Chapter 10: International Accounting Instructor’s Manual

CHAPTER HIGHLIGHTS
Chapter 10 examines the standard-setting process in other English-speaking countries, and the
attempt to achieve international harmonization, convergence, or equivalence (whatever the term
du jour is) of accounting standards. There are subtle differences between the terms, but in
practice they are increasingly used as having similar meanings.

The chapter covers several pre-IFRS approaches to accounting. Students may question why we
consider pre-IFRS; this lays the foundation for why variance from strict IFRS may occur. After
adopting IFRS, the countries’ historical accounting approaches may affect how IFRS may be
interpreted and comparability across countries may be affected.

The Anglo-Saxon (also called the Anglo-American) and the continental approaches to
accounting reflect some marked cultural differences within Western civilization. The Anglo-
Saxon approach is grounded in strong equity capital markets and a strong accounting profession
with accounting rule making usually centered in a quasi-private organization. For continental
countries debt financing through major banks has been far more important than the use of equity
capital though this is beginning to undergo change. In addition, the accounting profession has
not been especially strong in continental countries and accounting rules have been determined by
law.

The formation of the European Union (EU) brought changes to this picture, first by the issuance
of several directives that attempted to bring about harmonization of accounting to EU members.
However, in 2005 all countries within the EU began using International Accounting Standards
Board (IASB) standards for consolidated financial statements. EU standards are also allowed for
financial reporting on the New York Stock Exchange without the need for reconciling to United
States GAAP. The latter has come about as a result of an attempt to bring about “convergence,”
a moving together between IASB standards and U.S. GAAP. This EU adoption gave legitimacy
to the IASB as a global standards setter; it is now on equal ground with the FASB. For years, the
U.S. was relatively passive about international standards with little need to go beyond U.S.
GAAP. Without a doubt, U.S. GAAP provided the most developed and most broad set of
standards in the world for the last century. However, the corporate accounting and auditing
scandals left everyone reeling in the early 2000s. Hence, following directives from the SEC and
Congress, the FASB’s newfound interest in convergence with IFRS blossomed.

The IASB-FASB convergence projects started with the Norwalk Agreement of 2002 and are
reaffirmed in the annual Memorandum of Understanding. The projects are both short-term and
long-term in nature. The short-term projects are intended to remove numerous individual
differences in standards between IFRS and US GAAP. The long-term projects include those
areas where accounting guidance will be improved (e.g., share-based payments, revenue
recognition).

In 2004 the two bodies added a conceptual framework project to their joint work. They have
completed work on the objectives and qualitative characteristic (item 1) and are pursuing
convergence on (2) elements, recognition and de-recognition, and (3) measurements. Projects

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not yet started include: (4) reporting entity, (5) presentation and disclosure, (6) purpose and
status, (7) applicability to not-for-profits, and (8) finalization of the complete framework.
We recommend that you review the IASB’s most current work plan online before starting this
chapter. The changes are occurring significantly faster than any textbook can keep up with given
its publication cycle.

Note: There is a short project at the end of this file that you may want to use in your course. We
have found that it is best assigned to small student groups, 2-3 members per group. Once the
papers are submitted, group presentations to the class complete the projects.

QUESTIONS

Q-1 What does harmonization of accounting standards mean?

Harmonization concerns the degree of similarity or uniformity among the various sets of national
accounting standards and methods of financial reporting.

Q-2 What is convergence and how does it differ from harmonization?

Convergence arose as a result of an effort to eliminate major differences between IASB

standards and U.S. GAAP. The reasons for the convergence projects vary, but a generally
accepted one is an effort to improve financial reporting efficiency. Convergence of the two
standards would allow for American security registrations and for published financial statement
purposes without reconciliation between the two. The term “equivalence” has also been used
when referencing convergence projects.

Convergence projects are underway between the IASB, the USA, and Japan. However, as of
2011, the Japanese convergence project is moving significantly slower than the one with the
USA. The Norwalk Agreement of 2002 and the separate conceptual framework project of 2004
are moving forward, showing good progress towards convergence. U.S. laws now require
annual reporting by the SEC, FASB, and PCAOB on improving financial reporting (e.g.,
principles-based accounting, transparency, understandable standards), so continued progress
towards convergence of IASB and U.S. GAAP is probable, albeit slower than what we would
like to see. The IASB usually takes about five years to publish a new standard, so this is
definitely a long-term project.

Harmonization is more passive and involves a general movement among “first world” countries.
One aspect of harmonization, material harmonization, refers to making the accounting practices
of different enterprises similar. Note that recent articles in the popular press tend to use the
terms harmonization, convergence, and equivalence as meaning the same thing. The key thing to
look fro in the U.S. once convergence is attained will be “adoption.”

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Q-3 The EU opted to use exclusively IASB standards for consolidated financial statements
beginning in 2005. What drove this decision?

While the Fourth and Seventh Directives improved harmonization, the pace was not fast enough,
particularly since many firms needed access to major capital equity sources. As a result, the
IASB’s body of accounting standards allowed for a significantly faster harmonization of financial
reporting within the EU nations. In 2005, 7,000 listed EU companies began reporting using
IFRSs, creating a significant workload for the IASB.

Q-4 Compare the true and fair view of the United Kingdom, the “present fairly” outlook of
the United States, and the legalistic view of the Continental model.

The “true and fair” view is grounded in “economic reality” and refers to using judgment in order
to make financial statements more useful for decision-making purposes. This may well mean
going around existing standards. The “present fairly” outlook has been seen as somewhat similar
to the true and fair view, but generally means that financial statements are presented in
accordance with GAAP. Superficially, then, the present fairly outlook seems to correspond with
the legalistic view of the continental model, except that United States GAAP is much more user-
oriented than the continental model, which is geared more toward protecting creditors and
determining income tax liabilities.

Q-5 What are the different conceptions of the true and fair view?

The true and fair view, which is an abstract concept to begin with, appears to be subject to
individual interpretation within each of the EU nations according to their own needs. Note that
this term has drawn particularly strong responses from the UK accounting profession. The
IASB-FASB convergence project on a conceptual framework evoked strong words regarding
what the UK views on this term really mean. Note that translation of the words “true and fair” to
a non-English language is problematic, especially when the culture lacks a strong economic
language.

Q-6 Why has no Continental model country developed a conceptual framework?

The primary purposes of the continental model—at least prior to the EU directives, which are
geared to the true and fair view though done within the cultural restraints of each member
country—have been to protect creditors and to determine tax liability. These relatively narrow
objectives do not really need a broad theoretical document such as a conceptual framework for
developing accounting standards. Even more to the point, continental model countries do not
have standard-setting organizations such as the FASB. Conceptual frameworks would hardly be
used where company law alone is the primary instrument for making accounting rules.

Q-7 What is the relationship between the IFAC and IASB?

IFAC (International Federation of Accountants) and IASB (International Accounting Standards

Board) are complementary and work in different spheres, but they cooperate with each other.

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IASB’s primary function is the harmonization of accounting standards, which they attempt to
achieve by issuing international accounting standards. IFAC issues guidelines in areas such as
auditing standards, education, and ethics. A good class discussion question might address why
these two organizations should or should not consider merging at some point in the future.

Q-8 What are the main distinctions between the Anglo-Saxon and the continental models?

Anglo-Saxon countries are more user-oriented and less oriented toward the primary purposes of
protecting creditors and determining income tax liability. Anglo-Saxon countries have stronger
accounting professions than do the continental countries. They are also more likely to have
standard-setting agencies and conceptual frameworks, though these are much more recent
developments.

Q-9 How does the role of government differ in the United Kingdom and the United States
relative to financial reporting?

Standard setting in the United States is accomplished through private sector bodies; today the
FASB is that body. The SEC has statutory authority to set accounting standards, but has
relegated that to the FASB. It is important that the FASB receives its funding from the SEC
approval of its budget. The FASB’s funding comes from accounting support fees, not taxpayer
monies. However, the collected fees are funneled through the SEC for its approval of the
FASB’s annual budget.

There is no United Kingdom equivalent of the SEC. The main standard-setting thrust in the
United Kingdom has come through the company laws in the past. In addition, there have been
some government-sponsored committees that have made recommendations in the United
Kingdom in areas such as inflation accounting, but these committees have included members
from the profession. The United Kingdom has been moving closer to the American model of
standard setting since 1970.

Q-10 What are the possible implications if accountants outsource the balance sheet to
external appraisers (applying fair value accounting) for period-end financial statement
reporting?

This is a thought question. Might the internal accounting function be relegated to simply
bookkeeping with periodic receiving of finished parts from external vendors for assembly into a
finished financial report. Discuss whether accounting as a manufacturing entity, producing
financial reports, might benefit or be adversely affected by this type outsourcing. Might we learn
from the automotive industry? Might the audit be shifted from individual companies to the
suppliers (appraisers) supplying the fair values for balance sheet preparation. This would be a
paradigm shift that the accounting profession would resist and likely not see coming (consistent
with Kuhn’s view of paradigm changes).

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Q-11 For years the FASB had little interest in pursuing international harmonization projects.
What prompted its seemingly new interest in 2002 to work with the IASB in such a
cooperative manner?

Remarks by Paul A. Volcker before the Accounting Regulatory Committee of the European
Commission, Brussels, 25 Feb 2005. Paul Volcker, former Chair of the International Accounting
Standards Committee Foundation (IASCF) says that international standards were fine for years,
“so long as they were made in the good old U.S. of A”

It was the series of accounting and auditing frauds that created the more receptive attitude
towards international standards. The U.S. model of financial reporting was obviously not
working. Add some very specific changes in the law (SOX of 2002) requiring the SEC to act
and the idea of working with the IASB became significantly more attractive than in the past.

Q-12 Evaluate the IASB’s approach to convergence.

The IASB sees development of a single set of high quality, global accounting standards to help
users make economic decisions as its objective. It assumes that if attained: (1) financial
reporting costs will be reduced, (2) comparability will be enhanced, (3) investment risk will be
reduced and, therefore, lower the cost of capital, (4) international capital flows will be improved,
and (5) financial returns will improve.

Approximately 50% of the world’s market capitalization is in the U.S. and there are only two
major standard-setting bodies, IFRSs and U.S. GAAP. So, the IASB’s plan to converge with
U.S. GAAP, its only viable competitor, makes sense to us. IRFRs (as of 2007) are used in over
100 countries for listed companies and over 60 countries for unlisted companies. By converging
with U.S. GAAP, it enhances its credibility with the remainder of the non-IFRS world. It also
improves the possibility that the U.S. will eventually adopt IFRSs.

The challenge/risk with convergence is that differing standards will be negotiated to reduce
variances. The result could affect the high quality objective. Special interests could overrule the
need for transparent reporting. Finally, once convergence is stated as being achieved,
consistency of implementation (especially when translating the English standard) is a concern
that will need to be addressed. Otherwise, you may think you have comparability when none
exists.

Q-13 As Schipper seets it, why do the rules based and principles based approaches to
standard setting tend to converge?

Schipper, Katherine (2005). “The Introduction of International Accounting Standards in Europe:

Implications for International Convergence, “European Accounting Review” (May, 2005),
pp. 101-126.

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Schipper believes that a principles-based approach needs extensive implementational guidance to

make it work well. This will result in an erosion of the differences between rules-based and
principles-based approaches. Without the implementational guidance, preparers and auditors
will revert to other sources for guidance (e.g., local jurisdiction-specific GAAP, EITF
pronouncements), reducing comparability. So, as convergence progresses between U.S. GAAP
and IFRS, expect IFRS to look more like rules-based standards.

Q-14 How will the role of national standard-setting bodies be affected by adoption of IASB
standards?

This is a thought provoking question, one with no single correct response. One extreme would
be to assume that adoption of IASB standards would negate the need for any local (country)
standard-setting body. Politically, this is not likely. New Zealand is a good example of what has
occurred when this change took place. We suggest that if (probably when) the U.S. adopts IASB
standards, the FASB will remain as a standards-setting body, but with a revised role. That role
may be one of advisory to the IASB or it may morph to a standards setter for private companies.
For decades the U.S. has led the world with its accounting standards. This leadership culture
will resist relinquishing that role. However, if another round of accounting scandals emerges, we
believe IASB adoption is likely.

Q-15 How do de facto harmonization and de jure harmonization differ from each other?

De facto harmonization (also called material harmonization) refers to harmonization of the

financial reporting practices. De jure harmonization (also called formal harmonization) refers to
of harmonization of the accounting rules or regulations of different countries or groups. So, the
difference relates to the rules themselves versus how they are implemented. Harmonization is,
therefore, a moving target and measurement of the degree of harmonization is problematic.

Q-16 What are the advantages of convergence-harmonization of accounting standards?

Financial reporting costs will be reduced. Comparability of financial reports will be enhanced.
Investment risk will be reduced and, therefore, lower the cost of capital. International capital
flows will be improved. Financial returns will increase. Note that the idea of convergence is not
100% accepted by all as the way to go; ask your students to search for the positions of the larger
CPA firms.

Q-17 Is the revenue-expense orientation consistent with fair value measurement?

Benston, George, M. Bromwich, and A. Wagenhofer (2006). “Principles-Versus Rules-Based

Accounting Standards: The FASB’s Standard Setting Strategy,” Abacus (Vol. 42, No. 2), pp.
165-188.

BB&W suggest that the principles-based approach would work better in tandem with the
revenue-expense orientation rather than the asset-liability of SFAC No. 6. Their reason for this
view is that with fair value accounting increasingly coming on board, accounting standard setters
would have an extremely complex mechanism with many rules and guidelines (this point is true

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relative to SFAS No. 157). They see the revenue-expense model as being able to produce more
reliable and auditable numbers. However, there is an inconsistency between the revenue-expense
approach and fair value measurement because fair value is primarily geared to the primacy of the
balance sheet. BB&W would provide under either principles-based or rules-based standards, a
true-and-fair override which would give accountants more professional responsibility and
provide more transparent numbers.

CASES, PROBLEMS, AND WRITING ASSIGNMENTS

1. What are the main distinctions between the Anglo-Saxon and the Continental models
relative to accounting and financial reporting? Within the Anglo-Saxon group, how
does the United States differ from other members of the group? What developments
are leading to erosion of differences between at least some members of the Anglo-
Saxon and Continental groups?

The Anglo-American model is more strongly oriented toward providing financial information for
users (mainly investors and creditors), whereas the continental group is more oriented toward
protecting creditors and providing tax information. The accounting profession is much stronger
in Anglo-American countries as opposed to continental countries, whereas governmental
influence is stronger in the latter.

Within the Anglo-American group, the United States’ approach of a private-public partnership
regarding standard setting is unique. However, most countries in this group now have standard-
setting organizations that diminish, to some extent, the dominance of company laws in the
standard-setting arena. Also like the United States, the United Kingdom, Canada, and Australia
have now developed conceptual frameworks, although these newer conceptual frameworks have
a slightly broader purpose—accountability—as opposed to primarily being geared to user
(investor and creditor) needs. Organizations similar to the Emerging Issues Task Force are
arising in Anglo-American countries.

The great leveler between the Anglo-American and continental groups is that the European
Union consists of countries in both groups. Hence, differences within the EU were slowly
beginning to crumble in light of the Fourth and Seventh Directives, which favor the true and fair
view. Nations, however, could implement these directives within their own cultural orientation,
at least to a limited extent. The requirement that all EU countries must use IASB standards for
consolidated financial statements will – in a short time – tear down the wall between the two
groups.

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2. According to Alexander and Archer (2000), Anglo-Saxon (or Anglo-American)

accounting is a “myth.” Discuss their reasons for this. Do you agree with them?

Alexander, David, and S. Archer (2000). “On the Myth of ‘Anglo-Saxon’ Financial
Accounting,” The International Journal of Accounting (Vol. 35, No. 4), pp. 539–557.

Alexander and Archer analyze "true and fair view" and "fair presentation in accordance with
GAAP" showing that a difference exists between the UK and US approaches. The differences
between UK and US financial reporting are taking on an increased significance that is evident in
recent articles resulting from the IASB-FASB convergence projects. Increased SEC oversight of
the FASB suggests that the FASB as an Anglo-Saxon model member is changing, making the
term one for historical reference only.

CRITICAL THINKING AND ANALYSIS

1. Why do we need international accounting standards? Why not simply let each country
develop and use its own standards and let it go at that?

With increasing registration of foreign securities listings on domestic stock exchanges, securities
exchanges very likely want as much harmonization as possible whether it comes through IASB
standards or standards of the various nations. Securities exchanges such as the New York Stock
Exchange would also want harmonized standards which might be termed as “high quality”
standards.

From the standpoint of regional associations such as the European Union (and possibly NAFTA,
somewhere down the line) this may prove to be a boon because it is going to be very difficult to
attain harmonization within their grouping where national legislatures within continental model
countries retain so much power. A supranational organization such as IASB may be quite
helpful in terms of bringing about harmonization. Note, however, that the IASB has no authority
to force adoption of its standards.

The role of standard-setting agencies in Anglo-Saxon model countries, such as the FASB, is
most ambiguous. With the IASB playing a dominating role in harmonization, country-specific
standard-setters appear to be relinquishing power to the IASB. However, the politics behind the
scenes is an unknown at this point, a very intriguing topic. Another possibility involves a
possible two tiered approach with national standards by the FASB and other standard-setters
exceeding minimum level standards of the IASB is another possibility. How much freedom
domestic firms would have to choose IASB standards over their own national standards becomes
an interesting question.

2. The IASB and FASB are pursuing a single, converged conceptual framework. The
United States has a good start with SFAC No. 8. What additional changes should FASB
make to further improve its conceptual framework?

This is an appropriate in-class, small group discussion assignment. Have the students review the

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respective conceptual frameworks before class. The qualitative characteristics are converged, so
what needs to be done next? There is not a correct answer, but the process highlights the
difficulty in developing a single framework.

Emphasize that the FASB framework is for standard-setters; the IASB’s is for standard-setters
and practice. When faced with an unclear accounting problem, IFRSs practice first looks for
comparable existing standards and then relies on the conceptual framework for guidance.
FASB’s framework has no such authoritative nature.

3. In 2003, South Africa was the first country to adopt IFRS with fair value accounting.
The country does not allow for differential accounting treatment depending on the size
of enterprise. What type of response do you expect from this implementation?

Many of the country’s small farmers were outstanding vintners, but not accountants. Principles-
based IFRS was overly complex with relatively few guidelines for implementation. Language
and culture were obstacles that produced stress from the accounting, not from the production of
their grapes.

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Note: A small project, one not listed in the text book, for the semester that you may want to
consider follows:
Objective of the project
Obtain an understanding of U.S. GAAP, IFRS, and GAAP as practiced by a third accounting
body (e.g., Canada, China, India, Mexico, Russia, Taiwan, Vietnam). This triangular review of
these systems should identify the commonalities and analyze the differences between the three
accounting systems.
Small Group Collaboration
This assignment will completed by student teams of 2-3 students per team, a size of three
members being ideal. FASB and IASB GAAPs will be relatively easy to identify and analyze.
The third country’s GAAP may be difficult to locate and translate, so invest some time reviewing
individual country GAAPs before locking in your selection.
Outline of the Paper
Introduction: Tell me what you are going to tell me.
Specific country
• Description of country (e.g., demographics, language, economics).
• Description of its accounting standards setting body, equivalent of the FASB and IASB.
Include its history, board composition, processes, structure, whatever is necessary to
understand its processes used to create GAAP. Make sure you research your country on
the Internet to determine if the standards-related information is in a language you can
understand. Do this before telling your teacher which country you want to study.
• Country’s accounting standards, define its GAAP. Couch the description in the context
of the type model it tends to follow (e.g., Continental, Anglo-Saxon). This could become
lengthy, so talk with your teacher, if it appears to be overwhelming.
Comparisons
• Prepare a table that compares the three GAAPs. To facilitate comparability within the
class, format your table as follows:
o Column 1, IASB standard
o Column 2, FASB standard
o Column 3, your specific country’s GAAP
o Column 4, your qualitative assessment of the variance between the three GAAPs.
0. insignificant or no differences between the bodies
1. minor differences between the bodies
2. significant difference between two of the bodies
3. significant difference between all three bodies
Note that IASB has some 41 standards (some may have been superceded); this is too
many to address in your research. Instead, focus on 10-12 at most.
• Analysis
o Analyze those standards you have assigned a number three (3) in column 4 above,
a maximum of five (5) standards. If you have less than five number 3s, add
number 2s to your potential analysis list until you have a minimum of seven (7)
standards to analyze.
o In your analysis, determine the theoretical basis (the rationale) for each of the
respective GAAPs.
• Convergence

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o Present your proposal to harmonize/attain convergence of each standard (again,

focus on the five standards you identified as having the most significant
differences).
o Describe the largest obstacles to attaining convergence of each standard,
immediately following your proposal for each one.
o Which, if any, of your country’s GAAPs are possible solutions for IASB and
FASB differences?
Summary
• What are your conclusions from your study?
• Tell me what you told me.

Style Requirements

Submit your assignment electronically to Professor Dodd before the beginning of the class on 22
March.
• Microsoft Word document
• 12-point font
• Use the header and footer in this document
• Single-spaced body of the text
• Double-spaced between paragraphs
• Beginning of paragraphs is not indented
• Bibliography (references) is last page of your paper
• Parenthetically cite your references (e.g., Wolk, 1996)

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Example of the Comparisons section of your country-specific project

India
This is just a very brief comment to introduce you to the example country that follows.
The Institute of Chartered Accountants of India (ICAI) is the governing professional body
representing the accountancy profession at national and international levels. The Accounting
Standards Board of the ICAI issues statements of Accounting Standards (AS) prescribing
methods of accounting approved for application to financial statements. In addition to the AS,
the ICAI issues generally accepted accounting principles (GAAP), and guidance notes that must
be followed.

Comparisons
Prepare a table similar to the following one. Note that I added endnotes to clarify why I
classified the variance as a “1, minor differences in the bodies” in this single example. The
instructions do not require that you footnote/explain every number in your Variance column, but
you may find it helpful as you analyze each standard. I used IAS 7, Cash Flow Statements, as an
example of how to approach the assignment.

IFRSi FASB Indiaii Varianceiii

IAS 1
Presentation of Financial Statements
IAS 2
Inventories
IAS 3
Consolidated Financial Statements
superceded by IAS 27 and 28
IAS 4
Depreciation Accounting
replaced by IAS 16, 22, and 38
IAS 5
Information to Be Disclosed in Financial
Statements
IAS 6
Accounting Responses to Changing
Prices
Superseded by IAS 15, which was
withdrawn December 2003
AS 3, revised
SFAS 95
IAS 7 1997
Statement of Cash 1iv
Cash Flow Statements Cash Flow
Flows
Statements
etc. through IAS 41
IFRS 1 through 8

Note that the instructions require that you start with the IASB standards. This will be the
limiting factor in your analyses (41 IASs + 8 IFRSs). Note that some of the IFRSs have been
withdrawn and will require no comparisons or analysis; some may have no comparables at FASB

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or within your country. Once you have completed the table, go to the next step and analyze those
with variances rated as threes, significant difference between all three bodies, but limit your
analysis to only five standards. This will meet the requirements for this part of the assignment.
However, if you actually get interested in this assignment, you may want to go beyond this step
and identify differences that this methodology misses.

Remember that the objective of the assignment is to obtain an understanding of the similarities
and differences between the accounting standards of IASB, FASB, and a set of country-specific
standards. It requires detailed work that can become frustrating. So, remember that patience is
definitely a virtue.

i The term 'IFRSs'. The term International Financial Reporting Standards (IFRSs) has both a
narrow and a broad meaning. Narrowly, IFRSs refers to the new numbered series of
pronouncements that the IASB is issuing, as distinct from the International Accounting
Standards (IASs) series issued by its predecessor. More broadly, IFRSs refers to the entire body
of IASB pronouncements, including standards and interpretations approved by the IASB and
IASs and SIC interpretations approved by the predecessor International Accounting Standards
Committee. Reference: Deloitte URL: http://www.iasplus.com/standard/standard.htm
ii It may be helpful to add an appendix (for reference only) with the more detailed explanations
of each standard India uses. ICAI URL: http://www.icai.org/icairoot/resources/as_index.jsp
iii Qualitative assessment of the variance between the three GAAPs
0. insignificant or no differences between the bodies
1. minor differences between the bodies
2. significant difference between two of the bodies
3. significant difference between all three bodies
iv India requires that cash flows arising from interest paid and interest and dividends received in
the case of a financial enterprise be classified as cash flows arising from operating activities. In
the case of other enterprises, cash flows arising from interest paid are classified as financing
activities. IASB allows for interest classification as an operating or financing activity. FASB
requires that it be within the operating activities section.

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