© The McGraw-Hill Companies, Inc., 2007 Slide 11-1 McGraw-Hill/Irwin Chapter Eleven Worldwide Accounting Diversity and International Standards

© The McGraw-Hill Companies, Inc., 2007

Slide 11-1

McGraw-Hill/Irwin

Chapter Eleven

Worldwide Worldwide Accounting Accounting

Diversity and Diversity and International International

StandardsStandards


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Examples of International Accounting Diversity

Dutch companies report assets at

current replacement cost.

Dutch companies report assets at

current replacement cost.

German companies

amortize goodwill as a reduction of owners’ equity.

German companies

amortize goodwill as a reduction of owners’ equity.

Canada and France allow capitalization of R&D costs.

Canada and France allow capitalization of R&D costs.


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Magnitude of Accounting Diversity

2/3 of foreign companies report

material differences when compared to

GAAP.

2/3 of foreign companies report

material differences when compared to

GAAP.

A separate study showed that the average income would have been reduced 42% if

reconciled to US GAAP

A separate study showed that the average income would have been reduced 42% if

reconciled to US GAAP

Material differences are

spread relatively evenly across

countries.

Material differences are

spread relatively evenly across

countries.

Results of a 1993 SEC survey on the significance of the

differences between GAAP and non-

GAAP countries.

Results of a 1993 SEC survey on the significance of the

differences between GAAP and non-

GAAP countries.


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Reasons for Accounting Diversity

LegalLegal SystemSystem

Tax RegimesTax Regimes

InflationInflation

CultureCulture

Financial Financial ProvidersProviders

PoliticalPolitical andand

EconomicEconomicTiesTies

All these interact!!!All these interact!!!


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Legal System

Common Law Found primarily in English-speaking countries Limited statutory law Importance of courts establishing precedents Accounting profession plays a large role in standard setting

and tends to be independent Standards tend to be detailled

Roman (Codified) Law Based primarily on statute rather than precedent Corporation laws tend to establish parameters and stipulate

nature of financial statements Accounting profession tends to have little influence on

standard setting and is frequently an adjunct of the legal system

Accounting law tends to be lacking in detail Sharia (Islamic Law)

Based on interpretation of the Quran Interest is not permitted Accounting law is determined by religious authorities


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Tax Regimes

Some countries use financial statements as basis for taxation (single system)

Some countries adjust financial statements for tax purposes and require separate submission of tax returns (dual system)


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Financial Providers

Family members Less pressure for public accountability

Banks Focus on solvency and liquidity (balance sheet

emphasis) Tendency to conservatism in relation to assets

Governments Shareholders

Focus on profitability (income statement emphasis)

Higher demand for outside disclosure

Other creditors


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Inflation

High inflation tends to reduce historical cost accounting’s value

Accounting focus is on adjusting values to current or market value

Creditors tend to suffer under highly inflationary economies


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Political and Economic Ties

Accounting methods are readily conveyed from one country to another, either by trade or conquest Britain’s former colonies throughout the

world, such as Australia and Canada, tend towards “common law” systems

Former French colonies, such as Senegal and Congo, base their accounting standards on “codified law”

Japan has an SEC and a variety of American aspects to its accounting as a result of its occupation following WWII


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Culture

The various factors explaining accounting diversity are highly correlated, and there are many similarities in accounting “culture”: Common law countries tend to separate financial

and tax accounting, and frequently rely primarily on capital markets as sources of capital

Code law countries frequently link tax and financial accounting, require less detailed public disclosure and often rely more on banks as a source of financing. In turn, these countries tend to have banking representatives on corporate boards of directors


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Problems Caused By Diverse Accounting Standards

Problem Subs use local standards

in preparing financial statements.

To gain access to a country’s capital market, financial statements must be in accordance with local standards.

Statements are simply not comparable.

Solution The parent must adjust

the subs’ statements to be in accord with GAAP.

The parent must restate their own statements in accord with local standards.

Statements must be re-stated in common standards.


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Accounting Clusters

The Mueller classification scheme identifies four major accounting models: British-American Continental South American Mixed economy

Nobes’ micro-based/macro-based model.


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Exh. 11.3Hypothetical Classification of

Accounting Systems

B u s in e ssE co n om ics,

T h e o ry

B u s in e ssp ra c tice

p ra g m a tic,B rit ish o rig in

M ic ro -b a sed

C o n tine n ta l:G o v 't, T a x,

L e g a l

G o ve rn m e ntE co n o m ics

M a c ro -b a sed

D e ve lo p edW e s te rn

C o u n tries


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International Harmonization

The process of reducing differences in financial reporting practices across countries is called “harmonization.”

Arguments in favor of harmonization include: Improved comparability aids capital

globalization Reduced cost of producing financial

statement information Easier to shift accounting staff

worldwide Simplified auditing


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Arguments opposing harmonization: Magnitude of current differences

is an immense obstacle High political cost Nationalism Unnecessary (a thriving global

capital market already exists) Existing differences might be

“appropriate and necessary”


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Major Harmonization Efforts include: European Union (EU)

• The Fourth Directive (1978)

• The Seventh Directive (1983)

International Accounting Standards Board (IASB)

International Organization of Securities Commissions (IOSCO)


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European Union

1957 – European Economic Community (now called European Union) established free trade among member countries.

EU issues “Directives” to assist with harmonizing accounting across member countries 1978 – 4th Directive deals with valuation 1983 – 7th Directive deals with preparation

of consolidated financial statements.


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European Union – Unaddressed Differences Between Countries

Lease Accounting

Lease Accounting

Accounting Changes

Accounting Changes

Foreign Currency

Translation

Foreign Currency

Translation

Income TaxesIncome Taxes

ContingenciesContingencies

Long-term Construction

Contracts

Long-term Construction

Contracts


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International Accounting Standards Board (IASB)

International Accounting Standards Committee established in 1973

IASB superseded IASC in April 2001 Includes over 140 accounting bodies,

representing over 100 nations. The U.S. is represented by the AICPA and IMA

Standards produced by a 14-member board. Requires 11 of 14 members to issue a standard. 36 International Accounting Standards (IAS’s) and

International Financial Reporting Standards (IFRS’s) issued as of January 2005.


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International Accounting Standards Board

Consists of 14 members Technical competence is the most important

selection criterion 12 members are full-time, 2 are part-time Full-time members required to sever former

employment relationships and may not hold positions that would call their economic independence into question

7 full-time members have formal liaison responsibilities with national standard setters

Required member backgrounds:• At least five must have practiced auditing• Three must have prepared financial statements• Three must have been statement users• One must be an academic


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International Financial Reporting Standards (IFRSs)

In April 2001, the IASB adopted all of the IASs, and announced that its standards would be called “International Financial Reporting Standards” (IFRSs)

The IASB has sole responsibility for establishing IFRSs

As of 1 January 2005, there were 36 IASs and IFRSs

These can be thought of as “IASB GAAP” IASB has no enforcement authority!!


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Examples of IFRS Application

IFRS Required:IFRS Required:Belgium, France, IrelandBelgium, France, Ireland

Italy, NorwayItaly, NorwayIFIFIFIF

IFRS RequiredIFRS Required for Somefor Some::

China, Romania, RussiaChina, Romania, Russia

IFRS Permitted:IFRS Permitted:Bermuda, Switzerland,Bermuda, Switzerland,

Turkey, UruguayTurkey, Uruguay

IFRS IFRS NotNot Permitted Permitted::United States, Canada,United States, Canada,

India, JapanIndia, Japan


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Norwalk Agreement: FASB-IASB Convergence

In Norwalk, Connecticut, a joint meeting of FASB and IASB was held in September 2002

The “Norwalk Agreement” states that the two bodies will “use their best efforts” to: Make existing financial reporting

standards compatible “as soon as is practicable” and

Coordinate efforts to “ensure that once achieved, compatibility is maintained”


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FASB-IASB Convergence

FASB initiatives include Short-term convergence project Joint projects Longer-term convergence research Liaison IASB member at FASB offices Monitoring of IASB projects Explicit consideration of convergence

potential in FASB agenda decisions


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FASB’s Short-term Convergence Project

Intended to remove individual accounting differences between IFRSs and US GAAP that are not covered in broader projects and “for which a high quality solution appears to be achievable in a short period of time.”


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FASB’s Short-term Convergence Project (continued)

Inventory Costs SFAS 151 issued in December 2004 to converge with IASB’s

current period expensing of• Idle facility expenses• Excessive spoilage• Double freight• Re-handling costs

Asset exchanges SFAS 153 issued in December 2004 to eliminate APB Opinion

29 exception to the rule of fair value measurement for nonmonetary exchanges of similar assets

Accounting changes An Exposure Draft was issued in December 2003 proposing

that retrospective applications of new accounting principles would replace current reporting

Earnings per share An Exposure Draft was issued in December 2003 that would

enhance comparability


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FASB-IASB Joint Projects

Business Combinations Performance Reporting

Issues Include:• Should a single statement of comprehensive income be

required?

• Should direct method be required for reporting cash flows from operations?

• How many years of comparative data should be included in financial statements?

Revenue Recognition – Single Standard Common Conceptual Framework


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Current Differences Between IFRSs and US GAAP

RecognitionRecognition

MeasurementMeasurementPresentation andPresentation and

DislosureDislosure


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Examples of Differences Between IFRSs and US GAAP - Recognition

Recognition Differences (mainly relating to “whether,” “how,” and “when” an item is recognized) Research and Development Gains on Sale and Leaseback

Transactions Past Service Costs Related to Vested

Pension Benefits Deferred Tax Assets Purchased In-process R&D Negative Goodwill


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Examples of Differences Between IFRSs and US GAAP - Measurement

Measurement Differences Result from Different Methods of measurement

• While both value inventory using lower of cost or market (LCM) techniques, “market” is measured differently

– Replacement cost in US– Net realizable value for IFRS

Alternatives allowed by one set of standards but not the other

• LIFO allowed in US, but not by IFRS• IFRS required ‘benchmarking’ of borrowing, which

expenses these costs immediately. US GAAP requires capitalization of interest on certain self-constructed assets

• IAS 16, Property, Plant and Equipment


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Examples of Differences Between IFRSs and US GAAP – Presentation and Disclosure

Certain types of extraordinary gains and losses under US GAAP are not allowed under IFRS

US GAAP is less restrictive on the definition of “discontinued operations”

Segment Disclosure US GAAP requires management approach IAS 14 requires disclosures for both industry and

geographic segments, but one is given primacy. Geographic segments tend to be regions rather than individual countries


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The IOSCO Agreement

In 1987, partnered with the IASC’s Comparability Project.

Helped to rewrite IAS’s to eliminate unnecessary alternatives.

The goal is to help make it easier for foreign companies to use IAS’s when

reporting on different exchanges.

International Organization of Securities Commissions (IOSCO)


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Support of Securities Exchange Regulators

Since 1994, reconciliation to U.S. GAAP is not required for foreign registrants using IAS’s for:

Statement of cash flows.Amortization of goodwill.Translation of financial statements of subsidiaries in highly inflationary economies.


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Support of Securities Exchange Regulators

Number PercentSimilar approach and guidance 56 26%Similar approach, but different guidance 79 36%Different approach 56 26%Alternative approaches permitted 27 12%

218 100%

In 1996, the FASB compare GAAP to IASC standards.Significant differences were found.


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Accounting Environment:United Kingdom

The Companies Acts (1989) Legal foundation for accounting. Requires a “true and fair view” of a

company’s operating results and financial position.

Professional accountants are called Chartered Accountants. Membership is approaching 200,000.

The Accounting Standards Board (ASB) was established in 1990. Replaced the Accounting Standards

Committee


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Accounting Environment:Germany

Accounting principles set by the Bundesrat (legislature). The Third Book of the Commercial Code

(Handelsgesetzbuch). It is generally believed that strict

adherence to the law provides a “true and fair view”.

A professional accountant carries the designation “Wirtschaftsprufer”. Requires passing an exam and 6 years

of experience. Profession considered to be quite

conservative


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Accounting Environment:Germany

German accounting is greatly influenced by German banks.

A Statement of Fixed Assets is often produced in addition to the other common statements.

Income Statement is produced in one of two formats: Cost of Sales Approach Type-of-Cost Approach

Current and noncurrent designations are generally not used. “Provisions” are estimated, whereas “liabilities” are fixed

Tax conformity principle applies Notorious for the use of “hidden”

reserves


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Accounting Environment:Japan

Basic accounting principles are set by the government. Some rules are set by the Japanese

Commercial Code. The Business Accounting

Deliberation Council (BADC) provides additional accounting rules in the Financial Accounting Standards for Business Enterprises.

In 2001, the private sector Accounting Standards Board of Japan (ASBJ) was established. Modeled on the FASB, its authority is derived from the BADC.


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Accounting Environment:Japan

Financial statements required include: Balance sheet. Income statement. Proposal of appropriation of profit

or disposition of loss. Business report.

Extensive cash flow information is required in supplemental disclosures.

Income statement divided into two sections Ordinary Income Special Items (not as restrictive as

US GAAP’s “extraordinary” items)


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Summary

Different environmental factors contribute to the current variety of accounting standards in the world

Greater capital globalization has led to pressure for increased harmonization of accounting standards

The IASB, successor to the IASC, produces International Financial Reporting Standards (IFRSs)

The Norwalk Agreement of 2002 is leading the FASB to converge many areas of US GAAP with the IASB’s IFRSs


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Possible Criticisms

While there is significant pressure to harmonize accounting standards, there is still much opposition to the idea of “one world accounting”

WHAT DO YOU THINK?????


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When the ad said, When the ad said, “Extensive travel,”“Extensive travel,”

this isn’t exactly this isn’t exactly what I expected.what I expected.

End of Chapter 11

Documents

© The McGraw-Hill Companies, Inc., 2007 Slide 11-1 McGraw-Hill/Irwin Chapter Eleven Worldwide Accounting Diversity and International Standards