International Accounting Harmonization

N ow that Europe has fully established its owncurrency, the international competitiveness ofthat region is intensifying, particularly in rela-

tion to the United States. Asia and other regions are alsoworking to pool their influences. Affected by this compet-itive pressure are the preeminence of the dollar, the USstock markets, efforts to attract money from investors allover the globe, and the underlying systems for acquiringand deploying capital resources. A multitude of account-ing systems exist, creating difficulty in comparing finan-cial reports in different countries. The need for clarity inaccounting is acute. So an organization called the Interna-tional Accounting Standards Board (IASB) has been work-ing for more than ten years with the goal of creatingglobal accounting convergence by establishing standardsfor the world’s capital markets. Known as the Interna-tional Accounting Standards Committee until it was re-named in 2001, the IASB is the counterpart to America’sFinancial Accounting Standards Board (FASB).

The United States operates under accounting standardscalled Generally Accepted Accounting Principles (GAAP).To be listed on US stock exchanges for the purpose ofaccessing the world’s biggest capital markets, internationalcompanies have been required to restate their financialreports according to US GAAP, without regard to the costor difficulty of doing so. Yet, as significant as this issue is,it only comes to public attention occasionally.

Investors became aware of the international GAAP issuein 1993 as they anxiously awaited the opportunity to pur-chase shares of Daimler-Benz on the New York Stock Ex-change. Starting in May, company accountants in Stuttgartworked nights and weekends, seven days a week, for theOctober listing. Then came the final announcement:Having just told German investors that the company hadmade a profit of DM615 million, Daimler had to turnaround and inform investors in the US that the companyhad lost DM1.839 billion during the same year. WasDaimler-Benz making money or losing money? This tooksome of the sparkle off the Daimler deal, and the excite-ment never fully returned; investors on both sides of theAtlantic are bitter and contentious, even today.

Decision makers recognize the need to understand financial documents with transparency and clarity. So accounting rules are in the process of converging to a single international standard. This involves two dominant formats: the US GAAP and theInternational Financial Reporting Standards. Asports comparison in professional football is theAmerican style of a highly detailed rulebookthat is structured like a legal system, while theInternational Football Association operates withless than half as many rules, leaving refereesgreat latitude in making judgments on thefield. In accounting, the primary question isdetermining how much detail is necessary.

61

F. Robert BuchananDoctoral Student in Management, University of Texasat Arlington ([email protected])

International accountingharmonization: Developinga single world standard

Nevertheless, US GAAP continued earning respect andinternational legitimacy until the scrutiny following thebankruptcy filing of Enron in 2001—the 11th largest inthe Fortune 500 list of publicly traded firms and one ofthe largest bankruptcies in history. Accounting practiceswere alleged to have played a significant role in the col-lapse. The IASB commissioner stated that the rules of USGAAP featured prominently enough to cast doubt on thevalidity of the system. This came at a critical time in thedecision process in the EU as well as the United Statestoward allowing companies certain latitude in selectingInternational Financial Reporting Standards (IFRS; knownas IAS, or International Accounting Standards, until June2002) versus other forms of local and US GAAP.

This article discusses the harmonization of internationalaccounting standards in light of three specific areas: (1) acomparison of US GAAP to IFRS, especially IAS 39, thespecific rules that relate to financial instruments for evalu-ation by investors; (2) a discussion of corporate fraud,particularly the Enron debacle, pursued in the context ofhow either GAAP or IFRS might furnish safeguards; and(3) a general review of historic and regional issues thatmay or may not make it possible to fully standardizeaccounting practices to achieve the uniformity that isintended. Finally, implications of international accountingstandards harmonization are discussed, including thelong-term impact on managers and investors.

62 Business Horizons / May-June 2003

*This topic is currently being addressed as part of IASB’s Amendments to IAS 39 Project.

Source: Deloitte Touche Tohmatsu, IAS Plus

Figure 1Important differences between IFRS and US GAAP

The significance of the differences summarized below will vary with respect to individual companies, depending on such factors as thenature of the company's operations, the industry in which it operates, and the accounting policy choices it has made. Reference to theunderlying accounting standards and any relevant national regulations is essential in understanding the specific differences.

IAS

19

27

27

27

32

38

39

39

39

39

Area of difference

Minimum liability recognitionunder defined benefit plans

Basis of consolidation policy

Special purpose entities

Impact of different accountingpolicies or reporting dates ofparent and subsidiaries

Classification of convertibledebt

Development costs

Change in value of non-trad-ing investment

Hedge of a firm commitment

Use of partial-term hedges

Use of qualifying SPEs

IFRS

No minimum liability requirement

Control (look to governance and riskand benefits)

Consolidate if controlled; generallyfollow the same principles for com-mercial entities in determiningwhether or not control exists

Must conform accounting policies andreporting dates; if not practical, mustadjust for any significant differences inpolicy and subsequent transactions orevents

Split the instrument between its liabil-ity and equity components

Capitalize, if certain criteria are met

Recognize either in net profit or loss orin equity (with recycling)*

Cash flow hedge*

Permitted

Prohibited

US GAAP

At a minimum, the unfunded accumu-lated benefit obligation is recognized

Majority voting rights

Consolidate if certain criteria are notmet; generally look to whether or notthe SPE has a sufficient level of equity“at risk”

No requirement to conform reportingdates or accounting policies; need notadjust for any significant differences inpolicy or subsequent transactions orevents

Classify the entire instrument as aliability

Expense

Recognize in equity (with recycling)

Fair value hedge

Prohibited

Allowed

Comparison of US GAAP to IFRS

O ne of the fundamental differences between IFRSand US GAAP (outlined in some detail in Figure1) is the degree of specificity in reporting proce-

dures dictated by each group of standards. There seems tobe a distinct cultural dimension. For example, Americalikes highly detailed rules, much like in its approach tosports. The International Football Federation has less thanhalf as many rules as America’s NFL, reflecting a clearpreference for letting officials on the field make determi-nations in the course of the game; in contrast, the actionin an NFL game is stopped seemingly every few secondsto refer to rules that are written like a law book. Ameri-cans love complex rules at both work and play.

According to Coopers & Lybrand (1995), IFRS does notprescribe narrowly defined rules, leaving more room forinterpretation by the accountants preparing the reports.The auditing professional is called upon to make judg-ments that focus on the economic substance of transac-tions. Studies by Schultz and Lopez (2001) have shownthat compliance with a rigid set of narrowly articulatedrules does not necessarily guarantee economic relevanceof the resulting data. However, some analysts feel thatIFRS allows too many alternatives due to its reducedspecificity. Comparability between financial statementsof different firms is compromised when a transaction canbe treated in ways that are inconsistent.

IAS 39, “Financial Instruments: Recognition and Measure-ment,” is a standard that covers significant amounts of thefinancial reporting used by investors. Having taken theIASB nearly ten years to develop, it includes accountingprocedures for conventional assets and liabilities such ascash, trade receivables and payables, investments in debtand equity securities, and notes, bonds, and loans pay-able. It also includes accounting rules for derivatives aswell as futures, forwards, swaps, and options contracts.Guidance on accounting for financial instruments is con-tained primarily in a previous document, IAS 32, “Finan-cial Instruments: Disclosure and Presentation (1998).”Other documents that influence IAS 39 issued by theStanding Interpretations Committee of the IASB are SICInterpretation 5, “Classification of Financial Instru-ments—Contingent Settlement Provisions,” and SIC Inter-pretation 12, “Consolidation—Special Purpose Entities.”

IAS 39 was developed with US GAAP as a base. The IASBtried to take the basic approaches of US GAAP and codifythem in a format compatible with other IASB standards.This was a daunting task because in addition to compati-bility was the goal of having far less detail than its Ameri-can counterpart. US GAAP has developed over many yearsto its current huge volume and complexity of standards

and practices. Detailed guidance exists for specificallydefined instruments and individualized industries. Theprocedures are at times inconsistent between industries,and some financial instruments are not addressed at all.Included in the US documents are FASB statements, inter-pretations, and technical bulletins as well as SEC staffaccounting bulletins and other directives. Practitionerguidance comes from the American Institute of CPAs’audit and accounting guides, statements of position, prac-tice bulletins, and regulatory reporting requirements.Recent US standards, such as FASB Statements No. 125,Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities, and No. 133, Accounting forDerivative Instruments and Hedging Activities, are broader inscope than many of the older written standards.

The US standards have specifically addressed a great manyof the issues that arise in financial accounting, while theIASB’s more general approach allows individual reportingchoices to be made in applying the standards. Among sig-nificant general differences noted by Porter and Traficanti(1999) and Deloitte Touche Tohmatsu (2002) are:

● Some financial instruments that would be classified asliabilities under IFRS would be classified as equityunder US GAAP.

● IFRS standards require the issuer of a compound instru-ment that contains both liability and equity compo-nents (such as convertible debt) to account separatelyfor its debt and equity components. US GAAP pre-cludes that separate accounting in most circumstances.

● IFRS standards have trading, available-for-sale, or held-to-maturity classifications that apply to all types offinancial assets. Under US GAAP, those classificationsapply only to securities. As a result, measurement ofcertain financial assets, as detailed in Figure 2, woulddiffer depending on whether IFRS or US GAAP was fol-lowed.

● The US GAAP distinction between sales and securedborrowings is different from that in IAS 39. As a result,many asset transfers that would qualify for sale ac-counting treatment under IAS 39 would not qualifyunder US GAAP, and some asset transfers that wouldnot qualify for sale accounting treatment under IAS 39would qualify under US GAAP.

● Sale and leaseback accounting, as in removing an assetthrough sale but continuing to use it through a lease-back contract, is highly specified in US GAAP, particu-larly for transactions involving real estate. IFRS fur-nishes only generalized guidance.

● Companies with defined benefit pension plans have afinancial liability exposure. Under US GAAP, the com-pany must at the very least recognize its unfundedaccumulated benefit obligation. With IFRS there is no

63International accounting harmonization: Developing a single world standard

minimum liability disclosure requirement, potentiallyallowing the concealment of a firm’s pension liability.

The differences in actual results are substantial but notconsistent. For example, in 1999 Nokia reconciled its IFRSfinancial statements to US GAAP and had an identical netincome. Hoechst reported virtually identical net incomein 1998 under GAAP and IFRS, but in 1997 its GAAPincome was 75 percent less than that using IFRS. For BHPBilliton and Novartis, US GAAP net income in 1999 wasabout 80 percent of their IFRS income.

Financial assets can be measured and reported in numer-ous ways around the world, creating unwelcome surprisesfor investors when losses occur. For example, some compa-nies recognize assets at cost, others at the lower of cost ormarket, still others at fair market value. Daimler hasstopped publicly releasing results calculated according toGerman regulations (although it provided this informationto German authorities), and now reports using only GAAP.

In response to current events, the IASB is taking a leader-ship stance in requiring that stock options be fully ex-pensed in financial statements. Analysts are urging theFASB to follow suit. The FASB currently requires that thevalue of outstanding stock options be disclosed in thefootnotes of financial statements, requiring investors to

perform calculations and make their own adjustments tothe income statement in order to see the actual earnings.

International standards are taking an opposite approachwhen it comes to securitized transactions. IFRS will notallow this type of transaction; for example, loans or creditcard balances that are assets cannot be stated as a sale andremoved from the balance sheet because of continued riskexposure to the firm. Stock options are an area of con-tention, relative to goods or services that are secured bysuch and not reported on income statements. This contin-ues to be permissible in US GAAP, whereas the IASB hasnot fully decided on it.

The IASB has an interesting approach to a class of assetscalled “held-to-maturity investments.” These are typicallydebt securities and mandatorily redeemable preferredshares that are not intended to be disposed of. Becausethis classification depends on management intent ratherthan objective evidence, IAS 39 imposes a somewhat puni-tive burden. If an enterprise actually sells a held-to-matu-rity investment other than in a circumstance that could notbe anticipated or in insignificant amounts, all of its otherheld-to-maturity investments must be reclassified as avail-able-for-sale, which are measured at fair value. (See Figure2 for categories and measurements.) For available-for-sale


Figure 2Classification and measurement for financial assets under IAS 39

Source: Deloitte Touche Tohmatsu, IAS Plus

IAS 39 category offinancial asset

Originated loansand receivables

Held-to-maturityinvestments

Available for salefinancial assets—normal case

Available for salefinancial assets—unusual case

Financial assets held for trading

Description

Loans and receivables created by an enterpriseby providing money, goods, or services directlyto the debtor

Fixed maturity investments that the enterpriseintends and is able to hold to maturity

Includes: • Fixed maturity investments that the enterprise

either does not intend or is unable to hold tomaturity

• Equity investments with a quoted market price • Equity investments with no quoted market

price but able to estimate fair value

Equity investments with no quoted market priceand the enterprise is unable to estimate fairvalue

Financial assets acquired for the purpose of gen-erating a profit from short-term fluctuations inprice; includes all derivative assets and liabilities

Measurement basis

Amortized cost, subject to impairment recog-nition

Amortized cost, subject to impairment recog-nition

Fair value; enterprise has a one-time, enter-prise-wide choice of reporting changes in fairvalue in (a) net profit or loss or (b) equityuntil the asset is sold or otherwise disposedof, at which time the cumulative gain or lossis reported in net profit or loss.

Cost subject to impairment recognition

Fair value, changes in fair value in net profitor loss

financial assets that are remeasured to fair value, a firmwill have a single, company-wide option to adopt one orthe other of the following accounting policies:

● recognize fair value changes in net profit or loss for theperiod

● recognize the fair value changes directly in equity untilthe financial asset is sold, at which time the realizedgain or loss is reported in net profit or loss

Hedge accounting is allowed under IAS 39 in specific cir-cumstances. The hedging relationship must be clearly de-fined, measurable, and actually effective. Offsetting effectson net profit or loss has to be recognized symmetrically.

European companies have until 2005 to implement IAS39. Approximately 300 European companies that alreadyuse US GAAP exclusively have until 2007 to adapt to thenew system. The vast majority of about 6,700 companiesacross Europe report in their national local GAAP. Africa,Australia, and a number of former Soviet republics haveagreed to adopt IFRS. Stock markets that accept financialstatements of foreign listed companies in IFRS withoutany additional reconciliation include the London, Zurich,Frankfort, Luxembourg, Hong Kong, Thailand, Malaysia,Amsterdam, and Rome stock exchanges.

IAS 39 strictly forbids recognition of anticipated futurerevenues that are in any way speculative. Accountantswould ignore any non-contractual aspects of financialinstruments, such as future deposits by depositors andprojected purchases by credit card customers in valuationof a financial instrument. A bank is not allowed to assumerenewals of time deposits, and credit card companies arenot permitted to assume any additional purchases.

Off-balance-sheet financing is not allowed under IAS 39.For reporting purposes, a firm is deemed to be in controlof a financial asset or liability as long as it has the right tosell or pledge the asset, or to reacquire it, unless the assetis readily available on the open market. The FASB is takingaction on special-purpose entities (SPEs) that have beenthe vehicle for corporate fraud in America. The intent isnot to restrict the use of SPEs but to improve financialreporting by involved firms. We can expect to see moreassets, liabilities, and results of SPE activities consolidatedinto financial statements of parent firms that create theentities and are the primary beneficiaries. This effectivelyremoves advantages that deception would provide and, assuch, makes SPEs useful only if their intent is legitimate.IFRS is considerably more restrictive in the use of SPEs.

Both the IFRS and FASB are concerned about other itemsthat could be removed or omitted from financial state-ments, obscuring the extent of a company’s true assetsand liabilities. Operating leases are typically not reportedas either an asset or a liability. What about an airline that

has all of its planes on lease? A balance sheet that pres-ents an airline without any aircraft is clearly not a faithfulrepresentation of economic reality.

Corporate corruption issues

E nron is not unique in recent history for having bla-tantly endeavored to defraud investors. Sunbeam,Cendant, and Waste Management, Inc. notably

engaged in clear-cut fraud. Those companies, however,were not forced into bankruptcy when their shenaniganscame to light.

In its simplest accounting explanation, Enron was hidingbillions of dollars of debt by using off-balance-sheetfinancing. The purpose was to convince the marketplace topay no attention to the associated risks. The firm was actu-ally responsible for the debt of partnerships and specialpurpose entities that turned out to be controlled by Enron,various convoluted subsidiaries of Enron, or one of itsprincipals, such as Andrew Fastow, the CFO. In order to bein compliance with the SEC and procedures of the FASB,the liabilities in question, along with the assets and costs,need not be consolidated into the financial statements ifthe parent firm does not control 51 percent of the votingrights of the off-balance-sheet affiliate. Enron’s meltdownbegan when it filed Form 8-K to restate results for 1997through 2000, admitting that three of its affiliated partner-ships should have been consolidated after all. No reason isrequired or given in the document. Analysts suggest thatother investors in these particular partnerships might havebeen Enron employees, a violation of rule compliance.

In 1999, when Enron was flying high (along with the restof the market), company officials boasted about their useof leverage. Many analysts, consultants, academics, andjournalists agreed, holding up Enron as an award-winningexample to follow. In bragging about hiding the debt asso-ciated with the acquisition of three New Jersey powerplants from Cogen Technologies in 1999, Fastow said, “Weaccessed $1.5 billion in capital but expanded the Enronbalance sheet by only $65 million.” He also insisted,“We’ve completely segregated these assets, so if somethingwere to happen here, given the high leverage, it would notbe able to come back at Enron.”

As investigators have tried to ascertain exactly what wenton in Fastow’s financial black box, the marketplace hasbeen punishing the stock of other companies that use off-balance-sheet debt. El Paso Corp., another Houston com-pany that owns natural gas pipelines, consolidated $2 bil-lion in off-balance-sheet financing in the wake of theEnron debacle. Its press release said, “It has become clearthat the market now expects energy companies to main-tain lower leverage and more simplified balance sheets.”


The response by the US government is a congressionalscrutiny of how financial and commodity markets are reg-ulated, in addition to examining the inadequacy of fed-eral protection of employee retirement accounts. At aminimum, we can expect to see new standards for disclo-sure of off-balance-sheet liabilities. A key proposal to theFASB is to tighten the definition of when affiliates neednot be consolidated into financial statements. The SECplans to close certain loopholes in its disclosure require-ments. One salient point is the definition of materialinformation, since Enron’s auditors at Arthur Andersenaccepted the company’s claims that much of its off-bal-ance-sheet activities need not be disclosed because theamounts at stake were small enough to be consideredimmaterial. On a related topic, many people are suggest-ing it would be prudent to eliminate a huge potentialconflict of interest by banning accounting firms from fur-nishing consulting services to clients they audit. (In 2000,Arthur Andersen billed Enron $27 million for consultingservices, compared with $25 million for audit work.)

The Enron debacle, though having drawn great attentionin the IFRS dialogue, is not an indicator of any fundamen-tal accounting or regulatory system failure. Rather, it is acase of corrupt management that was seeking technicali-ties behind which to perpetrate investor fraud. It appearsthat its primary infraction, nondisclosure of off-balancesheet financing, might be more clearly prohibited underIFRS. That, however, would not necessarily have precludedthem from other fraudulent tactics under the interna-tional system, because the IFRS is generally less structuredthan US GAAP and more interpretive latitude is availableto corporate accountants.

Influence of history and region

A ctivities arising from systems with legal traditionsbased on Roman law (also known as code law)are quite different from the conceptual framework

that comes from common law. Roman law, as used inGermany and France, depends on civil codes, highly de-tailed and comprehensive, with little room for interpreta-tion. In a common law system such as the UK and the US,accounting standards are more general and are supple-mented by the input and governance of professionalorganizations. This creates inherent challenges in harmo-nizing international accounting standards, due to culturaland systematic differences.

Typically in a Roman law or code law country, the role ofthe professional accountant is to implement highly pre-scriptive and detailed legal requirements. This could becontrasted with the UK, where presentations of “a true and

fair view” of a company’s financial position and resultswill depend heavily on the judgment of the accountant asan independent professional. Gray (1988) postulates thatRoman law systems would favor less flexibility and a moreconservative approach. The development of IFRS is muchto the credit of accounting professionals in the UK, who

have taken a leadership role in gradually convincingRoman law countries that a common law format is viable.This has been facilitated by the experience of Europeanfirms using US GAAP methods to tap US capital marketsthat would prefer a much simpler rulebook.

Japan differs from the Asian-colonial countries of Singa-pore and Hong Kong, whose systems were initiated by theBritish Empire. Japanese favor high levels of uniformityand statutory control. They favor secrecy and are not com-fortable with Western concepts of disclosure and trans-parency. Politics are injected into the accounting system asneeded. For example, at the beginning of the Japanesebanking crisis the government informed banks that theyneed not recognize loan losses because the public mightlose confidence in the banking system.

In capturing broad differences in institutional structure,researchers may partition countries into the “shareholder-focused” group or “Anglo-American cluster,” which in-cludes the US, the UK, Canada, and Australia. By examin-ing environmental measures that include legal systemsand the relationships between business enterprises andsources of capital, one can see these market-oriented sys-tems as emphasizing the needs of investors.

France, Germany, and Japan are members of the “conti-nental” group, also known as the “bank-dominated


The Enron debacle, thoughhaving drawn great attentionin the IFRS dialogue, is not anindicator of any fundamentalaccounting or regulatory systemfailure. Rather, it is a case ofcorrupt management seekingtechnicalities behind which toperpetrate investor fraud.

economies” or “code law cluster.” Traditionally, banks andgovernments have been dominant in directing the use andevaluation of accounting information. High uniformity ofaccounting procedures is preferred over flexibility. Homo-geneity is assumed within each cluster, and between-clus-ter countries are considered to be dichotomous withrespect to bank-oriented vs. market-oriented financial sys-tems, public vs. private sector accounting standard-setting,and degree of importance of auditing.

The same divisions are present in defining the two institu-tional structures into two legal styles: common law andcode law. An empirical study by Ball et al., cited in Pow-nall and Schipper (1999), has shown significant differ-ences in the factors of accounting practices between com-mon law and code law countries. The structure of thisstudy was seven countries divided into the two groups.Regressions of net income per share were deflated byshare price on annual return per share, and again deflatedby price in order to capture the extent to which annualearnings reflect actual market share pricing movementsduring the fiscal year. This was interpreted by the re-searchers to measure the timeliness of accounting earn-ings. Hypotheses relating to differences in timelinessreflected group-specific differences in the use of account-ing earnings. Inferences relating to to timeliness betweencode law and common law countries were based on com-parisons of R-squared statistics from the regressions ofearnings on returns.

The researchers concluded that if international harmo-nization of financial reporting is to converge into a singlesystem, common law is more appropriate because of thearm’s-length transaction process most typical of it, whichis “shareholder focused.” Shareholders use earnings todetermine share value and compensate managers, whilein “stakeholder-focused” economies (code law countries)“earnings are used more for determining current payoutsto government (via taxation), to shareholders (via divi-dends), and to managers and employees (via wages andbonuses).” As a further endorsement of the common lawconcept, cross-border transaction participants are likely tobe unrelated and at arm’s length from one another, ratherthan related to the firm and its managers.

Another very interesting result of the study is the sugges-tion that accounting earnings in common law countriesare more conservative than reported earnings in code lawcountries, arising out of the arm’s-length relationshipbetween contracting parties (managers and shareholders).This adds to the degree of difficulty in comparing financialstatements from different legal traditions, due to informa-tion asymmetry. Reviewing the results of earnings suggeststhat bad news is incorporated more slowly and good newsmore quickly in code law than in common law countries.

Arguments in favor of harmonization

A study conducted by Whittington (2000) com-pared a steel company in France to one in the UKover an 11-year interval from 1988 to 1998. Each

company used GAAP in its own country and restated itsearnings to US GAAP for investor purposes. None of thedifferences between methods was decisive enough tomake any inferences. The US and UK GAAP were the mostclosely aligned and the French GAAP appeared slightlymore conservative, although other studies have indicatedGAAP to be somewhat more conservative in the US thanin France. As such, GAAP between US, UK, and Francemay not differ significantly. Earlier studies by Weetmanand Gray and Weetman et al. (cited by Whittington) hadconcluded that US GAAP is generally more conservativethan UK GAAP. Another study by Dumontier and Labelle(cited by Pownall and Schipper) found that in 117 pub-licly traded firms in the years 1981–1990, French GAAPearnings were no less value-relevant than were those of USor UK GAAP earnings.

Coopers & Lybrand conducted extensive research on case-specific reconciliations of IFRS to US GAAP. They con-cluded that the belief in lower standards as a result ofIFRS financial reporting is erroneous. Their studies didnot reveal material differences, and they emphasize thatin looking for areas of difference between US GAAP andIFRS it is important to bear in mind that there are oftendifferences in the application of the same domesticaccounting standards between US companies. Volcker(2002) believes that a single set of international account-ing standards would minimize compliance costs for com-panies and also assist enforcement.

The current practice for foreign firms that desire access toUS markets is to use US GAAP reporting. Their alternativeis to file a report with the SEC that reconciles their localstatements to US GAAP. A recommendation by Schwartz(2001) that has merit calls for an international standardthat approximates US GAAP to be supplemented asneeded with the use of an additional disclosure for re-maining differences in measurement, recognition, or dis-closures that are material. This furnishes an acceptablelevel of transparency without the burdensome accountingconversion processes that currently take place.

The overall need for accounting harmonization is fueledby globalization. While the US capital markets have beendominant, investors are interested in the broadest possi-ble access. The forces of accounting harmonization in-volve companies and investors that are fully committed toan international standard. This is supported by the long-term efforts of a considerable array of accounting profes-sionals, particularly the IASB.


Arguments againstharmonization

P erhaps the most pervasive resistance to acceptanceof IFRS is the pressure exerted by the United States.Certainly there is justification for the US GAAP

preference, based on the large portion of internationalcapital that flows through American markets. But the USis known for a heavy-handed style. Europeans see the USpulling strings behind the scenes, particularly in the SEC’sinfluence in the appointment of IASB trustees. The currentchairman is none other than Paul Volcker, former chair-man of the Board of Governors of the US Federal ReserveSystem. The European Community has wanted the IASBto have wider geographical representation in order to bal-ance the American influence somewhat.

Form 20-F is an accounting reconciliation of foreignfinancial statements to US GAAP that is filed with theSEC. Many non-US firms file this document. Analysis byPownall and Schipper shows the differences to be large inmagnitude from the original accounting standards used,although the differences are not in any consistent direc-tion. This indicates that the application of differentaccounting systems to a common set of events and trans-actions could produce essentially noncomparable reports.Hence, it may be inappropriate to impose uniform ac-counting standards because of cross-jurisdictional institu-tional differences. Some regulators and standard settersmay find it preferable to maintain at least some country-specific reporting that can capture qualitative, institution-driven differences in events that seem superficially similar.Reconciliations can be additionally furnished for firmsthat choose to report in numerous jurisdictions.

Another part of the problem is the previously mentionedlack of specificity in the IFRS model. Schultz and Lopezfound that when international accounting rules allow forsignificant discretion in application, de facto uniformityamong nations is unlikely to result. This impairs the util-ity of the harmonization effort.

In inviting comments for a 2003 discussion, FASB Chair-man Robert Herz (2002) stated,

Many believe that moving to broader, more princi-ples-based accounting standards such as those usedin other parts of the world would facilitate betterreporting in the US. Others, however, are concernedthat a principles-based approach could reduce thecomparability of financial information and leavetoo much room for judgment by companies andauditors.

Dzinkowski (2000) suggests that firms could suffer nega-tive effects from adopting non-local GAAP, in relation tolocal tax liabilities they have shielded themselves from

through careful use of their existing accounting standards.These amounts could be quite substantial. Costs andassets may be stated in any number of different ways,according to local custom. The fear of excessive trans-parency is of legitimate concern to a firm.

Barth, Clinch, and Shibano (1999) assert that local firmscould also experience a decrease in domestic trading vol-ume after harmonizing to an international standard dueto a decrease in domestic price informativeness. Domesticinvestors would experience an expertise acquisition deficitas they delay or decline an education in interpreting theunfamiliar reporting formats.

If the international standard is less stringent than USGAAP, it could place American companies at a disadvan-tage in competing for a pool of international funds. Thiswould be caused primarily by the higher level of trans-parency that appears in US standards of accounting thanthat required of firms from other countries, offering thosefirms a competitive advantage. At the same time, foreignfirms, if able to do business on US stock exchanges with-out full US GAAP compliance, will not have any reason ordesire to perform accounting conversions. Said MalcolmCheetham of Novartis, a Swiss pharmaceuticals company:

In completing our US listing we had to go throughthe costly exercise of making a bridge to US GAAP.It introduced a lot of complications in acquisitionaccounting. It didn’t result in our share price mov-ing at all, and I don’t see that it was of any realvalue to the business community. (Dzinkowski2000)

Into the future

T he past 20 years have seen increasingly creativeattempts by companies to avoid showing variousassets and liabilities on their balance sheets by

using transactions that may obscure the economic sub-stance of their financial position. There will always beloopholes to be exploited by corrupt managers in anycountry or company. It is a matter of opinion to whatextent the United States dominates in corrupt accountingpractices, but it has assuredly not cornered the market. USGAAP is already more restrictive overall and more detailedthan IFRS. Cairns (2000) points out that it would bemuch easier for a US GAAP company to be in compliancewith the IFRS than for a company that reports in IFRS toclaim compliance with US GAAP. In the case of the Enronfiasco, IFRS would have prohibited the particular account-ing procedures that misled investors. However, that can-not create the assumption that the company would havebeen unable to find any loopholes under IFRS with whichto perpetrate fraud.


As Paul Volcker told Congress, “A new profession of finan-cial engineering has emerged which exercises astonishingingenuity in finding methods to circumvent establishedaccounting conventions and tax regulations.” This wouldnot be one of America’s proudest exports. He also noted,

The accounting profession is facing increasing chal-lenges in responding to the growing complexity ofbusiness and finance, which features seeminglyendless varieties of securitizations, multiplying off-balance-sheet entities, and diabolically complicatedabstruse derivatives. This is a trend that will con-tinue. Along with this complexity, at least in theUnited States, there has been a certain amount oferosion of professional, managerial, and ethicalstandards, as well as internal company safeguards.

Compliance, enforcement, and jurisdiction are amongmany issues that will need to be worked out. An export ofAmerican litigiousness would be an unhappy addition tothe international community.

A possible future prediction is that accounting system har-monization will add to the international movement ofexecutives and managers as local business practicesbecome less preeminent in favor of global business strat-egy. Management skills will become ever more transfer-able. The high compensation of American managers willalso take place globally, though not to the lofty extentseen in America in the recent past. This will be contingenton the skill and value brought to the firm. The pay scaleswill be a shock in some places that have not had signifi-cant management compensation disparities into the toplevels. The rapid terminations of these highly paid man-agers will also come as a surprise in some countries andcultures that have featured employment stability. Over thenext 25 years, these pay disparities between top and mid-dle management will shift downward as the knowledgebase becomes more generalized.

University curricula will become less regionally focused asaccounting professors deal with the standardized systems.Needs and opportunities for academic research will be-come clearer as scholars apply their analysis to challengesthat are more universal and pervasive. For example, howdoes the homogenization of accounting and finance affectpolitical risk? Foreign exchange risk? Market risk? Doesrisk increase or decrease?

Homogenization of accounting practices will assist in theconsolidations of large businesses on a global basis. Merg-ers on the scale of Daimler and Chrysler, British Petro-leum and Mobil, will increase exponentially. Harmoniza-tion will assist executives in evaluating investments andacquisitions in totally different economies. This trend iswell established with media giants, oil companies, andautomobile manufacturers, to name just a few. We canexpect to see retailers and telecommunications the next inline to go the same way.

Access to capital markets will be facilitated by accountingstandards homogenization, for the benefit of both in-vestors and firms. The sophistication level of investorsaround the world will increase. Stock market exchangeswill have larger volumes in all markets as American in-vestors shop overseas and international investors becomeactive in their own markets as well as the US markets. Thetiming is perfect for the maturity and power of the Inter-net, with global investors able to access information andconduct transactions at low cost and high speed. Bound-aries and time zones are inconsequential on the Net. Any-one with a computer and a phone line can have tremen-dous access to information.

The burden associated with being a public company isgoing to produce a divergence in management and strat-egy between public and private companies. The lure of bigcapital is often later lamented and regretted as companiessacrifice their privacy and self-governance in favor of rais-ing money. International managers need to understandthe strategic disadvantage this can create in their particularcompetitive environment. Managers are going to find thatthey are furnishing transparency in ways they do not de-sire. We can expect to see subsequent restructuring trendsas companies rush into the capital markets and then latermove toward reprivatization to regain confidentiality afterthe firm has been built out. This may be an evolutionarytrend over the next 25 years.

We know from history that the growth of business global-ization is much higher than the overall growth in worldbusiness volume. More effort is expended in chasing thesame pool of money. This is counterproductive to theintent of moving beyond domestic markets. Companiessee global capital markets with similar hopes of accessinghigher volumes by reaching beyond borders. This hasbeen a spectacular failure for some firms, most notablyDaimler-Benz, whose launch on the New York Stock


Compliance, enforcement, andjurisdiction are among manyissues that will need to beworked out. An export ofAmerican litigiousness would bean unhappy addition to theinternational community.

Exchange was a dismal experience, and the results ofwhich are partially obscured by its adventuring into theChrysler acquisition.

One of the many possibilities that arise from transparencyand comparability of financial statements and the result-ing inflow from foreign investors is the opportunity per-haps to raise money globally but grow the businessdomestically, on home turf in familiar markets. It is some-what of a reverse globalization concept: global inputrather than global output. This gives a firm more fundingto use toward its core competency.

L ike it or not, the evolution of international ac-counting standards harmonization is inevitablytilted toward a strong resemblance to US GAAP. In

addition to the pressures exerted by the SEC and theFASB, there is the undeniable pull of the US mega-mar-kets. Europeans have strong faith in their future potential,but the current reality is not characterized by Americansscrambling to get into European capital markets. Thespotlight remains on the United States. ❍

References and selected bibliographyBarth, Mary E., Greg Clinch, and Toshi Shibano. 1999. Interna-

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Cairns, David. 2000. Waving a different flag. Accountancy 126/1,285 (September): 105-107.

Colvin, Geoffrey. 2002. Sick of scandal? Blame football. Fortune(22 July): 44.

Coopers & Lybrand. 1995. International accounting standards ver-sus U.S.-GAAP reporting: Empirical evidence based on case studies.Cincinnati: South-Western College Publishing.

Deloitte Touche Tohmatsu. 2002. International accounting stan-dards: A guide to preparing accounts. London: ABG ProfessionalInformation.

Dzinkowski, Ramona. 2000. The world according to US GAAP.CA Magazine 133/10 (December): 26-31.

Fechner, Harry H.E., and Alan Kilgore. 1994. The influence ofcultural factors on accounting practice. International Journal ofAccounting 29/3: 265-277.

Fink, Ronald. 2002. Beyond Enron. CFO 18/2 (April): 34-42.Gray, S.J. 1988. Towards a theory of cultural influence on the

development of accounting systems internationally. Abacus24/1 (March): 1-15.

Guerrera, Francesco, and Peter Norman. 2002. Call to scrap USrules on accounting in wake of Enron. Financial Times (21 Feb-ruary): 1.

Herz, Robert. 2002. FASB Press Release PDF 13k. @ www.iasplus.com/pastnews/2002oct.htm (October).

Kroll, Karen M. 1997. Closing the GAAP? Industry Week (3November): 61+.

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Pacter, Paul. 1998. International accounting standards. CPA Jour-nal 68/7 (July): 14-21.

Porter, T., and R. Traficanti. 1999. Comparative analysis of IAS32 (1998), financial instruments: Disclosure and presentation,and IAS 39 (1998), financial instruments: Recognition andmeasurement, and related US GAAP. In Carrie Bloomer (ed.),The IASC-U.S. Comparison Project: A Report on the Similaritiesand Differences Between IASC Standards and U.S. GAAP (137-138). Norwalk, CT: Financial Accounting Standards Board.

Pownall, Grace, and Katherine Schipper. 1999. Implications ofaccounting research for the SEC’s consideration of interna-tional accounting standards for U.S. securities offerings.Accounting Horizons 13/3 (September): 259-280.

Radebaugh, Lee H., and Sidney J. Gray. 1997. International ac-counting and multinational enterprises (4th ed). New York: Wiley.

Schultz, Joseph J., Jr., and Thomas J. Lopez. 2001. The impact ofnational influence on accounting estimates: Implications forinternational accounting standard-setters. International Journalof Accounting 36/3 (September): 271-290.

Schwartz, Don. 2001. What price global standards? CPA Journal71/5 (May): 40-48.

Tweedie, David. 2002. Speech to United States Congress (14February).

Volcker, Paul. 2002. Speech to United States Congress (14 Febru-ary).

Whittington, Mark. 2000. Problems in comparing financial per-formance across international boundaries: A case study ap-proach. International Journal of Accounting 35/3 (September):399-413.


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