July 1999 Issue

Accountancy in Poland's Market Economy

By Max Gottlieb

In Brief

Market Reforms Drive Change

Poland has made significant progress in moving from a communist, state-planned economy to a market economy. As part of the sometimes painful process, an accounting profession is emerging. Contributing factors are a functioning tax system, a lowering of import barriers, hard currency that can be transferred out of Poland, and confidence on the part of foreign investors.

In 1995 the Polish parliament enacted an accountancy act that requires annual financial statements for companies above a certain size, compliance with certain EU directives, and minimum record-keeping requirements. In order to practice auditing for the public, an accountant must belong to the Chamber of Certified Public Accountants. The chamber established a code of ethics and auditing standards. Polish auditing standards are based primarily upon international standards as issued by the International Federation of Accountants.

A low standard of living and lack of political freedom were among the factors that led to the establishment of the first Polish independent trade union after World War II, the Solidarity. To counteract its activity and--it was claimed--to prevent Soviet invasion, martial law was imposed in 1981. In response, Western countries imposed economic sanctions, deepening the country's economic crisis. By 1990 industrial production had fallen to 86% of the 1980 level, retail sales to 85.2%, and real wages to 75.8%.

To prevent social uprisings, communist authorities were forced to recognize the opposition movement. A so-called roundtable compromise led to the first free elections since before World War II. The Communist party lost its dominant position in Poland's political system and a new noncommunist government eventually took over.

An approach that became known as "shock therapy" was used to speed up the transformation to a free market economy. Price controls on most products were lifted and import restrictions were removed, opening the market to inexpensive foreign products and protecting consumers from a sharp rise in domestic prices.

Transformation to a Free Market Economy

The economic transformation of enterprises was performed in three ways:

* New private enterprises were established, usually in the form of partnerships and limited liability companies, with a majority of Polish ownership. These were mainly small but efficient enterprises such as factories, workshops, and trading and service companies.

* Joint ventures were formed with foreign investors, often through wholly owned foreign subsidiaries. Such enterprises were established mostly by the restructuring of state-owned companies. There were more than 28,000 of these companies in 1998. After 1991, foreign corporations such as Citibank, General Motors, Daewoo, Volkswagen, Goodyear, Procter & Gamble, Coca-Cola, and Pepsi-Cola began forming wholly owned subsidiaries to do business in Poland.

* State enterprises were privatized, either by selling them completely (most frequently under long-term leases) to their employees or management teams (there are 1,040 such companies now) or by maintaining partial state ownership and making the employees responsible for financial results and removing governmental subsidies. This involved the transfer of 10­15% of the shares to the employees (1,070 companies). Some of these newly commercialized enterprises were placed under control of national investment funds, whose shares were later sold for a nominal price to all citizens.

Many insolvent companies were simply liquidated by selling their assets. The commercialization and restructuring of coal mines, steelworks, heavy chemical plants, and military industries is incomplete, although many of these companies now have the same form of capital as state companies.

The positive results of privatization can be shown by the growth of the private sector, which captured the dominant share of the economy between 1992 and 1996. The Exhibit shows that the majority of production and employment is now provided by the private sector.

Regulation of Commerce

Along with the changes in the economy, the tax and commercial laws underwent a thorough revision.

* Taxes: A 22% value added tax (VAT) was imposed on most goods, and an additional excise tax was levied on alcohol, tobacco, cosmetics, passenger cars, and gasoline. These taxes now account for 43% of state revenues. Income taxes from business entities contribute 37%, while income taxes on individuals, partnerships, and sole proprietorships produce 20%.

* Customs Laws: Almost all restrictions have been lifted, and duty tariffs are gradually being reduced.

* Foreign Exchange: Many restrictions were eliminated, and most foreign
company earnings can be transferred out of Poland.

Poland's gross domestic product increased by 26% from 1992 to 1996, the fastest growth in central Europe. In 1997 the GDP grew by 6.9%, and in 1998 by nearly 6.5%. Nevertheless, the unemployment rate reached a high of 13.2% in 1996 before dropping to 10.5% in 1997, and then to 9.6% in October 1998. Inflation was 14.9% in 1997, decreasing to 9.9% in October 1998. The national debt totaled $40.5 billion in 1997, down from $48.5 billion in 1990.

Overall foreign direct investment reached $20.6 billion by the end of 1997, compared to $17 billion in Hungary and $8.2 billion in the Czech Republic. U.S. investors have led the way, with almost $4 billion invested by the end of 1997. The largest investment ($505 million) comes from the Polish-American Fund created by Congress, followed by Pepsi-Cola, International Paper, and Philip Morris. Many Americans of Polish descent have established small enterprises in Poland.

Poland offers a reasonably secure business environment, with protection against illegal expropriation. Profits and contributed capital can be fully repatriated in hard currency. Poland signed a tax treaty with the U.S. government to eliminate double taxation. Foreign companies may purchase real estate after obtaining a governmental permit, requests for which are usually granted. The government is trying to gradually establish an economic and legal environment that satisfies the European Union's requirements, with the hope of joining in a few years.

Enterprises finance their operations from--

* bank loans. The number and the total value of deposits are increasing, along with the value of loans granted.

* the stock exchange. Though still small (186 companies), the Polish exchange is growing. Public trading in corporate bonds and debentures recently began.

For obvious reasons, the banks, stock exchange, and the Polish Security Exchange Commission require reliable financial statements, reported upon by independent CPAs. Before discussing the new accounting requirements, it is useful to review the old standards.

The Old Accounting

There exists a strong tendency among Western accountants to disregard the old rules of accounting as useless. But, despite their shortcomings, these rules played an important role in supporting the existing economic reality. Even if financial statements contained no material misstatement, the results were distorted because of widespread state subsidies and the "expropriation" of profits in the form of excessively high taxes. An example of the latter is that depreciation was not a permissible tax deduction, although it is an important tax shelter for Western companies.

Many of the concepts were grounded in good accounting theory; the subsidies and excessive taxation, however, made the measurement of entity results unreliable:

* Going concern was not an issue because of state guarantees. A manager of an inefficient company could be fired or its employees denied a customary bonus. Financial losses did not lead to bankruptcy because the government would provide an infusion of capital or subsidize sales prices on an ongoing basis.

* Accrual accounting was practiced in most cases, except for interest on debt, which was recognized only upon payment. Depreciation rates were established by categories of assets on a straight-line uniform basis, without exception.

* Cost of goods sold was displayed separately from state subsidies. No real need existed for an allowance for bad debts because banks assured payment for goods sold via a system of direct transfers of funds based on submitted sale invoices. The lower-of-cost-or-market principle was unnecessary--chronic shortages of all merchandise created a steady demand.

* Consistency was dependent upon the finance ministry, not changing rules.

* State holding companies prepared aggregate financial statements, but they were simply arithmetical summaries, without accounting elimination. No cash flow statements were required, although some companies used internal reports to plan their cash needs.

The New Accountancy Law

In the new market economy, most governmental subsidies and excessive taxes have been discontinued. The need for realistic income measurement arose as many private-sector companies were formed, both newly created and privatized. After a transitional period, during which new ministerial provisions were instituted (1992­1994), the parliament passed an accounting act, effective in 1995. The act consists of three parts:

Part I: Enterprises required to prepare financial statements. All enterprises with prior year revenues in excess of approximately $400,000 are required to file their statements. A change is under deliberation in the parliament to increase this amount for sole proprietorships and partnerships to $800,000. It is guided by Western accounting concepts such as matching revenues with expenses, consistency, and accrual accounting. Failure to adhere to the act is punishable by a monetary fine or, in certain cases, imprisonment up to two years.

Part II: Source documents, books, control issues, record retention, computerized accounting, and inventory count. The auditor's responsibility, audit reports, and the frequency of audits are dealt with in this section. Only seven auditing standards have been issued to date. If a relevant auditing standard is needed for a particular aspect of an audit, Polish auditors are instructed to follow international auditing standards (IAS).

Part III: Format and content of financial reports, measurement of assets and liabilities, presentation of income, disclosure of accounting policies, and notes. Balance sheet amounts are stated in terms of historical values, even though high rates of inflation have been common. Companies may present schedules to account for inflation, but these are not compulsory. The rate's recent decline to under 10% has made disclosure about the effects of inflation less important. Both entity-only and consolidated statement formats are described in detail. Cash flow statements are required, even though many Western European countries do not have such a requirement. They are stipulated by international accounting standards.

The act complies with requirements of the European Union's (EU) fourth and seventh directives, which are compulsory for all its member states. Compliance is important for Poland because, as noted earlier, it has applied for membership in the European Union. The requirements of these directives are often quite general and allow for diverse alternative approaches. For example, British and American accounting statements are more closely aligned than British and German standards, even though Britain and Germany fully comply with all EU directives.

The accounting treatment of long-term construction projects, mergers and acquisitions, and financial instruments is not covered by EU directives. Polish accountants usually employ international accounting standards in the absence of their own.

In many EU countries there are different reporting requirements for large and small companies. Included in the large category are banks, trusts, pension funds, insurance firms, holding companies, and stock corporations, regardless of their size. Enterprises meeting two of the three following criteria are also included in this group: revenues in excess of $3 million, assets in excess of $1 million, and 50 or more employees. These companies must undergo an annual audit and publish their financial reports with an auditor's opinion in an "official journal." The remaining enterprises have a triennial auditing requirement starting in 1999; but their financial statements need not be published in the journal. The requirements for small companies are simpler: All annual financial statements, both audited and unaudited, must be filed in a regional court and are open to the public.

The Polish Security Exchange Commission has established additional reporting requirements. The Warsaw Stock Exchange gets high marks from foreign observers for its regulations and compliance procedures.

The number of nonlisted stock corporations is relatively small, approximately 3,800, whereas the number of other companies (similar to LLCs) approaches 100,000. Very few investors show interest in reading financial statements of unlisted enterprises despite their availability.

The Auditing Profession

In 1960, the Ministry of Finance introduced a chartered accountant designation. Before the reforms, chartered accountants tended to hold managerial positions in accounting departments. They had to pass examinations in accounting, commercial law, and controls. They examined and issued certificates of "correctness" on financial statements of enterprises on behalf of the finance ministry during a special three-week release time from their own place of work.

In 1992, under a grandfather clause, chartered accountants became certified public accountants. Subsequently, they underwent training in the new rules of taxation, accounting, and auditing. In order to practice auditing, an accountant must belong to the Chamber of Certified Public Accountants. The chamber consists of a
governing board, disciplinary representative (acting as a prosecutor), and disciplinary court. The minister of finance has overall responsibility for the chamber. The chamber elects its governing bodies every four years and establishes an ethics code and auditing standards, based on auditing standards issued by the International Federation of Accountants (IFAC). For quality control purposes, chamber designees are entitled to review the procedures and audit papers of any auditor. No statistics on the results of these reviews are published.

The chamber prepares and administers the CPA examination, approves continuing education courses, and has the responsibility of disciplining its members. As mentioned earlier, the accounting standards have been determined by an act of parliament, but the chamber issues auditing standards. The chamber's disciplinary court can employ far-reaching penalties, from a reprimand to an expulsion, which is equivalent to losing the right to practice. A temporary revocation of license may last from one to three years. A member has the right of appeal to the regional court in Warsaw. Imprisonment of up to two years (only in case of fraud) and financial penalties can be imposed by a state court. So far, some 400 complaints have been considered by the chamber, and two are pending in the state court.

In this country of 40 million some 6,300 accountants, mostly licensed through the grandfather clause, are presently entitled to practice. The average age of an accountant in Poland is 57. Foreign accountants can obtain a license if they possess an auditing license in their own country, but they must pass an examination in commercial and tax law given in Polish.

CPA candidates must complete a university degree, pass 10 examinations during three sittings, and have no
criminal record. Currently, some 4,000 applicants are trying to pass the examinations, while 450 are in the midst of their two-year apprenticeship. Only 26 licenses have been issued since 1992. Some observers question whether
the examinations are too complex and difficult.

Auditors may practice in the following organizational forms:

* Sole proprietor or partnership

* Partners, shareholders, or employees in units of legal status, in which CPAs are 1) the majority on the board of directors (If the board consists of no more than two persons, one of them must be a CPA.) or 2) the majority of the management (the board and the auditing committee).

An actively practicing CPA cannot work for a non-CPA entity except for a university. All practicing accountants must take 30 hours a year of continuing education courses. CPA firms pay one percent of their revenues to the chamber to cover its expenses, in addition to a small membership fee.

The Big Five and many large European auditing firms have offices in major Polish cities. In fact, most enterprises with foreign capital hire foreign auditors, as do many large Polish companies. It could be assumed foreign auditing firms are selected because of their experience, name recognition, and breadth of services, even though they charge higher rates than Polish auditors. The Polish offices of Big Five firms expect to grow significantly over the next few years, far faster than in Western Europe and the United States.

The Future

The accountancy act has raised the level of the auditing profession in Poland. However, no mechanism is in place for the continuous changes in accounting standards needed to respond to a fast-changing economic environment. The Polish accounting rules have much less detail, precision, and completeness in comparison to those of the U.S. GAAP. The Ministry of Finance is presently working on the correction of errors and gaps detected in the current act. At the same time, there is an effort under way to align the revised accounting rules with the expected changes in international accounting standards and EU directives. *

Max Gottlieb, PhD, CPA, is an associate professor at the College of Staten Island, the City University of New York. The author expresses his gratitude to Dr. Zdzislaw Fedak, deputy chair of the Polish Chamber of Certified Public Accountants and editor-in-chief of the Accountancy Journal (Warsaw), for his help in writing this article.

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