Case study of United Kingdom’s financial reporting standards

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Five characteristics of the development factors that would predict low levels of transparency and disclosure in the financial statements of German listed companies

1.        Traditionally bank credit plays a major role in corporate finance.

2.         German accounting is heavily influenced by tax law.

In Germany, tax law has a strong influence on accounting and financial reporting. The reason for this link between taxation and financial reporting is historical. When corporate income taxation was introduced in Germany in 1874, the requirement for annual accounting had already been codified in the Commercial Code in 1862. It was convenient to link corporate income taxation to existing financial statements. 

3.         German accounting rules allow companies to smooth income over time by using hidden reserves.

4.        There are two main external factors that have influenced financial reporting in Germany in recent years. They are, EU Directives and the forces of globalization. The 1985 Accounting Act implemented the Fourth, Seventh, and Eighth Directives and transformed them into German Commercial Law.

Although the EU’s Fourth Directive requires companies to present a true and fair view in their financial statements, it appears that extensive note disclosures are seen as a way of achieving this without changing the tax-based, income smoothing approach to financial reporting – i.e. Germany still only allows one set of reports.

5.            The EU’s decision to adopt IFRS from January 1 2005, was in recognition of the global trends in financial reporting. Even before the EU’s decision, large German companies like Daimler-Chrysler that had their shares listed on foreign stock exchanges were already using internally acceptable accounting standards.  

Since January 2005, all German listed companies are required to use IFRS in preparing their consolidated financial statements. However, German accounting practices differ from IFRS in some important respects.

German accounting law contains no specific rules in some areas. Examples include the translation of foreign currency financial statements of foreign subsidiaries, disclosures of fair values of financial assets and liabilities, and earnings per share.

Advantages and disadvantages of internal versus external corporate governance mechanisms

Internal corporate governance mechanisms are established to insure the proper actions of management. Because providers of capital do not control the daily operations of the business, so they set up corporate governance mechanisms to insure that management acts in the best interest of the owners. This mechanism is controlled directly by the owners of the firm. It can be applied to monitor corporate risks and assurance corporate controls

Examples for internal corporate governance mechanisms include the following: 1. Set up a board of directors which are normally composed of members of management and outside members who do not participate in daily operations of the firm to represent the interest of owners (typically shareholders). The board hires, controls and fires management and determines management’s compensation. 2. It could have voluntary codes of conduct. 3.  Internal auditing should be conducted. 4. Voluntarily provide internal information on firm’s operations.

Advantages of internal corporate governance mechanism include: 1 allow directors such as Woolworth who can both won major awards for their excellent governance practices, to differentiate themselves from their competitors. 2. The voluntary, internal and additional governance controls can make sure that their stakeholders such as customers, employees and investors are well protected and looked after.

Disadvantage: 1. additional cost could be generated. 2. Some countries tend to be secrecy; they are unwilling to disclose more information such as china. So cultural influence should be noted. Thirdly, “bad” companies will simply not adopt any internal governance requirements on their directors – requiring only the external ones be complied with and nothing more – even if some internal mechanisms are adopted by these companies, remember, given they are voluntary, they can be removed at any time. 

External governance mechanisms are not directly controlled by the current owners of the firm. Example can include 1. independent auditors. 2. Legal system which highlights directors duties and obligation and ensure the company comply with the accounting standards. 3. To comply with stock exchange list rules. 4. External taker-over market.

Advantages: they are imposed on all listed companies and a not subject to control by directors in terms of whether they will comply or not.

Disadvantage: although these mandatory rules do not allow companies to differentiate themselves in the market – i.e. all listed companies must comply with CG rules, thus no one company can claim to their shareholders/ the market that they are better at governance than any other company- not in terms of strictly external mechanisms.

Have US corporations lobbied against the US adoption of international financial reporting standards?

I think the US corporations have lobbied against the US adoption of international financial reporting standards.  The key issue to understand is the reason why corporations want to become involved in lobbying of the accounting standard process. The answer lies in the fact that the accounting standards set out mandatory rules for recording business transactions – e.g. they control when sales revenues can be recognised/ recorded as a sale in the accounts of the corporation.

If the standard rules are too restrictive or difficult to comply with, then corporation may be required to delay the recognition of some sales to a later financial reporting period – this delay would meant that the current overall profits of the corporation would fall.

Another example is the valuation of assets . The US accounting standard developed by the FASB, required banks to record their asset values at their market value. The back directors were very unhappy at this rule within the standard as they argued that they should be able to value their assets at Directors’ valuation –i.e. that the Directors should have total control of the asset values not the market. Again Directors were concerned here because low asset values could prevent investors from buying shares in the company and could also prevent banks from lending money.

Thus, it’s important to remember the connection between the rules in accounting standards and their impact then on the final accounting numbers – sales and asset values – in the financial reports for the listed companies.

Will the IASB and the FASB eventually merge, or will they remain separate accounting standard-setting bodies?

We doubt that the IASB and FASB will merge in the future.  First of all, various points discussed in the chapter mean that it is unlikely that the IASB will disappear and the FASB will become the global standard setter.  It also seems unlikely that the FASB will go away.  It is difficult to believe that the United States will cede its authority over accounting standard setting to a multinational group.  Even if the FASB felt that a merger was advantageous, would politicians or even the SEC allow international interests to supersede domestic ones? 

Another issue is principles- versus rules-based standards.  Generally speaking, IFRS are principles-based while U.S. GAAP are rules-based.  While it is true that IFRS are getting more rules-based and U.S. GAAP are (supposed to be) getting more principles-based, the litigiousness of the U.S. environment probably means that the United States will need additional implementation guidance even if IASB and FASB standards are converged.

Financial resources are another consideration.  Operating expenses for the IASC Foundation in 2005 were approximately €12 million (or approximately $15.6 million).  Operating expenses of the Financial Accounting Foundation in 2005 were approximately $31 million.  These numbers suggest that the FASB has a budget twice as large as the IASB.  Whether the IASB can match the resources of the FASB is unclear. 

Taken together, we argue that the IASB and FASB will remain separate accounting standard setting bodies in the future.