International Accounting, 7/e Frederick D.S. Choi Gary K. Meek Chapter 2: Development and Classification
Learning Objectives • Identify and understand the importance of the eight factors that have a significant influence on accounting development. • Understand the four approaches to accounting development found in market-oriented Westerneconomies and identify countries in which each approach is prevalent. • Have a basic working knowledge of accounting classifications and how they compare with one another. • Explain the difference between the “fair presentation” and “legal compliance” orientations of accounting and identify nations in which each is prevalent. • Explain why distinctions of accounting at the national level are becoming blurred.
Why Study Development and Classification? • Development • Helps understand a nation’s accounting. • Explains the differences and similarities in accounting around the world. • Classification • Helps understand why and how national accounting systems differ. • Helps analyze whether these systems are converging or diverging. • Are a way of viewing the world. • Reveals what group members have in common, and • What distinguishes groups from each other
Development • Sources of finance – who, how many, how close? • Equity markets • Profits measure how well managers have run the company. • Accounting is used to assess cash flows, risks, and to value the firm. • Extensive disclosures. • Banks • Conservative earnings for creditor protection. • Less extensive disclosures.
Development (contin) • Legal system • Code law • Laws are all-embracing. • Accounting tends to be prescriptive and procedural. • Accounting focuses on legal form. • Accounting standards and procedures are incorporated into national laws. • Common law • Laws develop on a case-by-case basis. • Accounting develops from experience and judgment. • Accounting tends to be flexible, adaptive, and innovative. • Accounting focuses on economic substance. • Accounting rules are established by private sector professional organizations.
Development (contin) • Taxation • Must companies record revenues and expenses in their accounts to claim them for tax purposes? • Are financial accounting and taxation the same? • Or are they different? • Political and economic ties • Accounting ideas and technologies are transferred through conquest, commerce, and other forces. • Inflation • Inflation distorts historical cost measurements. • Countries with high inflation often require that companies incorporate price changes into the accounts.
Development (contin) • Level of economic development • Affects the types of transactions and which ones are most prevalent in the economy which, in turn, • Affects the accounting issues that are faced. • Educational level • Affects the capability for professional accounting training. • Where education levels are low, countries import accounting training or send citizens elsewhere to get it. • SUMMARY • Several variables are closely associated. • Common law legal system, strong equity markets, and separation of financial and tax accounting. • Code law legal system, credit-based financing, and accounting rules that conform to tax law. • Result is two basic orientations of accounting. • Fair presentation • Legal compliance
Development (contin) • Culture and accounting values • Culture (Hofstede) • Individualism vs. collectivism • Power distance – high vs. low • Uncertainty avoidance – high vs. low • Masculinity vs. femininity • Accounting values (Gray) • Professionalism vs. statutory control • Uniformity vs. flexibility • Conservatism vs. optimism • Secrecy vs. transparency
Development (contin) • Linking the two:
Classification • Four approaches to accounting development (Mueller 1967) • Macroeconomic approach • Accounting derived from and designed to enhance national macroeconomic goals. • Example: Sweden • Microeconomic approach • Accounting derived from microeconomics. • Maintaining physical capital • Separation of capital and income • Replacement costs • Example: the Netherlands • Independent discipline approach • Accounting derived from business practices, judgment, and trial-and-error. • Examples: U.K. and U.S. • Uniform approach • Accounting is standardized by central government and used as a tool for administrative control. • Example: France
Classification (contin) • Legal systems:common law vs. code law accounting • Common law accounting • Oriented toward fair presentation, transparency, and full disclosure • Separation between tax and financial accounting • Accounting standard setting in private sector • Parallels stockholder model of corporate governance • Code law accounting • Legalistic orientation, opaque with low disclosure • Alignment between tax and financial accounting • Accounting standard setting in public sector • Parallels stakeholder model of corporate governance
Classification (contin) • Practice systems: fair presentation versus legal compliance accounting • Why national accounting distinctions are becoming blurred • Importance of stock markets as a source of finance is growing. • Dual financial reporting is becoming more common, particularly where duality is sanctioned. • Some code law countries are shifting responsibility for accounting standard setting to the private sector. • Fair presentation accounting • Substance over form. • Oriented toward decision needs of external investors. • Helps judge managerial performance and predict future cash flows and profitability • Extensive disclosures • IFRS are aimed at fair presentation. • Found in U.K., U.S., Netherlands and countries influenced by them. • The trend for consolidated financial statements.
Classification (contin) • Legal compliance accounting • Designed to satisfy government-imposed requirements, such as: • Calculating taxable income • Complying with macroeconomic plan • Conservative measurements • Income smoothing • Will persist in code law countries for individual-company financial statements