in order to form reserves. Low values for
17
tax purposes were, however, admitted in the commercial accounts as well (Pfaff and Schröer
1996).
In the final text, no definitive opinion was expressed as to whether hidden reserves were
allowed or not. Adler, Düring, and Schmaltz (1968) maintain that through the freedom of
choosing method and valuation approach and the valuation span admitted, hidden reserves
were indirectly accepted.16
The EC-directives in accounting were introduced in Germany through the BilanzrichtlinienGesetz (BiriliG). It was passed in 1985 and took effect at the beginning of 1986. Since
particularly the content of the 4th directive is strongly influenced by German company law,
the introduction led only to minor changes for German companies.17 Consequently this meant
a continuation of the situation in 1965. One of the issues that were discussed was that of tax
neutrality. Since the commercial balance sheet determines the tax balance sheet, changes in
the former would effect the latter. It was, however, undisputed that the implementation of the
4th directive shouldn't be allowed to increase the tax burden.
Fiscal legislation
After the Second World War, the authoritativeness principle was used to create a reverse
linkage (Umkehrmaßgeblichkeit) between commercial accounting and tax accounting for
certain items. This meant that accounting procedures were more and more guided by
(optional) tax rules. These rules came to permit even lower values than what would otherwise
be used in the commercial accounts. In 1965, this practice was codified in the commercial
legislation in the Companies Act. Apart from the specific items mentioned above, the 1965
Act marked an end to untaxed hidden reserves in assets. Such reserves do, however, still exist
but have now been replaced by Rückstellungen (provisions).
During the preparation of the new tax act, EStG 1974, a suggestion was made to separate
commercial and tax accounts, giving the latter an independent status. This proposal was,
however, not accepted, which mean that the implementation of the EC Accounting Directives
did not lead to any further decoupling of the two sets of accounts.18
The period 1985 –
Both Haller and Busse von Colbe point out that although unlimited under-valuation of
assets no longer were allowed, this hardly restricted the available valuation span. Put in
this way: while hidden reserves mainly were formed by under-valuation within the context
of the act of 1937, the act of 1965 gave a possibility to form hidden reserves through overvaluation of provisions.
17 The accounting rules changed primarily for the GmbH.
18 The present tax reform, which was enacted 14th of July 2000 is a further step towards a
seperation:
”Das Steuerentlastungsgesetz enthält eine Reihe von Sondervorschriften für die
Steuerbilanz, die zukünftig zu einem weitgehenden Auseinanderfallen von Handels- und
steuerbilanz führen werden......Im Zusammenhang mit bereits bei früheren
Gesätzänderungen eingeführten Vorschriften....wird durch die im Steuerentlastungsgesetz
erfolgten Neureglungen das Vorsichtsprinzip und das Imparitätsprinzip für den Bereich
der Steuerbilanz wesentlich eingeschränkt.“ (Günkel and Fenzl 2000)
16
18
Commercial legislation
The EC-directives in accounting were introduced in Germany through the BilanzrichtlinienGesetz (BiriliG). It was passed in 1985 and took effect at the beginning of 1986. Since
particularly the content of the 4th directive is strongly influenced by German company law,
the introduction led only to minor changes for German companies.19 Consequently this meant
a continuation of the situation in 1965.
The valuation rules in the act of 1985 prescribe acquisition or production cost as the upper
limits for fixed depreciable and non-depreciable assets and for current assets (Ballwieser
2000). According to the act, lower values are necessary or optional in particular
circumstances. Fixed assets with a limited service life must be depreciated systematically e.g.
through a straight-line model. All fixed assets must be further written down to a lower value if
a decrease in value at the end of the financial year is thought to be lasting. Current assets are
to be valued at the lower of cost or market. They may be written down further if it in
accordance with sound business judgement (im Rahmen vernünftiger kaufmännischer
Beurteilung) is thought necessary in order to prevent that der Wertansatz may have to be
changed in the near future as a result of changing values. According to Ballwieser, such a
write-down is often seen as a departure from the principle that the balance sheet shows dated
values of the assets.
Finally, as a result of the Umkehrmaßgeblichkeit, both fixed assets and current assets may be
reported at the lower value, which results from an application of the tax law. Such is the case
for e.g. investments in fixed assets that serve to protect the environment, which are subject to
a tax incentive to amortize 60% in the year of purchase. These lower values are required in
the commercial accounts in order to obtain the corresponding tax deductions. However, this
additional decrease in the accounted value may be shown as a special item with a reserve
component (Sonderpost mit Rücklageanteil). In the balance sheet this item appears as part of
owners’ equity instead of as a lower value for the asset in question.
Fiscal legislation
One of the issues that were discussed, when the 4th EC-directive was introduced through the
BiriliG, was that of tax neutrality. Since the commercial balance sheet determines the tax
balance sheet, changes in the former would effect the latter. It was, however, undisputed that
the implementation of that directive shouldn't be allowed to increase the tax burden. Further,
according to Ballwieser (2000), though there is much dispute about whether the combined
income determination for commercial and tax purposes makes sense, the lawmakers left no
doubt that the combination was essential when the HGB was amended in line with the
directive.
For internally produced fixed or current assets, the lower limit of production cost, according
to the HGB, is only: direct material costs + direct manufacturing costs + direct special
manufacturing costs (Ballwieser 2000). For tax purposes, the relevant material and
manufacturing overheads and depreciation of fixed assets have to be included in production
cost.
For the systematic depreciation of depreciable fixed assets, the tax authorities, in conjunction
with industry associations have drawn up depreciation tables that list average useful lives for
all conceivable classes of depreciable assets other than buildings. (For buildings and separate
19
The accounting rules changed primarily for the GmbH.
19
parts of buildings, depreciation rates are given in the EStG.) To simplify matters, the average
useful lives in the tables are often also used in commercial accounting, but it is necessary to
check whether these estimated service lives are consistent with the conservative estimate
necessary for commercial accounting. Depreciable movable fixed assets with an acquisition
cost not exceeding DM 800 need not be capitalised.
One instance where a lower value in the commercial accounts is driven by fiscal
requirements, concerns the tax concept of Teilwert, which is defined as “the amount that the
purchaser of the whole enterprise would pay for an individual item.” (Ballwieser 2000). The
idea behind this concept is that a fictitious price for the whole company can be apportioned to
its different assets and the rule is that no asset must be valued above its relative part of the
total price.
7. Contrastive analysis
A Parallel perspective
During the last part of the 19th century, no generally accepted valuation principles seem to
have been established among Swedish companies. The dominant practice appears to have
been valuation at current cost, which meant acquisition or production cost with the occasional
use of exit prices. The practice of depreciating fixed assets was gaining wider acceptance,
having been used by individual companies as early as in the 17th century. The saw mills
appear to have chosen a more conservative approach, valuing their inventories lower than
production cost. This was presumably caused by the changing market prices of their products
and a subsequent desire to hedge against fluctuation in prices. No evidence is found to
suggest that accounts were prepared backwards, using reserves to produce a profit figure
suitable for basing dividends.
This situation continued a decade into the 20th century. Sweden had during this period no law
requiring publication of annual accounts and no laws containing valuation rules. Taxation was
not uniform in the country, and, anyhow, financial accounting was not the basis for it.
In the case of Germany, one has to remember that Germany as such, did not exist until the
later part of the 19th century and that consequently all rule making previous to that was in the
hands of the different states like Prussia, Saxony etc. After the formation of Germany in 1871,
the rules from the end of the 19th century are markedly dominated by the experience from the
first years, die Gründerjahre. A lack of rules defining the highest admissible value for assets
led to exaggerated values in financial accounts and ensuing bankruptcies. This experience has
more than anything else formed the basis of an overriding ambition in German financial
accounting to protect the creditors, an ambition which is still strong today. Within taxation,
the principle that laid down that tax should be based on the financial accounts, the
authoritativeness principle (das Maßgeblichkeitsprinzip), was established during these years
Tax authorities expressed concerns that the lack of a defined lowest admissible value would
lead to the creation of hidden reserves and a subsequent loss of tax revenue. These concerns
seem to have been well founded.
In 1910 a new Companies Act was passed in Sweden. The act contained rules on the
valuation of assets with the purpose of preventing overvaluation i.e. rules giving the highest
admissible value. For current assets this was the lower of cost or market and fixed assets were
to be subjected to depreciation. No rules on lowest admissible value were included. In essence
20
the rules and the arguments echoed the German ones from the end of the previous century. In
1928 the first uniform tax system was introduced and taxation was to be based on the
financial accounts. The accounting rules, as in Germany, led to the formation of large hidden
reserves. Although the ambition of the Company Act of 1944 was to promote increased
openness, no attempt was made to restrict hidden reserves. Instead, unemployment in the
Swedish economy at the beginning of the 30s was seen as an argument for creating financially
strong companies. In this spirit and also influenced by Keynesian economics, specific rules,
so-called unrestricted depreciation, allowing machinery and equipment to be carried at a
value of 0 or 1 krona were introduced in 1938.
In Germany the policy of allowing the creation of large hidden reserves in financial accounts
was continued in Die kleine Aktienrechtsreform of 1931 and the Companies Act of 1937. Still
the laws contained rules for the highest admissible value, but gave no limit downwards. Tax
laws passed in 1920 and 1925 took, however, a more restricted view, introducing special rules
for tax purposes where creation of hidden reserves was not seen as permissible. The tax law
of 1925 led to what was later known as the Steuerbilanz (tax balance sheet). The tax law of
1934 changed this somewhat since the Nazis introduced concessions e.g. immediate writeoffs for machinery and equipment, which would promote self-financing. The rules limiting
dividends also had a downward effect on published profits. Divergence between rules for
accounting and taxation gave rise to differences in profit figures. Spoerer (1998) gives an
example of a company where the reported financial profits in the financial accounts for the
years at the end of the 30s amount to only a third of taxable profits.
After the 2nd World War, Swedish companies, not having been exposed to the war, made large
profits that could be more or less directly offset by the formation of reserves. In a directive to
a committee appointed to revise tax law at the beginning of the 50s, the minister expressed
that hidden reserves had negative effects inter alia destabilising business cycles and
promoting speculation in inventories. A revision of the tax law 1955 limited the extent of
hidden reserves in machinery/equipment and inventories by defining the lowest acceptable
value for tax purposes. LIFO was disallowed but the scope for reserves still remained
substantial. The law also introduced a reverse linkage in the sense that companies also had to
use the (favourable) tax rules in their financial accounting if they wanted the write-downs to
be tax deductible. During the late 50s and the 60s an increasing number of companies
furthermore started voluntarily to disclose both amounts and changes in the reserves in their
financial accounts. One important reason for this was presumably the greater role played by
the markets for capital, both nationally and internationally. The practice was later codified in
the Companies Act of 1975 and the Accounting Act of 1976, which stipulated that both
untaxed reserves and changes therein should be made public. At the beginning of the 90s, tax
deductible reserves in inventories were abolished and the Annual Accounts Act from 1997, a
consequence of the 4th EG directive, meant that rules on highest value were replaced by rules
specifying the value at which an asset can be reported.
The debate on hidden reserves in Germany, with the participation of both Schmidt and
Schmalenbach, led finally to an attempt to restrict the hidden reserves in 1965 when new
specific valuation rules were introduced as part of the Companies Act. The effect of the rules
was to abandon the idea of highest and lowest value in favour of specific valuation
techniques. However, the design of these techniques, together with tax regulations in certain
cases permitting lower values, still leads to reserves being maintained.
At the beginning of the new millenium, hidden reserves, in the sense we have used the
concept in this paper (cf p 6), have officially disappeared in Sweden. A method to defer taxes
uses fixed assets as its computational basis, but the amount thus determined is not included in
21
the book value of the assets. Germany is apparently going through the same development, but
in a somewhat slower pace. What used to known as Willkürreserven i.e. reserves created by
management in order not to report a fair value, is no longer an option. However, both reserves
based on estimation of future values and obligations (Schätzreserven or Schätzrücklagen), and
reserves created using tax law (Steuerreserven or Steuerrücklagen), still gives management a
certain room for choosing values.
In a comparison between Sweden and Germany, one may observe that Swedish lawmaking at
the beginning of the 20th century to a large extent seems to have been influenced by German
laws which were introduced some decades earlier. At the middle of the last century, Swedish
companies voluntarily disclosed their hidden reserves, something that did not take place in
Germany. A stronger German tradition of institutionalised secretiveness seems to have
slowed down a process of increased openness.
It may finally be observed that both in Sweden and Germany, taxation and dividends are
based on the individual company’s accounts and not on group accounts (d'Arcy 2000),
something which is not the case e.g. in the US.
A Stakeholder perspective
As can be seen from the preceding account, there is both similarity and difference between
the development of hidden reserves in Sweden and Germany, the basic similarity being of
course that such reserves have been both accepted and supported.
One fundamental reason behind the similarity in accepting hidden reserves has presumably to
do with the conception of the enterprise in both Sweden and Germany. In both countries
companies have been regarded as social entities:
“In Germany and in other ….countries, /the enterprise/ is seen not just as
an economic but as a social entity, in itself worth maintaining over the long
term (the stakeholder perspective). In the United States, by contrast, it is
regarded purely as an investment object (the shareholder
perspective).”(Ordelheide and Pfaff 1994)
Such a perspective have motivated governments (and parliaments) in both Germany and
Sweden to pass laws which permit profit to be concealed and therefore not leading to cash
being distributed in the form of dividends or taxes. For governments, the economic policy
interest has dominated over the taxation interest. In Sweden, the policy of the social
democratic government, which held power during the entire peak period for hidden reserves,
has been to promote financially strong companies that could be a remedy against
unemployment in periods of economic recession. Obviously, governments in Germany,
although at times with different political ideologies, have shared the same interest. Added to
this, the importance attached to protection of the creditor, given the experience from die
Gründerjahre, has had an enormous importance in Germany.
”Das wichtigste Anliegen der Aktiennovelle war, die Aufbringung des
Kapitals bei der Gründung der Aktiengesellschaft sicherzustellen und es
auch für die Folgezeit durch eingehende Vorschriften wenigstens insoweit
unverkürzt zu erhalten, als dies durch gesetzliche Maßnahmen erreicht
werden konnte.“ (Barth 1955)
22
Many researchers point out that the champion for hidden reserves is the management of the
companies:
“…die meisten Unternehmer betrachten die stillen Reserven als ein
wichtiges und unentbehrliches Instrument ihrer Betriebspolitik:“ (Kalveram
1950)
“…ein Verbot stiller Reserven den Intressen der Firmenleitungen
widersprich.:”(Schneider 1981)
From a principal-agent perspective, it is easy to understand that management can improve its
relative power position by trying to use discretionary valuation principles. If profits can be
locked in and not distributed to shareholders as dividends or as taxes, the company is made
more self-sufficient and is less dependent upon external financing. In turn this means that
funds at management’s disposition can be used in way that is not restricted by external
requirements and at a lesser cost of capital. Both the Swedish and German government
supported for a long time such a management interest.
“Most companies regard self-financing and debt-financing as more
important than adding to the equity by increasing share capital. Selffinancing leaves the management of large enterprises with greater freedom
of action than raising equity capital on the organized capital
markets.”(Ballwieser 2000)
The interest to conceal profits is further motivated internally by preventing excessive wage
demands. In the middle 70s when Swedish companies had made very large profits that could
not be concealed, they were confronted with high demands for wage increases from the
unions. The government then stepped in and created a new untaxed reserve, which allowed
the money to remain in the companies.
It is an open question how much such an interest can be influenced by the principal through
incentives tied to reported profit. Neither Sweden nor Germany is known for the widespread
use of profit-based bonuses for management. The use of hidden reserves can therefore not be
interpreted as an income smoothing method, since the idea of income smoothing is based on
the assumption that management is reimbursed in relation to stockmarket value, which in turn
is thought to reflect reported profit.
While it is relatively easy to understand the economic-political interest of governments and
the power perspective of management in the creation of hidden reserves, what remains to
understand is why shareholders accepted it:
“Why did shareholders….not exert stronger pressure on firms to improve
their financial disclosure standards…?”(Spoerer 1998)
According to Spoerer “It has never been satisfactorily explained why…”. The story
is somewhat different in Sweden and in Germany.
At the end of 19th century, large Swedish enterprises were still owned and managed by
families and consequently there existed no lack of information on the part of the shareholders.
When new categories of shareholders appeared in the first half of 20th century, taxation rules
made it advantageous for shareholders not to demand dividends since these were taxed twice.
Instead it was better to hope for an increased value of the shares by letting profits remain in
23
the company and facing a much more benevolent capital gains tax when shares were sold.
Since the middle of the last century, the information on hidden reserves has been available in
the annual accounts. If we are to believe in the semi-strong version of the efficient market
hypothesis, it really does not matter where and how the information is published as long as it
is available.20
According to Spoerer German shareholders have occasionally tried to demand a better
financial disclosure e.g. in the case of AEG in 1928. However, these attempts failed, as did
the arguments by business economists for more transparency.
The usual explanation offered for the weak influence of shareholders in Germany has to do
with the role of the large banks, which seem to have played a more active role in the
companies than in other countries. By demanding membership in the boards of the companies
they were in a position to be well informed and thereby protecting their stakes. Furthermore,
the banks held the proxy voting rights of some of the shareholders.
“Since banks as influential creditors are able to keep themselves well
informed by virtue of the seats they hold on supervisory boards, they seem
to be well placed, too. Their position is strengthened further by proxy
voting, which allows them a say in business policy.”(Ballwieser 2000)
Given the close contact between companies and banks, if the companies needed capital in
excess of the self-financing provided by the hidden reserves, they were not dependent on the
national stockmarket or the international capital market.
In the final analysis, even though it was not a system where “…everybody was happy with
it.” (Spoerer 1998), both in Sweden and Germany stakeholders enacted an institutionalised
structure that was, at the time, advantageous to at least the most influential of them. The
system was at the beginning rather closed and we can see it opening up at the end of the 20th
century with Swedish accounting being somewhat more transparent than its German
counterpart.
20
”Der Bewertungsmechanismus des Kapitalmarkts ließe sich durch buchtechnische Manöver
nicht verändern.” (Schneider 1981)
24
Selected list of references:
Adler, H, Düring, W, and Schmaltz, K. 1968. Rechnungslegung und Prüfung der
Aktiengesellschaft, Band 1. Stuttgart: C E Poeschel Verlag.
d'Arcy, A. 2000. The degree of determination of national accounting systems - an empirical
investigation. Schmalenbach Business Review Vol. 52, Jan: 45-67.
Ballwieser, W. 2000. GERMANY - Individual Accounts. In Transnational Accounting,
Ordelheide, D. 1395-1546. London: Macmillan (forthcoming).
Barth, K. 1953. Die Entwicklung des deutschen Bilanzrechts. Band I Handelsrechtlich.
Stuttgart: Selbstverlag des Verfassers.
Barth, K. 1955. Die Entwicklung des deutschen Bilanzrechts. Band II Steuerrecht, Teilband I.
Stuttgart: Selbstverlag des Verfassers.
Beeny, J H. 1975. European Financial Reporting. Vol. 1 West Germany vols. London: The
Institute of Chartered Accountants in England and Wales.
Carnegie, G D, and C J Napier. 2000. Exploring Comparative International Accounting
History: Nineteenth Century Accounts of Agriculture, 23rd Annual Congress of European
Accounting Association.
Choi, F, and Mueller, G. 1984. International Accounting. Englewood Cliffs, N.J.: PrenticeHall.
Dahlgren, J, and Nilsson, S-A. 1996. The Rise and Fall of Hidden Reserves in Swedish
Accounting. Lund, Institute of Economic Research.
Guba, E G, and Y S Lincoln. 1989. Fourth Generation Evaluation. Newbury Park, CA: Sage
Publications.
Günkel, M, and B Fenzl. 2000. Ausgewählte Fragen zum Steuerentlastungsgesetz:
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