THE IASC COMPARABILITY PROJECT AND CURRENT FINANCIAL REPORTING REALITY: AN EMPIRICAL STUDY OF REPORTING IN EUROPE

British Accounting Review (1996) 28, 1–22

THE IASC COMPARABILITY PROJECT AND CURRENT FINANCIAL REPORTING REALITY: AN EMPIRICAL STUDY OF REPORTING IN EUROPE CLARE B. ROBERTS University of Exeter

STEPHEN B. SALTER Texas A&M University

JEFFREY KANTOR University of Windsor The IASC recently introduced a variety of proposals beginning with E32, which together can be referred to as the Comparability Project. These proposals, which have resulted in the amendment of ten standards, have the effect of substantially narrowing the choice of available financial reporting practices. Using data from practising auditors, this study examines how closely the IASC’s revised standards match existing EU financial reporting practices, including those dictated by the Fourth and Seventh Directives. It finds that while EU financial reporting practices mirror many of the IASC recommendations, there are still considerable differences, both within the EU and between the EU countries as a whole and the IASC.  1996 Academic Press Limited

INTRODUCTION Over the last two decades the European Commission has attempted to achieve harmonization through administrative fiat and passage of national law. Despite some de jure success, there is considerable debate as to its practical impact, with recent contributions (FEE 1989, 1993; Emenyonu & Gray, 1992) coming to opposing conclusions. Over the same period, the International Accounting Standards Committee (IASC) has promulgated over 30 international accounting standards and 47 exposure drafts. Many The authors gratefully acknowledge the financial support of the Certified General Accountants of Canada Research Foundation. Correspondence should be addressed to: Clare Roberts, Department of Economics, University of Exeter, Amory Building, Rennes Drive, Exeter EX4 4RJ, UK. Received 10 October 1994; revised 7 April 1995; accepted 16 May 1995 0890–8389/96/010001+22 $18.00

 1996 Academic Press Limited

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of these have been criticized as being broad and ineffective. In order to remedy this situation the IASC issued Exposure Draft 32 (E32), a subsequent Statement of Intent (SoI) and, finally, a series of ten revised standards (collectively referred to hereinafter as the Comparability Project). Because the IASC has no powers to enforce its standards, it may be argued that the IASC is unlikely to secure a very high level of compliance with its standards if such standards are in conflict the extant accounting practices. This paper therefore seeks to assess the extent to which the revised IASs are in agreement with financial reporting practices in the EU. The study proceeds to examine the attempts made by the IASC and EU to harmonize financial reporting practices. This is followed by a description of the specific research questions addressed, the methods employed and the results found. The paper ends by considering the implications of the results found.

LITERATURE REVIEW Rationale for Harmonization Arguments for harmonization have been presented from a variety of perspectives. From an economic perspective, the cost of translating (or inability to translate) foreign financial statements has been presented as equivalent to a tax on capital, reducing gross and net foreign investment (Black, 1985; Stultz, 1985; Evans, Taylor & Holzman, 1985). Likewise, taking a capital market perspective, differences in financial reporting practices (FRPs) may be seen as an important source of capital market segmentation (Lessard, 1985; Alford & Folks, 1994). From a practitioner perspective, considerable evidence has been offered indicating that harmonization is favoured by both multinational corporations and major public auditing firms (Scott & Troberg, 1980; Golkarn, 1984; Evans et al., 1985; Cook, 1989; Choi & Levich, 1990; Turner, 1983; Doupnik, 1987). Finally, on the political level, El Safty (1989) argues that harmonization helps nation states in assessing the contributions of foreign multinational enterprises to national goals. Arguments against harmonization include the substantial political and bureaucratic cost of implementing harmonization and the relative dearth of evidence regarding its benefits (Peasnell, 1989). Further, some evidence exists that the market may drive its participants to provide the information required without a formal harmonization process (Meek & Gray, 1989). However, irrespective of the strength of the many arguments propounded in support of or against harmonization, considerable resources have been expended by a variety of organizations in attempts to increase either regional or global harmonization.

         3

International Harmonization Efforts The primary generators of international accounting harmonization efforts have been the EU (within Europe) and the IASC (world-wide). The Treaty of Rome in 1957 set out the objectives of what was then the European Economic Community. These included the free movement of persons, goods and services and capital. This necessitated harmonization of company law via a series of Directives. The most important of these, the Fourth and Seventh Directives, attempted to promulgate principles to be incorporated into national business laws. These included comprehensive regulations on content and form of accounts, audit requirements, and accounting measurement principles. The initial intention was to have a comprehensive European accounting system along the lines of the French ‘plan comptable’. Due, in particular, to the expansion of the Community in 1973 with the entry of the UK, Ireland and Denmark, this aim proved impossible, as consensus could not be reached. Instead, the Directives tend to lay down broad guidelines only and have relied upon the use of options as a device for gaining agreement across member states (Thorell & Whittington, 1994). Thus, while the Directives have resulted in certain requirements being incorporated into the national laws of all member states, in many other areas different options have been incorporated into the laws of the various member states. For example, the Fourth Directive allowed member states to either permit or require companies to present primary or secondary inflation adjusted financial statements using replacement costs or the revaluation of fixed assets or the valuation of all items by a method designed to recognize the effects of inflation. Similarly, options exist in the Seventh Directive on Group Accounts in such areas as: the definition of a subsidiary; exemptions from consolidations for parents that are not limited companies; exemptions where the ultimate parent is a non-EU company; exemptions for financial holding companies; the use of different valuation methods across the group; the use of proportional consolidation and; the immediate write-off of goodwill to reserves. Research into the effectiveness of these Directives has been somewhat mixed. The Federation des Experts Comptables Europe´ens (FEE), concluded in its 1989 survey (FEE, 1989) that where the Fourth Directive provides detailed proscriptions, there is a fairly high level of harmonization among the nine EU nations whose financial accounts were reviewed. Where the Fourth Directive was less comprehensive, this harmonization tended to fall away. Similar results were also obtained with respect to its later survey regarding the implementation of the Seventh Directive (FEE, 1993). These conclusions are also supported by the work of Emenyonu & Gray (1992). After an examination of annual financial statements for 26 very large companies in each of France, Germany and the UK, they concluded that for each of the six issues examined, all of which are covered in detail in the Fourth Directive, there are statistically significant differences among the

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three countries. Further, while certain pairs of countries may agree on a single issue, overall harmonization was found to be low. The IASC was set-up in 1973 by accounting bodies from nine countries and has grown to its current membership of 105 member bodies from 78 countries (IASC, 1992). Its objectives include to ‘formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their world-wide acceptance and observance’. While it has been suggested that the rationale for the IASC should be viewed in a less neutral way, with the self-interests of the members or auditors being paramount (Taylor, 1987; Wallace, 1990; Hopwood, 1994) it remains true that, since its inception, it has attempted to reduce cross national differences in FRPs through the promulgation of 31 international accounting standards and numerous exposure drafts. Unlike the EU, the IASC has no legal means to enforce its standards, but must instead rely upon the regulatory, legal or advisory position of its membership. This is one of the main reasons why the standards issued have included a number of alternative options or allowed treatments. While such an approach was perhaps inevitable, it meant that companies could comply with IASs while still employing methods that were far from standardized. Largely as a response to the International Organisation of Securities Commissions (IOSCO) the IASC issued E32, ‘Comparability of Financial Statements’, in January 1989 (IASC, 1989). IOSCO wants to see more companies listing on foreign stock markets and, as part of this process, wants to see uniform or standard accounting rules being used by all stock markets. They argued that existing international standards contained too many options or alternatives to be acceptable for this purpose. However, if the number of options could be reduced, international standards might be acceptable as a basis for stock market listing requirements. Given this prompting by IOSCO, E32 dealt with a variety of issues where choices of accounting treatments existed. Following comments, the ‘Statement of Intent: Comparability of Financial Statements’ (SoI) was issued in July 1990 (IASC, 1990). Three issues were amended from E32 namely: inventory valuation; development costs; and borrowing costs. Following further comments, the SoI was revised in October 1992 when the original E32 proposals were re-introduced for both inventory valuation and borrowing costs. The Comparability Project was very largely completed when, in November 1993, the IASC Board approved the final revision of ten standards (see Fig. 1). These revised standards came into effect for financial periods beginning on or after 1 January 1995. Several studies have attempted to directly test the efficacy of the IASC (for example, Burton, 1981; Evans & Taylor, 1982; McKinnon & Janell, 1984; Ruenfeldt, 1985) or to develop and test classification schemata for FRP’s that may be regarded as an indirect test of the success of harmonization efforts (for example, Nobes, 1987; Doupnik, 1987; Doupnik & Salter, 1993). These studies have shown, directly or indirectly, that little progress

         5 IAS2: IAS8: IAS9: IAS11: IAS16: IAS18: IAS19: IAS21: IAS22: IAS23:

Inventories Extraordinary items, fundamental errors and changes in accounting policies Research and development costs Construction contracts Property, plant and equipment Revenue recognition Retirement benefit costs Changes in foreign exchange rates Business combinations Capitalization of borrowing costs

Figure 1. International Accounting Standards revised in the light of the Comparability Project

has been made toward harmonization. However, they are all concerned with the position before the Comparability Project (Fig. 1). From this, it can be seen that the EU and the IASC are now taking very different approaches to accounting harmonization. The EU having achieved a certain minimum level of harmonization, has now adopted a hands-off approach which relies upon market forces to promote further harmonization if this is required. Under this approach it is argued that if market participants want more harmonized accounting information they will vote for this by their choice of stock market investments. Share prices will build in any demands that exist for more harmonized, or simply more, information and, therefore, companies will have an incentive to respond to such demands. If the internal dynamics of the IASC are ignored, the move towards more strict standards by the IASC can be interpreted as being due to a belief that the market cannot successfully articulate the demands that exist for more harmonized accounting information. Therefore, instead of relying upon market forces, direct intervention in terms of increased regulations, becomes necessary. Purvis, Gernon & Diamond (1991), in an empirical analysis of compliance with IASC standards pre-E32, grouped countries into three types: unstandardized; independent of the IASC; and dependent upon the IASC. Greece was found to fall into the unstandardized group while all other then EU members (with the exceptions of Luxembourg and Portugal which were not included in the study) fell into the independent group. This, however, does not mean that the overall level of congruence with IAS standards is necessarily low. The lowest degree of congruence was that of Denmark with a ‘conformity index’ of 60% followed by France at 76%, while the other EU members all followed at least 80% of the IASC standards. While this clearly suggests that there is a relatively high level of congruence between the IASC and EU, these results must be treated with a degree of caution. The results relate to the position before the Comparability Project. This set

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out to reduce the number of options available. Therefore, depending upon the specific options followed by companies, the degree to which companies follow those practices permitted by the Comparability Project may be very much lower than these results indicate. In addition, the data used were those generated by the IASC (1988) which relied upon member institutions reporting the extent to which national practices conformed to each IAS. As such, the results may indicate what member institutions would like to exist rather than what actually exists. Finally, and perhaps most importantly, the questions asked related to entire standards rather than to specific issues inside each standard. Companies may comply with most of a standard while specific parts are not complied with at all. To gain a full picture of the extent to which companies or countries comply with IASs far less aggregated data must be employed. It is necessary to know the level of compliance with specific rules or issues rather than compliance with the overall standards. RESEARCH QUESTIONS The EU and IASC are moving apart in terms of their approaches towards accounting regulations. At the same time, most of the EU member states now have standard setting bodies with at least indirect representation from professional accounting bodies. However, in most of the EU, nonGovernmental standard setters have little power and the professional accounting bodies have very little influence on mandatory accounting regulations. This means that most of the EU member states are likely to remain ‘independent’ of the IASC and the main way in which the IASC can influence corporate reporting practices remains via stock market pressures. If the IASC is propounding standards that are useful for stock market participants then corporations might be prepared to follow IASs even if domestic or regional standard setters are not influenced by or do not follow IASs when setting domestic regulations. In the light of these issues, this paper seeks to update the prior empirical work on the extent to which corporations comply with IASs by examining the position with regard to those issues covered by the Comparability Project. In particular, the position in the EU is considered. The EU is particularly interesting for two reasons. Firstly, the IASC has attempted to capture what it perceives to be the practices most commonly adopted by corporations world-wide. The EU is economically significant and home to many large international businesses. If the IASC is to succeed in setting standards that gain ‘world-wide acceptance and observance’ then, irrespective of the mechanisms involved, these standards must be followed by corporations domiciled in the EU. If this is not achieved then it is likely that the IASC will be seen as being increasingly irrelevant, at least as far as developed countries with active stock markets are concerned. Secondly, an examination of corporate practices in the EU may help to begin to throw

         7

some light onto the relative success of the two very different means of harmonization adopted by the EU and the IASC. In this context what is important is corporate practices rather than legislation or standards. Actual practices need not be the same as required practices for a number of reasons. It may be that companies simply do not follow regulations or standards if they feel that the costs, either direct or indirect, outweigh the benefits of compliance. This is likely to be the case especially where the costs of non-compliance are low, for example because the probability of being penalized for non-compliance is small. Of greater practical significance though is the fact that extant regulations in much of the EU fail to cover all those areas included in the IASC Comparability Project. Thus looking simply at regulations will provide little or no indication of actual corporate practices in areas such as the treatment of goodwill, foreign currency translation or pensions. In the light of these arguments, the following four questions will be addressed: 1. To what extent do the practices supported by the Comparability Project differ from extant EU practices?1 2. To what extent are EU practices harmonized across the areas covered by the Comparability Project? 3. Is the level of agreement between the Comparability Project and EU practices greater or less for those issues which are covered by the EU Fourth and Seventh Directives than for the issues not covered by these Directives? 4. To what extent do the EU member countries differ from other IASC members with regard to their practices in the areas covered by the Comparability Project?

DATA COLLECTION Perhaps the most obvious way to gather information on corporate accounting practices is to directly examine those practices by looking at corporate annual reports. However, while annual reports from the EU should include a description of the main accounting policies followed, these statements tend to be very general and often contain relatively little information. In most cases, accounting policy statements do not contain sufficient detail to allow the reader to ascertain whether or not the company follows all the practices supported by the Comparability Project. Because of this, it is necessary instead to directly ask either the companies themselves, or experts who are likely to have detailed knowledge of corporate accounting practices, what actual practices are followed by companies. Therefore, a questionnaire was developed upon Appendices 1 and 2 of

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the revised Statement of Intent (see Fig. 2). For each of the 27 issues, respondents were asked to indicate what percentage of economically significant organizations2 in their country followed each of several listed treatments. Listed treatments included, where appropriate: 1. 2. 2. 3.

IASC benchmark treatment IASC alternative treatment(s) Other described practices An unspecified ‘other’ category.3

The questionnaire was pre-tested on academics and practitioners in Canada, the UK and the USA. It was then distributed, in mid-1992, to managing or liaison partners of major international public firms in all the 78 IASC member countries.4 Three hundred and twelve (312) questionnaires from a total of 65 countries were returned. Because individuals were being asked their opinions regarding the practices used by companies it is necessary to attempt to ensure that the replies given were reliable. To do this, two filtering rules were adopted. Firstly, EU countries were eliminated from the sample if less than five responses were received from that country. In the case of other countries, which were not considered separately in the analysis that follows, replies were eliminated in those cases where only one response was received from a country. This resulted in nine countries being eliminated. Secondly, the replies from each of the remaining countries were tested to ensure that they were consistent one with another. Obviously, it is probable that no two responses will be identical across all questions as the replies are based upon personal experience which differs across the respondents. However, it would be expected that the differences should not be too great and, if they are, it suggests that the reply(s) received is probably unreliable. Thus, the replies from each country were compared one with another to see if it was reasonable to assume that they were drawn from the same population. If this assumption could not be made, then the reply which appears to come from a different population was rejected. This was done using the ANOVA routine (Doupnik & Salter, 1993). Tukey’s and Duncan’s contrasts were used to eliminate individuals whose responses, across all questions taken as a whole, were significantly different (at 5%) from the other respondents from the same country (SAS, 1988: pp. 597–599). Using this method, no inconsistent responses were found. This resulted in a final, usable sample of 295 completed questionnaires from 55 countries, of which 73 respondents were from nine of the EU countries (all the EU members as at that time, except Greece, Ireland and Luxembourg). Because any questionnaire-based study depends crucially upon the knowledge and experience of the respondents, respondents were also asked for information on their experience and the types of clients they dealt with, in terms of size, listing status and types of industries they operated in. It was found that the responding partners from the EU generally had considerable experience having been, on average, in practice in that country for over 16

         9 IAS2: Inventory valuation method 2A Method employed to determine the historical costs IAS8: Correction of fundamental errors or omissions and adjustments resulting from accounting policy changes 8A Treatment in current year accounts 8B Treatment in comparative year accounts IAS9: Accounting for research and development costs 9A Treatment of development costs IAS11: Revenue recognition on construction contracts 11A Method used when outcome of contract can be reliably estimated IAS16: Measurement of property, plant and equipment 16A Amount recorded when property, plant and equipment acquired in exchange for monetary asset 16B Amount recorded when property, plant and equipment acquired in exchange for dissimilar non-monetary asset 16C Amount recorded when property, plant and equipment acquired in exchange for similar non-monetary asset 16D Treatment of any revaluation increase when any previous revaluation decrease has been charged to income IAS18: Revenue recognition on transactions involving the rendering of services 18A Method used when outcome of contract can be reliably estimated IAS19: Retirement benefits under defined benefit plans 19A Benefit valuation method used 19B Treatment of assumptions about projected salaries 19C Treatment of changes in retirement benefit costs IAS21: Effects of changes in foreign exchange rates 21A Treatment of gains or losses on long-term monetary items 21B Treatment of losses on asset acquisitions resulting from severe devaluations against which it is impractical to hedge. 21C Exchange rate used to translate income statements 21D Treatment of differences on income statement items that are not translated at the closing rate 21E Method of translation used for the accounts of subsidiaries operating in hyperinflationary economies 21F Treatment of exchange differences arising from operations that are integral to those of the parent IAS22: Accounting for business combinations 22A Treatment of a business combination that is an acquisition 22B Treatment of a business combination that is merger or uniting of interests 22C Method used to measure minority interests 22D Treatment of positive goodwill 22E Treatment of negative goodwill IAS23: Capitalization of borrowing costs 23A Treatment of borrowing costs associated with assets taking a substantial period of time to complete IAS25: Accounting for investments 25A Amount recorded for investment property 25B Treatment of realized gains which were previously recognized in a revaluation surplus. Figure 2. Financial reporting practices included in the IASC Statement of Intent.

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TABLE 1 Demographics of respondents from the EU

Country

Number of respondents

Mean number of years practice in country

Belgium Denmark France Germany Italy Netherlands Portugal Spain UK Total

5 9 5 8 17 7 6 6 10 73

19 17 17 16 16 21 18 11 11 16

years (see Table 1). The clients of these respondents were companies from a range of different industries with, in no case, any one industry dominating. In addition, the majority of the client companies were either listed on a domestic stock exchange or large unlisted companies. DATA ANALYSIS AND RESULTS The initial analysis consisted of computing mean compliance rates5 for each country for each of the 27 issues examined. That is, the financial reporting practices of each country were taken as being equivalent to the mean of the responses received from that country. To the extent that any variance across responses might be considered to be valuable information, for example because it provides a measure of uncertainty, this process results in the loss of useful information. However, this approach was necessitated by the demands of the statistical tests required to test the hypothesis. In addition, when the variances across issues in each country were examined, they were generally found to be small, as would be expected given that the data had already been screened for reliability, which was measured in terms of the variance across responses, as discussed above. In addition, two composite measures of compliance across issues, COMPF and COMPX, were computed. COMPF is the mean level of compliance with the Comparability Project. COMPX is a similar index, but based upon a more limited number of items. Issues 25B (realized gains on revaluation) and 19A–C (pensions) were excluded from this index. These items were excluded as there were a substantial number of respondents who replied ‘not applicable’. In the EU, such replies were particularly common from

         11 TABLE 2 Financial reporting practices where significant differences exist between the Statement of Intent and EU countries—using ANOVA with Duncan’s multiple range test Issue1 9A 11A 16C 16D 18A 19B 19C 21A 21D 21E 22A 22D 22E 25A COMPX COMPF TOTAL

Belgium Denmark France Germany Italy Netherl. Port. Spain UK Total ∗ ∗ ∗ ∗ ∗ ∗ ∗ ∗ ∗ ∗ 8

∗ ∗ ∗

∗

∗ ∗

∗ ∗ ∗

∗ ∗ ∗ 5

∗ ∗ ∗ ∗ ∗ ∗ ∗ ∗

∗ ∗ 5

∗ ∗ 8

∗ ∗

∗ ∗ ∗

∗ ∗ ∗ ∗ 5

∗ ∗ ∗ ∗

∗ ∗

∗ ∗

∗

∗ ∗

∗

∗

∗

∗

∗ ∗

∗ ∗

∗

∗

∗ ∗

∗ ∗ 8

∗ ∗ 7

∗ ∗ 6

∗ ∗ 4

6 7 2 1 5 4 8 4 4 3 1 3 7 1 9 9

Key; ∗ Significantly lower than the IASC at 5% level Note; For all other issues, no EU country was significantly different from the IASC.

Germany (for issue 25B) and Italy and Denmark (for issue 19A–C). In the case of realized gains on revaluation, the German respondents indicated that revaluation is not permitted in Germany so this question becomes irrelevant. In the case of pensions, state pensions in Italy and Denmark were considered to be so universal that pension accounting is generally irrelevant. While some of the items included in the Comparability Project are undoubtedly more important than others, it was decided to use unweighted measures as any attempt at weighting would be entirely subjective. However, recognizing that any index, whether weighted or not, contains implicit value judgements regarding the relative importance of the items contained in the index, the compliance rates for the individual questions are given greater prominence in the analysis of the results obtained. Agreement Between the EU and the IASC The question of the extent to which EU practices are in agreement with the recommendations of the IASC was explored using two approaches. Firstly, analysis of variance (ANOVA) through the PROC GLM routine (SAS, 1988: pp. 549–640) was used and then Duncan’s multiple range tests were used to identify countries that were significantly different from the Comparability Project recommendations (see Table 2). To do this, the

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recommendations of the IASC were modelled using an artificial country, CIASC, which was in complete agreement (100% compliance) with the IASC across all issues. Thus, the nine EU countries were each compared with this artificial country, CIASC, on an issue by issue basis (see Table 2). Secondly, rather than looking at FRPs on an issue by issue basis, the overall level of agreement with the IASC recommendations was also considered. To do this, cluster analysis was conducted, similarly using all nine EU countries plus CIASC, to see which, if any, of the EU countries were sufficiently in agreement with the Comparability Project across all issues taken as a whole to cluster with CIASC. This cluster analysis was performed using the Proc Cluster (SAS, 1988: pp. 283–358) procedure on scores for all 27 issues covered by the CP. The results of Duncan’s multiple range test are reported in Table 2. This reveals that all the EU countries are significantly different from the IASC when all the IASC recommendations, as measured by both COMPX and COMPF, are examined. However, when the questions are instead examined individually, only 14 issues spread over eight standards yield current practices in at least one country that are significantly different from the revised IASC standards. Looking at individual countries, the greatest differences emerge for Belgium, Germany and the Netherlands. These countries all have eight issues whose utilisation patterns are significantly different from the IASC benchmark or alternative treatments. In contrast, the UK appears to be most like the IASC, with only four issues separating them. Examining the individual issues instead, for three of the issues only one of the nine EU countries is different from the IASC. In contrast, issues for which the majority of the EU are not in agreement with the IASC are as follows: Issue 18A, revenue recognition on services where only Belgium, France and Italy are not significantly different from the IASC; Issue 11A, revenue recognition on contracts where only Italy and the UK are not significantly different from the IASC; Issue 22E, negative goodwill where only Denmark and France agree with the IASC and; Issue 19C, treatment of changes in pension costs, where only the UK agrees with the IASC. Looking instead at the analysis of all issues considered together, the cluster analysis resulted in six clusters or groups using the t-drop algorithm (SAS, 1988: p. 333). The results found indicate that in no single EU country is there sufficient agreement with the new IASC standards for there to be an IASC clone group and, instead, the IASC stands alone. The clusters that formed were: 1. The IASC 2. The UK, which is generally more likely than the rest of the EU to follow those practices that are supported by the IASC. Indeed, as can be seen from Table 3, as discussed below, it is very noticeable that on six issues the UK is significantly more in agreement with the IASC

         13 TABLE 3 Financial reporting practices of the EU countries Countries that are significantly different Issue

Mean %∗

Std. Dev.

2A 8A 8B 9A 11A 16A 16B 16C 16D 18A 19A 19B 19C

95·5 98·7 74·7 50·2 56·8 98·4 59·2 51·9 50·7 47·4 90·1 52·7 36·4

6·7 2·3 24·9 20·1 22·2 4·7 16·6 21·5 26·6 14·5 14·4 30·7 26·8

21A 21B 21C 21D

56·0 98·6 65·7 52·7

25·8 4·2 14·2 26·0

21E

52·1

24·6

21F 22A 22B 22C 22D

59·6 84·1 45·6 97·8 64·3

24·3 15·4 11·7 6·7 33·7

22E

32·0

23A 93·9 25A 69·1 25B 40·8 COMPX66·4 COMPF 66·0

less than EU mean%

greater than mean% — — Port. Fran. Italy — — Port. Germ. — — UK UK

24·9

Spain — Italy Germ. Belg. — — Denm. Port. — — Germ. Denm. Italy Fran. — — Germ. Port. Belg. Germ. — Spain — — Denm. UK —

7·8 16·2 11·7 4·0 5·2

— Italy — Germ. Germ.

78·3 40·0 Spain 18·8 37·0 Germ.

41·7

23·1 Fran. 0·0

24·0

2·5 Italy 12·0 Germ. 15·6 Port. 20·0

21·4 8·5 12·5

26·3 Neth. 25·0 17·5 Fran. 37·5

15·6

100 87·0 86·7 UK

18·6 22·0

Spain

95·0

100

90·0

— — — 21·4

36·5 60·4 Port. 57·7

92·2

86·7 100

Port. — — UK

53·3 41·7 Neth. 5·0

46·7 88·0 72·7 UK

62·5

Denm. 62·5 Fran. Spain 51·7 — — — — Fran. 71·7 UK

74·0

74·8

∗ Percentage compliance of country with IASC recommendations.

than is the EU on average, while for only one issue (treatment of positive goodwill) is the UK significantly below the average EU position. 3. Germany, which in contrast to the UK, is the country that most often features in the list of countries whose practices are significantly below

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the average EU compliance rate. Thus, for eight issues, Germany is significantly less likely to adopt IAS recommendations, while for only one issue (treatment of revaluation increases) is it significantly more likely to adopt the IAS recommended practice. 4. Portugal and Spain 5. Belgium and France 6. Italy, Denmark and Netherlands. The group membership of some EU countries might be considered to be somewhat surprising. In particular, it might have been expected that Italy would have clustered with Spain and Portugal to form a Mediterranean group, rather than with Denmark and the Netherlands, neither of which have rigid tax- or code-based systems. The pattern found is probably because Italy has begun to develop what might be considered as a two-tier system. The traditional code-based system is still in existence and the accounts for single entities are used for taxation purposes. However, group accounts are not constrained by taxation considerations and the stock exchange authority, CONSOB, has encouraged the use of international standards in those areas where Italian legislation is silent. The other clusters which form are very similar to those that might have intuitively been expected. Overall, therefore, the results of both the analysis of variance and the cluster analysis clearly support the conclusions that, at least across the issues covered by the SoI, the level of consensus across EU member states is generally fairly low and that on many of the issues considerable diversity of practice exists. Intra EU Differences The question of the extent to which FRPs are harmonized inside the EU itself was similarly explored using two approaches. ANOVA and Duncan’s multiple range tests were used to identify those countries that were significantly different from the mean compliance rate across all nine EU countries (see Table 3). Cluster analysis was then explored to determine which EU countries were clustered together and how many clusters existed. The mean compliance rates across the EU countries for the 27 issues examined as well as COMPF and COMPX, are reported in Table 3. Duncan’s multiple range test was used to determine which of the EU countries were significantly different from the rest of the nine EU countries. Overall, there is relatively little variance across the countries. Thus, if COMPF and COMPX are considered, the mean compliance levels are 66·4% and 66·0%, while the standard deviations are 4·0% and 5·2% respectively. However, there are some significant differences (at the 5% level) across the EU countries, with the level of compliance in Germany being lower than the group mean for both COMPF and COMPX while Portugal is also significantly below the group mean for COMPX. In contrast, both the UK and France have compliance levels significantly above the group mean with respect to COMPF.

         15 TABLE 4 Comparison of issues covered by EU Directives and issues not covered in Directives % Compliance with IASC proposals Country

COMPF

Areas covered by Directives

Areas not covered

t-value

Significance

Belgium Denmark France Germany Italy Netherlands Portugal Spain UK

63·6 65·6 71·7 57·7 66·4 63·5 61·7 68·8 74·5

70·2 59·1 82·7 54·9 66·4 48·8 60·6 67·1 50·9

61·7 67·7 68·6 58·5 66·5 67·7 62·0 69·1 81·5

1·75 −2.63 2·15 −1·91 −0·46 −4·01 −0·29 −0·21 −5·72

— ∗∗ ∗ — — ∗ — — ∗

∗ Significant at 5% ∗∗ Significant at 1%.

If the issues are considered individually, 14 of the 27 issues yield significant intra-EU differences. While this is only slightly more than one-half of the issues, these 14 issues relate to all but two of the revised IASs. The two standards where no significant differences emerged were; IAS18, revenue recognition on services, and IAS23, capitalization of borrowing costs. Large differences emerge in a few of the other areas. Particularly noticeable are the recognition of revenue on construction contracts (Issue 11A), the treatment of gains or losses on long-term monetary items (Issue 21A) and the treatment of development costs (Issue 9A). For issue 11A, both Germany and Belgium adopt a more conservative approach than do the rest of the EU while, in contrast, Italy and the UK adopt less conservative attitudes. Similarly, Germany is the most conservative with regard to the expensing of development costs, while France is significantly less conservative than the rest of the EU. The cluster analysis confirmed the earlier results. Five groups of countries were formed that were identical to the five EU groups found above. Issues covered by the Fourth and Seventh Directives The question of whether the practices of the EU countries are more or less similar to those supported by the Comparability Project in the areas covered by the Fourth and Seventh Directives was explored by using t-tests. The average compliance level in each EU country over all those issues covered by these Directives was computed as was the average compliance level for those issues not covered by the Directives. These two were then compared, to test whether or not they differed significantly (see Table 4).

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For three areas, goodwill (Issues 22D and E), research and development (Issue 9A) and measurement of property, plant and equipment (Issue 16A–D), the Fourth Directive applies. For goodwill and R&D, the Directive has no mandated treatment but requires companies, if they capitalize such costs, to write them off over 5 years. Individual countries may also permit companies to use a longer period providing it does not exceed their useful economic life. The Seventh Directive on group accounts includes accounting for business combinations (Issues 22A–C) and goodwill (Issues 22D and E). This Directive also permits countries to allow companies to write goodwill off immediately to reserves. The IASC revised standards in contrast have fewer choices and companies may therefore comply with the Directives and not with the IASC standards. From Table 4, it can be seen that significant differences in the levels of compliance with those areas covered by Directives and those areas excluded were found for four of the countries. However, this does not imply that the Directives have effectively introduced those practices which the IASC also support. Indeed, three of the four countries, namely the UK, Denmark and Netherlands, were found to have significantly lower compliance rates with respect to those areas covered by the Directives. In contrast, only France had significantly higher compliance rates in those areas covered by the Directives. EU and the Rest of the World Finally, the practices of EU and non-EU countries were compared using a series of t-tests for each issue and for the two global measures, COMPF and COMPX. Table 5 reports the results of tests of agreement between the nine EU countries taken as a whole and the 46 non-EU countries. When all the countries were compared then, using both the COMPF and COMPX measures of compliance, the UK and France had the highest ranks of any of the EU countries (ranked 11th and 13th respectively for COMPF). Spain was in the second highest quartile (ranked 23rd out of 55 for COMPF). The remaining six EU countries were below the global mean (Germany, Portugal, the Netherlands, Belgium, Denmark and Italy). Similar positions also applied for the reduced (COMPX) index. Overall, there appears to be very little to differentiate the EU from the rest of the world. The overall compliance rate of the EU with all the IASC proposals is 66·0% compared with the marginally higher compliance rate of 68·1% for the rest of the world. Similar results also exist for the reduced (COMPX) index, namely 66·4% and 68·3% respectively. Similarly, relatively small differences exist in the mean compliance rates for the majority of the 27 individual issues examined. This conclusion is borne out by the results of the t-tests. While the mean compliance rates of the EU and the rest of the world differ by at least 10% for eight issues, for only two of these are

         17 TABLE 5 Financial reporting practices in the EU compared to the rest of the world EU

Rest of world

Issue

Mean %

Std. Dev. %

Mean %

Std. Dev. %

2A 8A 8B 9A 11A 16A 16B 16C 16D 18A 19A 19B 19C 21A 21B 21C 21D 21E 21F 22A 22B 22C 22D 22E 23A 25A 25B COMPF COMPX

95·5 98·7 74·7 50·1 56·8 98·4 59·2 51·9 50·7 47·4 90·1 52·7 36·4 56·0 98·6 65·7 52·8 52·1 59·6 84·1 45·6 97·8 64·3 32·0 93·9 69·1 40·8 66·0 66·4

6·7 2·9 24·9 20·1 22·4 4·7 16·6 21·5 26·6 14·5 14·4 30·7 26·8 25·8 4·2 14·2 26·0 24·6 24·3 15·4 11·7 6·7 33·7 24·9 7·8 16·2 20·2 5·2 4·0

93·2 97·0 83·5 57·0 67·0 100 73·0 41·6 29·8 61·9 89·9 59·8 46·2 70·1 97·5 80·6 37·2 27·5 56·0 85·6 50·1 98·4 65·3 40·7 95·9 68·5 45·0 68·1 68·3

11·4 2·3 20·7 25·9 22·4 0·0 22·4 29·4 26·6 20·3 19·7 28·1 30·2 25·6 6·8 16·5 29·9 29·1 33·4 17·0 34·9 6·2 29·8 33·4 11·7 16·2 29·9 7·0 7·0

t-test

Signif. Signif.

the differences significant (at the 5% level). In addition, neither of the two overall measures (COMPF and COMPX) yield significant differences. The significant differences that emerge both relate to accounting for foreign exchange rates. These two issues are: Issue 21C, exchange rates used to translate income statements and; Issue 21E, accounting for subsidiaries in hyper-inflationary countries. For Issue 21C, the IASC mandates the use of transaction date or average exchange rates for translating income statements. The non-EU world tends to agree, using this practice 80·6% of the time, while the rate in the EU is

18

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only 65·7%. The closing rate is particularly common in Denmark, where responding auditors indicated 62·2% of clients use the closing rate. For Issue 21E, a small majority of EU audit clients (52·1%) use the IASC approved method of restating financial statements for inflation and using a closing exchange rate. In contrast, the rest of the world uses this method only 29·1% of the time. However, there is considerable variability across the EU in this area. In particular, France and Denmark tend to translate at current rates without restatement, and Germany tends to use the temporal method. CONCLUSIONS The general picture that has emerged is one of a reasonable overall level of congruence between FRPs in the EU and the revised IASC standards. At first glance, it appears that the IASC has managed to reduce the number of options available to corporations, while at the same time permitting them to still employ the most commonly found practices. It must be remembered however, that to achieve this compliance the IASC had to revert to the original E32 position in allowing the expensing of interest on the construction of long-term assets and three inventory valuation methods (including LIFO). These compromises mean that the overall EU compliance rate is greater than it would have been had all the changes made in the original Statement of Intent been implemented. However, while the overall compliance rate with the IASC recommendations is relatively high, considerable diversity exists within the EU. Some countries will find it considerably more difficult to comply with the IASC recommendations than will others. The UK and France both have compliance rates in excess of 70%, suggesting relatively few problems. In contrast, Germany has a compliance rate of only 57·7% and Portugal 61·1% for all Issues or 60·4% and 62·5% for the reduced set COMPX. This is after the IASC compromise.6 Some Issues covered by the Comparability Project are clearly far more important than others, as they affect a greater number of corporations and the effects of using alternative methods are greater. Probably the most contentious of the Issues covered by the Comparability Project are goodwill, pensions, research and development and recognition of revenue on longterm construction contracts. A clash of approaches seems to emerge between what Gray (1988) would call highly conservative countries whose objective is to minimize both assets and net income (Germany, Portugal) and the more balance sheet/accrual-based countries of the world represented in the EU sample by the UK in particular. Harmonization attempts by the EU appear to have had no influence on the extent to which EU practices are congruent with the IASC standards. In only four of the EU countries examined were there significant differences

         19

in compliance rates between those areas covered by the Fourth and Seventh Directives and those not covered by the Directives. However, in three of these countries there was less agreement with IASC’s revised standards in those areas covered by the Directives than for those areas not covered by the Directives. Finally, when the EU and the rest of the world are compared, few significant differences appear. This is hardly surprising as the EU contains in the UK, France and Spain, the ancestors for most of the accounting systems found internationally (see, for example, Nobes, 1987; Doupnik & Salter, 1993). While it is possible to draw these general conclusions from this study, the limitations of the work undertaken must also be explicitly recognized. The results depend crucially upon the experience and knowledge of the respondents and their diligence in completing the questionnaires. While, to the extent possible, checks for reliability were conducted and data on the experience of the respondents also collected, it is obviously not possible to establish conclusively the reliability of the data collected. Thus, the results should be treated as indicative only, and it must be recognized that the precise figures reported above will be subject to some margin of error. This is likely to be a particular problem in those countries with more liberal regulations for group accounts than for single entity accounts. Thus, for example, in France, single entities incorporated domestically are required to follow regulations that are very largely driven by the Code Comptable General which tends to be a conservative and standardized system of accounting that is influenced by taxation considerations. In contrast, group accounts are far more influenced by the stock market regulator, COB. Group accounts therefore are often drawn up using different rules from those that pertain to the domestic entity, with international pressures being far more important. While the questionnaire, as discussed earlier, asked respondents to describe the practices of entities operating in their own country and therefore subject to the rules that apply to domestic single entities, further detailed research is required to ascertain the specific differences that exist across different types of organizations and the practical importance of these differences. The results found have suggested that there are some important differences across the EU. They also suggest that there are differences across specific issues with, in some cases, the IASC recommending practices that are followed by most organizations in most countries, while other IASC recommendations are followed by only a minority of organizations in most countries. Given these differences, what is important now is that future research seeks to answer the question of why these differences exist and what is their significance. These types of questions call for detailed in-depth study which cannot be tackled by questionniare-based research covering a broad range of issues and countries. Instead, what is needed in the future is case-study-based research which looks both at individual countries and

20

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particular FRPs across specific countries. Once this is done, such studies be compared and hopefully more detailed and richer conclusions can be drawn regarding FRPs internationally. N 1. The original research instrument was based upon the 1990 Statement of Intent. The questionnaire was administered in mid-1992, shortly before the revised SoI was issued. Because the revised SoI formed the basis for the later standards, the scoring of agreement was based upon the revised SoI of October 1992, rather than the original SoI or E32. As explained in the text, the only difference between the revised SoI and the original E32 was with respect to development costs. 2. Economically significant organizations were defined in a manner similar to that used by the IASC in IAS14, Para 2, namely, those whose level of revenue, profits, assets or employment are significant in the countries in which their major operations are carried out. 3. In an attempt to increase the validity of the responses, participants were not told that the questionnaire was concerned with the Comparability Project and the questionnaire was designed as far as possible to minimize the probability of recognition. Thus, for example, all treatments were fully described. 4. In each country, a minimum of three partners from each of the six major international accountancy firms were selected from the directories of partners provided by each firm, i.e. a minimum of 18 per country. If a country had multiple offices, partners were selected from as many of these offices as possible up to a maximum of ten partners per firm in each country i.e. a maximum of 60 per country. Only in three countries included in the final sample was it not possible to select at least 18 partners. These were Bahrain (13), Singapore (17) and Hong Kong (17). 5. Mean percentages reflect those respondents who provided responses only. Not applicable responses were treated as missing data. Compliance with IASC recommendations was taken as being compliance with the preferred treatment or, where applicable, the sum of compliance with preferred and any allowed alternative treatment(s). 6. This would be 52·83% for Germany and 53·81% for Portugal for the original Statement of Intent before the treatments of interest capitalization and inventory reverted back to the E32 position.

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