Chapter 2: Worldwide Accounting Diversity

Worldwide Accounting Diversity Nature of diversity in accounting Format (Exhibit 1.1) Terminology Recognition rules Measurement rules

Worldwide Accounting Diversity: Reasons Legal systems Common law Fewer statutes—more court interpretation Creation of precedents or case laws Great Britain and other English-speaking countries Accounting law is detailed and specific Sources are nonlegislative organizations Code law More statutes Non-English-speaking countries Legislated accounting rules Accounting law is general Other guidance required

Worldwide Accounting Diversity: Reasons Basis for taxation Published financial statements Germany—same taxable income and book income 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

Worldwide Accounting Diversity: Reasons Providers of financing 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

Worldwide Accounting Diversity: Reasons Inflation Some countries have historically high rates of inflation Necessitates adjustments to offset inflation Common in Latin American countries Political and economic ties affect how accounting rules are conveyed

Worldwide Accounting Diversity: Reasons Correlation of factors (Exhibit 2.4) 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

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

Preparation of Consolidated Financial Statements Problems due to: 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 from different countries 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

Accounting Clusters Accounting models 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

Judgmental Classification of Financial Reporting Systems Developed by Nobes Micro-based—Anglo-Saxon model Macro-uniform—Continental European model

Micro-based accounting systems First sub-class influenced by Business economics Accounting theory Example: Netherlands Second sub-class influenced by Business practice Pragmatic Example: British-origin United Kingdom and United States dominated

Macro-uniform accounting systems First sub-class: Aligned with national economic policies Example: Sweden Second sub-class: Continental: government, tax, legal Example: Continental European countries Law-based family: Germany, Japan Tax-based family: Southern European countries

Exhibit—2.5 Nobes’s Judgmental Classification

Influence of Culture on Financial Reporting Hofstede’s cultural dimensions Gray’s accounting values Religion and Accounting

Hofstede’s cultural dimensions Four cultural dimensions (Exhibit 2.7) Individualism (vs. collectivism) Preference for a loosely knit social fabric Power distance Acceptance of hierarchy and unequal power distribution Uncertainty avoidance Comfort level with uncertainty and ambiguity Masculinity Emphasis on masculine values vs. feminine values Long-term orientation Focus on fostering virtues oriented towards future rewards

Gray’s Accounting Values Four widely recognized accounting values to describe a country’s accounting subculture Professionalism vs. Statutory Control Uniformity vs. Flexibility Conservatism vs. Optimism Secrecy vs. Transparency Believes that national cultural values affect accounting values Accounting values of conservatism and secrecy have the greatest relevance Gray extended Hofstede’s model to understand how culture influences the corporate reporting systems

Exhibit—2.8 Framework for Accounting Systems Development

Religion and Accounting Religion defines National culture in many parts of the world It has significant effect on business practice Example: Banking companies under Shariah, the Islamic law of human conduct derived from the Koran

A Simplified Model to Explain Financial Reporting International Differences Nobes’s model argues that international reporting differences are due to different purposes Country’s financing system is considered most relevant factor to determine the purpose of financial reporting

A Simplified Model to Explain Financial Reporting International Differences Nobes divides reporting systems into two classes—A and B Class A Strong equity-outsider system 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

End of Chapter 2

Assignment Homework Case SKD GAAP