Chapter 2--Worldwide Accounting Diversity

Nobes's Judgmental Classification of Financial Reporting Systems (for 14 developed countries)

(it shows the comparative distances between countries and could be used as a blueprint for determining where financial statement comparability is likely to be greater) Macro-uniform -- government, economics--Sweden (closely aligned with national economic policies; income smoothing allowed to promote economic stability and social accounting has developed to meet macroeconomic concerns) -- continental, government, tax, legal ---- law-based -- Japan, Germany (accounting law is primary determinant of accounting practice) ---- tax-based -- Spain, Belgium, France, Italy (tax law is primary determinant of accounting practice) micro-based -- business practice, pragmatic (British origin) ----US influence -- Canada, US ----UK influence -- Ireland, UK, New Zealand, Australia -- business economics, theory -- Netherlands (may use current replacement cost accounting to value assets in their primary financial statements)

three major accounting models

Fair Presentation/ Full Disclosure Model (Anglo-Saxon or Anglo-American Model) -- oriented toward the decision needs of large numbers of investors and creditors; used in English-speaking countries or those closely aligned with them, using a common law system Legal Compliance Model --originated in code law countries; companies tied closely to banks as primary suppliers of financing; legalistic form of accounting, designed to provide information for taxation or government-planning purposes Inflation-Adjusted Model -- found primarily in South America, resembling the continental European model in its legalistic, tax, and government-planning orientation; extensive use of adjustments for inflation

differences in legal system

common law -- found in English speaking countries (England, US); limited amount of statute law interpreted by the courts; court decisions establish precedents, developing case law supplementing statutes; usually has a non-legislative body that develops accounting standards, so there are more detailed rules; FASB and ASC codified Roman law (code law) -- found in non-English speaking countries (Germany, France, Japan); based on Roman jus civile and developed in medieval universities; has more statute or codified law governing a wider range of human activity has corporation law establishing basic parameters; stipulates which financial statements must be published and according to what format; law passed by national legislature; accounting profession has little influence on the development of this law accounting law is rather general, doesn't provide much detail, companies use tax law, auditing profession and accounting academicians opinions

significant links (secrecy)

consistent with strong uncertainty avoidance high power-distance societies are likely to be characterized by restriction of information to preserve power inequalities consistent with a preference for collectivism long-term orientation suggests a preference for secrecy link with masculinity--less secrecy in societies where there is more emphasis on achievement and material success

Nobes argues that

culturally dominated countries use the accounting system of their dominating country regardless of the nature of the equity financing system as the financing system in a country evolves from weak equity to strong equity, the accounting system will also evolve in the direction of Class A accounting

amortization

expensing the acquisition cost minus the residual value of intangible assets (often intellectual property such as patents and trademarks or copyrights) in a systematic manner over their estimated useful economic lives so as to reflect their consumption, expiry, obsolescence or other decline in value as a result of use or the passage of time.

Nobes's simplified model of reasons for international accounting

external environment -- culture, including institutional structures -- strength of equity-outsider financing system -- class of accounting

FV

fair value

major providers of financing for business enterprises

family members banks governments shareholders

political and economic ties

former colonies tend to share accounting methods--Australia and Zimbabwe with England; western African countries with France; Canada, Mexico, and Israel with US

Class A Accounting System

found in countries with strong equity-outside shareholder financing systems (measurement practices are less conservative, disclosure is extensive, and accounting practice differs from tax rules--Anglo-Saxon accounting)

Class B Accounting System

found in countries with weak equity-outside shareholder financing systems (measurement is more conservative, disclosure is not as extensive, and accounting practice more closely follows tax rules--Continental European accounting)

GPP

general purchasing power (US GAAP requires PPE to be carried on the balance sheet at historical cost less accumulated depreciation)

GAAP

generally accepted accounting principles

factors leading to the failure of many banks in the 1997 East Asian financial crisis

highly leveraged corporate sector private sector's reliance on foreign currency debt lack of accounting transparency

HC

historical cost

less pressure for public accountability and information disclosure

in countries where company financing is dominated by families, banks, or the state (banks more interested in solvency and liquidity--emphasis on the balance sheet) Bankers tend to prefer companies to practice rather conservative accounting with regard to assets and liabilities.

more pressure for public accountability and information disclosure

in countries where company financing is dominated by shareholders (more interested in profit--emphasis on the income statement)

taxation

in some countries, published financial statements form the basis for taxation in Germany, congruency principle (massgeblichkeitprinzip) stipulates that published financial statements serve as the basis for taxable income, for an expense to be deductible for tax purposes, it must also be used in the calculation of financial statement income, minimize income for tax purposes through the use of accelerated depreciation in other countries, financial statements are adjusted for tax purposes and submitted to the government separately from the reports sent to stockholders in US, conformity between the tax statement and financial statements is required only if last-in, first-out (LIFO) inventory cost flow assumption is used; can use accelerated depreciation for tax purposes and straight-line depreciation for financial statements

order of listing in financial statements

in the US -- assets and liabilities listed in order of liquidity, from most liquid (cash) to least liquid (often intangible assets) -- also in Canada, Mexico, and Japan in Europe and other countries -- assets and liabilities listed in the opposite order -- from most liquid to least liquid

differences in financial statements prepared

in the US -- balance sheet, income statement, statement of cash flows, stockholders' equity in non-US -- balance sheet, income statement, statement of cash flows (most, but not all)

Hofstede's cultural dimension

individualism (loose- versus close-knit social fabric) power distance (extent to which hierarchy and unequal power are accepted in institutions and organizations) uncertainty avoidance (degree to which individuals are uncomfortable with uncertainty and ambiguity) masculinity (emphasis on performance/achievement versus relationship/caring/nurturing) long-term orientation (virtue-oriented toward future rewards, such as perseverance, thrift)

Reasons for accounting diversity

legal system taxation providers of financing inflation political and economic ties

correlation of factors

legal system, tax conformity, and source of financing common law countries tend to have greater numbers of domestic listed companies, relying more heavily on equity as a source of capital code law countries tend to link taxation to accounting statements and rely less on financing provided by shareholders

problems caused by accounting diversity

preparation of consolidated financial statements access to foreign capital markets comparability of financial statements lack of high-quality accounting information

PPE

property, plant, equipment

In the EU

publicly-traded companies now use a set of accounting standards based upon the Anglo-Saxon model of accounting in preparing their consolidated statements privately-held companies continue to use GAAP

recognition

the decision of whether an item should be reported in the financial statements

measurement

the determination of the amount to be reported

Nobes's model

two explanatory factors--culture and the nature of the financing system A country's financing system is seen as the most relevant factor in determining the purpose of financial reporting. whether or not a country has a strong equity financing system with large numbers of outside shareholders will determine the nature of financial reporting in a country.

significant links (conservatism)

uncertainty avoidance and long-term orientation less conservative approach to measurement consistent with a short-term orientation and optimism emphasis on individual achievement and performance likely to foster a less conservative approach to measurement

Non-comparability of financial statements

•Accounting rules often differ between countries. •International investors need to make their own reconciliations or adjustments to financial statements. •International investors also must face differing levels of disclosure, quality of accounting standards, and quality of auditing.

Legal systems --Code law

•Characterized by relatively more statutes . •Found more often in non-English-speaking countries. •Accounting rules in these countries tend to be legislated (i.e., the source is the government). •Less specific, so other sources needed to provide guidance.

Difficulties with access to foreign capital Markets

•Companies often need to go outside their home country in order to access financing. •Raising foreign capital often requires reconciliation to comply with different accounting rules or needs of investors and creditors.

Legal systems --Common law

•Fewer statutes—more court interpretation. •Leads to the creation of precedents or case law. •Found most often in Great Britain and other English-speaking countries. •The source of accounting rules tends to be non-governmental organizations.

Form 20-F

•Required by the SEC for companies using non-U.S. GAAP (unless they use IFRS). •Reconciles net income and stockholders' equity from the other GAAP to U.S. GAAP.

Inflation

•Some countries have historically high rates of inflation. •Accounting in these countries often requires adjustments to offset the impact of inflation. •This is common in Latin American countries. •Given extended periods of low inflation in the U.S., inflation accounting is not required.

Consolidated financial statements

•U.S. MNEs often have subsidiaries in a large number of countries. •Accounting records in local GAAP and local currency are rolled-up (i.e., consolidated) into U.S. GAAP. •Require conversion from local to U.S. GAAP. •Require translation from the local to U.S. currency.

Inflation Accounting

•U.S.(and many other countries)--financial statements are notadjusted for inflation. •Latin American countries--experience significant inflation, so financial statements are adjusted for changes caused by inflation.

goodwill and amortization

•U.S.--goodwill is not amortized, but is written down only if impaired. •Japan and Korea-goodwill is amortized over its useful life not to exceed twenty years. Instead of deducting the value of goodwill annually over a period of maximal 40 years, companies are now required to determine the fair value of the reporting units, using present value of future cash flow, and compare it to their carrying value (book value of assets plus goodwill minus liabilities.) If the fair value is less than carrying value (impaired), the goodwill value needs to be reduced so the carrying value is equal to the fair value. The impairment loss is reported as a separate line item on the income statement, and new adjusted value of goodwill is reported in the balance sheet.

Taxation

•U.S.--taxable income and book income are generally quite different. •Germany--rules governing taxable and book income tend to be the same, which generally results in more conservative accounting. •Deferred taxes are less of an issue in code law countries.

Asset revaluation

•U.S.--upward revaluation of fixed assets is not generally allowed. •European Union--publicly traded companies are free to choose between two different methods for valuing their assets.

Problems Caused by Accounting Diversity

Lack of high-quality accounting information •Lack of disclosures—i.e., lack of transparency.

MASB

Malaysian Accounting Standards Board

cluster analysis findings

Nine clusters companies in micro-based countries provide more extensive disclosure than do companies in the macro-uniform countries companies in the macro countries are more heavily influenced by taxation than are companies in the micro countries

Gray's accounting values

Professionalism versus statutory control uniformity versus flexibility conservatism versus optimism secrecy versus transparency

comparisons using Nobes's system

US and Canada more valid than US and UK US and UK more comparable than US and Netherlands US and Netherlands more meaningful than US and macro-uniform countries

inflation

a factor in Latin American countries--high inflation in the 80s and 90s--double- and triple-digit inflation renders historical costs meaningless

ASC

accounting standards codification

to avoid paying taxes on fictitious profits

adjusting income for inflation in countries where accounting statements serve as the basis for taxation

Goodwill

an intangible asset that arises when one company acquires another, but pays more than the fair market value of the net assets (total assets - total liabilities). The goodwill amounts to the excess of the "purchase consideration" (the money paid to purchase the asset or business) over the total value of the assets and liabilities. It is classified as an intangible asset on the balance sheet, since it can neither be seen nor touched.

harmonization

attempts to reduce the accounting differences across countries; the goal is to have one set of international accounting standards followed by all companies around the world