Harmonizing accounting

differences across the

countries
 Accounting

“The language of business”

Expression in Profit & loss statements,
balance sheets, budgets, investment
analysis, & tax analysis

Accounting information is the means by
which firms communicate their financial
position to the providers of capital ,
investors, creditors and government
 Accounting information and
capital flows

Good accounting function is critical to the smooth running of the firm

Determinants of national
accounting standards
Relationship between business and
providers of capital

Three external sources of capital:

o Individual investors
• Buying shares and bonds
o Banks.
Importance of each
• Loan capital varies from country
to country
o Government
• Make loans or investment

19-5
 Political and economic ties with
other countries

Accounting convergence:
o Influence of NAFTA

o Influence of the former British Empire

o Influence of the European Union

19-6
 19-7

Inflation accounting

Historic cost principle:

o Assumes currency is not losing
value to inflation
o Most significant impact in the area
of asset valuation

Current cost accounting:
o Factors out inflation
o Used in Great Britain until
inflation rate declined
 Level of development

Developed countries have more

sophisticated accounting procedures
o Accounting problems are more complex
o Sophisticated capital markets
o Lenders require comprehensive reports
o Educated workforce can perform complex
accounting functions

19-8
 Culture

Hofstede’s uncertainty avoidance has

an impact on accounting systems
o Low uncertainty avoidance - these
countries tend to have strong independent
auditing professions that ensure a firm’s
compliance with rules

19-9
 Accounting clusters

Few countries have identical

accounting systems.

Similarities exist in clusters

19-10
 Accounting clusters

British-American-Dutch Group
Firms raise capital from
investors. Accounting Europe-Japan Group
systems designed to
Have close ties to
inform investors banks. Accounting
South American Group practices meet
bank’s needs.
Countries have experienced
persistent and rapid inflation.
Accounting principles reflect
the inflation.
Accounting clusters

19-12
 National and international
standards

Diverse accounting practices are

enshrined in national accounting and
auditing standards

Accounting standards: Rules for
preparing financial statements

Auditing standards: Specify rules for
performing an audit

19-13
 Lack of comparability

One result of national differences in

auditing and accounting standards is
lack of comparability of financial reports

With growth of global capital markets

both transnational financing and
transnational investment have grown

Firm has to explain to investors why its

financial position looks different in two
accountings
19-14
 International standards

Efforts to harmonize accounting
standards across countries

Formation of International Accounting
Standards Board (IASB) in March 2001

15 members

Responsible for formulating international
accounting standards (IAS)

Has issued over 41 IAS
o Difficult to get requisite votes
o Voluntary compliance

Recognition is growing

19-15
 Multinational consolidation and
currency translation

Subsidiaries of multinationals
are separate legal entities but
not separate economic
entities

Purpose is to provide
accounting info about a group
of companies that recognizes
economic interdependence
(subsidiaries)

Transactions among
members of a corporate
family not included in
consolidated financial
statements. Only assets,
liabilities, revenues and
expenses statements with
external trade parties are
shown
19-16
 Currency translation

Financial statements
of subsidiary’s are
prepared in the local
currency

For the consolidated
accounts of a
Multinational these
accounts have to be
then converted into
currency of
Multinational’s home
country
 Currency translation

The current rate method:

o Exchange rate at the date on the balance
sheet is used to translate foreign
subsidiary financial statements into home
country currency
o Incompatible with ‘historic cost principle’

The temporal method:
o Translates foreign subsidiary assets into
home-country currency at the time of
purchase of the asset
o Changing exchange rates may mean the
balance sheet may not balance! 19-18
Accounting aspects of control
systems

Annual control process involves three
steps:
o Head office and subunit management jointly
determine subunit goals for the coming year.
o Throughout year, head office monitors
subunit performance against agreed goals.
o If subunit fails to achieve goals, head office
intervenes to determine why the shortfall
occurred, taking corrective action when
appropriate.

19-19
Accounting aspects of control
systems

Lessard- Lorange Model:
o Three exchange rates used to translate
foreign currency into corporate
currency for budget and performance
purposes.
• The initial rate, the spot exchange rate
when the budget is adopted.
• The projected rate, the spot exchange
forecast for the end of budget period (i.e.,
the forward rate)
• The ending rate, the spot exchange rate
when the budget and performance are
19-20
being compared.
Exchange rate combinations in the
control process

19-21
 Separation of subsidiary and
manager performance

Valuation of a subsidiary should be

separate from the evaluation of the
subsidiary manager

Manager’s evaluation should take into
consideration how hostile or benign the
countries environment is for business and
make allowances over items the manager
has no control e.g. inflation rates, interest
rates exchange rates
19-22