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Summary International Financial Managment (IFM) for Pre-MSc RUG
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Summary for the course International Financial Management 2020/2021 for Pre-MSc International Business. Course code: EBB627A05
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Chapter 1: Worldwide Accounting DiversityThere are five main reasons for accounting diversity:
• Legal system
• Taxation
• Providers of financing
• Inflation
• Political and economic ties
Legal System
There are two major types of legal systems used around the world: common law and code law.
Common law countries rely on a limited amount of statute law, which is then interpreted by the
courts. Code law countries tend to have relatively more statue or codified law governing a wider range
of human activity.
The type of legal system in a country tends to determine whether the primary source of accounting
rules is the government or a nongovernmental organization. Code law countries generally have a
corporation law that 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. The accounting law tends to be rather general and does not provide much detail
regarding specific practices.
In common law countries there are specific accounting rules established by the profession or by an
independent nongovernmental body representing a variety of constituencies. In common law
countries much more detailed rules are developed. An extreme case is the Financial Accounting
Standards Board (FASB) in the US.
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. Before 2009 Germany knew the principle of reverse
conformity = an expense deductible for tax purposes must also be used in the calculation of financial
statement income. In 2009 the accounting modernization law removed the reverse conformity
requirement.
Providers of Financing
In countries where financing is dominated by families, banks or the state, there will be less pressure
for public accountability and information disclosure because banks and the state will often be
represented on the board of directors. In countries where companies are more dependant on the
general populace through public offering of shares of stock for financing, the demand for public
information becomes greater.
Inflation
Countries with high inflation rates have found it necessary to adopt accounting rules that require the
inflation adjustment (especially Latin America) when inflation rates were two- or three digits.
Adjusting accounting records for inflation results in a write-up of nonmonetary assets with a
corresponding increase in expenses related to those assets.
Political and Economic Ties
Through political and economic links, accounting rules have been conveyed from one country to
another (i.e. colonialism). There’s 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 per capita than code law countries. This indicates a greater usage of equity as a source of
financing in common law countries. Code law countries tend to link taxation to accounting statements,
whereas common law countries don’t.
National Culture
Hofstede identified five cultural dimensions that can be used to describe general similarities and
differences in cultures around the world:
• Individualism
• Power distance
• Uncertainty avoidance
• Masculinity
• Long-term orientation
Gray identified four widely recognized accounting values that can be used to define a country’s
accounting subculture: professionalism, uniformity, conservatism and secrecy.
• Professionalism versus Statutory Control → preference for individual professional judgement and
the maintenance of professional self-regulation as opposed to compliance with prescriptive legal
requirements and statutory control.
• Uniformity versus Flexibility → preference for enforcement of uniform accounting practices
between companies and for the consistent use of such practices over time as opposed to flexibility
in accordance with the perceived circumstances of individual companies.
• Conservatism versus Optimism → preference for cautious approach to measurement so as to cope
with the uncertainty of future events as opposed to a more optimistic, risk-taking approach.
• Secrecy versus Transparency → preference for confidentiality and the restriction of disclosure of
information as opposed to a more transparent, open approach.
Gray argues that national cultural values affect accounting values, as shown in the figure below.
Problems caused by accounting diversity
One problem caused by diversity in accounting practice across countries is the preparation of
consolidated financial statements by companies with foreign operations. Local regulations require
companies to keep books in local currency using local accounting principles.
A second problem relates to companies gaining access to foreign capital markets. If a company obtains
capital by selling stock or borrowing money in a foreign country, it might be required to present a set
of financial statements in accordance with the accounting regulations in that country.
,A third problem relates to the diminished comparability of financial statements between companies
that use different GAAP (Generally Accepted Accounting Principles). This can significantly affect the
analysis of foreign financial statements for making investment and lending decisions. It can also have
an adverse effect on corporations when making foreign acquisition decisions. Either international
investors have to be extremely knowledgeable about multiple reporting methods or they have to be
willing to take greater risk.
A fourth problem relates to 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: highly leveraged corporate sector, the private sector’s reliance on foreign
currency debt, and a lack of accounting transparency.
Classification of accounting systems
Due to the fact that factors influence accounting practices worldwide, there are several classification
schemes that show clusters of countries using the same accounting orientation. Nobes identified three
major accounting models:
• The Fair Presentation/Full Disclosure Model (Anglo-Saxon Model) → UK and US where
accounting is oriented towards large numbers of investors and creditors. Most of these countries
follow a common law legal system.
• The Legal Compliance Model → originated in the code law countries of Continental Europe and
is referred to as the Continental European model. Used in most of Europe, Japan and other code
law countries. Countries usually were tied closely to banks that served as the primary suppliers of
financing.
• The Inflation-Adjusted Model → found primarily in South America. Resembles the Continental
European model in its legalistic, tax and government-planning orientation but distinguished itself
through the extensive use of adjustments for inflations.
, The terms micro-based and macro-uniform describe the Anglo-Saxon and Continental European
models. Each of these classes is divided into two subclasses that are further divided into families. See
the classification below.
Nobes also developed a simplified model with two explanatory factors: culture and the nature of the
financing system. Nobes argued that the major reason for international differences in financial
reporting is that different purposes exist for that reporting. Nobes divides financial reporting systems
into two classes labelled A and B. Class A corresponds to Anglo-Saxon accounting. Class B corresponds
to Continental European accounting.
Nobes argues that culturally dominated countries use the accounting system of their dominating
country regardless of the nature of the equity financing system. Thus, countries with a Type 1 culture
as well as countries historically dominated by a Type 1 country both use Class A accounting systems.
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