Turkey - Report on the observance of standards and codes (ROSC) : accounting and auditing

40949 TURKEY REPORT ON THE OBSERVANCE OF STANDARDS AND CODES (ROSC) ACCOUNTING AND AUDITING October, 2006 Contents Executive Summary......................................................................................................................... i. I. INTRODUCTION ...................................................................................................................1 II. Institutional Framework...........................................................................................................3 A. Statutory Framework...........................................................................................................3 B. The Profession...................................................................................................................10 C. Professional Education and Training.................................................................................12 D. Setting Accounting and Auditing Standards .....................................................................13 E. Enforcing Accounting and Auditing Standards.................................................................15 III. ACCOUNTING STANDARDS AS DESIGNED AND AS PRACTIcED.......................22 IV. AUDITING STANDARDS AS DESIGNED AND AS PRACTIcED..............................28 V. PERCEPTIONS ON THE QUALITY OF FINANCIAL REPORTING...............................30 VI. POLICY RECOMMENDATIONS...................................................................................30 Acknowledgements This report was prepared by a team from the World Bank on the basis of the findings from a diagnostic review carried out in Turkey in May 2005. The staff team was led by Frederic Gielen and comprised of Ayse Seda Aroymak, Georgine Ann-Marie Newman- Alawode, and Zeynep Lalik Mete (ECSPS), as well as a team of experts from relevant institutions in EU Member States. The review was conducted through a participatory process involving various stakeholders and led by the country authorities.  EXECUTIVE SUMMARY As work on the economics of information--the role of information in a well-functioning economy--demonstrates, enhancing the reliability and availability of financial reporting is conducive to economic growth and mitigating the risk of financial system instability. In that context, this report provides an assessment of accounting and auditing standards and practices in Turkey. It uses International Financial Reporting Standards (IFRS) and International Standards on Auditing (ISA) as benchmarks and draws on good practices in the field of accounting and audit regulation to assess the quality of financial information and make policy recommendations. For European Union (EU) candidate countries, such as Turkey, the assessment also has regard to the relevant requirements of EU law (also known as the acquis communautaire). There has been significant progress in recent years in improving the environment and framework for financial reporting in Turkey and further widescale reforms are in progress. In particular, a new draft commercial code will modernize statutory regulation of company financial reporting and will set a major challenge to the accounting and auditing professions in Turkey through the requirement to apply Turkish Accounting Standards based on IFRS and audits based in international Standards of Auditing (ISA). Corporate Sector Accounting and Auditing are at a Crossroads The role and regulation of corporate sector accounting and auditing are shaped by the economic context in which they take place, and by the structure of the market they serve. Until recently, private enterprises in Turkey were predominantly family-controlled, relying on private sources of finance (including family-owned banks) rather than capital markets, and financial information was not considered a public good provided to meet the needs of market participants generally, but rather a resource to which access was restricted, available only to those having the power to require its provision. Despite banking regulations that require that banks receive financial statements from companies as a pre-requisite to lending, in practice, bank lending decisions were primarily based on collateral and other sources of information about the enterprise with limited reliance on a borrower's financial statements. These considerations, among others, do much to explain the current arrangements for accounting and auditing in Turkey, to give insight into the causes of existing tensions, and to point the way to reforms required to meet the new needs of an economy undergoing radical transformation. The economic context resulted in an environment where each agency (e.g., the tax authorities) developed its own accounting and auditing requirements. With the exception of regulated entities, including publicly-held companies, there were minimal general requirements for the publication of financial information and the concept of published, general purpose financial statements meeting the needs of several user groups was effectively unknown. Consequently, there was little demand for an independent financial statement audit performed by qualified professionals to lend credibility to the financial information provided to the marketplace. In recent years, progress has been made in the accounting and auditing environment but much remains to be done for Turkey to achieve compliance with international good practices. Aligning the Statutory Framework with the Acquis Communautaire and International Standards This report highlights certain shortcomings in the legal and regulatory framework and stresses that addressing those should be a priority for Turkey in order to create a robust legal foundation for the provision of reliable financial information to market participants. Three issues stand out: Turkey