international accounting chapter 1
TRANSCRIPT
Financial Reporting in the Global Arena
By: Sommer Kaleohano-Knittleand Patricia Hardy
Number of non-U.S. companies listed on the NYSE increasing◦ 1986: 59 companies◦ 2007: 421 companies
Similarly other stock exchanges have seen an increase in foreign firms◦ London Stock Exchange: 719◦ NASDAQ: 307◦ Singapore Stock Exchange: 290◦ Mexican Exchange: 242◦ Luxemborg Stock Exchange: 227◦ Euronext Exchange: 225
Importance of International Accounting
Illustrates the dramatic pace of globalization
Points to the need for capital investors to have an understanding of the accounting concepts of international companies◦ Important when investing in companies listed on
domestic stock exchanges◦ Increases their ability to make informed financing
and investment decisions 10 factors that shape accounting
Importance of International Accounting
Nature of Capital Markets
Equity-Oriented Debt-Oriented
U.S. and Canada Primary source of capital
is the stock market Cosmetic Difference
◦ Companies invest a lot in their annual reports and other financial communications to investors
◦ Treat annual report as a marketing tool to attract investors
◦ Use annual reports to portray a positive image
Most other countries Primary source of capital
is bank financing Cosmetic Difference
◦ Annual reports are matter-of-fact and to the point
◦ Banks do not basis lending decisions on cosmetics
◦ Little reason to spend large amounts of money and time on production of annual reports
Nature of Capital Markets
Equity-Oriented Debt-Oriented
Substance Difference◦ Try to make accounting
numbers as positive as possible Capital markets punish
companies that report poor performance
◦ Bias to report well to stockholders
Companies: Bank of America
Substance Difference◦ Tendency to underreport
earnings◦ Relates to the type of
reporting regime◦ Financial statements in
international companies will show different earnings in U.S. versus other countries
Companies: BNP Paribas
Level of sophistication◦ Accounting has to keep up with finance in terms
of drafting rules for new financial instruments U.S. and Wall Street
Highly complex and innovative financial instruments Financial reporting is continuously changing to keep up
Simple capital markets and financial instruments Less need for accounting to constantly change
Nature of Capital Markets
Level of globalization◦ Varies with the type of foreign firms entering the
market Entering firms have high level of financial reporting
and disclosure standards Raises the general level of reporting in that country Example: U.S. firms listing on the London Stock
Exchange Entering firms have a lower reporting requirements
Not much impact on financial practices in that country Example: Indonesian firms listing on the Australian Stock
Exchange
Nature of Capital Markets
Dual set of rules for financial and tax reporting◦ Independent set of rules for each type of
reporting◦ “Financial reporting schizophrenia”
Normal for companies to show high levels of profitability on financial reports while not looking as profitable on tax filings
Allows companies to report optimistic earnings to their stockholders while avoiding possible tax liabilities
Perfectly legal
Type of Reporting Regime
Single reporting system◦ As mentioned before, debt-oriented companies
have a tendency to underreport earnings Use the same reporting system for financial and tax
purposes If these companies inflate earnings in financial
reporting, they face paying higher taxes
Type of Reporting Regime
Economically advanced countries◦ Large and complex companies such as
corporations Sell hundreds of products Employ thousands of people Do business in multiple countries
◦ Accounting rules are detailed and complex Emerging economies
◦ Small, simple and usually family owned businesses
◦ Accounting rules are not as complex
Size and Complexity of Business Entities
Type of Legal System
Code Law Common Law
Also called civilian law Characterized as
mandating acceptable behavior
Accounting is regulated through an accounting code that is highly detailed, procedural and set by legislature◦ Emphasis on protecting
creditors
Legalistic Deters undesirable
behaviors Accounting regulations
are set on a piecemeal bases◦ Set by private standard-
setting body◦ Emphasis is to present a
true and fair picture to shareholders
◦ Research shows that financial reporting is more transparent
Type of Legal System
Code Law Common Law
Less market oriented and rely on private information
Countries have adopted common law where governments generally established and enforced accounting rules
Examples: BNP Paribas
Viewed as being more adaptive and innovative in terms of financial reporting
Where international accounting standards are rooted
Examples: Bank of America
Factors affecting enforcement◦ Political system and leadership
Example: Asian financial crisis Investors believed companies were in compliance with
reporting requirements when they were not and therefore suffered losses when true financial position was disclosed
Shows a lack of willingness to enforce the rules
◦ Lack of resources Countries may adopt accounting standards but lack
the resources to implement and enforce them
Type of Enforcement of Regulations
High level of enforcement◦ Accounting practices are largely in compliance
with the requirements◦ Example: U.S.
Low level of enforcement◦ Businesses exhibit very little compliance with
regulations
Type of Enforcement of Regulations
Historical-cost model ◦ Economic transactions are recorded at values on
the date of the transaction◦ Dominant basis of accounting in most countries◦ Countries that have been able to hold inflation
steady use this model Based on the fact that inflation does not seriously
impact them United States and United Kingdom
Inflation-adjusted model◦ Countries that have suffered high levels of
inflation Bolivia and Mexico
Rate of Inflation
Countries have adopted the accounting regime of other countries both voluntarily and involuntarily
Colonization◦ When colonized for an extended period of time,
countries usually used the accounting system of the colonial power Example: Countries of British Commonwealth use
same accounting system as Britain. Philippines based on accounting in the U.S.
Political and Economic Ties
Post-independence◦ Countries have a choice on their accounting
method Some have chosen to continue using the accounting
method of the colonial power Others have chosen to replace their old method with
a different one Also has the potential to influence
accounting development◦ Geographic proximity (U.S. and Canada)◦ Economic alliances (EU and NAFTA)
If countries use the same methods of accounting, it often decreases costs of doing business
Political and Economic Ties
Stature of Accounting Profession
Code Law Common Law
France and Germany Less stature and
power Government takes the
lead role in regulating the profession
U.S. and Canada Held in high esteem Largely self-regulating
and plays a major role in setting accounting and auditing standards
Large role in establishing educational and licensing requirements
Influences the quality of financial statements
Strong accounting profession◦ Audit reports are more respected as independent
and reliable Weak accounting profession
◦ Quality of financial statements is questioned◦ Auditor independence and stature is questioned
Likely to influence the size of accounting profession◦ Strong stature = more accountants◦ Weak stature = less accountants
Stature of Accounting Profession
“A coherent system of interrelated objectives and fundamentals that can lead to consistent standards that prescribes the nature, function, and limits of financial accounting and financial statements” (FASB)
Associated with countries that embrace a micro-user oriented accounting system
Accounting in countries that have developed or adopted a conceptual framework are more similar than countries that do not have a conceptual framework
Existence of a Conceptual Framework
Factors affecting education are level of economic development, the political and economic ties with other countries and the stature of the accounting profession
Countries that hold the accounting profession in high regard have accounting programs at the undergraduate, graduate and doctorate degree levels
In other countries accounting education is weak because accounting is often equated with bookkeeping and viewed as a vocation rather than profession◦ Accounting education isn’t available at universities◦ Affects the accounting profession as a whole
Quality of Accounting Education
Diverse Roles of Accounting in Countries Primary role of accounting varies in different
countries◦ Affects orientation and information content of financial
statements◦ Influences how accounting reports are interpreted and
used Domestic capital markets can have an impact
on the development of accounting in countries◦ Demands arising from capital markets provide
rationale for adopting particular forms of accounting◦ Accounting perceived as a prerequisite for the growth
of domestic capital markets
Financial Reporting Central to process of allocating financial
resources in capital markets In non-securities sector, important basis for
decisions of financial institutions Essential for oversight and supervision of
banks and other financial institutions Financial institutions usually required to
submit financial statements to government agencies (and, in some countries, publish in major newspapers) as part of discharging their accountability requirements
Financial Reporting Regulatory requirements for banks and
other financial institutions often based on accounting information furnished by these enterprises
Financial crises in emerging capital markets◦ E.g., Argentina, Brazil, Indonesia, Malaysia, Russia
U.S. subprime mortgage collapse in 2008 Causes?
◦ Lack of financial reporting transparency and inconsistent application of auditing standards
Financial Reporting Accounting reports relevant to investors’
buy and sell decisions on corporate securities◦ Evident every time the stock price of a company
drops precipitously when questions arise about the reliability of its financial reporting
Crucial policy matter for less-developed countries (LDCs) aiming to attract capital to develop their economies
Regulation of Financial Reporting Consensus that financial accounting
important for efficient operation of capital markets has permeated policy making
International level ◦ International Accounting Standards Board (IASB)◦ International Organization of Securities
Commissions (IOSCO) Ensures adequate supply of reliable and relevant
financial information necessary for cross-border financial transactions
Multilateral lending institutions◦ International Monetary Fund (IMF)◦ World Bank◦ Asian Development Bank (ADB)
Forefront of recommending to LDCs the need to ensure a robust accounting system to enhance the development of their financial systems
Regulation of Financial Reporting
Policy Choices in AccountingHierarchy of Accounting Polices
Element of Accounting Accounting Policy Issues
Broad aims of financial accounting
•What should be the aim of financial accounting in terms of the user orientation of the accounts?•What should be the role of financial accounting in regard to capital markets, fiscal (tax) policy, and macroeconomic planning policy?
Institutional setting for accounting regulation
•Which approach(es) to formulating accounting regulation should be adopted?•Which approach(es) to enforcing accounting regulation should be used?
Hierarchy of Accounting Policies
Element of Accounting Accounting Policy Issues
Specific accounting rules and requirements
•Which specific disclosure and measurement rules should be adopted and to whom should these rules apply?
Corporate accounting practices •Which specific disclosure and measurement methods will be used in presenting the company’s accounts?
Policy Choices in Accounting
Relative scope and importance of policy decisions increases as one climbs the accounting policy hierarchy
Decisions regarding broad aims of accounting◦ Profound and long-term impact on institutional
basis, specific accounting rules, and corporate accounting practices in a country
Policy Choices in Accounting
Policy Choices in Accounting Broad aims of accounting
◦ Private-sector users (i.e., individual and institutional participants in capital markets
◦ Public-sector users (i.e., government ministries and agencies responsible for tax collection or economic planning)
Countries can be compared based on relative importance attached to particular roles of accounting in society
Policy Choices in Accounting• Macro-user oriented
◦ Intended users: government agencies—particularly tax and economic planning agencies
◦ Goals and role of accounting: guard against loss of assets, contribute to enterprise stability and continuity
◦ Conditions: Significant role of institutional creditors Conservative accounting methods Neutrality in accounting procedures subordinate to goal
of deliberately influencing the behavior of enterprise agents towards certain pre-defined goals
◦ Countries: France, Germany, Sweden, Japan
Marco-user oriented◦ Conservative accounting methods prevent
management from distributing dividends perceived to be detrimental to creditors, and provide rock-bottom asset values that do not overstate the security potential of assets in case of liquidation
◦ Requirements of government agencies and employees (including management) are ranked of the same, if not greater, importance as capital providers
◦ Enterprise viewed as helping to guarantee long-term, if not lifetime, employment and contributing towards national economic goals
Policy Choices in Accounting
Policy Choices in Accounting Micro-user oriented
◦ Intended users: Diverse set of capital providers◦ Goals and role of accounting: Provide “true
and fair” or “fairly presented” financial statements (reflect economic substance rather than the legal form of transactions), provide reliable benchmark for evaluating management performance
◦ Conditions: Neutral and unbiased accounting methods
Until collapse of Soviet Union, could observe specific role of accounting in planned economies with communist system of government◦ Private property and investment were frowned
upon, so government typically only direct stakeholder in economic entities
◦ Since no external stakeholders and few competitive markets for goods and services, there was no real concern with traditional measures of performance such as profitability or cost of containment
Policy Choices in Accounting
◦ Main role of accounting—to facilitate the economic plans under which the government would set priorities and targets at the national level, which would translate to production goals and quotas at the individual factory level
◦ Accounting used almost entirely to collect data to prepare national statistics and to determine whether the government’s economic targets had been achieved
Policy Choices in Accounting
One school of thought—deliberate efforts towards accounting harmonization can reduce gap regarding broad aims of countries◦ Even in EU, where greatest visible effort towards
attaining regional accounting harmony has been made, there remain substantial differences in terms of broad aims of accounting and, consequently, methods and practices among countries
◦ Evidence suggests that accounting differences are perpetuated by underlying differences in these countries’ capital markets United Kingdom and U.S. have long tradition of active
securities markets, however, Germany and France have, until now, relied on bank finance as a source of industrial capital
Policy Choices in Accounting
Effects of Diversity on Capital Markets Rationale to reduce global diversity
◦ Reduction of costs imposed by diversity◦ If accounting diversity presents a barrier to the
free flow of capital across borders, then reducing or removing this barrier should help direct capital to the most efficient users (and uses) globally
◦ Improve comparability of financial statements, making them easier to use across countries
Effects of Diversity on Capital Markets Diversity in financial reporting rules and
practices and their effects on firms ◦ Effects of differences in disclosure levels on listing
decisions◦ Effects of regulatory differences on user groups◦ Effects of differences in goodwill treatments on
mergers and acquisitions
Effects of Diversity on Capital Markets Debate as to level of disclosure that should
be required by regulators and stock exchanges from foreign firms listing within their jurisdiction◦ Regulators perspective: goal of protecting
domestic investors from potentially misleading financial disclosures by foreign firms must be weighed against demand for increased access to investment opportunities in foreign firms
Effects of Diversity on Capital Markets During 1980’s & 1990’s
◦ Securities and Exchange Commission (SEC) Insisted that foreign firms’ financial statements had to be
reconciled to U.S. GAAP◦ New York Stock Exchange (NYSE)
Argued reconciliation requirement imposed an unnecessary burden on foreign issuers that kept them from listing their securities and adversely affected the U.S. Economy
Argued it deprived U.S. investors of the opportunity to invest in many global blue chip companies and reduced the competitiveness of domestic stock exchanges and securities industries relative to countries where the net regulator burden was less than in the US
Effects of Diversity on Capital Markets Three main issues related to the interaction
between accounting diversity and the increasing globalization of the world’s capital markets◦ 1) Benefits and costs of listing on a foreign stock
exchange◦ 2) Effects of accounting disclosure levels on
foreign listing decisions◦ 3) Accounting policy issues posed by foreign stock
exchange listings and how authorities have responded
Effects of Diversity on Capital Markets Key question: Are choices regarding
alternative foreign stock exchange listings influenced by financial disclosure levels? Yes.
Surveys of Canadian companies listing in the U.S. and United Kingdom◦ Indicated that the financial reporting and
compliance requirements of the SEC to be greatest cost of listing their shares on U.S. stock exchanges*Significant because Canada is very similar to the US
in terms of business environment
Effects of Diversity on Capital Markets Other surveys gauge behavioral effects of
accounting diversity on major categories of capital market participants
Found—accounting differences are important and affect capital market decisions such as:◦ The geographic spread of investments◦ The types of securities selected◦ Assessment of security returns or valuation◦ Information processing costs
Effects of Diversity on Capital Markets Effects of differing rules of goodwill on
merger activity◦ Question: Whether national differences in the
accounting treatment of purchased goodwill were associated with differences in merger premiums offered by non-U.S. acquirers when bidding for U.S. target companies
◦ Found—merger premiums offered by foreign acquires based in countries with more favorable accounting and tax treatments for goodwill than the U.S. to be higher than those offered by U.S. acquirers
Object of classification in international financial reporting is to group countries according to common elements and distinctive characteristics of their financial accounting systems
Benefits of classification: ◦ Identifying similarities and differences has improved
overall understanding◦ Countries comprising of particular group likely to react to
new circumstances in similar ways◦ Countries may anticipate accounting problems and
solutions by looking at experiences of other countries in the same group
Classification of Financial Accounting and Reporting Systems
◦ Countries that lack resources to develop their own accounting standards may identify a group that can serve as a model
◦ Patterns can help organizations such as the IASB in their global harmonization efforts
◦ Financial statement communication problems are more severe when reporting across groups rather than within
Classification of Financial Accounting and Reporting Systems
Global Convergence◦ Convergence of accounting regulations will have a
significant impact on company’s investing, financing and business decisions Example: U.S. GAAP to IFRS
Quality of Financial Reporting in Developed and Emerging Economies◦ Recent economic and financial crises have highlighted
a need for reliable and transparent financial reporting◦ United States Agency for International Development
has been contributing resources to establish accounting and capital marketing regulations in developing countries
Challenges Facing Accounting Globally
Social Responsibility Reporting◦ A consequence of globalization is having stakeholders
all around the world◦ Becoming increasingly important to include reports
regarding the company’s social responsibilities within their operating communities
Financial Reporting in the High Technology Era◦ Is beneficial to investors for having information
available at any time◦ Investors demand timely financial reporting◦ Leading to the hard-copy annual reports becoming
obsolete
Challenges Facing Accounting Globally