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Chap. 1ACCOUNTING, ENTITIES, REGULATIONAccounting began as a practical activity in response to perceived needs. Accounting tended to develop in different ways as a response to a particular environment, essentially on the Darwinian principle.Accounting: is the art of recording, classifying and summar...

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Chap. 1 ACCOUNTING, ENTITIES, REGULATION Accounting began as a practical activity in response to perceived needs. Accounting tended to develop in different ways as a response to a particular environment, essentially on the Darwinian principle. Accounting: is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof. Different types of people deal with business entities: managers, investors, other lenders, employees, suppliers, customers, governments and the public. Very important distinction: • Management Accounting: concerned with the provisions of info useful to management (so with a inner scope, within the business) • Financial Accounting: intended for users outside the business itself. The users to whom financial accounting is addressed are very diverse. The same infos will not necessarily be valid for all their purposes. The IASB (International Accounting Standard Boards) is mainly concerned with investors and other lenders. There are different accounting practices. They reflect the biases and the norms of the society in which they are embedded. Management accounting has no rules: it is developed following the idea that it is giving informations to itself, so there is no need of hiding infos. Auditing: external control mechanism designed to provide an external and independent check on the financial statements and reports published by those entities. Another set of distinctions: • Finance: concerned with the optimal means of raising money • Financial management: concerned with the optimal means of using it inside the company • Financial accounting: the reporting on the results from having used it. Financial accounting must be distinguished from bookkeeping. Bookkeeping underlies all the other type of accounting. It is about recording data.

Entity: word (used by the IASB) designed to cover all ways of organizing business operations. Type of entities: 1. Not fully separate from owners ◦ Sole trader ◦ Partnership (without or with limited liability) 2. Fully separate from owners ◦ Private limited company* ◦ Public limited company (not listed or listed)** * in Italy = SRL

** in Italy = SpA

As business continues to grow in size and complexity, it might be useful to arrange its affairs as a group of companies (together managerially but not legally). Public companies are allowed their shares traded on markets. Accounting could be regulated in many ways, for example by markets, governments....... To the question of regulation there are two answers: 1. accounting should be determined purely by market forces 2. accounting should be regulated entirely by the “state” → bureaucracy The balance adopted between the two answers varies around the world, nation by nation. The profession of accountant is organized into associations under national jurisdiction. The coordinating organization is the IFAC (International Federation of Accountants). IFAC had a strong connection with IASC (International Accounting Standards Committee). From 2001 IASC has been replaced by IASB. The IASC's International Accounting Standards (IASs) were adopted by the IASB, but new standards are called International Financial Reporting Standards (IFRSs). Taken together, we tipically refer to them just with the acronym IFRSs. Objectives of IASB: • develop single set of globally-accepted financial reporting standards • promote the use and rigorous application of those standards • to take account of the needs of a range of sizes and types of entities • to promote and facilitate the adoption of IFRSs. The language adopted by IASB is a mixture of UK and US terms.

Chap. 2 SOME FUNDAMENTALS Balance sheet (or statement of financial position): is a document designed to show the state of affairs of an entity at a particular date. If it does not balance, mistakes have been done during calculations. They will have to be found. A balance sheet consist of two lists: 1. Resources (assets that are under the control of the company) 2. Claims (against the company) Assets = Equity + Liabilities If an outside person will put some cash in, we will refer to that as Equity Capital (Owners' equity) The separation of the entity from the owner is implied by showing the owner's contribution as a claim/source. Any transaction, event or adjustment can be recorded in a given balance sheet to produce a new and updated balance sheet. The calculation of profit will generally consists of these positive and negative elements. Income statement: it reports on flows of income and expenses of a period, whereas a balance sheet reports on the financial position at the balance sheet day. Assets + Expenses = Equity + Liabilities + Revenue Assets = Equity + Liabilities + Profit (or – Loss) The self-balancing nature of the accounting system shows up certain types of errors very efficiently. The equations are needed in computer systems that run the accounting of businesses. The term “equity” needs no separate definition because it rests on differences in the other four. Assets: the resources with remaining future benefits at the period end. Expenses: the resources used up in the period. Cash Flow Statement: shows how cash has come in and out in the period, as an explanation of the change in total cash in the balance sheet from the beginning to the end of the period.

Financial statements might be used for various purposes by many users. Although there are several variations around the world, the dominant type of accounting is that set out in IFRSs (International Financial Reporting Standards). The rules can be summarized as follows: • the main users of financial statements are investors (existing and potential) • the investors' main objective is to make economic decisions • this means that they need to predict an entity's future cash flows • so, financial reporting should provide relevant information that faithfully represents the underlying economic events. The IASB's conceptual framework makes it clear that the primary purpose of financial reporting under this system IS NOT: • to help management to make decisions or to calculate taxable income • to calculate what is legally and prudently distributable to the owners • to check up on what the managers have done with owners' money. A framework is not itself an accounting standard, as its main purpose is to guide the standardsetters when they are writing or revisiting accounting standards. It should also be used as a general guidance by those preparing or auditing financial statements. UNDERLYING CONCEPTS: Business Entity This convention holds that an entity has an identity and existence distinct from its owners. To the accountant, the business and its owners are considered completely separately. Equity is the balancing figure: is equal to the amount of wealth invested by the owners. Accounting Period This very simple convention underline the fact that profit must be referred to a specific period. The maximum length normally is one year. Large businesses report externally on a half-yearly or quarterly interim basis. Accrual basis, including matching The essence of this convention is that transactions should be recognized when they occur, not by reference to the date of the receipt or payment of cash. The process of profit calculation consist of relating together (matching) the revenues with the expenses; it is not concerned with relating together cash receipts and cash payments. The balance sheet and the income statement are based on the accrual convention. The cash flow statement is not based on the accrual convention. Going Concern In the absence of evidence to the contrary, it is assumed the business will continue for the foreseeable future. It allows the idea of depreciation. If the entity depreciates an item of plant over 10 years, then it is assuming that the plant will have a useful life to the entity of 10 years.

THE IASB'S LIST OF QUALITATIVE CHARACTERISTICS: The overall objective is to give a fair presentation of the state of affairs and performance of a business, so that users of financial statements can make good decisions. Figure 3.4 page 45 Relevance In order to be useful, information must be relevant to its purpose, which is economic decisionmaking. This requires predictions of future cash flows by the investors and others. Connected with this i the concept of materiality, which implies that insignificant items should not be given the same emphasis as significant items. Faithful Representation The readers of financial statements should not be misled by the contents of the statements. Transactions, assets and liabilities should be shown in such a way as to represent as well as possible what underlies them. • Economic Substance: it is sometimes expressed as showing the economic substance of transactions rather than their legal form. • Neutrality and Prudence: information needs to be free from bias, otherwise the prediction of the future will be warped. However, accounting is famous for having a bias: prudence or conservatism → in order to protect certain users from the risk of making financial statements too good. • Completeness: information needs to be as complete as possible. Enhancing Characteristics • Comparability, including consistency • Verifiability • Timeliness • Understandability The IASB is structured in several level of concept. • Level A: the ultimate purpose of accounting, to give a fair presentation of information in order to help users to make economic decisions. • Level B: a series of derivative concepts and conventions related to relevance and faithful representation. • Level C: detailed technical rules about how to recognize, measure and present assets, liabilities, equity, income, expenses, cash flow and various related disclosures.

A topic not currently covered by the IASB's framework is the reporting entity. Nearly all the world's important companies are groups of entities that operate together. The subsidiary of larger companies are legal entities that pay taxes locally. Accountants prepare “consolidated” financial statements for the group as a whole. These accountants prepare also as many “unconsolidated” financial statements as the number of subsidiaries: whether or not these statements are published depends on national regulations.

Chap. 4 THE REGULATION OF ACCOUNTING Regulation of financial reporting comprises two parts: • making the rules • monitoring/enforcing the rules. This chapter focuses on the first of these. The context here is is mainly the regulation of financial reports designed for those users who are outside the entity. One of the reasons why accounting is regulated in different ways is that the whole nature of the legal system differs internationally. Two main systems can be identified: 1. Codified Law 2. Common Law

1. Most countries in Western Europe have codified law that derives from the Roman jus civile. In such countries, commercial codes establish rules in detail for accounting and financial reporting. However, with the introduction of IFRSs for the consolidated financial statements of listed entities within the European Union, the relationship between financial reporting and national legal systems is becoming less strong. a) in France, Belgium, Spain, Portugal and Greece (all code law countries) much of the detail of accounting rules is found in “accounting plans”, which are documents under the control of government committees. b) in Italy, Germany and several other civil law countries, commercial codes contain many legal instructions on accounting.

2. By contrast to these codified systems, many other countries use a version of the english legal system, which relies upon a limited amount of statute law. This is then interpreted by the courts. The common law is less abstract than codified law. A common law rule seeks to provide an answer to a specific case rather then to formulate a general rule for the future.

The way in which accounting is regulated has great effect on how it works. In roman law countries, accounting tends to be in control of governments and lawyers. In common law countries, accountants are more important in the setting and interpretation of accounting rules. IAS 1 requires that financial statements (described as complying with IFRSs) should comply with all requirements of all the IFRSs. In the EU, listed companies are required to use IFRSs for their consolidated statements. IFRSs can either be compulsory, optional or not allowed. In 2009, IASB issued a separated “IFRSs for SMEs” (small and medium enterprises). It aims to provide a rigorous and common set of accounting standards for SMEs that is much simpler than the full IFRSs. Where IFRSs or IFRS for SMEs are not used, the national systems continue.

Chap. 5 INTERNATIONAL DIFFERENCES AND HARMONIZATION Different countries have contributed to the development of accounting over the centuries. The Romans developed sophisticated forms of single entry accounting. From the late 19th century onwards, the US has given us consolidation of financial statements, management accounting, capitalization of leases and deferred tax accounting. The common feature of all these international influences on accounting is that commercial developments led to accounting advances. Although international influences and similarities are clear, there are also great international differences. The large differences between German and US profit figures were a surprise to many accountants and users of financial statements. It is not possible to be sure about the factors that cause international differences, but relationships can be established and reasonable deductions can be made. On a worldwide scale, factors such as language, culture or geography have been referred to by researchers. To the extent that these also have some explanatory power, it seems more sensible to assume that this results from auto-correlation. If one wanted to encompass countries outside the developed Western World, it would be necessary to include factors concerning the state of the development of their economy and the nature of their political economy.

4 probable factors that cause differences in accounting: 1. Provider of Finance 2. Legal Systems 3. Taxation 4. Accountancy Profession PROVIDERS OF FINANCE In some countries, a major source of corporate finance for two centuries has been the share capital and loan capital provided by large numbers of private investors. The increased importance of institutional investors is perhaps a reinforcement for the following hypothesis: “In countries with a widespread ownership of companies by shareholder who do not have access to internal information, there will be a pressure for disclosure, audit and decision-useful info”. By contrast, in France and Italy, capital provided by the state or by banks is very significant, as are the family businesses. In germany, the banks, in particular, are important owners of shares in companies as well as providers of debt finance. If many companies in continental countries are dominated by banks, governments of families, the need for published information is much smaller because of this access to private information. Fairness: is a concept related to the existence of a a large number of outside owners who require unbiased information about the success of a particular business and its state of affairs.

The shareholders are interested in comparing one year with another and one company with another. This entails (implica) judgement, which entails experts. In countries such as the UK or the US, result in a tendency to require accountants to work out their own technical rules. This is acceptable to governments because of the influence and expertise of the private sector. In many continental European countries, the traditional scarcity of “outsider” shareholders has meant that external financial reporting has been largely invented for the purposes of governments, as tax collectors or controllers of the economy. However, it does lead to precision, uniformity and stability. → more prudent, conservative accounting. This is because creditors are interested in whether, in the worst case, they are likely to get their money back or not, whereas shareholders may be interested in an unbiased estimate of future prospects.

LEGAL SYSTEMS Already considered in Chap. 4, it was suggested that many countries in the world can be put into one of two categories with respect to their main legal system: Common Law or Roman Law.

TAXATION Although it is possible to make groupings of tax systems in a number of ways, only some of these ways are relevant to financial reporting. What is particularly relevant is the degree to which taxation regulations determine accounting measurements. Throughout Europe, tax is based on the unconsolidated statements of individual companies, which still largely use national accounting rules, rather than IFRS. Unlike traditional German or Italian accounting, there can be many differences between tax numbers and financial reporting numbers in the UK, the US and the Netherlands. For example, in the UK convention and pragmatism, rather than exact rules, determine the method of depreciation (usually straight-line because it is easier), the estimates of scrap value (often zero) and the expected length of life. With some variations, tax influence operates in Germany, France, Belgium, Italy and many other countries. It is perhaps due partly to the pervasive influence of codification in law and partly to the predominance of taxation as a use of accounting.

THE ACCOUNTANCY PROFESSION The power, size and competence of the accountancy profession in a country may follow, to a large extent, from the various factors outlined above and from the type of financial reporting that they have helped to produce. The nature of the profession also feeds back into the type of accounting that is practiced and could be practiced. To become an auditor, you must be member of the private professional accounting bodies.

Conclusion of the four factors: if the last three factors are largely influenced by accounting, the remaining potential independent variable is the financing system. This is the main explanatory variable of a country's accounting system and therefore for the most convincing explanation for the major international differences in accounting.

Many nations have contributed to the development of accounting. International influences had begun to affect accounting in all countries. The globalization of markets had led to an increased need for internationally comparable accounting information. Many large European companies responded to internationalization by volunteering to use one of two sets of internationally recognized rules: • the GAAP (US' Generally Accepted Accounting Principles) • the International Standards of the IASB. To combat the problems of accounting differences, several orgs are involved in attempts to harmonize or standardize accounting. Harmonization: is a process of increasing the compatibility of accounting practices by setting bounds to their degree of variation. Standardization: appears to imply the imposition of a more rigid and narrow set of rules. However, within accounting these two words have almost become technical terms, so one cenot rely upon the normal differences in their meanings. Harmonization is a word that tends to be associated with EU. Standardization tends to be associated with IASB. It is necessary to distinguish between: • de jure harmonization (that of rules, standards...) • de facto harmonization (that of corporate financial reporting practices) The EU achieves its harmonizing objectives mainly through: • Directives (which must be incorporated into the laws of member states) • Regulations (which have direct effect) The exact effect of a certain Directive on a particular country will depend upon what the previous rules were and then on the exact content of the laws passed by national legislatures to implement the Directives. The Directive covers either public and private companies.

The influence of Anglo-Saxon thinking opened the doors at the Fou...