The European Commission announced in 2000 that, from 2005, all listed companies in member states will have to prepare consolidated accounts in accordance with International Accounting Standards. A number of key issues, however, remain unresolved: the US Securities and Exchange Commission has not yet endorsed IAS, a European endorsement mechanism is yet to be established, and the means to ensure effective enforcement of IAS is undetermined.

At present, compliance with IAS is often still 'creative' or incomplete (see Accountancy, December 2000, pp 104-106 and May 2001, pp 98-99). Some of these issues are interrelated: an effective enforcement infrastructure for IAS is one of the conditions envisaged for the SEC's acceptance of the standards.

It appears from the European Commission's paper, Financial Reporting Strategy: The Way Forward, issued in June 2000, that the Commission wants to delegate enforcement to the member states. However, a study of existing enforcement systems in Europe by the Fédération des Experts Comptables Européens (FEE) - Enforcement Mechanisms in Europe: A Preliminary Investigation of Oversight Systems - published in April, shows that there is a lack of effective enforcement in most member states. Further, the existing mechanisms differ considerably by ranging from securities markets regulators to private sector enforcement systems such as the UK's Financial Reporting Review Panel (FRRP).

FEE perceives a particular strength of the latter to be the sanction of 'naming and shaming' through press notices.

Against this international background, current discussion in Germany is considering different models of enforcement. It is generally assumed that there is a need for enforcement beyond the statutory audit and the oversight function of the supervisory board (staffed by non-executive directors) of public companies. This current discussion results from a desire to improve the corporate governance of German corporations in order to improve investor protection, and therefore the attractiveness of German companies to foreign investors. This is the continuation of a reform process that began in Germany in the mid-1990s in response to pressures from the financial market and industry, and which has gained momentum ever since.

It reflects large German companies' desire to obtain equity finance through listings on international stock exchanges, which requires high-quality, internationally acceptable standards and enforcement mechanisms to be adopted. Therefore, the reform process has involved legislative changes that permit companies with publicly-traded securities to prepare consolidated accounts in accordance with US GAAP or IAS, and opened the way for a private sector German Accounting Standards Committee (GASC) to be formed in 1998.

More recently, the audit was strengthened by the introduction of a peer-review system based on the US model. Finally, a reform of the taxation system appears to be leading to a loosening, if not a severing, of the tie between accounting and taxation rules, which should open the way to fairer, more investororientated reporting.

The creation of an enforcement body can therefore be seen as a logical next step on the way to bringing the German accounting framework up to the standard that international investors expect. Such an enforcement body has been proposed by private sector and governmental working groups.

The most detailed proposal was put forward last year by the Institut der Wirtschaftsprüfer (IDW), the professional body representing auditors in Germany, and enforcement currently remains among the issues occupying the IDW, as reflected in the discussions at the latest IDW symposium in Berlin in September. In line with other interested parties' proposals, the IDW favours an FRRP-type, private sector enforcement body, as opposed to a capital market-based system such as the SEC, because the latter would be contrary to the current German trend towards deregulation and private sector involvement.

According to the IDW's proposals, the remit of this private institution is initially intended to be limited to single company accounts, consolidated accounts and directors' reports of companies whose securities are publicly traded (based on German accounting law or IAS). It is argued that the threat of adverse publicity will be most effective for these companies. Eventually, the institution's scope is likely to be broadened to embrace non-listed companies that exceed specific size criteria.

Similar to the British FRRP, and for resource reasons, it is envisaged that it will be reactive, ie, it will not carry out a review until a case has been brought to its attention. The German body is also expected to have the right to apply for a court order where an offending enterprise does not agree to correct the accounts.

Openness and full disclosure of the process, in the form of an annual report, are envisaged. It is intended that the body should be staffed by representatives from commerce, the user community, the auditing profession and the academic community.

The new body will be required to cooperate with the auditing profession and report to the Wirtschaftsprüferkammer (WPK, the chamber of auditors, which is, inter alia, responsible for disciplining auditors) regarding cases where its findings differ from the audit opinion on the accounts in question.

The IDW's proposal differs from the FRRP model in one important respect: it is assumed that companies will voluntarily correct their accounts in accordance with the enforcement body's findings and publish the amended accounts - the latter will be a requirement for consolidated accounts. However, for single company accounts it is envisaged that corrections can occur, with appropriate explanations and disclosures, in the following year's accounts.

Where the company does not make the appropriate corrections, the enforcement body can apply for a court order. The company would have to make this public through the same channels that would normally be used for publishing accounts. Where it fails to do so, the enforcement body can inform the public. This course of action is, however, considered to be exceptional. Compared with British practice, this places greater emphasis on the companies' right to confidentiality. A vehicle similar to the press notice has not yet been proposed.

Although there is consensus on the need for an FRRP-type enforcement body in Germany, many questions have not been addressed in sufficient detail in the IDW's proposal. These questions include the body's organisational structure, its integration into the German legal system, the selection process for members, the financing of the body, and its integration into a European or even worldwide enforcement system for IAS.

The proposal does not consider the question of how equivalent interpretation and enforcement of IAS on an international level can be achieved. Further, it is questionable whether the proposal contains effective sanctions to encourage better reporting and thus help to improve the reputation of German financial reporting.

Are the sanctions relied on in the UK likely to work in Germany, insofar as it is envisaged that they will be implemented there? Their effectiveness in the UK context has been well documented, eg, by Stella Fearnley et al in A Peculiarly British Institution (published by ABG Professional Information).

The cost of an investigation and of the corrective action required, and the 'naming and shaming' effect of the press notices, play very important roles in this context. The effectiveness of the naming and shaming is clearly a question of culture. It varies between countries and depends on an interest by the media in each case.

In the UK, media coverage of FRRP cases has decreased, and academic research findings on possible adverse market reactions as a result of FRRP investigations appear to be inconclusive. Nevertheless, press notices are regarded as an important feature in the UK enforcement system. It is therefore surprising that the IDW's proposal does not include them.

For single company accounts, the costs of corrections will also be greatly reduced compared to the British system - and therefore be less effective as a sanction - since only an amendment of the comparatives in the following year's accounts is foreseen. It seems, therefore, that the system envisaged by the German IDW lacks teeth.

Further, a more general concern arises with regard to the IDW's proposal to model the German system on the UK's: can an enforcement system developed within one particular legal and cultural context simply be transferred to another? An alternative approach might be to improve the existing enforcement infrastructure instead of importing totally new approaches that have to be grafted on to existing frameworks.

There are a number of differences in existing national infrastructures that would make such a transfer difficult. For example, will an FRRP-type system fit into a regulatory framework based on a Roman law legal system (such as that of Germany and other continental European countries)? Differences in legal systems are related to different cultures and traditions, and these are manifested in the relative influence of the profession, the relationship between accounting and the law, arguments for and against standard-setting, the effectiveness of sanctions, and traditions regarding the enforcement of rules.

Another important issue relates to the existing enforcement systems, and the question of why, and to what extent, they are considered to be insufficient. One of the reasons for introducing the FRRP in the UK was the perceived lack of auditor independence from companies. Is this equally the case outside the UK, or could it be that other countries' corporate governance systems have sufficient safeguards to ensure the quality of financial statements and/or compliance with IAS?

Surprisingly, the IDW's proposal does not address the criticisms of the FRRP expressed in the UK, nor the Company Law Review Steering Group's proposals to reform the British enforcement system. There appears to be a risk that the British system will be emulated without taking into account the experiences of the last 10 years, and the potential for improvement.

It may also seem surprising that the German profession is the driving force behind the establishment of the enforcement mechanism. However, the German auditing profession's proposal and commitment to an FRRP-type body appears to be strongly motivated by political and strategic considerations. Its proposal appears to reflect what is termed in German eine Flucht nach vorne ( approximately translated as 'to make a preemptive strike') in order to influence the body's formation and future duties.

Company collapses and alleged audit failures have weakened the public's trust in the audit function. The profession now appears to wish to distract from and to offload some of the auditors' responsibilities, instead of tackling necessary issues of improvement in the auditing function itself (such as more effective sanctions or more rigorous auditor independence rules).

Such action, of course, is not alien to the British situation either.

Lisa Evans is a lecturer in accounting at the University of Edinburgh, Brigitte Eierle is research assistant and Axel Haller is professor at the department of accounting and auditing, Johannes Kepler Universität, Linz, Austria.