Chapter 3 Major International Differences in Financial Reporting

Chapter 3 Major International Differences in Financial Reporting

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 + Financial Impact of Fact - + Figure 3.2.2 Perfect Information Reporting Line ACC4305 Michel Leseure Reporting Value of The Firm +

Enron Enron Overly reporting earnings Mark to Market of Investments in derivatives Mark to Enron (Bonus inflation) Financial Impact of Fact - + Severe losses but not report Hiding liabilities and losses

in Special Purpose Entities Off balance sheet - 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) RA 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

+ RR 15 Capitalized New Product Development Financial Impact of Fact - + 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 comptabilit, la provision est la constatation d'une moins-value probable sur un lment d'actif ou d'une augmentation du passif dit exigible . Cette notion ne doit pas tre confondue avec celle d'amortissement, qui correspond une dprciation d'une autre nature (la perte est irrversible et est lie au temps, l'usure, l'obsolescence) La dprciation doit tre nettement prcise quant sa nature ou son objet et elle doit tre value avec une approximation suffisante. Elle doit tre probable et pas seulement ventuelle. Cette probabilit doit tre la consquence d'un vnement survenu au cours de l'exercice. www.wikipedia.fr ACC4305 Michel Leseure French vs. US Provisions US FR

Allowances Provisions Provisions pour dprciation Provisions pour risques et charges ACC4305 Michel Leseure Provisions in Moroccan Accounting There are three types of provisions: Provisions pour dprciations 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 rglementes 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 dexploitation Dotations aux provisions pour risques et charges For an allowance Credit an asset account Example: Provisions pour dprciation des comptes de lactif 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 10,000

01/06/2006 Dotations aux provisions sur dprciation des actifs circulants Provisions pour dprciation des comptes clients 10,000 01/07/2006 Provisions pour dprciation des comptes clients Reprise de provisions pour dprciation des comptes clients 10,000 Tresorerie 10,000 10,000 10,000 Clients 10000 First Case: No VAT, No use of Clients DouteuxAccount, One customer only

ACC4305 Michel Leseure Example Bad Debt + asset + revenue First Case 01/01/2006 Client 10,000 Ventes 10,000 01/06/2006 Dotations aux provisions sur dprciation des actifs circulants Provisions pour dprciation des comptes clients 10,000

01/07/2006 Provisions pour dprciation des comptes clients Reprise de provisions pour dprciation des comptes clients 10,000 Tresorerie 10,000 10,000 10,000 Clients 10000 ACC4305 Michel Leseure Example Bad Debt Expense/loss Contra asset 10,000

First Case 01/01/2006 Client Ventes 10,000 01/06/2006 Dotations aux provisions sur dprciation des actifs circulants Provisions pour dprciation des comptes clients 10,000 01/07/2006 Provisions pour dprciation des comptes clients Reprise de provisions pour dprciation des comptes clients 10,000 Tresorerie 10,000 10,000

10,000 Clients 10000 ACC4305 Michel Leseure Example Bad Debt Cancel contra asset First Case 01/01/2006 Client 10,000 Ventes 10,000 01/06/2006 Dotations aux provisions sur dprciation des actifs circulants Provisions pour dprciation des comptes clients

10,000 01/07/2006 Provisions pour dprciation des comptes clients Reprise de provisions pour dprciation des comptes clients 10,000 Tresorerie 10,000 10,000 10,000 Clients 10000 Restore revenue ACC4305 Michel Leseure

Example Bad Debt Second Case 01/01/2006 Client 10000 Ventes 10000 01/06/2006 Clients Douteux Clients 10000 01/06/2006 Dotations aux provisions sur dprciation des actifs circulants Provisions pour dprciation des comptes clients 10000 01/07/2006 Provisions pour dprciation des comptes clients Reprise de provisions pour dprciation des comptes clients

10000 01/07/2006 Clients 10000 10000 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 10000 01/06/2006 Clients Douteux Clients 10000 01/06/2006 Dotations aux provisions sur dprciation des actifs circulants Provisions pour dprciation des comptes clients 10000 01/07/2006 Provisions pour dprciation des comptes clients Reprise de provisions pour dprciation des comptes clients

10000 01/07/2006 Pertes sur Creances Irrecouvrables Clients Douteux 10000 10000 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 T.T.C. PROVISIONS AU 31/12/99 ENCAISSEMENTS OBSERVATIONS A

1897,6 700 680 solde irrcouvrable B 2848,4 800 320 Provision ncessaire : 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 A B C D E ANCIENNES VERSEMENTS NOUVELLE PROVISION PROVISION CREANCES

S CONSTITUEE NECESSAIRE AJUSTEMENT PROVISION PERTE T.T.C. CREANCES T.T.C. + H.T. TVA 1897,6 680 1217,60 700 700 1018,06 199,54 2848,40 TOTAL 320

2528,40 2965 4669,6 7634,6 800 1268,42 991,63 2342,60 468,42 991,63 2342,60 3802,65 700 1189,96 2208,02 233,24

432,78 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 + Disclosure in a footnote would help to give a fair picture Impact of Provision in 2002 Impact of Provision in 2000 and 2001 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., Rserves lgales ) 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

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