© the mcgraw-hill companies, inc., 2007 slide 11-1 mcgraw-hill/irwin chapter eleven worldwide...
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© 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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International Harmonization
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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International Harmonization
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”
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