Is your balance sheet hiding untapped potential or hidden risks? The choice between IFRS and HGB for the valuation of development projects can impact your financial metrics by over 15%. Understand the differences to make strategically sound decisions for your portfolio.
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The topic briefly and concisely
IFRS aims at investor transparency through fair value assessment, while HGB focuses on creditor protection through the prudent acquisition cost principle.
Under IFRS (IAS 38), there is a requirement to capitalize development costs, whereas under HGB (§ 255 Abs. 2a), there is only an option, leading to significantly different balance sheet representations.
The IFRS valuation can improve the equity ratio and financing conditions due to higher recognized assets, but it also involves greater earnings volatility.
Evaluating development projects is more than just an accounting obligation. It is a strategic tool that determines financing conditions, investor confidence, and the ultimate success of the project. Whether you prepare your accounts according to the German Commercial Code (HGB) or the International Financial Reporting Standards (IFRS) has significant implications. While the HGB focuses on creditor protection and cautious valuation, IFRS aims for maximum transparency for the capital market. This article highlights the critical differences in the evaluation of development projects according to IFRS vs. HGB, shows the impact on your balance sheet, and helps you find the optimal path for your company.
HGB vs. IFRS: Two Fundamentally Different Philosophies
The fundamental decision between HGB and IFRS is a choice between two different objectives. The HGB primarily serves creditor protection, which is ensured by the principle of prudence and the historical cost principle. Assets are valued at their original costs at most, which can lead to the creation of hidden reserves. In contrast, the IFRS principle of a “True and Fair View” aims to provide investors with a realistic basis for decision-making. This often leads to valuation at fair value, reflecting current market opportunities and risks. The differences between IFRS and HGB are therefore not only technical but also strategic. This choice directly influences how the financial position, financial performance, and results of operations of your company are presented to external stakeholders.
Capitalisation of Development Costs: A Crucial Lever
A key difference in the evaluation of development projects according to IFRS vs. HGB lies in the capitalisation of internally-generated intangible assets. According to § 255 (2a) HGB, there is an option to capitalise development costs, whereas research costs must always be recognised as an expense. Many companies, out of caution, do not utilise this option, which can reduce equity by millions. IFRS is much stricter and more investor-friendly in this regard. Under IAS 38, there is an obligation to capitalise development costs once six defined criteria are met. Consistent capitalisation under IFRS can increase the balance sheet equity by 5-10%.
IFRS requires capitalisation if all the following points can be demonstrated:
Technical feasibility of the project.
Intention to complete and use or to sell.
Ability to use or sell the asset.
Evidence of future economic benefits.
Availability of adequate technical and financial resources.
Reliable measurability of attributable expenses.
Correct accounting of construction projects requires a clear distinction between research and development phases. This distinction is the first step towards an optimised balance sheet structure.
Fair Value under IFRS: How Market Values Impact the Balance Sheet
The valuation of investment properties according to IAS 40 is a prime example of the IFRS philosophy. Here, companies have the option between the cost model and the fair value model. If a company opts for the fair value model, changes in the property's value are recorded directly in the income statement. A property purchased for €10 million can be listed on the balance sheet at €12 million after two years, with positive market development, without an actual sale taking place. This revaluation increases the balance sheet total and significantly improves the equity ratio. The HGB does not recognise such a revaluation beyond acquisition costs; here, the acquisition cost model strictly applies. The application of the fair value valuation brings transparency about the actual value of the portfolio but also leads to greater volatility in results.
Impact on Metrics and Financial Strength
The different valuation approaches have direct consequences for key financial metrics and, consequently, for creditworthiness. Accounting under IFRS tends to lead to higher assets and stronger equity reporting due to fair value measurement and the obligation to capitalise development costs. This can reduce financing costs by up to 50 basis points. An HGB balance sheet appears more conservative and often shows hidden reserves, which is appreciated by traditional lenders but can obscure the true earning power of the company. The choice of accounting standard can impact the equity ratio by more than 20%.
Here is an overview of the typical impacts:
Equity Ratio: Generally higher under IFRS, improving credit ratings.
Profit (EBIT): More volatile under IFRS due to the recognition of value fluctuations.
Balance Sheet Total: Higher under IFRS due to revaluation of property assets.
Return on Equity (ROE): Can be distorted under IFRS by unrealised gains.
Debt-to-Equity Ratio: Generally lower under IFRS.
A clear understanding of the valuation differences is essential for the consolidated financial statements of real estate companies. The next challenge lies in dealing with impairments.
Managing Impairments: Impairment Test (IFRS) vs. Lower of Cost or Market Principle (HGB)
Both standards require the recognition of impairments of assets. However, the approach differs significantly. The HGB applies the mitigated lower of cost or market principle for fixed assets: an unscheduled depreciation is only required in the event of a presumably permanent impairment (§ 253 Abs. 3 HGB). This provides companies with a certain degree of discretion. The IFRS prescribe a significantly more formalised procedure with the impairment test according to IAS 36. For certain assets, such as goodwill, this test must be carried out annually, for others when there are signs of impairment (impairment indicators). The impairment test compares the carrying amount with the recoverable amount, often leading to earlier and more transparent write-downs. A project developer, for example, must carry out an impairment test under IFRS in the event of an unexpected increase in construction costs of more than 15%. The impairment test under IFRS ensures a timely reflection of risks in the balance sheet.
Conclusion: Strategic choice instead of accounting obligation
The evaluation of development projects under IFRS vs. HGB is not purely a technical question, but a strategic decision. While the HGB stands for stability, creditor protection, and smoothing of results, the IFRS offer transparency, international comparability, and a better reflection of the actual company value. Companies targeting the capital market or international investors benefit from an IFRS balance sheet that makes the value potential of their projects visible. The right evaluation can facilitate access to capital by a factor of 2. Regardless of the chosen standard, a precise, data-driven evaluation of your projects is essential. Tools like the ImmoGPT chat or a professional Auctoa valuation provide you with the objective data you need for an informed decision and optimal accounting. Make a conscious decision for the future of your portfolio.
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Additional useful links
The DRSC offers a document on International Financial Reporting Standards (IFRS).
The Federal Statistical Office (Destatis) provides a quality report on annual financial statements in the area of public finances.
The Federal Ministry of Finance (BMF) publishes a statement by the DRSC on a discussion draft.
The Chamber of Public Accountants (WPK) offers information on the topic of ESEF (European Single Electronic Format) and regulatory requirements.
Haufe Online offers an article on the topic of research and development costs.
Rödl & Partner provides an article on IFRS 16 (Leasing) and its impact on M&A transactions.
Wikipedia offers a comprehensive article on International Financial Reporting Standards (IFRS).
Wikipedia offers a comprehensive article on the Commercial Code (HGB).
FAQ
Why is the distinction between research and development costs so important?
The distinction is crucial because, under both standards (HGB and IFRS), research costs must always be immediately recorded as an expense. Only development costs can, under certain conditions, be capitalized as an asset on the balance sheet, which increases equity and the total assets.
What does 'Fair Value' mean in practice for a property?
Fair Value (beizulegender Zeitwert) is the price that would be achieved in a property sale under normal market conditions between independent parties (IFRS 13). It is based on current market data, such as comparative prices or income value calculations, and reflects the actual market value, not the historical acquisition costs.
Does reporting according to IFRS always lead to higher profits?
Not necessarily. While increases in property values can enhance profits, under the fair value principle, decreases in value must also be immediately recognized. This can lead to significant impacts on results in declining markets, whereas the German Commercial Code responds more slowly due to the lower-value principle.
Can a German company easily switch to IFRS?
Parent companies oriented towards the capital market must prepare their consolidated financial statements in accordance with IFRS. Non-capital market oriented companies can voluntarily prepare an IFRS consolidated financial statement. However, the individual financial statement according to HGB remains decisive for distribution measurement and tax purposes in Germany.
What are 'hidden reserves' in the HGB?
Hidden reserves arise when the actual market value of an asset (e.g., a property) exceeds its book value, which is limited by the German Commercial Code (HGB) to the acquisition or production costs. These reserves are only disclosed and taxed when a sale occurs.
How can Auctoa assist with evaluation under IFRS or HGB?
Auctoa provides fast and objective market and mortgage values for your properties with AI-driven analyses. These data-driven valuations can serve as a basis for determining the Fair Value according to IFRS or for verifying the asset value according to HGB, offering a neutral foundation for your accounting decisions.
