Financial Accounting Theory Craig Deegan Chapter 4

Financial Accounting Theory Craig Deegan

Chapter 4 International accounting Slides written by Craig Deegan and Michaela Rankin

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Learning objectives • In this chapter you will be introduced to  – an appreciation that there are many differences between some countries in the accounting policies and practices adopted  – various explanations about why countries adopt particular accounting practices in preference to others  – some of the arguments that suggest that it is appropriate that there are international differences in accounting practices

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Learning objectives (cont.)  – what is meant by the terms harmonisation and standardisation as they apply to international accounting  – some of the perceived benefits of standardising accounting practices on an international scale  – some of the obstacles to harmonisation and standardisation, and the criticisms that efforts to harmonise and standardise accounting internationally have attracted

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Evidence of international differences in accounting • When we apply different countries’ accounting rules to the same transactions we can find significant differences in profits and net assets (consider Accounting Headline 4.1, p. 97) • The sometimes significant differences in accounting profits have been used by many parties to justify the ongoing efforts of the IASB to standardise international accounting

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International financial accounting models • Historically Historically there have been two main models of financial accounting adopted internationally •  Anglo-Ameri  Anglo-American can model  – strongly influenced by professional accounting bodies rather than government, emphasises importance of capital markets, emphasises true and fair, considerations of economic substance over legal form

• Continental European Model  – relatively small input from accounting profession, little reliance on qualitative true and fair, strong reliance on government

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Reasons for international accounting differences • Underlying laws and political systems • Tax systems • Level of education • Level of economic development • Nature of business ownership and financing system

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Reasons for international accounting differences (cont.) • Colonial inheritance • Taxation • Culture • History • Language • Religion

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The effect of culture on accounting systems • Impacts on legal systems, tax systems and the way businesses are formed and financed etc. • Previously used to explain differences in social systems • ‘… an an expression of norms, values and customs which reflect typical behavioural characteristics’ (Takatera & Yamamoto 1987)

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The effect of culture on accounting systems (cont.) • ‘Culture’ reserved for societies as a whole or nations • ‘Subculture’ ‘Subculture’ used for the level of an organisatio organisation, n, profession or family • International differences in accounting systems may be explained by a framework incorporating culture

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Hofstede’s cultural dimensions • Four underlying societal dimensions along which countries could be positioned  – Individualism versus Collectivism  – Large versus Small Power Distance  – Strong versus Weak Uncertainty Avoidance  – Masculinity versus Femininity

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Individualism versus Collectivism •  Addresses degree degree of interdependence interdependence a society maintains among individuals  – Individualism refers to a preference for a loosely knit social framework wherein individuals care for themselves and their immediate families  – Collectivism stands for a tightly knit social framework where relatives, clan or other in-group look after each other

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Power Distance • Power Distance is the extent to which members of a society accept that power in institutions and organisations is distributed unequally  – Large Power Distance societies accept a hierarchical order in which everyone has a place  – Small Power Distance societies strive for power equalisation

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Uncertainty Avoidance • The degree to which the members of a society feel uncomfortable with uncertainty and ambiguity  – Strong Uncertainty Avoidance societies maintain rigid codes of belief and behaviour  – Weak Uncertainty Avoidance societies maintain a more relaxed atmosphere where practice counts more than principles

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Masculinity versus Femininity •  Addresses the way in which which a society allocates allocates social roles  – Masculinity stands for a preference for achievement, heroism, assertiveness and material success  – Femininity stands for a preference for relationships, modesty, caring for the weak, and quality of life

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Societal dimensions and accounting subculture • The value systems of accountants are derived from related societal values • The values of the accounting subculture will in turn impact on the development of the respective accounting systems at a national level  – should accounting systems be developed in a ‘one -sizefits-all’ fitsall’ approach?

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Gray’s accounting values • Gray developed four accounting values deemed to relate to the accounting subculture, with the intention of linking them to Hofstede’s four societal values  – professionalism versus statutory control  – uniformity versus flexibility  – conservatism versus optimism  – secrecy versus transparency

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Gray’s hypotheses • H1: The higher a country ranks in terms of Individualism and the lower it ranks in terms of Uncertainty Avoidance and Power Distance, the more likely it is to rank highly in terms of Professionalism • H2: The higher a country ranks in terms of Uncertainty Avoidance and Power Distance and the lower it ranks in terms of Individualism, Individualism, then the more likely it is to rank highly in terms of Uniformity

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Gray’s hypotheses (cont.) • H3: The higher a country ranks in terms of Uncertainty Avoidance and the lower it ranks in terms of Individualism and Masculinity, then the more likely it is to rank highly in terms of Conservatism • H4: The higher a country ranks in terms of Uncertainty Avoidance and Power Distance and the lower it ranks in terms of Individualism Individualism and Masculinity, Masculin ity, then the more likely it is to rank highly in terms of Secrecy

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Gray’s hypotheses (cont.) • Gray further hypothesised relationships between accounting values and  – the authority and enforcement of accounting systems  – the measurement and disclosure characteristics of accounting systems

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Other research using Hofstede’s cultural dimensions • Zarzeski (1996)  – used Hofstede’s dimensions to explain corporate disclosure  – entities with a higher international profile tend to be less secretive  – local enterprises are more likely to disclose information commensurate with the secrecy of their culture than are international enterprises

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Other research using Hofstede’s cultural dimensions (cont.) • Perera (1989)  – used Hofstede’s cultural dimensions and Gray’s accounting subcultural value dimensions to explain differences in the accounting practices of European and  Anglo-American countries countries

• Baydoun and Willett (1995)  – investigated the use of the French United Accounting System in Lebanon

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The effect of religion on accounting systems • Religion transcends national boundaries • Impacts on global harmonisation of accounting standards • Hamid, Craig and Clarke (1993) examined how Islamic cultures have failed to embrace ‘Western’ accounting practices  – compliance with Islamic beliefs can affect the structure of business and finance  – many Western accounting practices are incompatible with Islamic principles  – relevance of IASB standards to such cultures?

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The effect of religion on accounting systems (cont.) • Religion can affect how people do business and how they make decisions, for example  – Islam precludes debt financing and prohibits payment of interest  – the Western objective of financial reporting of rational economic decision making (refer to the conceptual frameworks discussed in Chapter 5) may not be a relevant objective in some societies

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Legal systems • Can be broadly divided into common law and Roman law systems  – in Roman Law systems the law tends to be very detailed  – in Common Law systems— systems —which is how Australia can be classified— classified —law typically evolves from the ruling of judges

• In Common Law countries accounting practices tend to rely relatively heavily on professional  judgment

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Business ownership and financing system •  At a country level the financing financing system is relevant to the purpose of financial reporting • Three types of financing systems  – capital market-based (e.g. United Kingdom and United States)  – credit-based system: governmental (e.g. France and Japan)  – credit-based system: financial institutions (e.g. Germany)

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Business ownership and financing system (cont.) • Systems relying on equity markets will have greater demand for public disclosures • Credit-based systems more concerned with the protection of creditors • Colonial inheritance also a major explanatory factor

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Taxation systems • Differences in accounting methods internationally have also been linked to differences in taxation systems • Where there are ‘insider systems of finance’ (common in continental European countries) financial accounting practices have typically been linked to taxation law

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Impact of international agencies • Examples of institutions or bodies which can impact on a country’s accounting policies are  – multinational companies  – international accounting firms  – large monetary organisations e.g. World Bank

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Approaching international differences • Hence, to this point we can see that there are many explanations for international differences • Given the many factors that explain why international differences in accounting will, or perhaps should  exist,  exist, then how logical are efforts towards international standardisati standardisation? on?

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Reasons for harmonisation and standardisation • There is a difference between harmonisation harmonisation and standardisation • Some arguments in support of standardisation include  – international investors are better able to understand the financial performance and position of local companies  – tied to the above point, there is an expectation that standardisation will facilitate greater capital inflows  – also tied to the above point, standardisation will make it easier for local companies to list on foreign stock exchanges

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Reasons for harmonisation and standardisation (cont.)  – companies listed on several stock exchanges would only need to produce one set of financial statements and this will have implications for cost savings  – the accounting and auditing staff employed by international organisations will be better able to move to other member companies  – there will be cost savings in the accounting-standard setting function— function —rather than individual companies duplicating the efforts of others, the majority of functions of the standard-setting process will be centralised at the IASB

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Obstacles to standardisation • Effects on standard setting of different  – business environments  – legal systems  – cultures; and  – political environments in different countries

• IASs and IFRS are strongly Anglo-American Anglo-American influenced • Relevance of IAS/IFRS to some countries is questioned • Economic implications of adopting a ‘new’ set of accounting standards

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International Accounting Standards Board (IASB) • The IASB replaced the IASC in 2001 (the IASC was formed in 1973) • IASB has 14 full-time members who have to sever their connections with other organisatio or ganisations ns •  Australia decided decided in the mid-1990s mid-1990s to harmonise its standards with those of the IASC • In 2002 a decision was made by the Financial Reporting Council that Australia would adopt standards released by the IASB

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International Accounting Standards Board (IASB) (cont.) • The FRC’s decision created a great deal of work for organisations in that they had to make quite significant significa nt changes to their accounting practices • The adoption of IAS/IFRS required companies to write off a great deal of assets— assets —particularly intangible assets • Worth the effort?

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Objectives of IASB • To formulate and publish accounting standards and to promote their worldwide acceptance • To work on the improvement and standardisation of regulations, accounting standards and procedures • The IASB does not appear to believe that the many reasons provided as to why different nations should have different accounting standards (e.g. tied to differences in culture, religion and so forth) outweigh the benefits of internationa internationall standardisation

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Aims of IASC/IASB • Short-term aim— aim—for national accounting standards and IASs to converge • Long-term aim of global uniformity— uniformity —a single set of accounting standards for all listed and economically significant business enterprises around the world

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International Organization of Securities Commissions (IOSCO) • Working with IASB, has assisted IAS/IFRS to achieve widespread acceptance • Developed a plan such that compliance with IAS/IFRS will allow an organisation to have securities listed in all global markets

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International Federation of Accounting Committee (IFAC) • Concentrates on international issues associated with the practice of auditing and accounting education •  Also issues issues associated associated with ethical conduct conduct

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