Chapter 2 Worldwide Accounting Diversity

Chapter 2:
Worldwide
Accounting
Diversity
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objectives
 Provide evidence of the diversity that exists in accounting
internationally
 Describe the major factors that influence the development
of national accounting systems and lead to cross-national
accounting diversity
 Explain the problems caused by accounting diversity
 Describe attempts to classify countries by financial
reporting system
 Describe a simplified model of the reasons for international
differences in financial reporting
 Categorize accounting differences internationally and
provide examples of each type of difference
2-2
Evidence of Accounting Diversity
Categories based on Accounting

Differences
Problems Caused by Accounting Diversity
Reasons for Accounting Diversity
Classification of Accounting Systems
Influence of Culture on Financial Reporting
Nobes’ Simplified Model to Explain Financial Reporting

International Differences
2-3
Evidence of Accounting Diversity
Superficial Differences Major Differences

 Format  Recognition rules
 Terminology  Measurement rules
Categories based on Accounting

Differences
1. Financial statements included
2. Format of financial statements
3. Level of detail in financial statements
4. Terminology
5. Disclosure
6. Recognition and measurement differences
2-4
Categories based on Accounting Differences
1. Financial statements included

2. Format of financial statements
3. Level of detail in financial statements
4. Terminology
5. Disclosure
6. Recognition and measurement differences
2-5
1. Financial Statements Included
Which FSs? Companies worldwide provide a balance sheet and an income

statement. However, there is less uniformity in relation to the
need to provide a cash flow statement
SOCI Location Statement of Other Comprehensive Income (SOCI) can either be
separate from the profit and loss account or combined in
Statement of Comprehensive Income (SCI)
Parent FSs? In addition to consolidated financial statements, UK companies
also include the parent’s separate financial statements
2-6
2. Financial Statement Format: Balance Sheet
Shape
Two-Sided assets (on the left) = credits (liabilities + equity)
Report Form assets (on top) = credits (liabilities + equity)
A Financial Position net assets (assets – liabilities) = equity
Format:
(used by UK companies)
Order of Liquidity
Liquidity decreasing (cash at top) US, Mexican, Canadian, Japanese companies list
assets and liabilities in the balance sheet from
most liquid (cash) to least liquid (fixed
assets/intangibles)
Liquidity increasing Companies in most other countries list assets and
liabilities in the reverse order
2-7
2. Financial Statement Format: Profit and Loss Account
Shape
Vertical Popular in countries with greater shareholder orientation
Two-sided
Ways of Combining Costs

Cost-of-Goods-Sold Format  Expenses recognised by function (cost of sales,
administrative costs, distribution costs)
 Allows the calculation of gross profit
Type-of-Expenditure Format  Expenses recognised by nature (total
purchases, total depreciation, total wages)
 Gross profit margin cannot be calculated
2-8
3. Level of Detail
Line Items Some (e.g., American) companies provide few line items on
the face of the financial statements as opposed to more
detailed line items by companies in other countries
Rounding Numbers? Some (e.g., UK, US) companies show rounded numbers while
other (e.g., Qatari) companies show numbers without
rounding
Note Column? Some companies show the note column while the practice of
showing the note column is unknown in the US
2-9
4. Terminology
United States United Kingdom
Sales revenue Turnover
Inventory Stocks
Accounts Payable Creditors
Accounts Receivable Debtors
Called up share capital Common stock
Provisions Estimated liabilities
Profit and Loss account Retained Earnings
2-10
5. Disclosure Differences
Many companies provide additional voluntary disclosures in the notes such as:
Number of employees by gender or geographical area and their total remuneration
Amount of audit and nonaudit fees
Post retirement benefit provisions (liability of uncertain timing or amount)
2-11
6. Recognition and Measurement Differences
Recognition is the decision of whether an item should be recorded in the
financial statements or not
Example IFRS US GAAP

Development Some development costs Most development costs must be
costs must be capitalized if they expensed under US GAAP and
meet certain criteria and therefore recognised as expenses
therefore are recognised as
assets
Internally Both IFRS and US GAAP agree that internally generated goodwill
generated should not be capitalized and therefore cannot be recognised as
goodwill assets
2-12
6. Recognition and Measurement Differences
Measurement is the determination of the amount to be reported on the
financial statements.
Example IFRS US GAAP

Inventory Only Weighted average and Allows FIFO, Weighted Average
Valuation FIFO are allowed and LIFO
Land in PPE Land can be measured at Land must be measured at HC
either Fair Value (FV) or
Historical Cost (HC)
2-13
Problems Caused by Accounting Diversity
1. Preparation of consolidated financial statements by
companies with foreign operations
2. Access to foreign capital markets
3. Comparability of financial statements
4. Lack of high-quality accounting information
2-14
1. Preparation of Consolidated Financial Statements by
Companies with Foreign Operations
Problems due to:
Books In local currency
Local accounting principles
For example, a US multinational company must first convert the subsidiary’s
financial statements into US GAAP before translating the foreign currency of its
subsidiary’s financial statements into US dollars
Requires:
Considerable effort and additional cost
Expertise in different country’s accounting standards
2-15
MCQ: choose the best answer:
For Apple, a US multinational company, consolidating the
financial statements of its foreign subsidiaries requires two
steps. First, the foreign subsidiary's statements must be restated
according to US GAAP. The next step is to
A. Restate the income statement using international

accounting standards
B. Calculate the translation adjustment
C. Convert the account balances into US dollars
D. Determine the exchange rate gain or loss
1-16
2. Access to Foreign Capital Markets
If a company desires to obtain capital by selling stock in a foreign country, it might
be required to present a set of financial statements as per local accounting
standards
For example, before 2007, if a Swiss company wanted to obtain capital by having its
shares listed on the New York Stock, it had to either prepare its financial statements
using US GAAP or provide a reconciliation of local GAAP net income and
shareholder’s equity to US GAAP
Reconciliation from one set of GAAP to another can be costly and requires
considerable effort
Listing in the US Before 2007 After 2007

Foreign companies must prepare financial statements must prepare financial
using US GAAP or provide a statements using US GAAP or
reconciliation of local GAAP net IFRS or provide a reconciliation
income and shareholder’s equity to of local GAAP net income and
US GAAP shareholder’s equity to US
GAAP
US companies must prepare financial statements must prepare financial

using US GAAP statements using US GAAP
2-17
3. Comparability of Financial Statements
Accounting diversity leads to a lack of comparability of financial statements

between companies that use different GAAP
Lack of comparability adversely affects:

Investment and Lack of comparability adversely affects the performance
lending decisions analysis of foreign financial statements for making
investment and lending decisions with respect to foreign
companies. For example, a potential investor will find it
difficult to compare the financial position of Volkswagen (in
Germany), Lamborghini (in Italy) and Ford (in the US)
Foreign acquisition Lack of comparability adversely affects foreign acquisition
decisions decisions by corporation because financial statements need
to be converted to local GAAP before acquisition of a
foreign company could be seriously considered
2-18
4. Lack of High-Quality Accounting Information
The Case of East Asia Financial Crisis

Lack of high-quality accounting standards in some parts of the world have led to the
1997 financial crisis in East Asia
Lack of appropriate disclosure requirements contributed to the crisis because
investors could not assess risk because the financial statements did not reveal the
extent of risk exposure
2-19
Reasons for Accounting Diversity
Legal Systems Taxation
 Common Law • Financial Statements form the basis for

 Code Law tax
• Financial Statements are adjusted for tax
Providers of Financing Inflation
 Banks/families/government  Common in Latin American

 Shareholders countries
 Requires adjustments to
offset inflation
Political and Economics Ties
• Former colonies
• EU mandating IFRS
2-20
Legal Systems
Common Law Code Law

Great Britain and other English- Non-English-speaking countries
speaking countries
Fewer statutes — more court More statutes or codified laws
interpretation. Creation of precedents
or case laws
Sources are non-legislative Legislated accounting rules. Accounting
organizations. Accountants profession have little influence on
themselves establish accounting accounting standards
standards
Accounting law is detailed and specific Accounting law is general and silent on
some areas. Guidance is found from
other sources such as tax law and
textbooks
An exception is the corporation law laying the

basic framework for accounting in the UK
2-21
Providers of Financing
‘Banks/family’ group ‘Outsider shareholder’ group

Less pressure for accountability. Demand for extensive disclosure
Disclosure is not important
Families, banks, and the government Shareholders have no access to internal
are represented on the board of accounting records
directors and have inside information
Emphasis on the balance sheet Emphasis on the income statement
because banks are interested in because shareholders are interested in
solvency and liquidity profits
Banks prefer prudent and conservative Shareholders prefer flexibility, judgment
accounting and fairness
2-22
Taxation
Financial statements form the basis Financial statements are adjusted for tax
for taxation purposes
Taxable income = Accounting income Taxable income = Accounting income
An expense deductible for tax There is no conformity between tax
purposes must also be used in the statement and financial statements
calculation of financial statement
income
For example, German companies use For example, US and UK companies use
accelerated deprecation to reduce tax accelerated deprecation for tax purposes
liability and straight-line deprecation in the
financial statements
A major exception is the use of LIFO

inventory valuation in the US, largely for
tax reasons
2-23
Inflation
Latin American countries for example have historically high rates of inflation
To offset inflation, it is necessary to adopt accounting rules that require inflation

adjustments to historical cost amounts
Adjustments for inflation results in a write-up of assets (inventory, PPE) with a
corresponding increase in deprecation expenses
Inflation has been successfully brought under

control in most countries, so this factor is no
longer important as it used to be!
2-24
Politics and Economics Ties
Political and Economic ties affect how accounting rules are conveyed from one
country to another
Through colonialism, England (to Australia, Zimbabwe and Qatar?) transferred their
accounting to many countries around the world
Politics and Economics have led the EU to require all listed companies to use IFRS
for their consolidated accounts
• The use of a standardised accounting system will strengthen EU capital markets
• The EU could not influence US GAAP used by some German companies for their
consolidated statements
2-25
Correlation of Factors
Legal Systems Providers of Financing Taxation
 Common law countries have many domestic listed

companies relying on equity for capital. This leads to a
separation between tax and accounting rules
 Code law countries tend to link taxation to accounting

statements and rely less on financing provided by
shareholders
2-26
Correlation of Factors
2-27
Classification of Accounting Systems
There were clusters of countries that share common accounting
practices: One classification identifies 3 accounting models
The Fair Presentation/Full The Legal Compliance The Inflation-Adjusted
Disclosure Model Model Model
Anglo-Saxon or Anglo-
Continental European Resembles the Continental
American model model European model
Accounting is oriented
Accounting is legalistic Accounting is legalistic and
toward the decision needsand used to provide used to provide
of large numbers of information for banks, information for banks,
investors and creditors taxation and taxation and government-
government-planning planning
Used in English-speaking Used in Europe, Japan, Requires extensive use of
countries and other and code law countries adjustments for inflation
common law countries
influenced by the United
Kingdom or the United
States
2-28
Question:
In japan the source of finance are banks, the legal
system is code law, the tax is linked to accounting, they
are politically and economically related to USA, the
inflation is low with a high economic and education level;
which accounting model we expect to find in Japan?
2-29
Answer:
Japan uses the legal compliance model where
accounting is legalistic and used to provide
information for banks, taxation and government-
planning
2-30
Nobes’ Judgmental Classification
This classification can be used as a blueprint for determining where
financial statement comparability is greater
2-31
Nobes’ Judgmental Classification of Financial Reporting
Systems
Micro-based Class of Accounting Macro-uniform

Systems Accounting Systems
Describes: The Anglo-Saxon model The Continental
European model
Each model is divided
into two subclasses:
First-subclass Government Economics Business Practice
Second-subclass Continental: government, tax, Business Economics
legal Theory
2-32
Micro-based Class of Accounting Systems
First-subclass Second-subclass
Business Practice Business Economics Theory
Based on: Business practice rather than Business economics and
economic theory: Pragmatic and accounting theory (the
theory of replacement
value)
Family UK Influence US Influence
Example UK USA The Netherlands is the only

Ireland Canada example (Dutch companies
New Zealand were permitted to use
Australia current replacement cost
accounting to value assets)
2-33
Accounting in the Netherlands: Current Replacement Cost
9-34
Heineken’s Example: Notes to the Balance Sheet and Income
Statement
9-35
Macro-uniform Accounting Systems
First-subclass Second-subclass
Government Economics Continental: government, tax, legal
Family Law-based Tax-based
Example Sweden Japan Spain
Germany Belgium
France
Italy
Swedish accounting is Accounting law determines Tax law dominates
closely aligned with accounting practice accounting
national economic policies practice
(e.g. income smoothing)
2-36
Hofstede’s Cultural Dimensions

Hofstede identifies five cultural dimensions along which countries could be
positioned
Gray’s Accounting Values

Gray extended Hofstede’s model to understand how culture influences the corporate
reporting systems
Gray developed four accounting values to describe a country’s accounting system
Gray believes that national cultural dimensions affect accounting values which
affect accounting systems
2-37

Hofstede identifies five cultural dimensions along which countries could be
positioned

Gray extended Hofstede’s model to understand how culture influences the corporate
reporting systems
Gray developed four accounting values to describe a country’s accounting system
Gray believes that national cultural dimensions affect accounting values which
affect accounting systems
Accounting Systems
5 Cultural 4 Accounting
(measurement and
Dimensions Values
disclosure)
2-38
1. Individualism vs. Preference for a loosely knit social fabric (where individuals
collectivism are supposed to take care of themselves) rather than tightly
knit social fabric (collectivism)
2. Large vs. small The extent of the acceptance of hierarchy and unequal
power distance power distribution in organisations and institutions
3. Strong vs. weak The degree to which individuals feel uncomfortable with
uncertainty uncertainty and ambiguity
avoidance
4. Masculinity vs. Emphasis on the masculine values of achievement and
femininity performance rather than the feminine values of relationships,
caring and naturing
5. Long-term Focus on fostering virtues oriented towards future rewards
orientation vs. short- such as perseverance and saving (as opposed to focusing on
term orientation the present or past)
Social Fabric is a metaphor for society. It considers all the individual members as
threads, the tighter the weave, the stronger the fabric. The looser the weave, the
weaker the fabric
2-39

1- Professionalism vs. Preference for exercise of individual professional judgement and
Statutory Control maintenance of professional self-regulation as opposed to
compliance with legal requirements and statutory control
2- Uniformity vs. Preference for enforcement of uniform accounting practices
Flexibility between companies as opposed to flexibility in accordance with
the perceived circumstances of individual companies
3- Conservatism vs. Preference for cautious approach to measurement so as to cope
Optimism with the uncertainty of future events as opposed to more
(influences optimistic, risk taking approach
measurement of
assets and profits)
4- Secrecy vs. Preference for confidentiality, and restriction of information
Transparency disclosure to those who are closely involved with
(influences disclosure) management/financing, as opposed to more transparent, open
and publicly accountable approach
Accounting values of conservatism and secrecy have the

greatest relevance to information in financial statements
2-40
Nobes’s model argues that international reporting differences are due to different
purposes
Country’s financing system is considered most relevant factor to determine the
purpose of financial reporting
Nobes divides reporting systems into two classes— A and B
2-41
Class A (Anglo-Saxon Class B (Continental European

accounting) accounting)
Strong equity-outsider shareholder Weak equity-outsider shareholder system
system
Measurement practices are less Measurement practices are more
conservative conservative
Extensive Disclosure Disclosure is not extensive
Accounting practice differs from tax Accounting practice follows tax rules
rules
2-42
End of Chapter 2
2-43

Chapter 2 Worldwide Accounting Diversity

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Chapter 2 Worldwide Accounting Diversity

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Chapter 2:

Categories based on Accounting

Problems Caused by Accounting Diversity

Reasons for Accounting Diversity

Classification of Accounting Systems

Influence of Culture on Financial Reporting

Nobes’ Simplified Model to Explain Financial Reporting

Superficial Differences Major Differences

Categories based on Accounting

1. Financial statements included

Which FSs? Companies worldwide provide a balance sheet and an income

Ways of Combining Costs

Example IFRS US GAAP

Example IFRS US GAAP

2. Access to foreign capital markets

3. Comparability of financial statements

4. Lack of high-quality accounting information

A. Restate the income statement using international

B. Calculate the translation adjustment

C. Convert the account balances into US dollars

D. Determine the exchange rate gain or loss

Listing in the US Before 2007 After 2007

US companies must prepare financial statements must prepare financial

Accounting diversity leads to a lack of comparability of financial statements

Lack of comparability adversely affects:

The Case of East Asia Financial Crisis

Legal Systems Taxation

 Common Law • Financial Statements form the basis for

Providers of Financing Inflation

 Banks/families/government  Common in Latin American

Common Law Code Law

An exception is the corporation law laying the

‘Banks/family’ group ‘Outsider shareholder’ group

A major exception is the use of LIFO

To offset inflation, it is necessary to adopt accounting rules that require inflation

Inflation has been successfully brought under

Legal Systems Providers of Financing Taxation

 Common law countries have many domestic listed

 Code law countries tend to link taxation to accounting

Micro-based Class of Accounting Macro-uniform

Family UK Influence US Influence

Example UK USA The Netherlands is the only

Hofstede’s Cultural Dimensions

Gray’s Accounting Values

Hofstede’s Cultural Dimensions

Gray’s Accounting Values

Gray’s Accounting Values

Accounting values of conservatism and secrecy have the

Class A (Anglo-Saxon Class B (Continental European

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