Harmonizing accounting

differences across the

countries

Accounting Accounting

� “The language of business”

� Expression in Profit & loss statements, balance sheets, budgets, investment analysis, & tax analysis

� “The language of business”

� Expression in Profit & loss statements, balance sheets, budgets, investment analysis, & tax analysisanalysis, & tax analysis

� Accounting information is the means by which firms communicate their financial position to the providers of capital , investors, creditors and government

analysis, & tax analysis

� Accounting information is the means by which firms communicate their financial position to the providers of capital , investors, creditors and government

Accounting information and

capital flows

Accounting information and

capital flows

Good accounting function is critical to the smooth running of the firm

Determinants of national

accounting standards

Determinants of national

accounting standards

Relationship between business and providers of capital

Relationship between business and providers of capital

� Three external sources of capital:

o Individual investors

• Buying shares and bonds

Banks.

� Three external sources of capital:

o Individual investors

• Buying shares and bonds

Banks.o Banks.

• Loan capital

o Government

• Make loans or investment

o Banks.

• Loan capital

o Government

• Make loans or investment

19-5

Importance of each

varies from country

to country

Political and economic ties with other countries

Political and economic ties with other countries

� Accounting convergence:

o Influence of NAFTA

o Influence of the former British Empire

� Accounting convergence:

o Influence of NAFTA

o Influence of the former British Empireo Influence of the former British Empire

o Influence of the European Union

o Influence of the former British Empire

o Influence of the European Union

19-6

Inflation accountingInflation accounting

� Historic cost principle:

o Assumes currency is not losing value to inflation

o Most significant impact in the area of asset valuation

� Historic cost principle:

o Assumes currency is not losing value to inflation

o Most significant impact in the area of asset valuation

19-7

of asset valuation

� Current cost accounting:

o Factors out inflation

o Used in Great Britain until inflation rate declined

of asset valuation

� Current cost accounting:

o Factors out inflation

o Used in Great Britain until inflation rate declined

Level of developmentLevel of development

� Developed countries have more sophisticated accounting procedures

o Accounting problems are more complex

o Sophisticated capital markets

� Developed countries have more sophisticated accounting procedures

o Accounting problems are more complex

o Sophisticated capital marketso Sophisticated capital markets

o Lenders require comprehensive reports

o Educated workforce can perform complex

accounting functions

o Sophisticated capital markets

o Lenders require comprehensive reports

o Educated workforce can perform complex

accounting functions

19-8

CultureCulture

� Hofstede’s uncertainty avoidance has an impact on accounting systems

o Low uncertainty avoidance - these

countries tend to have strong independent

� Hofstede’s uncertainty avoidance has an impact on accounting systems

o Low uncertainty avoidance - these

countries tend to have strong independent countries tend to have strong independent

auditing professions that ensure a firm’s

compliance with rules

countries tend to have strong independent

auditing professions that ensure a firm’s

compliance with rules

19-9

Accounting clustersAccounting clusters

� Few countries have identical accounting systems.

� Few countries have identical accounting systems.

� Similarities exist in clusters� Similarities exist in clusters

19-10

Accounting clustersAccounting clusters

British-American-Dutch Group

Firms raise capital from

investors. Accounting Europe-Japan Groupinvestors. Accounting

systems designed to inform investors

Have close ties to banks. Accounting practices meet bank’s needs.

South American Group

Countries have experienced persistent and rapid inflation. Accounting principles reflect

the inflation.

Europe-Japan Group

Accounting clustersAccounting clusters

19-12

National and international

standards

National and international

standards

� Diverse accounting practices are enshrined in national accounting and auditing standards

� Diverse accounting practices are enshrined in national accounting and auditing standards

� Accounting standards: Rules for preparing financial statements

� Auditing standards: Specify rules for performing an audit

� Accounting standards: Rules for preparing financial statements

� Auditing standards: Specify rules for performing an audit

19-13

Lack of comparabilityLack of comparability

� One result of national differences in auditing and accounting standards is lack of comparability of financial reports

� With growth of global capital markets

� One result of national differences in auditing and accounting standards is lack of comparability of financial reports

� With growth of global capital markets � With growth of global capital markets both transnational financing and transnational investment have grown

� Firm has to explain to investors why its financial position looks different in two accountings

� With growth of global capital markets both transnational financing and transnational investment have grown

� Firm has to explain to investors why its financial position looks different in two accountings

19-14

International standardsInternational standards

� Efforts to harmonize accounting standards across countries

� Formation of International Accounting Standards Board (IASB) in March 2001

� 15 members

� Efforts to harmonize accounting standards across countries

� Formation of International Accounting Standards Board (IASB) in March 2001

� 15 members15 members

� Responsible for formulating international accounting standards (IAS)

� Has issued over 41 IASo Difficult to get requisite voteso Voluntary compliance

� Recognition is growing

15 members

� Responsible for formulating international accounting standards (IAS)

� Has issued over 41 IASo Difficult to get requisite voteso Voluntary compliance

� Recognition is growing

19-15

Multinational consolidation and currency translation

Multinational consolidation and currency translation

� Subsidiaries of multinationals are separate legal entities but not separate economic entities

� Purpose is to provide accounting info about a group of companies that recognizes economic interdependence

� Subsidiaries of multinationals are separate legal entities but not separate economic entities

� Purpose is to provide accounting info about a group of companies that recognizes economic interdependence of companies that recognizes economic interdependence (subsidiaries)

� Transactions among members of a corporate family not included in consolidated financial statements. Only assets, liabilities, revenues and expenses statements with external trade parties are shown

of companies that recognizes economic interdependence (subsidiaries)

� Transactions among members of a corporate family not included in consolidated financial statements. Only assets, liabilities, revenues and expenses statements with external trade parties are shown

19-16

Currency translationCurrency translation

� Financial statements of subsidiary’s are prepared in the local currency

� For the consolidated accounts of a

� Financial statements of subsidiary’s are prepared in the local currency

� For the consolidated accounts of a For the consolidated accounts of a Multinational these accounts have to be then converted into currency of Multinational’s home country

For the consolidated accounts of a Multinational these accounts have to be then converted into currency of Multinational’s home country

Currency translationCurrency translation

� The current rate method: o Exchange rate at the date on the balance

sheet is used to translate foreign subsidiary financial statements into home country currency

� The current rate method: o Exchange rate at the date on the balance

sheet is used to translate foreign subsidiary financial statements into home country currencycountry currency

o Incompatible with ‘historic cost principle’

� The temporal method:o Translates foreign subsidiary assets into

home-country currency at the time of purchase of the asset

o Changing exchange rates may mean the balance sheet may not balance!

country currency

o Incompatible with ‘historic cost principle’

� The temporal method:o Translates foreign subsidiary assets into

home-country currency at the time of purchase of the asset

o Changing exchange rates may mean the balance sheet may not balance!

19-18

Accounting aspects of control

systems

Accounting aspects of control

systems

� Annual control process involves three

steps:

o Head office and subunit management jointly determine subunit goals for the coming year.

o Throughout year, head office monitors

� Annual control process involves three

steps:

o Head office and subunit management jointly determine subunit goals for the coming year.

o Throughout year, head office monitors o Throughout year, head office monitors subunit performance against agreed goals.

o If subunit fails to achieve goals, head office intervenes to determine why the shortfall occurred, taking corrective action when appropriate.

o Throughout year, head office monitors subunit performance against agreed goals.

o If subunit fails to achieve goals, head office intervenes to determine why the shortfall occurred, taking corrective action when appropriate.

19-19

Accounting aspects of control

systems

Accounting aspects of control

systems

� Lessard- Lorange Model:o Three exchange rates used to translate

foreign currency into corporate currency for budget and performance purposes.

� Lessard- Lorange Model:o Three exchange rates used to translate

foreign currency into corporate currency for budget and performance purposes.purposes.

• The initial rate, the spot exchange rate when the budget is adopted.

• The projected rate, the spot exchange forecast for the end of budget period (i.e., the forward rate)

• The ending rate, the spot exchange rate when the budget and performance are being compared.

purposes.

• The initial rate, the spot exchange rate when the budget is adopted.

• The projected rate, the spot exchange forecast for the end of budget period (i.e., the forward rate)

• The ending rate, the spot exchange rate when the budget and performance are being compared.

19-20

Exchange rate combinations in the control process

Exchange rate combinations in the control process

19-21

Separation of subsidiary and manager performance

Separation of subsidiary and manager performance

� Valuation of a subsidiary should be separate from the evaluation of the subsidiary manager

� Valuation of a subsidiary should be separate from the evaluation of the subsidiary manager

� Manager’s evaluation should take into consideration how hostile or benign the countries environment is for business and make allowances over items the manager has no control e.g. inflation rates, interest rates exchange rates

� Manager’s evaluation should take into consideration how hostile or benign the countries environment is for business and make allowances over items the manager has no control e.g. inflation rates, interest rates exchange rates

19-22