2. Accounting principles: Most reliable possible evaluation of assets and the profit situation

1. Principles

The primary objective of accounting is to allow the financial statement’s addressees the most reliable possible evaluation of assets and the profit situation, and representation of information about the financial situation, changes in it, economic performance and an enterprise’s risk capacity. This principle applies to all enterprises; its implementation is a prerequisite to ensure that shareholders can exercise their participatory and proprietary rights, and thus indirectly protects the guarantee of ownership. According to Article 716a of the Code of Obligations, supervisory management, including financial supervisory management, is a non-delegable duty of the board of directors. This duty can be exercised by boards of directors only if they are reliably aware of the assets and profit situation of the enterprise as well as its (balance-related) risk capacity, and know how their decisions affect the enterprise’s assets and profit situation.

Accounting is also a prerequisite for carrying out state duties. It is the basis for tax assessment1 and collection of social security fees. It is accounting which ultimately leads to transparency, and permits all business processes at the enterprise to be documented and substantiated. It thus has a preventive effect in combatting white-collar crime, and is an essential tool in the fight against corruption.

Accounting thus also serves the public interest, directly as a starting-point for taxation and combatting white-collar crime, but also indirectly because it gives the board of directors an instrument for permanently assessing financial performance and balance-related risk capacity, thereby stabilizing the enterprise on a lasting basis.

However, accounting can meet these objectives only if it represents the enterprise’s economic situation so as to provide a basis for reliable judgments, as also explicitly stated in article 958 CO of the new accounting law.

2. The objectives of accounting in detail

Traditionally, accounting is defined as having the following objectives:

a) Capital maintenance

The principle of capital maintenance is meant to effect distributions to shareholders only under highly qualified conditions with the help of special procedures. The principle of capital preservation is intended to prevent excessive payouts to shareholders. For this purpose, the company designates a specific equity capital. This equity capital is an item on the liabilities side, that is, it represents the source of funds, not the application of funds. Equity capital can also be described as net assets. It is the result of deducting outside capital from gross assets. The company’s net assets represent the amount not used to satisfy (known) creditors of the company. This amount is the equity capital. It describes the enterprise’s resistance to the risk of asset reduction through outflow of funds or incorrect valuations. The larger an enterprise’s equity capital, the more resistant the enterprise is against these risks. For this reason, equity capital can be described as the company’s „risk reserve“. Capital maintenance is an objective of the accounting rules in the Code of Obligations, but not in the IFRS

b) Accountability

Accounting also has accountability as an objective: The performance of the management, board of directors and company, as well as the processes in the enterprise are to be retrospectively evaluated and documented. In a certain sense, the company’s institutions „utilize“ the shareholders’ money similar to a agent acting in the interest of the principal. Just as the agent is accountable to the principal, the company’s institutions must also render accounts to the shareholders. This similarity to the representative is reflected by the ‘principal-agent’ rule, according to which the institutions must realize the shareholders’ wishes and be accountable for this. Accounting is the key instrument of such accountability.

The function of accounting in terms of accountability can also influence the conduct of the management and board of directors. Accounting according to the Code of Obligations provides ways of preventing wrong decisions by the management from being disclosed in the income statement and the balance sheet. Relinquishment of the principle of strict individual valuation allows the management to offset value increases and reductions within a valuation item. Generous provisions on formation and dissolution of hidden reserves can help disguise drops in earnings (at least in the short term). As a result, accounting as per the Code of Obligations can tempt the management and board of directors to take risks which they would otherwise avoid if measures were taken to ensure that accounting immediately and accurately reflects any wrong decisions by the management.

c) Management tool and decision-making basis for the management and board of directors

The management and board of directors should make the right decisions on the basis of accounting, and in awareness of the enterprise’s risk capacity. Accounting can meet this requirement only if it is as informative as possible and tries to be as truthful as possible. Excessively low valuation of assets as well as excessively prioritized and vague treatment of risks are harmful. As a result of this, the company is not able to fully exploit its risk potential (at the expense of the shareholders’ claim to profit seeking), or the management (knowing that the valuations are cautious) relies on an existence of large, hidden reserves and overestimates the enterprise’s risk capacity.

Swiss accounting practice exhibits a contradiction between the objectives of capital maintenance and the objectives of accounting as a management tool. As an outcome, the objective of capital maintenance is favoured by wrong numbers in the right place: If valuation of assets is too low and valuation of liabilities is too high, the objective of capital maintenance is promoted, and the balance sheet turns out to be more robust than would be the case if the enterprise tried to valuate assets and liabilities as accurately as possible. With regard to the objectives of accounting as a management tool, however, these undervaluations and overvaluations lead to wrong decisions. Accounting is useful as a management tool only if it tries to represent an enterprise’s values as precisely as possible. Valuation rules based on prudence have no place in accounting intended to serve as a management tool.

d) Protection of the capital market and starting point for tax law

Accounting serves not only for transparency vis-à-vis existing shareholders, but also vis-à-vis potential investors and the capital market, and is ultimately also a starting point for enterprise taxation.