Accounting Theory

International Accounting
Definition
Weirich, Avery and Anderson (1971) provide an
overview of three different ways in which
international accounting can be explained. It
encompass:
 Universal or world accounting
 comparative or international accounting
 parent-foreign subsidiary accounting
Universal or World Accounting
 Universal or world accounting considers issues
(such as costs, benefits, likely impediments)
associated with the implementation of a uniform
set of accounting rules that would be used
throughout the world.
 In the framework of this concept, international
accounting is considered to be a universal
system that could adopted in all countries. A
world-wide set of generally accepted accounting
principles (GAAP) would be established.
Comparative or International
Accounting
 Comparative or international accounting
relates to efforts to document and explain
differences in the ways different countries
undertake the practice of financial accounting.
 For example, accounting rules for different
countries differ in how they recognize and
value their fixed assets; how they account or
their inventory; if, when and how they
recognise goodwill; how they consolidate their
foreign subsidiaries and so forth.
Parent-foreign subsidiary accounting
 Parent-foreign subsidiary accounting refers
to the practices employed in consolidating
the financial statements of parent entities and
those of their overseas subsidiaries.
 Different countries adopt different

approaches.
Models of Financial Accounting
There are two main models of financial
accounting which have evolved within
economically developed countries
1. Anglo-American model
 it is strongly influenced by professional

accounting bodies rather than government.

 emphasizes the importance of capital markets

(rely mostly on public sources of equity and

debt finance)
 relies on terms as true and fair or presents fairly
Models of Financial Accounting
2. Continental European model
 characterized by relatively small input from the

accounting profession
 little reliance upon qualitative requirements such as

true and fair and has stronger reliance upon

government.
 heavily associated with the tax rules being in place,

and the information tends to be of a nature to protect

the interest of creditors rather than investors per se
 obtain most of their long term funds from family

sources, governments or lenders, often banks

Reasons given for differences in the accounting
methods of different countries:
 underlying laws of the country
 political systems in place (for instance a

capitalistic/free market system versus a

centralized/communistic system)
 level of development from an economic

perspective
Reasons proposed for international accounting
differences according to Nobes (1998)
 Nature of business ownership and financing system
 colonial inheritance
 invasions
 taxation
 inflation
 level of education
 age and size of accountancy profession
 stage of economic development
 legal systems
 culture
Reasons proposed for international accounting
differences according to Nobes (1998)
 history
 geography
 language

 influence of theory

 political systems, social climate

 religion
 accidents

Many of these factors are interrelated.

A number of them are said to be ‘institutional’
and some ‘cultural’.
Reasons for Differences in International
Accounting - 1. Culture
Looking at some of these Reasons for
differences in Accounting
ONE: Culture
 It will impact on -legal systems, tax systems

and the way businesses are formed and

financed
 Violet (1983) argued that accounting is a

socio-technical activity that involves

interaction between both human and non
human resources.
Reasons for Differences in International
Accounting - 1. Culture
 Violet (1983)“Accounting is a social
institution established by most cultures to
report and explain certain social phenomena
occurring in economic transactions. As a
social institution, accounting has integrated
certain cultural customs and elements within
the constraints of cultural postulates”.
Reasons for Differences in
Accounting - 1. Culture
 Violet (1983) “Accounting cannot be isolated
and analyzed as an independent component
of a culture. It is, like mankind and other
social institutions, a product of culture and
contributes to the evolution of the culture
which employs it. Since accounting is
culturally determined, other cultural customs,
beliefs, and institutions influence it” So it
cannot be considered culture free.
Reasons for Differences in
Accounting
 Takatera and Yamamoto (1987) defined
culture as “an expression of norms, values
and customs which reflect typical behavioral
characteristics”
Reasons for Differences in
Accounting - 1. Culture
 Gray (1988) stated that the value systems of
accountants will be derived and related to
societal values (which are reflected by
Hofstede’s cultural dimensions). The values
of the accounting subculture will in turn,
impact on the development of the respective
accounting systems at the national level. It is
questionable then whether accounting
systems can be developed in a ‘one-size-
fits-all’ perspective.
Hofstede’s Four Societal Value
Dimensions
Hofstede’s four societal value dimensions identified:
A. Individualism versus Collectivism
 Individualism stands for a preference for a loosely

knit social framework in society wherein individuals

are supposed to take care of themselves and their
immediate families only.
 Collectivism stands for a preference for a tightly

knit social framework in which individuals can

expect their relatives, clan, or other in-group to
look after them in exchange for unquestioning
loyalty.
Hofstede’s Four Societal Value
Dimensions
 Issue here is the degree of interdependence a
society maintains among individuals. It
relates to people’s self concept: ‘I’ or ‘we’.
 great deal of economic theory is based on

notion of self-interest where one undertakes

action to maximize personal wealth at the
expense of others. Based on individualism
dimension.
 On Collectivism, members of a society will

look after each other.

Hofstede’s Four Societal Value
Dimensions
B. Large versus small power distance
 Power distance is the extent to which the

members of a society accept that power in

institutions and organizations is distributed
unequally.
 This affects the behavior of the less powerful as

well as of the more powerful members of society.

 People in large power distance societies accept a

hierarchical order in which everybody has a place
which needs no further justification.
Hofstede’s Four Societal Value
Dimensions
 People in small power distance societies
strive for power equalization and demand
justification for power inequalities.
 How does a society handle inequalities

among people when they occur.

 This has obvious consequences for the way

people build their institutions and

organizations
Hofstede’s Four Societal Value
Dimensions
C. Strong versus Weak uncertainty avoidance
 Uncertainty avoidance is the degree to which

the members of society feel uncomfortable with

uncertainty and ambiguity.
 This feeling leads them to beliefs promising

certainty and to sustaining institutions

protecting conformity.
 Strong Uncertainty avoidance societies maintain

rigid codes of belief and behavior and are

intolerant towards deviant persons and ideas.
Hofstede’s Four Societal Value
Dimensions
 Weak uncertainty avoidance societies
maintain a more relaxed atmosphere in which
practice counts more than principles and
deviance is more easily tolerated.
 The issue in this dimension is how society

reacts to the fact that time only runs one way

and that the future is unknown.
 This has consequences for the way people

build their institutions and organisations

Hofstede’s Four Societal Value
Dimensions
D. Masculinity versus Femininity
 Masculinity stands for a preference in society

for achievement, heroism, assertiveness, and

material success.
 Femininity stands for a preference for

relationships, modesty, caring for the weak,

and the quality of life.
 The issue addressed here is the way in which

a society allocates social roles to the sexes.

Gray’s 4 Accounting values
Gray (1988) developed four accounting values that
were deemed to relate to the accounting subculture
with the intention that the accounting values would
then be directly linked to Hofstede’s four societal
values.
 Gray’s four accounting values were defined as

follows:
1. Professionalism versus Statutory Control
 Preference for individual professional judgment and

the maintenance of professional self-regulation, as

opposed to compliance with prescriptive legal
requirements and statutory control.
Gray’s 4 Accounting values
2. Uniformity versus Flexibility
 preference for enforcement of uniform

accounting practices between companies and

the consistent use of such practices over time
as opposed to flexibility in accordance with
the perceived circumstances of individual
companies.
Gray’s 4 Accounting values
3. Conservatism versus Optimism
 preference for a cautious approach to

measurement so as to cope with the

uncertainty of future events, as opposed to a
more optimistic, laissez-faire, risk-taking
approach.
Gray’s 4 Accounting values
4. Secrecy versus Transparency
 preference for confidentiality and the

restriction of disclosure of information about

the business only to those who are closely
involved with its management and financing,
as opposed to a more transparent, open and
publicly accountable approach.
Grays Hypotheses summarized
Cultural Values from Accounting
Hofstede Values (from
Gray)

Professionalism Uniformity Conservatism Secrecy

Power Distance - + ? +
Uncertainty - + + +
Avoidance
Individualism + - - -
Msculinity ? ? - -
Grays Hypotheses
Hypothesis 1: The higher a country ranks in
terms of Individualism and lower it ranks in
terms of Uncertainty avoidance and Power
distance, then the more likely it is to rank
highly in terms of Professionalism.
Hypothesis 2: The higher a country ranks in
terms of Uncertainty Avoidance and Power
Distance and the lower it ranks in terms of
Individualism, then the more likely it is to rank
highly in terms of Uniformity
Grays Hypotheses
Hypothesis 3: The higher a country ranks in
terms of Uncertainty Avoidance and the lower it
ranks in terms of Individualism and
Masculinity, then the more likely it is to rank
highly in terms of Conservatism.
Hypothesis 4: The higher a country ranks in
terms of Uncertainty Avoidance and Power
Distance and the lower it ranks in terms of
Individualism and Masculinity, then the more
likely it is to rank highly in terms of Secrecy.
Reasons – 2. Religion
TWO:Religion by Hamid, Craig and Clarke
(1993)
 Religion transcends national boundaries.
 Islamic cultures have failed to embrace

western accounting practices. Moslems

believe that they hold assets not for
themselves but for God. There is notion of
stewardship to God and not suppliers or debt
capital. They preclude debt financing and
prohibit the payment of interest.
Religion
 “The potential for the borrower to invest money and
earn a profit introduces an unacceptable
speculative element into the business undertakings.
To exact a higher amount than the sum lent on
that conjectural basis is regarded as being a kind of
unjust exploitation. Injustice is presumed to arise
wherever there is a guaranteed and fixed return to
one party, (in this case the lender) but an uncertain
and variable return to the other (the borrower). As a
consequence, all fixed income securities, such as
preferred stock, are unlawful”.
Religion
 This prohibition has significant implications
for processes aimed at the international
harmonization of accounting standards.
 Religion therefore can potentially affect how

people do business and how they make

decisions.
Reasons – 3.Legal Systems
THREE: Legal Systems
 Operating in different countries. These are

common law and Roman law systems.

 Common law has been developed by judges

applying both the limited amount of statutory law

and the outcomes of previous judicial decisions
to the facts of a specific case. Each judgment
then becomes a legal precedent for future cases.
 Roman law systems, parliamentary (statutory) law

tends to be very detailed and covers most

aspects of daily life.
Legal Systems
 The implication for accounting is that in
common law countries we would expect to
find relatively few detailed accounting laws
guiding accounting practices and therefore
historically the development of accounting
practices would have been left much more to
the professional judgment of accountants
(and auditors).
Legal Systems
 With Roman law systems, in contrast, we
would expect to find a body of codified
accounting laws prescribing in detail how
each type of transaction or event should be
treated in the accounts. There is therefore no
need of professional judgment in preparing
accounts or developing accounting practices.
 Common law was developed in England and

Roman law in continental European countries.

Reasons – 4. Business ownership and
financing system
FOUR: Business ownership and financing system
 Can be broadly divided into two distinct types –

this time referred to as ‘outsider’ and ‘insider’

systems.
 Outsider systems are external shareholders that

are a significant source of finance for much

business activity. (those not involved in the
management of the company)
 These need more financial accounting

information to make decisions about future

investments
Business ownership and financing
system
 In insiders system of finance, provision of
finance by external shareholders is much less
significant. There has been a dominance of
family owned businesses and/or the dominant
providers of long-term finance have historically
been either banks or governments. Family has
access to financial accounting information. No
need to provide information for investments.
 Countries using Roman law systems are those

dominated by insider systems. Outsider

systems are dominated by common law.
Reasons – 5. Taxation Systems
FIVE: Taxation systems
 A system with dominantly outsider systems of

finance requires that accounting reflects

some sort of economic reality with for
example each business selecting depreciation
methods that most closely reflect the manner
in which it uses its fixed assets.
Taxation systems
 An insider systems of finance there is no
pressure for financial report to have developed
to reflect fairly some form of underlying
economic reality. Financial reports here are
developed for different purposes mostly for the
calculation of tax. To claim an allowance for
tax, it must be included in the financial reports.
 In outsider financed countries, the tax accounts
have historically been separate from the
financial accounts.
Reasons – 6. Strength of the
Accounting Profession
SIX: Strength of the accounting profession
 has historically both been determined by and

helped to reinforce the influence on financial

accounting systems of the institutional.
 Common law country, which has

predominantly outsider system of long term

finance and where tax law has had little
influence on financial accounting, there will
have been relatively few statutory laws
determining the contents of financial reports.
Strength of the Accounting
Profession
 The primary purpose of these financial reports will have been to
provide a fair, balanced and unbiased representation of the
underlying economic performance of the business, and this will
have required the exercise of professional judgment to cope with
each different situation. Thus these countries would have a
demand for a large number of accountants who are able to apply
professional judgment to determine the most suitable way of
reflecting unique sets of transactions and events in financial
accounting reports of many companies. The accounting
professionals are strong in these countries and have been effective
in lobbying governments to ensure that accounting regulatory
systems give scope for the exercise of professional judgment.
 The Roman law countries which have largely insider systems of
finance have little need or scope for the use of professional
judgment when drawing up financial accounting statements.
Reasons – 7. Accidents of History
SEVEN: Accidents of history
 Accounting systems do not always follow common

law or Roman law model. Examples of accidents of

history are the Wall Street Cash of 1929 when the
United States established Securities Exchange
legislation aimed at investor protection, while there
was no such development at the time in the United
Kingdom. It included some accounting requirements
which have been delegated to private sector
accounting standard setting bodies and which have
produced a detailed set of US accounting rules
Reasons for Harmonization
Reasons for harmonization and standardization
 Harmonization according to Nobes and

Parker (2004, p. 77) is “a process of

increasing the compatibility of accounting
practices by setting bounds to their degree of
variation”
 According to the same authors,

standardization of accounting is explained as

a term which appears to imply the imposition
of a more rigid and narrow set of rules.
Reasons for harmonization
a) Increased globalization – investors
increasingly investing in companies from a
variety of countries and these investors use
financial reports as an important source of
information upon which to base their
investment decisions. They need to compare
financial reports and financial accounting
numbers of companies from different
countries.
Reasons for harmonization
b) Long-term finance for multinational companies
 If the long-term finance needs of a multinational

company are too great for the providers of finance in a

single country, then it may need to raise finance on the
stock exchanges of more than one country. For need of
domestic investor protection, the stock exchange
regulators in any country are likely to be reluctant to
permit a company’s’ shares to be traded on their
exchange if that company does not produce financial
reports which are readily comparable with the financial
reports of all other companies whose shares are traded
on that exchange and those reports will have been
prepared using comparable assumptions (or rules).
Reasons for harmonization
c) It will facilitate greater flexibility and
efficiency in the use of staff as they can be
easily transferred from one country to the
other.
Obstacles to Harmonization
Obstacles to Harmonization and Standardization

a) Cultural and institutional differences as we saw earlier. They may

be good reasons for example religion, cultural or institutional. Skills
transferred from Anglo-American countries may not work because
they are culturally irrelevant or dysfunctional in the receiving
countries’ context.
b) Lack of a developed accounting profession in some countries.
Problems of initially implementing international accounting
regulations based on the Anglo American professional judgment
model.
c) Economic consequences: Governments of individual countries
may be unwilling to give control over a process which has real
economic consequences to an international body over which they
have little influence
Processes and Institutions of International
Accounting Standardisation
 The main institution involved in international
standardisation of financial accounting is the
International Accounting Standards Board
(IASB) which is based in London. Previsously
it was called International Accounting
Standards Committee (IASC) and was
established in 1973. It was changed in 2001
to IASB.
Reference:
Deegan, C (2006) Financial Accounting Theory.
McGraw Hill Australia Pty Limited,
North Ryde.