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.

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.

The key rationales that support and against the development and widespread application of International Financial Reporting Standards

Evidence of support for IFRS

A growing body of evidence indicates that the goal of international convergence of accounting, disclosure and auditing has been widely accepted.

All dimensions of accounting are becoming converged worldwide.

Increasing numbers of highly credible organizations strongly support the goals of the IASB.

National differences in the underlying factors that lead to variation in accounting, disclosure, and auditing practices are narrowing as capital and product markets become more international.

International standards will improve the comparability of international financial information.

Time and money will be saved on international consolidations, the components of which now are subject to different national laws and practices.

There may be a tendency for accounting standards throughout the world to be raised to the highest possible level.

Widespread application of IFRS might also result in:

Improved managerial decision making within multinational enterprises.

Improved allocations of corporate investment money worldwide.

Better international understandability of financial statements. Cost reductions in accounting information processing and financial disclosure costs for multinational enterprises.

Greater international credibility for published financial statements.

Some countries disallow IFRS for domestic firms but allow foreign companies to use them.

U.S. and Japan, for example will allow foreign countries listing on their respective exchanges to file financials prepared in accordance with IFRS without reconciliation to U.S. or Japanese GAAP.

International Convergence Issues

The complicated nature of standards such as financial instruments and fair value accounting

The tax-driven nature of the national accounting regime

Disagreement with significant IFRS, such as financial statements and fair value accounting

Insufficient guidance on first time application of IFRS

Limited capital markets = little benefit

Investor satisfaction with national accounting standards

IFRS difficulties in language translation

Significant differences in standards currently exist.

The political cost of eliminating differences.

Overcoming “Nationalism” and traditions. 

Perhaps it will not provide significant benefits.

It will cause “standards overload” from some firms.

It diverse standards for diverse places is acceptable.