Country Differences in Accounting Standards

Read Closing Case: Adopting International Accounting Standards at the end of chapter 19 and write a 2-3 page paper in APA format with a detailed analysis that answers the following questions:

• What are the benefits of adopting international accounting standards for (a) investors, and (b) business enterprises?
• What are the potential risks associated with a move toward the adoption of international accounting standards in a nation?
• In which nation is the move to adoption of IASB standard likely to cause the revisions in the reported financial performance of business enterprises, the United States or China? Why?

CLOSING CASE

Adopting International Accounting Standards

Following a European Union mandate, from January 1, 2005, onwards approximately 7,000
companies whose stock is publicly traded on European stock exchanges were required to issue all
future financial accounts in a format agreed upon by the International Accounting Standards Board
(IASB). In addition, some 65 countries outside of the EU have also committed to requiring that public
companies issue accounts that conform to IASB rules. Even American accounting authorities, who
historically have not been known for cooperating on international projects, have been trying to mesh
their rules with those of the IASB.

Historically, different accounting practices made it very difficult for investors to compare the
financial statements of firms based in different nations. For example, after the 1997 Asian crisis a
United Nations analysis concluded that prior to the crisis two-thirds of the 73 largest East Asian
banks hadn’t disclosed problem loans and debt from related parties, such as loans between a parent
and its subsidiary. About 85 percent of the banks didn’t disclose their gains or losses from foreign
currency translations or their net foreign currency exposures, and two-thirds failed to disclose the
amounts they had invested in derivatives. Had this accounting information been made available to the
public—as it would have been under accounting standards prevailing at the time in many developed
nations—it is possible that problems in the East Asian banking system would have come to light
sooner, and the crisis that unfolded in 1997 might not have been as serious as it ultimately was.

In another example of the implications of differences in accounting standards, a Morgan Stanley
research project found that country differences in the way corporate pension expenses are accounted
for distorted the earnings statements of companies in the automobile industry. Most strikingly, while
U.S. auto companies charged certain pension costs against earnings, and funded them annually,
Japanese auto companies took no charge against earnings for pension costs, and their pension
obligations were largely unrecorded. By adjusting for these differences, Morgan Stanley found that
the U.S. companies generally understated their earnings, and had stronger balance sheets, than
commonly supposed, whereas Japanese companies had lower earnings and weaker balance sheets. By
putting everybody on the same footing, the move toward common global accounting standards should
eliminate such divergent practices and make cross-national comparisons easier.

However, the road toward common accounting standards has some speed bumps on it. In November
2004, for example, Shell, the large oil company, announced that adopting international accounting
standards would reduce the value of assets on its balance sheet by $4.9 billion. The reduction
primarily came from a change in the way Shell must account for employee benefits, such as pensions.
Similarly, following IASB standards, the net worth of the French cosmetics giant L’Oreal fell from
8.1 billion to 6.3 billion euros, primarily due to a change in the way certain classes of stock were
classified. On the other hand, some companies will benefit from the shift. The UK-based mobile
phone giant, Vodafone, for example, announced in early 2005 that under newly adopted IASB
standards, its reported profits for the last six months of 2004 would have been some $13 billion
higher, primarily because the company would not have had to amortize goodwill associated with
previous acquisitions against earnings.