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Topic 5: Comparative Accounting Systems – 1  

The US The EU

Questions 1.

Which US accounting practices seem out of line with those of many other countries? What explanations are there for this? (Nobes & Parker, 2012) 2. Discuss the causes of differences in financial reporting and its regulation (giving relevant examples of the effects) between your own country and the united states. (Nobes & Parker, 2012) 3. What effect, if any, has harmonization in the European Union had on non-member states in Europe? (Nobes & Parker, 2012) 4. Discuss the role of the European Union’s in promoting accounting standard-setting in a regional and global context. 5. Discuss the accounting convergence progress of the US 6. UK and US practices grouped together under the Anglo-American or Anglo-Saxon approach to accounting. Discuss the appropriateness of this classification approach. 7. ‘US accounting is the best in the world’. ‘The FASB is the best accounting standard setter in the world’. Discuss. (Nobes & Parker 2010, p. 201) 8. ‘German accounting rules for individual companies are ideal for domestic Nobes & Parker companies with no international connections’. Discuss. (2010, p. 377)

(Choi & Meek 2010, pp. 115-116)

Suggested Solutions 1. Here is a list of some of the cases where the United States is out of line with the rules of at least several other major countries. IFRS comparisons are also noted. (a) Strict historical cost for property, plant and equipment (tangible fixed assets). Although Germany and Japan share this US feature, most countries (and IFRS) do not. Some allow optional revaluation without tax disadvantage (e.g. United Kingdom and Australia); some have had governmentally demanded revaluations from time to time (e.g. France, Italy and Spain); some have had compulsory indexation (e.g. Brazil and Argentina) and some have had voluntary but controlled revaluations (e.g. Sweden and Korea). IFRS allows revaluations. The SEC’s influence seems to have been at work in the United States in opposing the subjectivity involved in revaluations. (b) The use of fair value for certain marketable securities. US rules (and IFRS) now require trading and available-for-sale securities to be held at fair value. The gains and losses go to income (for trading) and other comprehensive income (for available-for-sale). Although financial institutions in several countries value some investments at market, the US practice is not normal in other countries for most companies unless IFRS is followed. (c) No capitalization of research and development expenditure (except software) or set-up costs. Most countries (and IFRS) allow or require some of these expenses to be capitalized, but the Financial Accounting Standards Board (FASB) has gone for the prudent approach, which is easier to check. (d) Lack of standardized formats and terms. In most developed countries, standardized formats of financial statements (including technical terms) are required by law, accounting plan and so on. The extent of this in the United States (and IFRS) is not so well developed. This may be because of the lack of general regulatory framework or because the FASB and SEC see this as a trivial issue. (e) Detail of standards and disclosures. The US requirements are more extensive than anywhere else. This is partly because they are only compulsory for a relatively few SEC companies and partly because the SEC is an efficient regulatory mechanism that can enforce detailed rules. The general context is an enormous financial market which demands financial information.

2. This question can be answered by comparing any country with the United States by noting differences from the following features of the United States: (a) lack of legal regulatory environment for most companies, as an extreme form of the common law system; (b) existence of an SEC providing government enforcement for accounting rules; (c) lack of major influence of tax rules on accounting (with the obvious exception of LIFO); (d) strong, old and powerful accountancy profession, although this gave up formal control of standard-setting in 1972; (e) large capital market with millions of outside shareholders and lenders. For each of these points, US accounting practices can be contrasted to those of certain countries. For example, the long history of audit, consolidation and extensive disclosures seems to be connected with (e) above. The production of detailed rules results from (a), (c) and (d) by accountants and not by the government. 3. Norway and Switzerland (which have chosen not to enter the European Union but which trade extensively with EU countries) have seen major changes to accounting from the late 1980s; the Fourth and Seventh Directives have been implemented, at least approximately. This was partly in order to prepare for possible EU membership but partly because of the commercial pressure to harmonize with neighbours such as Germany or Denmark. Norway is a member of the European Economic Area (EEA), and so is obliged to implement the Directives. From 2005 onwards, the use of IFRS throughout the European Union (and other parts of the EEA) achieved much harmonization for the group statements of listed companies and more widely. This does achieve harmonization with the large Swiss groups that were already using IFRS. The most affected non-member states have been those with aspirations to join the European Union. The 12 countries that joined in 2004 and 2007 had already implemented many elements of the Directives. Other applicants for membership (Croatia and Turkey) have also been affected. 4. After the IOSCO endorsement of the core standards, the European Parliaments passing of the IFRS regulation on 19 July 2002 (EC 1606/2002) represented the IASB’s second major accomplishment in seeking global recognition of IFRS. This regulation saw the implementation of IFRS by EU listed firms for consolidated financial statements for financial periods beginning on or after 1 January 2005. The EU adoption of IFRS, described as “one of the biggest events in the history of financial reporting” (Hung and Subramanyam 2007, p. 623) was initially proposed by the European Commission in June 2000 and ratified by the European Council on 7 June 2002 (Deloitte_Touche_Tohmatsu 2010). Some 27 EU member countries and the three members of the European Economic Area (EAA) and an estimated 7,000 EU-listed firms were affected by the regulation (Jermakowicz and Gornik-Tomaszewski, 2006). EU and EAA members had the option to extend IFRS to and to unlisted firms and to the financial statement of individual entities (Haverals 2007; Whittington 2005). 5. 

In September 2002, the IASB and FASB released the Norwalk Agreement in which they identified their commitment to convergence.

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In 2006, the IASB and FASB used a Memorandum of Understanding to reaffirm their commitment to convergence and update their joint work program.

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In July 2007, the SEC released the following proposed rule: Acceptance From Foreign Private Issuers of Financial Statements Prepared in Accordance With International Financial Reporting Standards Without Reconciliation to U.S. GAAP.

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In August 2007, the SEC released Concept Release On Allowing U.S. Issuers To Prepare Financial Statements In Accordance With International Financial Reporting Standards

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In November 2008, the SEC released: Roadmap for the Potential Use of Financial Statements Prepared in Accordance With International Financial Reporting Standards by U.S. Issuers by 2014.

6. 

With the UK and US sharing a number of similarities in their approach to accounting standards (i.e. both are directed towards needs of investors), their practices are commonly grouped together as being part of a wider Anglo-American model.

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Despite being grouped together, it is important to note their technical differences (i.e. treatment of goodwill, internally generated intangible assets, revaluations) and how they generally represent different philosophies (i.e. rules-based v principles-based).

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Many have held that the strength of the US economy is testament to the strength of the American accounting profession.

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America has a long history of developing accounting standards, and a very comprehensive body of standards.

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Many IFRS are based on FASB standards.

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Many FASB standards were the first of their kind in the world.

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The revised IASB structure was based the FASB’s independent structure.

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The FASB is probably the best resourced standard setter in the world.

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The IASB referred to the FASB’s framework when developing its own.

7.

8. Certainly, the main use for the unconsolidated statements of small or medium-sized companies is unlikely to be investor decision-making, but rather calculating distributable income or taxable income. German accounting is better designed for these two purposes (Nobes & Parker 2010).

Case 4.1 Part 1  Principles-based standards rely on professional judgment. Rules-based standards require accountants/auditors to select the correct treatment based on detailed guidelines. 

Rules-based standards tend to be more voluminous and complex.

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Rules-based standards tend provide for treatment and scope exemptions (see for example Schipper 2003; Gill 2007; Benston et al. 2006).

Part II Some attribute the development of a rules-based approach in response to calls from the profession for detailed application guidance. That is, preparers and auditors called for the detailed rules as they tried to apply the underlying principles originally outlined by the FASB. A shift to a principlesbased approach in the US would be a fundamental change for US accountants and auditors and would require a change in the education system and the practices of accountants and auditors. Part III A shift to a principles-based approach in the US would require a change in practice for both auditors and preparers. This could require significant training. Part IV Pros and cons of rules-based approach: Pros  Increased comparability;  Increased verifiability for auditors and regulators (and a related reduction in litigation);  Reduced opportunities for earnings management through judgments (but increased opportunities through transaction structuring); and  Improved communication of standard setters' intentions. (Nobes 2005, p. 26)

Cons  May result in firms structuring transactions so as to avoid the rules.  Complex / voluminous.  Needs to be updated with changing business environment/activities. (Nobes 2005; Benston et al. 2006)...