Financial reporting in Romania - July 2006

Financial reporting and auditing requirements in Romania continue to undergo change and evolve towards application of standards comparable with the European Union1.

Financial reporting in Romania has taken time to develop since the country adopted a market economy in 1990. For much of the time since then, financial reporting has been focused on providing information to the government authorities rather than providing information to investors (current and prospective), management, financial institutions and other common users of financial reports in an international context. Financial reporting (and accounting in general) in Romania has tended to be more about form than about substance, dotting the “Is” and crossing the “Ts”, rather than focusing on whether the figures reflect the accurate financial position of the reporting entity and the results from activities during the reporting period.

The Ministry of Finance undertook a progranmme in 1997 to make Romania’s accounting and auditing legislation comparable to international standards and European Union directives on accounting and auditing.

Fundamental changes in legislation have taken place as a result of this programme including:

harmonisation of financial reporting in Romania with the requirements of International Accounting Standards and the European Union 4th Directive –Minister of Finance Order 94/2001 (MoF Order 94/2001);
harmonisation of the financial reporting for Romanian companies not applying MoF Order 94/2001 with the requirements of the European Union 4th Directive - Minister of Finance Order 306/2002 (MoF Order 306/2002); and
setting up a body responsible for the training and regulation of the independent audit function in Romania, the Chamber of Auditors – Emergency Ordinance 75/1999 (EO 75/1999) as approved by Law 133/2002;
approval of Accounting Regulations to comply with European Directives – Minister of Finance Order 1752/2005 (MoF Order 1752/2005);
conformity of Accounting Regulations with International Financial Reporting Standards and Respecting Conformity of Accounting Regulations with European Directives – Minister of Finance Order 907/2005 (MoF Order 907/2005);
application of International Financial Reporting Standards – Minister of Finance Order 1121/2006.
With effect from 1 January 2006, MoF Order 1752/2005 for the approval of accounting regulations compliant with European Directives has replaced MoF Order 94/2001, MoF Order 306/2002 and a number of other previously issued Minister of Finance orders and regulations.

Sources of accounting principles

Accounting in Romania is regulated by the provisions of Law 82/1991, republished in January 2005 (the Accounting Law).

In accordance with the Accounting Law, it is mandatory for all legal entities and authorised individuals to keep accounting records in Romanian language and in the national currency of Romania. For internal information purposes, entities may choose to draw up statements in another currency.

Legal entities or individuals have to keep written evidence of all transactions and record these transactions in their accounting books. The records required by the Accounting Law include: Journal Registers, Stock Register (based on an annual inventory of assets and liabilities), and Nominal Ledger (based on analysis of the accounting information posted from source documents or Journal Registers). The books and the accounting records may be hand-written or in an electronic format and can be used as evidence in court and are subject to review by Romanian fiscal and judicial authorities. Accountants should prepare a trial balance from the nominal ledger on an annual basis and this trial balance is the basis for preparation of periodic financial statements.

Accounting regulations issued require a specific chart of accounts and specific reporting disclosure contents and formats for entities. Previously these were indicated in MoF Order 94/2001 or MoF Order 306/2002 and the related regulations. From 1 January 2006, MoF Order 1752/2005 provides the applicable base to be followed and is accompanied by two regulations:

accounting regulations for compliance with the 4th Directive of the European Economic Communities (“AR4”); and
accounting regulations for compliance with the 7th Directive of the European Economic Communities (“AR7”).
The focus in the rest of this article will be mainly on looking at the situation from 1 January 2006 onwards, based on legislation, ministerial orders and regulations issued to date.

From 1 January 2006, MoF Order 1752/2005 applies and, in conjunction with the accompanying accounting regulations issued, it addresses: prescribed layout and content of the annual financial statements, accounting principles and valuation rules, rules to the preparation, approval, auditing and publication of the annual financial statements.

Fundamental concepts

MoF Order 1752/2005 looks to cover in one piece of legislation the financial reporting applicable to entities of all sizes, with differing level of disclosure relating to size and public interest consideration.

MoF Order 1752/2005 stipulates that the following general principles apply:

Accruals basis – Transactions and other events are recognized when they arise and are entered in the accounting records and reported in the financial statements for the related period.
True and fair view – Annual financial statements are to be prepared to give a true and fair view of the assets, liabilities, financial position and period results of an entity.
Comparative figures are to be disclosed for all statements prepared.
Going concern – The entity is presumed to be carrying on its business as a going concern. If this basis is not appropriate and the Administrator(s) are aware of that there is a doubt on the ability of an entity to continue its activities, then this should be disclosed in the explanatory notes.
Consistency – There should be an application of valuation rules on a consistent basis from year to year.
Prudence – In particular:
Only profits made at the balance sheet date are to be included.
Includes all liabilities relating to financial year or prior years, even if such liabilities become apparent or become known between the balance sheet date and the date of completion of preparation.
All depreciation (value adjustments) is to be included irrespective of whether the result for the financial year is a loss or a profit.
Independence – Income and charges relating to the financial year are recorded irrespective of the date of receipt or payment.
Separation – Components of asset and liability items are valued separately.
Intangibility – Opening balance sheet for each financial year must correspond to the closing balance sheet for the previous financial year.
No offset – Offset between asset and liability items in the period end balance sheet is not allowed.
Economic substance and reality of events – Carrying values and transactions should be considered and not only the legal form and/or substance.
Any departures from the above principles are seen as being exceptional and would require disclosure in the explanatory notes indicating reason for not applying and the effect on the disclosure of: assets and liabilities carrying value, the financial position and period results.

Valuation principles and accounting policies

Valuation in general is based on purchase price or production cost. In specific situations contribution value and fair value (including revaluations) may be used. MoF Order 1752/2005 mentions that assets and liabilities will be valued according to the contents of this Order and to norms issued by the Ministry of Finance.

Accounting principles are meant to reflect cost values, but “fair value” should also be considered for carrying values for annual financial statement preparation. This includes revaluations of tangible assets. It is indicated that valuations should be completed by a professional valuator (i.e. a member of a relevant professional body with national or international recognition).

MoF Order 1752/2005 includes guidance on valuation methods and accounting principles to be considered in the maintenance of financial records and in the preparation of annual financial statements.

There is no direct mention of International Financial Reporting Standards (IFRS) in MoF Order 1752/2005 or the accompanying accounting regulations (AR4 and AR7).

There is, as far as AR4 and AR7 are concerned, a consistency in many areas with IFRS, and we assume, but it is not stated, that where further guidance is required, there should be a reference to the relevant IFRS. In many areas IFRS will provide further guidance on valuation methods and accounting policies.

At the same time, there are some IFRS that are not applied or have only limited comment in AR4, such as:

Deferred taxation, while applying under MoF Order 94/2005, there is no requirement to apply IAS 12 “Income taxes” to consider calculation of deferred tax based on differences carrying value of assets and liabilities at period end for tax purposes compared to accounting carrying values.
For treatment of “financial instruments”2 there is some mention of treatment, but it is uncertain as to what extent the comments apply the requirements of IAS 32 “Financial instruments – disclosure and presentation” and IAS 39 “Financial instruments – recognition and measurement”.
No “functional currency” concept as indicated in IAS 21 “The effects of changes in foreign exchange rates”.
IFRS 3 “Business combinations” is not touched on.
IAS 18 “Leases”, some limited comment.
No specific addressing of matters referred to in: IAS 11 “Construction contracts”, IAS 14 “Segment Reporting”, IAS 19 “Employee Benefits”, IAS 35 “Discontinuing operations”, and IAS 41 “Agriculture”.
For intangible assets, there are some specific treatments prescribed, that are not in all cases consistent with IAS 38 “Intangibles”. This includes treatment for depreciation of goodwill arising from acquisition.
Extent of specific disclosure requirements is more limited than IFRS requirements.
IFRS have more guidance on accounting policies and principles in specific areas and for specific industries.
Broadly speaking, MoF Order 1752/2005 should provide enough guidance for most entities in most situations. As application commences, some issues on treatment and disclosure may arise, requiring further clarification. In addition, there are plans to issue a revised Company Law in 2006, which may also impact on MoF Order 1752/2005 practical application, as may subsequently issued rules and regulations by the Romanian Securities Commission and other authorities.

In relation to accounting policies, AR4 indicates that:

- specific principles and policies adopted by the entity in preparing, drafting and completing its annual financial statements;
- the management of each entity shall set the accounting policies for the operations carried out, to reflect the specific activity of the entity;
- in establishing accounting policies, an entity needs to ensure that the general accounting principles (“fundamental concepts”) as included in AR4 are observed;
- accounting policies should be:
-relevant for the needs of the users in the decision-making process;
- “credible” – present a “true and fair” situation, be neutral, be prudent and be complete in all significant aspects;
- only be changed if required by law or to present more relevant or “credible” information.

Disclosure, reporting and filing requirements

MoF Order 1752/2005 has been effective from 1 January 2006 for reporting year ending 31 December 2006.

MoF Order 1752/2005 differentiates between entities that need to meet all financial reporting requirements and those that can complete abridged financial reporting. The entities are differentiated by “size criteria”. The size criteria indicated are: [Art 3(1)]

Turnover
(for the period)

EUR million
Total assets
(at year end)

EUR million
Average number of employees for the period
31 December year end Over 7.3 Over 3.65 50

An entity that meets the size criteria during two consecutive financial years or that is a listed company3 is required to annually complete financial statements that comprise:

Balance sheet
Profit and loss statement
Statement of changes in equity
Cash-flow statement
Explanatory notes.
For 2006 reporting, the above criteria are to be based on the financial statements for the year ending 31 December 2005.

Some subcategories of main balance sheet items can be combined, where amounts are immaterial or where combination would provide for greater clarity. This does not apply for listed companies.

Entities that do not meet the size criteria are required to prepare:

Abridged balance sheet
Profit and loss statement
Explanatory notes to the simplified financial statements
At their own discretion, entities below the size criteria may prepare a statement of changes in equity and/or cash-flow statement.
In addition the annual financial statements for all entities (regardless of size) should be accompanied by a written declaration of the responsibility for entity management for the annual financial statement and an Administrator(s) Report on operations.

Certain Groups may be required to complete consolidated financial statements (see further comment below).

MoF Order 1752/2005 details a specified chart of accounts listing to be applied and includes direction for the mapping of individual accounts to the balance sheet and income statement formats.

The general chart of accounts has the following categories:

Class 1 – Equity accounts
Class 2 – Non-current assets
Class 3 – Inventories and work in progress
Class 4 – Third party accounts (receivables and payables)
Class 5 – Treasury accounts
Class 6 – Expense accounts
Class 7 – Revenue accounts
Class 8 – Special accounts (off-balance sheet)
Class 9 – Management accounts4.
Specified formats are provided in AR4 for:

Balance sheet (full and abridged)
Profit and loss statement
Statement of changes in equity
Cash-flow statement.
Explanatory notes are to be completed to:

present information on the accounting regulations underlying the preparation of the annual financial statements and the accounting policies used;
provide additional information that is not disclosed in the financial statements5, but that is relevant for the information user to understand the financial statements.
Specific details for compulsory explanatory notes preparation are included in MoF Order 1752/2005 (AR4). These include:

Non-current assets
Provisions
Profit distribution
Analysis of operating result
Statement of receivables and payables
Accounting principles, policies and methods
Interest and financing sources
Information regarding employees, administrators, management and supervisory bodies
Computation and analysis of the main economic and financial indicators
Other information.
If there is any departure from the indicated general accounting principles (“fundamental concepts”) that underlie MoF Order 1752/2005 requirements, then disclosure of the reason and impact is required.

MoF Order 1752/2005 in AR 4 details disclosures that are required as part of explanatory notes to the annual financial statements.

Specific disclosure requirements are also indicated for matters such as:

-accounting policies, including valuation methods and basis for conversion of transactions into national currency, as applicable;
-changes to accounting policies, including impact on current financial year results;
-name of entity, main place where activities are performed and registered office, main activities, name of parent and ultimate holding company;
-related parties for relationship, balances at period end and transactions during the period;
-non-current asset details and movements;
-information on revaluations, including method of revaluation and impact;
-information on financial instruments;
-details on participating interests and investments;
-disclosures by category for: receivables, payables and inventory and other relevant information;
-provisions, for comments on composition and movements;
-reconciliation between accounting results and fiscal result and taxation payable at period end;
-information on composition of share capital by type and securities issued during the year;
-turnover details by separate activities and geographic markets;
-information on distribution of net profits, including details on dividends proposed and/or paid;
-commitments and contingencies;
-events after balance sheet date;
-financial auditors fees disclosures.
-average number of employees by main categories and related personnel costs;
-information on payments to Administrator/(s), management and supervisory boards;
-amounts paid under lease agreements and on going obligations under lease agreements.

Report of the Administrator(s)

A Report of the Administrator(s) is to be completed with each financial year to accompany the annual financial statements.

The Report is to provide comment on the current year’s activities of the entity, the financial position and a description of the main risks and uncertainties facing the entity. Disclosure of financial ratios and non-financial ratios is encouraged.

Specific items to be addressed, as applicable are:

Significant events that occurred during the financial year
Probable evolution of the entity
Research and development activities
Purchase of own shares
Branches of the entity
Use of financial instruments and potential associated risks.

Approval and publication

The annual financial statements include details of the persons that have prepared the financial statements. The Administrator (or Chairman of the Administration Board) and the preparer are required to sign the annual financial statements.

On completion the annual financial statements and the Report of the Administrator(s) are presented to the general meeting of shareholders.

The annual financial statements, the Report of the Administrator/(s) and the Report of the Financial Auditor are published in compliance with legislation.

Current publication requirements are for the annual financial statements and related reports to be submitted to the Trade Register in the location where the entity is registered.

For entities the following deadlines apply for completion and submission of annual financial statements to the Trade Register:

150 days after closing of the financial year for operating entities above the size criteria and public interest entities;
120 days after closing of the financial year for operating entities not meeting size criteria or being public interest entities;
60 days after closing of financial year for micro enterprises;
60 days after closing of financial year for dormant companies.
A company which does not have its own accounting department and/or a qualified person in charge of the accounting records, and which has turnover greater than the lei equivalent of EUR 50,000, must contract an authorised person (individual or firm) to prepare its financial statements

Dividend distribution

Dividend distribution is based on the statutory accounting profit.

Consolidated financial statements

In addition to comments in MoF Order 1752/2005 [Art 7 and 8], specific guidance is provided in the accompanying “Accounting Regulations – Compliance with the 7th Directive of the European Economic Communities” (AR7).

Consolidation is required where an entity has the majority of voting rights in another entity or substantially controls another entity.

If any entity in the Group is a listed company then consolidated financial statements must be prepared.

If a Group does not contain a listed company, then it is only required to prepare consolidated financial statements if the Group meets “size criteria”. The requirement for the preparation of consolidated financial statements is to meet two of the following three criteria based on the latest annual financial statements:

Turnover
(for the period)

EUR million
Total assets
(at year end)

EUR million
Average number of employees for the period
31 December year end Over 35.04 Over 17.52 250

Even if a Group meets the requirements as indicated above, it is not required to prepare consolidated financial statements if the parent entity of the Group is also a subsidiary entity and its own parent entity is governed by Romanian law or EU member state law and:

- where the parent entity holds all the shares in the exempted entity; or
-where the parent entity holds 90% or more of the shares in the exempted entity and the remaining shareholders in or member of the entity have  approved the exemption.

The above exemption has some additional conditions that need to be met.

The exemption does not apply for entities that:

- are listed companies;
- have a requirement as a State institution or for employees’ information.

A subsidiary does not need to be included in the consolidation if:

- not material to provide a true and fair view of the assets, liabilities, financial position, results for the period for the consolidated Group as a whole;
- the individual entity:
- has severe long-term restrictions to hinder operations;
- information necessary for the preparation of consolidated accounts cannot be obtained without disproportionate expense or undue delay;
- the shares of that entity are held exclusively with a view to a subsequent resale.
- AR7 provides guidance for consolidated financial statements in relation to:

Preparation principles
Content of explanatory notes
Report of Administrator(s)
Audit requirements
Approval, execution and publication
Layout of consolidated balance sheet and consolidated profit and loss statement.
The guidance provided is consistent with the EU 7th Directive.

2007 year end requirements

MoF Order 907/2005 provides that subject to further regulations to be published by relevant Romanian authorities6, the following entities will be required to comply with applicable International Financial Reporting Standards for the 2007 financial year, including:

Credit institutions
Insurance and re-insurance companies
Listed entities and entities with securities traded on a regulated market
State-owned entities
Entities which benefit from State support or State guarantees.
For 2007 IFRS compliance, preparation of financial statements based on IFRS for the financial year ending 2006 would be required to enable comparatives to be available for 2007 reporting.

Banks and insurance companies

Over recent years, there have been changes in financial reporting for banks and insurance companies to bring Romanian requirements in line with European Union directives and International Accounting Standards for Banks. Initially legislative changes were under MoF/National Bank of Romania Order 1982/5/2001 (for banks) and MoF Order 2328/2001 (for insurance companies).

As indicated above, MoF Order 905/2005 requires compliance with IFRS for banks and insurance entities for the financial year 2007.

Further guidance on IFRS adoption

Minister of Finance Order 1121/2006 provides additional guidance on the application of IFRS commencing with the year ending 31 December 2007. MoF 1121/2006 is short and reiterates certain points from MoF Order 905/2005. Included in MoF 1121/2006 (article 4) is a comment that where IFRS financial statements are prepared by an entity, that the entity will be required to complete annual financial statements in accordance with the European Directives. It would appear from this that entities preparing IFRS financial statements will also be required to prepare financial statements for submission to the Romanian State authorities a set of financial statements prepared in compliance with MoF 1752/2005, under current legislation. This is a matter that further clarification is required.

Significant accounting concepts for investors and users of financial reporting information

Historically, Romanian accounting records have been heavily influenced by the use of information for tax compliance purposes. The primary function of financial/accounting details collection and recording process has been seen by many Romanian entities and the management/staff within the entities (both State and private) as being for taxation compliance and taxation reporting purposes. As a result of this, the reported information has tended to reflect a “form over substance” disclosure, that is, greater importance is placed on having particular documents or recording something in a specific way, rather than in “accurately” reflecting the financial position of the enterprise at a point in time or indicating whether the results for the period are an appropriate representation of what has occurred, as International Financial Reporting Standards and EU 4th Directive require.

Romanian accounting laws and regulations are not as such at fault, as they both seem to provide for and encourage treatments that are consistent in many ways with international accounting principles. Issues have, however arisen in how laws and regulations are applied and have tended to reflect the background and outlook of Romanian accountants.

Up to 31 December 2003, Romania was considered to be a hyperinflationary economy, under the criteria of IAS 29 “Financial reporting in hyperinflationary economies”. For Romanian statutory reporting IAS 29 was not applied. In looking at financial statements where there are significant non-monetary items, users should keep this in mind.

The introduction of MoF Order 1752/2005 should provide for consistency in accounting and presentation for Romania with current EU member states and has in mind the planned 2007 accession into the EU of Romania.

Audit requirements

All entities meeting the size criteria requirements and public interest entities (including listed companies) are required to have a financial audit.

Entities preparing simplified financial statements do not require a financial audit, unless required by other legislation (such as Company Law).

The “financial auditor” issues a report, which while not stated in MoF Order 1752/2005, it is assumed that the report of the independent financial auditor is addressed to the shareholders (or equivalent) at the annual general meeting of shareholders.

Matters to be included in the Report of the financial auditor are indicated in MoF Order 1752/2005. In addition the financial auditor is required to comply with audit standards as issued by the Romanian Chamber of Auditors.

A financial audit can be completed by a “financial auditor”, which can be an individual or a company that is a member of the Romanian Chamber of Auditors.

The Romanian Chamber of Auditors was established by Ordinance 75/1999 (as subsequently approved by Law 133/2002) to establish auditing standards in Romania and to monitor the profession in relation to membership and qualification standards, including establishment of examinations and membership criteria, ongoing training programmes, ethical standards and quality review procedures.

The Chamber of Auditors has adopted the International Standards on Auditing as issued by the International Federation of Accountants for application in Romania.

Listed companies

The report of the independent financial auditor is also issued to the Romanian Securities Commission with the annual financial statements for listed entities.

As indicated above, MoF Order 907/2005 introduces, subject to further regulations, a requirement for listed entities to prepare annual financial statements based on the requirements of IFRS for Financial Year 2007.

Impact of changes in Romanian Company Law on financial reporting

Further changes to Romanian Company Law (Law 31/1990, as amended) are expected to be completed during 2006. These are expected to further clarify the auditing requirements in Romania and address such accounting related matters as: reporting requirements, Administrator(s) and management roles and responsibilities, corporate governance and dividend declaration and payment.