Accounting and Financial Reporting: Global Aspirations, Local Realities
Abstract and Keywords
This chapter examines the functions of corporate accounting and financial reporting around the world, with particular emphasis on how local realities that explain persistent diversity often pose a barrier to aspirations for a universal system. It first charts the history and progress of contemporary efforts to move accounting from its diverse local roots to a unified global stage before turning to a discussion of the varying functions of accounting and reporting laws around the world. It then looks at aspects of accounting that are affected by national variation, including securities regulation, corporate governance, and corporate finance. Finally, the chapter explains how related forces contribute to persistent divergence in financial reporting.
1“You manage what you measure,” the late Louis Lowenstein noted when explaining the importance of accounting in corporate governance, and the insight remains durable. Highlighting the functions of corporate accounting and financial reporting worldwide, this chapter explores how aspirations for a universal system are often disappointed by local realities that explain persistent diversity. Section II provides context and background by summarizing the history and progress of contemporary efforts to move accounting from its diverse local roots to a unified global stage. Section III identifies the varying functions of accounting and reporting laws around the world and reflects on how related forces contribute to persistent divergence in financial reporting.
Despite a gloomy assessment of the prospects for achieving a universal system of accounting, a more profound and happier truth should be stressed at the outset. The goal of international accounting is instrumental in promoting cross-border economic exchange, not an artistic aspiration for pure uniformity of financial reporting. Although pure accounting harmony appears to be an impossible dream, its pursuit has helped to facilitate the expansion of global capitalism, a substantial accomplishment. There is work ahead to promote prosperous convergence, but progress is significant in absolute terms and probably in relation to what might be attained by continued investment in international standards.
(p. 490) 2 Accounting Contributes to Globalization
Through the late twentieth century, accounting systems in most countries developed within the traditions of each country and varied considerably across them. But, as globalization took hold in the century’s final decades, an appetite for a universal system emerged. After numerous fits and starts, beginning from 1973, international standards ripened in the twenty-first century into a comprehensive system achieving international recognition. But the struggle continues.
The quest for international accounting standards is motivated by increased cross-border capital flows manifested in worldwide stock market listings, foreign ownership of domestic securities, and an expansion of transnational business combinations. Unsurprisingly, differences in national accounting standards and their application interfered with expanding these desirable activities. Accountants produced different reports of income and equity for identical underlying transactions, a phenomenon famously illustrated the German automaker Daimler-Benz’s traditional German accounting results differed radically from the US accounting standards it applied when it first listed in the United States.2
Internationalization of accounting standards has historically centered in London. There, in 1973, a group of accountants began a process of articulating global standards.3 The organization, originally called the International Accounting Standards Committee (IASC), was formed by agreement among professional accountancy organizations in Australia, Canada, France, Germany, Ireland, Japan, Mexico, the Netherlands, the United Kingdom, and the United States.4 By 1983, IASC included all professional accountancy bodies that were also members of the International Federation of Accountants.5
Between 1973 and 1987, IASC issued twenty-six accounting standards (and by 2000 had issued a total of forty-one standards).6 However, IASC lacked an effective governance structure and the political clout to attract adherents.7 Its standards were too vague and contained numerous optional approaches to reporting identical transactions. The products were usefully adopted by developing countries that lacked accounting standards.8 But IASC’s founding countries largely ignored the standards, preferring to use their own.
(p. 491) Efforts to strengthen IASC were redoubled in 1988 with backing from the International Organization of Securities Commissions (IOSCO).9 IASC began to review its standards, omit optional treatments, enhance disclosure, and “specify in greater detail how each standard was to be interpreted.”10 The result was a formal 1995 agreement between IASC and IOSCO on a joint program to develop standards comprehensively.11 This project led IOSCO, in 2000, to endorse IASC revisions while letting national regulators add requirements such as disclosure, specificity, and reconciliation.12
During the 1990s, the US Securities and Exchange Commission (the SEC) emphasized that, to achieve requisite stature, IASC needed to develop a comprehensive, high-quality, generally accepted basis of accounting.13 It would be characterized by transparency, comparability, and full disclosure and would be susceptible to rigorous interpretation and enforcement. On process, the SEC prescribed modeling IASC’s governance structure after that of the US accounting standard-setting body, the Financial Accounting Standards Board (FASB).
The SEC was able to exert this power over IASC because of how, along with US GAAP, it had consolidated a position as the gold standard in financial reporting. Beginning in 1983, non-US companies interested in accessing US capital markets were required to use US GAAP, at least by reconciling their home-country statements to it.14 Adding to its influence, some multinational enterprises adopted US GAAP completely, including Daimler-Benz, which switched from German GAAP to US GAAP in 1993 to gain its US listing.15
US GAAP’s leadership paralleled US leadership in capital markets, which New York had dominated throughout the second half of the twentieth century. Traditionally, the United Kingdom was a strong competitor in capital market advancement, where London long rivaled New York. In the early 1990s, after the collapse of the Soviet Union and the end of the Cold War, world trade expanded and capital flows began to move more freely and rapidly across more national borders.
The existence of multiple, alternative accounting systems can increase the costs of cross-border deals. Multinational enterprises based in various countries moved from domestic accounting regimes toward internationally useful and recognized systems. Most often, this meant a shift from national accounting systems to US GAAP, although interest grew in the standards that IASC offered. The appetite for a universal accounting system increased during the late 1990s and early 2000s as market integration accelerated.
Signaling belief in the possibility of moving from country-specific accounting standards to an international approach, the SEC issued a concept release in 2000 outlining essential elements of international standards.16 The SEC did not pursue this concept, however, as (p. 492) accounting scandals at Enron and other companies diverted its attention. Instead, it entered a period of domestic regulatory activity that produced and implemented the Sarbanes–Oxley Act of 2002.
Meanwhile, the IASC, boasting more than one hundred professional accountancy bodies by 2000, revised its governance along the lines that the SEC had recommended.17 It modeled itself closely after FASB, renamed itself the International Accounting Standards Board (IASB), and renamed its standards as International Financial Reporting Standards (IFRS). IASB propounded new and revised international accounting provisions that were destined to set a new gold standard in financial reporting.
IASB also began a vigorous marketing campaign with numerous countries and blocs to gain recognition.18 This led the European Union to pass legislation in 2002 requiring all EU-listed companies to use IFRS beginning in 2005 (subject to the European Union’s endorsement of each new standard as it was produced).19 Additionally, IASB’s campaign led scores of other countries, from Australia to Singapore, to embrace its standards (subject, in most cases, to the same endorsement mechanism).20 Others, including Japan and the United States, agreed with IASB to work to converge national standards and IFRS.21
During this period, coordination accelerated between the United States and European Union. In 2004, the SEC and the Committee of European Securities Regulators (CESR)22 agreed to increase collaboration on accounting convergence, including a commitment to concentrate on the consistent application, interpretation, and enforcement of IFRS.23 Within one year, the SEC unveiled a “roadmap” to convergence (including ending the US reconciliation requirement for non-US issuers by 2009 or sooner),24 and CESR declared that US GAAP was substantially equivalent to the European Union’s IFRS.25 In both Europe and the US, as elsewhere, IFRS required making significant cultural adjustments from historical traditions.26
(p. 493) In 2006, the SEC and CESR reaffirmed and deepened their earlier commitment in a formal work plan to intensify joint investment in IFRS.27 Meeting the roadmap commitment, the SEC ended the reconciliation requirement in 2007 and broached letting US issuers choose to adopt IFRS instead of US GAAP.28 In 2008, however, the financial crisis sidetracked the SEC, much as the Enron-period scandals had earlier, this time under the weight of the Dodd–Frank Act of 2010. In 2012, the SEC staff issued its final report on the work plan. It might have endorsed IFRS and recommended that the Commission do so, but it did neither, putting its fate in the United States in limbo.
IASB’s impressive showing was reinforced by enthusiasm for the notion that IFRS largely took the form of principles as opposed to rules. This enthusiasm was a stunning turnabout since IASC standards set from 1973 to 1987 and into the late 1990s were criticized and did not catch on because they were too loose.29 Earlier objections to IASC’s relatively vague standards were based on the requirement that an accounting system must provide definiteness.
Specifically, an accounting system must enable preparing financial statements that meet basic criteria that are recognized worldwide for reliability and usefulness. Such a system is reliable when it is capable of transparently capturing, aggregating, and summarizing vast quantities of transactions with varying qualities, which is possible only if standards are sufficiently comprehensive to address most transaction types and categories.
To be useful, an accounting system must facilitate comparability across enterprises. Thus, one risk of principles that are too generic is that the role of subjective judgment diminishes the comparability of resulting statements. Yet that risk of excessive generality was offset by several forces, which together made a global turnabout from criticizing to applauding IASC’s standards, which came to be called “principles-based.”
Foremost among these forces, in the earlier period, there was less pressure for countries supporting IASC to adopt its standards. For example, countries like Australia, Britain, Germany, and France had respected systems; therefore, IASC standards were generally only taken up by less developed countries that lacked accounting traditions, such as countries in Eastern Europe and former members of the Soviet Union. The pressure equation changed as the value of international standards increased to developed countries amid post-Cold War globalization.
Moreover, to command acceptance among far-flung participants, from the European Union to the United States and scores of other countries, it is helpful for accounting standards to be written at a relatively high level of generality. If too detailed or overly tailored (p. 494) to specific attributes of particular nations, the standards appeal only to those nations and not to others.
In addition, literal and functional translation costs are proportional to the relative generality or specificity of the original text. Because of language differences, it is necessary to translate the standards from their original language, English, into other languages. More general language is easier to translate into other languages and easier for readers of the translated texts to comprehend.
Finally, the relative generality of IFRS was more appealing in the early 2000s than before because of events in the United States that reverberated worldwide. It was tempting to attribute the Enron debacle to how US GAAP were highly detailed and dense with rules. Enron’s managers—and managers at other companies in the heady period—appeared to manipulate US GAAP’s rules by designing transactions that could opaquely avoid triggering adverse accounting results and enable reporting beneficial ones.30 Critics of US GAAP, and foes of using rules in regulation generally, offered such examples as evidence that rules are costly and that it is better to regulate and design accounting systems using principles.31
The force of globalization and related harmonization efforts led to substantial but incomplete convergence in accounting standards worldwide. IFRS has many followers. Its standard-setters have worked closely with FASB to evolve US GAAP in harmony. However, there are still significant differences in the content of IFRS versus US GAAP on many topics.32 Centrally promulgated IFRS are often adopted in a slightly different form by given countries or companies, which prepare statements to comply with country-specific variations.33 Related auditing opinions tend to attest to the country-specific versions of IFRS rather than to the IASB version.34 There is also a wide variety of applications of given IFRS standards.35 Variety extends to the form of presentation,36 (p. 495) bottom-line income statement figures,37 cash flow statements,38 and a variety of transactional matters.
Despite powerful forces of globalization, then, the project of establishing a single-set of high-quality accounting standards has proven to be monumentally elusive. Some of the reasons may be found in the local character of traditional accounting, which produces significant counter-pressures, as discussed next.
3 Accounting Still Remains a Local Language
The following discussion uses familiar classifications from legal scholarship to highlight aspects of accounting that are affected by national variation. Underlying cultural and legal features shape the development of accounting standards. Those features explain the variability of traditional accounting standards from nation to nation, as well as the continuing differences between IFRS and US GAAP. The pressure of these features, which tend to be sticky, also explains sustained variation in the application of uniform international accounting standards.39
3.1 Legal Origins
National accounting systems are connected to local legal traditions. A broad contrast among legal traditions distinguishes common law and civil law.40 Accounting standards in common law countries, such as the United States and United Kingdom, traditionally obtained authority through general acceptance by the profession;41 accounting systems in civil law countries, including most continental European countries (the Netherlands is the major exception), obtain legitimacy by enactment as law.42 Japanese accounting exhibited a blending of these traditions.43
These origins play out in different views on how to apply identical accounting requirements. A salient manifestation of how legal origins influence the application of identical accounting requirements concerns the principle that financial statements should present a true and fair view of the business and financial condition of an enterprise.
(p. 496) This edict, perhaps the most famously flexible and contingent notion in all of accounting, can mean different things in different cultures and contexts. For example, in England, “fair” denotes that reports are within a range of fidelity to business records and economic reality; “true” negates its opposite—false.44 But, until the United Kingdom joined the European Union, the concept of “true and fair” was alien to non-Dutch Europe; the European Union’s 1978 Fourth Directive introduced the requirement.45
The Italian translation of “true and fair” is “true and correct” (rappresentare in modo veritiero e corretto),46 which is then equated with Italian civil law requiring “straightforwardness and truth” (evidenza a verita). 47 Many translations replace the compound phrase with a single word. In Greece, this is the equivalent of “real”; in Belgium, France, Luxembourg, the Netherlands, and Spain, it is the equivalent of “faithful.”48 In the United States, the concept is embedded in the requirement that financial statements “fairly present” an enterprise’s financial condition and results of operations.49
Substantive disagreements exist concerning the relationship between the principle and other accounting standards. Conflicts arise when applying the standards could impair the objective. There are at least three alternative approaches to resolving such a conflict.50 In the United Kingdom, an override is called for so that the true and fair view is privileged and conflicting standards are subordinated; in Europe, overriding the written rules is repugnant, despite the “true and fair” view concept; and in the United States, overrides have generally not been used because litigation risks induce people to comply with rules.51
These legal origins explain some of the observed and persistent divergence among companies purporting to use IFRS.52 Across the European Union, differences are (p. 497) significantly influenced by the legal origin of the firm’s home country (i.e., common law or civil law traditions).53 It appears unlikely that any international standard will be capable of reconciling these disagreements. After all, local cultural influences will retain a role in how any principle is applied.
3.2 Securities Regulation
Legal traditions continue to influence the shape of securities regulation in different countries. Securities regulation, in turn, influences accounting standards. The most forceful examples of these relationships appear in the contexts of investor protection and enforcement intensity.54 In the United States, investor protection is among the chief purposes of securities regulation, and accounting principles are designed to bolster investor protection.55 In many other countries, interests of constituencies other than investors matter, and investor protection is one among several competing goals of securities regulation.56
Enforcement intensity refers to the relative strength of legal institutions equipped to police adherence to securities regulations, including accounting provisions.57 The United States employs an intense enforcement apparatus, one that includes the SEC, private litigation, and various other state and federal authorities.58 Few countries match this level of enforcement intensity, and many exhibit a weak enforcement program.
These differences pose implications for a range of accounting issues. A general example concerns the preferred form that standards assume, ranging from detailed rules to vague principles. Indeed, it is possible to understand the relative rules-density of US GAAP as a product of an intensive enforcement environment.59 Thus, litigation threats may lead preparers and auditors to value clarity in accounting standards, leading to extensive provision of detailed guidance.60 Unlike US companies, European and Asian companies and constituents may be able to accept relatively more generic accounting standards, in part because of the comparatively lower level of private and public enforcement of securities laws through regulation, prosecution, and litigation.
Predicting the effects of cultural variance on the future of IFRS is not easy. It is conceivable that relative enforcement intensity and the value of investor protection can converge worldwide. That would mean making legal changes to US regulations in order to reduce the role of liability risk and litigation threats on preparers and auditors. These changes would curtail (p. 498) demand for detail or increase those levels in other nations. Both prospects entail momentous changes with uncertain prospects and payoffs. Even substantial reductions in the scope of legal liability for accounting violations are unlikely to eliminate litigation as a dispute resolution mechanism in the United States.61 Intensifying enforcement activity in other countries is possible but is by no means certain or desirable.
3.3 Corporate Governance
Corporate governance, referring to the combination of corporate purpose and organizational arrangements designed to achieve it, varies worldwide. Broadly defined, corporate purposes range from a shareholder profit maximization philosophy to a pluralistic conception of corporate constituencies that includes shareholders, creditors, employees, suppliers, communities, and the state.62 Organizational arrangements reflect these purposes through devices such as the design, composition, and duties of boards of directors.
Boards may have one or two tiers, members may be elected by shareholders only or by other groups, and duties may range from maximizing profits to assuring the corporation’s long-term sustainability. Accounting in systems characterized by shareholder profit maximization may naturally emphasize the measurement of profit from period to period, whereas more pluralistic systems may emphasize net worth and consistent levels of profit over time.
In addition, the role of employees, at both the senior executive levels and the broader level of laborers, can have significant effects on accounting philosophy. Labor plays an active role in corporate governance in many countries, a role rarely held in the United States.63 For example, employees are formally represented on boards of directors in Germany.64
For senior executives, the most pronounced global difference concerns levels and forms of compensation. US corporations pay executives considerably greater compensation than elsewhere, often by staggering multiples and often in the form of stock options and other compensation that is contingent on varying measures of corporate performance.65 Thus, setting the benchmarks of corporate performance and calculating compensation levels play a more important role in accounting systems such as those in the United States than in some other systems. However, such benchmarks assume less or no importance where executive compensation packages are more modest.
(p. 499) In the most general terms, the varying corporate purposes and organizational designs around the world reflect varying forms of capitalism.66 National accounting traditionally reflects competing conceptions of capitalism. Although these and other distinctive traditions are converging, enduring diversity in views on capitalism are likely to continue to exert influence at national levels, posing challenges to the formulation, acceptance, application, and enforcement of international standards.67
3.4 Corporate Finance
Even within corporate governance systems that exhibit family resemblance, there may be differences in corporate finance that lead to sharply different conceptions of accounting’s purpose and audience. Corporate finance refers to the sources of capital employed to fund a business organization and the entity’s resulting capital structure. The chief categories of capital are equity and debt securities. The combination, identity, and role that the two forms of investment play influence the audience for whom accounting is designed.68
Needs and interests of debt and equity investors differ. For equity investors, accounting standards and statements should be useful to form judgments concerning business value.69 Standards quality is evaluated in terms of the relationship between reported accounting figures and resulting stock market prices or returns. On the other hand, for debt investors, accounting standards should make contract negotiation more efficient. Standards quality is evaluated in terms of whether they translate into financial statements that are useful for establishing covenants and other contractual provisions that regulate the rights and duties of lenders and borrowers.
Corporate finance characteristics also influence the relative importance of transparency that accounting can provide. Anglo-American finance is oriented toward equity and open capital markets, often attracting dispersed and uninvolved equity owners, making transparency in financial reporting vital.70 Traditionally, Euro-Japanese finance relies on banks, which exercise considerable power within corporations.71 This reduces the importance of reporting transparency for external users.
The relative needs of equity or debt investors also bear on how accounting standards and statements address uncertainty. The traditional US approach to uncertainty is conservatism, meaning asymmetric recognition of losses compared to gains.72 However, investors and (p. 500) other constituencies may have different demands for relative conservatism. In general, debt demands greater conservatism than equity.73 Managers compensated heavily using stock options or other devices based on reported accounting results will demand a different level of conservatism than managers not so compensated. Managerial demand for conservatism relative to that demanded of equity or debt investors will differ accordingly.
Corporate finance also can influence the relative weight assigned to the income statement or balance sheet. This sometimes follows from the traditional forms of capital structure that prevail. To the extent that debt capital dominates, the balance sheet assumes greater importance to provide a basis for estimating solvency; where equity capital dominates, the income statement warrants a more central role in evaluating business performance. It is also possible for the relationship between financial and tax reporting (and the role of the state) to influence the relative importance of, and the relationship between, the income statement and the balance sheet. Accounting for inventory illustrates both points.
It is conceptually defensible to assume that goods in inventory are sold either in the direct order that they are produced (first-in-first-out, or FIFO) or in reverse order of production (last-in-first-out, or LIFO). In a period of rising prices, FIFO is more faithful to economic reality in the balance sheet, because it lists the inventory assets at more current values; conversely, LIFO is more faithful to economic reality in the income statement, because it records the costs of goods sold at more current costs. US GAAP permits choosing between these measurements, allowing enterprises to determine whether balance sheet or income statement fidelity is more important; IFRS requires using FIFO, suggesting balance sheet primacy.
Concerning taxation, the US Internal Revenue Code, requires conformity between inventory accounting for financial and tax reporting purposes.74 Specifically, a company must use LIFO for both or FIFO for both. The rationale is simple. In a period of rising prices, FIFO results in reporting higher income compared to LIFO. Thus, managers may prefer FIFO for financial accounting to show investors higher income but prefer LIFO for tax accounting to pay lower taxes. The Internal Revenue Code’s conformity requirement reflects how US culture generally considers tax and financial accounting separate subjects with generally different standards, whereas in many countries the two subjects are substantially co-extensive.75
A broader point about the cultural contingency of giving greater weight to the income statement or balance sheet is the question of which emphasis is more susceptible to manipulation (sometimes referred to as “tunneling”).76 In countries with dispersed equity ownership, such as the United States, controlling persons have greater incentives to manipulate the income statement, as their payoffs are a function of earnings per share.77 In countries with (p. 501) concentrated ownership, such as in Europe and Japan, the incentives are to manipulate the balance sheet, as controlling person payoffs come from allocating corporate assets to themselves rather than serving as stewards for other claimants.
It is not obvious whether IFRS provisions are designed to influence managerial propensity to manipulate the income statement or the balance sheet. It is likewise uncertain whether accounting standards could eliminate those propensities by proper design. Still, the cultural differences that lead to these alternative incentives matter in assessing universal accounting standards, both in production and application. Currently, it is more important for investors in US companies to constrain discretion over the income statement and for investors in European companies to constrain discretion over the balance sheet.78
Time horizons, referring to the distinction between the long-term and short-term, can be of great significance in conceiving appropriate accounting standards. Consider the case of traditional German accounting, which permitted and sometimes required the recognition of revenue or expense through hidden reserves across multiple time periods.79 Although relevant in some countries, these have little to do with recognition concepts in US or UK accounting, which reflect more immediate time periods.
The use of hidden reserves, also followed in other European countries, including Austria, Denmark, Finland, and Switzerland, and to lesser degrees in Spain, would constitute earnings management in the United States and United Kingdom and would be a violation of both accounting standards and securities laws.80 Even if these principles were abandoned for enterprises using IFRS, traditional knowledge and associated sensibilities would likely play a part in applications. The effect of this is that preparers in different countries could, in good faith, apply identical standards in different ways.
3.5 The Market
The relative role of markets in corporate activity covered by accounting reports can influence the character of accounting standards and the attitudes of those applying them. An example appears in the fundamental accounting issue of measuring assets. In general, there are two choices: measuring assets based on observed transactions (known as historical cost accounting) and measuring assets based on prevailing market conditions (known as fair value accounting).
National accounting systems take differing stances on whether to prefer historical cost or fair value accounting in general and in specific circumstances. Many are dual-attribute models, in which some items are measured using historical cost and others are measured using fair value. The choice is determined according to trade-offs between accounting’s goal of relevance and that of reliability.
(p. 502) The appeal of historical cost accounting is that measurements arise from observed transactions, such as the purchase price of an asset, which leads to reliable figures. Judgments are required to allocate that cost over the asset’s life. As time passes, the historical cost figure becomes less relevant in the context of prevailing conditions.
The virtue of fair value accounting is that measurements are based on prevailing conditions, such as market prices of an asset, which leads to relevant figures.81 But, cost allocations may require adjustment; a limitation occurs when exact market prices are inaccessible (either because the asset does not trade on a market, the asset trades infrequently, or the asset has few substitutes), making it less reliable than historical cost figures.
US GAAP traditionally preferred historical cost accounting, subject to a “lower of cost or market principle” that used market values when these were lower.82 A US trend toward favoring fair value accounting began in the late twentieth century.83 For its part, IFRS favors fair value accounting, in part as a product of the projects designed to converge IFRS and US GAAP.84 Other national accounting systems vary in their relative preference for historical cost and fair value accounting. Thus, any choice IFRS makes will entail cultural adjustment in some countries.
Further, a putative advantage of fair value accounting is its use of markets as a basis for asset measurement. Yet a limitation arises if markets are imperfect or unavailable to measure particular assets. When that occurs, preparers and auditors must estimate fair value using judgments based on hypothetical valuation modeling tools.
This activity raises a broad question of how much deference these actors should receive when making such judgments compared to how much power investors and other users of financial statements should have to challenge those judgments. The national significance of this question will vary according to local investor demographics, including the mix of debt and equity in a capital structure and the degree of ownership concentration or dispersion.
3.6 The State
The role of the state varies across nations, even within capitalist societies. In comparative terms, the social democrat traditions prevalent in many continental European nations demand a state role consciously committed to protecting its citizens, including in the context of economic policy. The European practice of designating some corporations as “national champions” illustrates this sensibility as does assigning a special status to some constituent groups, such as labor unions. In contrast, US sensibilities, certainly among conservatives and even among many centrists and liberals, evince a more individualistic proclivity that (p. 503) reduces the role of the state in economic life (and other spheres). Thus, there are no or few national corporate champions in the United States, and constituents vie for shifting political and economic power.
The consequence of these sensibilities is illustrated by differences between traditional French accounting compared to US (and UK) accounting. French accounting is heavily linked to, and co-extensive with, state fiscal policies,85 while in the United States, tax accounting and financial accounting are distinct. Also, the US/UK income statement is designed to present information in forms useful to decision making by equity owners, whereas traditional French income statements were organized according to a statutory scheme that reflected an orientation toward the French state.86 Similarly, US/UK balance sheets conceptualize assets in economic terms, while traditional French accounting conceives of them in a “patrimonial sense” of interests in tangible property.87
The state’s role also bears on relative accounting conservatism. States may prefer a level of conservatism designed to generate desired tax revenue from corporations subject to tax within their jurisdiction. The exact appetite various states have for relative accounting conservatism may depend on population demographics, the manner of raising fiscal revenue, and the influence of economic theories on national policy, such as views on what supply-side effects have on production and total tax revenue. Whatever a state’s appetite is, it may differ from those of the state’s constituents and from those prevalent in other countries.
A state’s net appetite for relative accounting conservatism may also be influenced by the demands of corporations and their constituents domiciled within the country. In countries that tend to identify national champions among their corporate elite, a national solicitude toward their interests is likely to interact with fiscal policy making. The net appetite also likely will be influenced by the historical relationship between financial and tax accounting. In the United States, because these accounting systems have been distinct, financial accounting can generally be evaluated independently of fiscal policy. For countries in which financial and tax accounting are co-extensive, the state’s interest will continue to influence desired choices within financial accounting.88
The state interest manifests in many matters of international affairs. Even when political blocs endorse IFRS, it does not mean that all member countries follow suit or companies within them do. Some members of the European Union, for example, are notorious for ignoring EU directives, especially the Czech Republic, Greece, Italy, Luxembourg, and Portugal.89 Many members, including such diverse countries as Cyprus, Germany, Hungary, and Spain, have altered IFRS to reflect local needs.90 Beyond the European Union, IFRS (p. 504) endorsers include such assorted countries as Armenia, Iraq, and Kuwait.91 Considering this diversity, it may be naïve to believe that accounting standards will be enforced uniformly in all these places.
It may be highly unlikely for countries to do so when national interest warrants non-compliance. An example is the experience of Japan in the late 1990s. When accounting rules required Japanese banks to record big losses on large loans in the 1990s, Japan’s government intervened against doing so to avert a national financial crisis.92 For another, after IASB adopted rules for financial instruments, the French government lobbied the European Union to obtain an exception to reduce volatility in reports of French banks.93 Steps like these will continue and, depending on frequency, could stealthily destroy global uniformity.
Pressure of global capitalism has induced the drive toward universal accounting standards, and it can be difficult for any centralized authority to control that journey. It may be possible to bridge diversity using a universal set of accounting standards that concentrates on points of congruence while appreciating the consequences of difference. After all, inchoate but real convergence has occurred in important aspects of modern culture. These aspects include melding of legal traditions, coalescing around some forms of capitalism, and expanding global coordination and governance in many spheres of human activity. Yet diversity endures in many of those spheres, including those that affect accounting, especially law, economics, politics, and language.
Other cultural phenomena have proven more or less susceptible to such transcendence. Consider the metric system—a standardized, uniform method of measurement. This innovation was important to expanding international trade. It was begun by France in the late eighteenth century and was gradually adopted by all countries except the United States and two smaller ones.94 Even in the United States, however, people are familiar with the metric system, and its use is widespread in everything from consumer goods to industrial production.
Although accounting is more complex and involves more than just measurement, measurement is an important aspect of accounting. Accounting’s more complex attributes explain the hackneyed adage that accounting is the language of business.
Thousands of languages exist in the world, and hundreds are in use in the United States alone. Still, English has emerged as a widely spoken, nearly universal language, at least among active participants in international matters. On the other hand, conscious efforts to create a universal language have failed. The infamous example is Esperanto. This was a (p. 505) high-quality language, grammatically sound and coherent, with a sizable vocabulary capable of extensive expression. Yet it never caught on and is not widely used anywhere.
Today’s accounting is more like the metric system than Esperanto. It is widely recognized if not universally embraced or uniformly implemented and has contributed substantially to the proliferation of global capitalism and related prosperity. That is quite an achievement, though the quest for a truly uniform system of accounting is elusive. It was shrewd or lucky that proponents set their sights on the bold vision of universal accounting, as such an outsized target equipped participants and followers to achieve the more realistic and practical objective.
In the nineteenth century, Max Weber explained how capital accounting was a pre-condition to the flourishing of capitalism.95 The spread of reliable systems of accounting contributed to the flourishing of capitalism even though those systems were imperfect, incomplete, and incompatible across countries. Today, a global financial reporting system may be seen as a pre-condition to globalization, and one that has already substantially been achieved despite inherent imperfections and persistent shortfalls from pure comparability.96 IFRS has helped to draw more countries into capitalist traditions. Its limits may simply reflect the different forms of capitalism and the different conceptions of corporate purpose and constituencies in the world.
The initial inspiration for international standards was to promote global capitalism, to facilitate cross-border capital flows, deals, and listings, an instrumental value, rather than the intrinsic beauty or Platonic value of an elegant universal ideal system. It has succeeded to a very large degree. We can accept both that the pure idea of universal accounting is a dream and that the practical efforts people took in its name have been valuable.
(1) Henry St. George Tucker III Research Professor of Law, George Washington University. This chapter is adapted and updated from my previous work, especially Lawrence A. Cunningham, “The SEC’s Global Accounting Vision: A Realistic Appraisal of a Quixotic Quest”, 87 N.C. L. Rev. 1 (2008).
(2) See David Waller, “Daimler-Benz Gears Up for a Drive on the Freeway”, Fin. Times, Apr. 29, 1993, at 18; Breeden Announces Daimler-Benz Will File to Trade Stock in US Markets, 25 SEC Reg. & L. Rep. (BNA) 477 (Apr. 2, 1993).
(3) See Gary John Previts & Barbara Dubis Merino, A History of Accountancy in the United States: The Cultural Significance of Accounting 361 (rev. ed. 1998).
(4) See David R. Herwitz & Matthew J. Barrett, Accounting for Lawyers 174 (4th ed. 2006).
(6) See Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with International Financial Reporting Standards Without Reconciliation to US GAAP, 72 Fed. Reg. 37,962, 37,964 n.23 (proposed July 2, 2007) (codified at 17 C.F.R. §249.220f).
(11) See A.A. Sommer, Jr., “IOSCO: Its Mission and Achievement”, 17 Nw. J. Int’l. L. & Bus. 15, 24–25 (1997).
(13) International Accounting Standards, Securities Act Release No. 33-7801, Exchange Act Release No. 34-42430, 65 Fed. Reg. 8,896, 8,897 (Feb. 23, 2000) (codified at 17 C.F.R. pts. 230 & 240).
(14) See Adoption of Foreign Issuer Integrated Disclosure System, Securities Act Release No. 33-6437, 47 Fed. Reg. 54,764, 54,764 (Dec. 6, 1982).
(16) International Accounting Standards, Securities Act Release No. 33-7801, Exchange Act Release No. 34-42430, 65 Fed. Reg. 8,896, 8,897 (Feb. 23, 2000) (codified at 17 C.F.R. pts. 230 & 240) (stating that the desired attributes of international standards are effective, independent, and high quality standards accompanied by capable firms with quality controls and backstopped by regulatory oversight conducting the auditing).
(17) See Strategic Working Party, International Accounting Standards Committee, Recommendations on Shaping IASC for the Future (1999).
(18) See David Tweedie, “Setting a Global Standard: The Case for Accounting Convergence”, 25 Nw. J. Int’l L. & Bus. 589, 592–93 (2005) (showing the reflections of IASB’s principal leader).
(19) Eur. Parl. Doc. PE 308.463, available at http://www.europarl.europa.eu/meetdocs/committees/juri/20020225/461067EN.pdf.
(20) See Donald T. Nicolaisen, “A Securities Regulator Looks at Convergence”, 25 Nw. J. Int’l. L. & Bus. 661, 664–65 (2005).
(21) See Press Release, International Accounting Standards Board, IASB and Accounting Standards Board of Japan Agree to Next Steps in Launching Joint Project for Convergence (Jan. 21, 2005), available at http://www.iasb.org/news; Financial Accounting Standards Board & International Accounting Standards Board, Memorandum of Understanding, “The Norwalk Agreement” (Oct. 28, 2002), available at http://www.fasb.org/resources/ccurl/443/883/memorandum.pdf.
(22) CESR has now been replaced by the European Securities and Markets Authority (ESMA).
(24) See Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by US Issuers, 73 Fed. Reg. 70,816 (proposed Nov. 21, 2008) (to be codified at 17 C.F.R. pts. 210, 229, 240, 244, & 249).
(26) Martin Gelter & Zehra G. Kavame, Whose Trojan Horse? “The Dynamics of Resistance Against IFRS”, 36 U. Pa. J. Int’l. L. 89 (2014).
(28) See, “SEC Concept Release on Allowing US Issuers To Prepare Financial Statements in Accordance with International Financial Reporting Standards,” Securities Act Release No. 8831, Exchange Act Release No. 56,217, Investment Company Act Release No. 27,924, 72 Fed. Reg. 45,600, 45,607 (Aug. 7, 2007) [hereinafter SEC Concept Release on Domestic IFRS].
(30) See William W. Bratton, “Enron, Sarbanes–Oxley and Accounting: Rules Versus Principles Versus Rents”, 48 Vill. L. Rev. 1023, 1030 (2003).
(31) The complaints overstated the case. See William C. Powers, Jr. et al., Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp. 3–4 (2002).
(32) See International Accounting Standards: Hearing Before the Subcomm. on Securities, Insurance, and Investment of the S. Comm. on Banking, Housing and Urban Affairs, 110th Cong., at D1413 (Oct. 24, 2007) (testimony of Jack Ciesielski, President, R&G Associates); Elaine Henry, Steve W.J. Lin, & Ya-Wen Yang, “The European-U.S. ‘GAAP Gap’: IFRS to U.S. GAAP Form 20-F Reconciliations”, 23 Acct. Horizons 121 (2009) (revealing a widening of the gap compared to previous findings from 1999).
(33) See SEC, Staff Observations, infra note 35 (“We found that the vast majority of companies asserted compliance with a jurisdictional version of IFRS and that most also asserted compliance with IFRS as published by the International Accounting Standards Board, commonly referred to as the IASB.”).
(34) Id. (“In the vast majority of the companies we reviewed, the company’s auditor opined on the company’s compliance with the jurisdictional version of IFRS that the company used, but did not opine on the company’s compliance with IFRS as published by the IASB.”).
(35) See SEC, “Staff Observations in the Review of IFRS Financial Statements” (July 2, 2007), http://www.sec.gov/divisions/corpfin/ifrs_staffobservations.htm [hereinafter Staff Observations]; see also SEC, Staff Comments on Annual Reports Containing Financial Statements Prepared for the First Time on the Basis of International Financial Reporting Standards (2007), http://www.sec.gov/divisions/corpfin/ifrs_reviews.htm.
(40) See Edward L. Glaeser & Andrei Shleifer, “Legal Origins”, 117 Q. J. Econ. 1193, 1193–97 (2002); Rafael La Porta, Florencio Lopez-de-Silanes, & Andrei Shleifer, “The Economic Consequences of Legal Origins”, 46 J. Econ. Lit. 285, 285–87 (2007).
(41) This is also true for Dutch accounting, despite a civil law tradition, and due in part to its use of a specialized commercial and company law court. See Miller, European Accounting Guide 700 (David Alexander & Simon Archer eds., 3d ed. 1998).
(44) Alternatively, “true” is defined as complying with the letter of rules and “fair” as complying with the spirit of rules. Tom K. Cowan, “Are Truth and Fairness Generally Acceptable?”, 40 Acct. Rev. 788, 788–94 (1965).
(45) See Lawrence A. Cunningham, “Semiotics, Hermeneutics, and Cash: An Essay on the True and Fair View”, 28 N.C. J. Int’l. & Com. Reg. 893, 902–13 (2003).
(47) Id. at 583 (citing Civil Code, Article 2217, section 2). Italian accounting also requires true and correct presentation with clarity and precision (chiarezza e precisione). Id. (citing Civil Code, Article 2423, section 2).
(48) See Christopher Nobes, “The True and Fair View Requirement: Impact on and of the Fourth Directive”, 24 Acct. & Bus. Res. 35, 42 (1993). Similar translation differences exist across Europe, such as right-looking (Denmark), according to facts (the Netherlands), and true and appropriate (Portugal). Id.
(51) Id. at 908–09. See generally Jonathan Rickford, “Legal Approaches to Restricting Distributions to Shareholders: Balance Sheet Tests and Solvency Tests”, 7 Eur. Bus. Org. L. Rev. 135, 147 (2006); David Alexander & Eva Eberhartinger, “The True and Fair View in the European Union”, 18 Eur. Acct. Rev. 571 (2009); David Alexander & Eva Jermakowicz, “A True and Fair View of the Principles/Rules Debate”, 42 Abacus 132, 139 (2006); Lisa Evans & Christopher Nobes, “Some Mysteries Relating to the Prudence Principle in the Fourth Directive and in German and British Law”, 5 Eur. Acct. Rev. 361, 363–65 (1996). The override approach was enacted as formal French law though its meaning remains uncertain C. Com. (France) art. L 123–14 al. 3. See Christian De Lauzainghein, Jean-Louis Navarro, & Dominique Nechelis, Droit Comptable 361 (3d ed. 2004) (“même vingt ans après son introduction dans notre droit la notion demeure souvent bien floue”) (Google translation: “even twenty years after its introduction into our law, the concept often remains very fuzzy”).
(52) The evidence summarized above attributed variation among IFRS users to different legal origins.
(53) See Donna L. Street, “International Convergence of Accounting Standards: What Investors Need to Know” (Oct. 2, 2007) at 9, available at http://www.sec.gov/comments/s7-20-07/s72007-24.pdf. see also D. Jetuah, Citigroup Lays out IFRS-US GAAP Gulf, Accountancy Age, Aug. 30, 2007 (reporting on similar results from Citigroup survey).
(54) See John C. Coffee, Jr., “Law and the Market: The Impact of Enforcement”, 156 U. Pa. L. Rev. 229, 230–34 (2007); see also Howell E. Jackson, “Variation in the Intensity of Financial Regulation: Preliminary Evidence and Potential Implications”, 24 Yale J. Reg. 253, 279–85 (2007).
(55) See Thomas Lee Hazen, The Law of Securities Regulation 9–10 (5th ed. 2005).
(59) See George J. Benston, “Public (US) Compared to Private (UK) Regulation of Corporate Financial Disclosure”, 51 Acct. Rev. 483, 484–85 (1976); Stephen A. Zeff, “A Perspective on the US Public/Private-Sector Approach to the Regulation of Financial Reporting”, 9 Acct. Horizons 52, 66 (1995).
(61) An additional explanation for the relatively greater use of principles in IFRS is simply its relative youth. Repeated application of even the vaguest standard reduces that vagueness. A maturing IFRS can be expected to metamorphose from principles to rules. There are also reasons to challenge as overstated the conventional view that IFRS are “principles-based” and US GAAP is “rules-based.” See Lawrence A. Cunningham, “A Prescription to Retire the Rhetoric of ‘Principles-Based Systems’ in Corporate Law, Securities Regulation, and Accounting”, 60 Vand. L. Rev. 1411 (2007).
(62) In Germany, to give a well-known example, short-term profits are subordinated to long-term financial survival. See Wolfgang Ballwieser, Germany: Individual Accounts, in 2 Transnational Accounting 1241 (Dieter Ordelheide & KPMG eds., 2d ed. 2001).
(63) See Brett H. McDonnell, “The Curious Incident of the Workers in the Boardroom”, 29 Hofstra L. Rev. 503, 513 (2000) (book review).
(65) See Charles M. Yablon, “Bonus Questions—Executive Compensation in the Era of Pay for Performance”, 75 Notre Dame L. Rev. 271, 279–81 (1999).
(66) See David Levi-Faur, “The Global Diffusion of Regulatory Capitalism”, 598 Annals Am. Acad. Pol. & Soc. Sci. 12 (2005).
(67) See Corporate Governance Regimes: Convergence and Diversity (Joseph A. McCahery et al. eds., 2002).
(68) The list of potential audiences for accounting information can be extended beyond debt and equity investors to include regulators, vendors, tax authorities, management, and potential merger partners.
(69) See Ray Ball, Ashok Robin, & Gil Sadka, Is Accounting Conservatism Due to Debt or Share Markets? A Test of “Contracting” versus “Value Relevance” Theories of Accounting, Working Paper 1 (Oct. 26, 2005).
(70) See Lawrence A. Cunningham, “Commonalities and Prescriptions in the Vertical Dimension of Global Corporate Governance”, 84 Cornell L. Rev. 1133, 1136–39 (1999).
(72) See Sudipta Basu, “The Conservatism Principle and the Asymmetric Timeliness of Earnings”, 24 J. Acct. & Econ. 3, 7–8 (1997).
(73) See William W. Bratton, “Shareholder Value and Auditor Independence”, 53 Duke L. J. 439, 477 (2003).
(74) Internal Revenue Code § 446(a); see Thor Power Tool Co. v. Comm’r, 439 U.S. 522 (1979).
(75) E.g., A. Frydlander & D. Pham, “Relationship Between Accounting and Taxation in France”, 5 Eur. Acct. Rev. Supplement 845, 845–46 (1996); Dieter Pfaff & Thomas Schröer, “The Relationship Between Financial and Tax Accounting in Germany”, 5 Eur. Acct. Rev. Supplement 963, 967–69 (1996).
(76) See John C. Coffee, Jr., “A Theory of Corporate Scandals: Why the United States and Europe Differ”, 7 Stud. Int’l. Fin. Econ. & Tech. L. 3, 15 (2005); Simon Johnson et al., “Tunneling”, 90 Am. Econ. Rev. (Papers & Proc.) 22 (2000).
(77) See John C. Coffee, Jr., Gatekeepers: The Professions and Corporate Governance 81, 88–91 (2006).
(78) But, if all use the same set of standards, it may be impossible to make these distinctions. On the other hand, a single set of global accounting standards may make the kinds of tunneling activities in which managers or insiders are engaged more transparent. See Vladimir Atanasov, Bernard Black, & Conrad S. Ciccotello, “Unbundling and Measuring Tunneling”, 2014 U. Ill. L. Rev. 1697 (2014).
(79) See Enno W. Ercklentz, Jr., 2 Modern German Corporation Law 442–45 (1979).
(81) See Lawrence A. Cunningham, “Finance Theory and Accounting Fraud: Fantastic Futures versus Conservative Histories”, 53 Buff. L. Rev. 789, 792–93 (2005).
(83) See Stanley Siegel, “The Coming Revolution in Accounting: The Emergence of Fair Value as the Fundamental Principle of GAAP”, 42 Wayne L. Rev. 1839 (1996).
(84) A prominent international accounting standard reflecting this appetite is IAS No. 39, Financial Instruments: Recognition and Measurement. See IASC Foundation, “IAS 39 Financial Instruments: Recognition and Measurement” (2005) (describing the steps by which IAS No. 39 affects the IFRS’ plan).
(86) See Jacques Richard, France: Group Accounts, in 2 Transnational Accounting 1137 (Dieter Ordelheide & KPMG eds., 2d ed. 2001).
(88) See Eva Eberhartinger & Margret Klostermann, “What If IFRS Were a Tax Base? New Empirical Evidence from an Austrian Perspective” (SSRN, Working Paper No. 1080512, 2008), available at www.ssrn.com/abstract_id=1080512; Wolfgang Schön, “The Odd Couple: A Common Future for Financial and Tax Accounting?”, 58 Tax L. Rev. 111 (2005).
(89) See Tobias Buck, Italy Under Fire for Worst Record on EU Market Laws, Fin. Times, July 19, 2005, at 9.
(90) See David Henry, “A Better Way to Keep the Books?”, Bus. Wk., Sept. 15, 2008, at 35.
(91) For a detailed list of countries requiring or permitting IFRS, see IAS Plus, Use of IFRS by Jurisdiction, available at http://www.iasplus.com/en/resources/ifrs-topics/use-of-ifrs.
(92) See Charles K. Whitehead, “What’s Your Sign? International Norms, Signals, and Compliance”, 27 Mich. J. Int’l. L. 695, 728 (2006).
(93) See Floyd Norris, Europe Closer to Accepting Uniform Accounting Rules, N.Y. Times, May 10, 2012, at B1.
(95) Max Weber, Economy and Society 85–86 (Guenther Roth & Claus Wittich eds., Ephraim Fischoff trans., Bedminster Press 1968) (exploring how the development of capital accounting was a pre-condition to the flourishing of capitalism during the eighteenth and nineteenth centuries).
(96) See Bernard S. Black, “The Legal and Institutional Preconditions for Strong Securities Markets”, 48 UCLA L. Rev. 781 (2001).