major international differences in financial reporting

ACC4305Michel Leseure

Major International Differences in Financial Reporting

Chapter 3

ACC 4305


Accounting Formats

Differences in Financial Reporting


Accounting Formats

• Display order of the accounting elements– Linked to the existence of a regulation– And to the targeted audience (shareholders’

orientation)

• Shape (configuration) of the balance sheet


Analysis of Annual Reports Should Include Four Questions Regarding Format

At what level is the company reporting? • In the UK and the USA, consolidated accounts have

been the rule for many years • Some countries still provide separate statements for

parent and subsidiaries Which statements are present? What is the flow of the statements?

• Reading from top to bottom, which items are first and which last?

Is there any netting or subtotals as we go along?


A Comparison of Reporting for Three Major Corporations

H J Heinz British Telecom Philips Entity reported on Consolidated Group Group Statements reporting income and expenses

Consolidated Statement of Income and retained Earnings

Group Profit & Loss Account

Consolidated Statement of Income of Group

Statements reporting assets, liabilities and equity

Consolidated Balance Sheet

Group Balance Sheet Consolidated Balance Sheet of Group

Statements reporting cash flow

Consolidated Statements of Cash Flows

Group Cash Flow Statement

Consolidated Statement of Cash Flows of the Group

Other Statements Statement of Retained Earnings(part of Income of Income Statement)

Group Statement of Total Recognised Gains & Losses (separate)

None

Level of Detail High Low - lots of summary headings

Lowest

Subtotals of Income Net Income Net Income

Net Income


A Comparison of Reporting for Three Major Corporations

H J Heinz British Telecom Philips Subtotals in the Balance Sheet

Assets; Liabilities and Owner's Equity

Computation of Net Current Assets Total Current Assets Less Current Liabilities. No bottom-line.

Assets; Liabilities and Owner's Equity

Subtotals in the Cash Flow Statement

Cash from various sources

Similar to US Similar to US

Order/Flow of Statements - Income

Revenue>>>Expenses Turnover>>>Expenses Sales>>>Expenses

Order/Flow - Balance Sheet

Current>>> Less Current

Long Term>>> Short Term >>> Net

Long Term>>> Short Term


Uniformity and Accounting Plans

• Uniformity of reporting can be required in:– Formats of financial statements– Accounting principles– Disclosure requirements

• But accounting plans may vary from one country to another


Fairness



Fairness

• Some accounting regulations require fairness in financial reporting– UK was one of the first EU country to require

fairness– Fairness means faithfulness to economic reality, i.e.

financial reports do not « mask » economic events

• Problem of substance over form– Do you grant some flexibility to present a fair view?– Or do you regulate the form of financial reports, at

the risk of twisting economic realities?


Example of a Fairness Issue

• Airlines companies typically own the airplanes they operate

• This means that airlines companies are capital-intensive and show high fixed assets (as a % of total assets)

• Some companies started to lease airplanes


Example of a Fairness Issue

• Leases are equivalent to renting a capital good• Typically, they are not capitalized – since there is

no ownership, there is no assets – only an expense charged to the Income Statement every period

• US accountants considered this practice as unfair, and mis-representing the capital intensive nature of activities of airline companies– Statement passed to capitalize certain leases


Substance over Form

• US accountants: Initiated the trend toward preferring substance over form– Fairness is defined by GAAP and the general

framework for accounting– In Europe, fairness is theoretically an over-ridding

concept

• Replacement cost accounting in the Netherlands– Stems from a fairness concern (true representation

of value)

• Germany– Preference for following legal requirements,

independently of fairness issues


Fairness and Perfect

Information Reporting

Figure 3.2.2 Perfect Information Reporting Line

Reporting Value of The Firm

Financial Impact of Fact

+

+

-

-


Enron

Reporting Value of The Firm


+

+

-

-Per

fect

Info

rmat

ion

Reporti

ng Lin

e

Figure 5.2.1.1 Enron Reporting Profile

Enron

Severe losses but not report

Overly reporting earnings

Mark to Market ofInvestments in derivatives“Mark to Enron”(Bonus inflation)

Hiding liabilitiesand lossesin “Special Purpose Entities”Off balance sheet


Conservatism



Conservatism and Accruals

• Conservatism is another adversary to fairness– Important differences in reporting result from a

more or less conservatism in analysis– Notion of « prudence » in the UK, – “Principe de prudence” in French Accounting

• Note: these differences can be observed nationally between private and government businesses


Conservatism

• Accountants “anticipate no profit, but anticipate all losses”

• FASB Statement No.2:– Conservatism is “a prudent reaction to uncertainty to try

to ensure that uncertainties and risks inherent in business situations are adequately considered” (FASB, 1980, p. 10)

• APB Statement No.4 – describes conservatism as a preference for possible

error in measurement to be in the direction of understatement rather than overstatement of net income and net assets (AICPA, 1970)


Example of Divergences in Conservatism

• Should R&D expenses be capitalized?– Okay in certain conditions in UK

accounting standards– In the past, never in US accounting

• Should a forecasted loss on work in progress inventory be recognised?– Yes in French accounting– No in US accounting


Conservatism

• Continental Europe tends to be most conservative

• A lot of research on conservatism– Use of conservatism index

A

DA

R

RRCI 1

(Gray, 1980)

RA = adjusted earnings under the GAAP of the country being used as a standardRD = disclosed earnings under the national GAAP of the country whose conservatism is being assessed|RA| = the absolute value of adjusted earnings under the GAAP of the country being used as the standard


Conservatism Index

Earnings

UK GAAP

£ Million

US GAAP

£ Million

Conservatism Index

1998 110 100 1.10* 1997 90 100 .90**

* 1 – (100 – 110)/100) = 1.10 ** 1 – (100 – 90)/100) = 0.90


The Impact of Conservatism Reporting Value of

The Firm


+

+

-

-

Figure 5.4.1.1 Volvo and Its Research & Development Reporting Profile

Volvo

with Its Old Research & Development Accounting Principle

RR 15 Capitalized New Product Development


Provisions and Reserves



Provisions

• Terminology can be confusing• Make sure to differentiate:

– Provision• A liability of uncertain timing and amount

– An allowance • against the value of an asset


Provisions in French Accounting

• En comptabilité, la provision est la constatation d'une moins-value probable sur un élément d'actif ou d'une augmentation du passif dit « exigible ».

• Cette notion ne doit pas être confondue avec celle d'amortissement, qui correspond à une dépréciation d'une autre nature (la perte est irréversible et est liée au temps, à l'usure, à l'obsolescence)

• La dépréciation doit être nettement précisée quant à sa nature ou son objet et elle doit être évaluée avec une approximation suffisante. Elle doit être probable et pas seulement éventuelle. Cette probabilité doit être la conséquence d'un événement survenu au cours de l'exercice.

www.wikipedia.fr


French vs. US Provisions

US

FR

Allowances Provisions

Provisionspour risques et

charges

Provisionspour dépréciation


Provisions in Moroccan Accounting

• There are three types of provisions:– « Provisions pour dépréciations »

• They are acknowledgements of the decrease in value of assets

• That is, the value of an asset is lower than its recorded value, or than its net value

• These are “allowances” in US accounting!



• There are three types of provisions:– « Provisions pour risques et charges »

• These are provisions, i.e. they recognize a potential future liability

• Examples:

– Provisions for legal disputes

– Provisions for warranties extended to customers

– Provisions for future losses on long term contracts

– Provisions for fines, penalties

– Provisions for foreign exchange losses



• There are three types of provisions:– « Provisions réglementées »

• These are provisions (i.e. future liabilities) not accounted in other categories and regulated

• Examples:

– Industry specific: mines, natural resources management

– Acquisition and building of housings


Accounting for Provisions

• Recording provisions and allowances– Debit an expenses account

• Impact on income statement• Examples of Moroccan accounts:

– Dotations d’exploitation– Dotations aux provisions pour risques et charges

– For an allowance• Credit an asset account

– Example: Provisions pour dépréciation des comptes de l’actif circulant

– For a provision• Credit a liability account

– Example: Provisions durables pour risques et charges


Accounting for Provisions

• Provisions are re-evaluated on closing dates

• They can be increased, decreased, or written-off

• Example: for a provision (risk-based)– Credit a revenue account

• Example: Reprise provision pour risques et charges

– Debit the liability account that was initially debited


Example – Bad Debt

• 01/01/2006: Credit sale for 10,000 euros to Mr Dupond

• The amount is due on June 1st

• On June 1st, Mr Dupond defaults on the payment• The accountant considers that the receivable

could be received (not lost with certainty)– Use an allowance

• On July 1st, Mr Dupond actually pays the bill


Example – Bad DebtFirst Case

01/01/2006 Client 10,000Ventes 10,000

01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10,000Provisions pour dépréciation des comptes clients 10,000

01/07/2006 Provisions pour dépréciation des comptes clients 10,000Reprise de provisions pour dépréciation des comptes clients 10,000

Tresorerie 10,000Clients 10000

First Case: No VAT, No use of “Clients Douteux”Account, One customer only



First Case

01/01/2006 Client 10,000Ventes 10,000




+ asset+ revenue



First Case

01/01/2006 Client 10,000Ventes 10,000




Contra asset

Expense/loss



First Case

01/01/2006 Client 10,000Ventes 10,000




Cancel contra asset

Restore revenue


Second Case

01/01/2006 Client 10000Ventes 10000

01/06/2006 Clients Douteux 10000Clients 10000

01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10000Provisions pour dépréciation des comptes clients 10000

01/07/2006 Provisions pour dépréciation des comptes clients 10000Reprise de provisions pour dépréciation des comptes clients 10000

01/07/2006 Clients 10000Clients Douteux 10000

01/07/2006 Tresorerie 10000Clients 10000



Example Bad Debt

• Customer is unable to pay (Certainty)01/01/2006 Client 10000

Ventes 10000

01/06/2006 Clients Douteux 10000Clients 10000

01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10000Provisions pour dépréciation des comptes clients 10000

01/07/2006 Provisions pour dépréciation des comptes clients 10000Reprise de provisions pour dépréciation des comptes clients 10000

01/07/2006 Pertes sur Creances Irrecouvrables 10000Clients Douteux 10000

When the loss/expense actually posted to the Income Statement?


Note – Bad Debt Expenses

• In practice, accountants try to estimate precisely which portion of the debt will be paid or not


Example – Several Customers

• On 31/12/2000, you receive the following table:

CLIENTS CREANCES

T.T.C.PROVISIONS AU 31/12/99

ENCAISSEMENTS 2000

OBSERVATIONS

A 1897,6 700 680 solde irrécouvrable

B 2848,4 800 320 Provision nécessaire : 60% du solde



• In 2000, the following new customers have become suspicious

CLIENTS CREANCES T.T.C PROVISION A CONSTITUER

C 2965,00 40%

D 4669,6 60%



• Client E who owns 1423,20 TTC has filed for bankruptcy

• His A/R is irreversibly lost



NOMS ANCIENNES CREANCES

T.T.C.

VERSEMENTS NOUVELLES

CREANCES T.T.C.

PROVISION CONSTITUEE

PROVISION NECESSAIRE

+ - H.T. TVA199,54

B 2848,40 320 2528,40 800 1268,42 468,42C 2965 991,63 991,63D 4669,6 2342,60 2342,60E 1189,96 233,24

7634,6 3802,65 700 2208,02 432,78TOTAL

A 1897,6 680 1217,60 700

AJUSTEMENT PROVISION PERTE

700 1018,06


The Impact of Provisions

• In 2000, Beaufort Accessories in France decided to build a roof for its factory. Work will take place in 2002 and which will cost approximately EUR 300,000.

• Under French Accounting, the company can recognize the expense of EUR 100,000 in 2000 for the roof construction as a provision, and then recorded the rest in 2001 and 2002 for EUR 100,000 each.


Example

Accounting

Expenses

Recognition

(EUR)

Actual Expense

(EUR)

Impact on Corporate Report

(EUR)

2000 100,000 - Under-reporting Profit (100,000)

2001 100,000 - Under-reporting Profit (100,000)

2002 100,000 300,000 Over-reporting Profit 200,000

Note: Assuming the roof would have been reported as an expense in 2002 – in most cases,it would be depreciated over

time


The Impact of Provisions Reporting Value of

The Firm


+

+

-

-

Figure 5.5.1.1 The Impact of Expenses Recognition in Advance on Corporate Reporting Profile

Impact of Provision in 2000 and 2001

Impact of Provision in 2002

Disclosure in a footnote would help to give a fair

picture

Corporate earnings


Reserves

– Reserves are an element of equity– They are set as an appropriation of profit (i.e.,

retained earnings)• The existence of reserves are linked to regulations

(e.g., « Réserves légales ») or to lenient tax regulations (e.g. income smoothing in Germany)

• Negative impact on fair reporting

– Fund – an asset invested and managed independently

• This fund reduces the corresponding provision one would have recorded on the B/S


Others



Valuation Bases

• Strict adherence to historical cost– Requires little judgement– Is expected of countries with strict taxation

regulations and commercial codes

• Use of replacement cost or current value– Requires judgement, and therefore a great

amount of flexibility given to accountants– Case of the Netherlands

• Middle of the road...– UK accounting


Consolidation

• The US provided leadership for consolidation accounting,

• Followed by the UK• Continental Europe was slow to develop

consolidation accounting • More on the consolidation lecture


Taxation

• Already discussed in chapter 2 – Can have a key impact on reporting

practice

• Taxation rules:– Are not necessarily consistent between

countries– Are often an enemy to fairness, e.g. in

Europe, where it takes precedence over a « fair » presentation of economic profit

major international differences in financial reporting

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