Culture

A number of academic accountants have argued that the culture of a country has an important impact upon the nature of its accounting system.⁶ Using the cultural typologies developed by Hofstede,⁷ which we reviewed in Chapter 3, researchers have found that the extent to which a culture is characterized by uncertainty avoidance seems to have an impact on accounting systems.⁸ Uncertainty avoidance refers to the extent to which cultures socialize their members to accept ambiguous situations and tolerate uncertainty. Members of high uncertainty avoidance cultures place a premium on job security, career patterns, retirement benefits, and so on. They also have a strong need for rules and regulations; the manager is expected to issue clear instructions, and subordinates' initiatives are tightly controlled. Lower uncertainty avoidance cultures are characterized by a greater readiness to take risks and less emotional resistance to change. According to Hofstede, countries such as Britain, the United States and Sweden are characterized by low uncertainty avoidance, while countries such as Japan, Mexico, and Greece have higher uncertainty avoidance. Research suggests that countries with low uncertainty avoidance cultures tend to have strong independent auditing professions that audit a firm's accounts to make sure they comply with generally accepted accounting regulations.⁹

Accounting Clusters

Few countries have identical accounting systems. Notable similarities between nations do exist, however, and three groups of countries with similar standards are identified in Map 19.1.¹⁰ One group might be called the British-American-Dutch group. Great Britain, the United States, and the Netherlands are the trendsetters in this group. All these countries have large, well-developed stock and bond markets where firms raise capital from investors. Thus, their accounting systems are tailored to providing information to individual investors. A second group might be called the Europe-Japan group. Firms in these countries have very close ties to banks, which supply a large proportion of their capital needs. Therefore, their accounting practices are geared to the needs of banks. A third group might be the South American group. The countries in this group have all experienced persistent and rapid inflation. Consequently, they have adopted inflation accounting principles.

National and International Standards

The diverse accounting practices discussed in the previous section have been enshrined in national accounting and auditing standards. Accounting standards are rules for preparing financial statements; they define what is useful accounting information. Auditing standards specify the rules for performing an audit--the technical process by which an independent person (the auditor) gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable.

Consequences of the Lack of Comparability

An unfortunate result of national differences in accounting and auditing standards is the general lack of comparability of financial reports from one country to another. For example, consider the following:

• Dutch standards favor the use of current values for replacement assets; Japanese law generally prohibits revaluation and prescribes historic cost.

• Capitalization of financial leases is required practice in Great Britain, but it is not practiced in France.

• Research and development costs must be written off in the year they are incurred in the United States, but in Spain they may be deferred as an asset and need not be amortized as long as benefits that will cover them are expected to arise in the future.

• German accountants treat depreciation as a liability, whereas British companies deduct it from assets.

Such differences would not matter much if there was little need for a firm headquartered in one country to report its financial results to citizens of another country. However, as you might recall from Chapter 11, one striking development of the past two decades has been the development of global capital markets. We have seen the growth of both transnational financing and transnational investment.

Map 19.1 see Accounting Clusters

Transnational financing occurs when a firm based in one country enters another country's capital market to raise capital from the sale of stocks or bonds. A Danish firm raising capital by selling stock through the London Stock Exchange is an example of transnational financing. As we saw in the opening case, a number of large German firms are increasing their use of transnational financing by gaining listings, and ultimately issuing stock, on the New York Stock Exchange. Transnational investment occurs when an investor based in one country enters the capital market of another nation to invest in the stocks or bonds of a firm based in that country. An investor based in Great Britain buying General Motors stock through the New York Stock Exchange would be an example of transnational investment.

The rapid expansion of transnational financing and investment in recent years has been accompanied by a corresponding growth in transnational financial reporting. For example, in addition to its Danish financial reports, the Danish firm raising capital in London must issue financial reports that serve the needs of its British investors. Similarly, the US firm with a large number of British investors might wish to issue reports that serve the needs of those investors. However, the lack of comparability between accounting standards in different nations can lead to confusion. For example, the Danish firm that issues two sets of financial reports, one set prepared under Danish standards and the other under British standards, may find that its financial position looks significantly different in the two reports, and its investors may have difficulty identifying the firm's true worth. Some examples of the confusion that can arise from this lack of comparability appear in the accompanying Management Focus.

In addition to the problems this lack of comparability gives investors, it can give the firm major headaches. The firm has to explain to its investors why its financial position looks so different in the two accountings. Also, an international business may find it difficult to assess the financial positions of important foreign customers, suppliers, and competitors.