Accounting 6570

1. Accounting 6570 Comparative Accounting

2. Comparisons • Language • Currency • Professional Accountancy Bodies • Accounting Standard Setting Bodies • Environmental Factors • Economic Factors • Predominant type of financing • Influence of tax rules on accounting reporting • Political Factors • Socio-cultural Factors • Legal Systems

3. Comparisons • Language • U.S., Canada, UK – English • Germany – German • Japan – Japanese • Mexico – Spanish • Currency • U.S. dollar, Canadian dollar, U.K. pound, Germany uses the euro, Japan yen, and Mexican peso

4. Comparisons • Professional Accountancy Bodies • U.S. – AICPA (over 330,000 members) • Canada – CICA (over 50,000 members) • U.K. – Institute of Chartered Accountants (over 97,000 members) • Germany – Institut der Wirtschaftsprufer (around 20,000) • Japan – Japanese Institute of CPAs (around 24,000) • Mexico – Mexican Institute of Public Accountants (MIPA)

5. Comparisons • Standard Setting Bodies • U.S. – Financial Accounting Standards Board (FASB) • Private • Canada – Accounting Standards Board (ASB) • Private • U.K. – Accounting Standards Board (ASB) • Private • Germany – German Accounting Standards Board (GASB) • Private but public tax laws dominate financial reporting • Japan – Accounting Standards Board of Japan (ASBJ) • Private but highly influenced by public Business Accounting Deliberation Council of the public Ministry of Finance • Mexico – Mexican Institute of Public Accountants (MIPA) • Private

6. Environmental Factors • Economics • Predominant type of financing (see handout) • Influence of tax rules on accounting reporting (see handout) • Political factors • Germany, U.K. – influenced by E.U. • Canada, U.S., Mexico – influenced by NAFTA • Trade ties – Japan • Internationalization – more internationalized, more accounting

7. Environmental Factors • Socio-cultural factors • Hofstede’s variables • Religion • Attitudes toward work and wealth • Legal systems (civil code versus common law) • Common law – U.S., U.K., Canada • Civil code – Germany, Japan, Mexico

8. Major Differences in Financial Reporting • Measurement Practices • Methods of Measurement • Goodwill • Consolidation • Deferred taxes • Long-term leases • Discretionary reserves • Construction accounting • Foreign currency translation

9. Major Differences in Financial Reporting • Measurement Practices • Depreciation • LIFO Inventory valuation • Research and development • Revaluation of fixed assets • Disclosure issues • Segmental reporting • Interim reporting

10. Differences in Financial Statements • Required statements • Format of statements • Group accounts • Parent only statements • Relevance of statements • Balance sheet more important • Income sheet more important

11. Analysis of Foreign Financial Statements Foreign portfolio investment • Investors can diversify away some risk by investing internationally. • While stock returns in many countries are positively correlated with U.S. returns, these correlations are far from perfect. • International investors, including managers of international mutual funds, rely on foreign financial statements.

12. Data Accessibility • Relative to the U.S., financial information is difficult to obtain in many countries. • While databases of foreign financial statements do exist, these can contain errors and present information in a variety of formats. • These databases also do not contain complete disclosure notes. • Another approach is to obtain a copy of the foreign company’s annual report. Often websites have financial statements.

13. Language • Since English is the language of business, companies in many foreign countries produce convenience translations of their financial statements in English. • Some international companies do not produce financial statements in English. • The financial statement user could hire a translator or develop foreign language capability.

14. Currency • Many international companies produce their financial statements in a currency other than the U.S. dollar. • These can be converted to U.S. dollars by translating all balances at the exchange rate at the end of the current year. • In order to avoid distortions, the current exchange rate should be used for all previous years. • Analysis using ratios is not distorted by different currencies.

15. Terminology • Differences in terminology exist between countries using the same language. • For example, sales in the U.S. is normally called turnover in the UK. • In cases of convenience translations, sometimes these include terminology unfamiliar to English speakers. • Knowledge of the business and accounting environment can help alleviate some of these problems.

16. Format • Some format differences are not problematic because the information is given, just in a different place. • However, other format differences are a problem because the information is not provided. • It is common in Europe to not provide cost of goods sold. • This prevents an analyst from determining gross margin percentage and inventory turnover.

17. Format • German and other continental European companies often do not distinguish between current and noncurrent liabilities. • This makes it difficult or impossible to compute a current ratio. • At least one Chinese company does not present sales as a separate item. • This would hinder analysis of top-line growth.

18. Extent of Disclosure • Disclosure internationally tends to be limited compared to the U.S. where full disclosure is fundamental. • Some of the most serious disclosure limitations are information on segments, asset valuation, foreign operations, interim statements, and reserves. • Lack of disclosure contributes to the significance of format problems. • Globalization of capital markets tends to enhance disclosure as companies attempt to attract investors.

19. Extent of Disclosure • Largest MNEs set trends in disclosing information • Larger companies tended to voluntarily disclose more information • Disclosure varies by industry • Companies from common law countries tended to disclose more information than civil code countries. • Corruption decreased the likelihood of disclosure. • European companies disclose a lot of nonfinancial information; especially environmental and employee information

20. Disclosure Regulation • New York Stock Exchange requires the most financial disclosures; London Stock Exchange second, Swiss Stock Exchange least disclosures (due to secrecy). • More developed stock exchanges tend to require more financial disclosures

21. Timeliness • Timeliness is one aspect of the relevance of information. • This varies significantly internationally since filing deadlines differ from country to country. • Among developed countries, the U.S. and Canada are the most timely whereas continental Europe is the least. • Requirements about the frequency of information also vary internationally from quarterly to annual reporting with the U.S. and Canada requiring quarterly reporting and few other countries demanding quarterly. • IAS 34 only requires interim reporting but does not state frequency. • There is very little investors can do to overcome these problems.

22. International Ratio Analysis • Differences in culture and economic environments have an impact on the relevance of ratios. • A study of companies in Japan, Korea, and the U.S. found significant differences due to business environment. • For example, Japanese and Korean companies borrow much more on a short-term basis than U.S. companies, leading to lower current ratios.

23. International Ratio Analysis • Debt ratios also tend to be higher in Japan and Korea because of the sources of financing. • Lower profit margins in Japan, relative to U.S., can be partly explained by those companies focus on market share as opposed to profits. • In summary, an investor needs to be aware of these differences and not forgo potentially profitable investments.

24. Restating Foreign Financial Statementsto U.S. GAAP Form 20-F • Foreign companies that file non-U.S. GAAP financial statements with the SEC are required to complete a Form 20-F. • The Form 20-F reconciles net income and stockholders’ equity to U.S. GAAP (Only net income in Canada) • However, there is no requirement to reconcile assets and liabilities. • In essence, this represents a partial restatement from foreign GAAP to U.S. GAAP. • Those using IFRS no longer have to reconcile as of 2007 (about 150 companies out of around 1,200).

25. Restating Foreign Financial Statementsto U.S. GAAP Form 20-F • Some ratios, such as return on equity, can be computed as if under U.S. GAAP. • Most other ratios, cannot be computed as if under U.S. GAAP. • The analyst can overcome this by performing the restatement of financial statement items.

26. American Depositary Receipts (ADRs) • American equivalent of shares of stock in a foreign company. • 1 ADR share may equal 2-10 shares of the foreign company’s domestic stock. • The amount is determined to equate stock exchange values.