International Accounting Harmonization

Adopting Universal Information Methods for a Global Financial System

J. Beke

• Publisher: Palgrave Macmillan
• Year: 2013
• Print ISBN: 9781137375308
• eBook ISBN: 9781137374349
• Topic: Economics
• Subtopic: Accounting
• Index: Economics

International Accounting Harmonization analyzes the differences between national accounting rules and international accounting methods, showing that when firms adopt international accounting standards they achieve significantly higher positive coefficients compared with firms that only take on local accounting strategies.

1. Introduction

Nowadays, especially during the current global financial crisis, companies are striving desperately to remain competitive and achieve sustainable levels of economic development. The highly competitive environment requires companies to create a clear business strategy, and accounting has to be part of this strategy since it helps individual enterprises to achieve their strategic objectives. International accounting standards are new global methods for business information systems and they are able to harmonize financial regimes worldwide. The increased globalization of markets, the complexity of commercial trading, and the concentration of business in global competition have led to a still greater need for international harmonization.

In today’s business environment, companies need to make use of every advantage available to remain competitive. Global competition, rapid innovation, entrepreneurial competitors, and increasingly demanding customers have altered the nature of competition in the marketplace. This new competitive environment requires companies’ ability to create value for their customers and to differentiate themselves from their competitors through the formulation of a clear business strategy. Business strategy must be supported by appropriate organizational factors such as effective manufacturing process, organizational design, and accounting information systems.

Modern business environments are increasingly competitive and dynamic. International competition through e-commerce and demand-based supply chain management dominates business. It is important for companies to develop coherent and consistent business strategies and to utilize management accounting tools to support strategic planning, decision-making, and control. To integrate business strategies with various management accounting tools, first companies need to identify the business they are in. It is essential to identify products and services, customer types, geographical markets, and delivery channels. It is useful to match the strategic business unit (SBU) with the related business unit strategy. An SBU is a company department or subsection that has a distinct external market for goods or services that differ from another SBU. A business unit strategy is about how to compete successfully in particular markets. It is important to focus on a certain segment, such as economically useful cars in the automobile industry or Internet and phone banking in the retail banking sector.

The financial crisis is also encouraging more critical examinations of the managerial innovations that have emerged from the audit industry, not least its pursuit of the bureaucratization of risk in the name of risk management. From the analysis of a crisis where risks have been real and perceived, it is increasingly becoming apparent that risk management mechanisms do relatively little to facilitate real management of risk. Adding as they do to costs—and the income of the consultancies involved—by isolating rather than integrating the management of risk, the bureaucratic mechanisms still promoted by the audit firms and their associates provide yet further evidence of the relatively limited understanding that the audit industry has of real time management in action.

Trying to understand the crisis and reflect on its implications also illustrates the dangers of the drift away from the world of accounting practice that has been a characteristic of so much accounting research for the last few decades. Indeed at times it is possible to think that for some there has been a drift away from accounting itself: at the very least there has been a pronounced move toward studying accounting at a distance. As yet this has not been as severe in its implications as for those of our colleagues in finance research, where increasing numbers have a very limited appreciation of the complexities of practice and its institutional context. Nevertheless, there has been a move away from analyzing just such complexities and institutional contexts in the accounting area, often in the name of theoretical elegance and methodological rigorous. Interestingly this is true for both statistically based capital market studies and a great deal of more critical theorizing. Of course theoretical and methodological issues are of real importance, not least in helping to avoid methodological capture by practice norms, frameworks, and ways of looking at the world. But as numerous other social science disciplines illustrate, there are ways of balancing interests in the need for sound and reliable research with genuine interests in the complexities of practice. It really is important to understand how accounting has become implicated with the creation of new financial practices, with objectifying and simplifying the increasingly complex financial transactions that have emerged from an ever-expanding investment in financial engineering. Equally significant is the need for a more informed understanding of the changes that have occurred in the influence structures in the world of accounting politics, both national and international, of the changing role that accounting plays in the informational environment of organizations, and how accounting changes in relation to shifts in the underlying nature of the socioeconomic system in which businesses operate.

Standardization is the process of developing and agreeing upon technical standards. The standard is a document that establishes uniform engineering or technical specifications, criteria, methods, processes, or practices. Some standards are mandatory while others are voluntary. Voluntary standards are available if one chooses to use them. Some are de facto standards, meaning a norm or requirement that has an informal but dominant status. Some standards are de jure, meaning formal legal requirements. Formal standards organizations such as the International Organization for Standardization or the American National Standards Institute are independent of the manufacturers of the goods for which they publish standards.

In social sciences, including economics, the idea of standardization is close to the solution for a coordination problem, a situation in which all parties can realize mutual gains, but only by making mutually consistent decisions. Standardization implies the elimination of alternatives in accounting for economic transactions and other events. Harmonization refers to reduction of alternatives while retaining a high degree of flexibility in accounting practices. It allows different countries to have different standards as long as the standards do not conflict. For example, within the European Union harmonization program, if appropriate disclosures are made, companies are permitted to use different measurement methods: for valuing assets, German companies could use historical cost, while Dutch businesses can use replacement costs without violating the harmonization requirements.

The purpose of using international accounting harmonization is that similar accounting transactions are treated the same by companies around the world, resulting in globally comparable financial statements. However, the consistent use of unified accounting information system by firms will show that they are changeable, because they depend on the varying economic, political, and cultural conditions in one state. Accountants, auditors, and information scientists around the globe are planning to harmonize accounting information systems with the goal of creating one set of high-quality accounting rules to be applied around the world.

With increasing globalization of the marketplace, international investors need access to financial information based on harmonized accounting systems and procedures. Investors constantly face economic choices that require a comparison of financial information. Without harmonization in the underlying methodology of financial reports, real economic differences cannot be separated from alternative accounting systems and procedures. Harmonization is used as a reconciliation of different points of view, which is more practical than uniformity and may impose one country’s accounting point of view on all others. With the growth of international business transactions by private and public entities, the need to coordinate different investment decisions has increased. This would also lead to the reduction of the information diversity between managers and investors. This information diversity is costly and can be blamed for the decrease in managers’ bonus, the increase of the equity’s cost, and the inaccuracy of economic and the financial forecasts.

Historically, harmonization of international accounting information systems has tended to follow the integration of the markets served by the accounts. For example, the move to unified national accounting system in the United States in the early twentieth century followed the integration of the national economy. Similarly, the present impetus for a global accounting information system follows the accelerating integration of the world economy. Without a common accounting system, cross-border portfolio and direct investments may be distorted, the monitoring of management by shareholders obstructed, the contracting inhibited, and the cost of these activities needlessly inflated by complex translation (Meeks and Swann, 2009).

According to business practices it is obvious that the usage of harmonized international accounting systems leads to a reduction of the information asymmetry between the owners and the managers. This information asymmetry is leading to increasing costs of equities and less accurate economic and financial forecasts. This requires the development and review of national accounting rules, the separate validation of tax and accounting regulations, the repeal of the subordinate role of accounting, and the issuing of international standards with the help of practical and theoretical accounting experts.

As an example, for a multinational company like Daimler Chrysler, which owns more than 900 subsidiaries operating in more than 60 countries spread across 5 continents, the published financial results according to the international accounting system is 1.5 times of the one according to German accounting rules. If earning after taxation (EAT)—deducted actual tax burdens—according to US GAAP (generally accepted accounting principles) is taken as 100 percent, due to the differences in national accounting rules, EAT would be 25 percent more in the United Kingdom, 3 percent less in France, 23 percent less in Germany, and 34 percent less in Japan (Barth et al., 2007).

PREVIOUS RELATED LITERATURE: A REVIEW

International accounting literature provides evidence that accounting quality has economic consequences, such as costs of capital (Leuz and Verrecchia, 2000), efficiency of capital allocation (Bushman and Piotroski, 2006), and international capital mobility (Günther and Young, 2002).

Epstein (2009) compared characteristics of accounting amounts for companies that adopted IFRS (International Financial Reporting Standards) to a matched sample of companies that did not, and found that the former evidenced less earnings management, more timely loss recognition, and more value relevance of accounting amount than did the latter. This study found that IFRS adopters had a higher frequency of large negative net income and generally exhibited higher accounting quality in the post-adoption period than they did in the pre-adoption period. The results suggested an improvement in accounting quality associated with using IFRS.

Botsari and Meeks (2008) found that first-time mandatory adopters experience statistically significant increases in market liquidity and value after IFRS reporting becomes mandatory. The effects were found to range in magnitude from 3 to 6 percent for market liquidity and from 2 to 4 percent for company by market capitalization to the value of its assets by their replacement value.

Daske et al. (2007) also found that the capital market benefits were present only in countries with strict enforcement and in countries where the institutional environment provides strong incentives for transparent filings. In the order of the IFRS adoption countries, market liquidity and value remained largely unchanged in the year of the mandate. In addition, the effects of mandatory adoption were stronger in countries that had larger differences between national GAAP and IFRS, or without a preexisting convergence strategy toward IFRS reporting.

The increased transparency promised by IFRS could also cause a similar increase in the efficiency of contracting between firms and lenders. In particular, timelier loss recognition in the financial statements triggers debt covenants violations more quickly after firms experience economic losses that decrease the value of outstanding debt (Ball and Shivakumar, 2005; Ball and Lakshmann, 2005).

Accounting theory argues that financial reporting reduces information asymmetry by disclosing relevant and timely information, for example, Frankel and Li (2004). Because there is considerable variation in accounting quality and economic efficiency across countries, international accounting systems provide an interesting setting to examine the economic consequences of financial reporting. The European Union’s (EU) movement to IFRS may provide new insights as firms from different legal and accounting systems adopt a single accounting standard at the same time. Improvement in the information environment following change to IFRS is contingent on at least two factors, however. First, improvement is based on the premise that change to IFRS constitutes change to a GAAP that induces higher quality financial reporting. For example, Ball et al. (2006a) found that the accounting system is a complementary component of the country’s overall institutional system and it is also determined by firms’ incentives for financial reporting. La Porta (1998) provides the first investigation results of the legal system’s effect on a country’s financial system. These results suggest that common law countries have better accounting systems and better protection of investors than code law ones.

Other factors associated with financial reporting quality include the tax system (Daske and Gebhardt, 2006), ownership structure (Jermakovicz et al., 2007; Burgstahler et al., 2006), political system (Li and Meeks, 2006), and capital’s structure and capital market development (Ali et al., 2000). Therefore, controlling for these institutional and firm-level factors becomes an important task in the empirical research design. As a result of the interdependence between accounting standards and the country’s institutional setting and firms’ incentives, the economic consequences of changing accounting systems may vary across countries. Few papers have examined how these factors affect the economic consequences of changing accounting standards. For example, Pincus et al. (2006) found that accrual anomaly is more prevalent in common law countries. Maskus et al. (2005) found that accounting quality is associated with tax reporting incentives. Exploration of the interaction between these factors and the accounting information system can provide insights into differences in the economic consequences of changing accounting principles across countries.

Prior researches, for example, Meeks and Meeks (2002), have raised substantial doubt regarding whether a global accounting standard would result in comparable accounting around the world. But differences in accounting practices across countries can result in similar economic transactions being recorded differently. This lack comparability complicates cross-border financial analysis and investment. Some evidence of earning management (e.g., reducing of transition costs and information asymmetry, benefits of investors in investment strategy) can be found in the research done by Iatridis and Rouvolis (2010). They showed how firms that operate in a non-common-law countries (e.g., Greece), which are stakeholder-based, respond to international accounting standards adoption as compared to shareholder-based systems (e.g., United Kingdom).

No matter how similar the accounting systems in different countries, there will be slight or even bigger differences in the way they are applied by companies due to the differences in the economic, political, and cultural environments. Chatterjee (2006) demonstrated how cultural differences can affect accounting practices in countries characterized by small power distance and weak uncertainty avoidance accounting measures, which are more likely to be used as an indicator of a manager’s performance than as a measure of the effectiveness of policies and procedures prescribed for them. Various researches draw the conclusion that countries having different cultures also have different accounting rules and practices.

2. Classification of Accounting Systems

This chapter presents the hypothetical classifications of international accounting system and shows the three main information systems in details: the European accounting system, the US GAAP, and international accounting standards. Here, “accounting system” will be used in terms of the financial reporting practices employed by a company for an annual report. The systems could be classified into groups by similarities and differences. If all or most of the enterprises in a country use very similar accounting practices, this might suggest that countries can be classified on the basis of accounting practices.

The classification of accounting systems will help to describe and compare international accounting systems in a way that will promote improved understanding of the complex realities of accounting practices. This classification should contribute to an improved understanding of:

• the extent to which national accounting systems are similar to or different from each other;

• the pattern of development of individual national systems with respect to each other and their potential for change;

• the reasons why some national systems have a dominant influence while others do not.

Classification will also help policymakers assess the prospects and problems of international harmonization. Developing countries seeking to choose an appropriate accounting system will also be better informe...

Table of contents

• Cover
• Title
• 1. Introduction
• 2. Classification of Accounting Systems
• 3. The Influencing Factors of Accounting Harmonization
• 4. Problems Caused by Accounting Diversity
• 5. Economic Factors of Accounting Harmonization
• 6. Comparative Statistical Analysis
• 7. Effects of Universal Information Methods on Company Performance
• 8. International Accounting Standardization Process
• 9. Summary and Conclusions
• References
• Index