Worldwide Accounting Diversity and International Standards Chapter Eleven Worldwide Accounting Diversity and International Standards Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

International Accounting Diversity Chinese companies use the direct method in preparing the statement of cash flows. Companies in Germany are allowed to report assets on the balance sheet at revalued amounts. Most companies in the United States and Europe use the indirect method. Chinese companies use the direct method in preparing the statement of cash flows. Most companies in the United States and Europe use the indirect method.

Explain the major factors influencing the international Learning Objective 11-1 Explain the major factors influencing the international development of accounting systems. Explain the major factors influencing the international development of accounting systems.

Reasons for Accounting Diversity Legal System Taxation All these interact!!! Political and Economic Ties Culture Financing Systems Inflation

Reasons for Accounting Diversity Legal Systems: ► Common Law ► Roman (Codified) Law Major providers of financing: ►Family members ► Governments ► Banks ► Shareholders ► Other creditors ► Taxation ► Inflation ►Societal Values ► Individualism ► Uncertainty Avoidance ► Power Distance ► Masculinity Common Law Found primarily in English- speaking countries, where courts establish precedent. Accounting profession plays a large role in standard setting and tends to be independent. Standards tend to be detailed. Roman (Codified) Law Based on statute rather than precedent. Laws govern business enterprises. Accounting profession tends to have little influence on standard setting, is frequently an adjunct of the legal system. Accounting law tends to be lacking in detail. Reasons for Accounting Diversity- Financing Systems Major providers of financing: Family members Banks Focus on solvency and liquidity (balance sheet emphasis) Governments Shareholders Focus on profitability (income statement emphasis) Other creditors Reasons for Accounting Diversity- Other Issues Taxation Financial statements are the basis for taxation in some countries. Others adjust financial statements for tax purposes, and submit separate reports to stockholders’. Inflation High inflation tends to render historical cost useless. High inflation rates force adoption of accounting rules that adjust historical costs to current or market value. Creditors tend to suffer under highly inflationary economies. Accounting methods are readily conveyed from one country to another, either by trade or conquest. Societal values found within cultures: Individualism Uncertainty Avoidance Power Distance Masculinity

Gray’s Framework for the Development of Accounting Systems Internationally Cultural Dimensions Individualism Uncertainty Avoidance Power Distance Masculinity Institutional Consequences Legal system Corporate Ownership Capital Markets Professional Associations Education & Religion Accounting Values Professionalism Uniformity Conservatism Secrecy Cultural Dimensions Individualism Uncertainty Avoidance Power Distance Masculinity Accounting Values Professionalism Uniformity Conservatism Secrecy Institutional Conseq. Legal system Corporate Ownership Capital Markets Professional Associations Education & Religion Accounting Systems Authority Enforcement Measurement Disclosure Accounting Systems Authority Enforcement Measurement Disclosure

Nobes’ Model of the Reasons for International Accounting Diversity Nobes’ simplified model has two explanatory factors: (1) national culture, including institutional structures, (2) the nature of a country’s financing system divided into two classes. Class A (Strong equity-outsider financing system) Less conservative Greater disclosure Financial and tax accounting separate Class B (Weak equity-outsider financing system) More conservative Less extensive disclosure Financial reporting follows tax rules Nobes’ Model of the Reasons for International Accounting Diversity Nobes’ simplified model has two explanatory factors: (1) national culture, including institutional structures, (2) the nature of a country’s financing system divided into two classes. Class A (Strong equity-outsider financing system) Less conservative Greater disclosure Financial and tax accounting separate Class B (Weak equity-outsider financing system) More conservative Less extensive disclosure Financial reporting follows tax rules

Understand the problems created by differences in Learning Objective 11-2 Understand the problems created by differences in accounting standards across countries and the reasons to develop a set of internationally accepted accounting standards. Understand the problems created by differences in accounting standards across countries and the reasons to develop a set of internationally accepted accounting standards.

Harmonization of Diverse Accounting Standards Problems Caused by Diverse Accounting Standards Subsidiaries use local standards for financial statements. Costly to prepare financial statements that comply with local standards. Accounting rules differ from country to country. Harmonization to reduce differences The International Accounting Standards Committee (IASC) began the movement. In 1987, the International Organization of Securities Commissions (IOSCO) 2001, the International Accounting Standards Board (IASB) Problems Caused By Diverse Accounting Standards Problems Subs use local standards for financial statements. The parent must adjust the subs’ statements to GAAP. Statements must be re-stated in common standards. To access foreign capital markets, costly measures must be taken to prepare financial statements that comply with local standards. Financial statements from different countries are simply not comparable. Accounting rules differ from country to country. Harmonization: Reducing differences in accounting practices across countries. Harmonization efforts have been ongoing for decades, and originally the International Accounting Standards Committee (IASC) led the movement. In 1987, the International Organization of Securities Commissions (IOSCO) joined the effort. Since 2001, the process has been led by the International Accounting Standards Board (IASB)

List the authoritative pronouncements that constitute Learning Objective 11-3 List the authoritative pronouncements that constitute International Financial Reporting Standards (IFRS). List the authoritative pronouncements that constitute International Financial Reporting Standards (IFRS).

International Accounting Standards Committee- IASC International Accounting Standards committee (IASC) established in 1973. IASB superseded IASC in April 2001. The IASB has sole responsibility for establishing IFRSs (“IASB GAAP”) IASB has no enforcement authority!! All of the 41 IASs issued by the IASC were adopted by the IASB. 28 are currently in effect. New standards are called “International Financial Reporting Standards” (IFRSs). As of January 2013, 13 IFRSs have been issued. International Accounting Standards committee (IASC) established in 1973. IASB superseded IASC in April 2001. 16-member board (13 full-time) The IASB has sole responsibility for establishing IFRSs (“IASB GAAP”) IASB has no enforcement authority!! International Accounting Standards Board (IASB) All of the 41 IASs issued by the IASC were adopted by the IASB. 28 are currently in effect. New standards are called “International Financial Reporting Standards” (IFRSs). As of July 2011, 13 IFRSs have been issued.

Describe the ways and the extent to which IFRS are used Learning Objective 11-4 Describe the ways and the extent to which IFRS are used around the world. Describe the ways and the extent to which IFRS are used around the world.

International Financial Reporting Standards (IFRSs) Countries can elect to use IFRS by: (1) adopting IFRS as its national GAAP (2) requiring domestic listed companies to use IFRS for their consolidated financial statements (3) allowing domestic listed companies to use IFRS (4) require or allow foreign companies listed on a domestic stock exchange to use IFRS. Ninety-two of the 153 countries using IFRS require all domestic listed companies to use IFRS for consolidated statements. (2) All publicly traded companies in the EU required to use IFRS. (3) Two significant exceptions – China and the U.S. International Financial Reporting Standards (IFRSs) Countries can elect to use IFRS by: (1) adopting IFRS as its national GAAP (2) requiring domestic listed companies to use IFRS in preparing their consolidated financial statements (3) allowing domestic listed companies to use IFRS (4) requiring or allow foreign companies listed on a domestic stock exchange to use IFRS. Of the 153 countries using IFRS as of June 2012: (1) 92 require all domestic listed companies to use IFRS in preparing their consolidated financial statements. (2) All publicly traded companies in the EU have been required to use IFRS since January 1, 2005. (3) Two significant exceptions – China and the U.S.

Describe the FASB–IASB Learning Objective 11-5 Describe the FASB–IASB convergence process and the SEC recognition of IFRS. Describe the FASB–IASB convergence process and the SEC recognition of IFRS.

Norwalk Agreement: FASB-IASB Convergence In Norwalk, Connecticut, FASB and IASB held a joint meeting in September 2002 and agreed to “use their best efforts” 1) to make existing financial reporting standards compatible “as soon as is practicable” and 2) Coordinate efforts to “ensure that once achieved, compatibility is maintained” In 2006- Memorandum of Understanding (MoU), FASB and IASB agreed that trying to eliminate differences between standards and create identical standards, is not realistic. Instead, they agreed that standards in need of improvement should be replaced with new jointly developed standards. Norwalk Agreement: FASB-IASB Convergence In Norwalk, Connecticut, FASB and IASB held a joint meeting in September 2002. The “Norwalk Agreement” states that the two bodies will “use their best efforts” to: 1. Make existing financial reporting standards compatible “as soon as is practicable” and 2. Coordinate efforts to “ensure that once achieved, compatibility is maintained” Memorandum of Understanding (MoU) developed in 2006, the FASB and IASB agreed that trying to eliminate differences between two standards that are in need of significant improvement is not a good use of resources. Instead, standards in need of improvement should be replaced with new jointly developed standards. The idea behind convergence is to have similar, but not necessarily identical standards. Indeed, the boards acknowledge that the development of identical standards, even if jointly developed, is not realistic.

FASB-IASB Convergence As of January 2013, the FASB‐IASB convergence process had resulted in changes made to U.S. GAAP, IFRS, or both: Business combinations ∙ Borrowing costs Consolidated financial statements ∙ Derecognition Non‐controlling interests ∙ Post‐employment benefits Acquired in‐process research costs ∙ Fair value option Non‐monetary asset exchanges ∙ Joint ventures Share‐based payment ∙ Fair value measurement Accounting changes ∙ Segment reporting Presentation of (OCI) ∙ Inventory accounting As of January 2013, the FASB‐IASB convergence process had resulted in changes made to U.S. GAAP, IFRS, or both in the following areas:  Business combinations  Consolidated financial statements  Non‐controlling interests  Acquired in‐process research costs  Joint ventures  Share‐based payment  Accounting changes  Inventory accounting  Borrowing costs  Derecognition  Post‐employment benefits  Non‐monetary asset exchanges  Fair value option  Fair value measurement  Segment reporting  Presentation of other comprehensive income

Recognize acceptable accounting treatments under IFRS and Learning Objective 11-6 Recognize acceptable accounting treatments under IFRS and identify key differences between IFRS and U.S. GAAP. Recognize acceptable accounting treatments under IFRS and identify key differences between IFRS and U.S. GAAP.

Current Differences Between IFRSs and US GAAP Recognition: If recognized, how? When? Presentation: Principles? Financial Statement Components? Disclosure: If allowed, How? Measurement: How is cost determined? n a comparison of IFRS and U.S. GAAP published by the SEC in November 2011, 24 the SEC Staff identified numerous differences in the two sets of standards across a wide range of topics. E xhibit 11.8 summarizes some of the key differences between IFRS and U.S. GAAP. Note that a number of these differences are within the scope of the FASB– IASB convergence projects and therefore are likely to be eliminated over time. The types of differences that exist between IFRS and U.S. GAAP can be generally classified as follows: 1. Recognition differences. 2. Measurement differences. 3. Presentation and disclosure differences. Discontinued Operations Extraordinary Items Inventory Fixed Assets

Determine the impact that specific differences between Learning Objective 11-7 Determine the impact that specific differences between IFRS and U.S. GAAP have on the measurement of income and stockholders’ equity. Determine the impact that specific differences between IFRS and U.S. GAAP have on the measurement of income and stockholders’ equity.

U.S. GAAP Reconciliations IASB: Principles- Based Provide general principles with limited guidance. Requires greater professional judgment. FASB: Rules-Based Provide detailed guidance. May encourage mindset of looking for loop-holes. IASB: Principles-Based Provide general principles with limited guidance. Requires greater professional judgment. FASB: Rules-Based Provide detailed guidance. May encourage mindset of looking for loop-holes. U.S. GAAP Reconciliations: Interest Capitalization Business Combinations Purchase vs. Pooling Methods Goodwill Amortization vs. Impairment Leases Revaluation of Fixed Assets Fixed Asset Impairment Losses