International Accounting, 7/e Frederick D.S. Choi Gary K. Meek Chapter 2: Development and Classification Choi/Meek, 7/e

Learning Objectives Identify and understand the importance of the eight factors that have a significant influence on accounting development. Understand the four approaches to accounting development found in market-oriented Western economies and identify countries in which each approach is prevalent. Have a basic working knowledge of accounting classifications and how they compare with one another. Explain the difference between the “fair presentation” and “legal compliance” orientations of accounting and identify nations in which each is prevalent. Explain why distinctions of accounting at the national level are becoming blurred. Choi/Meek, 7/e

Why Study Development and Classification? Helps understand a nation’s accounting. Explains the differences and similarities in accounting around the world. Classification Helps understand why and how national accounting systems differ. Helps analyze whether these systems are converging or diverging. Are a way of viewing the world. Reveals what group members have in common, and What distinguishes groups from each other Choi/Meek, 7/e

Development Sources of finance – who, how many, how close? Equity markets Profits measure how well managers have run the company. Accounting is used to assess cash flows, risks, and to value the firm. Extensive disclosures. Banks Conservative earnings for creditor protection. Less extensive disclosures. Choi/Meek, 7/e

Development (contin) Legal system Code law Common law Laws are all-embracing. Accounting tends to be prescriptive and procedural. Accounting focuses on legal form. Accounting standards and procedures are incorporated into national laws. Common law Laws develop on a case-by-case basis. Accounting develops from experience and judgment. Accounting tends to be flexible, adaptive, and innovative. Accounting focuses on economic substance. Accounting rules are established by private sector professional organizations. Choi/Meek, 7/e

Development (contin) Taxation Political and economic ties Inflation Must companies record revenues and expenses in their accounts to claim them for tax purposes? Are financial accounting and taxation the same? Or are they different? Political and economic ties Accounting ideas and technologies are transferred through conquest, commerce, and other forces. Inflation Inflation distorts historical cost measurements. Countries with high inflation often require that companies incorporate price changes into the accounts. Choi/Meek, 7/e

Development (contin) Level of economic development Educational level Affects the types of transactions and which ones are most prevalent in the economy which, in turn, Affects the accounting issues that are faced. Educational level Affects the capability for professional accounting training. Where education levels are low, countries import accounting training or send citizens elsewhere to get it. SUMMARY Several variables are closely associated. Common law legal system, strong equity markets, and separation of financial and tax accounting. Code law legal system, credit-based financing, and accounting rules that conform to tax law. Result is two basic orientations of accounting. Fair presentation Legal compliance Choi/Meek, 7/e

Development (contin) Culture and accounting values Culture (Hofstede) Individualism vs. collectivism Power distance – high vs. low Uncertainty avoidance – high vs. low Masculinity vs. femininity Accounting values (Gray) Professionalism vs. statutory control Uniformity vs. flexibility Conservatism vs. optimism Secrecy vs. transparency Choi/Meek, 7/e

Development (contin) Linking the two: Choi/Meek, 7/e

Classification Four approaches to accounting development (Mueller 1967) Macroeconomic approach Accounting derived from and designed to enhance national macroeconomic goals. Example: Sweden Microeconomic approach Accounting derived from microeconomics. Maintaining physical capital Separation of capital and income Replacement costs Example: the Netherlands Independent discipline approach Accounting derived from business practices, judgment, and trial-and-error. Examples: U.K. and U.S. Uniform approach Accounting is standardized by central government and used as a tool for administrative control. Example: France Choi/Meek, 7/e

Classification (contin) Legal systems: common law vs. code law accounting Common law accounting Oriented toward fair presentation, transparency, and full disclosure Separation between tax and financial accounting Accounting standard setting in private sector Parallels stockholder model of corporate governance Code law accounting Legalistic orientation, opaque with low disclosure Alignment between tax and financial accounting Accounting standard setting in public sector Parallels stakeholder model of corporate governance Choi/Meek, 7/e

Classification (contin) Practice systems: fair presentation versus legal compliance accounting Why national accounting distinctions are becoming blurred Importance of stock markets as a source of finance is growing. Dual financial reporting is becoming more common, particularly where duality is sanctioned. Some code law countries are shifting responsibility for accounting standard setting to the private sector. Fair presentation accounting Substance over form. Oriented toward decision needs of external investors. Helps judge managerial performance and predict future cash flows and profitability Extensive disclosures IFRS are aimed at fair presentation. Found in U.K., U.S., Netherlands and countries influenced by them. The trend for consolidated financial statements. Choi/Meek, 7/e

Classification (contin) Legal compliance accounting Designed to satisfy government-imposed requirements, such as: Calculating taxable income Complying with macroeconomic plan Conservative measurements Income smoothing Will persist in code law countries for individual-company financial statements Choi/Meek, 7/e

Other Chapter Exhibit Choi/Meek, 7/e