Transnational Accounting

Introduction to International Accounting u The field of accounting has had a notable international history and promises to have an even more significant future. u Like the other functional areas of business, accounting has changed as the environments it serves have changed, moving sequentially from the more rudimentary to the more complex and sophisticated.

The History of International Accounting u Accounting has evolved throughout recorded history to meet the needs of those who conduct economic transactions. u Naturally, as business has developed international dimensions accounting has kept pace.

International Accounting u Record keeping the foundation of accounting has been traced back to 3600 B.C.E. Accounting records from the ancient civilizations of China, India, and Mesopotamia (AKA the Cradle of Civilization) have been unearthed.

International Accounting u Double-entry accounting was developed in the Italian city-states between the 13 th and 15 th centuries. u When the Turks conquered Jerusalem in 1076, western Europe unleashed a series of crusades to free Jerusalem from Muslim rule that lasted 200 years.

International Accounting u The Crusades resulted in the establishment of trade routes between East and West, with Italy in the center of things. In essence Italian cities e.g., Genoa, Florence, Venice constituted the link between the Eastern and European cultures.

International Accounting u As a result, many of today’s accounting and financial words in English are of Italian origin. Some examples, include bank, capital, cash, debit, credit, folio, imprest and journal.

International Accounting u With the rise of the British Empire came unprecedented needs for British commercial interests to manage and control enterprises in the colonies, and for records to be reviewed and verified. u Organized public accounting profession in Scotland and England (1854)

International Accounting u Britain imported double entry from Italy and exported professional accounting and the concept of a true and fair view, first to the other countries of the British Commonwealth and, more recently, to the other member states of the European Union.

International Accounting u Multinational enterprises have played a major role in the transfer of accounting from one country to another. u Internationalization of capital markets due to deregulation of financial markets, the speed of financial innovation (involving new trading techniques and new financial instruments), dramatic advances in the electronic technology of communications, and growing links between domestic and world financial markets.

Scope of International Business Activity u As globalization of business activity and financial markets proceeds at a rapid pace, a desire for a single set of accounting standards has been expressed frequently.

Institutional Settings u Given differing institutional settings in many countries e.g., corporate governance, legal structure, taxation, capital market development, etc., it is implausible for one financial reporting system to adequately meet all needs.

Multinational Companies u Many companies operate in a manner that transcends idiosyncratic national characteristics. u These companies actively seek capital in international markets.

The Need for International Accounting u Need for comparable data u Information to serve international securities trading activities

The Focus of International Accounting u Identification and understanding of the various organizations and their interests involved in the process of establishing international accounting and auditing principles and standards Primary Areas of Interest Include:

The Focus of International Accounting continued.... u Identification and understanding of principles of financial, managerial, and taxation accounting used in different nations, especially how they differ between those nations

Factors Influencing the Development of Accounting u Legal Systems u Sources of Finance u Taxation u Political and Economic Ties (Accidental) u Inflation u Level of Economic Development u Education Level u Culture

Legal Systems u Laws regulate human behavior. The system of laws determines how individuals interact and relate to the laws of the land. u The Western world has been dichotomized into legalistic (code or civil law) and nonlegalistic (common or case law) orientations.

Legal Systems – Common Law u Common law – a legal system which relies upon a limited amount of statute law, which is then interpreted by courts, which build up large amounts of case law to supplement the statutes. u Common law is less abstract than codified or civil law. u A common law rule seeks to provide an answer to a specific case rather than to formulate a general rule for the future.

Legal Systems – Common Law u Common law naturally influences company law, which traditionally does not prescribe a large number of detailed, all-embracing rules to cover the behavior of companies and how they should publish their financial statements.

Legal Systems – Civil Law u Civil or codified law is a system of law which is based on the Roman jus civile as complied by Justinian in the sixth century and developed by European universities from the twelfth century. u Here rules are linked to ideas of justice and morality; they become doctrine. u This effects company law e.g., commercial codes which need to establish rules in detail for accounting and financial reporting.

Legal Systems – Civil Law u In code law countries, laws are a set of all- embracing, “thou shalt” requirements. Compliance with the letter of the law is expected. u Codification of accounting standards and procedures appears natural and appropriate in these countries. u Thus, accounting rules are incorporated into national laws and they tend to be highly prescriptive and procedural.

Common Law Codified Roman Law England and WalesFrance IrelandItaly United StatesAustria, Germany CanadaSpain AustraliaNetherlands New ZealandPortugal Japan (commercial) Western Legal Systems

u The laws of Scotland, Israel, South Africa, Quebec, Louisiana and the Philippines embody elements of both systems.

Types of Financial Systems u Capital Market Systems (e.g., U.K., USA) u Credit based governmental systems ( e.g., France, Japan) u Credit based financial institution systems (e.g., Germany and Austria)

Providers of Finance u The prevalent types of business organization and ownership is important. u In France and Italy, capital provided by the state or banks is very significant, as are small family businesses.

Providers of Finance u In Germany and Austria, the banks are important owners of companies as well as providers as debt finance. u In continental Europe and Asia, the need for published info and audits is less clear.

Ratio of debt to debt plus equity RankCountryGearing ratio 1Switzerland0.55 2Belgium0.51 3Italy0.45 4Ireland0.40 5Denmark0.34 6France0.34 7Germany0.30 8Sweden0.27 9Netherlands Spain UK0.20

Providers of Finance In countries with a widespread ownership of companies by shareholders who do not have access to internal info there will be a pressure for disclosure, audit, and “fair” information.

Providers of Finance In most continental European countries and in Japan, the traditional paucity of outside shareholders has meant that external financial reporting has been largely invented for the purposes of governments as tax collectors or controllers of the economy. This has not encouraged the development of flexibility, judgment, fairness, or experimentation.

Taxation Classical (US) vs.imputation (EU, Australia, Canada) systems of corporate tax The degree to which taxation regulations determine accounting measurements Correct & legal vs. true & fair Cash vs. accrual accounting

Taxation In Germany, Austria, France, Belgium, Italy, Spain, and many other countries, the tax accounts (Steuerbilanz) should be the same as the commercial accounts (Handelsbilanz) also known in German as Massgeblichkeitsprinzip

The Accountancy Profession u The strength, size and competence of the accountancy profession in the country. u 1975 Decree in Italy unfulfilled until 1980s

Inflation u There are some countries where inflation has been overwhelming. u In several South American countries, financial accounts are adjusted by a general price-level index. u In other countries revaluation of assets is permitted.

Theory u In a few cases, accounting theory has strongly influenced accounting practice. u Theodore Limberg, Jr. in the Netherlands allow accountants a wide latitude of discretion in presenting a firm’s accounting figures – fairness through judgment u In most of continental Europe and Japan, accounting is the servant of the state (e.g., for tax collection). u In the US – Conceptual Framework u Finland – accretion accounting

Accidents u The government induced economic crisis in the US in the early 1930s produced the SEC which diverted US accounting toward a course of extensive disclosure requirements. u German conquest of Europe influenced France which influenced Spain.

Harmonization of Accounting Principles u Company law is all-important in Austria and Germany, fairly important in the United Kingdom, but of little importance in France or the United States. u Accounting standards are very important in the United Kingdom and the United States, but of virtually no importance in France, Germany or Austria

Harmonization of Accounting Principles u In France uniformity is achieved through a national accounting plan, while in Austria and Germany, uniformity is achieved through statue law. In all three countries a close connection exists between the rules of financial accounting and the rules for corporate taxation.

International Accounting Classification Systems u Help in understanding accounting differences between countries u Can center around various characteristics including cultural differences

Classification Based on Cultural Differences u Anglo-Saxon accounting u Germanic accounting u Nordic accounting u Latin accounting u Asian accounting

Harmonization of Accounting Principles u Harmonization is the process of increasing the compatibility of accounting practices by setting bounds to their degree of variation. u The goal is a flexible approach to improving comparability of financial information, including the adoption of international accounting standards u The benefits of harmonization would extend to a variety of users including: governments, regulatory agencies (SEC), individual investors, trading partners

Approaches to Harmonization u Bilateral agreements between two or more countries u Single economic trading environments, such as the European Union u International standard setting involving professional accounting organizations

The International Accounting Standards Committee (IASC) u An independent private organization founded in 1973 u Taking a global approach to standard setting u Membership consists of 120 national accounting bodies representing 89 countries u Business is conducted by a Board and a Consulting group

Major Objectives of the IASC u Formulate and publish standards on financial accounting and reporting and to promote their worldwide acceptance u Work for the harmonization of accounting standards and procedures relating to the presentation of financial statements

International Accounting Standards (IAS) u Issued by the IASC u Over 30 standards are operative u In some instances the standards differ from US GAAP u Promulgated standards are being accepted by a number of countries and organizations u Standards serve as a benchmark against which developing and established accounting principles may be evaluated

International Federation of Accountants (IFAC) u A private organization whose membership is the same as that of the IASC u Concerned with aspects of the professional practice of accountancy u The leading organization for the international accounting profession u Not involved in the establishment of international financial accounting standards to the same degree as the IASC

Other Issues of International Importance u Transfer pricing strategies A set of tools and methods used to attribute revenues earned by the organization to organization sub- units

Transfer Pricing

Transfer pricing can be very arbitrary, especially if there is a high degree of interaction among the various responsibility centers

Transfer pricing approaches Market-Based Cost-Based Negotiated Administered

Market-Based Transfer Pricing u If a good external market exists for the transferred product or service, then market prices are the most appropriate basis for pricing u Unfortunately, these markets with well-defined prices seldom exist

Cost-Based Transfer Prices u Variable cost plus a markup u Full cost u Full cost plus a markup

Cost-Based Transfer Concerns Economists argue that only marginal cost transfer prices are optimal They do not focus on the intent of the system, which is to allow calculation of unit incomes They do not provide the appropriate economic guidance when operations are capacity constrained

Negotiated Transfer Pricing u Supplying and receiving responsibility centers negotiate prices u Prices reflect both negotiating skills and economic considerations u Optimal transfer price is the net realizable value of the last unit supplied for all units supplied

Negotiated Transfer Pricing u Reflect the accountability and controllability principles underlying responsibility centers u Can easily lead to decisions that do not provide the greatest economic benefits

Administered Transfer Pricing u Prices set by a rule, policy or an arbitrator u Easy to administer u Arbitrary u Tend to violate the spirit of the responsibility approach