Chapter 2 Worldwide Accounting Diversity Flashcards
U.S. vs U.K. financial statement preparation
-U.S uses GAAP
-UK uses IFRS
-order of assets on BS is different
-Inclusion of parent company BS
-Differences in terminology
Shareholders Equity = Capital and reserves
Paid-In-Capital = Share premium account
Treasury Stock = Own shares held
GAAP Terminology vs IFRS
GAAP IFRS
Income statement Profit and Loss Accounts
Account Receivable Debtors
Accounts Payable Creditors
Capital Lease Finance Lease
Allowance for uncollectible accounts Provision for bad debts
Inventory Stock
Common Stock Ordinary Shares
Statement of Cash Flows Cash Flow Statement
Accounts Receivable Confirmation Debtors Circularization
Reasons for Accounting Diversity
Legal system
Code Law
Taxation
Providers of Financing
Inflation
Political and Economic Ties
Correlation of Factors
Legal system diversity
Common law
Fewere statues-more court interpretation
Great Britain and other English-speaking countries
Accounting law is detailed and specific
Sources are non legislative organizations
Code Law diversity
more statutes
Non-English-speaking countries
Legislated accounting rules
Accounting law is general
Other guidance required
Taxation diversity
Published financial statements
Germany (prior to 2009) adjusted for tax purposes
Financial statements adjusted for tax purposes
U.S. - different taxable income and book income
Difference between tax and accounting income gives rise to deferred income taxes
Providers of Financing diversity
Accounting and disclosure is less important where major sources are families, banks, and the government
Accounting and disclosure is more important where major sources are diverse shareholders
Inflation diversity
Some countries have a historically high rates of inflation
necessitates adjustments to offset inflation
common in Latin American countries
Political and Economic Ties diversity
Affect how accounting rules are conveyed
Former colonies
European Union mandating IFRS
Correlation of Factors diversity
Common law countries have domestic listed companies relying on equity for capital
Code law countries tend to link taxation to accounting statements and rely less on financing provided by shareholders
Hofstede Cultural Dimensions
Original
1. Individualism
2. Power Distance
3. Uncertainty Avoidance
4. Competitiveness vs Cooperativeness
Newer
5. Long-term orientation vs Short-term orientation
6. Restraint: curbing one’s desires and withholding pleasures
Individualism
loose social fabric
degree of interdependence a society maintains among its members
self reliance
value privacy
self image defined in terms of “I” or “We”
high IND = people taking care of themselves and direct family only
Collectivism
tight social fabric
people belong “in groups” that take care of them in exchange for loyalty
group priority over the individual
families work together to support each other
coworkers work together to support each other and the company
value interdependence, group solidarity, and common goals
Most Collectivist Cultures/Countries
China- 43
*Japan; considered a mix of individualistic and collectivistic-
India-24
Turkey- 46
Indonisia-5
**Kenya- 4
Ghana-9
Guatemala-36
Brazil- 36
South Korea-18
*Asian culture is the most collectivistic
*South America, Asia, Central America, Africa
lower scores= more collectivistic culture
Individualistic Cultures/Countries
Netherlands-100
Sweden- 87
Germany-79
Switzerland- 79
UK- 76
France- 74
Australia-73
Canada- 72
New Zealand- 69
Spain- 67
*Japan- 62
US- 60
*higher the score the more individualistic
Power Distance
the extent to which hierarchy is accepted
Uncertainty Avoidance
the degree to which individuals feel uncomfortable with uncertainty
Competitiveness
emphasis on performance or achievement
Cooperativeness
emphasis on relationships, caring, nurturing
Long-term Orientation
emphasis on persistence
Short-term Orientation
emphasis on quick results
Indulgence
satisfying human needs and desires
Restraint
curbing one’s desires and withholding pleasures
Gray’s Accounting Values
Four widely recognized accounting values to describe a country’s accounting subculture.
- Professionalism versus. Statutory Control
- Professional judgment vs. Prescriptive legal requirements - Uniformity vs. Flexibility
- Uniform accounting practices vs flexibility - Conservatism vs. Optimism
- Cautious vs. risk-taking - Secrecy vs. Transparency
- Confidentiality/restriction of disclosures vs. transparency and openness
Gray’s Arguement
national cultural values affect accounting values
*accounting values of conservatism and secrecy have the greatest relevance
Conservatism is thought to be the most heavily influenced by strong uncertainty avoidance and short-term orientation
Secrecy is thought to be consistent with strong uncertainty avoidance, high power distance, collectivism, and long-term orientation
Gray’s Cultural Accounting Framework
Hofstede: classified into 10 different cultural areas
Gray:
- extended Hofstede’s model to understand how culture influences the corporate financial reporting systems
- positive relationship between secrecy and conservatism; Less disclosure = conservatism
others: modified Gray’s framework to argue that culture impacts both rules and how rules are applied
Framework for the Development of Accounting Sytsems
External Influences
Ecological Influences
Cultural Dimensions
Institutional Consequences
Accounting Values
Accounting systems
Ecological Influnces
geographic
demographic
genetic/hygienic
historical
technological
urbanization
External Influences
forces of nature
trade
investment
conquest
Accounting Values
professionalism
uniformity
conservatism
secrecy
Institutional Consequences
legal system
corporate ownership
capital markets
professional associations
education
religion
Accounting Systems
Authority
Enforcement
Measurement
Disclosure
Problems Caused by Accounting Diversity
- Preparation of consolidated financial statements
- differing GAAP and currencies - Access to foreign capital markets
- Comparability of financial statements
- Lack of high-quality accounting information
Problems With Preparation of Consolidated Financial Statements
local regulations
books in local currency
local accounting principles
requires:
considerable effort
additional cost
expertise in different country’s accounting standards
Access to foreign capital markets requires
financial statements as per local accounting standards
considerable effort and cost involved
Comparability of Financial Statements
Lack of comparability between financial statements
This adversely affects:
Investment decisions
Lending decisions
Performance analysis
Foreign acquisition decisions
Lack of High–Quality Accounting Information
Lack of high–quality accounting standards
Inadequate risk assessment
Lack of appropriate disclosure requirements
Disclosure deficiencies
Related–party transactions and off-balance-sheet financing
High exposure to foreign exchange risk
Investments in highly speculative assets
Contingent liabilities guaranteeing foreign currency loans
Loan loss provisions
Classification of Accounting Systems
Accounting models
- The Fair Presentation/Full Disclosure Model (Anglo–Saxon or Anglo–American model)
- The Legal Compliance Model (Continental European model)
- The Inflation–Adjusted Model
-Resembles the Continental European model.
-Requires extensive use of adjustments for inflation.
The 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 influenced by the United Kingdom or the United States.
The Legal Compliance Model (Continental European model)
-Legalistic
-Used to provide information for taxation and government-planning.
-Used in Europe, Japan, and code law countries
The Inflation–Adjusted Model
-Resembles the Continental European model.
-Requires extensive use of adjustments for inflation.
A Judgmental Classification of Financial Reporting Systems
Developed by Nobes.
Micro–based–Anglo–Saxon model.
Macro–uniform–Continental European model.
Micro–Based Accounting Systems
First subclass influenced by:
-Business economics
-Accounting theory
Example: Netherlands
Second subclass influenced by:
-Business practice
-Pragmatic
Example: British–origin
*United Kingdom and United States dominated
*Business economic theory- Netherlands
*UK influence - Ireland, Australia, New Zealand
Macro–Uniform Accounting Systems
First subclass:
Aligned with national economic policies
Example: Sweden
Continental: government, tax, legal
Example: Continental European countries
Law–based family: Germany, Japan
Tax–based family: Southern European countries (Spain, Belgium, France, Italy
*found in common law countries where there is separation of accounting from taxation and external shareholders are an important source of financing
*Information is developed primarily for equity investors, with adequate disclosure serving as a major objective
Empirical Test of the Judgmental Classification
Macro–Uniform
-Tax influence
-Less disclosure
Micro–Based
-Heavy disclosures
-Weak link between taxation and accounting
-Geared to equity investors
Nobes’s model argues that international reporting differences are due to
different purposes for that reporting.
Country’s financing system is considered most relevant factor to determine
the purpose of financial reporting
Nobes divides reporting systems into two classes–A and B:
- Class A
Strong equity–outsider financing.
Less conservative.
Extensive disclosure.
Accounting practice differs from tax rules. - Class B
Weak equity–outside shareholder financing.
More conservative.
Disclosure is not extensive.
Accounting practice follows tax rules.
Further Evidence of Accounting Diversity
Categories based on accounting differences:
Financial statements included.
Financial statement formats.
Level of detail in financial statements.
Terminology.
Disclosure.
Recognition and measurement.
A. Legal system
In code law countries, accounting rules tend to be legislated;
common law countries tend to have a non-legislative organization that develops accounting standards.
B. Taxation
Financial statements serve as the basis for taxation in many countries. In those countries with a close linkage between accounting and taxation, accounting practice tends to be more conservative so as to reduce the amount of income subject to taxation.
C. Providers of financing
— In those countries in which family members, banks, and the government are the major providers of business finance, there tends to be less demand for public accountability and information disclosure.
In countries where shareholders are a major provider of financing, the demand for information made available outside the company becomes greater.
D. Inflation
Countries with chronic high inflation adopted accounting principles in which traditional historical cost accounting was abandoned in favor of inflation-adjusted figures. This was especially true in Latin America. However, inflation has been successfully brought under control in most countries, and this factor is no longer as important in explaining accounting diversity as it once was.
E. Political and economic ties
Through previous colonization, a British style of accounting is used throughout most of the former British Empire. Ties between countries also help to explain similarities between financial reporting in the U.S., Canada, and Mexico.
Perhaps the most striking example of political and economic ties influencing accounting across countries is the adoption of IFRS for publicly traded companies in the 27 countries comprising the European Union.
There are variety of economic and institutional factors are thought to have influenced the development of a country’s accounting system and caused differences in those systems across countries.
Legal
Taxation
Providers of financing
Inflation
Political and economic ties
National culture
Conservatism hypothesis
Countries high on uncertainty avoidance and long-term orientation and low on individualism and competitiveness will foster a more conservative approach to measurement.
Secrecy hypothesis
Countries high in power distance, uncertainty avoidance, and long-term orientation and low on individualism and competitiveness will exhibit more secrecy (less disclosure) in accounting reports.
Gray’s framework has been modified to argue that national culture not only influences accounting rules but also the manner in which
accountants apply those rules
Differences in accounting across countries can create several problems
A. Consolidating foreign subsidiaries requires that the financial statements prepared in accordance with foreign accounting rules be converted into parent company GAAP.
B. Companies interested in obtaining capital in foreign countries may be required to provide financial statements prepared in accordance with accounting rules in that country, which could differ from rules in the home country.
C. Investors interested in investing in foreign companies may have a difficult time in making comparisons across potential investments because of differences in financial reporting across countries.
D. Historically, there has existed a lack of quality accounting standards in some parts of the world. The 1997 East Asian financial crisis was at least partially attributable to a lack of high-quality accounting in the region.
Nobe’s Simplification of the reasons for international differences in financial reporting
A. Class A accounting systems:
-oriented toward providing information to outside shareholders (less conservative, more disclosure)
-Consistent with the Anglo-Saxon model (micro-based) of accounting
B. Class B:
- geared toward taxation and creditors (more conservative, less disclosure, accounting follows tax rules)
-Consistent with the Continental European model (macro-based) of accounting
C. C. Nobes suggests that Class B countries that are interested in competing for equity capital will adopt a Class A accounting system if allowed to do so. Accounting developments in Europe over the last 30 years have shown this to be true.
Two models of accounting historically used across countries in the developed world
- the Anglo Saxon (Micro-based) model
- The Continental European (macro-uniform) model
Differences in accounting across countries exist in several areas.
A. Differences in the financial statements included in an annual report
B. Differences in the format used to present financial statements
C. Differences in the level of detail provided in the financial statements
