Adoption of international accounting standards: antecedents, processes and outcomes.

ABSTRACT

This paper examines international accounting standards focusing on the antecedents, processes, and outcomes influencing the adoption of a commonly accepted set of accounting standards. It is found that most critical antecedents are economic (stage of development, inflation, financial markets), political system stability, legal requirements relating to accounting reporting and general business laws, and cultural idiosyncrasies reflected in values, educational systems, religion and language. The most dominant processes relate to accounting practices (transparency, accountability, disclosure requirements), standardization efforts, motivation to harmonize, and exchange controls. Key outcomes include quality of financial reporting, adoption of explicit accounting standards, investment decisions, access to global capital markets, economic welfare and corruption controls.

1. INTRODUCTION

Accounting provides a critical service to society, and in the wake of the recent accounting scandals, where billions of dollars of investment and retirement wealth evaporated for millions of investors and employees, the very integrity and survivability of this service have been called into question. The globalization of international trade has had and continues to have a profound effect on the way business is conducted. It has not only turned companies into global institutions, but it has also challenged daily economic life, national identity, and created a persistent movement towards cultural and business homogenization. Being a product of the environment in which it operates, international accounting has been caught in this maelstrom of change. The international accounting community has heard the clarion call for a set of universally accepted set of accounting standards to facilitate understandability of financial information across borders.

Accounting diversity among societies is reflected in financial statements prepared under different accounting standards. If investors and creditors encounter difficulties in understanding financial statements, they would be reluctant to invest or lend funds to such companies (Schroeder & Clark, 1995). Therefore, it is imperative for financial reports to be written in a common accounting language that is understood globally (Pacter, 1998). In addition, globalization of business, foreign currency exchanges, and the need for consolidated financial statements are exerting tremendous pressure on the internationalization of accounting standards. Anderson (1993) stated that "An international set of accounting standards would allow a more level playing field because income statements and balance sheet ratios would become more consistent between competing companies." Against the backdrop of globalization several pertinent questions need to be asked. How does accounting differ in various countries? Does this diversity create problems? What are the causes of such diversity? What efforts are being made to meet the problems of that diversity and with what success or failure are they being met? What are the emerging issues with which the accounting profession will have to deal? What will be the future of international accounting?

The purpose of this manuscript is to synthesize into a coherent conceptual model diverse literatures describing antecedents, processes and outcomes relating to the degree of international accounting diversity and favors the adoption of a universally accepted set of accounting standards.

2. LITERATURE REVIEW

2.1. Historical perspective

The very first steps towards international accounting standards date back to 1959, when a founding partner of a major European firm of independent accountants urged that work begin on this subject (Choi, Frost, & Meek, 1999). Since then, the work of accounting and non-accounting organizations culminated in the setting up of the International Accounting Standards Committee (IASC) in 1973. In 1997 the IASC changed its structure to "bring about convergence between national accounting standards and practices and high quality global accounting standards." In July 2000 the IASC was renamed the International Accounting Standards Board (IASB), and in April of the following year, the IASB assumed the responsibility for promulgating international accounting standards.

The Asian crises of 1997-1998 marked an impetus for supporting international accounting standards, where many countries either adopted international accounting standards in their entirety, or with minor changes. Several companies in countries that did not implement international accounting standards, adopted international accounting standards nonetheless for their own financial statements in order to be able to compete in international markets (Hansen, 2003). Similar accounting adoption steps have been taken by Australia, Canada, and Russia, as well as in several countries in the Middle East and North Africa.

2.2. Conceptual framework of adoption

The model presented in this manuscript synthesizes information reported in diverse sources and literatures pertaining to antecedents of accounting standardization, the processes that facilitate/moderate adoption of common practices and the actual/expected outcomes of such processes. The conceptual foundations and presentation of this model are intended as a stimulus to generate academic and practitioner discussion and refinements on defining and measuring relationships among constructs.

2.2.1. Antecedents

Adhikari and Tondkar (1992) reported that financial "accounting reporting and disclosure standards and practices do not develop in a vacuum but reflect the particular environment in which they are developed" (p. 76). Accounting principles and practices are generally influenced not only by environmental factors such as history, values and culture, but also by the stage of that society's economic development and accounting system. If accounting is the language of business, then this language becomes relevant when it is easily understood and satisfies users and decision makers.

Several studies have been conducted to identify the reasons explaining accounting diversity (Gray, 1988; Cooke & Wallace, 1990; Doupnik & Salter, 1995). Meek and Saudagaran (1990) and Iqbal (2002) identified five key major environmental influences relating to the economic system, the political system, the legal system, the educational system, and religion. In particular, the level of inflation, sources of finance, the stage of economic development, financial markets, and managerial development or sophistication, accounting education, and culture affect accounting practices (Meek & Saudagaran, 1990; Gernon & Meek, 2001). Iqbal (2002) argues that the "degree of economic risk exposure to the investors and creditors in a country is directly related to the degree of economic instability of the country." In countries characterized by an unstable economy, economic forecasts are very difficult and require constant, if not drastic, changes leading to questionable accounting practices. Therefore, a stable economy facilitates the development of a conceptually sound accounting system.

A country's level of inflation is another determinant that shapes accounting systems and causes accounting diversity, in most countries, the historical cost concept is used for initially recording transactions. In times of generally rising prices, inflation exerts an enormous pressure on historical cost accounting and attracts a great deal of attention in reporting the effects of changing prices as it happened in the late 1970s and early 1980s in the U.S. and the U.K. (Iqbal, 2002; Saudagaran, 2004).

A country's stage of economic development is a reflection of the business transactions that are prevalent in that country. As Choi, Frost and Meek (1999) suggest, types of economic transactions determine the accounting issues that have to be addressed. The greater the complexity of business transactions, the more difficult the accounting issues.

Business ownership determines the extent to which financial disclosures are to be made. Thus, if business ownership is held by several investors, then a myriad of disclosures will be necessary to address the needs of such a diverse group of investors. If equity financing is the main source of an economy's source of capital, such as in the U.S. and the U.K., then financial reporting will be geared to equity holders. Conversely, in countries where debt financing is the major source of capital, such as Germany, Japan, and Switzerland, accounting reporting focuses on creditor protection that is achieved through conservative accounting measurements. Consequently, since financial institutions have direct and immediate access to information, detailed and transparent public disclosure is limited. Apart from the idiosyncratic sources of finance in a country, tax legislation has an impact on accounting. In many countries (e.g., Germany, Japan, France, and Sweden) tax law effectively determines accounting standards because firms are required to record revenues and expenses for tax purposes. In other instances such as the U.S., the U.K., and the Netherlands, financial and tax accounting are two separate and distinct disciplines. Taxable income is simply financial accounting income adjusted for the effects of tax laws.

Inextricably bound to a country's economic system is a country's political system and philosophy. Political and economic stability go hand in hand. If economic stability were a prerequisite for the development of an accounting system, then that development would be facilitated by a country's political stability. An Ernst & Young survey of the Global 1000 companies (Iqbal, 2002), identified that apart from financial risk, legal infrastructure, bureaucracy, exchange controls, and commercial infrastructure, political instability was the major barrier to investment in a country. Iqbal (2002) posits "the political instability of a country is often a result of the deterioration of economic conditions. The development of a comprehensive and sophisticated accounting system is difficult under such a set of circumstances."

Perhaps no other factor causes more diversity in accounting than the legal system that typically prescribes accounting rules and regulations. In certain countries, the private sector is entrusted with setting accounting standards and policies. Gernon and Meek (2001) discussed the dichotomization of the accounting world into those countries with a legalistic (code-law countries) orientation incorporating most of continental Europe and South America, and those countries with a non-legalistic (common-law countries) orientation such as the U.K. and the U.S. Prior studies have shown that whereas "common law" countries tend to be innovative and open to new business ideas, "code law" countries are likely to adhere to prescribed procedures. Doupnik and Salter (1995) found that the type of legal system (i.e., code versus common law) was the dominant explanatory variable and that the basic starting point lied in classifying accounting practices internationally. Closely related to this issue is judicial corruption. Apart from undermining the integrity of a country's legal system, judicial corruption erodes the very fabric of a society's ethics and values. This state of affairs has an impact on accounting since the behavior of a country's high institutions will trickle down and be emulated by all other institutions in that country. Although the U.S. has played a leading role in curbing global bribery, other countries have been slowly following suit. For example, in 1997, Thailand formed an anti-corruption organization, the National Counter-Corruption Commission. This Commission was instrumental in removing the interior minister from office. Similar steps have been taken in Indonesia (Iqbal, 2002).

The quality of accounting education plays a vital role in a country's accounting system. Saudagaran (2004) points out that there is an interaction between the quality of accounting education and a country's level of economic development, political and economic ties with other countries, and the reputation of that country's accounting profession. Iqbal (2002) surmises that whereas the economic, political, and legal systems are closely intertwined, the educational system can be a force to "counter, reinforce, or modify influences of the economic, political, and legal systems." One key outcome of education is the accounting profession's values. Not surprisingly, the shared values of the members of the accounting profession in a country influence the accounting system of that country. Furthermore, information from a country's accounting system impacts the economic, political, legal, and educational systems (Iqbal, 2002).

One key factor that houses the development of an accounting system is culture. Hofstede (1980) defined culture as "the collective programming of the mind which distinguishes the members of one human group from another." Culture in general is a very difficult construct to define and measure. Equally difficult is the relationship between cultural factors and accounting development. Several studies conducted by Hofstede (1980), and Gray (1988) have sought to examine such a link using traditional constructs of "individualism versus collectivism", "large versus small power distance", "strong versus weak uncertainty avoidance", "masculinity versus femininity", and "Confucian dynamism." Gray (1988) identified the four accounting values of "professionalism", "uniformity", "conservatism", and "secrecy" and argued that these values interact with the institutional consequences of culture such as capital markets in order to have a final set of accounting systems that include financial accounting reporting practices and professional structure.

Salter and Niswander (1995) tested Gray's (1988) theory and found that uncertainty avoidance is most strongly associated with Gray's accounting values. Individualism, which Gray thought would have overall relative importance, was only related to secrecy. Gray and Vint's (1995) study focused exclusively on the secrecy dimension and found that it was significantly related to uncertainty avoidance and individualism. Salter and Niswander (1995) also found that power distance had no relationship to Gray's (1998) four accounting values. They also concluded that masculinity was more strongly associated than Gray (1998) had actually hypothesized. Fechner and Kilgore (1994) asserted Hofstede's (1980) finding that uncertainty avoidance is the only dimension that significantly correlated with his other three cultural dimensions. Saudagaran and Meek (1997) concluded that the probable reason that uncertainty avoidance dominates the other three culture dimensions is because it is a "summary index for the other three cultural dimensions." It has also been argued, that culture has a more important bearing on disclosure--the secrecy dimension, than on measurement--the conservatism dimension, (Baydoun & Willett, 1995). Therefore, cultural factors directly influence disclosure whereas economic factors influence measurement (Fechner & Kilgore, 1994).

Language could also be deemed to have a cultural impact on accounting diversity. Perera (1994) summarized comments made by Gerhard G. Mueller that accounting seems to flourish in English speaking countries and languish in others, particularly Romance language countries. However, as with most elements of culture, it should be noted that language is not a causal factor per se but a correlate of other factors too (Saudagaran & Meek, 1997).

One cultural variable that affects all others, as well as basic accounting concepts, is religion. Religion is a question of faith and plays a very important role in a global economic context. Apart from the fundamental beliefs in each religion, certain religions practices crossover from the sublime to the business world. For instance, Muslim law prohibits interest on loans among Muslims (Iqbal (2002). In the Western world, interest plays such an integral part in daily transactions that in several countries, accounting or tax regulations require that interest be imputed even on non-interest bearing loans.

In summary, regarding culture, Saudagaran and Meek (1997) admit that it remains an elusive construct since it is very difficult to operationalize. Some researchers have even argued that culture has become "... a residue for everything that cannot be explained by other factors ..." and went even further by questioning whether culture is really a "homogenous phenomenon within countries" (Gernon & Wallace, 1995, p. 91).

2.2.2. Processes due to diversity

Saudagaran and Meek (1997) conjecture that pressure from international capital markets is likely to be one of the main reasons for moderating accounting diversity in the future. There are two main avenues of achieving accounting compatibility. The first is through standardization and the second is through harmonization. By its very definition, standardization is the imposition of a rigid and narrow set of rules that in the case of international accounting standards would ensure full compatibility. On the other hand, accounting harmonization is the minimization of diversity with a view to increasing the comparability of financial information across borders.

The recent flurry of activity in the international accounting arena augers well for the future of international accounting. Against this background, accountability, transparency, and integrity are crucial issues in both developed and emerging markets. According to DiPiazza and Eccles (2002-quoted in Baker 2002), investors want greater transparency from companies, boards of directors, independent auditors, and from sell-side analysts. They argue that greater transparency begets higher standards of accountability. Furthermore, principles based on global accounting standards should be pursued as keys to opening the door to the world's capital markets. Without such global standards, access to capital markets will be expensive and difficult. Thus, international accounting will play a pivotal role in the global financial arena. Until fairly recently, no one would have thought that U.S. GAAP would be assailed by some principles-based approach as that advocated by the IASB (Heffes, 2002). The providers of capital in an economy play a crucial role in shaping that economy's accounting system by determining their own information needs. Thus, in countries where there is a multitude of individual and institutional providers of capital, financial reporting generally focuses on transparency, profitability, and stewardship. Conversely, in credit-based countries, in which banks are to sole providers of capital, financial reporting focuses on creditor protection with conservative measurement rules.

The degree of international accounting harmonization will also be strongly influenced by the use of the new Internet-based technology known as Extensible Business Reporting Language or XBRL. This technology uses accepted financial reporting standards to translate financial statements into information that users will be able to access and analyze immediately for their decision-making. DiPiazza and Eccles (2002; quoted in Baker 2002), agree that XBRL will play a two crucial roles; the first is in promoting financial reporting transparency, while the second involves the increased speed with which information can be obtained and analyzed.

Another important process is the dissemination of knowledge to domestic and foreign students of accounting alike. A large proportion of the student bodies on several U.S. campuses are made up of foreign students exposed to U.S. and international accounting standards, principles, and practices. A significant majority of these students return home with terminal degrees in accounting and some of them even with professional designations such as the CPA and CMA. These highly U.S.-educated individuals play a crucial role in the development of accounting in their respective countries. For example, the Taiwanese accounting standard setter, the Financial Accounting Standards Committee, relies heavily on accounting academics, the majority of which received their doctorate degrees from U.S. universities. As a result, Taiwanese accounting academics and practitioners are very familiar with the US rules-based approach to accounting standard setting (Hussey & On, 2003).

Another key process affecting international accounting is the growth of emerging capital markets. Apart from the fact that these emerging economies have their own unique needs, financial reporting is seen as the foundation for the infrastructure for the growth of these markets (Saudagaran & Diga, 1997). Emerging markets are quite diverse in both size and history. For instance, the capital markets of Korea, Malaysia, Mexico, and South Africa have remarkably large market capitalization that even exceeds the market capitalization of shares traded on the stock exchanges of some developed economies. Some emerging capital markets, such as India, Malaysia, South Africa, and Zimbabwe have existed since colonial times. Yet others, such as Botswana and Ecuador have been in existed since the 1990s (Saudagaran and Diga, 1997).

Consequently, a well-functioning stock market in these emerging capital markets serves as a barometer for that country's economic well being specifying, to some extent, macroeconomic policy regarding growth and inflation. The World Bank pointed out that "... in developing countries, accounting and auditing practices are sometimes weak and financial laws and regulations do not demand accurate and timely reports. Developing an effective accounting and auditing profession is essential for building efficient capital markets" (World Bank, 1989, p. 90)

Financial reporting in emerging capital markets should rest on a tripod. The first leg should ensure that accounting information is available, adequate, timely, and readily accessible. The second leg should ensure that financial reports are prepared on the basis of sound accounting requirements and be made to comply with those accounting requirements. The third leg should ensure that financial information is comparable. Achieving comparability encompasses specific accounting policies that are used to prepare financial statements and also the need to understand the contextual significance of the financial information (Saudagaran & Diga, 1997). A universally accepted set of accounting standards is well poised to address these concerns.

In summary, as a result of the explosion of debt and equity placements in foreign capital markets and cross border transactions, the future of international accounting will see an increase in transparency and comparability among countries. As Fletcher (2002) predicts, national standard setters, securities regulators, multinational corporations, audit firms, and also investors will have the same goal of using one set of high quality international accounting standards. Hensen (2003) points to the harmonization of accounting standards for ensuring long-term global financial stability, creating international capital markets, and ensuring full transparency. From the U.S. perspective, once it resolves its issues over adopting international accounting standards, the goal of having a set of global accounting standards will become a reality in the not too distant future. The harmonization initiatives that have taken place of the past few years have been aimed at reducing this diversity even though many, like Saudagaran (2004) opine that these have been very expensive initiatives. As a matter of fact, even the International Accounting Standards Board (IASB) has embarked on a standard-setter role rather than solidifying its role as a harmonizer.

2.2.3. Outcomes

Prior studies have shown that diversity in financial reporting practices around the world affects firms in many areas. For example, Biddle and Saudagaran (1991), Saudagaran and Biddle (1992, 1995), and Cheung and Lee (1995) observed that differences in disclosure levels affect a firm's decision to list on a foreign stock exchange. Choi and Levich (1991) and Bhusan and Lessard (1992) studied the effects of regulatory differences on user groups and found that accounting differences are important and affect the capital market decisions of capital market participants, while the effects of differences in the treatment of goodwill on mergers and acquisitions was investigated by Choi and Lee (1991), Lee and Choi (1992), and Dunne and Ndubizu (1995).

Saudagaran and Biddle (1995) showed that the probability that a firm will list its securities on a foreign exchange is inversely related to the foreign exchange's disclosure level and directly related to that firm's exports to the foreign exchange's home country. Therefore, the less diversity in financial reporting across borders, the higher the probability that a firm will want to list its securities on a foreign exchange. In 1990, Beresford, then chairman of the Financial Accounting Standards Board (FASB), expressed his concerns as follows: "It is widely reported that many foreign companies are reluctant to offer their securities in the U.S. public markets or list them on U.S. exchanges because they are unwilling to comply with the voluminous and detailed U.S. accounting and disclosure requirements or submit to the SEC's jurisdiction. This is said to put the U.S. exchanges and securities industry at a competitive disadvantage."

Differences in accounting practices affect users of financial information. Choi and Levich (1991) found that diversity in accounting affects capital market decisions (such as the geographic spread of investments, the types of securities selected, and information processing costs) of a significant number of market participants regardless of nationality, size, experience, scope of international activity, and organizational structure. Perhaps a quick solution to alleviate the problem of accounting diversity for users would be to restate foreign accounting information. However, according to Choi and Levich (1991), restatement alone is insufficient to do away with accounting diversity. Choi and Levich (1991) likened the harmony and coordination of national accounting policies to "apple pie and motherhood" arguing that this promotes economic welfare. Of particular interest was the fact that in Choi and Levich's (1991) study, approximately 50 per cent of the companies surveyed felt that accounting diversity affected their capital market decisions. The other 50 per cent responded that accounting diversity did not affect them either because they employed coping mechanisms or simply because they thought that accounting diversity was not an issue. Thus, because of the ambivalence found in these results, it can be argued that accounting diversity does have necessarily negative behavioral effects on a variety of users.

Choi and Levich (1990) also found that accounting differences significantly affect a firm's capital market decisions. According to them, nationality seemed to play an important role in issuer behavior. They concluded that since U.S. and U.K. firms have to comply with fairly high disclosure standards at home, they appear to have greater flexibility in tapping international capital markets. This is in sharp contrast to German, Japanese, and other firms that provide less transparent financial statements.

Diversity of accounting practices also impacts international merger activity. For example, the accounting treatment of "goodwill" explains the premium firms place on acquiring target companies. Merger premiums offered by foreign companies based in countries that have a more favorable accounting and tax treatment for goodwill than the U.S., have been found to be higher than those offered by U.S. acquiring companies (Choi & Levich, 1991). Dunne and Ndubizu (1995) found that companies that write off goodwill against a reserve account, transfer more wealth to target shareholders that those that amortize goodwill against income. In addition, foreign acquirers that deduct goodwill for tax purposes, transfer more wealth to the target shareholders at the acquisition announcement than other acquirers. Consequently, the more advantageous accounting and tax treatment for goodwill may leave U.S. bidders at a disadvantage when they compete with foreign bidders in the merger arena (Dunne & Ndubizu, 1995).

3. CONCLUSION

Economic principles rely on the idea that wider opportunities should make people better off. When trade barriers are removed, opportunities are created. Such opportunities for cross border transactions and the lure of international capital markets, are facilitated by a set of high quality accounting standards. High quality necessarily implies comprehensiveness, rigorous implementation and application, clarity, comparability, and transparency. Regardless of the standing and endorsement of international accounting standards, the accounting profession is faced with challenges of substantial proportions. These global challenges include: global harmonization, the quality of financial reporting in developed and emerging markets, social and environmental reporting, financial reporting in the highly technological area (Saudagaran, 2004), special purpose entities (the likes of which got ENRON into trouble), and revenue recognition.

Accounting diversity will probably be very difficult to eliminate completely. National sentiments and pride are embedded in the consciousness of every people. Such traits have existed for centuries and are passed on from one generation to the next. Indeed, the efforts to minimize diversity in accounting are laudable but perhaps the reality is that the international community will have to live with such accounting diversity. As Haskins, Ferris, and Selling (2000) state, " Never before has there been so much pressure on, and opportunity for, leaders of financial reporting thought to help shape the most useful "language" by which suppliers of capital and seekers of capital communicate across companies, industries, countries, and cultures" (p. 1).

Care must be taken because the forces behind global economic change exalt deregulation, cater to corporations, undermine social structures, and ignore popular concerns. It has also been argued that globalization is hurting many people while helping few. In the words of John Gray, former advisor to Margaret Thatcher, the global market and free trade are not natural phenomena but creatures of state power, "an end product of social engineering and unyielding political will." Although there is a paucity of social and environmental disclosure requirements in both developed and emerging economies (Saudagaran, 2004), socially conscious stakeholders are demanding that firms report on the social and environmental impact of their business decisions. Thus, as Saudagaran (2004) forecasts, the growth in environmental consciousness and the increase in related legislation will make social and environmental reporting a crucial international accounting issue.

Clearly, a modus operandi would have to be found to continue to study the causes of international accounting diversity and to use the best global accounting practices. This will ensure that whichever body is responsible for promulgating international accounting standards will tackle future challenges with a global sense of purpose and equanimity of mind.

CONCEPTUAL FRAMEWORK

ECONOMIC

* Stage of development

* Inflation

* Sources of finance

* Financial markets

* Managerial development

* Accounting education

* Stability

* Complexity of transactions

POLITICAL

* System

* Stability

* Philosophy

LEGAL

* Type of system

* Tax Legislation

* System infrastructure

* Rules, regulations

* Contract law

* Corruption

CULTURE

* History

* Societal values/principles

* Education system

* Religion

* Language Language

PROCESSES ACCOUNTING PRACTICES

* Transparency

* Stewardship

* Accountability

* Disclosure

* Integrity

* Community

* Speed of analysis

* Dissemination of knowledge

STANDARDIZATION

HARMONIZATION

EXCHANGE CONTROLS

BUREAUCRACY

EMERGENT MARKET RESPONSE

OUTCOMES

QUALITY OF FINANCIAL REPORTING ACCOUNTING STANDARDS

INVESTMENTS/MERGERS/ACUISITIONS

GLOBAL COMPATIBILITY

ACCESS TO GLOBAL CAPITAL MARKETS

UNIVERSAL CODE OF ACCOUNTING ETHICS

LISTINGS IN FOREIGN STOCK MARKETS

ECONOMIC WELFARE

CORRUPTION CONTROL

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Bert Zarb, MBA, CPA, and DBA candidate at Argosy University, is an assistant professor of accounting at the college of business of Embry-Riddle University, Daytona Beach Florida.

Dr. Notis Pagiavlas earned his Ph.D. at University of Texas, Arlington in 1996. Currently he is as assistant professor of marketing strategy and ethics at the college of business of Embry-Riddle University, Daytona Beach Florida. He is a Sam Walton Free Enterprise fellow and chair of University Assessment.