4. Need for Accounting Information
• Enables providers of capital to
– access the value of their investment
– Access security of their loan
– Make decisions about future resource allocation
• Tax assessment
• Performance evaluation of the firm
• Control internal expenditure
• Planning for future expenditure and income
6. Relationship between business and
providers of capital
• Three external sources of capital:
– Individual investors
• Buying shares and bonds
– Banks.
• Loan capital
– Government
• Make loans or investment
7. Relationship between business and providers of
capital : Individual investors
• E.g in US and UK
– individual investors and major source of capital
– stock and bond market
– purchase small proportion of stocks and bonds
– No desire to be involved in day to day
management of firms
– Lack the ability to get information on demand
from management
– Financial accounting system provide information
required by small investors to make decisions
8. Relationship between business and
providers of capital : Banks.
• E.g Switzerland, Germany and Japan
– Banks satisfy most of capital needs
– Bank officials on board of firms
– Information need satisfied through personal
contacts, direct visit, board meetings
– Reports for public disclosure of financial
information
– Assets and valued conservatively, and liabilities
are overvalued to provide cushion for banks
9. Relationship between business and
providers of capital : Government
• E.g France and Sweden
– Government major providers of capital
– Financial information oriented towards need of
government planners
10. Political and economic ties with other
countries
• Accounting convergence due to close political
and economic ties between countries
– US system influenced accounting practices in
Canada and Mexico : NAFTA
– Former colonies of British Empire follow British
system
– European Union attempting to harmonize
accounting practices in its member countries
11. Inflation accounting
• Historic cost principle:
– Assumes currency is not losing value to inflation
– Most significant impact in the area of asset
valuation
• Current cost accounting:
– Factors out inflation
– Used in Great Britain until inflation rate
declined
12. Level of development
• Developed countries have more sophisticated
accounting procedures
– Accounting problems are more complex
– Sophisticated capital markets
– Lenders require comprehensive reports
– Educated workforce can perform complex
accounting functions
13. Culture
• Hofstede’s uncertainty avoidance has an
impact on accounting systems
– Low uncertainty avoidance - these countries tend
to have strong independent auditing professions
that ensure a firm’s compliance with rules
14. Accounting clusters
• Few countries have identical accounting
systems.
• Similarities exist in clusters
15. Accounting clusters
British-American-Dutch Group
Firms raise capital from
Europe-Japan Group
investors. Accounting
systems designed to inform Have close ties to
investors banks. Accounting
South American Group practices meet bank’s
needs.
Countries have experienced
persistent and rapid inflation.
Accounting principles reflect the
inflation.
16. National and international standards
• Diverse accounting practices are enshrined in
national accounting and auditing standards
• Accounting standards: Rules for preparing
financial statements
• Auditing standards: Specify rules for
performing an audit
17. Lack of comparability
• One result of national differences in auditing
and accounting standards is lack of
comparability of financial reports
– Dutch – current values for replacement assets –
Japan – prescribes historic cost
– Germany – depreciation is liability, Britain –
depreciation is deducted from assets
18. Lack of comparability
• With growth of global capital markets both
transnational financing and transnational
investment have grown
• Firm has to explain to investors why its
financial position looks different in two
accountings
19. International standards
• Efforts to harmonize accounting standards across
countries
• Formation of International Accounting Standards
Board in March 2001
• Members represent 79 countries
• Responsible for formulating international accounting
standards (IAS)
• Has issued over 30 IAS
– Difficult to get requisite votes
– Voluntary compliance
• Recognition is growing
20. Accounting aspects of control systems
• Annual control process involves three steps:
– Head office and subunit management jointly
determine subunit goals for the coming year.
– Throughout year, head office monitors subunit
performance against agreed goals.
– If subunit fails to achieve goals, head office
intervenes to determine why the shortfall
occurred, taking corrective action when
appropriate.
22. Accounting aspects of control systems
• Lessard- Lorange Model:
– Three exchange rates used to translate foreign
currency into corporate currency for budget and
performance purposes.
• The initial rate, the spot exchange rate when the
budget is adopted.
• The projected rate, the spot exchange forecast for
the end of budget period (i.e., the forward rate)
• The ending rate, the spot exchange rate when the
budget and performance are being compared.
23. Transfer pricing and control systems
• Transfer prices introduce significant
distortions into the control process
• Transfer price must be taken into account
when setting budgets and evaluating a
subsidiary’s performance.
24. Separation of subsidiary and manager
performance
• Valuation of a subsidiary should be separate from
the evaluation of the subsidiary manager
• Manager’s evaluation should take into
consideration how hostile or benign the
countries environment is for business and make
allowances over items the manager has no
control e.g. inflation rates, interest rates
exchange rates
