major international differences in financial reporting
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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) - PowerPoint PPT PresentationTRANSCRIPT
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ACC4305Michel Leseure
Major International Differences in Financial Reporting
Chapter 3
ACC 4305
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ACC4305Michel Leseure
Accounting Formats
Differences in Financial Reporting
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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?
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
Fairness
Differences in Financial Reporting
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ACC4305Michel Leseure
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?
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
Fairness and Perfect
Information Reporting
Figure 3.2.2 Perfect Information Reporting Line
Reporting Value of The Firm
Financial Impact of Fact
+
+
-
-
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ACC4305Michel Leseure
Enron
Reporting Value of The Firm
Financial Impact of Fact
+
+
-
-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
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ACC4305Michel Leseure
Conservatism
Differences in Financial Reporting
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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)
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
The Impact of Conservatism Reporting Value of
The Firm
Financial Impact of Fact
+
+
-
-
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
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ACC4305Michel Leseure
Provisions and Reserves
Differences in Financial Reporting
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
French vs. US Provisions
US
FR
Allowances Provisions
Provisionspour risques et
charges
Provisionspour dépréciation
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ACC4305Michel Leseure
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!
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ACC4305Michel Leseure
Provisions in Moroccan 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
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ACC4305Michel Leseure
Provisions in Moroccan Accounting
• 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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
Example – Bad Debt
First 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
+ asset+ revenue
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ACC4305Michel Leseure
Example – Bad Debt
First 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
Contra asset
Expense/loss
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ACC4305Michel Leseure
Example – Bad Debt
First 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
Cancel contra asset
Restore revenue
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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?
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ACC4305Michel Leseure
Note – Bad Debt Expenses
• In practice, accountants try to estimate precisely which portion of the debt will be paid or not
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
Example – Several Customers
• 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%
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ACC4305Michel Leseure
Example – Several Customers
• Client E who owns 1423,20 TTC has filed for bankruptcy
• His A/R is irreversibly lost
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ACC4305Michel Leseure
Example – Several Customers
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
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ACC4305Michel Leseure
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.
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
The Impact of Provisions Reporting Value of
The Firm
Financial Impact of Fact
+
+
-
-
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
Others
Differences in Financial Reporting
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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
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ACC4305Michel Leseure
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