MODULE 4 DEVELOPMENT OF INTERNATIONAL ACCOUNTING

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1 MODULE 4 DEVELOPMENT OF INTERNATIONAL ACCOUNTING

2 Outlines Economic Factors Influencing International Accounting Environmental Factors Shaping National Accounting Accounting in Less-developed Countries and in Emerging Economics International Harmonization of Accounting Accounting for Foreign Currency Transactions and Translation Analysis of Foreign Financial Statements

3 Economic Factors Influencing International Accounting 1. Sources of funding In countries with strong equity markets, accounting has focused on how well management runs the company (profitability), and is designed to help investors analyze the future cash flows and related risks. Instead, the credit-based system in which the bank is the main source of funding, accounting has focused on the protection of creditors through conservative accounting measurements. 2. Taxation In most countries, tax rules effectively set the standard because the company should record revenue and expenses in their accounts to claim it for tax purposes. While a separate tax and financial accounting, tax rules sometimes require the application of certain accounting principles. 3. Politics and Economics Association 4. Inflation Inflation causes the distortion of historical cost accounting and affect the propensity (tendency) of a State to apply the changes to the accounts of the company.

4 Economic Factors Influencing International Accounting 5. Levels of Economic Development These factors influence the types of business transactions are conducted in an economy and determine what is most important. 6. Level of Education Standard accounting practices are highly complex would be useless if misunderstood and misused. Disclosures about the risks of derivative securities will not be informative unless it is read by the competent authorities 7. Culture Four dimensions of national culture, according to Hofstede: individualism, power distance, uncertainty avoidance, masculinity. 8. Differences in magnitude and complexity of Business Companies Dichotomy between large and small companies continues, ranging from insurance, up to all the parent-child hierarchy, including the complexity of the problem. Large conglomerate that operates in a very diverse line of business requires financial reporting techniques that are different from small firms that produce a single product. Multinational companies are also requiring different accounting systems to accounting systems of domestic firms.

5 Environmental Factors Shaping National Accounting Choi et. al (1998: 36) describes a number of environmental factors are believed to have a direct impact on the development of accounting, among others: 1. Legal System Codification of standards and accounting procedures seemed natural and appropriate in countries that adhere to code law. In contrast, the formation of a non-legalistic accounting policies by the professional organizations which work in the private sector more in line with the prevailing system in common law countries (common law). 2. Political System The existing political system in a country, too. For example, the existing UK accounting during the turn of the 20th Century, exported to the Commonwealth countries. The Netherlands did the same to the Philippines and Indonesia, France to countries in Asia and African colonies. The Germans used to influence the political sympathies, among others, accounting in Japan and Sweden. 3. Economic development stage Countries still rely on the agricultural economy requiring accounting principles that are different from the advanced industrial countries.

6 Environmental Factors Shaping National Accounting contd In agricultural countries, the level of dependence on credit and long-term business contracts may still be small. So sophisticated accrual accounting is not useful and what is needed is a simple cash accounting. 4. Economic growth patterns Stable economic conditions encourage greater competition for existing markets that require a stable pattern of accounting and will be much different in countries where conditions are experiencing a prolonged war. 5. Status of Education and Professional Organizations In the absence of an organized professional accounting and accounting source of local authorities of a country, the standards of another area or another country may be used to fill the vacancy. Adaptation of the factors accounting from the UK is a significant environmental impact in the accounting world until the end of World War II. Since then, international adaptation process switch to U.S. sources.

7 Accounting in Less-developed Countries and in Emerging Economies A lesser-developed country (LDC) is a country that is considered lacking in terms of its economy, infrastructure and industrial base. The population of a lesserdeveloped country often has a relatively low standard of living, due to low incomes and abundant poverty. A lesser-developed country is usually poor, as measured by per capita gross domestic product, and un-modernized. LDCs rely primarily on agriculture as a source of income and industrial practices usually contribute to less than 10% of the nation s GDP. Many African and Arab nations are considered to be lesser-developed countries. Emerging Markets/Economies (EMs) are generally defined as nations whose economies are advancing toward becoming advanced. Such economies are considered to be in transition phase between developing and developed status

8 Accounting in Less-developed Countries and in Emerging Economies contd Problems associated with LDCs and Ems Poverty, rapid population growth, unequal income and wealth distribution, high levels of unemployment, regional unbalances, insufficient domestic savings, large foreign and/or domestic debt, low levels of technology, and a need to improve education. The effect of importing accounting systems of developed countries by LDCs and EMs are summarized under the following: 1. Different environments and needs 2. Different user groups 3. Market forces in LDCs and Ems 4. Acceptance of international accounting standards 5. Uses of financial statements in LDCs and Ems 6. Uniform accounting system for all LDCs and EMs

9 International Harmonization of Accounting The word harmonization appears to mean different things to different people. Some view harmonization as the same as standardization. However, whereas standardization implies the elimination of alternative in accounting for economic transactions and other events, harmonization refers to the reduction of alternatives while retaining a high degree of flexibility in accounting practices. Harmonization refers to the reduction of alternative while retaining a high degree of flexibility in accounting practices. Harmonization allows different countries to have different standards as long as the standards do not conflict. For example, prior to 2005, within the European Union harmonization program, if appropriate disclosures were made, companies were permitted to use different measurement methods: German companies could use historical cost for valuing assets, while Dutch companies could use replacement costs without violating the harmonization requirements.

10 International Harmonization of Accounting contd Arguments for Harmonization Proponents of accounting harmonization put forward several arguments. 1. They argue that comparability of financial statements worldwide is necessary for the globalization of capital markets. Financial statements comparability would make it easier for investors to evaluate potential investments in foreign securities and thereby take advantage of the risk reduction possible through international diversification. 2. It would simplify the evaluation by multinational companies of possible foreign takeover targets. 3. Harmonization would reduce financial reporting costs for companies that seek to list their shares on foreign stock exchanges. Cross-listing of securities and would allow companies to gain access to less expensive capital in other countries and would make it easier for foreign investors to acquire the company s stock. 4. National differences in corporate reporting cause loss of investor confidence, which affects the availability and cost of capital. Investors often build in a premium to the required return on their investment if there is any uncertainty or lack of comparability about the figures such premiums can be as large as 40%.

11 International Harmonization of Accounting contd 5. One set of universally accepted accounting standards would reduce the cost of preparing worldwide consolidated financial statements, and the auditing of these statements also would be simplified. Sixth, multinational companies would find it easier to transfer accounting staff to other countries. This would be true for the international auditing firms as well. 6. Harmonization would help raise the quality level of accounting practices internationally, thereby increasing the credibility of financial information. In relation to this argument, some point out that as a result of harmonization, developing countries would be able to adopt a ready-made set of high-quality standards with minimum cost and effort. Arguments against Harmonization The greatest obstacle to harmonization is the magnitude of the differences that exist between countries and the fact that the political cost of eliminating those differences would be enormous. As stated by Dennis Beresford, former chairman of the Financial Accounting Standards Board (FASB), high on almost everybody s list of obstacles is nationalism. Whether out of deep-seated tradition, indifference born of economic power, or resistance to intrusion of foreign influence, some say that national entities will not bow to any international body. Arriving at principles that satisfy all of the parties involved throughout the world seems an almost impossible task.

12 International Harmonization of Accounting contd Not only is harmonization difficult to achieve, but the need for such standards is not universally accepted. As stated by Seagram s chief financial officer, Richard Goeltz: Full harmonization of international accounting standards is probably neither practical nor truly valuable. It is not clear whether significant benefits would be derived in fact. A well-developed global capital market exists already. It has evolved without uniform accounting standards. Opponents of harmonization argue that it is unnecessary to force all companies worldwide to follow a common set of rules. They also point out that this would lead to a situation of standards overload as a result of requiring some enterprises to comply with set standards not relevant to them. The intentional capital market will force those companies that can benefit from accessing the market to provide the required accounting information without harmonization. Yet another argument against harmonization is that because of different environmental influences, differences in accounting across countries might be appropriate and necessary. For example, countries that are at different stages of economic development or that rely on different sources of financing perhaps should have differently oriented accounting systems.

13 Accounting for Foreign Currency Transactions and Translation Definitions The following terms are used in this Statement with the meanings specified: Foreign Currency is any currency other than the domestic currency, the Naira. Conversion is the process of expressing a foreign currency amount in Naira by the use of an appropriate rate of exchange. Translation is the restating of accounting balances of foreign operations at their equivalents in Naira. Exchange Rate is the rate at which the currency of a country is exchanged for the currency of another country. Some exchange rates that are used in practices are presented below:- Official Exchange Rate is that established by the appropriate governmental agency for eligible transactions. A country may have several official rates, each of which is designated for use for a particular economic activity and which also reflects governmental policies with respect to desired economic goals. Spot Rate is the exchange rate prevailing on a particular day. This is usually the rate used to settle accounts at the end of the day for immediate delivery of currency.

14 Accounting for Foreign Currency Transactions and Translation contd Closing Rate of Exchange is the exchange rate ruling at the balance sheet date. Forward Rate is the rate quoted or agreed upon now for future delivery of currency between the parties involved. A Foreign Entity is said to exist where the activities of a branch, a subsidiary, an associated company or a joint venture do not form an integral part of the activities of the related enterprise in Nigeria. Steps in preparing Financial Statements of a Foreign Subsidiary 1. Translate the financial statement of the foreign subsidiary. In balance sheet use the closing rate method according to SAS 7 as recommended. 2. Re-draft the financial statement of the foreign subsidiary using the home currency and consolidate with the result of the holding company. 3. Calculate the exchange rate loss or profit. 4. In consolidating the profit and loss translate the profit and loss account using the closing rate method or the historical rate. 5. In case of any foreign exchange profit, this should be consolidated in the, Consolidated Profit and Loss because it is an exceptional item.

15 Accounting for Foreign Currency Transactions and Translation contd ICT Ltd. has a subsidiary, Computer Ltd (located in New York). The financial statements of the holding company and its subsidiary, Computer Ltd are as follows:: Balance Sheet as at 31/12/05 ICT Ltd. COMPUTER Ltd. Fixed Assets: N 000 $ 000 Land & Building 500,000 3,000 Furniture & Fittings 400,000 1,500 Motor vehicle 300,000 1,200 Investment in HighTech Ltd 2,000, ,200,000 5,700 Current Assets: Stock 200,000 1,000 Debtors 800, Bank 1,000, Total Assets 5,200,000 8,200 Financed by: Ordinary shares 4,000,000 6,000 P & L 1,200,000 2,200 5,200,000 8,200

16 Accounting for Foreign Currency Transactions and Translation contd Additional information: i) ICT Ltd acquired 70% of the Ordinary shares in HighTech Ltd on 31/12/02 when the P&L account of HighTech Ltd $1,100 dollars. ii) The following relevant information has been extracted from the Nigerian foreign exchange market index in relation to the exchange rate. 31/12/02 N100 to $1; 31/12/05 N110 to $1; 1/1/02 N105 to $1 All the fixed assets were purchased by the holding company and subsidiary on 1/1/02. Liabilities were incurred on the same date. Required: a). Translate the above financial statement using: (i) Closing rate method. (ii) Temporal/Non-current method (iii) Monetary and Non-monetary method. b). Prepare the consolidated Balance sheet of ICT Ltd and its subsidiary HighTech Ltd.

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19 Review Questions 1. Critically examine the environmental factors that influence national accounting development and illustrate the ways in which these factors shaped the practice of accounting in Nigeria. 2. What are the reasons for accounting diversity across the globe? 3. Enumerate the consequences of accounting diversity? 4. What are the various strategies put in place to ensure uniform Accounting and Harmonization of Financial Reporting? 5. Accounting is an Information and communication system required for decision makers at national and international levels. However, the lack of objectivity in the preparation and presentation of financial statements have succeeded in misinforming stakeholders and enormous losses were suffered by organizations. Required: a) Identify the critical reasons for the imbalance between the goal of accounting as a language of business and effective decision making. b)suggest solutions to these anomalies.

20 Review Questions 6. The profit and loss account of Adebayo Ltd. and its subsidiary Joel Ltd (based in South Africa) are as given below as at 31/12/05. Adebayo Ltd. Joel Ltd. N R Turnover 30,000, ,000,000 COGS (12,000,000) (200,000,000) Gross profit 18,000, ,000,000 Admin cost (2,000,000) (50,000,000) Selling & Distribution (3,000,000) (40,000,000) Operating profit 13,000, ,000,000 Taxation (3,900,000) (33,000,000) PAT 9,100,000 77,000,000 Dividend (2,100,000) (7,000,000) Retained profit 7,000,000 70,000,000 Additional information a)the power value of ordinary shares in Adebayo & Joel Ltd are N1 and R1 respectively. Adebayo acquired 1,000,000 shares from the total of 1.5 million shares available in Joel Ltd on the 31/12/03, when the net profit and loss account of Joel Ltd stood at R30,000,000.

21 Review Questions b) It is the policy of the company to convert P&L items at the average of exchange rate. c) The dividend due to Adebayo Ltd is yet to be recognized or recorded in books of account. d) On 31/July/05 John Ltd paid on interim dividend of R4,000,000 and proposed the balance at the end of year. The following data has been extracted from the foreign exchange market: R to 1 as at this date 31/Dec. 05 R110 to N1 31/July 05 R110 to N1 Average Rate R105 to N1 Date of acquisition rate of exchange R102 31/12/05 7) Below are the balance sheet extracts of the company: N N Cash 7,089,000 3,000,000 Debtors 300, ,000 Prepayment 560, ,000 Bills receivable 480, ,000 Creditors 690, ,000 Accrued Expenses 470, ,000 Required: Prepare the Cash Flow Statement using: Direct and Indirect Method.

22 References Adejola, P. A (2010): Revision Pack on Advanced Corporate Reporting for Professionals, Conversion and Undergraduate Students, Danladi Press, Abuja. Adejola, P. A. (2011): Financial Accounting and Reporting Standards for Students and Professionals, Revised Edition Aborode, R. Advanced Financial Accounting, Lagos: Masterstroke Consulting Biggs, W.W. & Perrins, R.E.G. Spicer and Pegler s Book-keeping and Accounts, H.F.L Jennings, A. R., Financial Accounting Manual 1 & 2, DP Publications Okwoli, A. A., Principles of Financial Accounting, 3 rd Edition, Jos: Gogo International Ltd. Wood, F & Sangster A. Business Accounting 2 - Pitman Inter 10th Ed 2005.