Chapter Eleven Worldwide Accounting Diversity and International Standards Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education International Accounting Diversity Chinese companies use the direct method in preparing the statement of cash flows Most companies in the United States and Europe use the indirect method Companies in Germany are allowed to report assets on the balance sheet at revalued amounts Learning Objective 11-1 Explain the major factors influencing the international development of accounting systems 11-3 Reasons for Accounting Diversity Legal System Taxation All these interact!!! Political and Economic Ties Culture Inflation Financing Systems 11-4 Reasons for Accounting DiversityLegal System Common Law Found primarily in English-speaking countries, where courts establish precedent Accounting profession plays a large role in standard setting and tends to be independent Standards tend to be detailed 11-5 Reasons for Accounting Diversity-Legal System Roman (Codified) Law Based on statute rather than precedent Laws govern business enterprises Accounting profession tends to have little influence on standard setting, is frequently an adjunct of the legal system Accounting law tends to be lacking in detail 11-6 Reasons for Accounting DiversityFinancing Systems Major providers of financing: Family members Banks Focus on solvency and liquidity (balance sheet emphasis) Governments Shareholders Focus on profitability (income statement emphasis) Other creditors 11-7 Reasons for Accounting DiversityOther Issues Taxation Financial statements are the basis for taxation in some countries Others adjust financial statements for tax purposes, and submit separate reports to stockholders’ Inflation High inflation tends to render historical cost useless High inflation rates force adoption of accounting rules that adjust historical costs to current or market value Creditors tend to suffer under highly inflationary economies 11-8 Reasons for Accounting DiversityPolitical and Economic Ties Accounting methods are readily conveyed from one country to another, either by trade or conquest: – Britain’s former colonies, such as Australia and Canada, tend toward “common law” systems – Former French colonies, such as Senegal and Congo, base accounting standards on “codified law” – Economic ties with the US have impacted accounting in Canada, Mexico and Israel 11-9 Reasons for Accounting DiversityCulture Societal values found within cultures: Individualism Uncertainty Avoidance Power Distance Masculinity These values are thought to shape legal systems and capital markets They influence accounting values shared by members of the accounting subculture, which influences the nature of the accounting system 11-10 IFRS Framework Modifications could include: • Requiring additional disclosures beyond what is required by an IFRS • Prescribing which of two or more alternative accounting treatments allowed by IFRS should be followed by U.S issuers • Promulgating standards on issues not specifically addressed in IFRS 11-30 First-time Adoption of IFRS Large US publicly-traded companies may be required to adopt IFRS someday What does this mean? The company would prepare an opening balance sheet at the “transition date” and present re-stated comparative statements also prepared under IFRS 11-31 First-time Adoption of IFRS Steps To prepare opening IFRS balance sheet: Determine the applicable IFRS Recognize assets and liabilities not recognized under GAAP and derecognize those not allowed under IFRS Measure the balance sheet accounts under IFRS at the balance sheet date Reclassify certain assets and liabilities in accordance with IFRS Comply with disclosure and presentation requirements 11-32 IFRS Accounting Policy Hierarchy IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, establishes the hierarchy that firms must follow when dealing with an accounting issue: Apply specifically relevant standards (IASs, IFRSs, or Interpretations) Refer to other IASB standards Refer to the IASB Framework for guidance Consider the most recent pronouncements of other standard-setting bodies 11-33 IFRS Accounting Policy Hierarchy In establishing accounting policies to be followed under IFRS, the two extreme approaches that companies can follow are: Minimize change Under this approach a company would adopt accounting policies consistent with IFRS that are most consistent with current accounting policies Fresh start Under this approach a company would ignore current accounting policies and adopt accounting policies consistent with the IFRS that best reflect economic reality 11-34 Learning Objective 11-6 Recognize acceptable accounting treatments under IFRS and identify key differences between IFRS and U.S GAAP 11-35 Current Differences Between IFRSs and US GAAP Recognition: If recognized, how? When? Disclosure: If allowed, How? Discontinued Operations Extraordinary Items Presentation: Principles? Financial Statement Components? Measurement: How is cost determined? Inventory Fixed Assets 11-36 Current Differences Between IFRSs and US GAAP There are differences in nearly every area of financial accounting including: Inventory cost flow and write-offs PP&E measurement and subsequent costs Asset Impairment – measurement and subsequent reversals Construction contracts – recognition method R&D – capitalization vs expense Operating Leases – gain recognition Pensions – vested benefits 11-37 Current Differences Between IFRSs and US GAAP Continued… Income taxes – deferred tax assets Classification of deferred taxes Consolidated financial statements – Parent vs Subsidiary Interim reporting – Discrete vs integral Presentation of “extraordinary” items Definition of a “discontinued operation” Statement of Cash Flows – Interest classification 11-38 IAS 1: Presentation of Financial Statements IFRSs contain this single standard governing the presentation of financial statements There is no US GAAP equivalent Key guidance elements: – Purpose – Overriding principle of fair presentation – Basic principles and assumptions – Components of financial statements – Structure and content of financial statements 11-39 Presentation of Financial Statements IFRS COMPANY Income Statement 11-40 Learning Objective 11-7 Determine the impact that specific differences between IFRS and U.S GAAP have on the measurement of income and stockholders’ equity 11-41 U.S GAAP Reconciliations Interest Capitalization Business Combinations Purchase vs Pooling Methods Goodwill Amortization vs Impairment Leases Revaluation of Fixed Assets Fixed Asset Impairment Losses 11-42 U.S GAAP Reconciliations IASB: PrinciplesBased Provide general principles with limited guidance Requires greater professional judgment FASB: Rules-Based Provide detailed guidance May encourage mindset of looking for loop-holes 11-43 U.S GAAP Reconciliations Translation of IFRS into other languages IFRS are drafted in English, then translated into other languages Time has already proven that some terms (“probable” or “remote”) are not translating with the same meaning The impact of Culture Using professional judgment under IFRS, an accountant in one country may reach a different conclusion than an accountant in another part of the world 11-44 ... They influence accounting values shared by members of the accounting subculture, which influences the nature of the accounting system 11-10 Gray’s Framework for the Development of Accounting Systems... enterprises Accounting profession tends to have little influence on standard setting, is frequently an adjunct of the legal system Accounting law tends to be lacking in detail 11-6 Reasons for Accounting. .. as Senegal and Congo, base accounting standards on “codified law” – Economic ties with the US have impacted accounting in Canada, Mexico and Israel 11-9 Reasons for Accounting DiversityCulture