1 Matakuliah: F0142 / Akuntansi Internasional Tahun: 2006 Session 13 Cases (Guidance Concept to Cases)

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Matakuliah : F0142 / Akuntansi Internasional

Tahun : 2006

Session 13 Cases

(Guidance Concept to Cases)

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International Accounting Differences and Financial Statement Analysis

• The key question– How do differences in accounting affect

earnings and cash flow assessments?

• These assessments are important to– Investors– Corporations concerned with foreign direct

investment

• Many companies are listing on international exchanges (London, New York)

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International Accounting Differences and Financial Statement Analysis

• A tendency exists to looks at earnings from a home country perspective– This tendency may ignore accounting

differences

• A need exists to better understand foreign accounting principles in the context in which they are derived

• International comparability is important in considering alternative investments

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Major Differences in Accounting Principles Around the World

• Inventory measurement– Generally based on

“lower of cost or market” with market defined as either• Net realizable value • Replacement cost

– LIFO is permitted for tax purposes in U.S. and Japan, but not in the EU

• Construction contracts– Wide usage of

percentage-of-completion method

– Completed contract method – Switzerland, China, Japan

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• Measurement basis used– Historical cost is used

in the U.S., Brazil, Switzerland, China, and Japan.

– More flexible approach with some restatements to market value or replacement cost – U.K., Holland

• Depreciation accounting– Useful economic life

concept – U.S. and EU– Accelerated methods –

France, Germany, Switzerland, Japan

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• R&D costs– Expensed immediately

in Anglo-American and Germanic countries

– Brazil has a more flexible approach

– Some countries allow capitalizing the borrowed cost of assets

• Retirement benefits– Generally accounted

for on the basis of accrued and/or projected benefits payable to employees

– Pay-as-you-go approach in Brazil and China

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• Taxation– Accounting income

strongly influenced by the tax system in France, Germany, Brazil, Switzerland

• Business Combinations– Varies with allowance

of pooling-of-interests – Purchase method is

generally required– Goodwill is amortized

in Brazil, China, and Japan

– Goodwill impairment tests are used in U.S., U.K.

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• Intangibles– Generally are capitalized and subject to

amortization or impairment tests– Exception – Switzerland

• Foreign Currency Translation– Choice between average or closing rate– Generally flexible; actual or average rate

allowed

• Big Question: Do these differences matter?

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The Impact of U.S.-U.K. Accounting Differences

Index of conservatism (Gray, 1980)

1 – [RA – RD / l RA l]

Where RA = adjusted earnings (or returns) RD = disclosed earnings

Therefore,

1 – [U.S. GAAP Earnings – U.K. GAAP Earnings / l U.S. GAAP Earnings l]

If index value > 1, U.K. GAAP earnings are less “conservative”

If index value < 1, U.K. GAAP earnings are more “conservative”

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Example 1

U.K. earnings £110 million

U.S. earnings £100 million

Index1 – [100-100]/100 = 1.1

Example 2

U.K. earnings£90 million

U.S. earnings£100 million

Index1 – [100-90]/100 = 0.9

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It is possible to establish the relative effect of individual adjustments with partial indices of adjustment

Partial index of “conservatism”

1 – [partial adjustment / l U.S. GAAP Earnings l ]

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ExampleMillions of Pounds

U.K. GAAP earnings 120Adjustments for U.S. GAAP:Deferred taxation (15)Goodwill amortization (5)Adjusted earnings per U.S. GAAP (100)Overall index of ‘conservatism’ 1.2

Partial index for deferred taxation 1 – [-15/100] = 1.15

Partial index for goodwill 1 – [-5/100] = 1.05

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• Differences between methods are illustrated in the Form 20-F report

• Form 20-F can be used to test how conservative U.S. and U.K. GAAP are in comparison with each other

• Form 20-F is reliable because it is provided by the company itself

• Research findings show U.K. GAAP to be less conservative

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A Global Perspective on Earnings Management

• How do Anglo-American earnings compare with continental Europe and Japan?

• Continental Europe– Gray (1980) compared French and German

companies to British companies• Insert Exhibit 5.8, 5.9

• French and German earnings are more conservative than British earnings

– Weetman and Gray (1991) found that • Netherlands was less conservative that Sweden, U.K.

• Swedish methods were more conservative than U.S. GAAP

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A Global Perspective on Earnings Management

• Japan– Earnings are relatively understated compared to

the U.S. (33.9%, according to Aron (1991)– Historically high PE ratios were deflated by

adjustments for reserves, consolidation practices, depreciation, cross-holdings, and differences in capitalization (Morgan Stanley)

– Higher levels of gearing (leverage) and short-term payables are tolerated because of long-term relationships with bankers and suppliers

– Emphasis tends to be on long-term growth rather than instant profitability

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Factors Influencing Measurement Differences

• U.S. and U.K.– Stock market is the dominant influence

• Information needs of investors encourage a more “optimistic” view of earnings and higher share prices

– Accounting principles are flexible– Accounting profession is independent – Tax rules have a limited influence– Cultural values motivate a less

conservative approach to measurement

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• Continental Europe and Japan– Taxation and sources of finance are influential– Tradition of commercial codes and accounting

plans– Tendency to report lower earnings for tax

purposes

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• Continental Europe and Japan– Users of financial information may be more

concerned with balance sheet information• Black and White (2003) findings

– Balance sheet info is more informative in Germany, Japan– Income statement is more relative in the U.S.

– Professional influence is low due to legal requirements related to accounting

– Cultural values motivate a more conservative approach

Six National Financial Accounting Systems

France• Plan Comptable General (national accounting code) in

September 1947.• A revised plan came into effect in 1957.• A further revision in 1982 under the influence of the Fourth

Directive of The European Union (EU).• In 1986 the plan was extended to implement the requirements of

the EU Seventh Directive on consolidated financial statements, and it was further revised in 1999.

• The Plan Comptable General provides :• Objectives and principles of financial accounting and reporting • Definitions of assets, liabilities, shareholders’ equity, revenues and

expenses• Recognition and valuation rules.• A standardized chart of accounts• Model financial statements and rules for their presentation.


France• A feature of French accounting is :

– dichotomy between individual company financial statements and those for the consolidated group.

– The law allows French companies to follow International Financial Reporting Standards (IFRS) or US GAAP in their consolidated financial statements.

• Major organizations are involved in setting standards :– Counseil National de la Comptabilite or CNC (National Accounting Board)– Counseil National de la Comptabilite or CNC (National Accounting Board)– Comite de la Reglementation Comptable or CRC (Accounting Regulation

Committee)– Autorite des Marches Financiers or AMF (Financial Markets Authority)– Ordre des Experts Comptables or OEC (Institute of Public Accountants)– Compagnie Nationale des Commissaires aux Comptes or CNCC (National

Institute of Statutory Auditors)


France• French companies must report the following

– Balance Sheet– Income Statement– Notes to Financial Statements– Directors’ Report– Auditor’s Report

• Listed companies must provide half yearly interim

reports and starting in 2003, the results of their environmental activities. Information must be given on :– Auditor’s Report– Water, raw material and energy consumption, and actions

taken to improve energy efficiency– Activities to reduce pollution in the air, water, or ground,

including noise pollution and their costs, and– Amount of provisions for environmental risks.


Germany• In 1965 Corporation Law moved the German

financial reporting system toward British American ideas.

• The fourth, seventh and eighth EU directives all entered German law through the Comprehensive Accounting Act of December 19, 1985.

• The fundamental characteristic of German accounting :– Creditor protection as embodied in the commercial law

– The determination principle states that taxable income is determined by whatever is booked in a firm’s financial records.

– Its reliance on statutes and court decisions


Germany• The 1985 Accounting Act specifies the content and

format of financial statements, which include :– Balance Sheet– Income Statement– Notes– Management Report– Auditor’s Report

• A feature of the German financial reporting system is a private report by the auditors to a company’s managing board of directors and supervisory board. The report comments on the company’s future prospects and especially factors that may threaten its survival


United States• Accounting in the United States is regulated by

– A private sector body (FASB)– A governmental agency (SEC)

• Generally Accepted Accounting Principles are comprised of all financial accounting standards, rules, and regulations that must be observed in the preparation of financial report.

• The Sarbanes Oxley Act was signed into law in 2002, significantly expanding US requirements on corporate governance, disclosure and reporting and the regulation of the audit profession.

• Among its more important provisions is the creation of the PCAOB, a new non profit organization overseen by the SEC.


United States• A typical annual financial report of a large US corporation

includes the following :– Report of management– Report of independent auditors– Primary financial statements (income statement, balance sheet,

statement of cash flows, statement of comprehensive income and statement of stockholders’ equity)

– Management discussion and analysis of results of operations and financial condition

– Disclosure of accounting policies– Notes to financial statements– Five or ten year comparison of selected financial data– Selected quarterly data

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Items France Germany Japan Netherlands UK USA

Business Combination, Purchase or Pooling

Purchase Purchase Purchase Purchase Purchase Purchase

Goodwill Capitalize & Amortize

Capitalize & Amortize




Capitalize & Impairment

tested

Affiliated Companies Equity Method Equity Method Equity Method Equity Method Equity Method Equity Method

Foreign Currency Translation Current Rate Method

Autonomous Subsidiaries


All Subsidiaries




Temporal Method Integrated Subsidiaries

Integrated Subsidiaries

Not Used Integrated Subsidiaries



Asset Valuation Historical Cost Historical Cost Historical Cost Historical & Current Cost

Historical & Current Cost

Historical Cost

Depreciation Charges Economic Based Taxed Based Taxed Based Economic Based

Economic Based Economic Based

LIFO Inventory Valuation Not Used Not Used Not Used Not Used Not Acceptable Used

Finance Leases Not Capitalized Not Capitalized

Capitalized Capitalized Capitalized Capitalized

Deferred Taxes Accrued Accrued Accrued Accrued Accrued Accrued

Reserves for Income Smooting

Used Used No Some Some No

Summary of Significant Accounting Practices

Documents

1 Matakuliah: F0142 / Akuntansi Internasional Tahun: 2006 Session 13 Cases (Guidance Concept to Cases)