Question

Critically examine factors that influence contemporary accounting practices or standard setting in transition countries. (1k words)

- Country's level of cultural independence

- Financial Reporting System

- Country's Cultural

Answer 1

As a social science, accounting is affected by the environment in which it operates, but at the same time, it is one of the factors impacting on this same environment. This is a fact that points to the interdependency of accounting and its environment. A country’s accounting system is affected by a variety of historical, economic, socio – cultural, institutional, and other non – accounting factors, so it is highly unlikely for the influential factors of any two countries to be exactly the same. Therefore, it can be logically assumed that the factors affecting the development of a country’s accounting system are also the generators of special national traits and, thus, the generators of differences between accounting systems at the international level. After all, just as countries have different histories and political and legal order or even value systems, so will their accounting systems have more or less differing development and operating model. In the literature, affirming or refuting the importance of individual factors from the environment on the development of a country’s accounting system generally comes down to citing and describing impact factors, while few efforts have been made to quantifiably assert these factors or discern their interdependence that would account for the dissimilarities of accounting systems of countries based on the susceptibility of accounting to diverse business environments. Several comments on influential factors can be singled out from the literature. For example, Saudagaran (Saudagaran, 2004, 3 – 7) lists ten influential factors, while pointing out that this is not an exhaustive list, and that the intensity of differences in accounting at the international level depends upon the intensity of dissimilarities of individual factors between countries. In this case, he lists the following factors that affect a country’s accounting development: 1) Type of capital market, 2) Financial reporting system, 3) Types of business entities, 4) Legislative system, 5) Application degree of legislation, 6) Inflation level, 7) Political and economic relations with other countries, 8) Status of the accounting profession, 9) Existence of a conceptual framework, 10) Quality of education in accounting. In addition to the above, influential factors can also be classified as (Choi, Mueller, 1992, 39 – 43): 1) Legal system, 2) Political system, 3) Nature of ownership, 4) Differences in the size and complexity of business entities, 5) Social climate, 6) Level of sophistication of administration and the financial community, 7) Level of legislative interference in the operations of entities, 8) Existence of specific accounting legislation, 9) Speed of business innovations, 10) Level of economic development, 11) Growth pattern of an economy, 12) Status of professional education and profession associations. Other factors of influence also mentioned in the literature include (Mueller, Gernon, Meek, 1987, 10 – 15) 1) Relationships between business entities and sources of capital, 2) Political and economic relations with other countries, 3) Legal system, 4) Level of inflation, 5) Size and complexity of business entities, level of sophistication of business management and the financial community, and the general level of education. Finally, it is interesting to point out the claim that, notwithstanding all the frequently cited influential factors, five factors are all that are needed to explain how different reporting objectives are the cause of international differences in financial and accounting reporting. Basic models have been established in which the major influential factors are expressed as the following model variables: 1) A country’s culture, 2) Strength of the system of external sources of funding, 3) Types of business entities, 4) A country’s level of cultural independence, 5) Financial reporting system (Nobes, 1998, 177 – 180). Based on the above classification of influential factors, on factors that repeatedly appear in individual classifications, as well as on factors that certain authors particularly emphasise, several influential factors have been singled out and are explained in detail in the following section. That this paper focuses more on some factors and less on others results from the fact that the literature reviewed does not deal equally with all factors

2. CAPITAL MARKET The literature points to several factors affecting how an accounting system develops and is shaped that could be grouped under “capital market” as a common denominator1. Namely, although fundamentally different financing systems are involved, in this case the term “capital market” encompasses both the level of development of financial instruments and the globalisation level of a given capital market. Differences in financing systems Business entities within different accounting systems basically rely on earned capital; their external sources of funding, however, may differ. Therefore, depending on whether funds are raised by issuing securities or through credit loans from financial institutions, accounting systems can be characterised as those whose main source of funding is either the stock market (equity-oriented) (Saudagaran, 2004, 3) or a bank (debt-oriented) (Saudagaran, 2004, 3)2. In such a context, a capital market, through its attributes, impacts on a country’s

financial reporting system. This impact primarily depends on who are the investors or creditors (individuals, banks, a state), who are the information users and what are their information needs, as well as how many of them there are and what is their association to business entities. Namely, financial reports and the accounting information they hold are an indispensable and vital source of data on the performance of business entities regardless of the financing system and its attributes. For example, in countries whose businesses raise funds by issuing securities, investors see financial reports as a very important source of information about the performance of these businesses because investors have limited access to alternative sources of information. Hence reporting is directed towards and focused at their information need, regardless of whether they are investors in stocks or bonds, as countries with this type of system also have developed proprietary securities markets as well as debt securities markets. Because of the large number of stockholders and the impossibility of contacting each one individually, financial reports should be transparent and contain a sufficient amount of information to indicate how a business is performing. In systems in which the major sources of funding are banks' credits, with usually a few very powerful banks meeting most financial needs, financial reports are based on the information needs of creditors and are focused on their protection. The information needs of banks are often met through personal contacts and/or direct access to reports, which is the difference when compared to transparent financial reports mentioned above. In a way, exclusive access to information diminishes the need for developing a more open and informative reporting system. Although these business entities are also obliged to make public their financial reports, these reports differ in their scope of information from the ones previously mentioned. Level of development of capital markets In addition to the mode of funding, the level of development of capital markets also influences a country’s financial reporting. Briefly, in systems with developed securities markets, new and more complex financial instruments emerge that need to be covered and monitored in terms of accounting, causing changes to the contents of financial reports. Conversely, in systems in which long-term indebtedness with banks and simple financial instruments prevail, there is no need for frequent changes to the method of accounting coverage and monitoring to keep abreast of any possible financial innovations.

3. FINANCIAL REPORTING SYSTEM In explaining the preceding factor, we have explained its influence on financial reporting. On the other hand, considering a financial reporting system in the context of individual influential factor primarily implies the existence of singular or dual, that is, separate or joint reporting for business and taxation needs. In accounting systems in which rules are set based on individual decisions of precedence (Koletnik, 2001, 6) (Anglo-Saxon countries), tax reports are independent of financial reports that are external – user oriented, and are drawn up autonomously and independently of tax regulations. It is different in countries whose accounting systems are based on Roman law (Austria, Germany), that is, where accounting rules are stipulated and fixed by a country’s regulations, thus leaving them with little elasticity (Koletnik, 2001, 6). In this case, there is a single reporting system, with minor differences existing between reporting for tax purposes and reporting for business purposes. In other words, the association or non – association of accounting reporting with tax and business purposes will impact on and determine the attributes of the financial reporting system itself.

4. LEGAL SYSTEM The previously described influential factor implies an understanding of the legal system as a factor in how an accounting system is created and how it operates. The legal systems of most countries can be classified as systems marked by strict adherence to laws and regulations (Code law; legalistic; Roman law) (Saudagaran, 2004, 7; Mueller, Gernon, Meek, 1987, 13; Choi, Mueller, 1992, 40; Buchanan, 2003, 66 – 67), or as systems in which common law (Common law; non – legalistic) is predominant (Saudagaran, 2004, 7; Mueller, Gernon, Meek, 1987, 13; Choi, Mueller, 1992, 40; Buchanan, 2003, 66 – 67). Hence, in the relevant literature, this factor is very frequently mentioned in the context of classifying accounting systems either under the Anglo-Saxon cluster or the Continental Europe cluster. Characteristic of an accounting system influenced by Roman law is the legalisation of accounting standards and procedures. Prescribed by a country’s regulations, accounting rules are very detailed and comprehensive, leaving a very small margin for interpretation and no possibility for improvising. In this type of conservative and inadaptable system, the role of the accountant consists in literary applying prescribed and detailed legal requirements, with special emphasis on protecting creditors. Conversely, in accounting systems, which are under the influence of Anglo – Saxon rules and in which rules are set based on individual decisions, accounting rules and policies are set by professional organisations operating in the private sector. This type of legal system is more adaptable, more innovative and more topical than the system described above, and it focuses on transparent and timely financial reports, as well as on the information needs and protection of investors. 5. POLITICAL SYSTEM, POLITICAL AND ECONOMIC RELATIONS AMONG COUNTRIES The political system as an influential factor is often mentioned in the literature under the term of colonial inheritance (Nobes, 1998, 170) and as such, it is considered a major influential factor of accounting systems and reporting systems alike. The impact of this factor is also evident through history, with invading countries imposing their political, as well as their accounting system on the countries they have conquered and colonised. It is also a fact that many countries, upon gaining independence, have continued to use the same political and accounting system even though it no longer suits their current needs and economic situation, whereas others have opted for a different political and accounting system4. The influence of a political system is reflected in the strong effect of other cultures on certain countries because of their size (small), low level of their development or their previous colonial status

The influence of economic relations among countries on developing and designing an accounting system is the result of developed international exchange. Accordingly, a country’s accounting system can be affected by the accounting system of another country because its geographical position makes it a neighbour, and also because the former represents a large export market for the latter, with many of its businesses going over to the other’s securities market (Canada and the U.S., for example). 6. QUALITY OF ACCOUNTING EDUCATION AND THE STATUS OF THE ACCOUNTING PROFESSION In the literature, the quality of education in the field of accounting is often referred to as a factor in the development and design of an accounting system. Various authors agree that this factor, if lacking, can represent a constraining factor in accounting system development5. While the quality of accounting education is directly influenced by a society’s general level of knowledge, it is also affected by other factors such as the status of the accounting profession in a country, the level of economic development, economic relations with other countries, and so on. Accordingly, accounting will not be more than average in countries in which the general level of knowledge is low. Bringing in accountants from advanced countries or sending accounting professionals to advanced countries for education is not a perfect solution because advanced countries may not have or do not have the same accounting system as less developed countries. Also, advanced countries have a developed accounting system that is characteristic of large and complex businesses with complex accounting problems that can only be solved by highly qualified and skilled accounting professionals. Conversely, because smaller and simpler forms of business entities prevail in less developed and developing countries, the required level of accounting education and qualification is lower, and accounting is “primitive” (Mueller, Gernon, Meek, 1987, 15). Contrary to the reasoning that this factor impacts on the design and attributes of an accounting system, Nobes (1998) holds a different opinion. Calling upon the Doupnik – Salter (1995) (Nobes, 1998, 172) theoretical model explaining accounting differences, Nobes claims that a different level of accounting education is not a relevant factor in explaining differences because it can not be used to classify accounting systems. Accordingly, it could be viewed merely as an outcome of differences among accounting systems but not as the cause of these differences, and it could possibly serve in making comparisons between advanced and developing countries. Seen from this perspective, this factor could be considered within the framework of factors relating to a country’s level of economic development or to the tradition and strength of the accounting profession (Nobes, 1998, 172).

7. SIZE AND COMPLEXITY OF BUSINESS ENTERPRISES, FORMS OF BUSINESS OWNERSHIP In the literature, the influences of these factors are explained mostly together and in a very similar manner, based on the assumption that larger business enterprises also constitute systems that are more complex. According to one opinion, it is highly likely that the level of economic development a country has achieved will affect the number and size of business enterprises operating in that country (Saudagaran, 2004, 6). As this means that large business enterprises prevail in more developed countries, and small enterprises, in developing countries, the accounting system of developed countries with complex forms of business enterprises will differ from the accounting system of developing countries. The head offices of large and complex businesses producing and selling beyond the borders of their home country and generating profits greater than the gross domestic product of less developed countries, are generally located in developed countries. Accordingly, accounting and financial reporting will be more complex and demanding than in less developed and developing countries, whose economies are characterised by many smaller business enterprises with less complex operations and, in turn, with simpler accounting coverage and monitoring, as well as financial reporting. In other words, different accounting systems are generated. The size and complexity of business enterprises is an argument that has multiple implications in explaining accounting system differences. Namely, the accounting needs of large businesses that have several different production lines and a wide variety of products differ from the accounting needs of smaller enterprises producing, for example, only a single product. The information needs of multinational companies are different from the needs of large businesses that manufacture only for the home market, and they differ even more from the needs of small enterprises (Černe, 2007, 19). Although business entities' ownership, as an influential factor, is affected by other influential factors such as a country’s political system or its economic orientation, it should also be viewed separately in order to underline the impact of various business ownership forms resulting in different information needs, which in turn generate differences in accounting systems prevalent in the various forms of ownership. For example, the information needs and accounting requirements of stockholders differ from those of small, family-run business or enterprises in the majority ownership of states or banks. 8. LEVEL OF INFLATION An economy’s level of inflation can also be considered in the context of its influence on a country’s accounting system, in particular because it affects the asset valuation method and because, in conditions of high inflation, it is essential to have an accounting system suited to inflationary conditions. For example, countries such as the U.S. or Great Britain (Saudagaran, 2004, 8) in which inflation levels are mostly under control apply the historical

cost method for the needs of financial reporting. This method, however, cannot be fully applied in countries such as Bolivia or Mexico (Saudagaran, 2004, 8), which have had or do have a high rate of inflation; instead, these countries use different models that seek to reduce the impact of inflation on financial reporting to obtain relevant information. In other words, accounting for inflation is required, and is therefore more developed and pronounced in economies with high inflation levels, consequently leading to differences in accounting systems as a result of different inflation levels. Regardless of this, there are opinions that the level of inflation is not a crucial influential factor in elucidating the differences between accounting systems, although it could possibly be the cause for differences in accounting practices of those accounting system belonging to the same category (Nobes, 1998, 175). According to this perspective, a certain level of inflation will trigger a reaction in every accounting system, and procedures for accounting inflation will be applied. In this, it is crucial to know who will react and how: will it be the professional accountants or the state within the framework of the tax system (Černe, 2007, 20). 9. APPLYING AND ENFORCING LEGISLATIVE REGULATIONS IN ACCOUNTING The accounting systems of countries differ not only by accounting regulations but also by the degree to which current accounting regulations are applied in practice. This factor can be viewed as being a continuation of the influence of the political and legal systems, as well as the way in which a country has set up its accounting regulations. Accordingly, deviations between accounting regulations and accounting practice in a country will depend upon its degree of application assistance and degree of application control, that is, upon its power of enforcement. For example, accounting practice will be strongly consistent with regulations in countries in which accounting regulations are widely controlled and rigorously enforced, but will be less consistent in countries in which there is no supervision over how accounting regulations are enforced in practice. 10. ACHIEVED LEVEL OF ECONOMIC DEVELOPMENT The influence of the achieved level of economic development on an accounting system is also evident in some of the influential factors depicted above. Undoubtedly, the development of an accounting system is conditioned by a country’s economic development, that is, by the level of economic development it has reached. Considering that most of the world can be divided into the rich and the poor, countries can also be divided as “accounting “have” and “have nots” nations” (Mueller, Gernon, Meek, 1987, 15). In addition to a powerful economy, developed countries are also marked by a diversity of economic – and, in turn, financial – activities. Stockholders prevail in the ownership structure of capital; securities markets are present and operating. Earlier it was mentioned, when explaining the influence of the size and complexity of business enterprises, that a country’s level of economic development also affects these attributes. Hence, it follows that large and complex business enterprises whose operations exceed national boundaries are the prevailing form in developed countries, and that management is highly developed in terms of the application of complex techniques, tools and decision-making procedures. Also, the currencies of developed countries are more stable, and their inflation rate is lower in comparison to developing countries On the other hand, the influence of the state is evident in developing and less developed countries, in particular, regarding the contents and form of financial reporting, accounting periods, and the way profit is determined and costs are accounted. Their financing systems are not developed relative to the systems of developed countries,

11. CULTURE In addition to knowing a country’s legal, political or financing system, it is also necessary to know something about its culture in order to better understand the country’s differences and its accounting practice. Even when financial reports are comprehensible to users with regard to language, monetary unit or the accounting principles applied, culture should be considered as a factor that affects the development of an accounting system. The assertion that culture is interrelated with the environment and that it is, at the same time, affected by other influential factors is the likely reason of its rarely mentioning in the literature as an influential factor. Nonetheless, the influence of culture is considered and mentioned in several articles and studies6. Especially interesting is the theory that links some of the structural elements or dimensions of culture7 (Gray, 1998) to accounting values8 and

systems (Gray, 1998), and the testing of hypotheses formulated by this theory (Salter, Niswander, 1995). Among other things, the justification of considering culture as a criterion in classifying national accounting systems is analysed (D'Arcy, 2001). Contrary to the model mentioned, there is the opinion that culture is not primarily an influential factor because the use of cultural variables opens up new questions and because the way in which culture may possibly influence an accounting system is not completely obvious (Nobes, 1998). Nevertheless, we are of the opinion that culture can be seen as a factor that indirectly affects those factors whose influences are more direct, such as capital markets or financing systems. The influence of culture may also help in studying the differences in the behaviour of accountants in decision-making or the behaviour of auditors. Also, the influence of culture could be linked to the earlier mentioned political system or colonial heritage as influential factors in countries that were once colonies (Černe, 2007, 29). Schultz and Lopez (2001, 276) consider that cultural differences have a crucial role in developing accounting systems, in particular, in how accountants make personal judgements regarding evaluation and disclosure. The results of their study that takes into account cultural elements have shown that given similar principles, the judgement of accountants in different countries will vary9).

12. CONCLUSION The diversity of accounting systems' models of development and functioning is the result of the diversity of business environments around the world. The fact is that accounting, as a social science, is interrelated with its environment and, therefore, exceptionally susceptible to influences from this environment, with the similarities and differences in business environments being manifested in the similarities and differences of accounting systems. The relevant literature lists and describes the individual influential factors, seeking in this way to justify or refute their effects, rather than to quantifiably prove their influence, or to look for interdependence, for the purpose of explaining the differences in the accounting systems of countries. The intensity of accounting differences at the international level will also depend upon the intensity of dissimilarity of influential factors among countries. Because international accounting harmonisation continues to be a live issue, with its advantages and disadvantages frequently pointed out, it is necessary to consider and study in depth the factors that affect a country’s accounting system development and model. Taking into account the different classifications of these factors, and the factors that are singled out or underlined in most classifications, this paper has selected and briefly explained several influential factors. The reason that more space has been given to some factors and less to others lies in the fact that these factors are not dealt with uniformly in the literature reviewed.