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Recent Researches in Applied Economics and Management - Volume I

Financial Reporting Harmonization - Measurement Models

Accounting and Finance Department
University of Split, University Department of Professional Studies
Livanjska 5, 21000 Split

Accounting Department
University of Split, Faculty of Economics
Cvite Fiskovia 5, 21000 Split

Abstract: This paper analyses financial reporting harmonization, more precisely its development, effects of
globalization on financial reporting harmonization and how financial reporting harmonization is measured.
During last decades financial reporting faces major changes that affects many parties interested in financial
reporting. Since 2005, all listed companies in the European Union have to apply the International Financial
Reporting Standards to prepare their consolidated financial statements. Different measurement methods have
been developed so far and they can be classified according to their similarities in three different measurement
models: indices, measurement models based on the concept of Euclidean distances and association and
correlation coefficients. The implementation of International Financial Reporting Standards around the world
has not eliminated the need for further research in the field of financial reporting harmonization.

Key-Words: globalization, de jure harmonization, de facto harmonization, measurement of financial reporting


1 Introduction statements of foreign companies whose shares they

In the world of today the problem of financial want to buy. In the existing literature there is no
statements comparability is becoming more single definition of financial reporting
expressed because business and capital flows are harmonization. Tay and Parker [18] define
more international than ever and users of financial harmonization as a movement away from total
statements can be found worldwide. Accounting in diversity of practice towards harmony of accounting
the history was qualified as the language of business methods and is seen to be essential for improving
but as the volume of international business activities international comparability in financial statements,
and investments continues to increase, there is a thereby enhancing international capital flows and
need for a common international language of reducing the cost of preparing financial statements
business. The communication of financial for multinational corporations [4]. Nobes and Parker
information across country borders would be easier [14] define harmonization as a process of increasing
with the use of the same set of accounting standards. the compatibility of accounting practices by setting
Financial reporting harmonization has been seen as bounds to their degree of variation. Its main
an important way for achieving more reliable, objective is to enhance the comparability of
credible and comparable financial information at an accounting data and to facilitate smooth and
international level. International companies operate efficient international business activities. Walton et
on a global scale and are listed on several financial al. [22] define harmonization as a jargon used in
markets. Thus they find new investors on foreign international accounting to designate the reduction
financial markets that finance the expansion and of reporting differences between different countries.
modernization needed to keep pace with Van der Tas [19] pointed out that financial
competition. On the other hand, investors and statements are a target of harmonization and the one
financial analysts must understand the financial way to harmonize financial statements is to

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formulate standards, thus setting limits to the differences between the IAS and national
difference between financial statements. Accounting accounting standards. The growing world-wide
standards are also an object of harmonization trend towards deregulation of markets and
themselves. Therefore, the existing literature makes privatization of public sector companies, in many
a distinction between two types of harmonization, developing countries, has opened up new
namely material or de facto harmonization and opportunities for international investment [14] and
formal or de jure harmonization. According to [18] cross-border mergers and acquisitions.
formal or de jure harmonization refers to The increase of foreign direct investment, the
harmonization of accounting regulations (laws development of multinational companies, the
and/or accounting standards) and material or de growth of financial markets and the influence of
facto harmonization refers to harmonization in the such organizations as the World Bank, the
actual practice of companies. Organization for Economic Co-operation and
The two types of harmonization are interrelated, Development (OECD), the European Union (EU),
respectively formal harmonization would normally the International Organization of Securities
be a first step towards the material harmonization, Commission (IASCO) and the IASB all assist in
but this is not necessarily the case [3]. Material supporting harmonization and the concept of having
harmonization might take place without being a single accounting system. Between 1980 and 1990
furthered by formal harmonization. This different cross-border transactions in equity securities
form of harmonization, known as the spontaneous increased from $120 billion to $1.4 trillion per year
harmonization, was found at the level of accounting [12]. More and more companies were listing their
practices of the so-called global players [3], [8]. The shares on stock markets outside the home country in
spontaneous harmonization results as a consequence order to raise capital. Companies which were listed
of the market influences and not as an effect of on several stock markets were obliged to produce
accounting regulations. several financial statements, all depending on the
accounting regulations of the different countries in
which they operated. Multinational companies as
2 Incentives for financial reporting the information providers had to adapt to a global
environment in order to reduce restatement of
harmonization in globalized economy financial information. On the other hand, investors
There are many interested parties in harmonization,
as the information users had problems in comparing
including multinational companies, stock
financial data because of the use of different
exchanges, shareholders (especially investors), accounting standards. They were uncertain about the
accounting and auditing firms. The pressure for
credibility of financial statements. Companies which
international harmonization comes from those who
raised capital outside national boundaries were
regulate, prepare and use financial statements [14].
required to bear the cost of reconciling financial
The United States of America and European Union
statements prepared using national standards.
have the most important capital markets in the
European companies (so-called global players)
world, so the objective of their institutions which
which were listed on the New York Stock Exchange
have been issuing standards, namely Financial
or which were preparing for such cross- border
Accounting Standards Board (FASB) and
listing, had to prepare two sets of accounts, one set
International Accounting Standards Board (IASB) is
which is in conformity with the national accounting
to harmonize the accounting standards which are in
rules and another set which is required by the New
the use in the United States and in the European
York Stock Exchange.
Union. IASB is the institution which has been
Different standards also made transactions result
issuing accounting standards (International
in a profit in one country and a loss in another, as
Accounting Standards - IAS, also referred to as
was the case for Daimler-Chrysler when they had
International Financial Reporting Standards- IFRS)
their first listing on the New York Stock Exchange
since 1973 when it was formed under the name
in 1993 [6]. The company was obliged to prepare a
International Accounting Standards Commission
reconciliation statement that presented equity and
(IASC). IASCs mission was to improve the
profits according to US GAAP and after that it
comparability of financial statements even though in
reported a loss of DM 1,839 million under US
that time they were prepared under various sets of
GAAP rules, while there was a profit of DM 602
national accounting standards. The intention was to
million under German accounting rules. Investors
facilitate trading and free movement of capital were confused by these differences between the
between different countries by reducing the
figures for profit and for equity reported under the

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two sets of accounting rules. The harmonization of Where: H is Herfindahl Index, n the number of
financial reporting standards enables the users to alternative accounting methods and pi the relative
correctly interpret the financial information and thus frequency of method i.
make better decisions based on that information. The values H index can take are between 1/n to 1
Multinational companies can realize significant cost (all companies are using the same method). The H
savings if all their subsidiaries could use the same index equals the probability that two randomly
accounting standards as parent company. selected companies from the sample use the same
Performance figures would be the same regardless accounting method. The restriction of the H index
of the countries in which company operates and that is that it can be applied when companies only use
would facilitate the access to main financial one alternative accounting method because it does
markets. not allow the analysis of multiple financial reporting
In order to improve transparency and to achieve or of that offering supplementary information
harmonization of nancial reporting standards the through the notes to the financial statements [13].
EU requires listed companies to prepare their Another restriction is that it only measures
consolidated nancial statement in compliance with harmonization in one country at the time and
the IFRS from 2005. As Ball [2] pointed out IFRS international comparison is not possible. Companies
promise more accurate, comprehensive and timely may provide a reconciliation statement or other
financial statement information, relative to the information which allows the user to see the effects
national standards they replace for public financial of more than one accounting method. In these cases
reporting. Convergence of IFRS and U.S.GAAP is the H index would be based upon the method used
seen as the main activity of the IASB today. in the main financial statements and would ignore
Nowadays, more than 120 countries permit or the supplementary disclosures. This will have the
require IFRS for domestic listed companies. effect of underestimating the comparability of the
financial statements [16]. The existence of such
multiple reporting led Van der Tas to develop the C
3 Harmonization measurement index.
The C index is calculated by comparing the
models number of compatible pairs of companies with the
total number of pairs of companies. The financial
statements of two companies are compatible if both
3.1 Measurement models - Indices companies apply the same accounting method or if
The value of an index indicates how comparable the one or both companies give additional information
financial statements are at a given point in time to enable comparison [19]. The value of the index
while changes in the values measure harmonization. vary from 0 (no harmony, none of the pairs of
Comparability can be considered as an increase in financial reports is comparable with respect to the
the degree of consensus concerning the choice particular sort of transaction or event surveyed
between the alternative methods of accounting for because they all apply a different accounting
an item in the financial reports [19]. Van der Tas method) to 1 (maximum harmony, all pairs of
was one of the first researches who used indices to financial reports are comparable with respect to this
measure the comparability of financial statements. sort of transaction or event because all companies
He developed three indices, namely H, C and I apply the same accounting method under the same
index, which were used in his studies [20], [21]. circumstances). The C index is a simple ratio with a
These indices are based on measuring options` natural zero point, where no pair of financial reports
concentration and are used for measuring the level is comparable, so regression analysis can be applied
of de facto harmonization of financial reporting. as a test of significance of movements in the degree
Van der Tas developed a Herfindahl index (H of harmony. C index was criticized as the number of
index) to measure the harmonization degree of a companies studied affects the index, so in
certain national accounting system. The H index is comparative studies there would be desirable to
calculated as the square of relative frequencies of have equal numbers of companies [10]. It is
each of the alternative accounting methods for a calculated as follows [13]:
particular sort of transaction or event, applied by
companies [20]. It is calculated as follows [13]:


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Where: C is the Comparability index (C index), m Where: I is I Index, m the alternative accounting
the number of alternative accounting methods, n the method m, n country number n, pm.n the relative
number of considered financial reporting and at the frequency of the utilization of method m within
number of entities applying the t accounting country n.
method. The I index also ranges from 0 to 1 but, due to the
Archer et al. [1] decomposed the C index into multiplication involved, the I index is sensitive to
within-country and between-country components in zero proportions. The potential sensitivity increases
order to assess the impact of harmonization on as the number of countries surveyed increases. To
interfirm comparison within individual countries control for this sensitivity, [9] proposed an
and the effects of harmonization on international alternative the adjusted I index. In cases where all
interfirm comparison. Within-country comparability of the companies in a particular country chose one
index is calculated as follows [1]: of the two alternative methods, the proportions are
recorded as 0.99 for the unanimous method and 0.01
for the non-practiced method (instead of 1 and 0,
respectively). Morris and Parker [11] presented
statistical properties of Van der Tas' I index and
Archer et al's between - country C index. The latter
Between -country comparability index is calculated
was found to be more stable when the number of
as follows [1]:
countries increased.
The T index was introduced by R. H. Taplin to
quantify the degree to which the financial
(4) statements of companies are comparable. It is easily
interpreted as the probability that two randomly
and the Total comparability index is given by [1]: selected companies have statements that are
comparable, or as the average comparability of pairs
of companies. The T index is a generalization of the
H, I and C indices introduced by Van der Tas and is
a framework containing countless individual indices
[17]. The general formula for T index is given
Where: X+j is the number of cases in which the
below [17]:
accounting method j is selected, Xij is the number of
companies in country (i) using accounting method
(j), x+j is a total number of companies in all T= (7)
countries using accounting method (j), X ++ is the
grand total of companies across countries and Xi+ is Where: kl is the coefficient of comparability
the number of companies in country (i). between accounting methods k and l, ij is the
In order to facilitate the measurement of weighting for the comparison between companies in
international harmonization, i.e., harmonization of countries i and j, ki is the proportion of companies k
accounting practices among two or more countries country i that use accounting method k, lj is the
Van der Tas introduced the I index. The I index is proportion of companies in country j that use
computed by multiplying across countries the accounting method i, m is the number of countries
proportion of companies practicing a particular and n is the number of alternative accounting
accounting alternative and then summing over all methods.
alternative practices. The correction factor in the Value of the T index is between 0 (no two
exponent is used when more than two countries are companies are comparable) and 1 (all companies are
examined. The I index is not meant to give an comparable with each other) as long as kl and ij
indication of the statistical significance of are between 0 and 1 (inclusive) and that the ij sum
harmonization, but rather a scale upon which to to 1. According to [17] the researcher can choose
quantify harmonization for comparative purposes from several options for the T index under four
[9]. The formula for the I index is given below [13]: criteria: a) the weighting given to companies and
countries (companies can be weighted equally,
countries can be weighted equally or countries can
be weighted according to the total number of
companies in each country), b) international focus:
(6) overall, within country, or between countries, c) the

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treatment of multiple accounting policies, d) the and the 0 value for the i set of regulations, c is the
treatment of non- disclosure. number of elements which take the 1 value within
the i set of regulations and the 0 value for the j set
3.2 Measurement models based on the concept of regulations. The closer Jaccards coefcient is to
of Euclidean distances 1 (or 100%), the greater is a degree of de jure
Euclidean distances was used as a measure for harmonization of financial reporting. Rahman et al.
assessing and comparing the success achieved in [15] used Jaccards coefficients to measure de facto
converging any two sets of accounting regulations harmonization between two countries. They
[7], [8]. It is using to measure advances in de jure measured the extent of likeness between the
harmonization of financial reporting. Fontes et al. disclosure and accounting methods that were
[7] used the following formula for the computation adopted by companies and the degree of likeness for
of Euclidian Distance in the field of accounting: items that were not adopted by companies in the two
countries. [15] used Match coefficients for
n comparing the accounting regulations because they
m = d
i =1
k ,m (8)
are based on similar principles as Jaccards
coefficients. Fontes et al. [7] used Spearman`s
correlation coefficient as a measure of correlation
between a set on national accounting regulation and
Where: Dm IC/NC is a convergence measure between
IFRS. The results of their research [7] proved that
Phases IC and NC, m is the development phases
association and correlation coefficients are better
which are the analyzed period, k represents four
methods for measuring de jure harmonization of
strengths of accounting method and n is the number
financial reporting than Euclidian distances. These
of accounting issues in the sample.
coefficients can be used as a measure of
The lower the value of Euclidian Distance the
convergence between different regulations at
highest is the degree of harmonization between the
different points in time or among different countries.
two sets of accounting regulations. Measures based
on Euclidean distances have serious shortcomings
[7]. They are sensitive in quantitative terms but not
in qualitative terms. They do not express which 4 Conclusion
particular method is adopted, nor the strength of the Financial statements provide investors with
method adopted. It only recognizes the number of information about companies` economic and
methods but does not recognize which method of financial performance, thus enabling investors to
accounting it is. Such measures are weak so they make comparison of information published by a
need to be supported by other measures. target company with its competitors, whether based
on the same country or abroad. Comparable,
3.3 Measurement models association and transparent and reliable financial information as a
correlation coefficients result of financial reporting harmonization are
Fontes et al. [7] proposed Jaccards coefcient and fundamental for an efficient and integrated capital
Spearman`s coefficient to measure the similarity market. Harmonization of financial reporting is an
between two sets of accounting regulations in order outcome of the globalization of financial markets
to gain insight in the progress of de jure and of economic integration. Financial reporting
harmonization. Jaccards coefcient is able to harmonization has many benefits, namely it
measure the degree of likeness between two sets of facilitates cross-border investments, reduces the
binary observations. The formula for the costs of capital, facilitates data collection and
computation of Jaccard`s coefficient is given below decreases its costs, decreases the audit costs, and
[7]: increases the efficiency of the audit. Countries all
around the world permit or require IFRS for
a domestic listed companies because they are aware
S ij = (9) that using IFRS contributes to further development
of local capital markets and attracting of foreign
Where: Sij represents the similarity degree between investors.
the two sets of analyzed accounting regulations, a is It is important to examine and measure de jure
the number of elements which take the 1 value for harmonization of financial reporting because of the
both sets of regulations, b is the number of elements increasing influence of accounting regulations on
which take the 1 value within the j set of regulations accounting practice. Nowadays, when the numbers
of studies on de jure and de facto harmonization

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