Accounting Bits

Listed Companies using National Accounting Standards

This paper explores sophisticated measures for assessing and comparing the success achieved in converging National Accounting Standards with internationally-prescribed sets of accounting standards (such as those comprising IFRS).

The development of sophisticated measures of convergence is important for two principal reasons. First, not all countries have committed to adopting IFRS. For example, Iceland, Japan and Saudi Arabia are reported by the International Forum on Accountancy Development [IFAD] (2003) to have not yet expressed an intention to converge with IFRS. Some other countries (e.g. New Zealand) have opted to converge with IFRS over a longer time period (by 2007). Indeed, IFAD (2004) has reported also that as at December 3, 2004, IFRS were ‘not permitted for domestic listed companies’ in 36 countries (including Argentina, Brazil, Canada, Chile, Fiji, India, Indonesia, Mexico, Philippines Taiwan, Tunisia, United States and Vietnam). Consequently, for such countries, there are likely to be information benefits in measuring and monitoring the extent to which National Accounting Standards approximate IFRS. There are also likely to be benefits for capital markets and other users of financial statements in helping to assess the quality and comparability of published accounting data in those countries.

Measurement of convergence is important also because, in some EU countries that have adopted IFRS in 2005, the application of IFRS does not extend to all entities, but is confined to listed companies. The accounting standards that are to apply to non-listed companies are being debated in such countries, and an important issue is whether IFRS will affect the accounts of non-listed companies. Street and Larson (2005, p.1) conclude that ‘most EU members do not plan to converge national GAAP with IFRS, thereby highlighting … concerns regarding the emergence of a “two-standard” system in the EU’. The main barriers to convergence identified by the survey are the link between financial accounting standards and tax accounting; and disagreements about the complicated nature of certain IFRS, especially those associated with ‘fair value’ accounting.

It seems to be taken for granted that IFRS are good for non-listed companies and that they should supersede National Accounting Standards. Perhaps this is because the official discourse of international accounting standardization is made by ‘the audit industry and its agents’ in such a way that ‘users tend to be represented rhetorically rather than physically’. Why has there been such a sudden rush to converge national GAAP with IFRS, even for non-listed companies? Is financial accounting ‘solely a functional reflection of the internationalization of financial markets, or are other factors at stake?’. How does accounting, as a technology and a social practice, serve to structure various institutional fields affected by globalization? Why is it that accounting technologies and accountants help to propagate organizational agendas, policies and purposes and, in doing so, amplify certain voices but do not ‘amplify others, yet these others deserve to be heard’.

In 2003, the Portuguese Accounting Standards Board (Comissão de Normalização Contabilística) proposed a dual accounting model for Portugal. This model required individual and consolidated accounts of listed companies to be prepared using IFRS. However, other entities have the discretion to use either Portuguese Accounting Standards (issued by the CNC) or IFRS. Thus, a dual regime of accounting standards would prevail: one for listed companies and the other for non-listed companies. In these circumstances, a measure of convergence will be invaluable in assessing the extent to which the accounting methods allowable for non-listed entities converge with the methods permitted under IFRS. Obstacles to convergence in Portugal include the tax driven nature of national accounting requirements, the complicated nature of certain IFRS and the legal basis of Portuguese GAAP. Non-listed and local companies, audited by local auditors, feel more comfortable using National Accounting Standards because these standards are more in tune with their code-law, economic, and social backgrounds.

It is important to examine and measure formal harmonisation carefully because of the increasing influence of accounting regulations on accounting practice. The first of three measures of convergence we analyse was outlined by Garrido, León, and Zorio, 2002. It was intended to assist in evaluating progress in converging any two sets of accounting standards, and is based on the concept of Euclidean distances. But we argue that measures based on Euclidean distances have serious shortcomings.

Accordingly, we propose more robust measures involving Jaccard’s [association] coefficients and Spearman’s [correlation] coefficients because they provide a much stronger foundation for evaluation and seem likely to benefit a wide range of users of published financial statements. For investors, they provide a compact yardstick for comparison of the quality and content of financial statements published by companies in a variety of countries and settings. They provide enhanced measures of confidence and reliability by showing the similarity and dissimilarity between the allowable accounting methods that underpin those reports, and the variety of accounting ordained in IFRS. For regulators, the measures we advocate can be disaggregated to reveal the areas of accounting (such as valuation or revenue recognition) that are most dissimilar from IFRS and for which reform should be a priority. We illustrate the strengths and weaknesses of the three measurement methods by calculating the performance of Portuguese Accounting Standards setters in achieving convergence with IAS and IFRS between 1977 and 2003. Our choice of Portugal is opportunistic. It is motivated by our in-depth knowledge of Portuguese Accounting Standards-setting issues, and by assertions that Portuguese Accounting Standards are converging rapidly with international standards.

We begin by briefly reviewing prior literature on the measurement of formal and material harmonisation; and delineate several recent phases in the evolution of IFRS and of National Accounting Standards in Portugal. Thereafter, we review the measure of convergence (based on Euclidean distances) that was outlined by Garrido et al. (2002), and highlight its shortcomings. We then propose Jaccard’s association coefficients, supplemented by Spearman’s correlation coefficients as better measures of the convergence of National Accounting Standards with IFRS.

The distinction between formal (de jure) harmonisation and material (de facto) harmonisation is important. Formal harmonisation refers to the way accounting standards are written: that is, to their legal or quasi-legal specification. Material harmonisation refers to the level of concordance exhibited by the actual practices of companies in implementing accounting standards. Several indices and measures have been developed to evaluate material harmonisation in accounting (for example, the H, C and I Indexes, the Total Comparability Index, the Within-country Comparability Index, the Disclosure-adjusted Index, the Adjusted “Between-country” Index, and Associations Coefficients.

Association coefficients have been used by D’Arcy (2001) to cluster national accounting systems in terms of financial reporting requirements. Jaccard’s coefficients have been used to measure accounting practice harmony by Rahman et al. (2002). However, until now, the majority of empirical studies of accounting harmonisation have focused on material harmonisation. As a consequence, the absence of literature on formal harmonisation measurement methods is unsurprising.

Tags: accounting standards