Question

There are various accounting standards used in different countries around the globe. Different observers have different opinions on why each country should have its own financial accounting standards or if the world should have one set of accounting standards for all counties. List at least four problems caused by accounting standards diversity around the globe. Discuss each of these reasons in short essay format. Why do we need international accounting standards? Why not simply let each country develop and use its own standards and let it go at that?

Answer 1

The problems caused by accounting standards diversity around the globe are:

1. Preparation of Consolidated Financial Statements : The diversity in accounting practice across countries causes problems in preparation of Financial Statements of Multinational National Companies with foreign operations. Consider a company, which has subsidiaries operating in more than 50 countries around the world. Each subsidiary incorporated in the country in which it is located is required to prepare financial statements in accordance with local regulations. These regulations usually require companies to keep books in local currency using local accounting principles. Thus, every subsidiary have to prepare its financial statements in the respective local currencies. To prepare consolidated financial statements, in addition to translating the foreign currency financial statements into currency of country of parent company, the parent company must also convert the financial statements of its foreign operations. Each foreign operation must either maintain two sets of books prepared in accordance with both local and GAAP applicable in country of parent company or reconciliations from local GAAP to GAAP applicable in country of parent company must be made at the balance sheet date. In either case, considerable effort and cost are involved; company personnel must develop an expertise in more than one country’s accounting standards.

2. Access to Foreign Capital Markets : A second problem caused by accounting diversity relates to companies gaining access to foreign capital markets. If a company desires to obtain capital by selling stock or borrowing money in a foreign country (eg. Global Depository Receipts), it might be required to present a set of financial statements prepared in accordance with the accounting standards in the country in which the capital is being obtained. To have stock traded in a country, foreign companies must either prepare financial statements using the country’s accounting standards or provide a reconciliation of local GAAP net income and stockholders’ equity to the country’s GAAP. This can be difficult and quite costly and involve tremendous efforts form the professional of different countries.

3. Comparability of Financial Statements : A third problem relates to the lack of comparability of financial statements between companies from different countries. This can significantly affect the analysis of foreign financial statements for making investment and lending decisions. The job of deciding which foreign company to invest in is complicated by the fact that foreign companies use accounting rules that differ from country to country. It is very difficult if not impossible for a potential investor to directly compare the financial position and performance of an automobile manufacturer in Germany (Volkswagen), Japan (Nissan), and the United States (Ford) because these three countries have different financial accounting and reporting standards. A lack of comparability of financial statements also can have an adverse effect on corporations when making foreign acquisition decisions. In many cases, the international public accounting firms were called on to convert financial statements to a Western basis before acquisition of a company could be seriously considered.

4. Lack of High-Quality Accounting Information : A fourth problem associated with accounting diversity is the lack of high-quality accounting standards in some parts of the world. There is general agreement that the failure of many banks in the 1997 East Asian financial crisis was due to three factors: a highly leveraged corporate sector, the private sector’s reliance on foreign currency debt, and a lack of accounting transparency. International investors and creditors were unable to adequately assess risk because financial statements did not reflect the extent of risk exposure due to the following disclosure deficiencies:

• The actual magnitude of debt was hidden by undisclosed related-party transactions and off balance-sheet financing.
• High levels of exposure to foreign exchange risk were not evident.
• Information on the extent to which investments and loans were made in highly speculative assets (such as real estate) was not available.
• Contingent liabilities for guaranteeing loans, often foreign currency loans, were not reported.
• Appropriate disclosures regarding loan loss provisions were not made.

Because of the problems associated with worldwide accounting diversity, attempts to reduce the accounting differences across countries have been ongoing for over three decades. This process is known as harmonization. The ultimate goal of harmonization is to have one set of international accounting standards that are followed by all companies around the world.

To minimize the impact of the above mentioned problems that are caused by the accounting standard diversity, International Accounting Standards are the way forward.