TURKU SCHOOL OF ECONOMICS
AND BUSINESS ADMINISTRATION
Department of Accounting and Finance
HARMONISATION AND INFORMATION CONVEYED
IN FINNISH ANNUAL REPORTING
Lic. Sc. Niko Lappalainen
07 March 2016
Rehtorinpellonkatu 3, FIN–20500 Turku. Tel. +358 2 3383 11. Fax +358 2 3383 292
2
TABLE OF CONTENTS (preliminary)
1. INTRODUCTION .......................................................................................... 3
1.1 Accounting Law 1993 and 1997 in Finland .......................................... 5
1.2 Research question, aim and scope ......................................................... 6
1.3 Selection of data ..................................................................................... 8
2. HARMONISATION ...................................................................................... 8
2.1 Definition of harmonisation ................................................................... 8
2.2 Formal harmonisation – material harmonisation ................................... 9
3. DISCLOSURE INFORMATION .................................................................. 9
4. DATA AND METHOD ............................................................................... 11
4.1 Data ...................................................................................................... 11
4.2 C-index ................................................................................................. 11
4.3 The Conception of an accounting method ........................................... 12
(4.4 Disclosure index
4.5 Disclosure score-sheet
4.6 Survey of institutional investors
4.6.1 Settings
4.6.2 Effect of change in harmonisation
4.6.3 Effect of change in information
1.4. INSTITUTIONAL SETTINGS
1.4.1 Historical perspectives in Finnish accounting Law progress
1.4.1.1 FAS
1.4.1.2 EU
1.4.1.3 IAS
1.4.2 1992 law change
1.4.3 1997 law change
6. EMPIRICAL EVIDENCE
7. CONCLUSION)
3
1. INTRODUCTION
The corporate annual report can be seen as a very important device for diminishing
information gap between management and shareholders (and stakeholders too). Van
der Tas stated (1988): Many national and international organisation, such Accounting Standards Committee, the Financial Accounting Standards Board (FASB), the
International Accounting Standards Committee (IASC) the European Community
(EC), and also governments, are currently engaged in the process of national and
international harmonisation of financial reporting. And now it is new millennium
and the debate is still going on and it will go on in the future. The harmonisation
that has been taken place for past twenty years has not been as fruitful as planned.
The differences across countries appear largely unaffected by legislation enacted in
response to the European Union (EU) directives, which were intended to create an
integrated set of reporting standards to serve as a basis for cross-listing and facilitate
cross-border investment. Because the directives require a unanimous consent of
member countries, they tend to develop slowly and allow member states substantial
flexibility in the implementation of the directives into national law (Joos and Lang
1994, 141, 146). This is one reason why the progress of harmonisation has been
very slow in EU. Directives also allow member states a lot of flexibility of choosing
accounting methods and it is also possible that the member states may have adopted
EU-directives, but neither annual reports nor accounting standards does not have to
be harmonised with each other.
As Herrmann and Thomas (1995, 253) stated, there are three primary questions of
interest in the area of accounting harmonisation: Is there a need for harmonised accounting practices? What are the most favourable factors and most obstructive to
the harmonisation process? And to what extent are current practices harmonised? In
this study the attempt is to solve the last question with Finnish data, because no
fundamental analysis of the state of Finnish financial reporting has been made in
recent years. Furthermore there has been going on several changes, which may affect the Finnish measurement practice. The first of the major changes was the new
Accounting Law 1992. The second change is connected to the adoption of the 4th
and 7th EU-directives into the 1992 law. The third change took place in the form of
the recent Accounting Law 1997, in which the problems with EU-directives of Accounting Law 1992 are solved.
Over the last years in Finland there has been two major legislative changes in Finnish accounting law, which has been carried out to improve and harmonise the Finnish financial reporting practise. Lappalainen (1999) attempts to determine the level
of accounting harmonisation in Finland by measuring selected measurement practices from 1990/1991 and 1994/1995 annual reports of Finnish companies. He
found out that the measurement practices were mostly harmonised, but in some
practices occurred disharmonisation.
Finland has been one of the few countries in the world, which are using a theory as
a basis for accounting practice. Majala (1994, 76) states that there has been three
phases, paradigms in Finnish accounting practice:
4



Balance sheet equation conception
Expenditure – revenue – theory
European Accounting
Majala refers to the concept of a paradigm, which is the set of assumptions and
principles on which a branch of knowledge is based; for example he considers that
Martti Saario’s Expenditure – revenue – theory was the paradigm on which Finnish
financial reporting was based in the 1970s (Flower 1994, 275). Following Majala’s,
idea Flower distinguishes five paradigms, which are illustrated in figure 1. The view
of Finnish financial reporting differs among these authors, but they are very close.
The main point is that they agree on last phase, which is European paradigm. The
first, the German paradigm is the same what Majala calls balance sheet equation
conception, which was developed in German. In between these was the Nordic
phase, in which Nordic countries attempted to create a common accounting practice.
The third phase was then Martti Saario’s Expenditure – revenue – theory, which is
still the base of Finnish accounting practice. After that came IAS-phase due to Multinational enterprise’s needs to operate in several markets, implying the fact that the
Finnish accounting standards were not enough harmonised with the standards used
for example in United States and Great Britain.
EU
IASC
NORDIC
SAARIO
GERMAN
1930
1940
1950
1960
1970
1980
1990
2000
Figure 1. Flower (1994, 274): The prevailing paradigms in Finnish financial reporting
Now after the latest legislation change in 1997 it seems that the paradigms are still
the same although the future direction might be towards IAS-standards due the new
direction of the EU-commission. That will change the places of the two lines: IASC
and EU.
5
1.1 Accounting Law 1993 and 1997 in Finland
Accounting regulations expressed in various ways – in statute law and/or through
professional standards, through self-generated standards of acceptable practice. In
many countries accounting regulations originate from a combination of these
sources. (Tay and Parker 1990, 75) Finland is code law country, which mean that
we rely on statute law, although we have professional body KILA that gives recommendations and rules. Companies do comply with these recommendations voluntary in order to improve their financial reporting.
Underlying the new Finnish accounting law was the fact that Finnish accounting
standards did not match the needs of the users of financial reporting information.
Finnish companies became rapidly international companies after mid 1980´s. In this
situation the underlying theory was in many respects different from the accounting
practices of the other countries. At this point of the accounting law renewal 1993
there were three approaches to renew Finnish standards:



To evolve existing theory
To apply the IAS-standards
To adopt the EU-Directives
These routes to accomplish a better base for the accounting law were not separate
but very much intertwined. As an outcome of this “accounting-reform” we have in
Finland a measurement practice where the directives are above all as a overriding
rule and in the bottom there is still a theory base. Any enterprise can also use IASstandards if they are not against EU-directives. For the Act reform a committee was
set to work. Picture 2 illustrates the insight to committees work. As result of this
committee’s work Finland adopted EU-directives and still was able to keep theory
as basis of accounting practice.
Old theory based measurement practice
Renewal of existing
theory
International Accounting
Standards
The bond between accounting and taxation
Branch harmonisation
Propositions for the Law Renewal
New Accounting Law
The structure of Finnish accounting
standards
EU-directives
The relationship to other standards,
laws and acts
6
Figure 2. A framework for committee Accounting Act 1993
In the present situation we know that the changes in that point were insufficient and
1995 there were a need for new committee. Accounting law 1997 was put up to fulfil the aim and needs of the European Union 4th and 7th directives. Surprisingly even
this wasn’t enough and now the discussion has turned into International Accounting
Standards (IAS). What is left of the Saario’s theory is the pedagogical use and understanding the big picture of accounting and bookkeeping, unlike the Accounting
Law is concerning mainly the financial reporting.
Non-compliance with accounting regulations from different sources has different
consequences. Compliance with a legal regulation is compulsory, and noncompliance has legally defined repercussions – for example, the directors of the
company may be fined or even imprisoned. Non-compliance with a professional accounting standard with exactly the same requirement may have no such legal consequences, so that compliance is of a more voluntary nature. European Community
Directives, once they have been enacted into the relevant national legislation, falls
into the first category, while compliance with IAS issued by IASC falls into the
second. (Tay and Parker 1990, 75)
1.2 Research question, aim and scope
The aim of this study is to analyse recent changes in Accounting Law 1997 in Finland and measure the state of harmonisation and level of information in Finnish financial reporting before and after legislation change. The level of harmonisation is
measured by using Van der Tas C-index in several measurement practises and the
level of information is measured by scoring selected disclosure items. After the
recognition of the states of harmony and information is time to conduct a survey in
which institutional investors’ opinions are analysed. The major point is to find out
in survey whether the legislation change has been in any relevance.
This study has two main research questions:
Has the New Accounting Law 1997 harmonised corporate annual reports?
Has the New Accounting Law 1997 had an impact on the information content
of corporate annual reports?
Has the New Accounting Law 1997 had a relevance to institutional investors?
7
Harmonisation and information conveyed in
Finnish annual reporting
Information content of annual
reports
Harmonisation of annual
reports
H0: There is no change in the
level of information
H0: There is no change in the
level of harmonisation
H1: There is an increase in the
level of information
H1: There is an increase in the
level of harmonisation
Agency theory and asymmetric information
Method1:Disclosure index
Method2:Harmonisation index
Data: 70 Finnish Firms’ Annual Reports from the years 1994,
1995, 1998, 1999 - after and before Finnish Accounting Law
change 1997
Regulation: Changes in annual reports due the Accounting Law 1997
Method 3. A interview study to measure institutional investors’
opinions whether the changes has been in any relevance.
Possible results: 1) Information has increased after the
legislation change. There might be several reasons for that,but
in most of the cases the reasons can be found from the change
of legislation. 2) Harmonisation has increased due the
legislation in several measurement practises. Some of the
practices lag proper legislation which causes disharmonisation.
3)Institutional investors’ opinions proved that increased
information and harmonisation are relevant issues. “If a
company’s accounts are perceived as more transparent, capital
is more likely to stay loyal to that company in the longer term.”
Figure 3. Research design in short
8
1.3 Selection of data
Figure 2. Exclusion of the biased years
Biased years, namely year before change and the first year after the law is on effect
are excluded from the data. These years might be biased due three reasons:
 Companies are trying to adopt legislation in advance hoping to
achieve some benefit.
 During the process of legislation change there might occur some
misunderstandings etc. which might effect during the new law implementation process. That’s why the first year of accounting law on
effect is excluded.
 Some of the companies are adopting the same accounting methods
as its rivals, this process might take the first year the new law is on
effect.
2. HARMONISATION
2.1 Definition of harmonisation
Financial reporting is a communication process. A company translates the events
that influence its financial position and affairs into its financial report so as to provide users with information about its financial position and affairs. The translation
process is based upon the company’s accounting policies. As part of these policies a
company decides whether to translate a particular event in its financial report and
which accounting methods to apply. When formulating an accounting policy the
company’s choice between alternative degrees of disclosure and alternative accounting methods is restricted by standards. Standards will be defined as any finan-
9
cial reporting rule published by either government or a private standard setting
body. These standards can refer either to the degree of disclosure or to the accounting method to be applied. Harmonisation is co-ordination, a tuning of two or more
objects. Users are confronted with several financial reports. It would be useful for
then if these financial reports were more in harmony. Therefore, financial reports
are a target of harmonisation.
2.2 Formal harmonisation – material harmonisation
Tay and Parker (1990, 73) distinguish between de jure harmonisation and de facto
harmonisation. The former is harmonisation of rules and standards. The latter refers
to the actual practices of companies. Van der Tas (1988, 158) defines former as
formal harmonisation and the latter material harmonisation. The harmonisation of
financial reports or standards can refer either to the degree of disclosure or to the
accounting method applied. Harmonisation of the extent of disclosure will be called
disclosure harmonisation, while harmonisation of the applied accounting methods
will be called measurement harmonisation. As a conclusion Van der Tas (1988)
reached following definition:
Material measurement harmonisation is an increase in the degree of comparability and means that more companies in the
same circumstances apply the same accounting method to an
event or give additional information in such a way that the financial reports of more companies can be made comparable.
In this study the aim is to measure existing practice, which is studying material, de
facto harmonisation. As Ball, Kothari and Robin (2000) states that there is several
advantages studying actual reporting over simply studying the standards. Much accounting practice is not determined by rules, for reasons that include: practice is
more detailed than rules; rules lag innovations in practice; and companies do not
invariably follow the rules. The extent to which accounting practice is determined
by formal standards varies internationally, and the incentive to follow accounting
standards depends on penalties under different enforcement institutions, so studying
accounting rules per se is incomplete and potentially misleading in an international
context.
3. DISCLOSURE INFORMATION
The widely impact of corporate disclosure on market values and stakeholders’ perceptions does not directly indicate the ultimate beneficiaries of disclosure. Does disclosure primarily benefit financial analysts in reducing their costs of search for information, or competitors who learn about the company and its plans, or just the sophisticated investors with ready access to the new information? While the above
might occasionally benefit from disclosure, the major beneficiaries are, in general,
the company’s managers and its stakeholders. Two largely unappreciated phenome-
10
na lead to this conclusion: disclosure has a significant effect not just on outsiders
but also on managers’ decisions and corporate activities; and a substantial and permanent information gap generally exists between company insiders and outsiders.
(Lev 1992)
Disclosure affects company activities. The information disclosed by a company
and sometimes the absence of disclosure, affect outsider’s perceptions of its economic condition and future prospects. These perceptions, in turn affect key decision
variables, such as the company’s cost of capital and input prices. For example,
when the performance of a company or its financial health are under-appreciated by
investors due to incomplete information, the securities of this company will be under valued, leading to low prices and high yields (cost of capital) for new stock and
bond issues. The detrimental effects of low capital market valuations and negative
investor sentiments are not restricted to new securities issue. It is well known, for
example, that bank loan officers consider firm’s capital market performance determining the cost of loans. Similarly, large suppliers and customers watch the company’s market performance and analysts’ reports when considering terms of trade. The
high cost of capital resulting from low valuations and negative perceptions will depress earnings and cause managers to forego beneficial investment opportunities,
impeding the firm’s growth and its ability to compete- These consequences of inadequate disclosure will obviously have detrimental effects on the company’s managers and its stakeholders. (Lev 1992)
Permanent Information gap – The above-outlined benefits of an active disclosure
policy might be questioned on the grounds that investors, customers, and suppliers
have strong incentives to obtain company-specific information. Therefore, there
seems to be no need for an active corporate disclosure policy – sooner or later the
truth will come out. This is yet another misconception. Economic theory has recognised that without active disclosure the truth may never come out – a permanent information gap generally exists between outsiders and insiders. This view is clearly
espoused in agency theory, which focuses on conflicts of interests between principals and agents and examines the adverse consequences of such conflicts as well as
the mechanisms aimed at mitigating them. (Lev 1992)
Agency theory postulates that firms’ values are permanently depressed by the cost
of the agency relationship, since investors aware of the conflict of interests will not
be willing to bear the costs resulting from them. While agency costs are present in
all public companies due to the inherent separation of ownership from control, the
magnitude of these costs and the consequent depression of market values vary considerably across firms, depending, among other things, on the costs and difficulties
outsiders encounter in evaluating (monitoring) managers’ performance. Accordingly, a disclosure strategy that effectively disseminates timely relevant and credible
information, allowing outsiders to evaluate the firm and its management in an effective low-cost manner will not only narrow the information gap but will create
shareholder value by decreasing the agency costs which depress values. Such value
creation by disclosure is permanent and not just a correction of a temporary undervaluation. The detrimental effects of agency costs extend beyond capital markets.
When managers, for example, are perceived to maximise short-term earnings at the
11
expense of long-term growth, employees’ and suppliers’ confidence in the firm’s
survival will deteriorate. Credible, well-planned communications can allay such
stakeholders’ concerns, leading to improved positioning of the firm in the labour,
input and output markets. (Lev 1992)
To summarise, information disclosure is not indifferent, in principle, from other major corporate activities. Absent an active, well-planned disclosure policy there is no
assurance that the full value of the firm’s other activities will be recognised by outsiders. Information disclosure can create value in two ways: directly, by narrowing
the information gap (asymmetry) thereby decreasing investors’ uncertainty about
the firm (agency costs); indirectly, by enhancing value creating activities through a
reduced cost of capital and improved suppliers’ and customers’ terms of trade. It is
important note that the detrimental consequences of the information gap and agency
costs are particularly pronounced for companies which for certain reasons are not
prominent in the public’s mind set. Consequently, the benefits of a disclosure strategy will be particularly large for such companies. (Lev 1992)
4. DATA AND METHOD
4.1 Data
Study, which measures harmonisation of disclosures in one country, is a research of
national harmonisation. The data used in this study are from 280 annual reports
published 1994, 1995, 1998 and 1999 by largest 100 Finnish companies. Two sub
periods are made, namely before and after the Accounting Law 1997 reform. As a
result we know what was the state of harmony before New Accounting Law and
after. There is several different methods measuring the harmonisation. In this
section the aim is to analyse these methods with using a narrow sample of data.
4.2 C-index
Van der Tas (1988, 159) uses Herfindahl index to measure the degree of concentration. This index is calculated by weighting the relative frequencies of the alternative
opinions against each other. As a results we have an index value, which fluctuates
between 0 and 1. The value is zero when there is no concentration and the value is
one when total concentration occurs. Van der Tas (1988) uses following example to
illustrate the use of H index:
Method
Period
A
B
H Index
1
0,5
0,5
0,52 * 0,52 = 0,5
2
0,7
0,3
0,72 * 0,32 = 0,58
3
0,9
0,1
0,92 * 0,12 = 0,82
12
This very simplified example, but shows that H index increases when concentration
around method A increases. The advantage of the index is that it is simple and easy
to calculate.
4.3 The Conception of an accounting method
As a prerequisite for discussing the definition of comparability of financial accounting information, the notion of accounting method has to be agreed upon. Since
comparability of information is dependent on its contents, the concept of accounting
method comprises all methods of collecting and transforming information, which
influence the contents of the annual accounts. (Krisement 1997)
To begin with, the recognition methods form part of the accounting methods. If
events of some distinct kind are recognised in the annual accounts of an enterprise,
while another enterprise does not recognise similar events in its accounts, comparability of information referring thereto is impaired. Moreover methods of valuation
and income determination are accounting methods as well (van der Tas, 1992a: 7071; 1992b: 408; 1992c: 13, 36, 46).
Furthermore, the contents of financial accounting information are influenced by the
choice between alternative disclosure policies. If information on specific kind of
events may be disclosed separately or combined with information on events of a different kind in a summary item, the latter alternative results in less detailed financial
accounting information than the first one. However, if supplementary notes are added which allow breakdown of the summary item, the degree of detail of financial
accounting information is not affected by the choice between the two alternatives
which, in this case, is a matter of presentation and not of disclosure policy. Therefore, alternatives of disclosure are looked upon as accounting methods, whereas alternative methods of presentation are not. Depending on which kind of accounting
method is under consideration comparability may be characterised as concerning the
recognition, valuation, income determination or disclosure alternatives applied to
collect and transform information on specific transactions or events. (Krisement
1997)
4.3.1 Measurement practices
As results of this study is the analysis different measurement practices in the financial statements. These measurement practices are illustrated in scoresheet.
13
APPENDIX 1. HARMONISATION SCORESHEET
Annual report accounting methods- scoresheet
Date of entry
Date of recheck
Firm
Year
________
________
________
________
Harmonisation in financial statements accounting methods
1. Fixed Asset Valuation
 Historical Cost
 Modified historical
2. Depreciation
 Straight-Line
 Straight-Line and declining balance
3. R&D
 Expense
 Capitalise
4. Inventory valuation methods
 Lower cost / market
 Cost
 Market
5. Inventory costing methods
 FIFO
 LIFO
 Combination
6. Retirement benefits
 Benefit valuation methods used A
 Benefit valuation methods used B
7. Consolidation: Method used to measure minority interest
 As its proportion of the pre-acquisition carrying amount of the net assets
or fair value of the net assets.
 The amount of acquisition (as cost)
8. Consolidation: business combination
 Purchase acquisition method
 Pooling of interest method
9. Consolidation: Goodwill
 Write-off
 Capitalise
10. Consolidation: Foreign currency translation of foreign subsidiary assets and liabilities
 Current
 Current/historical
11. Consolidation: Foreign currency translation of foreign subsidiary revenues and expenses
 Average/actual
 Current
12. Consolidation: Treatment of translation differences
 Reserves
 Income