Chapter 19 Outline

National and International Standards

The diverse accounting practices discussed in the previous section have been enshrined in national accounting and auditing standards. Accounting standards are rules for preparing financial statements; they define what is useful accounting information. Auditing standards specify the rules for performing an audit--the technical process by which an independent person (the auditor) gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable.

Consequences of the Lack of Comparability

An unfortunate result of national differences in accounting and auditing standards is the general lack of comparability of financial reports from one country to another. For example, consider the following:

• Dutch standards favor the use of current values for replacement assets; Japanese law generally prohibits revaluation and prescribes historic cost.

• Capitalization of financial leases is required practice in Great Britain, but it is not practiced in France.

• Research and development costs must be written off in the year they are incurred in the United States, but in Spain they may be deferred as an asset and need not be amortized as long as benefits that will cover them are expected to arise in the future.

• German accountants treat depreciation as a liability, whereas British companies deduct it from assets.

Such differences would not matter much if there was little need for a firm headquartered in one country to report its financial results to citizens of another country. However, as you might recall from Chapter 11, one striking development of the past two decades has been the development of global capital markets. We have seen the growth of both transnational financing and transnational investment.

Map 19.1 see

Accounting Clusters

Transnational financing occurs when a firm based in one country enters another country's capital market to raise capital from the sale of stocks or bonds. A Danish firm raising capital by selling stock through the London Stock Exchange is an example of transnational financing. As we saw in the opening case, a number of large German firms are increasing their use of transnational financing by gaining listings, and ultimately issuing stock, on the New York Stock Exchange. Transnational investment occurs when an investor based in one country enters the capital market of another nation to invest in the stocks or bonds of a firm based in that country. An investor based in Great Britain buying General Motors stock through the New York Stock Exchange would be an example of transnational investment.

The rapid expansion of transnational financing and investment in recent years has been accompanied by a corresponding growth in transnational financial reporting. For example, in addition to its Danish financial reports, the Danish firm raising capital in London must issue financial reports that serve the needs of its British investors. Similarly, the US firm with a large number of British investors might wish to issue reports that serve the needs of those investors. However, the lack of comparability between accounting standards in different nations can lead to confusion. For example, the Danish firm that issues two sets of financial reports, one set prepared under Danish standards and the other under British standards, may find that its financial position looks significantly different in the two reports, and its investors may have difficulty identifying the firm's true worth. Some examples of the confusion that can arise from this lack of comparability appear in the accompanying Management Focus.

In addition to the problems this lack of comparability gives investors, it can give the firm major headaches. The firm has to explain to its investors why its financial position looks so different in the two accountings. Also, an international business may find it difficult to assess the financial positions of important foreign customers, suppliers, and competitors.

International Standards

Substantial efforts have been made in recent years to harmonize accounting standards across countries. The International Accounting Standards Committee (IASC) is a major proponent of standardization. The IASC is composed of representatives of 106 professional accounting groups in 79 countries. Governed by a 14-member board of representatives from 13 countries plus a representative from the International Federation of Financial Analysts, the IASC is responsible for formulating international accounting standards (IAS). Other areas of interest to the accounting profession worldwide, including auditing, ethical, educational, and public-sector standards, are handled by the International Federation of Accountants (IFAC), which has the same membership.

The IASC was begun in 1973 as an outgrowth of an effort by Canada, the United States, and Great Britain to develop international accounting standards. The IFAC was established in 1977, when it was determined that the IASC did not have the expertise to deal with broader professional issues. The two organizations work closely, but they are operated and funded separately.

By the mid-1990s, the IASC had issued over 30 international accounting standards.¹¹ To issue a new standard, 75 percent of the 14 members of the board must agree. It can be difficult to get three-Despite this, support for the IASC and recognition of its standards is growing. Increasingly, the IASC is regarded as an effective voice for defining acceptable worldwide accounting principles. Japan, for example, began requiring financial statements to be prepared on a consolidated basis after the IASC issued its initial standards on the topic. By 1998, the IASC claimed that more than 450 companies around the world currently follow its rules, including Central African Cable from Zimbabwe, Guangshen Railway Company from China, Bayer from Germany, and Microsoft from the United States.

The impact of the IASC standards has probably been least noticeable in the United States because most of the standards issued by the IASC have been consistent with opinions already articulated by the US Financial Accounting Standards Board (FASB). The FASB writes the generally accepted accounting principles by which the financial statements of US firms must be prepared. In sharp contrast, some IASC standards have had a significant impact in many other countries because they eliminated a commonly used alternative.

Another body that promises to have substantial influence on the harmonization of accounting standards, at least within Europe, is the European Union (EU). In accordance with its plans for closer economic and political union, the EU is attempting to harmonize the accounting principles of its 15 member countries. The EU does this by issuing directives that the member states are obligated to incorporate into their own national laws. Because EU directives have the power of law, we might assume the EU has a better chance of achieving harmonization than the IASC does, but the EU is experiencing implementation difficulties. These difficulties arise from the wide variation in accounting practices among EU member countries. Accounting practices in Great Britain, for example, are closer to those of the United States than to those of France or Germany. Despite these difficulties, developments in the EU should be watched closely. If the EU achieves harmonization (in all probability, it eventually will), the accounting principles adopted in the EU could have a major influence on future IASC pronouncements.

In a move that indicates the trend toward adoption of acceptable international accounting standards is accelerating, the IASC hoped to develop by mid-1999 accounting standards for firms seeking stock listings in global markets. Also, the FASB has joined forces with accounting standard setters in Canada, Mexico, and Chile to explore areas in which the four countries can harmonize their accounting standards (Canada, Mexico, and the United States are members of NAFTA, and Chile may join in the near future). The Securities and Exchange Commission also is dropping some of its objections to international standards, which could accelerate their adoption. In 1994, the SEC for the first time accepted three international accounting standards on cash flow data, the effects of hyperinflation, and business combinations for cross-border filings.¹³ A taste of what is to come if increasing numbers of international firms jump on the bandwagon and adopt IASC principles can be found in the accompanying Management Focus, which details the impact of adopting these standards on Ciba, the Swiss pharmaceuticals and chemicals group.