Chapter 2 Worldwide Accounting Diversity

Question 1

U.S. vs U.K. financial statement preparation

Answer 1

-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

Question 2

GAAP Terminology vs IFRS

Answer 2

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

Question 3

Reasons for Accounting Diversity

Answer 3

Legal system
Code Law
Taxation
Providers of Financing
Inflation
Political and Economic Ties
Correlation of Factors

Question 4

Legal system diversity

Answer 4

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

Question 5

Code Law diversity

Answer 5

more statutes
Non-English-speaking countries
Legislated accounting rules
Accounting law is general
Other guidance required

Question 6

Taxation diversity

Answer 6

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

Question 7

Providers of Financing diversity

Answer 7

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

Question 8

Inflation diversity

Answer 8

Some countries have a historically high rates of inflation
necessitates adjustments to offset inflation
common in Latin American countries

Question 9

Political and Economic Ties diversity

Answer 9

Affect how accounting rules are conveyed
Former colonies
European Union mandating IFRS

Question 10

Correlation of Factors diversity

Answer 10

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

Question 11

Hofstede Cultural Dimensions

Answer 11

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

Question 12

Individualism

Answer 12

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

Question 13

Collectivism

Answer 13

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

Question 14

Most Collectivist Cultures/Countries

Answer 14

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

Question 15

Individualistic Cultures/Countries

Answer 15

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

Question 16

Power Distance

Answer 16

the extent to which hierarchy is accepted

Question 17

Uncertainty Avoidance

Answer 17

the degree to which individuals feel uncomfortable with uncertainty

Question 18

Competitiveness

Answer 18

emphasis on performance or achievement

Question 19

Cooperativeness

Answer 19

emphasis on relationships, caring, nurturing

Question 20

Long-term Orientation

Answer 20

emphasis on persistence

Question 21

Short-term Orientation

Answer 21

emphasis on quick results

Question 22

Indulgence

Answer 22

satisfying human needs and desires

Question 23

Restraint

Answer 23

curbing one’s desires and withholding pleasures

Question 24

Gray’s Accounting Values

Answer 24

Four widely recognized accounting values to describe a country’s accounting subculture.

1. Professionalism versus. Statutory Control
   - Professional judgment vs. Prescriptive legal requirements
2. Uniformity vs. Flexibility
   - Uniform accounting practices vs flexibility
3. Conservatism vs. Optimism
   - Cautious vs. risk-taking
4. Secrecy vs. Transparency
   - Confidentiality/restriction of disclosures vs. transparency and openness

Question 25

Gray's Arguement

Answer 25

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

Question 26

Gray's Cultural Accounting Framework

Answer 26

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

Question 26

Framework for the Development of Accounting Sytsems

Answer 26

External Influences Ecological Influences Cultural Dimensions Institutional Consequences Accounting Values Accounting systems

Question 26

Ecological Influnces

Answer 26

geographic demographic genetic/hygienic historical technological urbanization

Question 26

External Influences

Answer 26

forces of nature trade investment conquest

Question 27

Accounting Values

Answer 27

professionalism uniformity conservatism secrecy

Question 27

Institutional Consequences

Answer 27

legal system corporate ownership capital markets professional associations education religion

Question 28

Accounting Systems

Answer 28

Authority Enforcement Measurement Disclosure

Question 29

Problems Caused by Accounting Diversity

Answer 29

1. Preparation of consolidated financial statements - differing GAAP and currencies 2. Access to foreign capital markets 3. Comparability of financial statements 4. Lack of high-quality accounting information

Question 30

Problems With Preparation of Consolidated Financial Statements

Answer 30

local regulations books in local currency local accounting principles requires: considerable effort additional cost expertise in different country's accounting standards

Question 31

Access to foreign capital markets requires

Answer 31

financial statements as per local accounting standards considerable effort and cost involved

Question 32

Comparability of Financial Statements

Answer 32

Lack of comparability between financial statements This adversely affects: Investment decisions Lending decisions Performance analysis Foreign acquisition decisions

Question 33

Lack of High–Quality Accounting Information

Answer 33

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

Question 34

Classification of Accounting Systems

Answer 34

Accounting models 1. The Fair Presentation/Full Disclosure Model (Anglo–Saxon or Anglo–American model) 2. The Legal Compliance Model (Continental European model) 3. The Inflation–Adjusted Model -Resembles the Continental European model. -Requires extensive use of adjustments for inflation.

Question 35

The Fair Presentation/Full Disclosure Model (Anglo–Saxon or Anglo–American model)

Answer 35

-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.

Question 36

The Legal Compliance Model (Continental European model)

Answer 36

-Legalistic -Used to provide information for taxation and government-planning. -Used in Europe, Japan, and code law countries

Question 37

The Inflation–Adjusted Model

Answer 37

-Resembles the Continental European model. -Requires extensive use of adjustments for inflation.

Question 38

A Judgmental Classification of Financial Reporting Systems

Answer 38

Developed by Nobes. Micro–based–Anglo–Saxon model. Macro–uniform–Continental European model.

Question 39

Micro–Based Accounting Systems

Answer 39

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

Question 40

Macro–Uniform Accounting Systems

Answer 40

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

Question 41

Empirical Test of the Judgmental Classification

Answer 41

Macro–Uniform -Tax influence -Less disclosure Micro–Based -Heavy disclosures -Weak link between taxation and accounting -Geared to equity investors

Question 42

Nobes’s model argues that international reporting differences are due to

Answer 42

different purposes for that reporting.

Question 43

Country’s financing system is considered most relevant factor to determine

Answer 43

the purpose of financial reporting

Question 44

Nobes divides reporting systems into two classes–A and B:

Answer 44

1. Class A Strong equity–outsider financing. Less conservative. Extensive disclosure. Accounting practice differs from tax rules. 2. Class B Weak equity–outside shareholder financing. More conservative. Disclosure is not extensive. Accounting practice follows tax rules.

Question 45

Further Evidence of Accounting Diversity Categories based on accounting differences:

Answer 45

Financial statements included. Financial statement formats. Level of detail in financial statements. Terminology. Disclosure. Recognition and measurement.

Question 46

A. Legal system

Answer 46

In code law countries, accounting rules tend to be legislated; common law countries tend to have a non-legislative organization that develops accounting standards.

Question 47

B. Taxation

Answer 47

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.

Question 48

C. Providers of financing

Answer 48

— 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.

Question 49

D. Inflation

Answer 49

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.

Question 50

E. Political and economic ties

Answer 50

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.

Question 51

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.

Answer 51

Legal Taxation Providers of financing Inflation Political and economic ties National culture

Question 52

Conservatism hypothesis

Answer 52

Countries high on uncertainty avoidance and long-term orientation and low on individualism and competitiveness will foster a more conservative approach to measurement.

Question 53

Secrecy hypothesis

Answer 53

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.

Question 54

Gray's framework has been modified to argue that national culture not only influences accounting rules but also the manner in which

Answer 54

accountants apply those rules

Question 55

Differences in accounting across countries can create several problems

Answer 55

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.

Question 56

Nobe's Simplification of the reasons for international differences in financial reporting

Answer 56

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.

Question 57

Two models of accounting historically used across countries in the developed world

Answer 57

1. the Anglo Saxon (Micro-based) model 2. The Continental European (macro-uniform) model

Question 58

Differences in accounting across countries exist in several areas.

Answer 58

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