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Mar
21
Written by:
admin
3/21/2008
 Remarkable differencesBefore globalization there were and there still are national economies. Each country has developed and regulated its own accounting standards with remarkable differences which are a consequence of local cultures and history. For instance, the Anglo-Saxon countries are inspired by principle of seeking to report “true and fair” value of assets and liabilities and strict adherence to the matching principle.
It requires judgment when applying it to not codified situations. Europe instead follows the principle of conservatism, which tends to underestimate assets and income, which can lead to substantial underestimation in certain industries. The Latin American systems include particular attention to the effects of inflation into reporting accounts.
But why are Accounting Standards important?The main reason for countries to regulate accounting is taxation. The way profits are reported drives how much taxes governments are taking of them.
But not only: accounts are one of the most important sources for company valuations and trustworthiness, used by investors when deciding to invest, by creditors and suppliers when trading with them, by banks when deciding the terms of their loans.
An important consequence is that Stock Exchanges need to publish them to the wider investors and public for trading. Besides, any cross-border trading requires a common language (or a translation) between the traders. Therefore there should be a common way of reporting activities, assets, liabilities and so on. The financial industry is probably one of the most “globalised”, with investors trading assets, companies, shares and derivatives products around the globe at the click of a mouse. With barriers of time and transactions costs rapidly falling, the markets are getting closer to the Efficient Market ideal. However, this fast change in trading has not been adequately followed by the legal and regulatory frameworks. A company may look profitable according to a certain accounting standard and wasting shareholders money with another: a big difference and not so uncommon, especially in the Real Estate industry. Not to mention the assets often off-books like derivatives.
Typically the main differences lie on the way to amortize investments, how to consolidate the accounts of acquisitions and participations (and associated minority interests), whether to capitalize or expense the R&D costs, whether or not to update the book value of properties, whether or not to defer unrealized losses and gains of hedge products, how to account for derivatives, the treatment of intangible assets, and so on.
Integration or Harmonization?Historically, the most important market and economy was the US, which also hosts the most important Stock Exchanges. In time US has developed what is now called the US-GAAP (Generally Accepted Accounting Principles).
International investors, though, had increasing difficulty understanding and comparing companies from different countries. It became obvious that a more “generally accepted” system was needed.
In order to “integrate” those various systems a body was created back in 1973, the International Accounting Standards Committee (IASC). It has developed the International Financial Reporting Standards (IFRS). However, its adoption has been slow, and mainly by American companies, despite the fact that it was largely inspired by the US system. An important reason is that US Stock Exchanges still require the US-GAAP to be used anyway (and further made dull by the Sarbanes-Oxley directive). Another reason is that established local practices are hard to change.
The result is that non-US companies who want to be listed in the US have to carry over two sets of accounts, which increases cost and complexity.
Therefore, up to now the trend was towards harmonizing such rules with a process-oriented approach, without forcing each country to abandon their own rules.
Furthermore, since the balance of power is changing, with European and Asian economies getting stronger, this process will continue, but experts do not predict a full integration any time soon and even discourage it for reasons of innovation and preservation of local specificities (Ball, 1995).
The world has then seen the emergence of several derived versions of IFRS, which again defeats the original integration intent.
Companies that want to be listed internationally have wider options, with the result that New York is losing further weight beyond the “damage” created by the cited tightening reporting rules. The benefits of being listed there do not always justify the associated costs.
More from our Accounting Consultants
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franco@financialconsultantsguide.com
References:
Ball, R. (1995) Making Accounting More International: Why, How, and How Far Will It Go? Bank of America; Journal of Applied Corporate Finance, vol. 8, no.3.
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1 comment(s) so far...
Re: Accounting Standards
Nice overview. I'd like to add that, as part of the "true and fair" approach, these days there is a lot of talks on market value, i.e., "marking to market" approach, which in a way this is what investors indirectly do when trading shares of companies with large tangible assets. If we believe that the market is right in several areas such as the price of a stock, or gold, or oil, then it makes sense to follow the same principle when evaluating assets, under depreciation or not. Depreciation, in fact, is a model that tries to predict the future value of assets, but cannot possibly be right. Of course, marking to market may cause higher value fluctations and volatility to both companies and portfolio managers, but if that better reflects the reality and helps anticipating crisis, so be it.
By Gene on
3/21/2008
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