Following a public consultation that the Finance Ministry had promoted on the implementation in Italy of the Directive 2013/34/EU on annual and consolidated financial statements and related reports, the Italian Government has recently issued (May 2015) the Legislative Decree n. 171 draft containing modifications to the current legislation that will affect the domestic framework on accounting and audit requirements. The document, which is currently under examination by the Parliament, contains many innovative elements; the most relevant will be commented and analyzed in the present article.
The main innovation that the Decree will introduce consists of an obligation, imposed on large undertakings and public-interest entities operating in the extractive industry or the logging of primary forests, to prepare and publish an annual report on payments made to governments (or any other entity or authority governed by a State). Such obligation, which is imposed only if the total annual sum of payments to governments is higher than Euros 100.000, is meant to establish full transparency on payments made by companies to governments of those countries where the company has the concession to extract or use natural resources; specifically, those public entities receiving payments from large companies and public-interest entities will have to report on their specific utilization to their citizens, thus ensuring a transparent communication on the inflows and outflows of payments of certain State-owned or governed bodies. The report shall contain the total amount of payments made to each government, detailing it by type and project, and the payments disclosed must be presented reflecting the substance over the form, avoiding artificial aggregations or groupings.
Entities falling under the provision of this Decree, will have to publish this report in the Companies Registry Book together with the annual financial statement; the company’s Directors have full responsibility on the preparation, presentation and publication of such report, which also needs to be accompanied by a specific audit report (different from the one disciplined by Legislative Decree n. 39/2010) in order to assess its compliance to the applicable framework.
Other important elements introduced by the new Decree will have an impact on the Civil Code, specifically in the Chapter related to accounting and audit requirements of Companies; the most important changes will be now analyzed and commented, together with the indication of the specific article of the Directive that has imposed the modification.
Own shares acquisition (Article 10). The acquisition of own shares shall be recorded in the accounting books by reducing the net capital of the corresponding amount and registering a negative amount in the balance sheet. This is the new requirement that modified article 2357-ter will impose, thus changing the existing discipline that allows the recording of own shares acquired in the fixed asset section of the balance sheet. Consequently, articles 2424 and 2424-bis will also be modified.
Cash flow statement (Article 4). The Directive states that the minimum set of documentation that composes a financial statement is made up of a balance sheet, a profit and loss account and notes to the financial statement. In addition, it allows Member States to require additional statements to all those entities that do not fall under the classification of small undertakings; consequently, Legislative Decree n. 171 draft has opted for the introduction of the cash flow statement as the additional report to be presented with the financial statement, as already imposed to listed companies. Modified article 2423 (first paragraph) will therefore state that financial statements are made up of balance sheet, profit and loss account, cash flow statement and notes to the financial statement. The composition of the cash flow statement is contained in the new article 2425-ter, which explains that such statement will report on the movements and composition of cash and cash equivalents, as well as on the cash flows deriving from operations, investments, financings and transactions involving shareholders. The cash flow statement will have to be presented for both the current and the previous year.
Materiality (Article 6.1.j). The Legislative Decree draft introduces the new principle of materiality on the basis of which, with reference to recognition, measurement, presentation and disclosure, entities do not need to comply with the requirements set out in the applicable legislation when the effect of complying is immaterial. Such new principle will modify article 2423 by introducing a new paragraph (number 4), which also requires entities to disclose the criteria used to apply the materiality principle. In addition, the article stresses the importance of respecting the general standards and rules in order to ensure a correct bookkeeping and accounting process.
With respect to the original provisions set out in the Directive, the Legislative Decree draft has not made any reference to the consolidation process, which is on the contrary included in the Directive as one of the activities in relation to which the materiality principle should apply.
Based on the introduction of the concept of materiality, some articles or paragraphs in the Civil Code which currently contain similar provisions (often unclear or ambiguous), will either be repealed or modified. As an example, article 2426, paragraph 1.12 related to tangibles and stock constantly renovated whose amount is immaterial with respect to the total balance sheet, currently states that those elements can be recorded at a fixed value; such article will be repealed.
Substance of the transaction (Article 6.1.h). Article 2423-bis, paragraph 1.1 related to the evaluation of items based on the “economic function of the balance sheet element under consideration”, expresses a general principle that has always led to misunderstanding and misinterpretation. Directive 2013/34/EU focuses on the importance of accounting for and presenting items in the balance sheet or profit and loss having regard to the substance of the transaction or arrangement concerned, therefore stressing the importance of the correct interpretation of the underlying contract or agreement giving rise to items that need to be recorded. However, the same article at paragraph 6.3 allows Member States to exempt entities to apply the requirements of article 6.1.h. Such exemption has not been applied by the Italian legislator, that has in fact taken the opportunity to modify the existing article 2423-bis, eliminating any reference to the aforementioned “economic function” and introducing the new paragraph 1-bis, in which the substance of the operation or the agreement constitutes the key element of accounting for and presenting items in the financial statement.
Fair value measurement (Article 8). The Directive specifically aims at strengthening the fair value measurement to those items representing financial instruments, including derivatives, as well as other categories or assets; the article allows Member States to either permit or require such application, which is extended to all categories of undertakings. With the intention of embracing a consolidated international approach on the evaluation of financial instruments, Legislative Decree draft has imposed the application of fair value measurement to all items representing derivatives, even if embedded in another financial instrument, through the new sub-paragraph 11-bis of article 2426. Such new sub-paragraph also establishes that changes in the fair value must be included in the profit and loss account if the item it relates to is included in the financial statement, while it should be accounted for in the fair value reserve if it refers to future operations or financial flows. In the second scenario, when the real effects of the operation occur, the gain or loss will be included in the profit and loss. In case of non-hedging financial instruments, relative gains are included in a non-distributable fair value reserve.
The second paragraph introduced in the article 2426 states that definition of terms such as financial instruments, derivatives, fair value, financial asset and financial liability relates to the meaning and explications found in the International Accounting Standard set, thus significantly bringing the Italian accounting discipline closer to the International accounting framework.
In relation to commodity-based contracts that give either contracting party the right to settle in cash or some other financial instrument, new paragraph 3 of article 2426 introduces the provisions set out by article 8.2 of the Directive, that considers them as financial instruments, except where such contracts were entered into and continue to meet the undertaking’s expected purchase, sale or usage requirements at the time they were entered into and subsequently, were designated as commodity-based contracts at their inception, and are expected to be settled by delivery of the commodity.
One of the most interesting modifications in the domestic discipline refers to new paragraphs 4 and 5 of article 2426, related to article 8.7 of the Directive, which specifically establishes that fair value measurement of a financial instrument must be carried out with reference to the market value (if a reliable market value can be identified), or alternatively to the value of its components or a similar instrument. If a market value is not available, fair value measurement should be based on generally accepted valuation model or techniques that approximate the market value, and exhaustive explanation shall be disclosed in the notes to the financial statement. If those measurements cannot be reliably put in place, fair value cannot be determined. The provisions contained in this new paragraph clearly relate to the indication and rules contained in the International Accounting Standards (specifically in the IFRS 13 which establishes a fair value hierarchy), thus allowing a significant harmonization of the domestic discipline with the current international accounting standards.
In relation to the new requirements and changes on financial instruments, articles 2424 (balance sheet), 2425 (profit and loss account) and 2427-bis (fair value of financial instruments) have consequently been changed.
Smaller undertakings (Article 3 and Article 19). In relation to small undertakings that respect the parameters set out in the article 2435-bis, there is the possibility to present a synthetic financial statement with simplified information and disclosure and the exemption to present the management report. Furthermore, new article 2435-ter introduces the new category of micro undertakings that are exempted from presenting the cash flow statement, the management report and the notes to the financial statement if relevant information pursuant to article 2427 paragraphs 9 and 16 are reported at the bottom of the balance sheet.
Dimensional limits set out by the Italian Civil Code with reference to small and micro undertakings differ from the parameters established by the European Directive; more specifically, for small undertakings the Italian discipline imposes limits which are slightly higher that the Directive in terms of both balance sheet and turnover, while for micro undertakings the limits set by the Italian discipline are lower for all three criteria (balance sheet, net turnover and average number of employees). In such a situation, Italian companies that would be classified as micro by the European Directive but are in fact small according to the domestic discipline, do not benefit from the exemptions granted to micro undertakings. This situation imposes a domestic burden which is certainly heavier than the European one, thus violating the gold plating rule; perhaps the Legislative Decree draft should be amended in order to align the domestic discipline to the European Directive as to the limits and parameters used to classify the dimensions of companies.
BP&A, Finance and Business Consulting
Co-author of the volume “Codice commentato dei principi contabili internazionali IAS/IFRS“, Maggioli Editore