International Accounting, Chapter 2 ch 02

International Accounting, 7/e

Frederick D.S. Choi

Gary K. Meek

Chapter 2: Development and

Classification

Learning Objectives

 Identify and understand the importance of the eight factors

that have a significant influence on accounting development.

 Understand the four approaches to accounting development

found in market-oriented Western economies and identify countries in which each approach is prevalent.

 Have a basic working knowledge of accounting classifications

and how they compare with one another.

 Explain the difference between the “fair presentation” and

“legal compliance” orientations of accounting and identify nations in which each is prevalent.

 Explain why distinctions of accounting at the national level are

Why Study Development and

Classification?



Development

 Helps understand a nation’s accounting.

 Explains the differences and similarities in accounting

around the world.



Classification

 Helps understand why and how national accounting

systems differ.

 Helps analyze whether these systems are converging or

diverging.

 Are a way of viewing the world.

 Reveals what group members have in common, and  What distinguishes groups from each other

Development



Sources of finance – who, how many, how

close?

 Equity markets

 Profits measure how well managers have run the company.  Accounting is used to assess cash flows, risks, and to value

the firm.

 Extensive disclosures.

 Banks

 Conservative earnings for creditor protection.  Less extensive disclosures.

Development (contin)

 Legal system

 Code law

 Laws are all-embracing.

 Accounting tends to be prescriptive and procedural.  Accounting focuses on legal form.

 Accounting standards and procedures are incorporated into national

laws.

 Common law

 Laws develop on a case-by-case basis.

 Accounting develops from experience and judgment.

 Accounting tends to be flexible, adaptive, and innovative.  Accounting focuses on economic substance.

 Accounting rules are established by private sector professional

Development (contin)



Taxation

 Must companies record revenues and expenses in their

accounts to claim them for tax purposes?

 Are financial accounting and taxation the same?  Or are they different?



Political and economic ties

 Accounting ideas and technologies are transferred through

conquest, commerce, and other forces.



Inflation

 Inflation distorts historical cost measurements.

 Countries with high inflation often require that companies

Development (contin)

 Level of economic development

 Affects the types of transactions and which ones are most prevalent in the

economy which, in turn,

 Affects the accounting issues that are faced.  Educational level

 Affects the capability for professional accounting training.

 Where education levels are low, countries import accounting training or send

citizens elsewhere to get it.

 SUMMARY

 Several variables are closely associated.

 Common law legal system, strong equity markets, and separation of financial and tax accounting.

 Code law legal system, credit-based financing, and accounting rules that conform to tax law.

 Result is two basic orientations of accounting.  Fair presentation

Development (contin)



Culture and accounting values

 Culture (Hofstede)

 Individualism vs. collectivism  Power distance – high vs. low

 Uncertainty avoidance – high vs. low  Masculinity vs. femininity

 Accounting values (Gray)

 Professionalism vs. statutory control  Uniformity vs. flexibility

Development (contin)

Classification

 Four approaches to accounting development (Mueller 1967)  Macroeconomic approach

 Accounting derived from and designed to enhance national macroeconomic

goals.

 Example: Sweden

 Microeconomic approach

 Accounting derived from microeconomics.

 Maintaining physical capital  _{Separation of capital and income}  Replacement costs

 Example: the Netherlands

 Independent discipline approach

 Accounting derived from business practices, judgment, and trial-and-error.  Examples: U.K. and U.S.

 Uniform approach

Classification (contin)



Legal systems:

common law vs. code law

accounting

 Common law accounting

 Oriented toward fair presentation, transparency, and full

disclosure

 Separation between tax and financial accounting  Accounting standard setting in private sector

 Parallels stockholder model of corporate governance

 Code law accounting

 Legalistic orientation, opaque with low disclosure  Alignment between tax and financial accounting  Accounting standard setting in public sector

Classification (contin)

 Practice systems: fair presentation versus legal compliance

accounting

 Why national accounting distinctions are becoming blurred

 Importance of stock markets as a source of finance is growing.

 Dual financial reporting is becoming more common, particularly where duality is sanctioned.

 Some code law countries are shifting responsibility for accounting standard setting to the private sector.

 Fair presentation accounting

 Substance over form.

 Oriented toward decision needs of external investors.

 Helps judge managerial performance and predict future cash flows and

profitability

 Extensive disclosures

 IFRS are aimed at fair presentation.

Classification (contin)



Legal compliance accounting



Designed to satisfy government-imposed

requirements, such as:

 Calculating taxable income

 Complying with macroeconomic plan



Conservative measurements



Income smoothing



Will persist in code law countries for

Development (contin)

Classification



Four approaches to accounting development (Mueller 1967)

 Macroeconomic approach

 Accounting derived from and designed to enhance national macroeconomic goals.

 Example: Sweden

 Microeconomic approach

 Accounting derived from microeconomics.

 Maintaining physical capital  _{Separation of capital and income}  Replacement costs

 Example: the Netherlands

 Independent discipline approach

 Accounting derived from business practices, judgment, and trial-and-error.  Examples: U.K. and U.S.

 Uniform approach

 Accounting is standardized by central government and used as a tool for administrative control.

Classification (contin)



Legal systems:

common law vs. code law

accounting



Common law accounting



Oriented toward fair presentation, transparency, and full

disclosure



Separation between tax and financial accounting



Accounting standard setting in private sector



Parallels stockholder model of corporate governance



Code law accounting



Legalistic orientation, opaque with low disclosure



Alignment between tax and financial accounting



Accounting standard setting in public sector

Classification (contin)



Practice systems: fair presentation versus legal compliance

accounting



Why national accounting distinctions are becoming blurred

 Importance of stock markets as a source of finance is growing.

 Dual financial reporting is becoming more common, particularly where duality is sanctioned.

 Some code law countries are shifting responsibility for accounting standard setting to the private sector.



Fair presentation accounting

 Substance over form.

 Oriented toward decision needs of external investors.

 Helps judge managerial performance and predict future cash flows and profitability

 Extensive disclosures

 IFRS are aimed at fair presentation.

 Found in U.K., U.S., Netherlands and countries influenced by them. The trend for consolidated financial statements.

Classification (contin)



Legal compliance accounting



Designed to satisfy government-imposed

requirements, such as:



Calculating taxable income



Complying with macroeconomic plan



Conservative measurements



Income smoothing



Will persist in code law countries for