Factors for International Differences of Financial Reporting

In this chapter are firstly the causes of the international differences and the existing
differences being explained. After that are the reasons and obstacles with harmonization
described. This chapter also describes different accounting standard setters and in the last
part of this chapter is the convergence project being discussed.

Causes of international differences

Many researches and a lot of teaching have been done about international differences in
financial reporting, particularly since the 1980s onwards and in this part focus on the
most important causes of the international differences (Nobes 2006).

1- External environment and culture

There are cultural differences between nations and they have become a significant
influence factor on disclosure and reporting behavior with consideration to financial
statements (Alexander et al. 2009). In every country the culture consists of peoples most
important values and it have an effect on the way that people want their society to be
structured (Nobes & Parker 2000). People have created principles or laws which are a
societies norms or customs. These norms or customs does eventually become social
institutions that are different between one group to another. They are affected by
geographic areas and other features that either is original or that comes from other groups
(Marrero et al. 2007).

Hofstede is one of the most important researches on cultural differences and he defined
following four basic dimensions of culture based on a study of over 100 000 IBM
employees in 39 countries (Alexander et al. 2009).

Individualism versus collectivism: Individualism represents a society where people are

expected only to watch out for themselves and their closest family. Collectivism
represents a society where people expect their relatives or other in-group to look after
them in return of total loyalty. The problem with this dimension is the level of
independence that a society has among the individuals (Alexander et al. 2009).

Large versus small power distance: Power distance stands for how the people in a society
allow the power to be spread unequally in institutions and organizations. In large power
distance the people think that it is okay that there is a hierarchical order which means that
everybody has a special place and that place needs no further vindication. The main
problem with this dimension is how the society takes care of differences among people
when it comes up (Alexander et al. 2009).

Strong versus weak uncertainty avoidance: Uncertainty avoidance is how uncertainty and
vagueness affects the feeling of uncomfortable of the peoples in the society. When a
society has strong uncertainty avoidance the members of the society do not tolerate
people with different behavior and ideas. But when a society has weak uncertainty
avoidance the members have a more peaceful feeling and different people are more easily
tolerated (Alexander et al. 2009).
Masculinity verses femininity: Masculinity stands for accomplishment, material success
and great courage. Femininity is the opposite and stands for humility, relationships and to
take care of the weak (Alexander et al. 2009).

2- Legal systems
Two types of legal systems have been developed over the years; the common law system
and the code law system. The code law system emanates from Roman Empire and is
distinctly legalistic which means that it is based on obliged and written law. The common
law system emanates from England and it is found in many other countries. The written
law has only had a limited influence on this legal system and instead, it has grown case
by case. It is qualified organizations of the private sector that does the accounting
regulation in common law countries and the accounting rules are not part of the law
(Smith 2006).

The company law is very detailed in code law countries and accounting standard are
regularly incorporate in the company law. It is the government that has the responsibility
of the accounting regulation in code law countries and that leads to that the financial
reporting often is condensed to a minimum defined by the detailed set of legal rules
(Alexander et al. 2009).

3- Provision of finance
When companies had to get extra capital to finance expansion they reacted in different
ways in different countries. In countries like France and Germany banks became the most
important supplier of additional resources. In these countries the companies was more
dependent on debt to provide capital for their activities than on equity. In other countries,
like USA and UK, the companies got the extra finance from shareholders. In these
countries the companies was more dependent on equity for the finance of their activities
and a lively stock exchange was and still is in attendance (Alexander et al. 2009).

In countries where companies are mostly financed with equity financial statements will
have an investor or shareholder direction. Because of that the financial statements must
give the kind of information that will make it possible for a conceivable shareholder to
make the best investment choice. This kind of information is called “high-quality”
accounting information. Empirical research has pointed out that when countries have a
strong capital market influence, then it is a higher quality of accounting earnings
compared to countries with creditor orientation. The financial statements have a creditor
orientation in those countries where companies rely more on debt financing. This means
that information given by the annual accounts must be valuable to form an opinion of
whether a company is able to pay back its debt or not. It is important to remember these
kinds of differences in financial statements when companies from different countries are
being compared to each other for financial analysis purposes (Alexander et al. 2009).

4- Taxation
The fiscal authorities use information given in the financial statements in order to find out
the taxable income in countries like Sweden and Germany. In several countries in Europe
you only need to pay tax on expenses if they are also documented in the profit and loss
account. This means that it is in these countries the financial reporting turn out to be tax
influenced. The connection between taxation and financial reporting is frequently found
in countries where they do not have a clear investor approach in their financial reporting
direction. In other countries, like USA and UK, the connection between taxation and
financial reporting is a lot weaker and they have separate accounts or other accounts for
tax purposes (Alexander et al. 2009).

Most important differences in financial reporting

Accounting reacts to its environment and that’s why different environments make
different accounting systems, but similar environments make similar accounting systems.
We focus on these differences in accounting systems in this part. They are brought up as
separate items but they are connected to each other (Alexander et al. 2009).

1- Shareholder orientation
The shareholder orientation affects how the financial statements are designed (Nobes &
Parker 2000). It is important that published financial information is of high-quality in
countries where they have a widespread ownership. It is important because existing and
potential shareholders do not have access to internal information but they need to know
the financial situation about the company where they might want to invest or increase
their investments. In other countries the provider of finance (creditors/insiders) has the
power to get access to the internal information and thereby it is not as important for
revelation in the published information. There are more things that affect the valuation
and one of them is if the company has debt or equity orientation. In debt oriented
countries the financial information has to give several types of stakeholders such as
creditors and the government the information they need to take the right decisions. In
other countries, where the companies are financed with equity, the financial information
should inform about the business performance and effectiveness to existing and potential
shareholders. The dept versus equity orientation lies at the source of the different
reporting and principles that will be explain next (Alexander et al. 2009).

2- Fairness
A fair picture of the financial situation is the purpose in common law countries and in
some countries this is called the “true and fair view” concept. The opposite of fairness is
legality and in code law countries financial reporting is focused on legal demands and tax
laws. The differences between the two concepts can be explained by how they take care
of a lease contract. When the focus is fairness and the country has a strong shareholder
orientation the company is not the real owner of the asset but it is still accounted for the
lease in the balance sheet. In other countries where the focus is on legality, an asset is not
accounted in the balance sheet if the company uses it but is not the real owner of it. This
variation can have a big effect on the debt/equity percentage of companies (Alexander et
al. 2009).

3- Conservatism and accruals

The valuation rules is more conservative in countries where the financial information is
more creditor oriented and used for tax purposes, in contrary to countries where they
have a shareholder orientation where the financial information is more accrual. These two
types of valuation methods lead to a different way of accounting practices and valuation
rules. When a conservative accounting is used it often reports lower profits than if accrual
accounting is being used (Alexander et al. 2009).

4- Uniformity, accounting plans and formats

The regulator thinks it is important with uniformity in code law countries. Fulfillment of
a comprehensive set of balance sheet and profit/loss result based on officially approved
plans for accounting is a base for improved standardization. When it is the government
that does the regulation the layout of the balance sheet, profit and loss accounts and notes
is a lot more detailed (Alexander et al. 2009).

5- Consolidated accounts
The commonness of consolidation has been very different between the countries (Nobes
& Parker 2000). The practice of plans and published consolidated financial statements
came a lot earlier in countries where they had a strong shareholder orientation. In other
countries where they were more creditor oriented, and usually also code law countries,
consolidation was decided by law (Alexander et al. 2009). In the United States they have
used consolidation at least as far back as the 1890s and it was commonly used in the early
1920s. Despite from UK and Netherland, consolidation is anyhow quite new or so far
very unusual. Now when the majority of the developed countries ask for consolidation
the interesting variation are in the description of subsidiaries and associates and how
goodwill and other technical issues is being handled (Nobes & Parker 2000).

6- Deferred taxation
There are countries where there are no straight connection between accounting income
and tax income and their practice of recording deferred taxes on the balance sheet is
deep-rooted and common practice. In other countries where there are a strong connection
between accounting income and tax income the practice of recording and compute
deferred taxes is quite new (Alexander et al. 2009).

Harmonization
There are a lot of accounting differences between countries. Many people want to
decrease these differences and even eliminate them if it is possible. But it is not an easy
process because of the deep-rooted causes of the international differences that has been
discussed earlier. Many attempts have been made to reach a harmonization and EU has
made one of the most significant attempts (Alexander et al. 2009).

It might be easy to mix up harmonization and standardization but harmonization is a

process that increases the comparability of accounting practices by setting bounds to their
level of variation. Standardization on the other hand appears to imply the imposition of a
more inflexible and thin set of rules (Alexander et al. 2009).

Harmonization could be either on de jure-level which is rules and regulation, or on de

facto-level which is how accounting is used in practice by companies. There are three
strategies about harmonization on de jure-level and they are:
 1. Standardization with rules that are uniform and with no chance to choose. FASB
applies this model.
2. Equal rules with notes. EU applies this model.
3. Choice alternatives where wanted alternative has been indicated. IASB has
applied this model.1

Harmonization

Choice alternatives Equal rules Standardization

(Figure 1. Model from Gunnar Rimmel, lecture 090929, Karlstads Universitet)

1
Gunnar Rimmel, lecture 090929, Karlstads Universitet