Chapter Six Comparative Accounting Copyright © 2012 The McGraw-Hill Companies, All Rights Reserved McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Comparative Accounting Chapter Topics Accounting environment, profession, regulation, principles/ practices, and differences with IFRS in China Germany Japan Mexico United Kingdom 6-2

Comparative Accounting Learning Objectives Describe some aspects of the environment in which accounting operates in five countries: China, Germany, Japan, Mexico, and the United Kingdom. Explain the nature of the accounting profession in the selected countries. 3. Discuss the mechanisms in place for regulating accounting and financial reporting in the selected countries.

Comparative Accounting Learning Objectives Examine some of the accounting principles and practices used by companies in these countries. 5. Identify the areas where national accounting practices in these countries differ from International Financial Reporting Standards (IFRS).

China Background World’s largest country with population of over 1.3 billion. People’s Republic of China (PRC) established in 1949. Politically: Communist, one-party state. Economically: Until the 1980s, all firms state-owned. Currently in transformation to socialist market economy. World’s fourth largest economy and fastest growing among large economies, and is largest recipient of FDI. Learning Objective 1

China Background First securities regulations adopted in 1984. Two major stock exchanges, Shanghai and Shenzhen established in 1990 and 1991. Government controls capital market via Chinese Security Regulatory Commission (CSRC) similar to SEC. Domestic companies list four types of shares: A, B, C, H. Market characterized by speculation, high share turnover. Learning Objective 1

China Accounting Profession Profession less prestigious than in U.S./U.K. Accounting and auditing have developed separately. Chinese Institute of Certified Public Accountants (CICPA) and Chinese Association of Certified Practicing Auditors (CACPA) merged in 1998. Economic reform and the large number of joint ventures with foreigners has led to emergence of the audit profession. Learning Objective 2

China Accounting Profession In October 2007, the ICAEW (Institute of Chartered Accountants in England and Wales) and CICPA launched a joint project for cooperation between the professional bodies in the two countries. Most domestic Chinese accounting firms are “hooked up” to a government-sponsoring body, although the government has encouraged independence. “Guanxi” or tight, close-knit networks, is common way of doing business, but may collide ethically for accountants. Learning Objective 2

China Accounting Regulation Government continues to act as accounting regulator. Recent activity is focused on harmonizing variety of domestic systems which vary by industry. Committed to converging with IFRS, spurred by desired membership in World Trade Organization (WTO). Audits of financial statements widely required. Death penalty in an accounting fraud case suggests that it is taken very seriously. Ministry of Finance (MoF) in similar role as FASB. MoF has issued several pronouncements to achieve harmony. Learning Objective 3

China Accounting Principles and Practice Computation of taxable income is of primary importance. Conservatism is criticized as a method by which owners can understate income and justify low wages. Lack of conservatism is still a major difference with IFRS. Lack of accounting infrastructure contributes to the gap between accounting principles and practice. Accounting System for Business Enterprises (ASBE) is followed by over 500,000 firms, including all listed companies. Learning Objective 4

China Differences with IFRS Property, plant, and equipment -- historical cost, whereas IAS 16 permits revaluations. Asset impairments – Chinese standards are silent, whereas IAS 36 requires impairment test and recognition of loss. Pre-operating expenses – deferred, then expensed when operations begin, whereas, under IAS 38, expense immediately. Business combinations – no specific rules, whereas IAS 22 specifically discusses accounting for business combinations. Learning Objective 5

Germany Background European Union’s largest country, population 83 million. West Germany and East Germany established in 1949, were reunified in 1990. Historically, banks have been primary source of finance via both loans and equity. Since reunification, the economy has been affected by internationalization. Learning Objective 1

Germany Background German companies increasingly listing on foreign exchanges, e.g., New York Stock Exchange. Most common business forms are Aktiengesellschaft (AG) and Gesellschaft mit beschrankter Haftung (GMBH). AG are publicly traded/GMBH are non-publicly traded. Historically had significant influence on accounting systems in a number of other countries. Japan’s commercial code is modeled on Germany’s. Learning Objective 1

Germany Accounting Profession Profession has traditionally been less influential than in U.S./U.K. Auditing is dominant part of profession and certified auditors title of Wirtschaftprufer (WP) was created in 1931. Institut der Wirtschaftprufer similar to the AICPA. Obtaining WP title is extremely rigorous. Wirtschaftpruferkammer (WPK) is a state-sponsored group that oversees auditing profession. Learning Objective 2

Germany Accounting Regulation Commercial code and tax laws are main sources of accounting rules. Traditionally has not used a system of independent institutional oversight. Stock exchange rules have less influence than in U.S. Prudence (conservatism) is fundamental--recognition of revenues only when realized, losses when they appear possible. Began change away from creditor orientation in 1960s towards shareholder orientation. As of 2009 the German Accounting Standards Board (GASB) worked on IASB projects relating to the financial crisis. Learning Objective 3

Germany Accounting Principles and Practices Historical cost attribute for measuring tangible assets is strictly adhered to. Traditional focus on creditor protection is at odds with the true and fair view concept. Importance of tax laws led to the reverse authoritative principle which requires expenses to be deducted from accounting income if they are to be tax deductible. Differences between accounting and tax income are minimal, thereby reducing need for deferred taxes. Learning Objective 4

Germany Accounting Principles and Practices In contrast to China, conservatism has been used to resist labor’s wage demands. Standards allow for income smoothing, frequently accomplished via early recognition of losses. EU fourth directive requires true and fair view, but Germans have a unique interpretation of the concept. Commitment to globalization reflected in rule that allows public companies to use IFRS for consolidated statements. Main intention of German Accounting Law Modernization Act is conformity with IFRS. In August 2010 only about 10 German companies were listed on the NYSE due to NYSE overregulation. Learning Objective 4

Germany Differences with IFRS Goodwill – deducted immediately against equity, whereas, under IFRS 3, accounted for as an indefinite life intangible asset. Internally generated intangibles – not recognized, whereas, under IAS 38, recognized as an asset under some conditions. Leases – accounting uses tax rules, with capitalization rare, whereas IAS 17 criteria result in more frequent capitalization. Accounting for subsidiaries – allow exclusion of dissimilar subsidiaries, which are consolidated under IAS 27. Learning Objective 5

Japan Background Population 127 million, world’s third largest economy. Banks are primary source of finance via both loans and equity, and cross-corporate equity ownership is also common. Keiretsu (and predecessor Zaibatsu) emphasize close business ties and reflect cultural value of collectivism. 1990s recession led to an increase in Japanese firms’ attempts to obtain capital internationally. Learning Objective 1

Japan Accounting Profession Certified Public Accountants Law (1948) established the profession. JICPA is one of the nine founding members of the IASC. Profession is significantly less influential than in U.S./U.K. and is also much smaller in numbers than U.S. Obtaining CPA title is extremely rigorous, as in Germany. Low status within Japanese society vs. engineers and scientists. Collectivism leads to lack of trust of auditors. Tax advising is a much larger, separate, profession. Learning Objective 2

Japan Accounting Regulation Government influences accounting via Commercial Code, Corporate Income Tax Law and Securities and Exchange Law. Similar to Germany, strong creditor orientation and accounting rules closely tied to tax rules. Big Bang financial reforms are leading to harmonization with international standards. These reforms included requirements for consolidation and fair value accounting for tradable securities. Business Accounting Principles issued by Ministry of Finance consist of 7 guidelines (the equivalent of a conceptual framework). In December 2009 Japan Financial Services Agency (FSA) permitted domestic use of IFRS and established framework for voluntary adoption of IFRS starting with fiscal years ending on or after March 31, 2010. Learning Objective 3

Japan Accounting Principles and Practices In contrast to U.S., net income is less a measure of performance and seen more as funds available for dividends. Since providers of financing tend to be close to the firm, there has historically been little pressure for disclosure. Lack of disclosure is apparent in segment reporting. 2007 Tokyo Agreement goal to eliminate all Japanese GAAP and IFRS differences by June 2011 (except major new IFRS developed after 2011. Learning Objective 4

Japan Differences with IFRS Revaluation of Land – allowed, but updating not required, whereas, under IFRS 16, revaluations require regular updating. Pre-operating costs – capitalization is allowed, whereas, under IAS 38, expensed immediately. Construction contracts – completed contract method is allowed, whereas IAS 11 essentially requires percentage-of-completion. Provisions – allows for provisions prior to actual obligation, whereas IAS 37 only allows for present obligations based on past transaction. Learning Objective 5

Mexico Background History of significant inflation-- government control of business is partially blamed for this. Significant changes in 1990s, including privatization of state-owned firms and NAFTA. Historically, most businesses family-owned-- even the very large—prefer to raise capital via debt vs. equity—but gradually changing. Mexico’s one stock exchange, the Bolsa Mexicana de Valores, is privately-owned. Represents one of the largest U.S. trading partners (75% of Mexico’s imports, more than 80% of her exports, and 60% of all FDI). Learning Objective 1

Mexico Accounting Profession The Asociacion de Contadores Publicos, first professional accountant organization, established in 1917. This group was succeeded by the Mexican Institute of Public Accountants (MIPA) in 1964. MIPA establishes accounting and auditing principles. In order to practice public accounting in Mexico, one needs a “professional diploma.” Contador Publico Certificado (CPC) is equivalent of U.S. CPA and can have reciprocal privileges in U.S. and Canada based on passing certain exams. Learning Objective 2

Mexico Accounting Regulation The Mexican Securities Law (1975), was amended in 1993 to comply with NAFTA issues. Accounting standards, grounded in a conceptual framework, have four classes of Bulletins, A, B, C, and D, and, with few exceptions, are similar to U.S. GAAP. Fairness-oriented vs. legal compliance. Corporate tax rules require a report in accordance with Mexican GAAP audited in accordance with Mexican GAAS. Enforcement mechanisms (e.g. for insider trading) not effective. Learning Objective 3

Mexico Accounting Principles and Practices Mexican GAAP heavily influenced by U.S. GAAP due to NAFTA, geographical proximity, and comprehensiveness of U.S. GAAP. Despite international influences, Mexico’s Bulletin B-10 on inflation accounting shows how harmonized accounting may not be appropriate for all circumstances. In November 2008 the Mexico Securities and Exchange Commission announced that all companies listed on the Mexican Stock Exchange will be required to use IFRS in 2012. Learning Objective 4

Mexico Accounting Principles and Practices Bulletin B-10, Recognition of the Effects of Inflation, reflects a major difference to U.S. GAAP. Nonmonetary assets and liabilities to be restated for purchasing power changes of the peso. Inventory can be restated using current replacement costs. Recognition in income (generally) of the gain or loss from the net monetary position, asset or liability. In line with IAS 29, Mexico has given up on inflation accounting recently, due to low rate of inflation. Learning Objective 4

Mexico Differences with IFRS Statement of cash flows – statement of changes in financial position required, whereas IAS 7 requires a statement of cash flows. Inflation Accounting – requires inflation adjustments regardless of inflation rate, whereas IAS 29 required only for hyperinflationary countries. Negative Goodwill – recorded as a deferred credit and amortized over a period of up to five years, whereas IFRS 3 requires immediate recognition of gain. Learning Objective 5

United Kingdom Background Population of about 62 million, comprised of England, Northern Ireland, Scotland, and Wales. Among the five countries in this chapter, its financial structure is closest to the U.S. 15,000 Private Limited Companies (PLCs) with about 2,500 of these listed on the London Stock Exchange. Learning Objective 1

United Kingdom Accounting Profession World’s first association of professional accountants, The Society of Accountants in Edinburgh, established in 1853. Six professional chartered bodies coordinated through Consultative Committee of Accountancy Bodies (CCAB). The profession developed in response to the needs of industry and has influenced the development of professions in a number of other countries. Compared to the U.S. the certification requirements focus more on work experience and less on university education. Learning Objective 2

United Kingdom Accounting Regulation The Companies Act, accounting pronouncements, and stock exchange rules comprise accounting regulation. Similar to the U.S., and unlike Germany and Japan, tax rules do not significantly influence financial reporting. Standard-setters have historically taken a principles-based approach using a statement of principles as a conceptual framework. Has not historically had a strong, SEC type agency, but recent scandals have led to increased regulation. Learning Objective 3

United Kingdom Accounting Regulation The Financial Reporting Council (FRC) annual report for 2008/2009-- key themes for 2009/2010 would be to influence: Market participants to high standards of reporting and governance Legislators and standard-setters to encourage proportionate and principles-based approach in furtherance of the first goal International regulatory authorities to encourage effective cooperation Learning Objective 3

United Kingdom Accounting Principles and Practices A primary objective of accounting is to support an effective capital market. The true and fair view principle is paramount. True and fair view override requires that companies not comply with standards that would result in misleading financial statements. Professional judgment is essential additional component to true and fair view. Financial Reporting Review Panel 2010 annual report says there has been continuous improvement in the general quality of IFRS financial reporting. Learning Objective 4

United Kingdom Differences with IFRS Goodwill – amortization allowed, whereas IFRS 3 prohibits amortization and requires an annual impairment test. Related party disclosures – requires disclosure of related party names, whereas IAS 24 requires disclosure by type, not name, of related party. Revaluation gains/losses – generally not taken to income statement, whereas IAS 40 requires gains and losses to affect net income. Learning Objective 5