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Financial Accounting Theory

Topic 2
Reference:
Chapter 4, International
accounting
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Learning objectives
In this chapter you will be introduced to:
an appreciation that there are many differences between
some countries in the accounting policies and practices
adopted
various explanations about why countries adopt particular
accounting practices in preference to others
some of the arguments that suggest that it is appropriate
that there are international differences in accounting
practices
the background to recent actions by the IASB and FASB
to further standardise international accounting

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Learning objectives (cont.)


what is meant by the terms harmonisation and
standardisation as they apply to international accounting
some of the perceived benefits of standardising
accounting practices on an international scale
some of the obstacles to harmonisation and
standardisation, and the criticisms that efforts to
harmonise and standardise accounting internationally
have attracted

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Evidence of international differences


in accounting
Although many countries now adopt IFRS, if we go back a
few years and apply different countries former accounting
rules to the same transactions we can find significant
differences in profits and net assets (consider Accounting
Headline 4.1, p. 108)
The sometimes significant differences in accounting profits
has been used by many parties to justify the ongoing efforts
of the IASB to standardise international accounting
But do we really need to standardise accounting on an
international basis because of these differences, and if we
do, what are some of the costs and benefits? This lecture
covers these issues

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Standardisation versus
harmonisation
In relation to international accounting, two terms that are
commonly used are standardisation and harmonisation.
We can define harmonisation as a process of increasing the
compatibility of accounting practices by setting bounds to
their degree of variation.
Standardisation, by contrast, appears to imply the
imposition of a more rigid and narrow set of rules [than
harmonisation].
Therefore, the term harmonisation appears to allow more
flexibility than standardisation.
What is happening through the efforts of the IASB is a
process of standardisation.

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Does it really matter if different countries


use different accounting methods?
Many varied views about the costs and benefits of
international standardisation.
Some perceived benefits would include:
international investors are better able to understand the
financial performance and position of local companies
tied to the above point, there is an expectation that
standardisation will facilitate greater capital inflows
also tied to the above point, standardisation will make it
easier for local companies to list on foreign stock
exchanges

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Does it really matter if different countries


use different accounting methods? (cont)
companies listed on several stock exchanges would only need
to produce one set of financial statements and this will have
implications for cost savings
the accounting and auditing staff employed by international
organisations will be better able to move to other member
companies
there will be cost savings in the accounting-standard setting
functionrather than individual companies duplicating the
efforts of others, the majority of functions of the standard-setting
process will be centralised at the IASB
a perception that IFRS will lead to more accurate,
comprehensive and timely financial statement information,
relative to the information that would have been generated from
the national accounting standards they replaced
to the extent that the resulting financial information would not be
available from other sources, this should lead to more-informed
valuations in the equity markets, and hence lower the risks
faced by investors

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But obviously it is very difficult to quantify any


benefits associated with international
standardisation
There is very little empirical research or theory that
actually provides evidence of the advantages or
disadvantages of uniform accounting rules
nationally, or internationally.
For example, whilst the FRC in Australia said that
real benefits would flow from Australia adopting
IFRS there is no quantifiable evidence of such
benefits
Whether the benefits of adopting IFRS are shared
by a majority of corporations within a country, or
whether the benefits are confined to larger multinational corporations, is a matter of conjecture.
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Objectives of IASB
The body at the centre of international standardisation is the
IASB
It seeks to formulate and publish accounting standards and
to promote their worldwide acceptance
It seeks to work on the improvement and standardisation of
regulations, accounting standards and procedures
The IASB does not appear to believe that the many reasons
provided as to why different nations should have different
accounting standards (e.g. tied to differences in culture,
religion and so forth) outweigh the benefits of international
standardisation (we will consider some arguments against
international standardisation shortly)

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International Accounting Standards


Board (IASB) (cont.)

The Institute of Chartered Accountants of England and Wales, the


Canadian Institute of Chartered Accountants and the American
Institute of Certified Public Accountants initially established an
Accountants International Study Group in 1967.
The Accountants International Study Group then formed the basis
for the establishment of the IASC in 1973
The IASB replaced the IASC in 2001
Australia decided in the mid-1990s to harmonise its standards with
those of the IASC
But then, in 2002, a decision was made by the Financial Reporting
Council that Australia would adopt standards released by the IASB
IFRS still not accepted by the US SEC for US domestic companies,
however the US FASB and the IASB are currently working on a
convergence project which might ultimately see the US adopt IFRS

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International Accounting Standards


Board (IASB) (cont.)
The FRCs decision that Australia would adopt
IFRS created a great deal of work for
organisations in that they had to make quite
significant changes to their accounting practices
The adoption of IAS/IFRS required companies to
write off a great deal of assetsparticularly
intangible assets
Was it all worth the effort?

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The United States role in the international


standardisation of accounting
One notable exception to the global adoption of IFRS is the
US
Within the US, accounting standards are developed by the
FASB
The SEC has the power to over-ride the standards
developed by the FASB
US was traditionally strong in its resolve not to adopt IFRS
But this resolve diminished in the light of collapses such as
Enron
US standards are considered to be more rules-based
whereas IFRS are more principles-based
A belief grew that principles-based standards may be more
effective in reducing accounting fraud

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Does the international standardisation of accounting


standards necessarily lead to the international
standardisation of accounting practice?

Somewhat obviously, the IASB was seeking to


standardise practice.
However, there are a number of reasons why the
standardisation of accounting standards will not
necessarily lead to standardisation of accounting
practice (there is a difference).
Hence, consistent with Nobes (2006), we would
argue that the study of international differences in
accounting practice (and the reasons and
motivations therefore) will remain an important
area of research despite the ongoing
standardisation efforts of the IASB.

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Does the international standardisation of accounting


standards necessarily lead to the international
standardisation of accounting practice? (cont.)

Reasons why international differences in


accounting practice will survive beyond the
introduction of IFRS would include:
Differences in taxation systems
Tax driven accounting choices, which are domestic, might
flow through to IFRS statements

Differences in economic and political influences on


financial reporting
Powerful local economic and political forces determine how
managers, auditors, courts regulators and other parties
influence the implementation of rules. These forces have
exerted a substantial influence on financial reporting
practice historically, and are unlikely to suddenly cease
doing so, IFRS or no IFRS (Ball, 2006).

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Reasons why international differences will


survive beyond the introduction of IFRS would
include (cont.)
Modifications made to IFRS at a national level

the IASB has no ability to enforce the application of its


accounting standards in countries that have made the decision
to adopt IFRS. This is a key limitation.
Regulatory bodies in particular countries may take the decision
to modify a particular IFRS before it is released (for example,
the EU in relation to their acceptance of IFRS 39).

Differences in implementation, monitoring and enforcement

Unless there is international consistency in the implementation


of accounting standards and subsequent enforcement
mechanisms then we cannot expect accounting practices to be
uniform despite the actions of the IASB.
Investors might be misled into believing that IFRS adoption has
created a consistency in international accounting practices. That
is, the adoption of IFRS might (incorrectly) be construed as a
signal that a country has improved its quality of reporting.
In a sense, the adoption of IFRS brings a level of legitimacy to a
country's financial reporting despite any limitations in the level of
enforcement of the standards.

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International differences in
implementation and enforcement
Ball discussed the 'free rider' problem associated with
IFRS.
If a 'symbol of legitimacy' - such as IFRS - can be acquired
at low cost then some countries with low accounting
proficiency will make the choice to adopt IFRS because of
the reputational benefits such a choice may generate.
Such a choice will have costly implications for countries with
higher levels of accounting proficiency and who put in place
appropriate implementation, monitoring and enforcement
mechanisms.

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So is a belief in the international standardisation


of accounting practice realistic?

Given the arguments just provided we might question the belief that
the global adoption of IFRS will lead to consistency in international
accounting practices.
There will arguably continue to be international differences in
accounting practice and such differences will continue to provide an
interesting area of research for accounting academics.
However, at a more fundamental level, is it really a good idea that
there should be global consistency in accounting practice anyway?
Is it appropriate to have a global 'one-size-fits-all' approach to
financial reporting when there are international differences:

in the nature of capital, labour and product markets;


in monitoring and enforcement mechanisms;
in economic and political influence; and,
differences in cultures?

The next part of this lecture explores various reasons why, in the
absence of globalisation efforts such as those being undertaken by
the IASB, we would expect to find international differences in
accounting practices

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International financial accounting


models
Historically there have been two main models of
financial accounting adopted internationally
Anglo-American model
strongly influenced by professional accounting bodies
rather than government, emphasises importance of
capital markets, emphasises true and fair, considerations
of economic substance over legal form

Continental European Model


relatively small input from accounting profession, little
reliance on qualitative true and fair, strong reliance on
government

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Reasons for international accounting


differences

Underlying laws and political systems


Tax systems
Level of education
Level of economic development
Nature of business ownership and financing
system

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Reasons for international accounting


differences (cont.)

Colonial inheritance
Taxation
Culture
History
Language
Religion

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The effect of culture on accounting


systems
Differences in national cultures has been used by many
researchers to explain why, prior to the efforts of the IASB,
there were fundamental differences between nations
accounting practices (although, keep in mind the previous
discussion that suggests that the global use of IFRS will not
necessarily standardise accounting practice)
Culture impacts on legal systems, tax systems and the way
businesses are formed and financed etc.
Previously used to explain differences in social systems
Culture can be defined as an expression of norms, values
and customs which reflect typical behavioural characteristics
(Takatera & Yamamoto 1987)

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The effect of culture on accounting


systems (cont.)
Culture reserved for societies as a whole or
nations
Subculture used for the level of an organisation,
profession or family
International differences in accounting systems
may be explained by a framework incorporating
culture

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Hofstedes cultural dimensions


Four underlying societal dimensions along which
countries could be positioned

Individualism versus Collectivism


Large versus Small Power Distance
Strong versus Weak Uncertainty Avoidance
Masculinity versus Femininity

The value systems of accountants will be derived


from and related to societal values
Without the intervention of organisations such as
the IASB, these societal values will in turn impact
on the development of accounting standards at a
national level

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Individualism versus Collectivism


Addresses degree of interdependence a society
maintains among individuals
Individualism refers to a preference for a loosely knit
social framework wherein individuals care for themselves
and their immediate families
Collectivism stands for a tightly knit social framework
where relatives, clan or other in-group look after each
other

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Power Distance
Power Distance is the extent to which members of
a society accept that power in institutions and
organisations is distributed unequally
Large Power Distance societies accept a hierarchical
order in which everyone has a place
Small Power Distance societies strive for power
equalisation

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Uncertainty Avoidance
The degree to which the members of a society feel
uncomfortable with uncertainty and ambiguity
Strong Uncertainty Avoidance societies maintain rigid
codes of belief and behaviour
Weak Uncertainty Avoidance societies maintain a more
relaxed atmosphere where practice counts more than
principles

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Masculinity versus Femininity


Addresses the way in which a society allocates
social roles
Masculinity stands for a preference for achievement,
heroism, assertiveness and material success
Femininity stands for a preference for relationships,
modesty, caring for the weak, and quality of life

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Societal dimensions and accounting


subculture
The value systems of accountants are derived
from related societal values
The values of the accounting subculture will in turn
impact on the development of the respective
accounting systems at a national level
should accounting systems be developed in a one-sizefits-all approach?

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Grays accounting values


Gray developed four accounting values deemed to
relate to the accounting subculture, with the
intention of linking them to Hofstedes four societal
values

professionalism versus statutory control


uniformity versus flexibility
conservatism versus optimism
secrecy versus transparency

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Grays hypotheses
H1: The higher a country ranks in terms of
Individualism and the lower it ranks in terms of
Uncertainty Avoidance and Power Distance, the
more likely it is to rank highly in terms of
Professionalism
H2: The higher a country ranks in terms of
Uncertainty Avoidance and Power Distance and
the lower it ranks in terms of Individualism, then
the more likely it is to rank highly in terms of
Uniformity

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Grays hypotheses (cont.)


H3: The higher a country ranks in terms of
Uncertainty Avoidance and the lower it ranks in
terms of Individualism and Masculinity, then the
more likely it is to rank highly in terms of
Conservatism
H4: The higher a country ranks in terms of
Uncertainty Avoidance and Power Distance and
the lower it ranks in terms of Individualism and
Masculinity, then the more likely it is to rank highly
in terms of Secrecy

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Grays hypotheses (cont.)


Gray further hypothesised relationships between
accounting values and
the authority and enforcement of accounting systems
the measurement and disclosure characteristics of
accounting systems

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Other research using Hofstedes


cultural dimensions
Zarzeski (1996)
used Hofstedes dimensions to explain corporate
disclosure
entities with a higher international profile tend to be less
secretive
local enterprises are more likely to disclose information
commensurate with the secrecy of their culture than are
international enterprises

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Other research using Hofstedes


cultural dimensions (cont.)
Perera (1989)
used Hofstedes cultural dimensions and Grays accounting
subcultural value dimensions to explain differences in the
accounting practices of European and Anglo-American
countries

Baydoun and Willett (1995)


investigated the use of the French United Accounting System in
Lebanon

Chand and White (2007)


explored various cultural attributes within the Fijian society to
determine whether the recent adoption of IFRS within the Fijian
context made sense. Their view was that rules-based standards
would be more appropriate than the principles-based standards
that have been developed by the IASB.

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The effect of religion on accounting


systems
Another factor that has been used to explain
differences in accounting is religion
Religion transcends national boundaries
Impacts on global harmonisation of accounting
standards
Hamid, Craig and Clarke (1993) examined how
Islamic cultures have failed to embrace Western
accounting practices
compliance with Islamic beliefs can affect the structure of
business and finance
many Western accounting practices are incompatible with
Islamic principles
relevance of IASB standards to such cultures?
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The effect of religion on accounting


systems (cont.)
Religion can affect how people do business and
how they make decisions, for example
Islam precludes debt financing and prohibits payment of
interest
the Western objective of financial reporting of rational
economic decision making (refer to the conceptual
frameworks discussed in Chapter 5) may not be a
relevant objective in some societies

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Legal systems
Another factor that will cause international
differences in accounting is the legal system in
operation
Legal systems can be broadly divided into
common law and Roman law systems
in Roman Law systems the law tends to be very detailed
in Common Law systemswhich is how Australia can be
classifiedlaw typically evolves from the ruling of judges

In Common Law countries accounting practices


tend to rely relatively heavily on professional
judgment

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Business ownership and financing


system
Another factor is the business ownership and
financing system
At a country level the financing system is relevant
to the purpose of financial reporting
Three types of financing systems
capital market-based (e.g. United Kingdom and United
States)
credit-based system: governmental (e.g. France and
Japan)
credit-based system: financial institutions (e.g. Germany)

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Business ownership and financing


system (cont.)
Systems relying on equity markets will have
greater demand for public disclosures
Credit-based systems more concerned with the
protection of creditors
Colonial inheritance also a major explanatory
factor

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Taxation systems
Differences in accounting methods internationally
have also been linked to differences in taxation
systems
Where there are insider systems of finance
(common in continental European countries)
financial accounting practices have typically been
linked to taxation law

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Impact of international agencies


Various international agencies have also had an
affect on the accounting systems used within
particular countries
Examples of institutions or bodies which can
impact on a countrys accounting policies are
multinational companies
international accounting firms
large monetary organisations e.g. World Bank

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So there are many forces working


against international standardisation
Hence, to this point we can see that there are many
explanations for international differences
Given the many factors that explain why international
differences in accounting will, or perhaps should exist, then
how logical are efforts towards international standardisation?
Do we think that the efforts of the IASB are likely to succeed
in the long-run?
Will diverse countries with different cultures, religions,
finance systems and so forth start to question a one-sizefits-all approach emanating from London?
Time will tell

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