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The Convergence of International Accounting Standards and Practices. Cynthia Jeffrey Iowa State University. How different is accounting internationally (across countries)? What historical factors have contributed to these differences?.

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the convergence of international accounting standards and practices

The Convergence of International Accounting Standards and Practices

Cynthia Jeffrey

Iowa State University

How different is accounting internationally (across countries)?
  • What historical factors have contributed to these differences?
Each nation has its own accounting rules that tend to mirror certain elements in that nation.
  • A country's economic, legal, and political systems; stages of technological development or sophistication; culture and tradition; and various other socioeconomic factors all influence the development of accounting standards and the accounting profession in that nation.
These differences have led to significant diversity in accounting standards from one nation to another.
  • Given the growth of international business activity, and especially international investment, comparability of accounting standards has a high priority.
  • International diversity in national accounting standards has the potential to diminish the international flow of investment capital and thereby hinder economic development and the efficient international allocation of resources.
what are the international responses to across country accounting differences
What are the international responses to across-country accounting differences?
  • Reconciliations versus mutual acceptance versus one set of global accounting standards and practices.
convergence of accounting standards
Convergence of Accounting Standards
  • It is useful to think about a continuum ranging from total flexibility and diversity to total uniformity.
  • Convergence implies a more flexible approach whereby a limited set of alternatives are acceptable, compared to standardization, which implies a state of uniformity.
What kinds of problems are allegedly caused by international accounting differences?
  • Potential inefficient allocation of scare resources.
convergence of accounting standards8
Convergence of Accounting Standards
  • Arguments for convergence:
  • Not only can convergence help with resource allocation, but a multinational accounting firm and the preparers of financial information, can make a strong argument for increased convergence.
  • The burden of financial reporting would be lessened with increased convergence, which would simplify the process of preparing individual and group financial statements.
how different is different
How Different is Different?
  • Example: The News Corporation (an Australian firm) reported 1992 earnings of $502 million (Australian dollars). Under US GAAP, earnings would have been about $421 million (Australian dollars). The difference is about 16% of income under Australian GAAP.
potential costs
Potential Costs?
  • As an example of the financial cost of complying with the differing accounting rules in different countries, an article in WSJ described the costs incurred by an international firm which sought to sell an offering of securities in the US, Canada, and the UK.
  • The offering required three sets of financial statements and finally cost $2.8 million to get the $55.5 million offering registered.
  • In general, there are difficulties in comparing income, net assets, and shareholders equity across countries.
international barriers to convergence
International Barriers to Convergence

1. Accounting itself is a judgmental and social discipline, reflecting the needs of its particular business environment

2. National traditions, educational opportunities, and business and accounting attitude differences among nations

3. Legal and economic differences among the nations

4. State sovereignty

5. Economic gaps between developed and developing nations.

recognition criteria differ
Recognition Criteria Differ
  • What items are recorded in the financial statements, at what times?
  • Intangible assets, certain leases, goodwill
measurement criteria differ
Measurement Criteria Differ
  • Historical cost versus inflation adjustments versus fair values
disclosure rules differ
Disclosure Rules Differ
  • What should be reported in the notes and supporting schedules?
  • Management compensation
broad categorizations

True and fair view

Shareholder orientation

Disclosure emphasized

Tax rules separate

Professional Standards


Legal-oriented view

Creditor orientation

Secrecy is emphasized

Linked to tax rules

Government rules

Broad Categorizations
example of specific policies
Depreciation over useful lives

Limited or no use of legal reserves

Lease capitalization

Cash flow or funds statement

Depreciation by tax rules

Extensive use of legal reserves

No leases capitalized

No cash flow or funds statement

Example of Specific Policies
examples of countries
United Kingdom

United States







Examples of Countries
historical reasons for differences
Historical Reasons for Differences
  • Predominant modes of financing and ownership.
    • Banks, and small groups of owners
    • Government
    • Shareholders
  • Each of these different types of financing arrangements implies differences in what accounting information is needed for decision making.
Legal system
    • English common law versus codified law systems
    • Differences in approaches to securities regulation
  • Use of financial reports for taxation
    • Audited reports for capital markets versus for tax calculations
what kinds of issues are allegedly raised by international accounting differences
What kinds of issues are allegedly raised by International Accounting Differences?
  • The holding of shares across international boundaries is becoming more common, so more users are confronting noncomparabilty of financial statements
  • It is sometimes alleged that international capital flows are needlessly hampered by the need for users (investors) to develop their own comparability adjustments.
Multinational firms are expanding their operations cross-nationally, so more preparers are confronting noncomparable accounting standards and rules
What is viewed as acceptable or even desirable accounting practice in one country might be viewed as unacceptable or even misleading in another country.
  • Example: LIF|O inventory valuation in the United States.
Internal performance evaluation in large multinational firms might be affected by the use of different accounting and measurement systems
Large CPA firms are expanding their wold-wide operations and facing attestation engagements under widely varying accounting and reporting systems. What does an audit report mean if there are divergent practices across countries?
The US accounting system (part of the overall US securities regulation system) is allegedly needlessly stringent and discouraging to international capital flows
  • Worldwide equity capitalization (one measure of the demand for capital) is current estimated at about $17 trillion. (Privatizations in China, Europe coming)
There is intense competition for non-domestic listings, particularly among the NYSE, NASD, and the LSE. This competition could increase to the extent the European exchanges develop new alliances (remember the proposed alliance between the LSE and the Frankfurt exchange--derailed because of an unfriendly takeover bid for the LSE)
  • Convergence refers to the process of increasing the consistency and comparability of accounting across countries, with the goal of removing (alleged) impediments to international capital flows.
is it possible or desirable
Is it Possible? Or Desirable?
  • To the extent that accounting differences result from underlying differences in economic, legal, social, and other environmental factors, accounting convergence may simply not be appropriate.
The differences in accounting are so deep and numerous that they are structural in nature and it would take extremely strong actions to remove them.
  • Some countries do not have a long tradition of a strong accounting profession while others do. Government intervention would be necessary to achieve convergence, and this raises problems of nationalism.
two approaches to convergence
Two Approaches to Convergence

1. Evolution in the development of accounting principles.

  • This approach recognizes the reasons for the differences in accounting principles: countries with different economic and legal systems should have different accounting principles.
  • Time and the natural development of the countries' economies would be necessary to bring accounting principles into closer harmony.
  • That is, the natural evolution of accounting principles within each nation would tend to narrow the alternatives, and this would reduce the degree of diversity from country to country.
  • Other forces, including international competition for investment and loan, would also work to reduce diversity.
two approaches to convergence32
Two Approaches to Convergence

2. The more dominant view posits that formal action should be taken to reduce diversity.

  • This view looks to organizations for standard setting with multi-country authority.
  • This is the problem! Enforcement?
  • For a country to voluntarily give up their own accounting destinies and delegate to others the power to set accounting standards represents a reduction in the national sovereignty.
Some who interpret convergence as implying the use of a single set of financial reporting standards worldwide favor the use of International Accounting Standards, as promulgated by the International Accounting Standards Board (IASB)

International Accounting Standards Committee

  • The concept was introduced as early as 1904 with the First International Congress of Accountants in St. Louis.
  • But it wasn't until 1973 that the International Accounting Standards Committee (IASC) was founded by the leading professional accounting bodies in 9 nations:
    • Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the UK, and the US.
  • Members are not nations, but rather accounting bodies within nations are members.
    • In the US, the AICPA is a member, not the FASB or the SEC.
  • In this way, no nation completely surrenders its accounting sovereignty to the IASC.
  • Now, accounting bodies from over 91 nations are members.
Recently, the IASC was restructured. The IASC is the foundation that oversees the International Accounting Standards Board IASB.
  • The International Accounting Standards Board is an independent, privately-funded accounting standard setter based in London, UK. Board Members come from nine countries and have a variety of functional backgrounds. The Board is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the Board cooperates with national accounting standard setters to achieve convergence in accounting standards around the world.
IASC was be established as an independent foundation. The foundation has two main bodies, the Trustees and the Board, as well as a Standing Interpretations Committee and Standards Advisory Council. The Trustees would appoint the Board members, exercise oversight and raise the funds needed, whereas the Board would have sole responsibility for setting accounting standards.
iasc iasb


1. To formulate and publish international financial standards

2. To promote worldwide acceptance and observation

3. To facilitate a "common international approach" to the harmonization of accounting principles

Develop and aid the implementation of international accounting standards that satisfy the needs of developing and newly industrialized countries;
  • Narrow the differences between international accounting standards and the various national accounting requirements with a goal of developing greater compatibility and easier comparability of financial reporting.
The IAS Standards tend to follow the principles of “true and fair” value and full disclosure, consistent with the “Type A” view above.
  • A conceptual framework (Framework for the Preparation and Presentation of Financial Statements) is being developed for guidance.
    • objectives of financial statements,
    • qualitative factors of financial information,
    • the elements and the recognition criteria of financial statements.
  • By the beginning of 1993, IASC had produced 31 statements which are very similar in content and format to FASB statements.
  • Member organizations have pledged to use their best efforts to have the standards adopted by their national authoritative standard setting bodies.
iosco charge
IOSCO Charge:
  • In July 1995, the IOSCO Technical Committee stated its agreement with the work plan, as follows:
  • The [IASC] Board has developed a work plan that the Technical Committee agrees will result, upon successful completion, in IAS comprising a comprehensive core set of standards.
Completion of the comprehensive core standards that are acceptable to the [IOSCO] Technical Committee to recommend endorsement of IAS for cross-border capital raising an listing purposes in all global markets.
  • The goal is for 40 “core standards.”
The project was completed late in 1998.
  • IOSCO, the International Organization of Securities Commissions, has agreed to consider these standards for registering and listing shares.Within IOSCO, the key commissions are those in Canada, Japan, and the US. These countries are the most restrictive with regard to to the use of (or reconciliation to) domestic GAAP.
  • May 30, 2002--IOSCO Annual Conference encourages cooperation to achieve convergence
adopters of iascs
Adopters of IASCs
  • Some countries have adopted IASC standards with few amendments (Nigeria, Malaysia, Russia). Such adoptions can be advantageous to countries with developing market economies.
  • Stock exchanges in more than 30 countires (but not the US) allow international standards, at least for foreign registrants.
us policies
  • Under current US regulations, any issuer who wishes to access the US equity market must conform to SEC rules, including filing reconciliations of income and shareholders equity with US GAAP on Form 20-F.
  • IF the SEC were to accept IAS for cross-border listings, these form 20-F reconciliations would presumably disappear for IAS users.
why would a non us issuer object to reconciliations
Why Would a Non-US Issuer Object to Reconciliations?
  • Out of pocket costs to prepare
  • Disclosure of proprietary information, including reserves, segment data, and Form 10-Q
why might the sec insist
Why might the SEC insist?
  • Possible belief that US GAAP is superior
  • Investor protection under US securities laws, accounting rules and enforcement mechanisms
  • Emphasis on individual investor. IS this important any more? Funds, and the effects of online brokerages. 65% of trades are individual investors.
sec decision
SEC Decision
  • The SEC is a voting member of the IOSCO Technical Committee that endorsed the IASC core standard project.
sec decision51
SEC Decision
  • The broad policy decision is whether to allow IAS for cross-border capital raising.
  • Complete acceptance and complete rejection are not the only options
  • Partial acceptance? (early vs. late?)
  • Continue to require some reconciliations?
  • What would acceptance of current standards imply for subsequent standards?
sec criteria
SEC Criteria
  • Comprehensiveness
  • High quality, including Transparency, Full Disclosure, and Comparability
  • Rigorous interpretation and application
  • These criteria (presumably) derive from the investment framework of US standard setting, with its focus on the role of accounting in capital allocation decision
  • Consider the structure and decision process:
  • IASC standards have been criticized for imprecise language, and PURPOSEFUL ambiguity
  • No mechanisms for ascertaining what constitutes compliance. (Recent establishment of the Standing Interpretatins Committee to assist in application of IAS)
Under the old structure, More than 91 people could attend (and could speak) at each meeting; meetings were held only about four times per year.
  • Some feel that the current IASC standards fall short by allowing too many free choices of accounting treatments and by lack of any comment on some important aspects of financial reporting.
  • The FASB’s comparison project identified 225 instances of differences between US GAAP and IAS, but there is no measure of materiality of the differences.
  • How do we distinguish between uniformity and equivalence?
  • Equivalence--of equal usefulness in terms of relevance and reliability
  • Example, are LIFO and FIFO, with note disclosure of the “LIFO reserve” equivalent?
  • The user must make a conversion--does this affect comparability?
  • International Federation of Accountants
  • 1977 - Two objectives:

1. To arrange future international congresses

2. To achieve international technical, ethical, and educational guidelines for the accounting profession;

      • that is, to promote a coordinated, worldwide accounting profession with harmonized standards
  • Main work to date:
    • Issuing auditing and professional guidelines and issues and the enhancement of the quality of the accountancy profession.
    • Five standing committees:
      • Auditing, Education, Ethics, Public Sector, Management, Financial.
ifac and iasc

Interactions between IFAC and IASC

  • IASC is sole source for issuing international accounting standards
  • IFAC nominated all members on IASC board and contribute 10% of IASC's budget.
  • IFAC is "spokesperson for the worldwide accounting profession"
european community
European Community
  • The roots of the European Community can be traced back to 1948 and the establishment of the Organization for European Economic Cooperation to administer the Marshall Plan.
  • The Marshall Plan was an aid program designed to rebuild Europe economically after WWII.
  • In 1952, the European Coal and Steel Community was established among France, Germany, Italy, Belgium, the Netherlands, and Luxembourg.
european community61
European Community
  • From this beginning, the Common Market evolved in 1957 with the signing of the Treaty of Rome.
  • The same 6 countries participated in the new union, joined by Great Britain, Denmark, and Ireland in 1973, Greece in 1981, and Spain and Portugal in 1986.
  • The belief supporting the Common Market is that cross-country economic integration is necessary for Europe to compete with the US (and formerly with the USSR).
european community62
European Community
  • The first step was Customs Union, which involved the abolition of national import tariffs and restrictions.
  • This union was achieved in the late 60s, and a common external trade policy was implemented.
  • The remaining two steps are Economic Union, which involves the harmonization of national social, fiscal, and monetary polices.
  • This phase is in process.
  • The third phase is political union which is envisioned as a "United States of Europe."
european community63
European Community
  • The European Community has made convergence of accounting standards a part of the second level of integration.
  • Each nation in the EC has its own approach to accounting, and these are often on opposite ends of the accounting spectrum.
  • The convergence of accounting standards within the EC is being carried out by means of EC directives, which, when approved by the EC's Council of Ministers, become binding on the member nations.
european community64
European Community
  • The nations must change their own national legislation, typically within 18-36 months, to comply with the directive.
  • However, a great deal of time (up to 10 years) can elapse from the initial conception of a directive to its final approval!
  • The EC Commission consults with the EC Accounting Study Group, which is composed of representatives from the leading professional accounting organizations of the EC countries.
european community65
European Community
  • The EC has also established an Accounting Advisory Forum made up of users, preparers, and standard setters as a consultative group.
  • This body is expected to work with the IASC.
  • Historically the EC has tended to ignore the IASC, but they are making efforts to bridge this gap.
european community66
European Community
  • There have been directives that relate to accounting and financial reporting:
    • 4, 5 (withdrawn), 7, 8, and 11.
  • The 4th is outlined in great detail in your book.
  • The 7th Directive dealt with consolidation concepts
    • instead of following the traditional legal basis in defining a group, it concentrated on economic factors, such as dominance and dependence among entities.
    • For example, as US firm with EC operations would have to prepare an EC consolidation for its EC operations--a broader perspective than commonly used in the US.
european community67
European Community
  • The 8th Directive is primarily concerned with the qualification and training of auditors performing statutory audits.
    • It initially dealt with auditor independence.
    • This issue was eventually excluded because agreement could not be reached.
    • The final version of the directive simply states that an auditor should be a "person of good repute," and should carry out audits with "professional care," and should follow the appropriate national standards for independence.
    • The 11th Directive concerns disclosure requirements for a branch located in an EC country with its parent company based in another company.
european community68
European Community

Post 1992 Europe

  • In 1985, leaders of the EC promised that by the end of 1992 they would eliminate all of the bothersome internal barriers.
  • Europe 1992 became a code word signifying the coming birth of an economic superpower, perhaps on its way to becoming one very powerful federation of interdependent countries.
  • To a very large extent, this has occurred although not to the extent envisioned.
european community69
European Community
  • New opportunities for businesses and consumers opened up on January 1, 1993 with the official launching of the Single European Market.
  • Many barriers were removed and much harmonization of standards (including accounting standards) has been established in a process of creating a unified European economy.
european community70
European Community
  • Internal customs checks have been eliminated.
  • Banks licensed in any EC country may now offer their services anywhere within the EC
    • although special licensing procedures are faced by banks from countries which have been slower in incorporating EC banking rules into national legislation.
  • Capital adequacy and solvency standards applying to banks are the same throughout the EC.
  • Restrictions on intra-EC capital movements and double taxation of affiliated companies have been eliminated, and a set of EC-wide merger controls have been established.
european community71
European Community
  • Similar efforts are underway on behalf of the investment services and insurance industries.
  • Labor mobility is being improved by mutual recognition of qualifications.
  • Some 30 additional European Countries are knocking on the door to join the 12 countries now in the EC.
  • A great many barriers still remain, and there are problems and disagreements.
  • There is no easy way to enforce all aspects and there is no clear cut method to mediate disputes.
european community72
European Community
  • The EC has also established an Accounting Advisory Forum made up of users, preparers, and standard setters as a consultative group.
  • This body is expected to work with the IASC.
  • Historically the EC has tended to ignore the IASC, but they are making efforts to bridge this gap.
where does the fasb fit in
Where Does the FASB Fit In?
  • The attitude of the FASB toward the IASC has been characterized as benign neglect, uncooperative, uninterested, and less than enthusiastic.
  • It has also been said that the FASB's idea of convergence has been to play the lead role.
  • The FASB does keep in close touch with international accounting developments
    • In 1991 they indicated a plan for increased involvement in international activities.
  • The FASB's objective is to "create a body of superior international accounting standards accepted in all countries as GAAP for general purpose external financial statements.
where does the fasb fit in74
Where Does the FASB Fit In?
  • The board intends to work in the international arena through the following standard setting efforts:

1. Intensify consideration of IASC and other standards

2. Engage in joint standard-setting activities with foreign counterparts to produce results consistent with IASC standards

3. Consider adopting some superior foreign standards in the US and to convince others to consider adopting superior US standards. Make joint choices where neither principles are superior.

4. Continue efforts to encourage equality of financial statement requirements for US and foreign issuers in their use of US markets.

two international pressure sources for accounting and audit harmonization
Two International Pressure Sources for Accounting and Audit Harmonization

1. Global Capital Markets

2. Global Trade in Goods and Services

global capital markets
Global Capital Markets
  • More investors seek investment opportunities in other countries
  • In 1975, $65 billion was the grand total for all transactions involving foreigners buying US securities and US citizens buying foreign securities.
  • By 1989, that amount had grown 80 times to $5.4 trillion!
  • More securities are sold internationally.
  • In 1990, more than 500 companies were listed on at least one stock exchange outside their home country, and there were more than 50 mutual funds specializing in single country investments.
global capital markets77
Global Capital Markets
  • More capital crosses borders for investment in a variety of industrial and other undertakings.
  • In 1989, foreigners spent $65 billion to buy or establish 1,101 business in the US.
  • Many European corporations with global operations wish to sell their securities in the countries where they have a business presence.
  • On Monday, October 19, 1987, national stock markets crashed simultaneously because they were now part of a global market.
global capital markets78
Global Capital Markets


1. The investor in foreign markets is exposed to greater risks since his/her funds are being allocated on the basis of nonuniform accounting information.

2. Opportunity cost in lost transactions to the local financial community of the country with more rigorous requirements.

global capital markets79
Global Capital Markets
  • SEC Commissioner Lochner took issue with US listing rules for foreign securities that require compliance with US GAAP
    • Some companies apparently do not list in this country to avoid US GAAP compliance costs.
  • The Commissioner believes:
    • Harmonized GAAP would provide investors with financial statements that are far more comparable than those they may be currently using.
    • Harmonization would increase dramatically the willingness of foreign issuers to participate in US securities markets.
global capital markets80
Global Capital Markets

For sophisticated GAAP countries, there are serious economic consequences to a capital flight to less sophisticated markets:

1.The protective mission of their securities regulators is thwarted by their investors' considerable flight to lower GAAP markets.

2.Their investors' choices may be suboptimal since they are based on financial statements lacking uniformity.

3.Their financial services industry loses transaction revenues.

4. Their cost of debt and equity capital increases.

global capital markets81
Global Capital Markets
  • According to the chair of the NYSE:

“We've got to trade foreign securities here; this is one industry in which this country is the leader of the world. And we're going to lose that leadership. Unless we get started this thing will pass us by.” (WSJ, 1991)

global capital markets82
Global Capital Markets
  • The NYSE already trades over 100 foreign companies, but there are some 2,000 to 3,000 such companies that could qualify for listing.
  • About 250 of these have stock market values about 20 times the size of the average NYSE listing.
  • Many of these firms don't meet NYSE listing standards because of the GAAP they use.
  • The SEC is aware of this but is reluctant to ease accounting requirements because they fear it may introduce unwarranted greater risks in US securities markets.
global capital markets83
Global Capital Markets
  • Some foreign issuers see the tough US rules as valuable for those who meet them.
  • 1990:
    • Compania de Telefonos de Chile listed on the NYSE and raised $100 million, followed shortly by another offering of $90 million.
    • The company's CFO stated:

“When we prepared for the issue in 1990, we made the decision to go for a public US offering. The accounting rules were far stricter, but by complying with them we gained credibility not only in the US but also in Europe and Asia. We wouldn't have been so successful in achieving financing if investors hadn't already known that we fully complied with the SEC and GAAP.”

global capital markets84
Global Capital Markets
  • Despite accounting diversity, the international dimensions of capital markets have experienced tremendous growth.
  • Diversity may not be insurmountable, but is it still serious enough to create strong pressures for its reduction or elimination?
global capital markets85
Global Capital Markets
  • Choi and Levich surveyed investment-related public.
  • Groups surveyed:
    • Institutional investors, Corporate issuers, Rating agencies' representatives, Underwriters, Market regulators, an international financial data service, an organization working for increased accounting harmony
    • FROM: NY, Frankfurt, Tokyo, London, Zurich
global capital markets86
Global Capital Markets

Main findings:

  • Approximately half of the respondents felt that accounting diversity affects market decisions.
  • The remaining respondents either had developed coping mechanisms which nullified the negative effects of accounting diversity or felt that the lack of accounting uniformity was not a significant problem.
  • Choi and Levich concluded that accounting differences are important and affect the investment decisions of a significant number of market participants regardless of nationality, size, experience, scope of international activity, and organization structure.
  • Restatement was not sufficient to remove the problem of lack of uniformity.
global trade in goods and services
Global Trade in Goods and Services
  • Growing willingness to try free market approaches to the trade of goods and services.
  • This seems to be leading many nations to join in free trade zones or common markets.
  • IT is somewhat of a halfway point between highly protected national markets and a free trade based global economy.
  • GATT--General Agreement on Tariffs and Trade (1985)
    • Participants agreed to vigorously decrease a host of protectionist practices