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CHAPTER 2
WORLDWIDE ACCOUNTING DIVERSITY
Chapter Outline
I. Considerable differences exist across countries in the accounting treatment of many items.
These differences can result in significantly different amounts being reported in the financial
statements prepared by companies using different GAAP.
II. A variety of factors influence a country’s accounting system.
A. Legal system – in code law countries, accounting rules tend to be legislated; common
law countries tend to have a non-legislative organization that develops accounting
standards.
B. Taxation – financial statements serve as the basis for taxation in many countries. In
those countries with a close linkage between accounting and taxation, accounting
practice tends to be more conservative so as to reduce the amount of income subject
to taxation.
C. Providers of financing – in those countries in which family members, banks, and the
government are the major providers of business finance, there tends to be less
demand for public accountability and information disclosure. In countries where
shareholders are a major provider of financing, the demand for information made
available outside the company becomes greater.
D. Inflation – countries with chronic high inflation adopt accounting principles in which
traditional historical cost accounting is abandoned in favor of inflation adjusted figures.
E. Political and economic ties – through previous colonization, a British style of
accounting is used throughout most of the former British Empire. Ties between
countries also help to explain similarities between the U.S. and Canada, and
increasingly, the U.S. and Mexico.
III. Differences in accounting across countries cause several problems.
A. Consolidating foreign subsidiaries requires that the financial statements prepared in
accordance with foreign accounting rules must be converted into parent company
GAAP.
B. Companies interested in obtaining capital in foreign countries may be required to
provide financial statements prepared in accordance with accounting rules in that
country, which are likely to differ from rules in the home country.
C. Investors interested in investing in foreign companies may have a difficult time in
making comparisons across potential investments because of differences in
accounting rules across countries.
D. There is a lack of quality accounting standards in some parts of the world. The 1997
East Asian financial crisis was at least partially attributable to a lack of high quality
accounting in the region.
IV. There are two major classes of accounting systems, the micro-based class and the macro-
uniform class.
A. The micro-based class of accounting is found in common law countries, where there is
a separation of accounting from taxation, and shareholders are an important source of
financing. Information is developed primarily for equity investors, with adequate
disclosure serving as a major objective.
B. The macro-uniform class exists in code law countries, where accounting serves as the
basis for taxation, and families, banks and government are the major providers of
capital. Income measurement is more conservative and disclosure is lower than in the
micro-based class of countries.
V. National culture is another factor long thought to influence a country’s accounting system.
Using Hofstede’s (1980) societal value dimensions, Gray (1988) developed the
following hypotheses:
A. Conservatism hypothesis – countries high on uncertainty avoidance and long-term
orientation, and low on individualism and masculinity will foster a more conservative
approach to measurement.
B. Secrecy hypothesis – countries high in power distance, uncertainty avoidance, and
long-term orientation, and low on individualism and masculinity will exhibit more secrecy
(less disclosures) in accounting reports.
C. Research results provide some support for these hypotheses, especially the hypothesis
that culture affects the level of disclosure in accounting reports.
VI. Nobes introduced a simplified model of the reasons for international differences in financial
reporting in 1998. In this model, the class (A or B) of accounting used in a country is a
function of the strength of the equity-outsider financing system, which is a function of a
nation’s culture, including its institutional structures.
A. Class A accounting systems are oriented toward providing information to outside
shareholders (less conservative, more disclosure). This is consistent with the micro-
based class of accounting.
B. Class B accounting systems are geared to taxation and creditors (more conservative,
less disclosure, accounting follows tax rules).
C. Nobes suggests that countries in Class B countries that are interested in competing for
equity capital will adopt a Class A accounting system if allowed to do so.
VII. Differences in accounting across countries exist in several areas.
A. Differences in the financial statements included in an annual report – for example, cash
flows statements are not required in all countries.
B. Differences in the format used to present financial statements – for example, assets are
presented in order of liquidity in the U.S., but in reverse order of liquidity in most
countries.
C. Differences in the level of detail provided in the financial statements – for example, an
Italian balance sheet can comprise up to five pages of the annual report.
D. Terminology differences – for example, sales revenue in the U.K. is called “turnover,”
and inventory is called “stock.”
E. Disclosure differences – for example, companies in some countries provide extensive
disclosures related to their employees.
F. Recognition and measurement differences – for example, differences exist across
countries with respect to the accounting for goodwill, development costs, and leases.
Answers to Questions
