Question

Why is there a difference and diversity in accounting between countries?

The advantages and disadvantages of accounting diversity?

Answer 1

Below is the detailed reply to the question raised. Although the answer is being given in an elaborate manner as the required length of the answer is not prescribed, the student can accordingly change the length of the reply based on the broad structure given below.

REASONS FOR ACCOUNTING DIVERSITY

Accounting scholars have hypothesized numerous influences on a country’s accounting system, including factors as varied as the nature of the political system, the stage of economic development, and the state of accounting education and research. A survey of the relevant literature has identified the following five items as being commonly accepted as factors influencing a country’s financial reporting practices: legal system, taxation, providers of financing, inflation, and political and economic ties.

1. Legal System

There are two major types of legal systems used around the world: common law and codified Roman law. Code law countries generally have corporation law (sometimes called a commercial code or companies act), which establishes the basic legal parameters governing business enterprises. The corporation law often stipulates which financial statements must be published in accordance with a prescribed format. In countries where accounting rules are legislated, the accounting profession tends to have little influence on the development of accounting standards. In countries with a tradition of common law, although a corporation law laying the basic framework for accounting might exist (such as in the United Kingdom), specific accounting rules are established by the profession or by an independent nongovernmental body representing a variety of constituencies.

2. Taxation

In some countries, published financial statements form the basis for taxation, whereas in other countries, financial statements are adjusted for tax purposes and submitted to the government separately from the reports sent to stockholders. The difference between tax and accounting income gives rise to the necessity to account for deferred income taxes, a major issue in the United States as well as in Nigeria. Deferred income taxes are much less of an issue in Germany; for many German companies, they do not exist at all. This is also true in other code law countries such as France and Japan.

3. Providers of Financing

The major providers of financing for business enterprises are family members, banks, governments, and shareholders. In those countries in which company financing is dominated by families, banks, or the state, there will be less pressure for public accountability and information disclosure. Banks and the state will often be represented on the board of directors and will therefore be able to obtain information necessary for decision making from inside the company. As companies become more dependent on financing from the general populace through the public offering of shares of stock, the demand for more information made available outside the company becomes greater. It simply is not feasible for the company to allow the hundreds, thousands, or hundreds of thousands of shareholders access to internal accounting records. The information needs of those financial statement users can be satisfied only through extensive disclosures in accounting reports. There can also be a difference in financial statement orientation, with stockholders more interested in profit (emphasis on the income statement) and banks more interested in solvency and liquidity (emphasis on the balance sheet). Bankers tend to prefer companies to practice rather conservative accounting with regard to assets and liabilities.

4. Inflation

Countries experiencing chronic high rates of inflation found it necessary to adopt accounting rules that required the inflation adjustment of historical cost amounts. This was especially true in Latin America, which as a region has had more inflation than any other part of the world. Adjusting accounting records for inflation results in a write-up of assets and therefore related expenses. Adjusting income for inflation is especially important in those countries in which accounting statements serve as the basis for taxation; otherwise, companies will be paying taxes on fictitious profits.

5. Political and Economic Ties

Accounting is a technology that can be relatively easily borrowed from or imposed on another country. Through political and economic links, accounting rules have been conveyed from one country to another. For example, through previous colonialism, both England and France have transferred their accounting frameworks to a variety of countries around the world. British-style accounting systems can be found in countries as far-flung as Australia and Zimbabwe. French accounting is prevalent in the former French colonies of western Africa. More recently, it is thought that economic ties with the United States have had an impact on accounting in Canada, Mexico, and Israel.

6. Correlation of Factors

Whether by coincidence or not, there is a high degree of correlation between legal system, tax conformity, and source of financing. Common law countries tend to have greater numbers of domestic listed companies, relying more heavily on equity as a source of capital. Code law countries tend to link taxation to accounting statements and rely less on financing provided by shareholders.

Advantages of Accounting diversity:

The Diversity on accounts have a limited advantages as below:

1. It helps in reduction of the cost of business: The diversity in accounting helps the small businesses to save the costs which they otherwise would incur, if they were asked to follow a common international system. It is because, there would be required, a lot of return and report filings for a common system to be prevelant. The diversity in accounting helps the businesses to be compliant to their own country's accounting

2. It helps in avoiding the high enforcement efforts required for global consistency in auditing:

Although the United States has an effective enforcement policy on its accounting rules, trying to enforce this level of consistency on other member countries can be challenging. The differences in political and economic systems works to reduce the amount of comparability which is available, even if it can improve the efficiency of audits or eliminate information understanding.

3.To limit the amount of work placed on accountants:

Although the CFO of each organization would be responsible for this task under most circumstances, the implementation of the a standardised system of accounting would come from the accounting team. These departments are already busy trying to manage the rules and regulations that are in place currently, so they would be asked to continue with their daily work while creating the foundation for this system to receive implementation too.

4.The home-court advantage for the modern firm:

Investors prefer to work with companies that are closer to home, so foreign firms receive fewer direct investments even when the switch to the global system takes place.

Disadvantages of accounting diversity

1. Preparation of Consolidated Financial Statements: The diversity in accounting practice across countries causes problems that can be quite serious for some parties. One problem relates to the preparation of consolidated financial statements by companies with foreign operations. Consider General Motors Corporation, which has subsidiaries in more than 50 countries around the world. Each subsidiary incorporated in the country in which it is located is required to prepare financial statements in accordance with local regulations. These regulations usually require companies to keep books in local currency using local accounting principles. Thus, General Motors de Mexico prepares financial statements in Mexican pesos using Mexican accounting rules and General Motors Japan Ltd. prepares financial statements in Japanese yen using Japanese standards. To prepare consolidated financial statements in the United States, in addition to translating the foreign currency financial statements into U.S. dollars, the parent company must also convert the financial statements of its foreign operations into U.S. GAAP. Each foreign operation must either maintain two sets of books prepared in accordance with both local and U.S. GAAP or, as is more common, reconciliations from local GAAP to U.S. GAAP must be made at the balance sheet date. In either case, considerable effort and cost are involved; company personnel must develop an expertise in more than one country’s accounting standards.

2. Access to Foreign Capital Markets A second problem caused by accounting diversity relates to companies gaining access to foreign capital markets. If a company desires to obtain capital by selling stock or borrowing money in a foreign country, it might be required to present a set of financial statements prepared in accordance with the accounting standards in the country in which the capital is being obtained. To have stock traded in a country, foreign companies must either prepare financial statements using the country’s accounting standards or provide a reconciliation of local GAAP net income and stockholders’ equity to the country’s GAAP. This can be quite costly. In preparing for a New York Stock Exchange (NYSE) listing in 1993, the German automaker Daimler-Benz estimated it spent $60 million to initially prepare U.S. GAAP financial statements; it expected to spend $15 million to $20 million each year thereafter.

3. Comparability of Financial Statements A third problem relates to the lack of comparability of financial statements between companies from different countries. This can significantly affect the analysis of foreign financial statements for making investment and lending decisions. The job of deciding which foreign company to invest in is complicated by the fact that foreign companies use accounting rules different from those used in Nigeria and those rules differ from country to country. It is very difficult if not impossible for a potential investor to directly compare the financial position and performance of an automobile manufacturer in Germany (Volkswagen), Japan (Nissan), and the United States (Ford) because these three countries have different financial accounting and reporting standards. According to Ralph E. Walters, former chairman of the steering committee of the International Accounting Standards Committee, “either international investors have to be extremely knowledgeable about multiple reporting methods or they have to be willing to take greater risk.” A lack of comparability of financial statements also can have an adverse effect on corporations when making foreign acquisition decisions. In many cases, the international public accounting firms were called on to convert financial statements to a Western basis before acquisition of a company could be seriously considered.

4. Lack of High-Quality Accounting Information A fourth problem associated with accounting diversity is the lack of high-quality accounting standards in some parts of the world. There is general agreement that the failure of many banks in the 1997 East Asian financial crisis was due to three factors: a highly leveraged corporate sector, the private sector’s reliance on foreign currency debt, and a lack of accounting transparency. To be sure, inadequate disclosure did not create the East Asian meltdown, but it did contribute to the depth and breadth of the crisis. As Rahman explains: “It is a known fact that the very threat of disclosure influences behaviour and improves management, particularly risk management. It seems that the lack of appropriate disclosure requirements indirectly contributed to the deficient internal controls and imprudent risk management practices of the corporations and banks in the crisis-hit countries.”