measurement of international harmonisation in financial reporting, The
Several developments in the harmonisation of accounting standards are described in the accompanying article by Howieson. This article explains how harmonisation can be measured and refers to studies of the harmonisation of accounting standards and of financial reporting in practice. These studies have measured harmonisation in Europe, the US and Japan, as well as comparing accounting standards and reporting practices under Australian accounting standards (AASBs) and international accounting standards (IASs).
Harmonisation has been described as a process, a “movement away from total diversity of practice” and harmony as a state “indicated by the clustering of companies around one or a few of the available methods” (Tay and Parker 1990, p. 73). Harmonisation can be categorised as either “formal” or “material”, the former being the harmonisation of accounting standards or regulations, and the latter harmonisation of actual financial statements produced under the accounting standards (Van der Tas, 1988).
Both approaches are important when measuring harmonisation. Similarities and differences between relevant accounting standards need to be determined in order to be able predict the comparability of the financial statements produced under those standards. However, it is also necessary to consider how the accounting standards are used in practice. Even where a high level of harmony exists in the accounting standards, the required accounting treatments may not be followed, and the use of alternative treatments and reliance on professional judgment may result in financial reports that lack harmony.
STUDIES OF FORMAL HARMONISATION
Studies of formal harmonisation compare the accounting standards applying in various countries or jurisdictions. Early studies considered the impact on the standards of the International Accounting Standards Committee (IASC). Although Nair and Frank (1981) found that the IASC’s existence coincided with a growing harmonisation of accounting standards, McKinnon and Janell (1984) concluded that the IASC had not changed existing standards or set new ones, but had codified generally accepted accounting practice. Doupnik and Taylor (1985) noted great diversity in accounting practice in Western Europe. These studies focused on regulations rather than practices (Tay and Parker 1990) and have been criticised on the grounds that the Price Waterhouse “opinion” surveys on which they are based are not sufficiently reliable to support the conclusions (Nobes 1987).
Other studies of formal harmonisation have been undertaken by standard-setting bodies. The Australian Accounting Research Foundation (AARF 1994) compared Australian standards with those in the United States, United Kingdom, Canada, New Zealand and the IASC, and found differences in application, definitions, recognition and measurement, and disclosure. A study by the Financial Accounting Standards Board (Bloomer 1996) compared US GAAP and IASC standards and again found many differences. Standard-setters are interested in measuring the harmony between jurisdictions so they can determine which standards have common requirements and which differences must be addressed if harmonisation goals are to be achieved.
Rahman, Perera and Ganeshanandam (1996) measured the formal harmony of Australian and New Zealand accounting standards. The major differences in disclosure requirements related to earnings per share1, reserves and partnership accounting2, while in measurement requirements the greatest differences concerned bloodstock3, earnings per share, pensions4 and investment properties5.
Curran (1996) found numerous differences between AASBs and IASs, as shown in Table 1. While some differences may affect only a few companies, others would have a significant impact on the financial statements of many. Curran argued that full compliance with both sets of standards would entail considerable additional cost and effort. Many changes will be necessary if compliance with the Australian standards is to result in full compliance with IASs, which is the aim of the current Australian harmonisation process (see Reilly 1997).
The progress in the formal harmonisation of accounting standards, and the amount of work remaining to be done, is an indication of the difficulty of achieving harmony even where there is a desire to do so. The level of harmonisation of standards is a guide to the level of material harmonisation that may be expected in the financial reports. Where there are incentives to follow standards, and the standards themselves lack harmony, a high level of harmony is unlikely to be found in the financial reports.
STUDIES OF MATERIAL HARMONISATION
Studies of material harmonisation focus on the financial reports produced under particular accounting standards or requirements. The early studies, for example Evans and Taylor (1982), used simple statistics such as percentages to record particular accounting practices. Van der Tas (1988) proposed instead a holistic method for quantifying harmonisation and developed what he termed the H, C and I indexes. These have been used in several studies to measure material harmonisation (see Tables 2a, 2b, 3, 4 and 5).
The H index – based on the Herfindahl index, a concentration index used in economics (Theil 1973) – measures the extent to which companies reporting in a country choose particular accounting methods. It assumes that the company uses only one of possibly several alternative methods. The H index is calculated by summing the squares of the relative frequency with which a particular accounting method is chosen.
The C index also measures the extent to which companies within a country concentrate on a particular accounting method. An extension of the H index, it recognises that companies may use more than one accounting method for the same item. For example, non-current assets may be valued at historical cost in the balance sheet with market values disclosed in the notes to the accounts. Where the number of countries is large, the C index gives the same result as the H index.
The I index measures the extent to which companies in all the countries considered concentrate on a particular accounting method. It is calculated by multiplying the relative frequency of application of a particular method in country X by the relative frequency of application of the same method in country Y and then summing the products over all methods.
The formulas for the indexes are given in Appendix 1. The indexes range in value from 0 (zero compatibility) to 1 (perfect harmonisation), but they can be difficult to interpret as they lack benchmarks. Further, they do not give information on the significance of the methods used, such as whether they comply with a country’s standards. However, it is possible to compare the indexes between countries or over time and conclude whether there has been a change in the concentration on an accounting method and hence in the level of harmony.
Van der Tas (1988) used the H, C and I indexes to measure harmonisation in the UK, Netherlands and the US. For five out of the six accounting policies studied, harmonisation increased over the period, as shown in Table 2a. Van der Tas (1992) also used the C index and found an increase in harmonisation in relation to accounting for deferred income tax (Table 2b).
Subsequent studies which have used the I index to measure material harmonisation are shown in Table 3. These studies also calculated a chi-square statistic to test whether the frequency of use of an accounting method differs by country. Emenyonu and Gray (1992) found that French, German and UK companies differed significantly in the five accounting policies studied. Herrmann and Thomas (1995) considered more countries and a larger sample of companies than Emenyonu and Gray (1992). They found significant differences in eight of the nine accounting policies they studied. Emenyonu and Adhikari (1998) considered companies from the US, Japan, UK, France and Germany, finding significant differences in seven out of the ten accounting policies reviewed.
Archer, Delvaille and McLeay (1995) decomposed the C index into its within-country and between-country components, rather than using separately the C and I indexes of Van der Tas. Their comparability indexes show the number of compatible pairs of financial reports as a percentage of the maximum possible number of pairwise comparisons of financial reports. Their results, presented in Table 4a, show that for deferred tax total comparability increased from 1987 to 1991 because of an increase in between-country comparability. For goodwill there was a slight increase in total comparability, while within-country comparability declined and between-country comparability increased.
In a follow-up study, Archer, Delvaille and McLeay (1997) developed a set of analytical models as an alternative to the index approach. Their nested hierarchy of log linear models used the variables of countries, period (number of years) and accounting policy choices. The models attempted to capture the impact on accounting policy choice of international harmonisation, different national accounting methods and company-specific accounting choices. Table 4b shows that the results using the full model were very close to those of Archer et al’s 1995 study.
The C index, the I index and a chi-square statistic (calculated from frequencies observed and expected by chance) were used by Tarca (1997) to compare the level of harmonisation of financial reporting under IASs with financial reports produced to comply with Australian accounting standards (see Table 5). The C index for the AASB-reporting companies, when compared with the C index for the IAS-reporting companies, had a higher level for the eight accounting policies studied. The I index, calculated between the AASB-reporting companies and the IASreporting companies, showed a high level of harmony for inventory valuation, a moderate level of harmony for segment reporting, cashflow statements and revaluation of non-current assets, and a low level of harmony for inventory costing, research and development expenditure, goodwill recognition and goodwill amortisation.
The chi-square statistic (Table 5) reveals significant differences in accounting policies between the AASB and the IAS companies for seven of the eight accounting policies. These results are consistent with Curran’s (1996) formal harmonisation study. Together they suggest that Australian financial reporting would be significantly different if IASs were adopted instead of AASBs. However, the high level of harmony found for several of the AASBs accounting policies would be maintained if these Australian accounting standards continue to exclude the optional treatments available in comparable IASs and if they retain the present legislative backing of s298 of the Corporations Law.
Material harmony between Australian companies and those in countries using lASs will not necessarily increase unless all companies comply with lASs. Formal harmonisation of standards, for example Australian standards with IASs, is insufficient in itself to achieve material harmonisation of financial reports.
When new standards are issued in Australia on topics previously covered by tASs but not AASBs, such as AASB 1036 Borrowing Costs, there is the potential to improve the level of harmony in Australian reporting. Where Australian practices have been found to be diverse, the introduction of a standard could improve harmony within Australian reporting.
If lASs and Australian standards include a choice of accounting treatment, then the formal harmonisation of standards will not necessarily result in the harmonisation of financial reporting in practice. In some standards it is considered necessary or appropriate to allow the use of alternative methods and the exercise of professional judgment (SAC 3, ASCPA and ICAA, 1997). For example, the IAS and Australian standards for inventory costing could be identical, but financial reporting may not be, as preparers exercise their professional judgment in choosing an inventory-costing method.
Financial reporting nonetheless may be more relevant and reliable, because of the use of professional judgment. Accounting practices reflect the culture and environment of a particular country (Gray, 1988). If reporting requirements are adopted which are less appropriate to a country’s culture and environment, harmony in reporting may be achieved at the cost of less relevance and reliability. This was illustrated by Lowe (1990) who found that Japanese companies’ consolidated financial statements prepared according to US GAAP were misleading rather than more informative for users. The same could be true of the move to adopt IASs in Australia.
Significant differences between IASs and AASBs present a major challenge for the harmonisation project. To meet the goals of this project, the business community can expect many changes to Australian accounting standards over 1998. New standards will be issued where there is currently an IAS but no Australian standard, and where there are points of difference between existing IASs and AASBs. Harmonising Australian and international standards may require a move away from some principles of the Australian conceptual framework and different technical perspectives on some measurement and disclosure issues.
A study of the level of harmony of reporting practices of companies using IASs and those using AASBs found significant differences in a number of accounting practices (Tarca, 1997). The level of harmony was influenced by the existence of legislative backing for accounting standards, perceived conflict between the requirements of the accounting standards and the corporations law, and the acceptability of alternative treatments in the standards.
The adoption of lASs in Australia would result in significant changes in financial reporting. To achieve a high level of harmony in Australian reporting, the IASs adopted for use in Australia should retain legislative backing to discourage non-compliance. It is also important that there be no conflict between the requirements of IASs and those of the corporations law. The inclusion of alternative treatments in standards, and the reliance on professional judgment for interpretation, can be important for the quality of financial reporting, but they could also contribute to less harmonious reporting practices.
While legislative backing for accounting standards can facilitate harmonisation in Australian reporting, the level of harmony between Australian reporting and that of other countries will be restricted where companies in those countries follow standards that are not harmonised with IASs, or where IASs are adopted as national standards but not followed by preparers. These are issues that must be recognised by standard-setters, as well as preparers and users of financial reports.
Ann Tarca is an associate lecturer in the Department of Accounting and Finance, University of Western Australia. The author thanks Bryan Howieson and Philip Brown, of the Department of Accounting and Finance, University of Western Australia, for their assistance in the preparation of this article.
1 Australia has a standard but New Zealand does not.
2 New Zealand has standards with nine and ten
requirements respectively, while Australian standards are silent on these issues.
New Zealand has a technical practice aid, while Australia has an exposure draft.
Australia has a standard but New Zealand does not.
New Zealand has a standard while Australia has issued a discussion paper.
Group accounting based on the legal relationship between companies reflected their links in the US, but it did not necessarily do so in Japan where there were commitments between companies that were not shown by their legal relationship.
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