CHAPTER 2:
WORLDWIDE ACCOUNTING DIVERSITY
WORLDWIDE ACCOUNTING DIVERSITY
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Chapter Topics
• Evidence of accounting diversity.
• Reasons for accounting diversity.
• Problems caused by accounting diversity.
• Accounting clusters.
• The influence of culture on financial reporting.
• The reason for international differences in reporting.
• Further evidence of accounting diversity.
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LEARNING OBJECTIVES
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1. Provide evidence of the diversity that exists in
accounting internationally.
2. Explain the problems caused by accounting diversity.
3. Describe the major environmental factors that influence
national accounting systems and lead to accounting
diversity.
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LEARNING OBJECTIVES
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4. Describe a judgmental classification of countries by
financial reporting system.
5. Discuss the influence that culture is thought to have on
financial reporting.
6. Describe a simplified model of the reasons for
international differences in financial reporting.
7. Categorize accounting differences internationally and
provide examples of each type of difference.
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What is Worldwide Accounting Diversity?
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Worldwide Accounting Diversity
Differences in accounting and financial reporting rules
between countries. For example:
Accounting for Goodwill
• U.S. -- goodwill is not amortized, but is written down only
if impaired.
• Japan and Korea – goodwill is amortized over its useful
life not to exceed twenty years.
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What is Worldwide Accounting Diversity?
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Worldwide Accounting Diversity
Asset revaluation
– U.S. -- upward revaluation of fixed assets is not
generally allowed.
– European Union publicly traded companies are free
to choose between two different methods for valuing
their assets.
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What is Worldwide Accounting Diversity?
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Worldwide Accounting Diversity
Inflation Accounting
• U.S. (and many other countries) -- financial statements
are not adjusted for inflation.
• Latin American countries -- experience significant
inflation, so financial statements are adjusted for
changes caused by inflation.
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Problems Caused by Accounting Diversity
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(1) Preparation of Consolidated financial statements
• U.S. MNEs often have subsidiaries in a large number
of countries.
• Accounting records in local GAAP and local currency
are rolled-up (i.e., consolidated) into U.S. GAAP.
• Require conversion from local to U.S. GAAP.
• Require translation from the local to U.S. currency.
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Problems Caused by Accounting Diversity
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(2) Difficulties with access to foreign capital Markets
• Companies often need to go outside their home
country in order to access financing.
• Raising foreign capital often requires reconciliation to
comply with different accounting rules or needs of
investors and creditors.
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Problems Caused by Accounting Diversity
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(3) Lack of comparability of financial statements
• Accounting rules often differ between countries.
• International investors need to make their own
reconciliations or adjustments to financial statements.
• International investors also must face differing levels of
disclosure, quality of accounting standards, and quality
of auditing.
• Example, It is very difficult if not impossible for a
potential investor to directly compare the financial
position and performance of an automobile
manufacturer in Germany (Volkswagen), Japan
(Nissan), and the United States (Ford)
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Problems Caused by Accounting Diversity
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(4) Lack of high-quality accounting information
• Lack of disclosures—i.e., lack of transparency.
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Environmental Factors Leading to
Accounting Diversity
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Why do financial reporting practices differ across
countries?
1. Legal systems -- Common law
• Fewer statutes—more court interpretation.
• Leads to the creation of precedents or case law.
• Found most often in Great Britain and other English-
speaking countries.
• The source of accounting rules tends to be non-
governmental organizations.
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Environmental Factors Leading to
Accounting Diversity
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1. Legal systems -- Code law
• Characterized by relatively more statutes .
• Found more often in non-English-speaking countries.
• Accounting rules in these countries tend to be legislated
(i.e., the source is the government).
• Less specific, so other sources needed to provide
guidance.
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Environmental Factors Leading to
Accounting Diversity
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2. Taxation
• U.S. -- taxable income and book income are generally
quite different.
• Germany -- rules governing taxable and book income
tend to be the same, which generally results in more
conservative accounting.
• Deferred taxes are less of an issue in code law
countries.
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Environmental Factors Leading to
Accounting Diversity
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3. Providers of financing
• In many countries major sources of capital are families,
banks, and the government.
• Accounting and disclosure in those countries tend to be
less important.
• In the U.S. and U.K. the providers of financing are
diverse shareholders, so accounting and disclosure are
more important.
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Environmental Factors Leading to
Accounting Diversity
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4. Inflation
• Some countries have historically high rates of inflation.
• Accounting in these countries often requires adjustments
to offset the impact of inflation.
• This is common in Latin American countries.
• Given extended periods of low inflation in the U.S.,
inflation accounting is not required.
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Environmental Factors Leading to
Accounting Diversity
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5. Political and economic ties
• These linkages tend to make information sharing
easier.
• Nations that share ties often have similar accounting
systems, such as France and former colonies in
western Africa.
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Financial Reporting System Classification
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Accounting Clusters
Environmental factors related to accounting diversity,
there are clusters of countries that share common
accounting orientation and practices:
(1) Fair presentation / full disclosure model
• Oriented towards the information needs of investors and
creditors.
• Most descriptive of the U.K. and U.S.
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Financial Reporting System Classification
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Accounting Clusters
(2) Legal compliance model
• Accounting heavily influenced by tax rules and needs of
government.
• Commonly found in continental Europe and other code
law countries such as Japan.
• Banks are primary source of financing.
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Financial Reporting System Classification
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Accounting Clusters
(3) Inflation-adjusted model
• Similar to the legal compliance approach.
• Is distinguished by the requirement for adjustments to
mitigate the effects of inflation.
• As such, found mostly in South America.
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The Influence of Culture on Financial Reporting
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• National culture is also widely considered to influence
financial reporting systems.
• Hofstede’s six cultural dimensions is the most
commonly used scheme to discuss cultural influences.
Hofstede’s Cultural Dimensions
Individualism (vs. Collectivism)
Power Distance
Uncertainty Avoidance
Masculinity
Long-term Orientation
Indulgence Vs Restraint
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The Influence of Culture on Financial Reporting
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Hofstede’s Cultural Dimensions
Individualism (vs. Collectivism)
• Individualism refer to preference for a loosely knit social
fabric.
• Collectivism represented by a tightly knit social fabric.
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The Influence of Culture on Financial Reporting
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Hofstede’s Cultural Dimensions
• Power Distance -- Level of acceptance of unequally
distributed power within and across the society’s
institutions and organizations.
• Uncertainty Avoidance – Degree to which members of
a society feel threatened by uncertain or unknown
situations.
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The Influence of Culture on Financial Reporting
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Hofstede’s Cultural Dimensions
• Masculinity – Emphasis on traditional masculine
values of performance and achievement vs. feminine
values of relationship, caring and nurturing.
• Long-term Orientation – The extent to which the
society values persistence, thrift, observing order and
respect for tradition.
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The Influence of Culture on Financial
Reporting
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Gray’s Accounting Values
Four widely recognized accounting values that can be
used to define a country’s accounting subculture:
• Professionalism vs. Statutory Control
• Uniformity vs. Flexibility
• Conservatism vs. Optimism
• Secrecy vs. Transparency
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The Influence of Culture on Financial Reporting
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Gray’s Accounting Values
Professionalism vs. Statutory Control
• Professionalism is reflected by individual professional
judgment and self-regulation of the profession.
• Statutory control focuses on legal compliance and
legislative control of the profession.
• The former is more indicative of the U.K. and U.S. and
the latter more so with continental Europe.
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The Influence of Culture on Financial Reporting
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Gray’s Accounting Values
Uniformity vs. Flexibility
• Uniformity indicates preference for standardized
accounting methods.
• Flexibility is reflected in the varying of accounting
practices for differences between companies.
• U.K. and U.S. approaches are examples of flexibility.
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The Influence of Culture on Financial
Reporting
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Gray’s Accounting Values
Conservatism vs. Optimism
• Conservatism indicates preference for caution and
prudence.
• Optimism tends more toward fair presentation.
• Germany has traditionally reflected a strong tendency
toward conservatism.
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The Influence of Culture on Financial Reporting
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Gray’s Accounting Values
Secrecy vs. Transparency
• Secrecy reflects a preference for minimal information
disclosure.
• Transparency reflects openness and full disclosure.
• Countries with predominantly family-owned and bank-
financed firms tend toward secrecy.
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Gray framework
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A Model to Explain International Differences
in Financial Reporting
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Nobes’ model
• Describes international differences as a function of culture
and the system of financing.
• Culture influences the development of the system of
financing which influences the development of accounting.
• Uses two classifications -- A and B.
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A Model to Explain International Differences
in Financial Reporting
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Class A Accounting
• Strong outside shareholder equity-financing.
• Optimism.
• Transparency.
• Example: UK, New Zealand, …
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A Model to Explain International Differences
in Financial Reporting
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Class B Accounting
• Descriptive of continental Europe.
• Less widespread outside shareholder equity-financing.
• Conservatism.
• 6 Secrecy.
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Nobes’s Classification
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Further Evidence of Accounting Diversity
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Additional differences between countries
• Different financial statement formats.
• Level of detail in financial statements varies between
countries.
• Terminology, level of disclosure, and rules governing
recognition and measurement.
• Different financial statements included in the annual
report.
• Recognition and measurement differences.
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Problem solving 1
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• Gray’s secrecy hypothesis
- High secrecy = High PD , High UA, Low IND, Low MASC, high LTO
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