1.0 Introduction
The recent expansion of international capital markets and availability of instantaneous global communication have placed on accounting the onus to provide useful and comparable information across international borders (Rivera, 1989). International Financial Reporting Standards are being used by nearly 100 countries including European Union, Australia, and South Africa; while some companies have their own accounting standards. Many countries including United States of America use Generally Accepted Accounting Principles (GAAP) which differs from International Financial Reporting Standards (IFRS) in some aspects. International Accounting Standards are issued by International Accounting Board. The main purpose of this board is to make IFRS accepted globally.
World is becoming ‘single country’, what is why world need one standardized accounting system. Businesses are expanding worldwide and becoming international and the information of the companies is being analyzed by different investors worldwide; thus there is a need for a change in accounting standards. Comparison between the companies becomes very difficult if we have different accounting standards. What is why according to Doupnik (1987) harmonization of financial reporting is the process by which differences in financial reporting practices among countries are reduced? However making one standardized accounting system throughout the world can be difficult as every country has a different tax rule, and different laws.
Nair and Frank also argue that a number of international organizations are working to reduce the differences in accounting standards between nations and trying to eliminate all necessary differences (Nair and Frank, 1980). These authors also said same thing with Doupnik. Other hand, every country thinks differently and has different tax rules, laws, business plans and that is the reason different countries use different accounting standards.
For some countries where capital market reporting is not so important, this change in accounting system will be a big change. This change is very necessary for the betterment of the businesses.
Accounting keeps the record of all financial reports which is very important for all the managers and stake holders like share holders, creditors or owners. Every country has its own set rules and follows their own accounting standards (Duquesne University, 2006).
As there has been a tremendous growth in the market place with the existing accounting practices, this leads us to question why do we need harmonization of International accounting standards, what are its advantages and what are the barriers that hinder harmonization? Although accounting may be the "language of business," a common language has never been necessary — at least as long as the world economy consisted of a set of more or less distinct national economies.
Introduction of IFRS is over 100 countries across the world. With the U.S. as one of the last big exceptions sticking to their own national GAAP, the IFRS are destined to be the lingua franca of the international accounting world. However, starting with the co-signed Norwalk Agreement in 2002, major efforts between the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have cleared the way towards a convergence between both standards.
There are four historical models accounting standards in industrial countries: United, Europe, the United States and Latin American models. International Accounting Standards Committee (IASC) has taken a major role in this model standardization:
- The IASC is a result of the efforts that began in 1973, the United States, Canada and Great Britain for Raya internationalism in accounting standards. Currently, there are representatives from the accountancy bodies in 106 countries and 31 standards that have been received so far. Most of this opinion correlated with the American Institute of Certified Public Accountants (AICPA’s) Accounting Principles Board and the Financial Accounting Standards Boards (FASB) statements.
- Harmonization must begin with a standardization of the reporting supplies by national securities regulators. Participants in the globalized financial markets are challenging international accounting standards.
- The International Organization of Securities Commissions (IOSCO), of which the U.S. Securities Exchange Commission is a member, is taking the lead in the development of accounting policy for securities regulator’s reporting requirements. IOSCO has a "built-in desire to reduce the number of acceptable alternatives" corporations can choose from when reporting the results of operations and net worth.
- In lesser-developed countries standardization has been promoted through the establishment of regional accounting associations and accountant education programs. The International Monetary Fund has aided in this effort by assisting governments with their financial management procedures. The industrialized nations’ foreign assistance programs include training local accountants and professional development.
In the long run, the "level playing field" provided by harmonization (and the attendant market efficiency) should be expanded to include financial institution regulation, audit requirements, ethical standards, and tax and custom policies.
Harmonization is concerned with reducing the diversity that exists between accounting practices in order to improve the comparability of financial reports prepared by companies from different countries.
All explanations consider harmonization as a condition in which only a limited number of related methods of Accounting Standards is available. Harmonization means that the rejection of rules, which do not exclude me, can continue to exist next to each other. This means that harmonization is not aimed at eliminating differences, but on the reduction of conflicting rules. That the goal of the process of international harmonization of accounting standards is to reduce or overcome the divisions throughout the world, in order to achieve better international comparability of financial reporting.
3.0 Differences in International Accounting Practices
3.1 Causes of differences in International Accounting
The environment in which a country operates shapes its Accounting Practices. “Just as nations have different histories, values, and political systems, they also have different patterns of financial accounting development”, (Nobes et al., 1997:2). According to Roberts et al. there are not two countries, which have the same Accounting Practices. The followings give an overview on variables, which can cause differences in Accounting Practices:
Legal system
The Accounting world can be divided into “those countries which have a ‘legalistic’ orientation toward accounting and those with a ‘nonlegalistic’ orientation” (Nobes et al., 1997:8). The non-legalistic approach can be found in countries, which use common law. In common law countries, Accounting does not depend upon law. Accountants (professional organizations) arrange accounting rules. Hence, it is the private sector, which determines Accounting and not the law. The task of the legal system is to give an answer to a specific case rather than to formulate general rules for the future.
The legalistic approach can be found in countries, which use the so called code (or codified) law. In contrary to the common law, the codified law system needs to develop rules in detail for the Accounting and financial reporting. This means that “Accounting rules are incorporated into national law and tend to be highly prescriptive and procedural” (Choi et al., 2002:43). In these countries the role of law is to describe behavior, which is considered to be acceptable in the society.
Such fundamental difference in legal origin has an impact on the role played by accounting information.
According to these authors the U.S., Canada or the U.K. belongs to the common law countries and France or Germany for example to the codified countries. The laws of Scotland, Israel, South Africa, Quebec, Louisiana and the Philippines contain elements of both systems. The codified law system is as well used in South America.
Provider of finance
The three main sources for external capital are shareholders, banks and government (Hill, 1999). It varies from country to country, which of these three provides most of the financial capital to companies. In countries like Germany and Italy banks provide companies with capital. In countries like England and the United States shareholders provide companies with capital. The government is the provider of capital in countries like France and Sweden.
This diversity of capital providers means that Accounting Practices differ in order to satisfy needs of capital providers. In the case of shareholder ownership, (e.g. in the U.K. and the U.S.), information disclosure will be more important than in countries, where capital is raised from banks or governments. This is explained by the fact that in the latter countries information will be transmitted more directly. It is impossible for a company to inform each shareholder with its specific information needs, because they are a big and unorganized group. Therefore financial statements in the US and UK are “oriented toward providing individual investors with the information they need to make decisions about purchasing or selling corporate stocks and bonds”. The Accounting Practices in countries with banks as main capital providers have an interest to protect bank’s investment. This led to more conservative methods, which are characterized by overvaluation of liabilities and underestimation of assets. In countries where capital is provided by the government, Accounting Practices are oriented towards needs of governmental planners.
Taxation
The key question here is to ask, how much taxation regulations determine Accounting measurements. In countries like the U.S., U.K. and Netherlands there is no interplay between tax and Accounting law. When Accounting Standards are developed, the only focus is how to conduct the information function. Questions about taxation are not considered in those countries.
In contrary, in nations as France and Germany, tax and Accounting Systems are ruled equal. There is the principle of decisiveness in continental European countries. This means that the profit of the balance sheet is at the same time the foundation to snap income taxes (Achleitner, 2000).
National culture
National culture of countries influences Accounting Practices as well. Authors like, for example, Nobes and Parker, Roberts et al. refer to the study of Hofstede in order to explain how national culture could influence Accounting Practices of countries.
Hofstede compared cultural behavior in an American company, which was represented in over 50 countries. His aim was to define characteristics of national culture with help of the four following dimensions.
- Large versus small power distance,
- Strong versus weak uncertainty avoidance,
- Individualism versus collectivism and
- Masculinity versus femininity.
The importance of Hofstedes dimensions of national culture in the International Accounting field is that national culture influences the behavior of accountants and therefore the nature of Accounting Practices. According to Roberts et al. dimensions as individualism and uncertainty avoidance are most significant for Accounting. They argue that in a country with high uncertainty avoidance, efforts are made to minimize uncertainty. This means in the area of Accounting that rules and regulations tend to be rather explicit, detailed, prescriptive, all comprising and rigid. Individualism affects Accounting in terms of disclosure practices and income measurement rules. It depends on the dimension of individualism, how willing people are to accept rules and controls from above. Gray is another author, which studied national culture, as an important influence factor on Accounting.
Other influences
Another influence on Accounting Practices can be called `factor of accident of history`. Accidents of history refer to rules of practices of Accounting, which developed due to crisis or shocks of systems in general. To such kind of accidents of history belong for example collapses of companies or financial crisis like in the beginning of the 1920`s when the German and US stock markets collapsed. In the United States this accident of history resulted in the creation of the Securities Exchange Commission and stricter Accounting regulations in order to protect the shareholder. In Germany the same accident leaded to Accounting regulations, which protect the creditor.
In countries with high economic growth and hyperinflation, as for example in South American countries, inflation has a big influence on Accounting Practices as well. For example, a practice of general price-level adjustments instead of traditional practices of historical cost measurements can be found there. Political and economic ties with other countries play another important role in shaping Accounting Practices. Accounting Practices are not only used in the home country but have been exported since the earliest beginning of Accounting. For example, the movement of accountants between United States and Great Britain led to many similarities between these two countries. Furthermore, Hill mentions that the American and British Accounting Practices had enormous influence on other countries. Hill argues that America influenced Accounting Practices of Canada and Mexico. Britain influenced their former colonies like, for example, India and Pakistan. Several authors argue that Accounting problems vary dependent on the development of an economy. Hill points out that Accounting in developed countries might be more complex and sophisticated than in less developed countries. He argues that developed nations might have larger and more complex organizations with more educated workforce. He thinks that they have a need for more advanced Accounting Practices.
3.2 Classification of Accounting Practices
My aim with presenting classifications of Accounting Practices is to give an overview about the international diversity of them. I want to show, which characteristics (factors) are used to group Accounting Practices. National systems can be clustered. Both similarities and differences become clear with classifications.
Nobe`s Classification of Accounting Practices
Nobes classes measurement practices of fourteen western countries into a hierarchy of three levels.
On the first level he distinguishes between the micro-based and the macro-uniform orientation. While the macro-uniform orientation corresponds with the code law, the micro based corresponds with the common law. This marks the high importance of the legal system as a dominant factor in shaping Accounting Practices. Radebaugh and Daniels argue that macro-uniform countries are shaped by more governmental influence than the micro-based ones.
On the second level Nobes analyses that influences Accounting Practices most. He differentiates between business theory and business practice under the micro-based classification. Under the macro-based one he considers influence factors as the government/tax/legal orientation, in contrast to the government/economic one.
As a last step he deviates between the U.K. and U.S. influence under the business practices orientation. Further, he differs between tax-based and law-based systems under the government/tax/legal orientation.
In 1998 Nobes proposed a new classification of Accounting Practices. In comparison to his first study he commits “that the type of finance is now more important than the legal system in classifying financial reporting systems” (Choi et al., 2002:53). Furthermore, he is aware that “many companies modified their financial reporting to suit the information needs of international capital investors. In particular, companies from code law countries began to adopt shareholder oriented reporting found in common law countries” (Choi et al., 2002:53).
Therefore, he saw a need to focus his classification on financial reporting of companies instead of countries. Hence his new classification divides between strong equity and weak equity reporting. With strong equity is meant a shareholder-oriented reporting. Additionally, his classification divides outsider from insider financiers. “Outsiders are not members of the board of directors and do not have privileged relationship with the company (e.g., such as that enjoyed by a company’s banker who is also a major shareholder” (Nobes, 1999:166).
But also the standards of the IASB (IAS/IFRS) belong to this class of more focus for shareholder orientation.
Following from the graphic above the Accounting Practice are divided into two systems, which stand at the extremes. These two practices are the Anglo-American Model and the Continental- European Model.
Anglo-American-Model
An orientation towards decision needs of investors is emphasized in the countries of this model (Mueller et al., 1991). The security of the creditor is of subordinated importance according to that approach. In foreground stand performance and financial position of the company. The financial statement shall be used in order to give information about the future development of the company. Accounting Practices are characterized in Anglo-American countries by more focus on the addressee in order to mobilize capital, because of the bigger influence of capital markets. Extensive disclosure and an attenuation of the prudence principle in favor of the accrual accounting are characteristic for Accounting Practices of those countries. Wolk et al. stress the strong Accounting profession, the limited role of government and the importance of stock markets in those countries.
The standards of the IASB belong to the Anglo-American Model. (Wollmert and Achleitner, 2002). Countries as the UK, many members of the British Commonwealth, the US, the U.K., Australia, New Zealand, Canada, the Netherlands, Mexico, Pakistan or Kenya belong as well to this model.
Continental-European Model
Countries as Germany, France, Spain, Italy, Japan, Switzerland or Egypt belong to the Continental-European Model 10. In contrast to the Anglo- American-Model, countries of this cluster rely on banks as capital providers and have therefore a close relationship with them. These countries rely less on public equity market than countries of the Anglo-American-Model. Hence, the task of financial statements is not in first line to provide information (to capital providers) but to please government imposed requirements (e.g. tax collection and to protect creditors). Accounting Practices can be characterizes as legalistic and as highly conservative. “France and Germany, as continental model countries, are less concerned with the primacy of investors needs and more concerned with issues such as tax determination and the protection of creditors” (Haller et al. in Wolk et al., 2001:729). The main tasks of Accounting according to that model are therefore the security of creditor as well as the long-term stability of the enterprise. The prudence principle can be called as the dominating accounting principle under this model and is more important than accrual accounting.
Influence factors on Accounting Practices are diverse. It has been shown that Nobes theories emphasis the legal system. Nowadays, Nobes considers the provider of finance as a very important influence factor in terms of classification of Accounting Practices. Another factor in order to classify Accounting Practices is culture.
Gray´s cultural classification of Accounting Practices
Gray proposed a theory how to link culture and Accounting. Gray discovered the following pairs of accounting values, which can be used in order to describe a nation’s Accounting Practices and how to distinguish them from each other. (Gray in Nobes and Parker, 2000)
Professionalism versus statutory control
This dimension is concerned with attitudes towards regulations, in particular how Accounting control is done. A high level of professionalism describes a system of self-regulation and a lower degree denotes high level of government regulation (Wolk et al., 2001).
Uniformity versus flexibility
Uniformity versus flexibility describes the attitudes towards regulations, in particular how Accounting control is done. It describes the preference for uniformity and consistency over flexibility in reacting to conditions.
Wolk et al. describe this value as following: “The higher the degree of uniformity, the more Accounting rules are applied in a – cook book – fashion and the less professional judgment is employed”.
Conservatism versus optimism
Conservatism and optimism explains the attitudes towards measurement in financial reporting. While conservatism aims at a more cautious approach to value assets and recognize income, optimism is a more risk taking and liberal approach to measurement.
Secrecy versus transparency
Is concerned with the attitude how much information companies show the public in their disclosure. Secrecy is consistent with a restricted information disclosure “on a need-to-know basis”. Transparency is characterized by a willingness to disclose much more open to the public.
Gray classes ten cultural areas according to his four above described accounting values. As can be seen from the graphics below, Gray differentiates twice. First, he classes the cultural areas according to their attitudes towards regulations. Hence, he puts the value professionalism versus statutory control and uniformity versus flexibility at extremes. Second, he classes the cultural areas according to measurement and disclosure practices. For this, he takes the values conservatism versus optimism and secrecy versus transparency. Thus, in contrary to Nobes, who consider only measurement practices as classification characteristics, Gray differentiates between:
- Regulation authority in Accounting and
- Measurement and disclosure practices.
When considering graphic it can be said in general that areas within the same quadrant are more similar to each other than countries in another quadrant. As an example countries like France and Spain, which belong to the More-developed Latin group, are characterized by uniformity. That can be explained with the imposition of tax rules for measurement purposes, and the focus “to facilitate national planning and the pursuit of macroeconomic goals“ (Radebaugh and Gray, 1997:78) in those countries. Furthermore, one can see that Anglo countries, as the U.K. or U.S., are characterized with a high degree of flexibility and a low degree of uniformity in their rulemaking. Countries in this cultural area are market by professionalism or the private sector, and a less degree of statutory control by the public sector when making regulations. Figure 2 shows the distribution of the cultural areas concerning measurement and disclosure practices.
Again I have asked me, what can be seen from the above figure? Gary argues that the measurement and disclosure practices range according to the conservatism dimension from countries like Japan, with a very strong conservative approach, to much less conservative countries, characterized through less risk-taking approaches of accountants, found in the U.S., U.K. (Anglo) or Netherlands (Nordic).
To sum it up: Gray´s classification makes clear that the Anglo and Nordic cultural areas have to be differentiated from the Germanic, More-developed Latin, Japanese, Near Eastern, Less-developed Latin, less-developed Asian and African cultural areas. (Radebaugh and Gray, 1997) Radebaugh and Daniels detect according to Figure 2 that countries in the upper right quadrant (e.g. Germanic ones) are moving more towards optimism and transparency. This is a result, according to the authors, of the influence of capital markets, which require disclosure more in line with the Anglo-American Model. Except from Radebaugh and Daniels none of the authors, who use Gray´s theory in their textbooks, e.g. Choi et al. 2002, refer to possible changes in the theory of classification. I criticize this because I expect that there have been movements already. I assume that there are changes due to the ongoing international harmonization process of Accounting Standards.
4.0 Reasons for the harmonization process
In the following part I want to describe which factors have triggered an international harmonization of Accounting Standards. Nobes and Parker argue that “the pressure for international harmonization comes from those who regulate, prepare and use financial statements” (Nobes and Parker, 2000:66).
4.1 Advantages for preparers
Companies prepare financial statements. Therefore the following advantages can be seen from the standpoint of preparers of financial reports. It is quite obvious to understand that international companies are not interested in dealing with a new set of Accounting Standards in each country they invest. Uniform Accounting Standards provide efficiency gains both internally and externally. Internally multinational companies would make savings if all their subsidiaries could use the same Accounting System. A similar internal reporting system gives the chance of better comparisons, less confusion and mistakes between the parts of the company. It allows uncomplicated communication and transfers of finance personnel. One set of Accounting Standards could be used in various jurisdictions and capital markets. Further cost savings can be realized, because the preparation of consolidated financial statements will be easier for companies. With one set of Accounting Standards as well the credibility of the externally reporting could be raised. No longer are different performance figures shown for the same company in different countries. Furthermore, international companies can realize significant cost savings if they do not have to change their financial statements to conform to each country’s rules, when listing on security exchanges. In other words the access to main financial markets will become easier for global acting companies and by this it will be possible to acquire capital simpler for them.
The following example will make this clearer. Imagine a company, which has a subsidiary in Cuba, the parent company is located in Germany and the shares are listed on the NYSE. This company would have to prepare financial statements in Cuba, in Germany and in order to be listed on an U.S. stock exchange it would have to prepare also financial statements in accordance with U.S.-GAAP. Thus, it is easy to understand, which advantages a harmonized world-wide accepted set of Accounting Standards would have.
4.2 Advantages for users
From the standpoint of the users of financial statements (e.g. investors, banks or owner) one can see the following advantages. Investors, banks or owners are interested in obtaining information, which enables them to make buy/sell/hold investment decisions. I argue that similar financial statements would make it possible for users of financial statements to make useful comparisons between countries and companies. This can be explained with the circumstances that similar transactions are accounted for and reported in the same manner everywhere in the world. With other words, similar Accounting Standards lead to a better comparability between companies. It would enable investors, banks or financial analysts to make better decisions. Therefore, greater comparability results in better understanding, lower risks and more efficient selections of investments.
Choi et al. argue that “financial statement users have difficulty interpreting information produced under non-domestic Accounting Systems. They claim that harmonization will make it more likely that users will interpret the information correctly, and thus make better decisions based on that information” (Choi et al., 2002:293). For the society at large it can be said that harmonized Accounting Standards are important, because they lead to a well-developed and good functioning capital market. That is important in my view, because companies and others can raise money for investments there. This again is a pre-condition for a good economy and development.
5.0 Conclusion
On one hand I see the ‘official’ role of the IASB, which is the development of world-wide accepted Accounting Standards. Even if the global acceptance of them is not achieved yet, I believe that they will gain importance the next years. Opponents of the IASB might doubt that the IASB is the most important factor in the field of harmonization. However, it cannot be denied that they play an important role in the harmonization process, because its standards are supported by major organizations as the EU, the IOSCO. In my view an acceptance of the SEC and FASB is probable in the future.
On the other hand I see the role of the IASB as a mediator between different Accounting Standards and Philosophies. I consider the efforts of the IASB as an important attempt, to overcome differences of national Accounting Standards. It tries to combine opinions of several national standard-setters by inviting them to take part in its organization as well as in the due process. It tries to converge different national Accounting Standards and wants to develop one globally accepted set of Accounting Standards. However, I am aware that the IASB needs consistent back up, in order to be able to fulfill its role. The IASB have no legal empowerment. Therefore, the compliance with its standards is voluntary. Hence, the IASB depends on organizations and national standard-setters for the acceptance of the IAS worldwide. In this we see the main weakness of the IASB. Here, I can find as well the reasons, why the IASB is trying to work so close together with other organizations. With each agreement it strengthens its importance and the acceptance of its standards.
When discussing the harmonization process one should also consider future prospects of it. There is a comment of the American Institute of Certified Public Accountants (AICPA), which gives a good idea of future prospects in the field of Accounting: "All accounting regimes, including U.S. GAAP, evolve over time and require improvement. With convergence of IAS and national regimes around high quality standards, fewer reconciling items will exist over time, and at a future date, reconciliation will become unnecessary” (SEC, 2002 b).
In my opinion the IAS/IFRS have a good chance to be the global standards for consolidated financial statements. First, they are already accepted at some capital markets (e.g. Germany, Austria or Hong Kong) and will be accepted at other ones, because in my view the democratic work of the IASB will further support an acceptance of IAS/IFRS. Secondly, I think the advantages of one single set of Accounting Standards; will convince further preparer and user as well as regulators.
International recognition will be achieved by a further co-operation between standard-setters in my view. National options in measurement/valuation methods, as well as national characteristics as the coupling of taxation law and commercial law should be dropped in my thoughts, in order to reach international similarity and comparability of financial statements.