Major differences in the financial reporting practices of companies in different countries lead to problems for those preparing, consolidating and interpreting published financial statements. These differences will be discussed in the first part of the essay. Attempts to harmonise financial statements on an international scale have been made by bodies such as the IASC, more recently, the IASB and the EU. The success of these, however, remains open to interpretation.
A company’s annual accounts, wherever they may be produced, provide information as to the financial situation of a company. Although the general aim is the same in most countries, each has a different mix of influences on financial accounting and so, inevitably, differences between countries occur. These differences arise from differing environmental, institutional, and cultural differences. Some of the most important causes will now be discussed.
The first concerns the provision of finance. From the early 1800’s companies started to increase in scale and private capital alone became insufficient to finance their activities. This saw companies in different countries react differently when dealing with the increased need for funds (Alexander, Britton, Jorissen; 2007). In nations such as Germany, France and Italy, they relied on debt from banks to finance their activities. However, in the UK and the USA, shareholders were seen as the source of gaining the extra funds. These companies relied more on equity to finance their activities. In companies where companies were largely financed through equity, the financial statements have an investor orientation. The financial statements must provide the relevant info for a potential investor to make the best decision. This is different in nations where companies rely more on debt financing. Their statements have a creditor orientation. Their information must be useful to judge whether a company is able to repay its debts.
Differing legal systems also cause differences in accounting practice. Countries such as England, Wales and the USA have adopted a Common Law system. This system is developed by case law and does not provide specific rules which could be widely applicable. In such countries accounting rules are not part of the law but regulations are set out by private professional bodies. Countries such as Scotland, France and Spain use a Code Law system which provides a wide set of rules that try to provide for all situations (Alexander, Britton, Jorissen; 2007). Accounting regulations are in the hands of the government and quite often set in the country’s company law. Financial reporting here can often be reduced to simply conforming to a set of detailed legal rules.
In some countries financial statements are used to determine a company’s taxable income. This can lead to financial statements becoming tax influenced as a company will want to reduce tax as much as possible. This is often found in nations who do not have an explicit investor approach to their reporting. Countries such as Italy, Sweden and Norway have accounting dependent on taxation in this way (Alexander, Britton, Jorissen; 2007). In other nations like the Czech Republic, Ireland and the UK, separate accounts are filed for tax purposes and so the relationship is much weaker. All of the differences mentioned above will have a profound effect and accounting and those who use financial statements. Differences in information provided will create confusion in investors and affect decision making in companies. Some sort of harmonisation is obviously needed.
Accounting practice responds to its general environment and so it seems logical to say that differing environments produce differing accounting systems, while similar environments produce similar accounting systems. Types of accounting regulation and differences in the organisation of the accounting profession can see GAAP vary form country to country, thus creating different accounting systems. Some countries see their regulations set by private sector organisations, such as the ASB in the UK, and in other nations this will be set by the government. These different accounting systems will produce their own accounting standards. There are several differences in financial reporting characteristics, one such being shareholder versus stakeholder orientation. In countries where shareholders are the main users of financial reports there is a need for high quality information. This is the case because possible investors do not have internal information with which to base their decisions on. The pressure for disclosure here is much greater than in countries where the providers of finance can obtain internal information. The quality of information really should be equally as good no matter what nation, so some form of standardisation is needed to even this problem out.
Another difference concerns the representation of the financial situation of the company. In common law countries the aim of financial reporting is to show a fair view of a company’s situation whereas, in code law countries, the emphasis is focused on meeting legal requirements. An example of this in practice can be seen by looking at the accounting treatment of lease contracts. In countries such as the UK and the USA, lease contracts are accounted for in the balance sheet despite companies not legally owning the assets. However, where legal compliance has more influence lease contracts are kept off the balance sheet as there is no legal ownership. This difference can have a major impact on the debt/equity ratio of a company (Alexander, Britton, Jorissen; 2007). The need for harmony in financial reporting seems obvious here as this could affect possible investors. Investors looking between countries at companies to invest in would be influenced by this ratio, among others, and so to have a common approach would be beneficial.
Furthermore, with the increasing scale and size of companies there has been a rise in the number of multinational companies. For multinational companies, the benefits to be gained from accounting harmonisation are very important. The task of producing comparable information for a company with many subsidiaries in different countries would be much easier. Moreover, the accountants producing this information would find their job much easier if there was a simple set of rules to adhere to. Also, investors and financial analysts have a need to understand the financial statements of foreign companies whose shares they may wish to buy. They also need to be sure the statements they are examining are reliable and comparable, at least on some level (Nobes, Parker; 2000). Some sort of standardisation would also be of use to high level management and company directors of multinationals. Aspects of performance evaluation and decision-making could be greatly improved by harmonisation.
From looking at the sources of accounting differences and differences in practices the need for harmonisation becomes clear. With the internationalisation of accounting and companies nowadays, a standard set of rules would be very useful to all involved. Attempts to do this have been made by bodies such as the IASB and the IASC. However the success of these can be debated.
The International Accounting Standards Committee (IASC) is considered by many to be the most important and successful of the many bodies working for international harmonisation. However, on 1st April 2001 the IASB resumed accounting standard setting responsibilities from the IASC. It should be noted though the IASC did introduce many IAS’s in its time. The IASB aims to ‘formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance’ (IASC, 1992). This can be seen in IAS 1 which concerns the presentation of financial statements. This standard gives a basis for the presentation of statements to ensure comparability with previous statements and those of other companies. To achieve this it sets out ‘overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content’ (IAS1; technical summary; www.IASB.com.). Putting this into practice would obviously be an effective starting point for ironing out differences. The comparability of statements would be increased hugely for the users of statements. This IAS would also see info become more reliable and relevant as a result. Other IAS’s introduced by the IASC/IASB are IAS16 and IAS 17 concerning Property, Plant and, Equipment and Leases respectively. However there is a huge problem concerning the enforcement of these IAS’s in accounting practice.
The IASB does not have any real authority but relies on that of its members and there is great difference of the influence of the professional accounting bodies in different countries. Where the law is stricter on accounting they have less influence. In the UK and Ireland, however, standards are mainly set by the professional bodies belonging to the IASB. Hence, there is a closer contact with the IASB. The standards in these nations are brought into line with the IASB wherever possible. It can be said then that the IASB’s attempts at international harmonisation have been extremely successful where they can have a close liaison with their members, creating similarity between nations. Therefore it could be said the IASB’s aim of ‘promotion and observance of standards’ has had a variation of success.
The IASB’s aim to create worldwide harmonisation is an unbelievably huge task and, until recently, seemed a naÃ¯ve and unattainable target. Until the 1990’s, bringing the Soviet Union or China into line with the accounting practices of the IASC would have been of very little benefit if even possible. Nowadays though, the IASB has an important influence on these countries (Nobes; Parker; 2000). This would suggest that their aim of creating worldwide harmony is becoming increasingly more realistic.
The EU has also attempted to harmonise company law and accounting through setting directives. One such directive is the Fourth Directive of 25 July 1978. This directive covers all public and private companies and has an affect on valuation rules and the format of published financial statements, among other things. The main area of change here was the inclusion of the ‘true and fair view’ principle (Gray and Coenenbourg; 1984). Again, this is an example of the divide between the Code and Common Law traditions. The definition of a ‘true and fair view’ has been widely debated. Where common law prevails, definitions of such concepts are gained mainly from courts in relation to specific situations. In code law countries there is the ability to interpret the legislation, but not provide absolute definitions. Thus, the harmonisation of accounting in the EU has seen an attempt at narrowing the divide between these traditions. It could be said from this then that the inclusion of this principle was a controversial but crucial requirement. Any harmonisation between these two traditions is a huge step.
Thus was then proceeded by the Seventh Company Law Directive of 13 June 1983. This extended the Fourth Directive to include the preparation of consolidated group accounts. More specifically, this Directive requires full worldwide consolidation for subsidiaries, not simply as far as the national border. Methods must also be applied consistently to eliminate inter-company debts, transactions and profits in group accounts. This Directive has had the biggest impact in nations such as Germany and France, where it brought about more consolidations than previously existed. It has obvious rewards for multinationals as their information will be much more reliable and comparable. Investors and analysts using financial statements will also take many positives from this. The Directives introduced by the EU here seem to have been reasonably successful attempts at international harmonisation.
The need for harmonisation is made evidently clear through looking at the sources of international differences and the differences in traditions. Differences concerning the provision of finance and cultural differences could be overcome relatively easy through complete accounting procedure and greater communication. However, opposing legal systems and the effect of taxation on accounting are much harder to overcome. The influences of tradition are powerful obstacles to overcome for a body such as the IASB which has no real authority. However, it has had reasonable success and this can only grow through time. They have created 39 standards, along with a conceptual framework and other publications. Improved liaison between members should see more standardisation for accounting practice. The EU Directives previously mentioned also seem to have a good effect on the standardisation of accounting procedures. So, although there are still many problems, international harmonisation is becoming an ever more realistic target.
• Comparative International Accounting; 6th edition; C. Nobes and R. Parker; Prentice Hall; 2000.
• International Financial Reporting and Analysis; D. Alexander, A. Britton, A Jorissen; Thomson; 2007.
• EEC Accounting Harmonisation: implementation and impact of the fourth directive; S. J. Gray and A. G. Coenenbourg; North- Holland; 1984.
• Accounting Problems of Multinational Enterprises; Elwood. L. Miller; Lexington Books; 1979.
• www.IASB.org .uk