CHAPTER 5
COMPARATIVE ACCOUNTING
Chapter Outline
China
I.There are some unique features in the accounting profession in China. They include the following:
A.Until the 1980s, those who carried out accounting work were not held in high regard in society, and this has had an adverse effect on the development of the accounting profession in China.
B.Accounting and auditing in China have taken different paths in their development processes. Auditing firms audited mainly domestic companies, and were under the State Administration of Audit (SAA), whereas accounting firms focused on companies using foreign investments and were sponsored by the Ministry of Finance.
C.Unlike in the U.K., where there was a good legislative and judicial environment during the early stages of the development of the profession, in China,a market-oriented legislative and judicial environment is still emerging.
D.Unlike in the U.K., where auditors receive support from the established professional bodies, these support mechanisms are still lacking in China.
II.The recent economic reform program stimulated the growth of the accounting profession in China.
A.With the recognition by the State of joint stock company form, the demands for financial information from investors and other interested parties increased.
B.The establishment of two stock exchanges helped rapid growth of the accounting activities.
C.Various government regulations on the implementation of economic reform measures require the involvement of independent auditors.
D.The laws on joint ventures with foreign companies require the audit of annual statements.
E.International accounting firms were allowed to be involved in training local auditors and setting auditing standards.
III.There are clear signals that Anglo-American accounting principles are replacing Soviet-style accounting.
A.This was required as a result of the movement towards private ownership.
B.The Ministry of Finance is following international accounting practices in settingChinese standards; a conceptual framework was promulgated in 1992, and the China Accounting Standards Committee (CASC) was established in1988.
C.The Chinese Security Regulatory Commission (CSRC) has improved disclosurerequirements for companies. For example, it requires listed companies to post their annual reports on the web site of the relevant stock exchange.
D.Both CSRC and the two stock exchanges have developed new corporate governance rules basedon those that are common in Anglo-American countries.
E.The CSRC and Ministry of Finance, consistent with the Sarbanes-Oxley Act, require auditor rotation every five years.
IV.Major differences between IFRSs and Chinese GAAP include:
A.Accounting standards and practices in China lack conservatism.
B.There are no coherent interpretations of the relevant requirements.
C.In some areas covered by IFRSs there are no specific rules in China, including business combinations, impairment of assets, and the definitions of operating andfinance leases.
Germany
I.Unique features in German accounting include:
A.The primary source of finance for German companies is bankloans ratherthan equity, and this determines to a large extent thepurpose for financial reporting by companies.
B.Auditing dominates the financial reporting related professional activities.
C.The auditing profession is headed by the Chamber of Auditors, a State-supervised organization.
D.The Commercial Code contains most of the German financial reporting principles, and sanctions for non-compliance.
E.Unlike in the U.S., partnership accounting is regulated in Germany.
F.The principle of prudence (conservatism) is established in the law.
II.There are signs of a change in financial reporting from a creditor orientation towards a shareholder orientation.
A.The Companies Act 1965 was the initiator of this change.
B.In 1998, German law was amended to allow a private sector body (GASC) to develop accounting standards (until then the Ministry of Justice coordinated the accounting ruledevelopment process).
C.Since 1998, German accounting standards have been developed by following due process, and promotion of international convergence is a main objective.
D.GASB (the standard-setting body of GASC) has been modeled on the U.S. FASB.
E.In 2004, the Financial Reporting Enforcement Panel (FREP) was created.
III.Traditionally, the primary function of financial accounting has been the conservative determination of distributable income, rather than presentation of a true and fair view.
A.Traditionally bank credit plays a major role in corporate finance.
B.German accounting is heavily influenced by tax law.
C. German accounting rules allow companies to smooth income over time by using hidden reserves.
D.Although the EU’s Fourth Directive requires companies to present a true and fair view in their financial statements, it appears that extensive note disclosures are seen as a way of achieving this without changing the tax-based, income smoothing approach to financial reporting.
IV.Since January 2005, all German listed companies are required to use IFRSs in preparing their consolidated financial statements. However, German accounting practices differ from IFRSs in some important respects.
A.German accounting law contains no specific rules in some areas. Examples include the translation of foreign currency financial statements of foreign subsidiaries, disclosures of fair values of financial assets and liabilities, and earnings per share.
B.There are inconsistencies between IFRSs and German rules in some areas. For example,according to German rules, goodwill arising on consolidation can be deducted immediately against equity, and inventories can be valued at replacement cost.
C.According to German tradition, a management report is an important part of acompany’s financial statements, whereas IFRSs do not include specific requirements in this regard.
Japan
I.Unique features in the Japanese business environment include:
A.The economy is dominated by a few conglomerates known as Keiretsu.
B.The main sources of finance for business are bank credit and cross-corporate ownership, rather than outside equity finance.
C.Corporate earnings are regarded as the source of funds that can be distributed, and notas a measure of corporate performance.
D.Stock exchanges in Japan are government regulated rather than self-regulated. The stock exchange law is administered by the Ministry of Finance.
II.There are differences between the Japanese accounting profession and its counterparts in Anglo-American countries, including:
A.The Ministry of Finance plays a major role, through its Business Accounting Deliberation Council (BADC), in developing financial reporting standards in Japan, and the influence of the Japanese Institute of Certified Professional Accountants (JICPA) in this respect has been minor compared to that of its counterparts in Anglo-American countries.
B.The accounting profession has a relatively low social status in Japan.
C.For cultural reasons, the concept of independent auditor is not readily acceptable within Japanese companies.
D.Unlike in the U.S., and similar to Germany, financial reporting is heavily influenced by tax law.
III.Recently, major attempts have been made to ensure that Japanese accounting standards fall into line with international standards.
A.A Big Bangapproach has been taken to achieve this.
B.In 2001, the Accounting Standards Board of Japan (ASBJ), modeled on FASB, was formed.
C.In January 2005, the ASBJ and IASB agreed to launch a joint project to reduce differences between IFRSs and Japanese GAAP.
IV.There are several important differences between IFRSs and Japanese GAAP.
A.In general, companies are not under pressure from their main providers of finance todisclose information publicly, and Japanese companies are reluctant to provide information voluntarily.
B.There are no specific rules in some areas covered by IFRSs, such as impairment of assets, discontinuing operations and segment reporting.
C.There are inconsistencies between Japanese GAAP and IFRSs; for example, inventories can be valued at cost under Japanese GAAP rather than at the lower of cost and net realizable value as required by IFRSs.
Mexico
I.Many features of the Mexican business environment are common to other developing countries.
A.Until recently, a substantial portion of the Mexican business sector was government controlled, and a large number of business enterprises were government owned.
B.The economy has suffered from persistent balance of payments problems.
C.As a result of the effect of the “Tequila crisis,”Mexico accepted a bailout package from the IMF and the U.S. Treasury.
D.In recent years, there has an effort to privatize state-owned enterprises, and many of the restrictions to foreign investment have been removed.
E.The measures aimed at achieving economic growth stimulated the activities of the stock exchange.
II.Mexico has an established accounting profession with a long history.
A.The first professional body was established in 1917.
B. The Mexican Institute of Public Accountants (MIPA) was one of the nine founding members of the IASC.
C.Public accounting firms mainly provide bookkeeping, tax, and audit services.
D.A professional diploma is required to practice as a public accountant.
III.Regulation of accounting and financial reporting is through legislation, stock exchange listing requirements, and bulletins issued by MIPA.
A.The law requires that annual financial statements of listed companies must be audited by a Mexican CPA and published in a nationally circulated medium.
B.The National Banking and Securities Commission (NBSC), an equivalent of U.S. SEC, oversees information disclosure by publicly owned companies.
C.MIPA is responsible for issuing accounting and auditing standards, and follows a due process.
D.MIPA has developed a Code of Ethics which prohibits advertising for public accountants.
IV.As a result of Mexico’s membership with NAFTA, Mexican accounting principles are heavily influenced by U.S. accounting practices in recent years.
A.The U.S. influence also is exerted through the presence of subsidiaries of U.S. companies and the Big 4 international accounting firms.
V.A unique feature of Mexican accounting practice is the treatment of the effects of inflation in financial statements by using general purchasing power accounting.
VI.Bulletin B-10 introduced a novel concept known as the “integrated result of financing,” which is calculated by adding the nominal interest expense, the gain or loss due to price level changes on the company’s net monetary position, and the gains and losses due to exchange rate fluctuations on the company’s monetary assets and liabilities denominated in foreign currencies.
VII.There are several differences between Mexican GAAP and IFRSs. For example, according to Mexican rules, research and development costs are to be expensed as incurred, pre-operating costs can be capitalized, a statement of inflation is mandatory irrespective of the inflation rate.
United Kingdom
I.In the U.K. the capital market provides the main source of funding for companies, and the limited liability company is the main form of business organization.
A.The primary purpose of accounting in the U.K. is to provide information for the efficient functioning of the capital market.
B.Accounting in the U.K. grew as an independent discipline, responding to business needs.
C.The first professional accounting body in modern times was established in the U.K. in 1853, and currently there are six professional bodies in that country, coordinated by the Consultative Committee of Accountancy Bodies (CCAB).
D.The U.K. accounting profession has favored a principles-based approach rather than a rules-based approach to standard setting.
II.Accounting regulation in the U.K. has been driven by the idea that determination of acceptable accounting principles and standards should be left in the hands of the profession.
A.U.K. legislators did not feel the need to have a powerful securities commission to regulate accounting and financial reporting with detailed rules.
B.The responsibilities for developing accounting standards and auditing standards lie with the Accounting Standards Board (ASB) and Auditing Practices Board (APB), respectively, both independent bodies.
C.Changes to traditional thinking began as a result of U.K. joining the EU in 1973. The amendments to the 1948 Companies Act in 1981 as a result of integrating the EU’s Fourth Directive in British law made U.K. company legislation highly prescriptive.
D.In 2003 the Financial Reporting Council (FRC) became the single, independent regulator of accounting and auditing in the U.K.
E.ASB is one of the several national accounting standard-setters that have formal liaison with the IASB, and is committed to align U.K. accounting standards with IFRSs.
III.Accounting principles and practices in the U.K. emphasize investor needs and the importance of transparency.
A.The 1985 Companies Act requires corporate financial statements to provide a true and fair view of the firm’s financial position and results of operations for the financial year. Auditors are given the corresponding duty to render an opinion on whether this requirement is fulfilled. Provision of a true and fair view is an overriding requirement in the U.K.
B.Since January 2005, U.K. listed companies are required to use EU adopted IFRSs to prepare their group (consolidated) financial statements.
C.Financial statements generally are prepared on the basis of historical cost, but companies are allowed to revalue tangible assets.
D.U.K. accounting standards are generally similar to IFRSs, but there are also differences in some areas. For example, U.K. GAAP allows companies to amortize goodwill at their discretion, whereas IFRSs require goodwill to be tested for impairment annually.
Answers to Questions
- Gradual capital market liberalization will open up international investment opportunities for national investors. Poor rating assignments of national firms could therefore trigger an immense outflow of investment capital providing national firms with strong incentives to implement sound and internationally comparable accounting practices.
- The economic reforms have increased demand for accounting services in many ways. Key aspects of the economic reforms in China include privatization of SOEs, liberalization of controls, commitment to encourage private investment in business and to attract foreign investment, and emphasis on commercial viability and competition among businesses. All these are integral parts of a market system, and lead to increased demands for accounting services. For example, when businesses compete, they become increasingly cost conscious. Investors need accurate information about the financial performance and position of the businesses they have invested in. When Chinese companies seek to raise funds in overseas markets or the government attempts to attract foreign investors, it is important to ensure that proper financial records are kept, and information is disclosed using internationally acceptable standards. Further, various government regulations on the implementation of economic reforms require the involvement of independent auditors.
3.A unique feature in the development of accounting and auditing in China is that, unlike in many other countries, until recently (1998), these two areas developed as two rival disciplines competing with each other, supported by two separate government agencies.
4. The pressures arise from the need to change from an accounting system designed to provide information to government for planning purposes to a system that is capable of providing useful information for economic decision making. China has expressed a commitment to adopt IFRSs. This is particularly important to China because of the requirement under WTO membership and the need to attract foreign investment. The ultimate objective of accounting regulation is to achieve a high level of compliance with the mandated reporting standards. This requires an adequate number of professionals who are willing and able to implement the standards. However, the accounting profession in China is still at the early stage of development, and a lack of skilled professionals will create problems for regulators. IFRSs are based on western cultural values. Some of the concepts that are fundamental to IFRSs, such as true and fair view or fair presentation and transparency, may not be clearly understood by Chinese accountants.
5. One of the distinct Japanese cultural values is collectivism or group consciousness. This has directly affected the Japanese attitude towards external auditors and the audit function. Prior to the American occupation of Japan after the Second World War, there was no external auditing profession. When it was introduced in 1949, Japanese corporations often considered it as unnecessary. Because of the cultural value orientation of not trusting someone from outside the group, independent auditors had difficulty being accepted by clients.
6. In the 1990s, Japanese companies were compelled to seek finance from overseas markets due to various reasons, such as large scale losses among Japanese banks and other companies, and the collapse of Japanese asset prices. However, the financial reporting standards used by Japanese companies were criticized for their failure to produce information in a transparent manner. In the mid-1990s the Japanese government initiated a program of financial reform, which included a series of major changes aimed at aligning Japanese financial reporting regulations with internationally acceptable standards. The term “Accounting Big Bang” was used to describe this reform program because of the magnitude of the changes involved.
7. The principle of prudence is firmly established in the German law mainly because of theheavy losses suffered by creditors of German companies during the Great Depression in the late 1920s and early 1930s. The accounting system at the time allowed companiesto revalue assets as they wished, and was blamed for the losses as it failed to protect the creditors from becoming victims of companies, which adopted highly optimistic methods to value their assets. The objective of establishing the principle of prudence in the 1937StockCorporations Law was to ensure that the events of the 1920s and 1930s would not happen again. This is reflected in the strict adherence to the use of historical cost for measuring asset values.
8. In Germany, tax law has a strong influence on accounting and financial reporting. The reason for this link between taxation and financial reporting is historical. When corporate income taxation was introduced in Germany in 1874, the requirement for annual accounting had already been codified in the Commercial Code in 1862. It was convenient to link corporate income taxation to existing financial statements.
9.There are two main external factors that have influenced financial reporting in Germany in recent years. They are, EU Directives and the forces of globalization. The 1985 Accounting Act implemented the Fourth, Seventh, and Eighth Directives and transformed them into German Commercial Law. The EU’s decision to adopt IFRSs from January 1 2005, was in recognition of the global trends in financial reporting. Even before the EU’s decision, large German companies like Daimler-Chrysler that had their shares listed on foreign stock exchanges were already using internally acceptable accounting standards.