McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2-2 Chapter Topics Evidence of accounting diversity. Reasons for accounting diversity. Problems caused by accounting diversity. Accounting clusters. The influence of culture on financial reporting. The reason for international differences in reporting. Further evidence of accounting diversity.

2-3 Learning Objectives 1. Provide evidence of the diversity that exists in accounting internationally. 2. Explain the problems caused by accounting diversity. 3. Describe the major environmental factors that influence national accounting systems and lead to accounting diversity.

2-4 Learning Objectives 4. Describe a judgmental classification of countries by financial reporting system. 5. Discuss the influence that culture is thought to have on financial reporting. 6. Describe a simplified model of the reasons for international differences in financial reporting. 7. Categorize accounting differences internationally and provide examples of each type of difference.

2-5 Worldwide Accounting Diversity Differences in accounting and financial reporting rules between countries. For example: Accounting for Goodwill U.S. -- goodwill is not amortized, but is written down only if impaired. Japan and Korea – goodwill is amortized over its useful life not to exceed twenty years. Learning Objective 1

2-6 Worldwide Accounting Diversity Asset revaluation U.S. -- upward revaluation of fixed assets is not generally allowed. European Union publicly traded companies are free to choose between two different methods for valuing their assets. Learning Objective 1

2-7 Worldwide Accounting Diversity Inflation Accounting U.S. (and many other countries) -- financial statements are not adjusted for inflation. Latin American countries -- experience significant inflation, so financial statements are adjusted for changes caused by inflation. Learning Objective 1

2-8 Additional evidence of differences in accounting between countries Form 20-F Required by the SEC for companies using non-U.S. GAAP (unless they use IFRS). Reconciles net income and stockholders’ equity from the other GAAP to U.S. GAAP. Learning Objective 1

2-9 Consolidated financial statements U.S. MNEs often have subsidiaries in a large number of countries. Accounting records in local GAAP and local currency are rolled-up (i.e., consolidated) into U.S. GAAP. Require conversion from local to U.S. GAAP. Require translation from the local to U.S. currency. Learning Objective 2

2-10 Difficulties with access to foreign capital Markets Companies often need to go outside their home country in order to access financing. Raising foreign capital often requires reconciliation to comply with different accounting rules or needs of investors and creditors. Learning Objective 2

2-11 Non-comparability of financial statements Accounting rules often differ between countries. International investors need to make their own reconciliations or adjustments to financial statements. International investors also must face differing levels of disclosure, quality of accounting standards, and quality of auditing. Learning Objective 2

2-12 Lack of high-quality accounting information Lack of disclosures—i.e., lack of transparency.

2-13 Legal systems -- Common law Fewer statutes—more court interpretation. Leads to the creation of precedents or case law. Found most often in Great Britain and other English- speaking countries. The source of accounting rules tends to be non- governmental organizations. Learning Objective 3

2-14 Legal systems -- Code law Characterized by relatively more statutes. Found more often in non-English-speaking countries. Accounting rules in these countries tend to be legislated (i.e., the source is the government). Less specific, so other sources needed to provide guidance. Learning Objective 3

2-15 Taxation U.S. -- taxable income and book income are generally quite different. Germany -- rules governing taxable and book income tend to be the same, which generally results in more conservative accounting. Deferred taxes are less of an issue in code law countries. Learning Objective 3

2-16 Providers of financing In many countries major sources of capital are families, banks, and the government. Accounting and disclosure in those countries tend to be less important. In the U.S. and U.K. the providers of financing are diverse shareholders, so accounting and disclosure are more important. Learning Objective 3

2-17 Inflation Some countries have historically high rates of inflation. Accounting in these countries often requires adjustments to offset the impact of inflation. This is common in Latin American countries. Given extended periods of low inflation in the U.S., inflation accounting is not required. Learning Objective 3

2-18 Political and economic ties These linkages tend to make information sharing easier. Nations that share ties often have similar accounting systems, such as France and former colonies in western Africa. Correlation of factors In summary, correlations exist among these factors. Code law countries tend to link taxation to accounting statements and are less reliant on shareholder financing. Learning Objective 3

2-19 Accounting Clusters Environmental factors related to accounting diversity have been used to identify three broad based clusters: Fair presentation / full disclosure model Oriented towards the information needs of investors and creditors. Most descriptive of the U.K. and U.S. Learning Objective 4

2-20 Accounting Clusters Legal compliance model Accounting heavily influenced by tax rules and needs of government. Commonly found in continental Europe and other code law countries such as Japan. Banks are primary source of financing. Learning Objective 4

2-21 Accounting Clusters Inflation-adjusted model Similar to the legal compliance approach. Is distinguished by the requirement for adjustments to mitigate the effects of inflation. As such, found mostly in South America. Learning Objective 4

2-22 Nobes’ judgmental classification Shows how accounting systems in 14 developed countries relate to each other. Classified by influences of government, economics, taxes, legal systems and business practices. Learning Objective 4

2-23 Culture is also widely considered to influence financial reporting systems. Hofstede’s five cultural dimensions is the most commonly used scheme to discuss cultural influences. Learning Objective 5

2-24 Hofstede’s Cultural Dimensions Individualism (vs. Collectivism) Power Distance Uncertainty Avoidance Masculinity Long-term Orientation Learning Objective 5

2-25 Hofstede’s Cultural Dimensions Individualism (vs. Collectivism) Preference for a loosely knit social fabric. Collectivism represented by a tightly knit social fabric. Learning Objective 5

2-26 Hofstede’s Cultural Dimensions Power Distance -- Level of acceptance of unequally distributed power within and across the society’s institutions and organizations. Uncertainty Avoidance – Degree to which members of a society feel threatened by uncertain or unknown situations. Learning Objective 5

2-27 Hofstede’s Cultural Dimensions Masculinity – Emphasis on traditional masculine values of performance and achievement vs. feminine values of relationship, caring and nurturing. Long-term Orientation – The extent to which the society values persistence, thrift, observing order and respect for tradition. Learning Objective 5

2-28 Gray’s Accounting Values Professionalism vs. Statutory Control Uniformity vs. Flexibility Conservatism vs. Optimism Secrecy vs. Transparency Learning Objective 5

2-29 Gray’s Accounting Values Professionalism vs. Statutory Control Professionalism is reflected by individual professional judgment and self-regulation of the profession. Statutory control focuses on legal compliance and legislative control of the profession. The former is more indicative of the U.K. and U.S. and the latter more so with continental Europe. Learning Objective 5

2-30 Gray’s Accounting Values Uniformity vs. Flexibility Uniformity indicates preference for standardized accounting methods. Flexibility is reflected in the varying of accounting practices for differences between companies. U.K. and U.S. approaches are examples of flexibility. Learning Objective 5

2-31 Gray’s Accounting Values Conservatism vs. Optimism Conservatism indicates preference for caution and prudence. Optimism tends more toward fair presentation. Germany has traditionally reflected a strong tendency toward conservatism. Learning Objective 5

2-32 Gray’s Accounting Values Secrecy vs. Transparency Secrecy reflects a preference for minimal information disclosure. Transparency reflects openness and full disclosure. Countries with predominantly family-owned and bank- financed firms tend toward secrecy. Learning Objective 5

2-33 Nobes’ model Describes international differences as a function of culture and the system of financing. Culture influences the development of the system of financing which influences the development of accounting. Uses two classifications -- A and B. Learning Objective 6

2-34 Class A Accounting Descriptive of Anglo-Saxon countries. Strong outside shareholder equity-financing. Optimism. Transparency. Learning Objective 6

2-35 Class B Accounting Descriptive of continental Europe. Less widespread outside shareholder equity-financing. Conservatism. Secrecy. Learning Objective 6

2-36 Additional differences between countries Different financial statement formats. Level of detail in financial statements varies between countries. Terminology, level of disclosure, and rules governing recognition and measurement. Different financial statements included in the annual report. Learning Objective 7