Worldwide Accounting Diversity Watch
Companies in North America commonly present assets in order of liquidity, beginning with cash; companies in Europe commonly present assets in reverse order of liquidity, beginning with “fixed assets.”
The two major types of legal system are “code law” and “common law.” Code law countries tend to have an accounting law, which is rather general and does not provide much detail. In common law countries, a non-legislative organization generally develops accounting standards, which tend to provide much more detail than is found in the accounting laws of code law countries.
In those countries in which published financial statements form the basis for taxation, there is an incentive for companies to minimize financial statement income so as to also minimize income taxes. This incentive does not exist in those countries in which expenses taken for tax purposes are not required to be recognized in the financial statements.
The major providers of financing are equity investors (shareholders), banks, family members, and government. As equity financing becomes more important in a country so does the disclosure of information available to the public. It is not feasible for a company to allow hundreds and thousands of investors’ access to internal accounting records.
Worldwide accounting diversity causes additional complexity for MNCs in the preparation of consolidated financial statements on the basis of parent company GAAP. Each foreign subsidiary must either keep two sets of books – one in local GAAP and one in parent company GAAP – or the foreign subsidiary’s local GAAP financial statement must be reconciled to parent company GAAP. Accounting diversity also complicates MNCs gaining access to foreign capital markets, as investors and lenders in foreign countries might require financial statements prepared in local GAAP. A third problem for MNCs caused by worldwide accounting diversity relates to a lack of comparability of financial statements when making foreign acquisition decisions. The MNC might need financial statements for the potential acquisition target prepared in accordance with a set of accounting standards with which the MNCs managers are familiar and that fairly present operating performance and financial position.
Comparisons of companies across countries for making portfolio investment decisions are complicated by the diversity in accounting practice that exists worldwide. There is a so-called “apples and oranges” problem associated with trying to directly compare a company that uses one set of accounting standards to measure income and report financial position with another company that uses a different set of accounting standards.
Strong uncertainty avoidance countries are hypothesized to favor conservative measures of profit and assets following from a concern with security and a perceived need to adopt a cautious approach to cope with uncertainty of future events. They are also hypothesized to prefer secrecy (less disclosure) following from a need to restrict information so as to avoid conflict and competition and to preserve security.
The Anglo cultural area is expected to favor less conservatism and more disclosure and the Less developed Latin cultural area is expected to favor more conservatism and less disclosure.
Nobes (1998) argues that the two most important factors influencing differences in accounting systems across countries are (a) nature of culture and (b) type of financing system. Nobes’ notion of culture appears to go beyond the rather narrow notion in Gray’s framework to include institutional structures found in a country. Countries that are culturally dominated by a country with a self-sufficient culture are expected to have an accounting system similar to the dominant country. Some cultures lead to strong equity-outside shareholder financing systems, and other cultures lead to weak equity-outside shareholder financing systems. Countries with a strong equity-outside shareholder financing system use a Class A accounting system in which measurement practices are less conservative, disclosure is extensive, and accounting practice differs from tax rules. Countries with a weak equity-outside shareholder financing system use a Class B accounting system in which measurement is more conservative, disclosure is not as extensive, and accounting practice more closely follows tax rules.
Financial statements can differ across countries in terms of:
a. which financial statements are included in an annual report;
b. the format used to present individual financial statements;
c. the level of detail provided in financial statements;
e. disclosure requirements; and
f. recognition and measurement rules.
Cost of goods sold is comprised of materials, labor, and overhead. In a type of expenditure format income statement, separate line items for cost of materials, personnel expenses, and depreciation are presented in the income statement. In addition, the line item change in work in process and finished goods inventories adjusts for the manufacturing costs included in cost of materials, personnel expenses, and depreciation that are not part of the cost of the inventory that was sold in the current year.
A statement of added value added presents information on the wealth created by the company and the distribution of this wealth to employees, banks, stockholders, and the government. Value added is calculated as income before deduction of the amounts distributed to employees (wages, salaries, pensions, etc.), banks (interest), and the government (taxes).
Fixed assets can be reported on the balance sheet subsequent to acquisition at:
a. historical cost,
b. historical cost adjusted for changes in the general purchasing power of the currency,
c. fair value.
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