Chapter 3 Major International Differences in Financial Reporting
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Major International Differences in Financial Reporting Chapter 3 ACC 4305 ACC4305 Michel Leseure Accounting Formats Differences in Financial Reporting ACC4305 Michel Leseure Accounting Formats • Display order of the accounting elements – Linked to the existence of a regulation – And to the targeted audience (shareholders’ orientation) • Shape (configuration) of the balance sheet ACC4305 Michel Leseure Analysis of Annual Reports Should Include Four Questions Regarding Format At what level is the company reporting? • In the UK and the USA, consolidated accounts have been the rule for many years • Some countries still provide separate statements for parent and subsidiaries Which statements are present? What is the flow of the statements? • Reading from top to bottom, which items are first and which last? Is there any netting or subtotals as we go along? ACC4305 Michel Leseure A Comparison of Reporting for Three Major Corporations H J Heinz Consolidated Consolidated Statement of Income and retained Earnings Consolidated Balance Sheet British Telecom Group Group Profit & Loss Account Group Cash Flow Statement Level of Detail Consolidated Statements of Cash Flows Statement of Retained Earnings(part of Income of Income Statement) High Subtotals of Income Net Income Entity reported on Statements reporting income and expenses Statements reporting assets, liabilities and equity Statements reporting cash flow Other Statements Group Balance Sheet Group Statement of Total Recognised Gains & Losses (separate) Low - lots of summary headings Net Income Philips Group Consolidated Statement of Income of Group Consolidated Balance Sheet of Group Consolidated Statement of Cash Flows of the Group None Lowest Net Income ACC4305 Michel Leseure A Comparison of Reporting for Three Major Corporations Subtotals in the Balance Sheet H J Heinz Assets; Liabilities and Owner's Equity British Telecom Computation of Net Current Assets Total Current Assets Less Current Liabilities. No bottom-line. Similar to US Philips Assets; Liabilities and Owner's Equity Subtotals in the Cash Flow Statement Cash from various sources Order/Flow of Statements - Income Order/Flow - Balance Sheet Revenue>>>Expenses Turnover>>>Expenses Sales>>>Expenses Current>>> Less Current Long Term>>> Short Term >>> Net Long Term>>> Short Term Similar to US ACC4305 Michel Leseure Uniformity and Accounting Plans • Uniformity of reporting can be required in: – Formats of financial statements – Accounting principles – Disclosure requirements • But accounting plans may vary from one country to another ACC4305 Michel Leseure Fairness Differences in Financial Reporting ACC4305 Michel Leseure Fairness • Some accounting regulations require fairness in financial reporting – UK was one of the first EU country to require fairness – Fairness means faithfulness to economic reality, i.e. financial reports do not « mask » economic events • Problem of substance over form – Do you grant some flexibility to present a fair view? – Or do you regulate the form of financial reports, at the risk of twisting economic realities? ACC4305 Michel Leseure Example of a Fairness Issue • Airlines companies typically own the airplanes they operate • This means that airlines companies are capital-intensive and show high fixed assets (as a % of total assets) • Some companies started to lease airplanes ACC4305 Michel Leseure Example of a Fairness Issue • Leases are equivalent to renting a capital good • Typically, they are not capitalized – since there is no ownership, there is no assets – only an expense charged to the Income Statement every period • US accountants considered this practice as unfair, and mis-representing the capital intensive nature of activities of airline companies – Statement passed to capitalize certain leases ACC4305 Michel Leseure Substance over Form • US accountants: Initiated the trend toward preferring substance over form – Fairness is defined by GAAP and the general framework for accounting – In Europe, fairness is theoretically an over-ridding concept • Replacement cost accounting in the Netherlands – Stems from a fairness concern (true representation of value) • Germany – Preference for following legal requirements, independently of fairness issues ACC4305 Michel Leseure Fairness and Perfect Information Reporting Reporting Value of The Firm rf ec Financial Impact of Fact + Pe - tI nf or m at io n R ep or tin g Li ne + Figure 3.2.2 Perfect Information Reporting Line ACC4305 Michel Leseure Reporting Value of The Firm + Enron Enron Overly reporting earnings Pe r R fec ep t I or nf tin or g ma Li tio ne n Mark to Market of Investments in derivatives “Mark to Enron” (Bonus inflation) Severe losses but not report Hiding liabilities and losses in “Special Purpose Entities” Off balance sheet Financial Impact of Fact + - Figure 5.2.1.1 Enron Reporting Profile ACC4305 Michel Leseure Conservatism Differences in Financial Reporting ACC4305 Michel Leseure Conservatism and Accruals • Conservatism is another adversary to fairness – Important differences in reporting result from a more or less conservatism in analysis – Notion of « prudence » in the UK, – “Principe de prudence” in French Accounting • Note: these differences can be observed nationally between private and government businesses ACC4305 Michel Leseure Conservatism • Accountants “anticipate no profit, but anticipate all losses” • FASB Statement No.2: – Conservatism is “a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered” (FASB, 1980, p. 10) • APB Statement No.4 – describes conservatism as a preference for possible error in measurement to be in the direction of understatement rather than overstatement of net income and net assets (AICPA, 1970) ACC4305 Michel Leseure Example of Divergences in Conservatism • Should R&D expenses be capitalized? – Okay in certain conditions in UK accounting standards – In the past, never in US accounting • Should a forecasted loss on work in progress inventory be recognised? – Yes in French accounting – No in US accounting ACC4305 Michel Leseure Conservatism • Continental Europe tends to be most conservative • A lot of research on conservatism – Use of conservatism index (Gray, 1980) R A RD CI 1 R A RA = adjusted earnings under the GAAP of the country being used as a standard RD = disclosed earnings under the national GAAP of the country whose conservatism is being assessed |RA| = the absolute value of adjusted earnings under the GAAP of the country being used as the standard ACC4305 Michel Leseure Conservatism Index UK US GAAP GAAP £ £ Conservatism Earnings Million Million Index 1998 110 100 1.10* 1997 90 100 .90** * 1 – (100 – 110)/100) = 1.10 ** 1 – (100 – 90)/100) = 0.90 ACC4305 Michel Leseure The Impact of Conservatism Reporting Value of The Firm + Financial Impact of Fact rf ec + Pe - tI nf or m at io n R ep or tin g Li ne RR 15 Capitalized New Product Development Volvo with Its Old Research & Development Accounting Principle Figure 5.4.1.1 Volvo and Its Research & Development Reporting Profile ACC4305 Michel Leseure Provisions and Reserves Differences in Financial Reporting ACC4305 Michel Leseure Provisions • Terminology can be confusing • Make sure to differentiate: – Provision • A liability of uncertain timing and amount – An allowance • against the value of an asset ACC4305 Michel Leseure Provisions in French Accounting • • • En comptabilité, la provision est la constatation d'une moins-value probable sur un élément d'actif ou d'une augmentation du passif dit « exigible ». Cette notion ne doit pas être confondue avec celle d'amortissement, qui correspond à une dépréciation d'une autre nature (la perte est irréversible et est liée au temps, à l'usure, à l'obsolescence) La dépréciation doit être nettement précisée quant à sa nature ou son objet et elle doit être évaluée avec une approximation suffisante. Elle doit être probable et pas seulement éventuelle. Cette probabilité doit être la conséquence d'un événement survenu au cours de l'exercice. www.wikipedia.fr ACC4305 Michel Leseure French vs. US Provisions US FR Allowances Provisions Provisions pour dépréciation Provisions pour risques et charges ACC4305 Michel Leseure Provisions in Moroccan Accounting • There are three types of provisions: – « Provisions pour dépréciations » • They are acknowledgements of the decrease in value of assets • That is, the value of an asset is lower than its recorded value, or than its net value • These are “allowances” in US accounting! ACC4305 Michel Leseure Provisions in Moroccan Accounting • There are three types of provisions: – « Provisions pour risques et charges » • These are provisions, i.e. they recognize a potential future liability • Examples: – Provisions for legal disputes – Provisions for warranties extended to customers – Provisions for future losses on long term contracts – Provisions for fines, penalties – Provisions for foreign exchange losses ACC4305 Michel Leseure Provisions in Moroccan Accounting • There are three types of provisions: – « Provisions réglementées » • These are provisions (i.e. future liabilities) not accounted in other categories and regulated • Examples: – Industry specific: mines, natural resources management – Acquisition and building of housings ACC4305 Michel Leseure Accounting for Provisions • Recording provisions and allowances – Debit an expenses account • Impact on income statement • Examples of Moroccan accounts: – Dotations d’exploitation – Dotations aux provisions pour risques et charges – For an allowance • Credit an asset account – Example: Provisions pour dépréciation des comptes de l’actif circulant – For a provision • Credit a liability account – Example: Provisions durables pour risques et charges ACC4305 Michel Leseure Accounting for Provisions • Provisions are re-evaluated on closing dates • They can be increased, decreased, or written-off • Example: for a provision (risk-based) – Credit a revenue account • Example: Reprise provision pour risques et charges – Debit the liability account that was initially debited ACC4305 Michel Leseure Example – Bad Debt • 01/01/2006: Credit sale for 10,000 euros to Mr Dupond • The amount is due on June 1st • On June 1st, Mr Dupond defaults on the payment • The accountant considers that the receivable could be received (not lost with certainty) – Use an allowance • On July 1st, Mr Dupond actually pays the bill ACC4305 Michel Leseure Example – Bad Debt First Case 01/01/2006 Client 10,000 Ventes 01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10,000 10,000 Provisions pour dépréciation des comptes clients 01/07/2006 Provisions pour dépréciation des comptes clients 10,000 10,000 Reprise de provisions pour dépréciation des comptes clients Tresorerie 10,000 10,000 Clients 10000 First Case: No VAT, No use of “Clients Douteux”Account, One customer only ACC4305 Michel Leseure Example – Bad Debt + asset + revenue First Case 01/01/2006 Client 10,000 Ventes 01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10,000 10,000 Provisions pour dépréciation des comptes clients 01/07/2006 Provisions pour dépréciation des comptes clients 10,000 10,000 Reprise de provisions pour dépréciation des comptes clients Tresorerie 10,000 10,000 Clients 10000 ACC4305 Michel Leseure Example – Bad Debt Expense/loss Contra asset First Case 01/01/2006 Client 10,000 Ventes 01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10,000 10,000 Provisions pour dépréciation des comptes clients 01/07/2006 Provisions pour dépréciation des comptes clients 10,000 10,000 Reprise de provisions pour dépréciation des comptes clients Tresorerie 10,000 10,000 Clients 10000 ACC4305 Michel Leseure Example – Bad Debt Cancel contra asset First Case 01/01/2006 Client 10,000 Ventes 01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10,000 10,000 Provisions pour dépréciation des comptes clients 01/07/2006 Provisions pour dépréciation des comptes clients 10,000 10,000 Reprise de provisions pour dépréciation des comptes clients Tresorerie 10,000 10,000 Clients 10000 Restore revenue ACC4305 Michel Leseure Example – Bad Debt Second Case 01/01/2006 Client 10000 Ventes 01/06/2006 Clients Douteux 10000 10000 Clients 01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10000 10000 Provisions pour dépréciation des comptes clients 01/07/2006 Provisions pour dépréciation des comptes clients 10000 10000 Reprise de provisions pour dépréciation des comptes clients 01/07/2006 Clients 10000 10000 Clients Douteux 01/07/2006 Tresorerie 10000 10000 Clients 10000 ACC4305 Michel Leseure Example Bad Debt • Customer is unable to pay (Certainty) 01/01/2006 Client 10000 Ventes 01/06/2006 Clients Douteux 10000 10000 Clients 01/06/2006 Dotations aux provisions sur dépréciation des actifs circulants 10000 10000 Provisions pour dépréciation des comptes clients 01/07/2006 Provisions pour dépréciation des comptes clients 10000 10000 Reprise de provisions pour dépréciation des comptes clients 01/07/2006 Pertes sur Creances Irrecouvrables Clients Douteux 10000 10000 10000 When the loss/expense actually posted to the Income Statement? ACC4305 Michel Leseure Note – Bad Debt Expenses • In practice, accountants try to estimate precisely which portion of the debt will be paid or not ACC4305 Michel Leseure Example – Several Customers • On 31/12/2000, you receive the following table: CLIENTS CREANCES PROVISIONS AU 31/12/99 ENCAISSEMENTS T.T.C. OBSERVATIONS A 1897,6 700 680 solde irrécouvrable B 2848,4 800 320 Provision nécessaire : 60% du solde 2000 ACC4305 Michel Leseure Example – Several Customers • In 2000, the following new customers have become suspicious CLIENTS CREANCES T.T.C PROVISION A CONSTITUER C 2965,00 40% D 4669,6 60% ACC4305 Michel Leseure Example – Several Customers • Client E who owns 1423,20 TTC has filed for bankruptcy • His A/R is irreversibly lost ACC4305 Michel Leseure Example – Several Customers NOMS ANCIENNES VERSEMENTS NOUVELLE CREANCES S T.T.C. CREANCES PROVISION PROVISION CONSTITUEE NECESSAIRE AJUSTEMENT PROVISION PERTE T.T.C. + A 1897,6 680 1217,60 700 B 2848,40 320 2528,40 800 1268,42 - H.T. TVA 700 1018,06 199,54 1189,96 233,24 2208,02 432,78 468,42 C 2965 991,63 991,63 D 4669,6 2342,60 2342,60 E TOTAL 7634,6 3802,65 700 ACC4305 Michel Leseure The Impact of Provisions • In 2000, Beaufort Accessories in France decided to build a roof for its factory. Work will take place in 2002 and which will cost approximately EUR 300,000. • Under French Accounting, the company can recognize the expense of EUR 100,000 in 2000 for the roof construction as a provision, and then recorded the rest in 2001 and 2002 for EUR 100,000 each. ACC4305 Michel Leseure Example Accounting Expenses Actual Expense Impact on Corporate Report Recognition (EUR) (EUR) (EUR) 2000 100,000 - Under-reporting Profit (100,000) 2001 100,000 - Under-reporting Profit (100,000) 2002 100,000 300,000 Over-reporting Profit 200,000 Note: Assuming the roof would have been reported as an expense in 2002 – in most cases,it would be depreciated over time ACC4305 Michel Leseure The Impact of Provisions Reporting Value of The Firm Impact of Provision in 2002 Impact of Provision in 2000 and 2001 R ep or tin g Li ne + Disclosure in a footnote would help to give a fair picture + Pe rf ec tI nf or m at io n - Financial Impact of Fact Corporate earnings Figure 5.5.1.1 The Impact of Expenses Recognition in Advance on Corporate Reporting Profile ACC4305 Michel Leseure Reserves – Reserves are an element of equity – They are set as an appropriation of profit (i.e., retained earnings) • The existence of reserves are linked to regulations (e.g., « Réserves légales ») or to lenient tax regulations (e.g. income smoothing in Germany) • Negative impact on fair reporting – Fund – an asset invested and managed independently • This fund reduces the corresponding provision one would have recorded on the B/S ACC4305 Michel Leseure Others Differences in Financial Reporting ACC4305 Michel Leseure Valuation Bases • Strict adherence to historical cost – Requires little judgement – Is expected of countries with strict taxation regulations and commercial codes • Use of replacement cost or current value – Requires judgement, and therefore a great amount of flexibility given to accountants – Case of the Netherlands • Middle of the road... – UK accounting ACC4305 Michel Leseure Consolidation • The US provided leadership for consolidation accounting, • Followed by the UK • Continental Europe was slow to develop consolidation accounting • More on the consolidation lecture ACC4305 Michel Leseure Taxation • Already discussed in chapter 2 – Can have a key impact on reporting practice • Taxation rules: – Are not necessarily consistent between countries – Are often an enemy to fairness, e.g. in Europe, where it takes precedence over a « fair » presentation of economic profit ACC4305 Michel Leseure
