European accounting harmonisation: Myth or reality?

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European Management Journal Vol. 12, No. 3, pp. 332-337, 1994 Copyright © 1994 Elsevier Science Ltd

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European Accounting Harmonisation: Myth or Reality? JOHN BLAKE, Professor of Accounting, University of Central Lancashire; ORIOL AMAT, Associate Professor, Pompeu Fabra University, Barcelona.

In the European Union, governments through Directives, and the accounting profession through the International Accounting Standards Committee (IASC), both claim to be seeking to harmonise accounting practices. In this article, John Blake and Oriol Amat explore these claims. They first identify the continuing wide variation in accounting practice within Europe and internationally. Second, they consider the demand for harmonisation of accounting practices within Europe and internationally. Third, they offer a list of the environmental factors that obstruct international accounting harmonisation. Finally, they discuss the limitations of the work of the European Union in achieving accounting harmonisation.

Variety of Practice The significance of international differences in accounting practices can be identified in a number of ways. One is to see how profit measured for a single company varies under different national rules. D'IUiers (1990) cites the example of a European company that computed earnings per share on the basis of three different national accounting systems:

Germany 3 ECU France 4 ECU UK 6 ECU

Simmonds & Azieres (1989: 45) used a set of accounting data which was analysed in seven European Union Countries. They found that the range of profit figures (in millions of ECU) was:

Lowest Highest Most Likely Permitted Permitted

ECUm ECUm ECUm Belgium 135 90 193 Germany 133 27 140 Spain 131 121 192 France 149 121 160 Italy 174 167 193 Netherlands 140 76 156 UK 192 171 194

Gray (1980) looked at the adjustments made to company accounts by European security analysts for investment decision making, and found that French and German accounts were regarded as very much more conservative than UK accounts in their measurement of income.

One London research bureau, Smithers and Co, used national income accounts to estimate a 'true' income figure to compare with company accounts in each country and suggested the following ratio of 'true to published profits':

Japan 1.69 USA 0.77 Britain 0.75 France 0.84 Germany 1.00

This is 'a factor by which company accounts should be adjusted to make them comparable from country to country. In Germany, no adjustment is needed. In Britain, by contrast, reported profits should be multiplied by a factor of 0.75 because of inventive accountants and a history of inflation' (reported in the Economist, 22 February 1992, p. 94).

The lack of comparability of different national accounting practices has also been revealed when apparent national differences in financing have been investigated. Thus White (1984) looked at gearing levels for France, Germany, Japan, the UK, and the US, and found that after making adjustments for differences in national accounting practices the 'effective differences in gearing ratios between the five countries which have been considered are much smaller than one is led to believe from looking at reported data'. Similarly Michel and Shaked (1985) found that when comparing US and Japanese companies differences in gearing are very much less significant if equity is measured on the basis of market capitalisation rather than reported accounts. They point out that this has important policy implications for both countries. Table 1 illustrates this variation in accounting practice for five topics in four countries.

332 EUROPEAN MANAGEMENT JOURNAL Vol 12 No 3 September 1994

EUROPEAN ACCOUNTING HARMONISATION: MYTH OR REALITY

Table 1 Examples of Variations in National Accounting Practices

Issue France Germany Spain UK

Treatment of Range of Either write Amortise goodwill practice off against

reserves on acquisition or amortise

Fixed asset Discouraged No Not since revaluation by tax system 1983, except permitted? in Basque

country

Unrealised No gains on currency translation taken as profit?

Any R&D Yes capitalisation allowed?

Capitalisation of finance leases?

No No Yes

No Yes Yes

Only in Rare and Yes - - narrow consolidated subject to tax definition of accounts rules finance lease

Either write off against reserves on acquisition or amortise

Yes

Yes - - broad definition of finance lease

The Demand for European and International Accounting Harmonisation Major reasons for seeking to achieve international accounting harmonisation include:

• Serving the need of international investors. • Facilitating the work of transnational corporations. • Exchanging accounting skills on a global basis. • Offering an alternative to US domination of

accounting practices.

Investor Needs In a survey of 160 individuals with an interest in international accounting Mason (1978:53) found that "investors and potential investors" ranked as the class of user to benefit most highly from international standardisation of accounting practices. An OECD survey found a concern amongst transnational corporations (TNCs) that international diversity in accounting practices may discourage international investment (OECD 1980).

Cook (1989:40) makes the point that global capital markets are likely to be more volatile than domestic capital markets because they are not attached to particular investments as a normal component of a national portfolio or by 'traditional loyalties'. Thus • clarity of communication between management and the international investment community will be an essential element of support for the share price'.

Thus failure to achieve international accounting harmonisation is seen as creating 'an unlevel playing

field for those international companies that are competing with one another for business opportunities. As a result, the free flow of capital and business is blocked'. (Barthes de Ruyter 1990).

Easing the Work of Transnational Corporations Mason (1978:32) identifies three potential benefits of accounting harmonisat ion for t ransnational corporations:

* Costs of accounts preparation for the individual company would be reduced.

• Costs would also be saved with a reduction in the number of adjustments required on consolidation.

• The integration of internal and external reporting systems and the development of uniform measures of performance would be facilitated.

Cecchini (1988:32) reports that in a sample of European transnational firms 'the extra administrative burden imposed by different auditing and fiscal systems was estimated by the report at between 10%-30% of the costs of the company departments involved'.

Exchange of Accounting Skills Turner (1983) observes that !a third improvement from harmonisation would be the tendency for accounting standards throughout the world to be raised to the highest possible level and to be consistent with local economic, legal and social conditions'.

Mason (1978:33) observes that small and developing nations lack a sufficiently large or well developed

EUROPEAN MANAGEMENT JOURNAL Vol 12 No 3 September 1994 333


accounting profession to produce a full set of domestic accounting standards, and benefit accordingly from the availability of international standards.

Within Europe the inflation accounting debate offers an example of wasteful duplication of resources in researching the issues. The 'value to the owner' concept found its way into the English language debate from the works in Bonbright (1937) independently of the similar concept taught in the Netherlands by Limperg (see Tweedie & Whittington 1984: 25, 32).

An Alternative to US Dominat ion Mason (1978:36) observes that 'there are those who consider - - and perhaps fear - - that if international standards are not developed, US generally accepted accounting principles (GAAP) will fill that vacuum and become increasingly widely used as the international accounting language'.

Reasons for this potential US domination suggested by Mason (1978) include:

• The economic significance of US TNCs. • The influence of US dominated international

firms. • The high technical quality of US produced

standards. • The quality of US accounting publications. • The strength of the US academic accounting

community.

Hopwood et al (1990) argue that 'International trade and investment will increasingly require internationally acceptable and understandable financial statements. Standards will either need to provide for more harmonisation than at present or, increasingly, o n e

nation's system will come to dominate. That nation will be the United States'.

Reasons for Distinctive National Accounting Practice We have seen that major areas of variation in national accounting practice exist between different European community countries despite the case for international accounting harmonisation and the work towards this end of the European Community and the IASC. Reasons for this include:

Economic consequences Published accoun, ts are used in two ways:

• To make judgements on a company's position by interested parties such as shareholders, lenders, employees, and government.

• To define the company's rights and obligations. Examples include borrowing restrictions expressed as a multiple of the reported equity, profit sharing schemes, and tax liabilities in so far as these are based on the figures reported in the profit and loss a c c o u n t .

Management will tend to lobby for accounting regulations that they believe will promote the user reaction they wish to see and define the company's rights and obligations to their advantage. Different countries have different patterns of use of accounts; indeed, a study in Canada has shown that within o n e

country English and French speakers each use accounts in a different way (Chevalier, 1977).

These different patterns of use mean that the perceived 'economic consequences' of an accounting rule will differ between countries, with consequent differences in the preferred choice of accounting regulation.

Issues of this kind can be specific to one accounting issue. In the UK successful lobbying to permit the treatment of some development expenditure as an asset, to be amortised against future related income, rather than subject to an immediate write off, was a result of UK government regulations on the basis for computing prices to be paid for 'cost plus' defence contracts (see Eccles & Lifford, 1979; Hope & Gray, 1982).

In other cases a particular aspect of national patterns of use of accounts can have a general impact on attitudes to accounting regulation. In Germany shareholders are entitled to demand a certain proportion of profit as dividend. This is one reason why German managers, wishing to retain profits in the business, prefer conservative accounting procedures (Busse von Colbe, 1984)

Taxation In some countries there is an explicit binding link between the rules for computing taxable profit and the rules for computing accounting profit. Germany is the leading nation to take this approach, applying the 'massgeblich keitsprinzip' variously translated as the principle of 'b indingness ' , ' congruency ' , or 'authoritativeness'. A system of generous tax allowances can only be enjoyed if reflected in equivalent charges in the published accounts. The effect is to produce a particularly conservative accounting system, and has lead to the implementation of EC directives in Germany with a 'very conservative transformation' (Hailer, 1992). By contrast a number of countries, such as the UK, make no such binding link. Nevertheless, even where there is no explicit link in tax and accounting rules, a national tax rule can have an indirect impact on accounting rules and practices. AUK survey of accounting practitioners found that the majority agrees or strongly agrees with the proposition that tax factors influence company choice of accounting policies (Naser, 1993: 215).

Sources of Finance In countries where the stock market is a major source of finance, such as the US and the UK, we tend to find accounting systems that provide more economically realistic information. The tendency for companies with a stock exchange listing to provide a higher quality and quantity of accounting information has been confirmed

334 EUROPEAN MANAGEMENT JOURNAL Vol 12 No 3 September 1994


by studies in the US (Cerf, 1961; Singhvi & Desai, 1971), the UK (Firth, 1973), Sweden (Cooke, 1989), and Italy (Hagigi & Sponza, 1990).

Users and Objectives Accounts may vary from country to country because they aim to satisfy different objectives and different user groups. In both the US and the UK, for example, the prime users of accounts have been seen as investors, so that accounting information is designed to give information useful for estimating the value of a company. By contrast, in Germany the main functions of accounts are seen as providing a basis for taxation and restricting the ability of a company to payout excessive dividends that would deplete the company's capital base and so endanger creditors. In this context objective unambiguous rules that tend to compute profit on a conservative basis are appropriate (Busse von Colbe, 1984).

Economic Environment Distinctive features of the national economic environment may influence a country's accounting system. One example is that the traditional historic cost approach to accounting ceases to be meaningful in times of high inflation. In response to this, some Latin American countries with a long-running high level of inflation have introduced inflation accounting systems (see Tweedie & Whittington, 1984: 234-6). In countries where inflation rates fluctuate it has been found that the degree of interest in inflation accounting varies in line with the level of inflation (for the UK example, see Westwick, 1980).

South Africa offers an interesting illustration of a country which has traditionally followed accounting practices in the major English speaking countries. As a result of inflation rates substantially higher than those countries, it has become necessary for South Africa to consider an inflation accounting system independently (see Everingham, 1989; Stobie, 1989).

Legal System Different legal systems may give rise to differences in approaches to accounting. For example, countries such as England and Wales with a common law tradition tend to prefer to legislate on the broad principles of accounting, while countries such as Germany with a Roman Law tradition prefer a codified set of rules (Nobes, 1988). Accounting practices may also depend on how strictly rules are applied in practice -- Busse von Colbe (1983) cites Italy as an example of a country where application of rules tends to be flexible.

Influence of Theorists In some countries a dominant school of accounting theory may influence accounting practice. An example is the influence of Theodore Limperg Jr in promoting the strong Dutch replacement cost accounting tradition (van Seventer, 1984).

The strength of academic influence varies between

I

countries. Thus a Swedish survey found 6 academics amongst 39 accountants most respected by practitioners (Jonsson, 1984). By contrast Sterling (1973) saw the professional training of US accountants to be totally unrelated to academic research.

Nationalism As Cummings (1976) observed, accountants calls for uniformity 'weren't sounded in Esperanto . . . All thought their accounting standards were best, and should be applied universally'.

Language Even when agreement on a common accounting approach is agreed between countries, translation into different languages can vary the shades of meaning.

Davidson & Chrisman (1993) took a number of expressions in International Accounting Standards that express degrees of probability such as 'beyond any reasonable doubt', 'remote possibility', and 'significant uncertainty'. They then compared this with the matching terms used in the French official translation e.g. 'quasi absolu', 'risque minimis4', and 'incertitude' 'importante'. They asked two groups of English speakers and French speakers in Canada to state the degree of probability implied in their own language by each expression. They found that:

• There were some significant differences between the probability levels identified for the same term by the different groups.

• The French speaking group tended to have a wider range of probability levels for some terms than the English speaking group.

Other Country Influence Sometimes one country comes to be under the influence of another country's accounting approach. For example, the French "Plan" based system of accounting was first introduced by the German occupying forces in World War II and was continued after the war as a useful tool for economic management (see Standish, 1990).

Scandal or Crisis Accounting and audit regulation can emerge in response to a scandal or crisis. Thus the introduction of a bank audit requirement in the UK in 1879 was a direct response to the failure of the City of Glasgow Bank (see Tyson, 1974).

The Limitations of Accounting Harmonisation in the European Union The wide variety of accounting practice within the European Union that we have identified above exists despite the endeavours of two bodies, the International Accounting Standards Committee (IASC) and the EU itself, to achieve harmonisation.

IASC was founded in 1973 by the professional



accounting bodies of nine countries including the UK and the US, countries which continue to have a particularly significant influence in IASC. In twenty years, IASC has grown to embrace some eighty countries and has issued over thirty standards. The professional bodies that make up IASC are committed to promoting International Accounting Standards (IASs) in their countries. There are two major limitations on this work:

• To secure a 75 per cent majority of the 14 members of the committee it is generally necessary to compromise on the range of approaches that continue to be permitted. In 1988 IASC embarked upon a project to reduce the range of choice permitted in earlier IASs but it is still uncertain as to how much the range of accepted practice will be reduced.

• Since IASC is a private sector body, its influence in each member country depends on the degree of influence of the accounting profession in that country. IASC has sought to involve governmental regulators in its processes to increase its influence.

As part of an overall programme of harmonising company law, the European Union has issued three directives specifically relating to accounting issues:

1. The fourth directive, adopted in 1978, covers the form and content of annual company accounts.

2. The seventh directive, adopted in 1983, covers the requirement to prepare consolidated accounts.

3. The eighth directive, adopted in 1984, deals with the requirements for an audit.

Although these directives have duly been incorporated in national legislation throughout the EU, effective harmonisation, as we have seen, has not been achieved. Table 2 summarises the various levels of at which obstacles to harmonisation have arisen.

1. The EU itself has failed to produce directives that provide for a comprehensive scheme of accounting harmonisation. Major areas of controversy have been ignored; thus the EU directives give no guidance on foreign currency translation, deferred taxation, or accounting for lease commitments. In other areas individual countries may choose from a range of options; an example is the permitted range of formats. An overriding requirement to present a ' true and fair view' drew on a traditional UK formula that has been ambiguous and ill defined (see Higson & Blake, 1993), and poses major problems in translation (Rutherford, 1980).

2. At the stage of national legislation some countries have interpreted the directives in line with national accounting traditions. To give two illustrations:

• The German draft law introducing the EC fourth directive offered the comment on the 'true and fair view' requirement: 'In spite of the pretentious formulation it is supposed that for practice there will be no principal changes' (Busse von Colbe, 1984:123).

336

Table 2 Obstacles to Accounting Harmonlsatlon in the European Community

Level Obstacles to Harmonisation

European Commission

National legislation

National accounting profession

Individual business

Unresolved issues. Choice of options. Ambiguous prescriptions.

Adapted to national tradition. Failure to implement.

Interpretation of national legislation against the spirit of EU directives.

Non compliance with rules.

In the UK, the min is te r respons ib le for implementing the fourth directive announced in parliament that the UK government was 'at pains to impose the minimum change necessary in actual accounting practice' (cited in McBarnet & Whelan, 1992:99).

3. National accounting professions have, on occasion, interpreted national legislation implementing the EU fourth directive in a conflicting national tradition. Thus while the fourth directive prescribes that all assets with a finite useful life should be depreciated, a UK standard, SSAP 19, prescribed annual revaluation instead of depreciation for investment properties.

4. At the individual company level there may be failure to comply with the spirit of the rules. As an example, in Spain the law now requires a fair estimate of depreciation in the published accounts. Nevertheless, in practice most businesses use the tax permitted rates for accounting purposes.

Conclusion The diversity of accounting practices in Europe is so great as to seriously impair the comparability of accounts from different countries, and creates substantial costs for E u r o p e a n co m p an i e s . Desp i t e subs tan t ia l harmonisation projects at both governmental level, through the EU, and the professional level, through IASC, this diversity is likely to continue.

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J O H N B L A K E , University of Central Lancashire, Dept. Accounting and Financial Services, Preston PR1 2HE, UK.

John Blake is Professor of Accountancy in the Department of Accounting and Financial Services at the University of Central

~ ~ Lancashire, UK. Previously he held appointments at Loughborough

• University of Technology and at Huddersfield University. He has held appointments at universities in Sweden, Spain and New Zealand. He is author of a number of books, including a recent book European Accounting written with Oriol Amat.

ORIOL AMAT, University Pompeu Fabra, Barcelona, Spain.

Dr Oriol Amat is Associate Professor at the University Pompeu Fabra in Barcelona. He has held visiting appointments at universities in Europe and America. He is author of a number of books published in Spanish, Catalan,

English and French, including a recent book European Accounting written with John Blake, and is a member of the Jury judging the Annual Case Writing Competition in Management of the European Foundation for Management Development, Brussels.


European accounting harmonisation: Myth or reality?

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