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University of Newcastle upon Tyne
Department of Accounting and Finance
I nternational F inancial Analysis
Measur ing I nternational Accounting Harmonisation
between
Large Companies from France, Germany and the UK
Supervised by Dr Simon Pallet
Prepared by Imad Alsuwaih
September 2002
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Acknowledgment
I am most grateful to all those who have supported me dur ing
my research and provided assistance to al low me to complete
my cour se.
Special thanks to:
Simon Pallet (Newcastle University-UK)
Don Hermann (Oregon State University-USA)
Wayne Thomas (Oregon State University-USA)
I an Dobbs (Newcastle University-UK)
And my dear parents in Tr ipoli -L ibya
From: I mad Alsuwaih
Newcastle upon Tyne
6 September 2002
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Abstract
The measurement of harmonisation is dependent upon, and therefore affected by, the
importance of accounting and various international attitudes towards harmonised
accounting. Through the analysis of various areas of harmonisation this study aims to
measure harmonisation between large companies located in France, Germany and the
UK.
The methodology adopted in this study has previously been used by several authors,
such as, Emenyonu and Gray (1992) and Hermann and Thomas (1995). However, a
more diverse range of accounting practices has been used to measure accounting
harmonisation for the purposes of this study. These practices have been sub-divided
into those regulated by the Fourth European Directive and those not regulated by the
Directive.
Within this study a comparison of my results to those of EGs enables the process of
harmonisation in the context of common practices between the two studies to be
measured. Results of the current study indicate a high level of harmony can be found
in many accounting practices, despite accusations that the Fourth European Directive
has failed to meet its aim for harmonisation. The study also shows that the accounting
reporting in these three countries are affected by five main regulations: German
GAAP, French GAAP, UK GAAP, US GAAP and the IASs.
As most studies in this area do not provide an explanation of the methodology
adopted, a modest addition to the literature has been included in this study which
provides a clear explanation of the methodology used.
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TABLE OF CONTENTS PAGE NO.
ACKNOWLEDGEMENT II
ABSTRACT III
TABLE OF CONTENTS IV
LIST OF TABLES VI
CHAPTER 1
1.1INTRODUCTION 1
1.2DEFINITIONS 2
CHAPTER 2
2.1 FACTORS DIFFERENTIATE ACCOUNTING SYSTEMS
2.1.1. THE LEGAL SYSTEM 4
2.1.2. METHODS OF FINANCE 4
2.1.3. THE ROLE OF TAXATION 5
2.1.4. THE ACCOUNTING PROFESSION 5
2.2 STANDARD SETTING IN THE THREE COUNTRIES
2.2.1. UK 6
2.2.2. FRANCE 7
2.2.3. GERMANY 8
2.3. RELATED ACCOUNTING RULES IN DIFFERENT REGULATIONS
2.3.1. STOCK VALUATION 9
2.3.2. DEPRECIATION 11
2.3.3. TREATMENT OF GOODWILL 13
2.3.4. R&D 15
2.3.5. FIXED ASSETS VALUATION 16
2.3.6. DEFERRED TAXATION 17
2.3.7. CURRENCY TRANSLATION 19
2.3.8. BORROWING COSTS 20
2.3.9. LEASES 20
CHAPTER 3
3.1 REVIEW OF EXTANT LITERATURE
3.1.1. LITERATURE REVIEW BY TAY AND PARKER 24
3.1.2. MORE STUDIES 28
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3.2 METHODOLOGY 35
3.2.1. STATISTICAL ANALYSIS 36
3.2.1.1. INDICES 36
3.2.1.2. CHI-SQUARE TEST 42
3.2.2. MULTIPLE REGRESSION 46
3.2.3. MEASUREMENT PRACTICES 47
3.2.4. HYPOTHESIS 48
3.2.5. PROBLEMS OF NON-DISCLOSURE 49
CHAPTER 4
4.1 PRESENTATION OF RESULTS 50
4.1.1. STOCK VALUATION 50
4.1.2. DEPRECIATION 51
4.1.3. TREATMENT OF GOODWILL 53
4.1.4. AMORTISATION OF GOODWILL 54
4.1.5. R&D 55
4.1.6. FIXED ASSETS VALUATION 56
4.1.7. DEFERRED TAXATION 57
4.1.8. CURRENCY TRANSLATION 59
4.1.9. BORROWING COSTS 60
4.1.10. LEASES 61
4.2 DISCUSSION AND COMPARISON WITH EG 62
4.2.1. COMPARISON WITH EGS RESULTS
4.2.2. OTHER ACCOUNTING ISSUES 63
4.2.3. BICOUNTRY I-INDICES 64
4.2.4. DIFFERENCES FROM EG 65
4.3 CONCLUSION 67
APPENDICES
APPENDIX-1-FRENCH COMPANIES 70
APPENDIX-2-UK COMPANIES 71
APPENDIX-3-GERMAN COMPANIES 72
APPENDIX-4-I-INDEX BETWEEN MY STUDY AND EGS (CHART) 73
APPENDIX-5-2X BETWEEN MY STUDY AND EGS (CHART) 74
List of references 75
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List of Tables
Table 1. Regulations comparison 23
Table 2. Studies Reviewed by TP 27
Table 3. Stock valuation 50
Table 4. Depreciation............................................................................................... 52
Table 5. Treatment of Goodwill 53
Table 6. Period of Amortisation 55
Table 7. Research and Development Costs.............................................................. 56
Table 8. Fixed Assets Valuation .............................................................................. 57
Table 9. Deferred Taxation ...................................................................................... 58
Table 10. Translation of Financial Statements of Foreign Subsidiaries .................. 59
Table 11. Results of HTs study 60
Table 12 Capitalisation of borrowing costs ............................................................ 60
Table 13. Leases: ..................................................................................................... 61
Table 14. Comparison with EGs: ........................................................................... 62
Table 15. issues out of the 4th D scope: ................................................................... 62
Table 16.Bicountry I indices 64
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Chapter 1
I ntroduction and defi ni tions
1.1 Introduc t ion
Measuring harmonisation is a subject which attracted the attention of many
researchers in the last two decades as the importance of international harmonisation
has increased over time. This importance emerged from the changes in the form of
stock markets across the globe. These markets have become more international, and
large numbers of multinational companies have become inter-listed on more than one
stock market. Another factor is the existence of international investors either
individuals or corporations, both trying to find the most profitable and most secure
investments and to benefit from the free business situation in the developed countries
(comparing with business closely controlled by government in the developing
countries). The European Union as well has a big interest in international accounting
harmonisation, where one of its main goals in the treaty of Rome 1957 is to guarantee
freedom of capital movement across its member states. All this factors increased the
attention paid to international comparability between the financial reports produced
by the companies which might attract investments at an international level. This
increasing importance of international harmonisation made the measuring process
inevitable. Therefore a methodology for measuring harmonisation has evolved, and
different techniques have been developed. This study is aims to use some of this
methodology in measuring harmonisation between three countries of the European
Union, France, Germany and the UK. These countries are chosen because in addition
to the Netherlands they are described as vital countries for the process of international
harmonisation (Nobes 1996). Moreover, Germany and the UK represent the origins of
the two opposed primary accounting philosophies worldwide, the Anglo-Saxon and
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the Continental models. Historically the first model has focused on shareholders
working within the frame of the true and fair view; whereas the German (Continental)
model has focused on debt holders, and prudence is characterised by strong links
between financial and tax reporting. The Anglo-Saxon model has had a strong
influence on accounting in countries which were colonised by the UK, whereas the
Continental model has influenced most of Continental Europe, Japan and the
countries colonised by Germany and France, as France was traditionally closer to
Germany; nevertheless it appears that it has shifted now towards the Anglo-Saxon
model. Therefore studying these countries might provide insight into the situation of
accounting practices in other countries (see Joos and Lang 1995). However, the
Netherlands is excluded from this study as the researcher aims to compare his results
with the results of Emenyonu and Gray (1992), which does not include the
Netherlands. The difference between the level of harmony measured in this study and
the one measured by EG will be the measurement of harmonisation as a process.
One cannot discuss the subject of harmonisation without to mention the crucial rule of
the IASB, which has been trying to produce a uniform framework for international
accounting. In this study, my intention is to focus on the subject of measuring
harmonisation rather than discussing harmonisation concepts and the role of IASB.
However, the conclusion of this study may cast light on the importance of IASB.
1-2 Definit i on s
Since there have been many studies which concentrated on the subject of accounting
harmonisation, there have been many definitions given to the terminology related. For
the purpose of this study, some of these definitions will be provided. Tay and Parker
(1990) presented these definitions: harmonisation (a process) is a movement away
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from total diversity of practice. Harmony (a state) is therefore indicated by a
clustering of companies around one or few of the available methods. Standardisation
(a process) is a movement towards uniformity (a state). It includes the clustering
associated with harmony and reduction in the number of available methods.
Moreover TP (1992) in their reply to van der Tas (1992), stated that standardisation is
associated with reduction of exclusion of choice, whereas harmonisation is associated
with the degree of flexibility and some choice.
Harmonisation and standardisation exist at the levels of regulations and practice. The
former can be referred to as formal harmonisation de jure, whereas the second is
referred to as material harmonisation de facto. This paper is confined to measuring
material harmonisation.
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Chapter 2
Dif ferent account in g system s and dif ferent regulat ions
2.1 Factors d if ferent iate acco unt in g sy stems
In the area of international accounting, there have been some efforts to determine the
factors which may cause differences in financial reporting systems across countries.
Nobes (2000) suggests seven principal causes of difference, which provide a useful
framework for analysing the three countries under review. Four of these factors are
more important than others and this review concentrates upon them.
2.1.1. The leg al system
France and Germany, like much of continental Europe, have legal systems based on
Roman Law. This type of legal system requires detailed codification of rules covering
all eventualities. Thus accounting and financial regulation in these two countries is
largely a part of law, instead of being a professional discipline in its own right. Such a
system by its very nature is difficult to change (Watts, 1996). The UK (excluding
Scotland), on the other hand, has a legal system based on Common Law. In such a
system, statute law provides a framework which is followed by judgements based on
the findings of individual cases. Thus in countries such as France and Germany,
company laws and commercial codes contain detailed rules for accounting and
financial reporting. This has made accounting practices strongly tied to government
regulations and to be restricted in different accounting areas. On the other hand,
accounting in the UK is practiced independently from laws. In the UK the Company
Act regulates many accounting issues. However, it leaves a large area for profession
and judgements to take place in the frame of the true and fair view.
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2.1.2. Methods of fin ance
Where companies raise their capital is considered to be an influence on the nature and
quality of financial reporting Patterns of financing are different in each of France,
Germany and the UK. In France, for example, a significant proportion of companies
capital has been provided by the state or banks; whereas German companies are
substantially financed by banks and providers of loan capital. UK companies, on the
other hand, are largely financed by shareholders. This is reflected in an active stock
exchange. In a country like the UK with a major tradition of private shareholders,
audited information is required to a large extent as these shareholders do not have
access to detailed internal information. Moreover, there will be a strong need to seek
advice from financial analysts. The majority of investors in the UK are financial
Institutions, which are short-term investors. Therefore they need high degree of
disclosure and rely on the approach of true and fair view. All this has led accounting
in the UK to be more transparent than in the Continental Europe. In the case of
Germany and France, the major shareholders are able to access internal information
and have less need for transparency. Banks and providers of loan capital are also
more likely to favour a conservative view of accounting (J Watts, 1996).the different
pattern of ownership in these countries produces different views about shareholders
equity and the treatment of distributable earnings. However, in the move towards one
European market, laws in France and Germany related to disclosure issues have been
developed since the Sixties.
2.1.3. The ro le of taxation
Taxation is a significant effectual factor in determining the type of financial reporting
in a country. In countries such as Germany and France, tax laws regulate for
accounting practices. Thus, the accounts for shareholders and the commercial
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accounts are to a large extent similar to the tax accounts. In the UK, on the other hand,
by the time taxation became important, financial reporting and auditing were already
well established. Such a divorce between accounting reporting and taxation reporting
in the UK has created the issue of deferred taxation, which is not a significant issue in
either France or Germany (J Watts, 1996). Still it is not the case for Group accounting
in France and Germany. In France for example, group accounts are separately
regulated from individuals accounting, whereas in Germany group accounting is
generally based on US GAAP and the IASs. Therefore deferred taxation is also an
important issue for the large French and German companies. From another point of
view, the tax based accounting lead to conservative tendency in reporting profits.
Moreover, it is less likely to show true and fair view, because of the concentration on
the compliance with tax rules and producing lower figures of profits.
2.1.4. The account ing pro fession
Factors such as, number of private shareholders and number of public companies are
likely to create the need for a large number of accountants and auditors These factors
can be considered responsible for the massive number of professionals in the UK,
which is larger than the number of accounting and auditing professionals in the whole
continental Europe. However, one should notice that many of them work in other
fields than professional practice. The size of profession and the authority delegated to
it by governments affect the standard setting process. In the UK the ASC which
comprised part-time representatives has ruled the accounting practices for long time
before it was replaced by ASB. However, even in countries where governments are
setting accounting rules, professionals still may affect the standard setting process by
acting as advisors to the government (Roberts et al., 1998). This factor can be related
to the legal system factor mentioned above. In countries such as the UK, un-detailed
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rules activate the process of producing accounting standards and relative
recommendations.
2.2 Standard sett ing in the three coun tr ies1
To complete the background about the accounting practices in France, Germany and
The UK, it is necessary to explain at least in short about the mechanism of standard
setting in the three countries.
2.2.1. UKStandard setting: In 1970 the Accounting Standards Steering Committee was
established by the Institute of Chartered Accountants in England and Wales (ICAEW).
In 1976 it was reformed as the Accounting Standard Committee (ASC). Over a period
of approximately 14 years the ASC issued 22 Statements of Standard Accounting
Practice (SSAP). ASC was accused of being slow and too willing to compromise.
Moreover, there has been increasing complexity of accounting issues. Subsequently,
there has been pressure to find more highly developed standard setter. In 1990 the
pressure produced a new body which is the Financial Reporting Council (FRC). The
FRC, comprise the Accounting Standards Board (ASB) which is considered to be the
successor of ASC, the Financial Reporting Review Panel (FRRP) and the Urgent
Issues Task Force(UITF). The FRRP is for investigating the requirements of the
Companies Act and that financial statements show a true and fair view; whereas the
UITF prevents and treats any misinterpretation of the FRSs. Most of the UK listed
companies if not all, tend to follow the FRSs, unless there is a lack of regulation for a
certain accounting variable. In such case an IAS or a FASB would be practiced.
1The main resource for this section is (Deloitte 2000a & Deloitte 2000b)
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The companies Act: the Companies Act of 1985 was amended by the Companies Act
of 1989 to introduce a definition of accounting standards; alongside with a
requirement for companies over a certain size to disclose their compliance with
accounting standards. Auditors in the UK are obliged by the law to regard to
2.2.2. France
Standards setting: standards in France are complied with by the power of law as they
are part from basic business law. There are different resources for accounting
regulation:
European Directives.
Code de Commerce (including general accounting obligations for all
commercial entities and general rules for consolidated accounts).
Regulatory texts such as decrees and regulations (regulations are now
issued by the CRCsee below).
Jurisprudence.
Guidance, interpretations and recommendations (issued by CNCC and
OEC for all companies, and by the COB for listed companies).
In 1998 CRC was formed for approving the new accounting standards. Accounting
standards are proposed by the Conseil National de la Comptabilit (CNC), and
reviewedby the CRC before issuance. For interpretation of existing standard the
Comit dUrgence du CNC (Urgent Issues Committee), is comprised of a limited
number of CNC members.
According the French Code de Commerce, the companies listed on the French stock
exchange are permitted to prepare their financial statements using the IAS. However,
French companies still have to prepare their financial statements under French GAAP
as the CRC has not yet endorsed the requirements for adopting this option.
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2.2.3. Germany
Standards setting: German companies are required to prepare their financial
statements according to German GAAP by the force of the Commercial Code (HGB).
In 1998 the German Accounting Standards Committee (GASC) was set by the
German government to accomplish the following tasks:
Developing accounting standards for listed companies consolidated financial
statements
Advising the German Ministry of Justice on new legislation concerning
accounting standards
Link with international standard setters and to represent Germany in
international accounting committees.
The GASC since it was set has issued a number of accounting standards with the
name Deutsch Rechnungslegungs Standards (DRS). Moreover, since 1998 four laws
have been introduced which have significantly affected the process of bringing
German accounting practices to a divergence with the IASs.
However, the listed German companies are divided in three categories in terms of the
accounting practices the embrace: following German GAAP, IASs and US GAAP in
case they are listed on the American stock exchanges.
2.3 The rules relat ing to the tested accou nt ing variables in
dif ferent regulat ions2
Most of the accounting variables which are subject to this study are regulated in the
systems of the UK, France, Germany, IASB, the USA and the Fourth European
Directive, which is included in Companies Law of the three countries. One might ask
2For France, Germany and the UK, the main information resource is (report of Deloitte & Touche
2000a & 2000b)- For the US and IASs the main resource is (PricewaterhouseCoopers 2002)
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why we should be interested in IASs and US GAAP. The answer is that the German
companies which are a part of our sample are following either, German GAAP, IASs
or US GAAP, in case where they are listed on American stock exchanges. Thus the
following part illustrates the most important points these regulation tell about the
accounting variables which we are interested in, taken in account that these
regulations are guided in many areas by the Fourth European Directive.
2.3.1. Stock Valu ation
UK In general, stock valuation in the UK is regulated by SSAP 9 and Sch 4 CA
1985. According to SSAP 9 stocks must be valued at the lower of cost and net
realisable value (sale proceeds less all further costs to bring the inventories to
completion). Cost can be of production or purchase and must include all expenses
incurred in the normal course of business in bringing the product to its present
location or condition. According to the Companies Act the cost of borrowing capital
which is used to produce an asset can be capitalised and added to the cost of that asset.
Although SSAP-9 requires following the principle of the lower of cost and net
realisable value, the Companies Act does allow stocks to be valued at current value
and in certain industries (such as commodity brokers and plantation companies) at
market value. For the determination of stock cost, various methods are permitted
under UK GAAP such as the weighted average, first in first out (FIFO) and Unit cost.
However, last in first out (LIFO) is not considered to be acceptable.
FranceAs in the UK, French GAAP requires that stocks must be valued at the
lower of cost and net realisable value which is calculated at same way as in the UK.
Expenditures included in the cost of stocks are rather similar to the ones under the UK
and the German GAAP.
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Cost flow methods allowed under the French regulations comprise FIFO, unit cost
and weighted average. The LIFO method, however, is just allowed for the
consolidated accounts. Conventions which regulate stock valuation in France include
(Code de Commerce, Art. L123-18 al 3), (Decree of 23 March 1967, Art. D 248-8c),
(PCG art 321-3; PCG art 333-1, 321-3) and (Decree of 23 March 1967, Art. D248-8d).
Germany According to the German Commercial Code (HGB) stocks must be
valued at the lower of cost and either of net realisable value, market value,
replacement value or another permitted value permitted by tax rules. Unlike the UK
rules the German rules do not permit stocks to be carried at a value which surpasses
cost.The HGB states some guidelines about what might be included in the cost of an
asset such as the interest on loan capital used to finance the production of that asset.
To determine the cost of stocks both LIFO and the weighted Average are permitted
for tax purposes. However, FIFO is not allowed for tax purposes unless it is consistent
with the real pattern of consumption. Some of the conventions regulate stock
valuation in Germany are; ( 253 (3), 254 HGB), ( 280 HGB), ( 255 (2) HGB) and
(255 (3) HGB)
IASsSimilarly to the UK GAAP and French GAAP, under the IAS stocks are
carried out at the lower of cost and net realisable value. However, all of cost flow
assumptions FIFO, LIFO and weighted average are allowed under the IASs.
USA under US GAAP stocks must be valued at the lower of cost and market
value. Market valued is defined as being current replacement cost subject to an upper
limit of net realisable value and a lower limit of net realisable value less a normal
profit margin3. For cost determination LIFO is widely used for tax benefits gained
from following this method; nevertheless FIFO and weighted average are both
3PricewaterhouseCoopers 2000
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acceptable. Whereas under both UK GAAP and the IASs allocation of fixed
production overheads is based on normal capacity, under US GAAP some idle
capacity costs may be allocated to inventory costs.
The Four th Directive:in its article 39 the Fourth Directive states that stock
should be valued at the lower of cost and market value or another lower value
attributed to them at the balance sheet date. However, for cost determination, article
40 allows any of the recognised cost flow methods including FIFO, LIFO and the
weighted average.
2.3.2. Depr eciati on
UKIn general, under UK GAAP depreciation is to bring down net book value to
the estimated residual value over the assets useful economic life. Different
depreciation methods are acceptable in the UK including straight-line and the
reducing balance. Unlike France and Germany, the capital allowances (equivalent to
depreciation rates in other countries) given by tax authorities are completely
independent from the accounting practices.
FranceIndividual companies accounts in France are usually tax driven. Thus
the depreciation charge is based on advantageous rules and options. For the purpose
of taxes, the reducing balance method and accelerated tax depreciation may be used in
the statutory accounts. Although for consolidated accounts, different depreciation
methods are permitted, the straight-line method is widely used. Tax laws determine
the rates for depreciation; nevertheless companies are not obliged to use them as long
as the rates used by them are not 20% above the ones determined by the Tax
authorities. Similarly to the UK the estimate of the economic useful life of fixed
assets can be revised and changed.
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Germany As in France, depreciation in Germany is tax driven and rates are
determined by the Tax authorities. Different depreciation methods are accepted by
these authorities including the reducing balance method, accelerated depreciation and
the half year simplification rule. The reducing-balance method is commonly used for
movable fixed assets in the first years after acquisition in order to achieve the
maximum possible tax benefits. Then it is common to switch to the straight-line
method, if this method results in a higher depreciation, in order to maintain tax
deductions at their highest possible level (KPMG 2001)4. Depreciation calculated for
individual accounts is accepted to be included in group accounts; nevertheless it is
also permissible to correct the tax-driven values when preparing group accounts
(Ordelhide and KPMG 2001).
IASs and USADepreciation should reflect the consumption pattern of the fixed
asset in a systematic way. Various depreciation methods are permitted under both
IASs and US GAAP, including reducing balance and straight-line. While under UK
GAAP and IASs changes in the depreciation method used or the expected life are
dealt with as changes in accounting estimate, which means they are reflected in the
current and prospective years accounts, under US GAAP these changes are dealt with
as changes in accounting principle and its cumulative effect is treated in the current
years results.
The Fourth Direct iveThe only point mentioned about depreciation in the
Fourth Directive is in article 31, which states that depreciation must be taken in
account whether the result is a profit or a loss.
4A report prepared by KPMG- see references list
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2.3.3. Treatment o f Goodw ill
Generally, goodwill arising on a business combination is calculated as the difference
between the cost of the firm acquired and the fair value of the net identifiable assets
acquired. However, the amount of goodwill calculated under different conventions
may differ because of the difference in requirements for calculating the cost of
acquisition and its allocation to identifiable assets and liabilities required. What
matters here in this research is exploring whether all companies are harmonised in the
respect of capitalising goodwill.
UKbefore FRS10 was issued,although capitalisation of goodwill was permitted
under UK GAAP, the full amount of goodwill used generally to be eliminated against
reserves. For accounting periods ending on or after 20 December 1998, positive
goodwill has been required to be capitalised as an asset with a useful economic life
presumed to be less than 20 years. However, this presumed period is not definite, as it
can be a longer or an indefinite life if the stability of the acquired business can be
demonstrated, and justifies that the economic life is to exceed 20 years, and the
goodwill is capable of continued measurement. Impairment review for goodwill is
required by FRS 11 as amortisation is not compulsory.
France according to Code de Commerce: Art. L123-14; Rg n99-02 ( 212),
goodwill in consolidated accounts arising on acquisition of a company must be
capitalised and shown as an asset within fixed assets; nevertheless, under French
regulations goodwill can be written off, if that provide a true and fair view, this might
means the case where goodwill has no real value. Under French GAAP non-
amortisation of goodwill is permitted, and in French laws there is no requirement for
amortising goodwill in the accounts of individual companies. the period of
amortisation, there is no specific requirement, except that it must be on a reasonable
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basis in the consolidated accounts. Moreover, under French regulations, goodwill
amortisation is not tax deductible.
Germanya definition of goodwill is stated in the convention ( 255 (4) HGB).
As in French law, requirements about goodwill for individual companies are different
from the ones for consolidated accounts. For the purpose of individual companys
financial statements, goodwill can be written off immediately against reserves or
amortised over four years. Another alternative is to amortise it over its estimated
useful life, which is commonly assumed to be fifteen years. Before August 2000
according to the convention ( 309 (1) HGB), goodwill in consolidated accounts was
allowed to be written off against reserves or amortised over four years but after that
date, accounting standard DRS 4 required that maximum useful life of goodwill is 20
years and that the amortised proportions should be taken through the profit and loss
account and no longer be offset against reserves.
IASsaccording to IAS 22 goodwill must be capitalised and amortised over a
period not to exceed 20 years as the one of the UK regulations.
USA goodwill under US GAAP used to be capitalised and amortised over a
period of less than 40 years. However, effective January 1, 2002, SFAS No. 142
eliminates the requirement to amortise goodwill and instead requires periodic testing
of goodwill for impairment. If goodwill is impaired, it must be written down to its
estimated fair value.
The Fourth Direct iveas article 9 from the Directive prescribes the layout of the
balance sheet, this article states that Goodwill acquired for a valuable consideration, is
an element of the intangible fixed assets. Article 4 affirms that capitalised expenses
should be amortised over a maximum period of 5 years. This was followed by article
37 which says that goodwill is a part of those expenses. However, article 37 allows
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companies in member states to amortise goodwill over a period exceeding 5 years and
no longer than the useful economic life of the asset, which must be stated in the notes
to the accounts, with the reasons therefore.
2.3.4. Research and Development Cos ts
UKunder UK GAAP research costs are differentiated from development costs.
Whereas the first must be expensed as incurred, the later may be capitalised provided
that outcome of the project can be measured with reasonable certainty as they are
technically feasible and commercially viable. In other words, costs of development to
be capitalised, must be recoverable and adequate resources must exist. Exception
from this is development costs which are related to contracts with a third party, or the
ones which are incurred while locating and exploiting mineral resources. Nevertheless,
the last practice is rarely chosen.
Franceunlike UK GAAP, French regulations [PCG art 361-2, 361-3] do not
distinguish between research and development costs. However, it allows both of them
to be capitalised under the same conditions UK GAAP requires for capitalising
development costs. Amortisation of capitalised R&D must be charged over a
maximum period of 5 years. Furthermore, unamortized R&D should be deducted
from retained profits before calculation distributable earnings.
Germany according to the convention ( 248 (2) HGB) R & D costs must be
expensed when incurred.
IASssimilarly to UK GAAP, IAS 38 does distinguish between research and
development costs. While the first must be expensed as incurred; the latter must be
capitalised provided met certain criteria built on conservative basis similar to ones of
UK GAAP. Costs of development which written of prior meeting the criteria, may be
capitalised, if the criteria are met later.
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USA with no differentiation between research and development costs and
according to SFAS No. 4, R&D must be expensed when incurred
The Fourth Direct iveresearch and development costs are recognised in article
9 as an element of intangible fixed assets as long as national permits their being
shown as assets. Similarly to the case of goodwill, article 37 refers to article 34 in
amortising R&D costs so that may be amortised within a period of maximum 5 years.
However, it affirms that exception to this period may take place, but it must be
explained in the notes to the accounts.
2.3.5. Fixed A ssets Valuation
In this research attention will be on the valuation of just one part of fixed assets: -
property, plant and equipment. Thus issues about revaluation of investment are
avoided.
UK under UK GAAP, initial measurement of fixed assets is carried out at cost.
However, Companies Act (1985 CA, Sch.4) permits tangible fixed assets to be
revaluated. FRS 15, which is effective for periods ending on or after 23 March 2000,
determines some bases on which revaluation of fixed assets must be carried out.
France fixed assets under the French rules are initially recorded at cost, except
items with value less than FF 2,500 to be expensed. Still revaluation of tangible fixed
assets is permitted in both statutory and consolidated accounts. When revaluation
policy is adopted all relevant asset categories must be revalued; nonetheless intangible
assets and stocks may not be revalued. Although legal revaluation-tax free of tangible
and intangible assets was allowed in the year 1976-1977, surpluses from voluntary
revaluation from 1984 onwards are taxable. Thus revaluation practices are rare in
France and much less common that in the UK. Revaluation is regulated by the
conventions [Code de Commerce, Art. L123-18al.4, PCG art 350-1]
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Germany although revaluation of fixed assets is permitted by the Fourth
European Directive, German regulations do not permit fixed assets to be revalued at
more than original cost as reduced by depreciation.
IASsessentially the base is the historical cost, but revaluation is permitted by IAS
16, which states some conditions under which revaluation must be carried out. On the
other hand, IAS 40 is considered with revaluation of investment property.
USA under the US GAAP no revaluation for PP&D is permitted.
The Fourth Direct ivethroughout section 7 the Directive states the criteria must
be met when companies valuate items in their annual accounts. Article 33, shows that
tangible fixed assets can be revaluated and that inflation must be taken in account.
2.3.6. Deferred Taxation
UK according to SSAP 15, deferred taxation must be provided for timing
differences for which a liability or an asset is probable to crystallise (partial provision),
and that liability method is required. However, in December 2000 FRS 19 was issued
requiring companies to report their deferred taxes in a form of full provision, called
the incremental liability approach. FRS 19 is effective for accounting periods ending
on or after 23 January 2002. By this convention assets and liabilities of deferred taxes
are allowed to be discounted. Under UK GAAP deferred taxation requirements are the
same for consolidated financial statements and single entity accounts.
France for single entity accounts, deferred taxes are not required. Yet they are
required to be reported in consolidated accounts using the full provision approach and
the liability method. Deferred taxes assets in both the UK and France, must be
recognised to the extent that recovery is assured beyond a reasonable doubt. Material
about deferred taxation in the French regulations will be found in the provisions [PCG
art 441/14] and [CGI, art. 39-1-5]
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Germany For individual companies financial statements, and according to the
German provision ( 274 (1),(2) HGB and DRS 10), deferred taxes liabilities are
required; whereas deferred taxes assets are optional. On the other hand, for
consolidated accounts both assets and liabilities of deferred taxes are required by the
provision ( 306 HGB) to the extent that they will reverse in the future years (partial
provision). The method required under the German code is the liability method,
although it is not mentioned by name ( 274 (1) and (2) HGB, SABI 3/1988).
IASsIAS-12, which was amended by IAS-10 and IAS-40, requires full provision
for deferred taxes arising from nearly all timing differences calculated at tax rate
expected at time of settlement (liability method).
USA full provision is required under the US GAAP. However, it differs for the
other countries in requiring provision for all deferred tax assets, and then provides
valuation allowance if recovery is less than 50% likely. As explained in the
publication of PricewaterhouseCoopers (2000), it is Recognise in the balance sheet at
full value, but reduce by a valuation allowance if, based on the weight of available
evidence, it is more likely than not that some portion, or all, of the deferred tax asset
will not be realised.
The Fourth Direct iveThe only requirement in the Fourth Directive about
deferred taxation is that they must be disclosed in the balance sheet as a cumulative
amount under a separate item with an appropriate heading (art. 43, par. 11). Neither
the Fourth Directive nor the Seventh Directive contains any requirements in respect of
reporting deferred taxes in full or partial provisions.
2.3.7. Translatio n o f Financ ial Statements o f Foreign
Subsidiar ies
UKUK GAAP distinguishes between independent and dependent subsidiaries,
according to way they are financed or operate in relation to the parent company. The
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current method is used to translate the financial statements of independent
subsidiaries, whereas the temporal method is required for the dependent ones.
However, under UK GAAP, it is permissible to translate the profit and loss account at
either the closing rate or the average rate. For countries with hyperinflation, UK
practitioners may adopt IASs or US GAAP. The case of hyperinflation is regulated by
SSAP 20 and UITF 9. In short they require either the financial statements reflect the
current price level, or using a stable currency as a functional currency.
France under the French GAAP, conditions required in choosing either the
current method or the temporal method, are the same as the ones required under UK
GAAP. Nevertheless, for translating the profit and loss account, just the average rate
for the period is used.
Germanythere is not any specified method required under German GAAP, for
translating financial statements of foreign subsidiaries. Yet, there are some methods
which are recognised in practice, such as the current method, modified current method
and the temporal method. Translation differences are either taken to the reserves or
offset against profit and losses.
IASsas in the UK, the temporal method is required for dependent subsidiaries
and the current method for the independent ones. However, just the average rate is
allowed to translate the profit and loss statement, whereas under UK GAAP closing
rate is permitted. Another difference from the UK is that exchange differences are
taken to equity, as in the UK they are reported in STRGL. (PricewaterhouseCoopers
2000)
USA under US GAAP, requirements of translation are comparable to the ones of
the IASs, except the treatment of statements from countries with hyperinflation.
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The fourth Direct ivetranslation of foreign financial statements is not in the
scope of the fourth Directive. However, the only requirement in the Seventh Directive,
which is concerned with consolidated accounts about this, is to disclose the chosen
policy in the notes to the accounts.
2.3.8. Capital isat ion o f bo rrow ing cos ts
UK according to the Companies Act (1985 CA, Sch. 4), Interest on capital
particularly borrowed to finance producing an asset, can be added to the cost of the
asset to the extent it accrues in the period of production.
Franceunder the provision [PCG art 331-1], as in the UK interest may be
capitalised providing it incurred in period of the asset production and it is on external
borrowings.
Germanysimilarly to the UK and France, it is allowed under the German
regulations to capitalise the interest on the capital used to finance certain assets. (
255 (3) HGB)
IASregulated by IAS 23, interest can be capitalised.
USA US GAAP has a different treatment from the others, as borrowing costs are
required to be capitalised by FAS 34.
The Fourth Direct ive there is no any requirement related to this accounting
variable.
2.3.9. Leases :
UKunder UK GAAP (SSAP 21), a lease should be capitalised and stated as an
asset (finance lease), if it transfers to a large extent all the risks and rewards of
ownership of the asset to the lessee. An asset and a liability should be reported at the
present value of the minimum lease payments. Another case of finance leases is when
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the present value of the minimum lease payments equals 90% or more of the assets
fair value.
Francefor individual companies accounts, all leases are considered to be
operating leases and expensed. On the other hand, for consolidated financial
statements capitalising finance leases is preferred but they are mandatory. Therefore
in case they were considered as operating leases additional information about the
amount may be capitalised must be provided (multiple reporting).
Germanywhereas tax law in Germany distinguish between operating leases and
finance leases; the German commercial law does not distinguish between them. Thus,
definitions in the tax law are used by the companies, to account for finance leases.
This means that leases can be capitalised but in contrast to UK GAAP, the present
value of minimum lease payments is not a criterion for classification of leases.
However, in practice they are frequently not disclosed separately, unless material.
(Deloitte)
IASIAS-17 (revised) has the same requirements as UK GAAP.
USA FAS-13 has similar requirements to those of UK GAAP and IASs.
The Fourth Direct ivethis directive does not provide any guidance in the area
of foreign currency translation. However, the seventh Directive on consolidated
accounts refers to translation methods only in the requirement that the bases of
foreign currency translation be disclosed in the notes to the accounts. Thus in most of
Europe, the choice of method is left to the company (HW, 1995)
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Chapter 3
3.1 Review of extant literature
3.1.1. Literature review b y Parker and Tay
A study by Tay and Parker (1990) might be the most appropriate start for reviewing
the extant literature about measuring harmonisation. TP analysed six important
studies dealing with the measurement of international harmonisation of financial
reporting. The approach used to review the six studies was by analysing the problems
which arise when measuring harmony, harmonisation, uniformity and standardisation.
Seeing that the issues discussed in this analysis are important for this research, I have
chosen to provide a summary of each issue. However, before that we need to know
which studies have been used and criticised in this analysis; thus TPs table, which
was used by them to illustrate the most important information from these studies has
been reproduced as table 2 (p27). The studies reviewed by Tay and Parker in
chronological are: Nair and Frank (1981), Evans and Taylor (1982), McKinnon and
Janell (1984), Doupnik and Taylor (1985), Nobes (1987) and van der Tas (1988).
These authors will be referred to as NF, ET, MJ, DT, N and VDT respectively.
Summary of the main problems associated with measuring harmonisation as
defined by Tay and Parker 1990:
Possible data resources: There are two main types of data resources used in the six
studies; surveys and financial statements. NF, DT and MJ used international surveys
whereas van der Tas used national ones. The international surveys were the ones
prepared by Price Waterhouse, whereas the national surveys used by VDT were
prepared by professional bodies in the Netherlands, the US and the UK. Surveys have
some advantages such as making work easier for researchers, as other people have
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done the tiresome work of collecting the information and put it in a particular form.
However, there are some drawbacks in dealing with surveys as a resource for this
kind of study. One disadvantage is that they have been prepared for other purposes, so
they are not necessarily valid for the purposes of this kind of research. In some cases
surveys are not available in a form suitable for the researchers. This could cause
problems when comparing data from different surveys with each other. Surveys might
not be sufficiently detailed and that might lead to researchers to draw the wrong
conclusions. Moreover there are some inaccuracies in the data given; such as the ones
spotted by Nobes (1981)5 in the PW survey of 1979. There is also the possibility of
misinterpreting data as because of unfamiliarity with accounting systems in the
different countries. The last disadvantage of the surveys is the time lag which can be
found between the periods surveyed and the publication date.
Financial statements: TP describe the data of financial statements as raw. It can be
easily manipulated by researchers. Collecting data from financial statements can also
be tedious and time consuming. Other problems about financial statements are
associated with companies placed in other countries, where it takes long time to get
copies of their financial statements, although nowadays the Internet might provide us
with electronic versions. The annual reports of foreign companies might not be
available in a language the researcher understands. In some cases even if translated
versions are available, they might be abridged or restated in a way which is different
from the original statements.
Operational Definitions: in this part TP indicate that the operationalisation of the
concepts of harmony, harmonisation, uniformity and standardisation is necessarily
linked with the type of data used. The use of data and the categories in which this
5It is a reference for TPs paper, but not a reference for my research.
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data is classified will imply a concept of what is measured. Therefore in some cases
such as in the study of NF (1981) the measured harmonisation might not be consistent
with its definition.
Statistical methods: The methodology used in the six studies reviewed by TP can
be classified into three categories; descriptive statistics, nonparametric statistics and
indices. The first one, descriptive statistics, used to be the most common method
where three of the reviewed studies (N, ET and MJ) employed this kind of method.
This is applied by calculating the number or percentage of companies within the
sample which complied with specified regulations, where the percentage represents
the degree of uniformity. One of the shortcomings of this methodology is that it does
not measure the overall degree of harmony, either between countries or across time.
The second type of type of methodology is the nonparametric test: Two of the studies
used nonparametric tests. NF (1981) used Friedmans ANOVA to deal with the
categories of PW survey, which were given different ranks. On the other hand, using
the same survey data, DT (1985) allocated weights to the different categories, and
ranked the weighted average scores they calculated for the countries surveyed. The
prepared data was tested by employing the Kruskal-Wallis test and Mann-Whitney U
test which was used to examine the significance of the differences between the mean
scores of the E.C. and non-E.C. groups of countries. TP see that this kind of
methodology is appropriate for the purpose of measuring harmonisation. Yet the
concept of what is to be measured must be accurately defined and operationalised,
while data is to be accurately interpreted and categorised.
The last type of methodology is the indices which are discussed later in the
methodology section of this research. In the two following pages, Table 2 illustrates a
summary of the studies reviewed by Tay and Parker:
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In 1988 van der Tas provided his important paper about measuring
harmonisation. The importance of this paper was the newly developed technique for
measuring harmonisation. This paper aimed to determine when and to what extent
harmonisation had taken place at the level of some accounting practices in the UK,
the Netherlands and the USA. Another aim of the paper was to determine the impact
of some organisations such as the ASC, FASB, IASC and the EU on the process of
harmonisation Data for this study was collected from some national surveys, such as
the survey of ICAEW over the period 1968-1981 and some other surveys prepared in
the US and the Netherlands by national institutions. The practices chosen by van der
Tas to be examined in his paper are deferred taxes and investment tax credits. To
measure harmonisation van der Tas presented the Herfindahl index, which was
originally used to measure concentration and monopoly in industries. Two secondary
indices are developed from the H index for the purpose of measuring harmonisation in
the case of multiple reporting; the C index and the I-index. (See p38, p39)6
At the international level van der Tas found disharmonisation had taken place
between the US and the Netherlands, as each of the two countries had concentrated on
a different method. In the USA there had been an increasing application of the flow-
thorough method, while in the Netherlands the deferral method had been the preferred
method. In fact at the end of his study, van der Tas did not relate his results strongly
to the aims he stated at the beginning of the paper, such as measuring the impact of
the organisations mentioned above on the harmonisation process. However, what van
der Tas emphasised and analysed very well is the indices suggested for measuring
harmonisation.
6Details are in the methodology section in my research.
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After about four years in 1992van der Tas provided his second paper which
aimed to measure the degree of harmony of the deferred taxation accounting policies
of 154 European listed companies over the period 1978-1988. Furthermore, this study
explores the impact of the EC harmonisation endeavours in the context of the deferred
taxation issue. The methodology used by van der Tas in this study is developed from
the one he used in 1988. In addition to the C index which is used to measure
harmonisation, van der Tas suggested using multiple regression analysis to measure
the statistical significance of the impact of the ECs efforts (see p 49)7. Furthermore,
van der Tas in this study defended the use of his indices as they were criticised by Tay
and Parker (1990). At the same time he criticised the use of the Chi-square test which
had been suggested by them. Additionally van der Tas rejected the idea that three of
the other studies reviewed in the article of TP; Evans and Taylor (1982), Doupnik and
Taylor (1985) and Nobes (1987a) can be considered as attempts to measure
harmonisation. Van der Tas argues that these studies are measuring the compliance
with or observance of international standards. Furthermore, he is arguing that their
methods are not appropriate for measuring material measurement harmonisation, as
high compliance with the standards does not mean high level of material harmony. To
support his opinion van der Tas, explained that when an IAS allows various methods
and companies apply these methods, the degree of harmony may be low all the
compliance with the IAS is high. On the other hand, when all large companies choose
the same practice, the degree of harmony is high; nonetheless the degree of
compliance with the IASs may be low when that method is not permitted by the IAS.
The researcher indicated that the sample he used was not random and that the results
of his study cannot be regarded as a statistically valid estimate of the degree of
7Methodology section
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harmony of financial reporting. Because he believed that it should be considered as a
demonstration of the application possibilities of the methods of measuring
harmonisation.
3.1.2. More s tudies
During the nineties there were a number of studies which attempted to use different
techniques to measure harmonisation. Some of these studies introduced new
methodology, while some other used previous methods with some adjustments. The
following are a sample of these studies:
Emenyon u and Gray in 1992In this paper EG aimed to measure the level of
harmony in accounting practices between France, Germany and the UK under the
scope of the Fourth European Directive. They used the I-index of van der Tas (1988).
This study is considered to be important for the use of the non-parametric test Chi-
square to determine how significant the differences are in the accounting practices
chosen by a number of the largest companies in the three countries. In fact using this
statistical test was suggested by Tay and Parker in their critical article (1990). EG
chose to examine the methods of treating six accounting issues: Stock valuation,
depreciation, goodwill, fixed assets valuation, R&D and exceptional items, all of
which had been included in the Fourth European Directive. Their general null
hypothesis was that there is no significant difference in any of the methods used by
the companies in their sample to treat the six accounting variables. Data for their
study was obtained from the annual reports of 78 of the largest listed companies on
the stock markets of France, Germany and the UK for the 1989 financial year.
Emenyonu and Gray found that there were very significant differences in the
treatment of stock valuation, goodwill, fixed assets valuation and depreciation.
However, there was no significant difference in the treatment of
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extraordinary/exceptional items and it was not possible to test the treatment of
research and development, because of a lack of disclosure about this item. EG ran bi-
countries tests to get different results. For instance, there was no significant difference
in the stock valuation methods adopted by German and UK companies which means
the significance in the difference was caused by the French companies. The same test
was applied to goodwill treatment and again they found that there was no significant
difference in the German and UK choices. For the harmonisation measurements there
was a very low degree of harmony in the treatment of depreciation, which was
explained by the influence of tax accounting on French and German financial
reporting. A low level in harmony was in the treatment of goodwill was caused by
96% of the UK companies and 75% of the German companies writing off goodwill
immediately against 92% of the French companies amortising it over a period of time.
The main conclusion of EGs study was that there were significant differences, and a
lack of harmony which is found by using the I-index. However, there is no benchmark
yet available to test whether the levels of harmonisation measured were acceptable or
not.
Arc her et al in 1995measured harmonisation at the level of both within and
between countries. The countries chosen to be studied were Belgium, France,
Germany, Ireland, Sweden, Switzerland, the Netherlands and the UK; while the
practices examined in their study were the ones of deferred taxes and goodwill.
Although van der Tas had introduced the I-index to measure international
harmonisation and the C index to measure national harmonisation, the authors in this
paper chose to develop new technique using the c index. They decomposed the C
index into two indices; one was to measure comparability within countries; while the
other was to measure comparability between countries. The main purpose of this
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study, as it was stated by the authors, to study the impact of accounting
harmonisation on the financial reporting practices or policy choices of the companies
of our sample was not satisfied at all. Because the concentration in this paper was on
measuring international harmonisation between the samples countries, and nothing
was mentioned about the impact of accounting harmonisation on the financial
practices or policy choices. Data was collected from annual reports of some selected
large companies for the financial years 1986/87 and 1990/91. The researchers found
that there was a little progress in harmonisation at the level of deferred taxation and
consolidated goodwill between the eight countries over the period studied.
In 1995 Hermann and Thom aschose Belgium, Denmark, France, Germany,
Ireland, the Netherlands, Portugal, and the UK to measure harmonisation with respect
to selected accounting practices. These practices were selected according to two main
criteria. First, the policy choices must significantly affect measures of net assets and
profits. Second, the annual reports must contain sufficient disclosure to determine the
policy choices selected. Data examined is taken from the annual reports of 217
companies for the 1992/93 fiscal year. The general hypothesis of this study was that
there are differences in the frequency of accounting measurement policy choices
across the eight countries. However, the authors did not mention the significance of
these differences, although the methodology they chose is to measure significance.
The methodology employed was the same as used by Emenyonu and Gray (1992) (I
index and Chi-square). However, the I index in this study is developed to avoid the
effect of zero in cases where all the companies in a country applied one method (see p
42)8. From the conclusions of this study, we find the highest degree of harmonisation
is identified in the areas of foreign currency translation and stock valuation in addition
8see methodology section
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to the treatment of depreciation after excluding German practices. On the other hand
the accounting for research and development, fixed assets, goodwill and stock costing
is significantly different. Although Hermann and Thomas used the same methodology
used by Emenyonu and Gray before, the number of countries in this paper is larger
and more accounting practices are examined.
Rahman et al in 1996presented their study in which they aimed to measure
formal (de jure) harmonisation, where it was different from the previous studies
which concentrated on material harmonisation (de facto). However, what is measured
in this study is not harmonisation as a process, but just a state of harmony in the
context of the rules and regulations (both disclosure and measurement requirements)
between Australia and New Zealand at 30 October 1993. The methodology of this
study is confined to measuring the significance of the differences in the regulations,
using the statistical test called Mahalanobis distances. The writers suggested that the
results of this study can be used to see how much of the material harmony is
explained by the formal harmony by correlating the distances calculated in their study
with the differences of actual practice. Out from the 59 categories of requirements
tested 38 indicated a distance of 0 to 0.99; whereas 15 indicated a distance of one to
19.99. A distance of over 20 was just in six categories. These distance measures are
comparable to the 2R resulted in regression analysis. However, the authors did not
provide enough information to work as a guidance to show how to interpret these
ranks of distance measures.
In 1999 McLeay et alintroduced another new methodology in the field of
measuring harmonisation. They believed that international harmonisation will occur
by working a way from local regulations where firms would have; a free choice from
a set of international standards and to choose what is suitable to their own
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circumstances without being constrained by national conventions and regulations. In
other words they introduce harmony as the probability that a particular accounting
method will be used in given operating circumstances is identical across all firms in
all countries. Then measuring harmonisation is measuring this probability. Their
methodology was a series of models with different functions such as separating
harmonisation from standardisation; indicating systematic harmonisation (as it is
explained by the authors it is the reduction in disharmony that has occurred during a
period and is attributable to movement within countries towards international norms)
and non-systematic harmonisation. In my opinion, a shortcoming of this study is that
the authors do not provide simple examples to show how these models work. They
just show the results of their study without illustrating how the models were applied.
3.2 Methodology
3.2.1. Data this study aims to measure the material harmonisation (de facto)
between the largest listed companies in Germany, France and the UK; therefore the
most suitable source for data in this case is the annual reports of large companies,
which shows the actual accounting policies practised within these companies. The
annual reports used in this study are for the fiscal year 2001 because they are the most
recent annual reports available for most of the companies studied here. As a matter of
convenience, for the purpose of this study complete versions of annual reports
available on the internet were downloaded. Annual reports as a data resource are
criticised by Tay and Parker (1990) (see p24). The number of companies is 78
(Appendice1, 2, 3), which is equal to the sample used by EG (1992), so comparability
with their results will be reasonable. The companies are the selected from the Worlds
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largest 500 published by the Financial Times 9 . Choosing a sample from largest
companies guarantees benefits which might not be available for medium and small
companies; such as publishing documents in English. Furthermore, these companies
are the most likely to attract international investors for whom international
harmonisation is considered an important issue. Our sample here is not biased by any
sector. It is selected randomly from different sectors avoiding any effect which might
be caused by the nature of sectors on the policy choices made by these companies.
3.2.2. Statis tical analy si sThe methods employed here are two different ones, which have different functions.
These methods are the Chi-square test and the I-index. In this section I explain both of
them, showing the concepts behind them and how they work.
3.2.2.1. Ind ices
Employing Indices for the measurement of harmonisation was pioneered by van der
Tas (1988) where he introduced the Herfindahl index for the purpose of measuring
international harmonisation. To be more precise, what is measured is a state of
harmony at a certain point of time and subsequently harmonisation (the process) will
be computed by the difference between two dates.
3.2.2.1.1. Herfin dahl (H) ind exoriginally is a measurement of concentration
used by economists to measure the level of concentration in an industry and
calculated by summing the squared percentages of market share of all firms in that
industry. Applying this index in the context of financial reporting harmonisation
implies an analogy between the accounting harmonisation and industrial
concentration. Tay and Parker (1990) say that the validity of this analogy must be
discussed. Measuring industrial concentration determines the situation of a market
9annual publication by FT (see references list)
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between the two extremes of monopoly and perfect competition. The match with
monopoly in accounting is when all companies practise the same accounting method
(uniformity), whereas the match perfect competition is where every company is free
to choose a different accounting policy. Tay and Parker see that this situation is not
possible in reality. However, they think that a combination of accounting methods
used for the financial statements as a whole can be the match with a good in a perfect
competition situation- very few companies use identical combinations of accounting
methods). They suggest that some questions need to be answered, such as, when using
the concentration measurement in accounting, what is number of accounting methods
available for each accounting variable? Which ones should be considered (the ones
regulated or all the ones used in practice)?
The Herfindahl (H) index is calculated by weighting the relative frequencies of the
alternative options against each other. This means when the methods chosen by
companies involved concentrate more on one or only a limited number of alternative
methods, the H index will rise. A very small example here might help to show this
idea: Suppose that we have 100 companies and two accounting alternatives A and B.
Assume that in period 1, 50% of the companies applied the alternative A and the other
50% applied B. The H index will be: 5.05.05.0 22 H . If in period 2, 75% of the
firms applied method B, whereas 25% applied A, H will be: 22 25.075.0 0.6875.
It is clear from the example that H figure rose, because of more concentration on one
of the methods available.
Van der Tas (1988) found that the H index is unsuitable for multiple reporting (the
situation in which companies provide information that help comparisons with another
accounting policy) because each company can only be assigned to one of the
alternative accounting methods (see van der Tas 1988, p163). To overcome this
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problem he derived the C index and the I-index from the H index. The first is derived
to measure harmonisation within countries (national harmonisation), whereas the
latter (I-index) is derived to measure harmonisation between countries (international
harmonisation). These indices do not measure harmonisation as a process directly;
where they are used to measure levels of harmony at different points of time and
consequently the harmonisation would be the fluctuations in these levels.
3.2.2.1.2. The C indexmeasures the degree of comparability of financial
reports in a country as the ratio of compatible pairs of companies to the number
possible pairings. The compatible pairs are every two companies which follow the
same method or at least provide additional information to enable comparison. Van der
Tas (1992), defending against the criticisms of Tay and Parker (1990), argues that the
C index has three advantages. First, its measurement of the degree of harmony is
directly linked with to comparability; second, its capability with multiple reporting;
and third, its results can be used in an effective significance test to calculate the
significance of movements in the degree of harmony. The C index formula is as
follows:
nn
nai
i
i
C
2
1
2 )(
where:
ia The number of companies applying accounting method i
i The number of alternative accounting methods
n The total number of companies
However, the C index can be related to the H index by using the formula:
n
nHC
/11
/1
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3.2.2.1.3. The I-indexon the other hand is derived from the H index for the
purpose of measuring international harmonisation; it can be calculated by multiplying
the relative application frequency of a method in country A by the relative application
frequency of the same method in country B and subsequently by adding the results of
all alternative methods. In 1995 Archer et al decomposed the C index into two indices
to use at both levels, national and international. However, what we are using here is
the I-index, since it is the same methodology used by Emenyonu and Gray (1992).
The general formula of this index is:
I = ( )......( 21
1
ififif cm
i
) )1/(1 c
Where:
I= I index
fi Relative frequency of method i in country m
c = Number of countries
m = Number of alternative accounting methods
I index is calculated by multiplying across countries the proportion of firms adopting
a specific accounting option followed by summing up all these products for each
accounting method. Hermann and Thomas (1995) indicate that the I-index is not
meant to give a signal of the statistical significance of harmonisation, as it is a scale
upon which to quantify harmonisation for comparative purposes justifying the use of
the Chi-square test.
Van der Tas 1988 applied the I- index to compare accounting policies applied in two
countries. However, he realized that the application to more than two countries will
lead to a very small value of the I-index for the large number of frequencies and
subsequently will lead to a very unequal distribution of the I index over the interval 0-
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1 (the two points of time). Therefore in appendix 2 of his paper, van der Tas
suggested a correction factor )1/(1 m which is the exponent in the formula shown
above. The following is a simple example which will help to understand the way this
index works and to show the effect of the correction factor:
Assume that we are testing the use of two accounting methods 1m and 2m in two
countries 1c and 2c at two points of time 0 and 1. For more explanation assume that
in time 0 all companies in 1c choose the method 1m , while all companies in 2c
choose the method 2m . At time 1 the proportions of companies choosing 1m in the
two countries were 0.75 and 0.35 and the ones choosing 2m was 0.25 and 0.65
respectively.
Country Country
Time 0 1c 2c Time 1 1c 2c
1m 1 0 1m 0.75 0.35
2m 0 1 2m 0.25 0.65
In time 0:
I= 1001 = 0
In time 1:
I= )65.025.0()35.075.0( 0.43
As can be seen above the I index is between 0 and 1, whereas in the first case there is
no in common accounting practices between the two countries and the value is 0.
Complete uniformity would give an index value of 1. The I-index in the example
indicates the level of harmony between 1c and 2c at time 0 and 1. Thus
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harmonisation as a process is measured by the movement from 0 to 0.43 over the
period 0-1.
In the example shown we did not need to use the correction factor we mentioned
above; but if we assume that we have a third country the application of the index will
need the support of this correction factor. Using the previous example suppose that
the proportions of companies in a third country using 1m and 2m are 0.6, 0.4
respectively.
The I-index without correction: I = 4.065.025.06.035.075.0 0.22
The I-index with correction: I= ( 4.065.025.06.035.075.0 ) )13/1( =0.47
As can be seen from this addition to the previous example, excluding the correction
factor changes the value measured from 0.47 to 0.22. As we increase the number of
countries this value decreases because of adding more fractions. Therefore the
correction factor cancels the effect of this mathematical property.
The final problem with the I-index is its sensitivity to zero proportions due to the
multiplication process involved in the calculation of the index. This problem was
recognised by Hermann and Thomas (1995). Thus they suggested a simple
modification for the application of the I-index. This fault in the index and its
treatment can be illustrated through the next hypothetical example:
Assume that there is no company in 3c which follows 1m ; while there is no company
in 1c which follows 2m , whereas in 2c 50% of the companies practise 1m and the
rest practise 2m , in this situation the proportions will be as the following
Country
1c 2c 3c
1m 1 0.5 0
2m 0 0.5 1
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Calculating the I-index in this case gives the following result:
015.0005.01
It is clear that there is a degree of harmony between 1c and 2c . However, I is zero and
that is because of the multiplication property of the zero. Therefore the modification
suggested by Hermann and Thomas is to give the value of 0.99 for the proportion of 1
in the case of the unanimous method, and 0.01 for the proportion of 0 in the case of
non-practiced method (instead of 1 and 0 respectively). Applying this small
adjustment will give the following result:
( 2/1)99.05.001.001.5.099.0 0.00495
(see Hermann and Thomas 1995 for more examples of this).
3.2.2.2 Chi -squ are test:
This test is suitable to test whether data classified into categories will differ in
frequency from each other. For example people may be classified into categories
according to their opinion towards a certain subject e.g. in favour of, indifferent
to, or opposed to. The hypothesis to be tested in this situation is that these
responses differ in frequency. (see Siegel and Castellan 1988).
Application of The Chi-square test for k independent samples:
The Chi-square test can be used to measure the significance of differences among k
independent groups. Siegel and Castellan determined certain steps to be taken to
perform the Chi-square test:
1- arrange the frequencies in an kr contingency table where the kcolumns are
used for the groups (countries in our study) and the r rows for responses
(different accounting policies)
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2- Find out the expected frequency under 0H for each cell of the table. This
expected frequency ijE can be found by the product of the marginal totals
common to the cell and dividing this product by N which is the sum of each of
the marginal totals and represents the total number of independent
observations. (In our case it is the number of companies in a particular country
multiplied by the actual number of companies practicing a particular
accounting policy divided by the total number of companies in all countries).
In fact in the case of our study it can be easier to find the expected frequencies
as the number of companies examined in the three countries is equal. Thus the
ijE can be obtained by dividing the actual number of companies practicing a
certain policy into three equal proportions.
3- Calculate Chi-square statistic 2X and determine the degrees of freedom.
N
E
nX
r
i
k
j ij
ij
1 1
2
2
).1)(1( krdf
4- Determine the significance of 2X by finding the probability of 2X to occur
within dfand compare this by the value of (5%) (using the table of the
Chi-square distribution). So if this value falls in the rejection area (larger than
the critical value of
=0.5 and ).1)(1(
krdf ), the null hypothesis will be
rejected, which means there is a significant difference between the frequencies
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