Harmonization of financial report is the process of improving public accountancy, is beginning to arouse interest among the professionals and academics, both in national and international context. Harmonisation allows making comparisons of international financial accounts easier, faster and cheaper (Carlson, 1997).
One of the characteristics of public sector accounting among the local government in Malaysia is the lack of homogeneity or harmonisation in financial disclosure (Mahamad & Combs, 1997; Syed Soffian, Ayoib, Shamharir & Engku Ismail, 2001; Emilin & Asmah, 2001; Mailah, 2001; Auditor General Report, 2003; Mohamed Azhar, Engku Ismail, Syed Soffian & Zainol, 1994; Workshop Conference for Local Government, 2007). Harmonisation can be defined as "a process of increasing the comparability of accounting practices, by setting bounds to their degree of variation" (Nobes & Parker, 1995). Therefore, by doing this process, it can guarantee that accounting information is comparable by reducing accounting diversity.
The accounting profession has long recognized the need for a harmonized accountancy framework (Harding, 1999). The profession undertook this initiative when it created the International Accounting Standards Committee (IASC), which is now known as the International Accounting Standards Board (IASB). This body was established, together with the International Federation of Accountants (IFAC), to promote worldwide improvement and harmonization of accounting and auditing standards. The key role of the IASC was to establish a uniform set of accounting standards for financial reporting, which was done by developing and promulgating the International Accounting Standards.
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The international harmonization of accounting has been defined as "the attempt to bring together different systems". It is the process of blending and combining various practices into an orderly structure which produces synergistic result (Samuels & Piper, 1985). While some see harmonization more as a process of moving to a system of uniformity or standardization, most view harmonization as a process whereby the number of allowed accounting alternatives is reduced as a means of promoting greater comparability.
The root of international accounting harmonisation can be traced back to a series of international congresses beginning in St. Louis, Missouri, United States of America in 1904. These, as well as other movements and events, increased support for the harmonization of accounting standards over the years. The harmonization movement essentially culminated in the formation of the IASC in 1973.
There are a range of international bodies with an interest in the harmonization and standardization of accounting practices. First of all, it is important to distinguish between the two terms as used in the international accounting context; "standardization" and "harmonization". Standardisation implies uniform standards in all countries that participate in the effort (Tay & Parker, 1990; Nobes & Parker, 2000). Harmonisation however, implies a reconciliation of different points of view and permits different requirements in individual countries provided that there is no logical conflict (Tay & Parker, 1990; Nobes & Parker, 2000). Harmonisation is a process, a movement towards harmony, which is a state. Standardisation is also a process, a movement towards uniformity, which is also a state (Tay & Parker, 1990; Nobes & Parker, 2000). Harmonisation is a more realistic and conciliatory approach and seems more attainable than right standardization. As Van der Tas (1988) points out; "Harmonisation is a coordination, a turning of two or more objects. Users are confronted with several financial reports. It will be useful for them if these financial reports are in harmony". The term "harmonization" also implies reducing the variety of practice, standardization implies eliminating variety. In practice, as Nobes and Parker (1981) point out, the EC's programme of harmonization is more detailed than the IASC's programme of standardization. Authorities who offer lists of reasons variations in national accounting practices include Nobes (1988), Busse von Colbe (1983), Samuels & Piper (1985) and Choi & Mueller (1992).
Through harmonization, the free flow of comparable financial information can be reached (Mora, 2000). The objective of harmonization is to lead financial reports to a higher degree of comparability (Wolk & Heaston, 1992).
Generally today, there is a different variety of financial report issued by public sectors in each country and even different agencies in the same country (Tay & Parker, 1990; Barthes, 1989). Although some countries have financial reports using the right basis of accounting system, but it is presented by using different methods (Scott & Troberg, 1980; IASC, 1982; Sanchez, 2003; Chand, Patel & Day, 2008). Therefore, it is so difficult to find a standard way for financial report. Typically, the financial reporting standard is so general and issued along with regulation or state prescription. However, only few countries issued independent standards for the public financial report that are used by the government agencies (Sanchez, 2003; Chand, Patel & Day, 2008).
1.1 Background of the Study
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Financial reporting is the key to accountability and decision making for both public and private sectors. Without exception Malaysian government would also produce financial report to discharge their accountability for the resources entrust to them. Therefore, their financial reporting is influenced by the government financial policies and reporting practices which is embedded in the provision of legislation and legal prescription. Hence, it is a challenging job for public sector to encourage greater transparency and accountability (Walker, 1998; Mahamad, 1994; IFAC, 2000; Ryan, Stanley & Nelson, 2002).
Accounting harmonization research literature also relies on the notion that accounting practice harmony is related to accounting regulation harmony. This association has been examined mainly through as assessment of the move towards harmonization among certain countries, initiated by the publication of prominent IASC Standards (Nair & Frank, 1981; Evan & Taylor, 1982; Yang & Lee, 1994).
In the new millennium, local government accountants use a common accounting standard in an effort to achieve a quality financial reporting. However, due to the difference in the environment of the state and agencies, it had led to the diversity in accounting reporting practices such as the income measurement and asset valuation practices adopted and the quality of disclosure in the published financial statement (Frantl, 1971; Von Colbe, 1983; Luder, 1989, 1992; Nobes & Parker, 1991; Choi & Mueller, 1992). This diversity, the resultant lack of understanding ability and comparability of financial reports among local governments has the potential to create substantial difficulty for the users, preparers and auditors of such statement (Scott and Troberg, 1980; IASC, 1982). For example, local governments may encounter problems of interpreting financial statement of other local governments, which are prepared in accordance with different interpretation of Financial Procedure Act, 1957, Treasury Instruction, Treasury Circular and Accounting Standards/Financial Reporting Standards (FRS). In light of such problems, some have asserted that the statement of harmony in financial reporting is a desirable goal since such harmony may enhance the comparability and usefulness of financial information which among local governments, substantially reduce the current problems faced by preparers, users and auditors of financial reports (Workshop Conference for Local Government, 2007). This consequently will greatly facilitate the growth of economic activities and efficient allocation of resources in achieving their objectives (Engku Ismail, Mohamad Sharofi, Syed Soffian, Siti Zabedah & Zarifah, 2006).
Frantl (1971), Von Colbe (1983), Luder (1989, 1992), Nobes & Parker (1991) and Choi & Mueller (1992) have observed that the principles, practices and objectives of financial reporting adopted is shaped by environmental factors such as economic activities and the stage of economic development, political system, tax management system, level of sophistication of accounting profession, legal system and the stage of development of the capital market. The rapid expansion of investment, the increased sense of economic interdependency among the local governments, advances in communications technology and the emergence of new market opportunities have added a sense of urgency for a common accounting language. Hence, these responsibilities have inevitably fallen on the accounting community (Rivera, 1989; Wolk & Heaston, 1992).
1.1.1 The Need for Accounting Standards
From the evidence, the need for harmonization of accounting standards in the local governments financial reporting are much appreciated (Workshop Conference for Local Government, 2007). This is because the advantage or the need for harmonization in local government financial disclosure can be seen from the formation of International Public Sector Accounting Standards Board (IPSASB) since November 2004 by International Federation of Accounting Committee (IFAC). The purpose of the formation is to develop high quality accounting standards for the usage of public sector entities around the world. It provides a vehicle for the pursuit of the harmony in financial reporting. Its objective is to formulate and publish accounting standards and procedures relating to the presentation of financial statement for public sector.
Accounting standards exist to help the government make clear decisions about future resource allocation. In addition, the adoption of the accounting standards will also improve confidence in the quality and the reliability of financial reporting. Therefore, it is important that initiatives towards the adoption of one single set of accounting standards be made as soon as possible.
1.2 Problem Statement
Financial reporting is a communication process. A local government translates the events that influence its financial position and affairs into its financial report so as to provide users with information about its financial position and affairs. The translation process is based upon the local government's accounting policies. As part of these policies, a local government decides whether to translate a particular event in its financial report (the decision between alternative degress of disclosure) and which accounting method to apply (the choice between alternative methods of valuation, fund balance determination, consolidation and presentation). For example, the local government must decide whether to provide segmental information and forecasts, and whether to use historical cost or current value.
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When formulating an accounting policy the local government's choice between alternative degrees of disclosure and alternative accounting method is restricted by standard. Standards will be defined as any financial reporting rule published by either the government or a private standard setting body. These standards can refer either to the degree of disclosure or to the accounting method to be applied.
Harmonisation is coordination, a tuning of two or more objects. Users are confronted with several financial reports. It would be useful for them if these financial reports were more in harmony. Therefore, financial reports are a target of harmonization. One way to harmonise financial reports is by formulating standards thus setting limits the difference between financial reports.
As a government agency, a local government or authority does not focus on profitability but rather providing services for the well being of the community. Recently (in 2009), the Prime Minister of Malaysia, Dato Seri Mohd Najib has highlighted and announced that all ministries and government department should implement the key performance indicator (KPI) system to monitor and measure their performance (Engku Ismail, 2006; Ambrin, 2006; Nafsiah & Ruhaya, 2006; Emilin & Asmah, 2004). The question now is, how reliable can the KPI system for financial performance be, considering that the local authorities do not follow uniform accounting standards. The application of harmonizing in accounting standards will enhance the accountability and transparency of the local government and shown their financial reports more meaningful. This basic lack of comparability may result in poor decision making across the board.
In the absence of accounting standards for local authorities, there is inconsistency in the disclosure of information in the financial statements. Thus, comparisons between local authorities are not possible. Therefore, it is difficult to assess how well a local authority is performing because there is no bottom line or easily quantifiable outcomes that can be used as benchmarking.
Assessing financial performance is important in gauging how well a local authority is fulfilling its objectives, how efficiently their resources are allowed and how well the organization is positioning itself financially. From the financial performance information, it will help the local government to develop key performance indicators for the public to gauge their performance which would enhance public confident and transparency toward the government.
The existing accounting standards in Malaysia do not state that the standards are applicable to the public sectors, specifically the local authorities. In the absence of accounting standards specifically for local authorities, there is inconsistency in the disclosure of financial statements information. Thus, comparisons between local governments are not possible. Therefore, it is difficult to assess how well a local government is performing because there is no effort or initiative taken to measure their performance. On the other hand, there is no bottom line or easily quantifiable outcomes that can be used as a benchmark.
From a public benefit perspective, accountability by local governments is important. The most common method of discharging accountability to stakeholders is through the annual report. However, the diversified practices of accounting and financial reporting in local authority could hamper this goal. One way of reducing the diversified practices and financial reporting in local authority is through harmonization of financial reporting.
Financial performance is very important, not just for profit making organization but also for any type of organization, including the local government. Financial information can be easily accessible from annual reports. These statements provide users with information indicating whether resources were obtained and used in accordance with legally adopted budget. Assessing financial performance is important in gauging how well a local authority is fulfilling its objectives, how efficiently their resources are allocated and how well the organization is positioning itself financially.
Preparation of accounts not following a common accounting standard for the public sector and the poor quality of financial information reported that has led to some of them getting qualified audit reports (Engku Ismail, 2006; Ambrin, 2006; Nafsiah & Ruhaya, 2006; Emilin & Asmah, 2004). In order to enhance the quality and uniformity of financial report, the local authorities need to have a common set of accounting standard. The primary reason for accounting's existence is that it satisfies a need for information. Accounting is generally defined as the language of business but what happens when there is more than one accounting language. Therefore, the adoption of a common set of accounting standards should be the main agenda for all local authorities. It is believed that the adoption of accounting standards would produce more reliable and better quality financial report and make users more inform on the operations of the public sector entities.
Previous research on local government has been primarily descriptive into annual accounts or comparability of standards and legislation. The lack of works regarding the factors relating to the harmonization disclosure is due to the difficulties of harmonizing the disclosure among the local government. There has been little previous research on the issue of comparative financial reporting practices between countries in the public sector in general and specifically in the local authority content. There are, however, financial reporting practices in the private sector (Benjamin & Stanga, 1977; Gray & Roberts, 1986; Tayib, 1987; Choi & Mueller, 1992).
Therefore, the focus of this study is to identify the factors relating to achieving harmonization of financial disclosure among local government in Malaysia. Hence, this research will initiate the effort to look into reasons or factors affecting the financial disclosure of local government in Malaysia. This will gauge the extent of financial disclosure and factor affecting harmonization of financial performance from one local government to another.
1.3 Research Questions
On the basis of the research background, this study will be guided by the following research questions as follows:
What is the extent of the financial disclosure harmonization in selected accounting disclosure practices in local authorities in Malaysia?
What is the relationship between the status of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
What is the relationship between the size of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
What is the relationship between the surplus or deficit of income of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
What is the relationship between the liquidity of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
What is the relationship between the management lag of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
What is the relationship between the audit lag of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
1.4 Research Objectives
There are numerous studies related to harmonization of financial disclosure in local government. The literature, however, is limited in identifying certain factors that could be associated with the harmonization of financial disclosure in local government. Therefore, it is appropriate to examine what are the factors associated with harmonization of financial disclosure of local government in Malaysia. Surplus or deficit of income, management lag and audit lag are new variables identified in this study and could be associated with the harmonization of financial disclosure in local government in Malaysia. Hence, the research objectives of this study are as follows:
To examine the extent of the financial disclosure harmonization in selected accounting disclosure practices in local authorities in Malaysia.
To examine the relationship between the status of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
To examine the relationship between the size of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
To examine the relationship between the surplus or deficit of income of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
To examine the relationship between the liquidity of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
To examine the relationship between the management lag of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
To examine the relationship between the audit lag of local government on the harmonization of financial disclosure among the local authorities in Malaysia?
1.4 Scope of Study
The scope of this study is only limited to local government in Peninsular of Malaysia (exclude Sabah and Sarawak) for the year 2008. There are currently 98 local governments that can be identified as city councils, town councils and district councils (refer to Appendix 1).
1.5 Contribution of the Study
The adoption of a common set of accounting standard should be the main agenda for all local government (Nair and Frank, 1981; Evans and Taylor, 1982; Young and Lee, 1994). It is believes that the adoption of accounting standards would produce more reliable and better quality financial report and make users more inform on the operations of the public sector entities. Therefore, the study will hopefully contribute through the following:
From a theoretical perspective, this study will hopefully support how stewardship theory provides the financial disclosure incurred by the stakeholder and the user.
This study will be useful to policy makers such as the government and stakeholders regarding the financial disclosure of the local government.
This study hopefully will help the administrator to detail all the information that is useful and important to the external users such as the public. The public need a clear picture of how the public monies are being utilized. This will improve in transparency and accountability.
This study will also assist the users of the financial report to learn and understand important items that should be disclosed. Indirectly, the quality of understanding and the knowledge about the content of the financial report can be improved. This will show a stronger performance and more comprehensive accountability at agency level.
Increase the confidence of the public towards the government in disclosing the financial performance and measuring their performance by comparing one local government to another.
Furnishing clear and accurate information to all concerned especially to the stakeholder and the user.
This study will hopefully confirm the factors associated with financial disclosure of local government in Malaysia which in future will identify environment towards harmonization of local government financial reporting for comparability and measurement performance.
1.6 Term of Operation
Van der Tas (1988) establishes two classifications for the harmonization concept. On the one hand, he distinguishes between formal and material harmonisation, which were also denominated de jure and de facto (Tay and Parker, 1990), the former being related to uniformity between accounting standards and legislation and the latter associated with the annual accounts. Furthermore, the author differentiates between measurement harmonisation, which analyses the diversity of the applied accounting methods, and disclosure harmonization, which tests the extent of the information disclosed through the annual accounts. In addition, spontaneous harmonization takes place without any standardization process being initiated.
Harmonisation in this study is defined as a process which seeks to eliminate the diversity of accounting practices, while harmony is a state where the entities are clustered around one or a few of the available procedures. According to Van der Tas (1992), harmonization is a process of coordination. Thus, harmonization represents the efforts undertaken by legislators and accounting standards setters to reduce the diversity of accounting treatments used to register transactions or to elaborate balances.
2. Financial Disclosure
Financial disclosure in this study referred to the financial reporting, which tests the extent of the information disclosed through the annual accounts. According to Ingram and Copeland (1981, 1984), annual accounts are the principal vehicle of information available for citizens and other stakeholders. Even though entities all over the world has annual accounts, it has different intensities, with a regulation and modernization of the contents of local government and with the objective of improving the quality of financial reports (Ryan et al., 2002).
1.7 Organisation of the Study
The organization of the study follows the standard Doctor Business Administration (DBA) thesis format and the content of this study is organized into five chapters. Chapter 1 provides the background of the study, problem statement, research questions, research objectives, and the scope of the study, contribution of the study and organizing of the remaining chapters.
Chapter 2 contains the literature review and a summary of previous research that are related to this study.
Chapter 3 describes the research model and methodology employed in the study. Hypothesis development, research design, sample and data collection, research instrument, operational definition and measurement of the variables and method of data analysis are also discussed in this chapter.
Chapter 4 presents an analysis and interpretation of the results of the study.
Finally, Chapter 5 summarises and discusses the major findings, implications and limitations of the study including a statement as to the conclusions reached. In addition, recommendations for further research will also be included in this chapter.