differences in financial reporting standards

University Degree Business and Administrative studies

OLA IGUN UCARD NO-0700205

Development of accounting and financial reporting

Introduction

I will be discussing the definition of financial reporting, the origin of national differences and the factors that give rise to these differences. I will also be mentioning the importance of harmonisation, standardisation and standard setters, the regulation involved such as The International Accounting Standard, as well as other approaches taken in an attempt to regulate accounting and financial reporting in different countries.

Definition of Financial Reporting

Financial Reporting is a way of presenting data about a company's financial position, the company's operating performance, and the flow of funds over an accounting period.

Financial Reporting is defined by The American Financial Accounting Standards Board as “activities which are intended to serve the informational needs of external users who lack the authority to prescribe the financial information they want from an enterprise and therefore must use the information that management communicates to them”.

Origin and Factors of National Differences

Origin

With reference to the above definitions, it shows that a company’s financial information should be communicated to its relevant stakeholders such as shareholders and investors, government, lenders, and others in making investment, credit, and business decisions.

For example, proposed investors looking at financial statement of two companies can find it difficult to make a decision as to which company to invest in or not, especially if the companies are located in different countries of each other.

However, as companies become larger, and mostly international, accounting practices and regulations became different across different countries and consistency became a very important issue. It became difficult to measure income and expenditure in the income statement, as well as measuring and recognising assets and liabilities in the balance sheet.

If different accountants from different countries or even the same country are faced with the same transaction in which they are required to prepare financial statements, they will not draw up the same statement. Even if they all follow a set of rules and regulations, whether implicit or explicit, there is no format or set of rules that completely covers every eventuality to the minutest detail, which makes financial reporting inconsistent.

An example of inconsistency in financial reporting is that of German car manufacturer Daimler-Benz AG. Before its merger with Chrysler Daimler, Benz obtained in 1993 a listing of their shares in the US and in so doing needed to report under both US Generally Accepted Accounting Principles (GAAP) and German GAAP.

You would expect that the profit reported under the same principles would be the same but the company reported a loss of $1 billion under the US GAAP and a profit of $370 million under German GAAP. Robert Greenwood & David Eyles. (2005). International Financial Reporting Standards, p.3.

International Accounting Standard Board comes in as the international regulator to ensure that companies meet the standard requirement in the preparation of their financial statements. However, this does not entirely solve the problems of financial reporting as different countries have different factors such as their cultural environment that shape up financial ...

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Factors

In the past 25years of the 20th century, many researchers have come up with a number of factors that cause differences in international financial reporting when the need for harmonisation and standardisation became crucial due to a large increase in the globalisation of the business world.

Among the ones discussed in the text, International Financial Reporting and Analysis (David Alexander, Anne Britton, Ann Jorissen, 2007, p.26) are:

Cultural differences
Legal system
Taxation
The provision of finance.

Now let us consider each in much more detail,

Cultural Differences

Cultural differences among countries have been seen to be a very important factor in the development of accounting and financial reporting especially in the preparation of financial statements and how the behaviour of a country shapes this up.

The same term used in financial reporting and accounting in different countries does not necessarily mean the same thing.

For instance, in the US, there is a tendency to say things are correct, while in the UK accountants prefer to use the true and fair view approach.

Legal System

The legal system in a country does not only shape the behaviour of its citizens, it also regulates accounting and financial reporting. Countries that practice common law have their accounting regulation in the hands of professional organisations with fewer regulations while on the other hand, companies that practice Roman or code law e.g. France and Germany rely on detailed rules that are often included in their company legislation. This leads to less flexibility in the preparation of financial reports and are less likely to justify the accounting treatments as used in common law.

Taxation

In majority of countries, the government uses the financial statements of a company to determine the proportion of corporation tax to be paid over that period. Countries such as Germany uses the same accounts for stakeholders and tax purposes while countries like the UK use separate accounts for external stakeholders and tax purposes. It means in the UK, there is a clear distinction between the information used by directors to run the business and that reported externally to stakeholders.

These differences can lead to difficulties in interpretation and comparisons of financial report of companies in different countries.

Provision of Finance

Borrowing and equity seems to be the source of finance in a lot of countries. Countries such as Germany and France have a higher debt/equity than companies in countries like UK. Equity is much more important in countries such as the UK. They rely more on shareholders equity for the financing of their activities. This means that financial statement will provide information that will enable a potential investor to make good investment decision.

In countries such as Belgium and Germany, borrowing from banks is the main source of financing. This means that financial statement will provide information to show that the company can repay its debt.

Barry Elliot and Jamie Elliot, also in their text Financial accounting, reporting and analysis considered the same points as discussed by David Alexander et al but with the following additional factors influencing the development of accounting and financial reporting:

Influence and status of the accounting profession
The extent to which accounting theory is developed
Accidents of history
language

Influence and status of the accounting profession

The growth of shares and capital markets in majority of countries has brought about the need for transparency and true and fair view in the preparation of financial reports. This resulted in the need for more financial and management accountants and the growth of accounting and professional bodies to monitor and attest to the reliability of the reports produced, and hence more accounting regulations to comply with.

The extent to which accounting theory is developed

Accounting theory can influence the way accounting is practiced. For instance, theories such as the accrual concept is been practiced by a lot of financial accountants today when making adjustments in the preparation of their financial reports. In dealing with this in practice, accrual is treated as an expense and as a liability in the balance sheet.

Accidents of history

Past history such as company failure in the USA in the 1920s and 1930s, and also in the UK in the 1960s and 1980s at a time of recession has had a great impact in such countries. In the UK, there has been an increasing control over the content and format of financial statements through improvement in the accounting standard setting process set by standard setters such as The Financial Reporting Council.

Language

Language has played, and still plays a very important role in the preparation of financial statements of companies. Certain companies only speak their language and provide financial statements only in their language, and this has prevented them from benefiting from the knowledge and wisdom presented by other countries. While for countries who speak more than one language or provide financial statements in more than one language, it has been beneficial to them because they can interact with other countries.

Majority of companies publish their financial statements and accounts in more than one language so that they can raise money and have their shares traded on the floor of the US and UK stock exchange.

For example, Nokia publishes its annual reports and financial statements in Finnish and Swedish (as used in Finland) as well as in English. This will enable its stakeholders nationwide to understand the information given to them and aid them in decision-making such as estimating future dividends and capital growth.

Elliot, B., Elliot. (2008). Financial Accounting and Reporting. 12th edition, p134-139.

Approach taken to the regulation of accounting and financial reporting

Two approaches –standardisation and harmonisation

Having considered the factors described above, and how it affects companies internally, externally, and internationally, there has been impressive attempts to reduce them particularly by the IAS who is the issuer of International Financial Reporting Standards (IFRS). The aim of this body is to achieve harmonisation in accounting practices so as to enhance globalisation in capital markets.

The International Accounting Standards Committee

The IASC was formed in 1973 and it is responsible for issuing IASs but in 2001, the International Accounting Standard Committee gave the standard setting responsibilities to the International Accounting Standard Board, who is now responsible for setting accounting standards, amending accounting standards and ensuring the applications of those standards. The IASs enables comparability in financial statements not only within UK companies but also to achieve quality in accounting standards around the world.

For example, IAS 18 that deals with revenue recognition and measurement. IAS 18 covers the definition and the way revenue has to be classified. Revenue was defined as the gross inflow (before the deduction of any expenses) of economic benefits from ordinary activities, when those inflows result in increases in equity. This definition does not include gains from other activities that are not in the ordinary course of the business. When determining revenue figure, all companies using IAS18 have to follow this definition.

The European Union

The EU also attempted to solve this problem by issuing directives and regulations on accounting and financial reporting, so also has other standard setters and regulators. The aim of this body is to achieve standardisation, compliance and accuracy in the rules that have been imposed.

Member states in the EU all have to follow a set of directives and include them in their legislation - The 4th directive, 7th directive and 8th directive dealing with company accounts, consolidated accounts and auditor’s accounts respectively. The aim of these directives is to ensure comparability and a true and fair view in the set of financial statements provided by the countries in the EU member states.

Conclusion

Having discussed the reasons for these differences ranging from cultural differences to taxation, language and the influence of accounting as a practice, will difference in financial reporting really disappear in the future?

Culture for instance is a set of learned beliefs, values and behaviours of the way of life shared by the members of a social group or organisation. It is what they believe to be right and it will be difficult to change their belief or behaviour. So can rules and regulations actually change what people believe in? Or can it change their behaviour? It will to some extent. For example, if a country observes the accounting practices of another country, they may see it as reasonable and decide to follow suit if it contributes to their learning experience of what is right or wrong.

Also because of the expertise of the accounting profession, there is always some sort of professional judgement which is dependant on the accountant and the factors in operation in that country.

Finally, there is no best fit approach to dealing with these differences. Different accountants in different countries use the best practice approach that suits the problem at hand. There are so many rules and regulations by different standard setters and regulators to choose from. If there was a single approach that fits or a single body of accounting standard whose regulations are compelled on all the countries, then maybe there can be a complete elimination of these national differences.

These regulatory bodies have to some extent lessened the national differences but they have not succeeded in eliminating them completely. International harmonisation and standardisation in accounting is viewed theoretically as desirable but has proved difficult to achieve in practice.

References:

Paul Tuck - lecturer, Financial Reporting Lecture notes 1 and 2. Accessed 10 March 2008.

Christopher Nobes, Robert Parker. Comparative International Accounting, 9th edition, p4.

Robert Greenwood, David Eyles (2005). International Financial Reporting Standards.

David Alexander, Anne Britton, Ann Jorissen, (2007). International Financial Reporting and Analysis, 3rd edition.

Barry Elliot and Jamie Elliot. (2008). Financial Accounting and Reporting, 12th edition.

Copyright © International Accounting Standards Committee Foundation: International Accounting Standards Board, (), Available: . Accessed 11 march 2008.