Financial reporting systems The financial reporting systems of EU member states have evolved from their political, culture histories, and have different levels of regulatory control and responsibility.
UK The accounting and financial reporting system in the UK has been developed in the main by accountants (Nobes and Parker, 2006, p.485), although in latter decades the state and EU have had a significant influence upon its rules. Accountants have also been involved with the main legal regulations that apply to audits and reporting, such as the Companies Act 1989 and later amendments, including that of 2006.
Historically, the UK reporting system has been geared towards meeting the needs of investors and therefore has a high level of transparency and disclosure. As such, the impact of the taxation system is of less importance than in other EU countries. This has led to some differences between taxable and accounting income (Blake and Amet, 2003, p.213).
The thrust of the system is to achieve financial reports that show a true and fair value. Statements confirming this, and that “applicable accounting standards” have been used, or explanations for deviation from this, must be included within the report (Nobes and Parker, 2006, p.287). Following the introduction of increased legal and regulatory rules of corporate governance, and the formation of the Financial Reporting Council (2004), responsibility for accuracy falls on auditors, directors and shareholders.
“From 2005 UK listed companies must use IFRS for their consolidated statements” (Nobes and Parker, 2006, p.103)
France France has a much smaller accounting profession than the UK, with only 45 compared with 352 accountants per hundred thousand of the population (Saudagaran, 2003, p.10). Historically, its accounting system has been dominated by a macroeconomic central system and geared to providing information for government control purposes (Blake and Amet, 1993, p.114). Tax Law is the dominant influence and auditors are responsible to, and regulated by, the Ministry of Justice (Nobes and Parker, 2005, p.236).
French accounting falls under the “National Accounting Plan” regulation, which is administered by the CNC (National Accounting Council). However, a peculiarity of the French accounting system is that the regulations apply to individual companies, but not to groups (Nobes and Parker, 2005, p.226).
The regulation requirements call for a uniform chart of accounts with standard bookkeeping procedures, account title and classification numbering. For example, all individual companies must report salary and associated costs under account 641. Similarly, there are standard accounting statement formats as laid down by EU directives and a uniform procedural treatment for items such as fixed asset valuation and creation of legal reserves (Nobes and Parker, 2006, p.301). There are also strict regulations with regard to the methods of depreciation and expense calculation for use in reducing tax liabilities.
At present, the detail between French and IFRS reporting details and procedures differs significantly.
Germany Like France, the accounting professions influence in Germany is low. Accounting rules are mainly determined by Tax law and Federal fiscal Courts, although these incorporate EU directives. The keeping of books and records is a statutory requirement of the German Commercial Code (HGB 1985) and historical cost accounting is operated with strict revaluation restrictions (Choi and Meek, 2005, p.79).
Unlike the UK, the German accounting reporting system is heavily geared towards the protection of creditors and therefore, accruals and provisions tend to be high (Nobes and Parker, 2006, p.301). The income results are also aimed at a conservative position. Asset valuation tends to be reported on a forced sale basis and the financial results must equate to the taxable position. In addition, there is a requirement for a value of one tenth of nominal capital to be held in legal reserves. Whilst the effect of the German accounting reporting system is to protect creditors, because of the impact on results, it has also led to a position that does not encourage outside investment into German Businesses.
Whilst IFRS rules apply in Germany, it is only applicable to a limited number of organisations. The majority still use German regulations for financial reporting purposes (Nobes and Parker, 20-06, p.290).
Poland Historically Poland, which is the largest ex-communist country to join the EU (Nobes and Parker, 2006, p.229), came from a state dominated economy, where enterprises were not autonomous, with all aspects of business controlled by the state. The accountancy profession was not very strong (Sucher and Kosmala-MacLullich, 2004, p.484) and there is a lacked of skilled professionals that is still being addressed.
Since returning to a market economy, Poland has introduced accounting regulations, embodied within the Accounting Act 1994 and subsequent amendments, which are regulated by the Accounting Standards Committee, set up in 1997. Under these regulations, all businesses are required to adopt an accounting plan. Whilst these regulations incorporate parts of the EU directives, it is primarily geared to the protection of the state and tax policies.
Like France, the Polish state is the main instigator and influence on accounting reforms (Sucher and Kosmala-MacLullich, 2004, p.438) and, because of this their system is not inherently geared as much towards attracting investors as more market based economies like the UK.
Similarly, although IFRS is widely used, there are significant differences in the Polish system (Nobes and Parker, 2006, pp.236-8).
Summary As can be seen from the above individual country analysis, whilst accounting reporting systems may all have similar aims, namely to provide financial information to end users, there are a range of factors that influence and create differences in accounting reporting systems between nations.
From an internal viewpoint, the differences are driven primarily by cultural, political and economic factors. Added to these are the influence of the accountancy profession, which is greater in some countries than others, and the domination of state taxation requirements.
Externally, individual reporting systems may respond to perceived dominant position of the United States and growing stature of the European Union in international trade. From an investment stance, the growth of share ownership that has resulted from the global expansion of financial markets has also had an effect (Nobes and Parker, 2006, p.6).
Lastly, the changing face of commercial organisation because of the continuing globalisation of trade has affected their need for differing accounting reporting systems. As has been seen, multinational corporations require a significantly higher level of control in these areas than do nationally focused organisations. As Nobes and Parker (2006) earlier publications (1980 and 1998) have shown over the years, this has resulted in differing reporting classes of nations, between those who are driven by business or state and who have weak or strong equity markets.
Historically the EU opposed international reporting standards, partially out of fear of the US dominance in this area. However when, by the early 1990’s it was shown that EU attempts at harmonisation was failing, it took on board international standards and became the most dominant force for change in this area (Nobel and Parker, 2005, p.105), certainly within its own community.
Among the areas that the EU has dominated are the legalisation of enforcement, such as those used to support its 4th and 7th directives and the requirement for all corporations to adhere to international standards. By using EU regulations as a vehicle for this legislation, it is incumbent upon member states to incorporate these within domestic legislation. Although such legislation is not compulsory for multinational organisations for reporting, the EU “transforms them into EU standards,” (Flowers, 2002, p.273).
The EU regulation has met with mixed reactions. Sir David Tweedie (2003, p.15) states that it provides the opportunity to “unite its [the EU’s] many national markets.” However, others state, “the reality is disparity and muddle” (Amat and Blake, 1993,p.5)
The International standards are extensive and aimed to cover all aspects of financial reporting within corporations (Flowers, 2002, p.263). In general, they cover five main areas. These include treatment of assets and revenue; liabilities; accounting for groups; the context within which reporting takes place and disclosure statements (Nobes and Parker, 2000, p.6). In reality, the regulations have the effect of moving accounting away from the historical cost accounting format to a more current fair value system.
Currently the international accounting and financial reporting system is subjected to thirty seven different standards (Nobes and Parker, 2006, p.6), although this is likely to change in the future as further harmonisation and clarification is sought.
Conclusion Despite IFRS and its joining with US GAAP in 2002, individual nations financial reporting differences remain (Nobes and Parker, 2006, p.19). Attempts to harmonise the EU position across its member states are continuing but, until or unless the influences that attach to individual nations are addressed both internally and nationally, it will be difficult to achieve.
As Gregoriou and Gaber’s (2006) publication reveals, internationally there are still numerous accounting systems in place. In the opinion of the author, the relevant national and international regulatory and legal bodies will need to be cognisant of national differences as they seek improvements and further harmonisation of the global accounting reporting systems that currently exist.
However, it is apparent from the current direction of international standards that they will lead to the end of individual nations reporting standards and influences (Nobes and Parker, 2006,p.103)
References Blake, John and Amat, Oriol (1993). European Accounting. FT Prentice Hall.
Choi, Frederick D.S and Meek, Gary K (2005). International Accounting. 5th Ed. FT. Prentice Hall. UK.
Feature (2003). IAS Who’s Who – setting the pace. Accountancy Age, UK 4th September 2003, p.15.
Flower, John (2001). European Financial Reporting: Adapting to a Changing World. Palgrave Macmillan. UK.
Gregoriou, Greg N and Gaber, Mohamed (eds.) (2006) International Accounting: Standards, Regulations, Financial Reporting. Butterworth-Heinemann. UK.
Nobes, C. and Parker, R. (2006). Comparative International Accounting. 9th Edition. FT Prentice Hall. UK.
Saudagaran, Shahrokh M (2003). International Accounting: A User’s Perspective. 2 Rev. Ed. South Western College Publishing. UK.
Sucher, Pat and Kosmala-MacLullich, Katarzyna (2004). A Comparative Analysis of Auditor Independence in Economies in Transition. Institute of Chartered Accountants of Scotland, UK.
Tarca, Ann. (2002). Achieving International Harmonisation through Accounting Policy Choice. University of Western Australia – Department of Accounting and Finance. Australia
 Brackets added by author
Basic Assumptions in Accounting
Accounts are produced by all companies as a way of providing information to all third parties interested in the company’s performance. One of the primary aims of these accounts is to reduce the problems inherent in the agency relationship of the directors with the other interested stakeholders such as investors, employees and even government bodies. Due to the wide range of uses for accounts, it is little wonder that research into the way that these accounts are drafted and presented has had to lay down some fundamental assumptions in the way that accounts are written.
However, in reality the assumptions that have underlined the analysis of accounts may, at times, be flawed, causing the overall analysis of these accounts to be at best incomplete and possibly even inaccurate (Hermanson, 2005).
Assumption 1 – Accounts are Primarily for Shareholders
This is a very common assumption and in many cases is not a damaging one. Even the law seems to support this assumption, with legislation requiring that annual accounts are produced and supplied to the shareholders (Companies Act 2006). This fuels the concept that the accounts are for the use of the shareholders, only.
It is true, however, that accounts are largely for shareholders. The company belongs to the shareholders and is managed and run by the directors. This structure produces an agency problem with those running the business not being those individuals who ultimately benefit or suffer from its success or failure.
Shareholders need the accounts in order to determine whether their investment is safe, whether they should be investing more, withdrawing their investment or asking certain questions of the board in relation to policies or activities. The accounts give valuable information to the shareholders in relation to the volume of sales, profitability, comparative analysis of key competitors and the overall value of the shares.
Accounting standards have been developed with this key use in mind. It is necessary for all accounts to be audited by an independent auditor to determine that the accounts offer a true and fair value of the state of the financial position of the company. This is, of course, vital for the shareholders as they must trust the accounts being produced by the directors to be accurate, in order for them to make their investment decisions.
Whilst all of these principles appear to be geared towards the shareholders, there are other users of the accounts that benefit equally from the standard set out in relation to published accounts. Other key users include the lenders. For many businesses, these stakeholders are absolutely vital and they will be largely interested in the same information as the shareholders, although will only really be concerned about whether the company has sufficient resource to pay back the loan that they have advanced to the company and that suitable security over assets exists (Watts, 2003).
Employees are clearly interested in knowing the health and profitability of the company so that they can be comfortable with their own job security. However, this stakeholder group is often overlooked, despite its central role within the organisation.
In addition, government agencies should not be overlooked, with agencies such as HM Revenue and Customs requiring information in order to collect the correct amount of corporation taxes (Brennan, 2000).
Therefore, whilst shareholders may be the most visible group of stakeholders with an interest in the accounts, there are other stakeholders which also have an interest and should not be disregarded.
Assumption 2 – Accounting Measures a Concrete Reality which is ‘Out There’
Prepared accounts are required to follow the basic principles such as relevance, understandability, consistency and comparability. Therefore, whilst accounts are prepared in line with the directors’ decisions and interpretations, there are certain underlying rules that must be followed to ensure that the accounts are as close to an unbiased, concrete reflection of the state of the business as is possible.
In particular, this is important for the benefit of investor and shareholder comparisons. In order to make suitable judgements regarding investments and decisions about which company should be given support, the accounts of the two companies must be comparable. To be comparable the accounts must be as objective and factual as possible.
However, just because it is desirable for the accounts to be a concrete reflection of what is ‘out there’ in the company does not mean that this is an assumption which can be drawn as being true.
This need for consistency has been recognised by the International Accounting Standards Board which has developed, in so far as is possible, the financial reporting standards that companies need to follow in a bid to ensure that accounts are as close to being a concrete and comparable reflection as possible (Kroll, 2004).
Take, for example, the way in which a company chooses to report its cash earned. The company could choose to operate on either a cash or on an accrual basis. Under the cash basis, the company would report income as soon as it actually arrives within the company, whereas the accrual basis shows the income earned at the time of the writing of the accounts, regardless of whether or not it has been already received. It is clear to see that the choice as to whether to follow a cash model or an accrual model will have a significant impact on the way in which the profit and loss appears in relation to the company.
Other policies that are managed by international standards include issues such as the treatment of goodwill or depreciation, both areas that have traditionally allowed considerable director discretion. By having these basic accounting standards that companies must follow, there is certainly a move towards establishing concrete accounts. This, however, has not been fully achieved yet and, therefore, it is not fair to assume that all accounts are a completely concrete reflection of what is ‘out there’.
Assumption 3 – Accounting Can be Neutral
Clearly, it is desirable that financial accounts produced by companies are entirely neutral in the way that they are presented. Inaccuracy in accounts generally falls into two distinct categories, dishonesty or incompetence. Dishonesty has several different gradients and may be as simple as the desire by the management team to present a certain aspect of the business, whilst minimising the importance of other activities within the business.
One of the main ways that a company could ensure that there is no element of dishonesty in the accounts is to have external auditors checking the accounts to ensure that they are a fair and accurate reflection of the company situation. Furthermore, with the financial reporting standards that have now been developed to ensure neutrality in the published accounts, companies are required to state definitively if they have deviated from the financial reporting standards, so that any move away from neutrality can be immediately and categorically identified.
Therefore, whilst not all accounts will always be unbiased or neutral, identifying where neutrality has been deviated from, companies are now required to draw attention actively to this fact, thus increasing transparency.
The use of external auditors in the preparation of the accounts is also a useful check and balance to ensure lack of misleading statements in the accounts (Cottingham, 1995).
Despite all these measures, there remains the biased element of the accounts in the chairman’s statement. This is the opportunity for the board of directors to state their opinion and to detail the rationale of the company in terms of previous decisions and the direction which the company is taking in the longer term. This element of the report will naturally result in a non-neutral position (Goch, 1975).
Company accounts are produced, as established earlier, for the benefit of many stakeholders, although primarily they are used by the shareholders and lenders to assist their investment decision. It is only natural, therefore, that companies will choose to forward their best possible position for the accounts. Whilst there are checks and balances in place in the form of financial reporting standards and the requirement of the independent auditor, it is fair to state the accounts are not entirely neutral, at all times.
Assumption 4 – Accountants are Professionals and Have the Ability to use ‘Sound’ Judgement
Accountants are used at all levels by companies of all sizes to manage the financial affairs of the company and ultimately to produce the accounts for external use, on an annual basis. All qualified accountants are required to be members of professional bodies such as Institute of Chartered Accountants of England and Wales and have strict codes of professional ethics in relation to the way in which they conduct their role (Riahi-Belkaoui, 1992).
Despite the need for these accountants to be controlled and to be managed in a way that they conduct their role, it is essential that they are given suitable freedom to exercise their own professional judgement.
Increasing transparency requirements and the greater degree of prescription that is being placed on the accounting profession, in terms of financial reporting standards and requirement is changing the role of accountants in the preparation of accounts. Accounting standards have resulted in accountancy becoming much more of a science than an art form. There is a danger in this shift of emphasis. Accountants are professionals and their sound professional judgement is essential in ensuring that the most accurate company accounts are produced. However, this sound professional judgement is only useful if it is unbiased to the company itself, i.e. through an independent accountant or auditor (Thomas Keim, 2003).
Internal accountants who are employees of the company are under the influence of the directors and, as such, may have an unhelpful level of bias towards the company. In this case, where there are competing requirements, accountants cannot be relied upon to exercise the same degree of sound professional judgment.
Published accounts are only as good as the information that is supplied to the accountants preparing these accounts. If accountants are not given the full information in relation to the company, they will simply not produce accurate accounts, regardless of how sound their professional judgment is (Chisnall, 2001).
Professional accountants, as a whole, are required under their own code of ethics to exercise professional judgment when conducting their roles and this is generally followed. Constraints are increasingly being placed on the way in which accountants can prepare accounts and this is restricting the ability to exercise professional judgment in all cases. Care must also be taken when considering accountants who are biased due to their position with the company.
Conclusions Many assumptions are made when it comes to published financial accounts. In almost all cases, these assumptions are not universally true and care should always be taken to reconsider these assumptions, whenever accounts are being analysed. Any deviations from these assumptions could dramatically impact on the way in which the company accounts are viewed by all stakeholders concerned.
Bibliography Brennan, N.