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Accounting is a social practice that is influenced by different contexts. Due to the diverse contexts among countries, various forms of accounting systems have been developed. This has led to differences in the accounting standards worldwide. As a result, attempt to harmonize accounting standards such as the IASB and FASB convergence project has been made. However, it is also suggested that the view that it is possible to eliminate the accounting differences reflects the lack of appreciation of real world context. This essay would discuss and evaluate the influential contexts that lead to accounting differences and their impacts, followed by explaining why the complete elimination of accounting difference would hardly be achieved due to the real world context.
Political factor is an essential factor that influences the change of accounting and reporting system. It affects the way of a country’s economy is governed and controlled, which can has important impacts on financial accounting development.
According to Lawrence (1996)’s views, those influences can be explained in term of extent of government intervention and degree of other countries intervention. The extent of state invention can determine the type of regulatory structure is used. He argues that the greater state control can strengthen the impact of legal system and weaken the influence of accounting profession in the process of standard setting. This means that accounting is heavily regulated by government and there would be less regulation delegation. This argument can be well verified with the example of Japan, a country with strong government control which has little direct impact from accounting profession (Doupnik and Perera, 2009).
The level of foreign countries control can be explained through previous colonialism (Nobes, 1998). For example, The United Kingdom as the one of major colonial power in history, did not just export its accounting standards and practices, but also its accountants in its colonials (such as New Zealand and Australia) through political way (Mueller, Gernon and Meek, 1994). Although those countries have become independent, there is still British shadow in their financial accounting systems.
Legal factor is another influencing factor usually mentioned in many academic papers (e.g. Nobes, 1998; Zeff, 2007). It affects accounting system development through level of detailed and specific accounting legislation.
There are two main types of legal system: Code law and common law. Countries that such as Germany and Japan, in Europe and Asia are based on code law system. Those countries’ financial reporting rules are specified and detailed under legal principles. In contrast, common law countries, such as the United State, their accounting standards are set up by their own financial accounting standard board (Doupnik and Perera, 2009). In addition, code law countries make less disclosures and common law countries care more about whether the disclosure of information are ‘true and fair’(Jaggi and Low, 2000).
Those examples can all explain that legal system is a crucial cause of differences in financial reporting system.
Moreover, the legal system also has a close relationship with tax regulations. Tax law is separated from the general accounting regulation in common law countries, but code law countries are more likely to have common tax and financial reporting legislation. This may influence the development of financial accounting system, as different tax regulation affect businesses and individual behaviors. (Sawani, 2009)
One factor influencing the development of accounting system is culture. As defined by (Hofstede, 1980, p.24), culture is the “collective programming of the human mind that distinguishes the members of one human group from those of another”. Hofstede (1984, p.83-84) then identified four cultural dimensions for evaluating cultural differences: Individualism versus Collectivism, Power Distance, Uncertainty avoidance and Masculinity versus Femininity.
Extending Hofstede’s study, Gray (1988) proposed that cultural values, stemming from external and ecological factors, would lead to institutional impacts on political system, capital market etc and create accounting values, which would both shape the accounting system and eventually reinforce cultural values and ecological factors. Gray then derived four accounting values to illustrate the accounting subculture: Professionalism versus Statutory control, Uniformity versus Flexibility, Conservatism versus Optimism, and Secrecy versus Transparency.
Salter and Niswander (1995) analyzed relationship between Hofstede’s and Gray’s work. It is found that, except power distance, all Hofstede’s cultural dimensions relate to certain accounting values. In particular, uncertainty avoidance has most significant influences on the Gray’s accounting values. Countries with high uncertainty avoidance such as Germany would therefore more likely to have uniform and conservative accounting systems, with higher statutory control and lower disclosure. In contrast, countries with low uncertainty avoidance tend to have more optimistic, flexible and transparent accounting systems, with less statutory control.
Corporate financing context
The next influencing factor is the corporate financing system. Under this context, it refers to the sources of finance – whether businesses rely more on equity financing or debt financing and if the fund providers are insiders or outsiders of the businesses. According to Nobes (1998), the equity/debt financing reliance could impact the development of accounting system by influencing businesses’ measurement practices while the insiders/outsiders financing could impact the accounting system through disclosure issues.
In countries which equity financing dominates such as the US, financial information tends to more be oriented to investors. For instance, there would be more forecasting information that aids their decision making. Meanwhile, in countries with strong credit market, the accounting information such as profit and asset valuations would be more conservative in order to protect creditors. Regarding the divide between insider and outsider fund, Nobes (1998) suggested that in countries that rely more on outsider fund, businesses would experience a higher pressure for disclosures in published financial statement. This is because unlike insiders, outsiders do not have quality access to businesses’ internal financial information due to their distanced relationship with businesses.
Nobes’ idea was affirmed by Leuz in his journal examining the reasons behind different regulation to companies’ financial reporting (2010). It is concluded that as businesses would react to the needs of their investors/creditors, their accounting practices could reflect the corporate financing nature in their respective countries.
Evaluation of the key differences with impact
After identifying the different contexts that shape the accounting system, this essay would now move on to evaluate the accounting differences and discuss their impacts.
Under political pressure, countries have adapted various accounting systems. Accounting’s form, content and role are affected by governments that have control of the economy through central planning. Political pressure might encourage the developments of accounting in a positive way. Nobes (2006) explained that due to needs of developments after the fall of Berlin Wall, German government encouraged investment. Consequently, German companies opened further to EU and the use of international standards. This reduced the inconvenience in preparing the financial reports. However, political pressure could also cause inefficiency in developments of accounting practice. In early 1970s with new British Labour Government, the theories of inflation accounting was perceived as attractive, but due to the fear of new power structure around firms, the change of accounting practice did not happen (Hopwood, 2000) . Therefore, accounting varies because of social and political pressure in different countries. In Australia, although companies are legally imposed, they are not required to ensure compliance with IFRS. Similarly, Zeff and Nobes (2010) found in Israel market, compliance is only required for listed companies.
The theoretical models of Harrison and McKinnon (1986), Nobes (1987), and the empirical work of Salter and Doupnik (1992) (as cited in Salter and Niswander, 1995) all showed that legal system strongly impact the development of accounting. Based on these studies it was anticipated that countries with code legal systems would lay down accounting rules that were similarly rigid and that discouraged inter-company variability and inter-temporal change.
Under legal system, different forms of system would affect the accounting regulations. As mentioned before, code law is to mandate acceptable behaviour. Rules and procedures have to be followed, leading to fewer voluntary disclosures. Analysts will be less able to interpret financial statements due to the fewer disclosures like the case in Germany (Nobes, 2006), where the national rules for accounting statement is mostly detailed by the Handelsgesetzbuch (HGB) and tax law.
Besides, accounting income in code law countries is less timely, particularly in incorporating economic losses (Ball et al., 2000). However, due to the conservatism in code law countries such as Germany, tax reporting dominances over financial reporting (Haller, 1992). Furthermore, Germany has a stronger tax- influence on financial reporting than UK (Lamb et al., 1998). Regarding common law countries such as the US, companies receive tax benefits by raising funds through long-term leases, (Zeff, 2007). In UK, IFRS allowed individual companies to use financial statements for tax reporting under the national requirements. However, the listed companies whose financial statements are believed to be not giving a ‘true and fair view’ are required to modify their financial statement for taxation purpose (Zeff, 2007).
Culture affects accounting in several ways (Gray, 1988). Nobes (1998) suggests that it might be better to see culture’s impact on accounting through legal system or financial reporting system. For example, in Germany, due to their rule based accounting culture, tax in asset impairments is deductible, causing controversy in IFRS consolidations. Therefore, judgments in IFRS impairment procedures are necessary in this country. Some countries have well-organised lobby groups of finance directors. Some countries have appreciated the use of leasing because of particular features of their tax systems.
Meek and Gray (1989) found that even companies that are voluntarily disclosing their information on international level, they still have a “national flavor” attached with the information. This problem is of particular has a significant impact in emerging markets. Hence difficulties will arise with the implication of a unified system. While the process of harmonization of accounting standards has seen major development in the right direction (Carmona 2008), emerging markets still present a challenge.
Under corporate finance context, the resource of finance varies internationally. For example, Nobes (2006) states that UK and the US rely more on shareholder ‘outsiders’ while bank/state/family ‘insiders’ dominate in Germany and France. The differences in source of finance create information asymmetry and further lead to the competition. Nobes (1998) said the purpose of giving useful information for investors between insiders and outsiders creates strong competition in accounting and taxation information.
Zeff (2007), when exploring the difference between business cultures, mentions that financial analysts might not actually have superior understanding of accounting. He also suggests that corporate structure varies across countries. These differences have major impact when it comes down to understanding companies’ business model, which is crucial for investors’ decision making.
Differences in accounting system
An example of the impact of differences in accounting can be seen in Carmona (2008). There the authors present Daimler Benz AG – a German company, which in 1993 wanted to be listed amongst others on the NYSE. What followed was that under German GAAP the company achieved 615 million net profits, but under US GAAP that profit turned into 839 million losses. Clearly, this incident was caused by differences in the accounting practices between the two countries.
However, with the aid from globalization and the fast development of businesses across countries progress towards unified system has been observed. In 2007 US Securities and Exchange Commission (SEC) allowed foreign companies to join the NYSE as long as their reports are reconciled with IFRS (Carmona 2008).
Differences existed in the harmonization process
The acceptance of IFRS in SEC is not the only evidence on the process of convergence with IFRS, so does the endorsement process of IFRS in European Union and the later adoption in Canada and Australia. They all show the trend of harmonization in accounting reporting system. Besides, Shil, Das and Pramanik (2009) suggested that the harmonization on accounting standards can fasten enterprises’ decision- making process; reduce reporting exchanging costs and provide better financial information to markets. Therefore, many international organizations are engaging to remove the national differences in accounting standards (Nair and Frank, 1981). Nowadays, IFRS is endorsed boarder and it seems that all the converged countries are accounting statement might be the same under one accounting principles.
However, due to the US hegemony in international economy, IASB seems to push its standard closer to the Anglo- American standard (Crawford et al, 2014). Therefore, the IFRS is highly influenced by the US GAAP. For instance, the IFRS 8 “operating segment” is similar to the US standard, SFAS 131. This may benefits countries that economic activities are similar or high association with the US economic activities. However, other counties, such as India, China, and some in EU may find it hard to adopt the IFRS due to the conflict with national standard. Thus, they may try to fight with IASB in the endorsement process. For example, Crawford el al (2014) described that EU’s endorsement process showed conflicts between two diverse legal systems: civil law (rules approach) and case law (principle approach). Besides, the loss of national sovereignty on standard setting has led to the uprising anti –Americanism in terms of accounting standards in some European countries. This might allow the EU to put more political pressure to IASB and get involve to the international standard setting process. The above example showcases why eliminating accounting differences worldwide is such a difficult task.
Regarding IFRS alone, due to international differences, there is still different version of IFRS. For example, the differences in the endorsed IFRS in EU and the IFRS in IASB that described in Nobes (2006)’s paper. In early 2005, the IAS 39 in IASB’s IFRS allowed companies to specify any liability or financial asset at a fair value despite any profit or not. Yet, this option has been removed in the EU’s endorsed version (Nobes, 2006). So was the limitation on the hedge accounting permission in IAS 39, which is more restrict in IASB’s version than the EU’s (Whittington, 2005). Beside the different in regional context, the diversity of IFRS is also found in national context: the compliance with IFRS in Australia. For instance, the IAS 31 in IFRS provides a choice to a group that holding in a joint venture company between the equity accounting and proportional consolidation, but in Australia, option and equity accounting is not required (Nobes, 2006).
Additionally, IFRS allowed companies to keep national accounting practices while preparing financial reporting under IFRS standards. Nobes (2006) argued that insert options in the international financial standard is likely the only way to get the standard passed. This is because the members and representatives of large companies or audit firms came from difference countries with diverse cultures and political pressures. He also divided options into two groups: overt (options show in content) and covert (options discovered in vague principles), both show evidences of differences in national accounting in this uniformed standard. For instance, under a choice of using weighted average or FIFO method to calculate the cost of inventories in IFRS principle, UK companies will use FIFO as usual, but German firms will adopt weighted average method, as the FIFO method is restricted by the tax law under HGB practice (Kesti, 2005; cited in Nobes, 2006). This difference is caused by the difference legal systems apply in both countries.
To conclude, this essay has first identified four major contexts that had influenced the development of accounting system: political, legal, cultural and corporate financing. Differences in these contexts among countries have created discrepancies in accounting standards around the globe. After evaluating these differences, it is found that the differences in accounting standards actually cause much inconvenience in terms of information exchange, fund raising, decision making etc. In contrast, it is suggested that the convergence of accounting standards could actually be beneficial by improving decision making process; reducing information costs and providing better financial information.
However, with closer examination, it is found that the differences in context are in fact deeply rooted and could hardly be eliminated. Consequently, the differences in contexts among countries would continue to haunt the convergence effort made by IASB and FASB. There is also political struggle for power in harmonizing accounting standards, which can be shown by EU’s reluctance to adopt a standard that assimilate US GAAP. Therefore, the view that it is possible to eliminate accounting differences does lack a realization of the divide in real world contexts. However, while it seems to be impossible to completely harmonize international accounting practices, adopting a principle-based standard that allows countries to add their own “flavor” might be a much more feasible way.