Implications of the ‘IAS Regulation’ for Research into the International Differences in Accounting Systems

Abstract

Meek and Thomas (2004) call for research on the continued relevance of ‘rediscovered’ dichotomous accounting classifications. We provide such evidence by examining how developments surrounding the ‘IAS Regulation’ (1606/2002) influenced international differences in accounting systems in the European Union. Since a sufficient time series of actual post-2005 International Financial Reporting Standards (IFRS) reporting practice is not yet observable, we propose an initial re-classification of accounting systems based on evidence available to date, that is, the degree of implementation of the IAS Regulation in the Member States. Consistent with Nobes (1998), we find that the degree of public accountability to outside investors (the ‘public/private’ criterion) is becoming the primary differentiator for accounting systems in Europe, surpassing country-level variables such as legal system and culture. The distinction between consolidated and individual financial statements is the second emerging differentiator. While consolidated accounting is becoming more uniform across countries, cross-country cultural differences are most likely to persist in individual accounting. Based on our analysis we highlight two important areas of future research beyond the consolidated financial statements of listed firms (e.g. Nobes, 2005; Schipper, 2005). First, at the country level, the interaction of IFRS and individual financial statements will need to be reassessed. In addition, research could help introduce a degree of differentiation into financial reporting regulation for unlisted firms, because these firms are not a homogeneous group. Also, the convergence of national GAAP systems with IFRS will benefit from fresh research insights. Second, at the firm level, future research could analyze the extent to which the determinants and consequences of IFRS adoption, an area well researched for publicly traded firms (e.g. Cuijpers and Buijink, 2005), generalize to unlisted firms. Such research will help detect emerging patterns of accounting systems within an international context. It will generate insights into the disconnect of consolidated accounts from national influences, the degree of uniformity of consolidated accounts among international firms, the continued relevance of traditional classifications of international accounting systems for individual accounts and accounts of unlisted companies, and the convergence of national standards with IFRS.

Acknowledgements

We thank Peter Walton (the editor) and two anonymous reviewers for helpful comments and suggestions. We are also grateful to Christopher Nobes (the discussant) and participants at the workshop ‘Accounting in Europe beyond 2005’ in Regensburg, Germany. Furthermore, we thank Brigitte Eierle, Rolf Uwe Fülbier, Joachim Gassen, Gary Meek, Bernhard Pellens and seminar participants at the Ruhr-Universität Bochum for providing helpful comments on an earlier version of this paper.

Notes

¹IFRS include the International Accounting Standards (IAS) and related interpretations adopted by the International Accounting Standards Board (IASB) from its predecessor, the International Accounting Standards Committee (IASC).

²According to Article 4 of the IAS Regulation, publicly traded companies are those which at their balance sheet date have securities admitted to trading on a regulated market of any Member State within the meaning of Article 1(13) of Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field. Haller and Eierle (2004, pp. 42–43) also highlight the growing importance of this new differentiator.

³Accordingly, Haller and Eierle (2004, pp. 43–46) also note a ‘growing apart’ of consolidated and individual accounts. See also Delvaille et al. (2005).

⁴We include in our analysis the three non-EU European Economic Area (EEA) states Norway, Iceland and Liechtenstein, because since 1 January 1994, most Single Market legislation applies in them.

⁵Reviews of the earlier literature can be found in Nobes (1983) and Meek and Saudagaran (1990). More recent work is reviewed in Nobes (1998).

⁶See Nobes (1998, Figure 2). An exception to this rule occurs when a country is culturally dominated by another country, from which it ‘imports’ its accounting system.

⁷See Nobes (1998, Table 4).

⁸The full model developed by Nobes (1998) includes five propositions. The first three propositions are as follows: the dominant accounting system in a culturally self-sufficient country with a strong equity-outsider system is class A (P1); the dominant accounting system in a culturally self-sufficient country with a weak (or no) equity-outsider system is class B (P2); and a culturally dominated country has an accounting system imported from its dominating country, irrespective of the strength of the dominated country's equity-outsider system (P3). P5 is described below.

⁹Again, refer to Haller (2002) for a detailed account of these changes.

¹⁰Such a move might be caused by commercial pressure and the prospect of lower cost of capital.

¹¹Examples given by Nobes (1998, p. 180) are Deutsche Bank, Bayer and Nestlé, who adopted IAS in the early 1990s.

¹²The discussion between d'Arcy and Nobes took place in Accounting, Organizations and Society and comprises d'Arcy's original report of her study (d'Arcy, 2001), Nobes' criticism of that study (Nobes, 2004) and d'Arcy's reply in which she defends her approach and data (d'Arcy, 2004).

¹³Under ‘dual’ reporting, firms such as Bayer AG prepared consolidated accounts in a way that simultaneously fulfilled the requirements of local, EU Directives-based GAAP and internationally accepted standards. Under ‘parallel’ reporting, firms such as Daimler-Benz AG prepared consolidated IFRS/US GAAP statements in addition to their local GAAP reports. See Haller (2002, p. 168). Predicting these developments, Nobes (1998) notes that legal constraints such as those described here might hinder firms' movement towards ‘class A’ accounting.

¹⁴The application decrees, however, have never been adopted in France and Italy (Delvaille et al., 2005, pp. 147, 158).

¹⁵Nobes (1998, p. 183) hints at these developments. A description of similar Austrian, French, Italian and Belgian legislation is found in Haller (2002, pp. 169–170).

¹⁶By the time the IAS Regulation was deliberated and enacted, almost all European stock exchanges accepted financial statements, if presented by foreign issuers, based on either one of these two sets of standards.

¹⁷In addition, nine Danish, four Dutch and one Swedish company also provided either ‘parallel’ or ‘dual’ IAS reporting.

¹⁸For more data on different countries and years, see, for example, Ashbaugh (2001, p. 140) and Cuijpers and Buijink (2005, p. 494).

¹⁹See, for example, Busse von Colbe et al. (2003, p. 128).

²⁰Compliance with GAS results in assumed compliance with German GAAP (Grundsätze ordnungsmäßiger Buchführung), whereas GAS noncompliance does not result in assumed GAAP violation. Furthermore, German firms are not required to disclose their GAS noncompliance in the notes and German auditors need not comment on their clients' GAS compliance in their audit opinions. See Gebhardt and Heilmann (2004a, p. 117).

²¹For example, Gebhardt and Heilmann (2004a) show that most large German firms, explicitly or implicitly, did not follow GAS 4 on acquisition accounting in the consolidated accounts for 2001 and 2002. For GAS 2 on cash flow statements, these findings are partly corroborated by Gebhardt and Heilmann (2004b).

²²The data is taken from the EU internal market website and reflects legislation as of 15 May 2006.

²³Industry is another such differentiator, because unlisted financial institutions are frequently required to use IFRS even where other unlisted firms are not even permitted to do so. See Table 2 for details.

²⁴With respect to France and Germany, see Delvaille et al. (2005).

²⁵This is certainly the case in Germany. See Haller and Eierle (2004, p. 37) for the related arguments. We elaborate on this point in Section 4.

²⁶Haller and Eierle (2004) provide a detailed discussion of this issue. See also Pellens and Sellhorn (2006).

²⁷Day and Taylor (2005) discuss the role of accounting and auditing in the process of accession of new Member States to the EU.

²⁸See, for example, the literature summarized in Sucher et al. (2005, p. 575). Jindrichovska and McLeay (2005), Kosmala (2005), and Solodchenko and Sucher (2005) provide detailed discussions of aspects of accounting reform in Poland, the Ukraine and the Czech Republic, respectively.

²⁹The implementation was originally scheduled for 2005, but later deferred to 2006 due to observed difficulties in the full application of IFRS from 2005 in the individual accounts (CBSO, 2005).

³⁰The 2003 collapse of the Italian dairy and food giant Parmalat Finanziara is a case in point. Grant Thornton SpA served as Parmalat's auditor from 1990. After it was replaced as the company's main auditor by Deloitte & Touche SpA in 1999, Grant Thornton stayed on to review the individual books of Bonlat, the Cayman Islands subsidiary at the heart of Parmalat's bankruptcy. Deloitte & Touche was responsible for the consolidated group accounts. Both auditors were later sued under allegation of a myriad of financial improprieties, including fraud, negligent misrepresentation and breach of fiduciary duty.

³¹However, some firms are exempted from this option (see Table 2).

³²See Section 4 for potential determinants of IFRS adoption in group 3 accounts.

³³We note that public firms required to apply IFRS can potentially avoid such compliance by restructuring themselves in a way that would allow them to publish only individual accounts. In our view, this possibility represents a gap in the IAS Regulation, because publicly traded firms should in all cases report under IFRS even if, under their domestic regulation, they are only required to prepare individual financial statements.

³⁴Sucher and Jindrichovska (2004) stress this argument in the context of IFRS implementation in the Czech Republic.

³⁵Refer to Section 4 for research suggestions pertaining to this issue.

³⁶ Section 4 discusses possible areas of future regulatory efforts at the Member State level.

³⁷At this point, we do not consider accounting classification based on differences in standard setting. The main differentiator here is private-sector vs. public-sector standard setting. Whether standard setting is a cause or an effect of different accounting systems is quite disputed in the literature. For an overview, see d'Arcy (1999, pp. 74–78) and Nobes (1992).

³⁸Presentation given by Christopher Nobes at the Workshop ‘Accounting in Europe beyond 2005’ in Regensburg, Germany, in September 2005.

³⁹In light of the IAS Regulation, it seems critical to ensure consistent and rigorous application of IFRS throughout the EEA, especially since IFRS are principles-based and there is less implementation guidance than in the case of, for example, US GAAP (SEC, 2003). In its Standard No. 1, ‘Enforcement of Standards on Financial Information in Europe’, the Committee of European Securities Regulators (CESR), which was established in June 2001 as a coordinating forum for national regulators, set out 21 high-level principles that EU Member States should adopt in enforcing IFRS. Standard No. 2, ‘Coordination of Enforcement Activities’, specifically addresses the issue of consistent application and enforcement among countries of the EU (Gornik-Tomaszewski, 2005).

⁴⁰According to Choi and Meek (2005, p. 76), German accounting is dominated by commercial law: ‘To understand German accounting, one must look to both HGB and a considerable body of case law.’

⁴¹In the view of many, providing decision-useful information is only of secondary importance. See Leuz (1996, p. 3, esp. footnote 14).

⁴²See also Delvaille et al. (2005, p. 159).

⁴³Haller and Eierle (2004) provide a detailed discussion of this issue. See also Evans et al. (2005, pp. 30–32) and Pellens and Sellhorn (2006) for detailed summaries of the arguments put forth in this discussion.

⁴⁴In addition, firms listed in the USA are required by the SEC to reconcile their earnings and equity numbers to US GAAP.

⁴⁵For example, Davydenko and Franks (2005) show for a sample of 2,280 small firms defaulting on their bank debt that median recovery rates are 67% in Germany, compared with 92% in the UK.

⁴⁶The High Level Group is an expert panel established by the European Commission. Its proposals are summarized in High Level Group (2004).

⁴⁷The group, named ‘Rickford group’ after its chairman Jonathan Rickford, consists of accountants, business representatives, economists and lawyers, assisted by public servants who participated as observers. Its proposals are found in Rickford (2004).

⁴⁸See Pellens and Sellhorn (2006).

⁴⁹Unlike the legislation adopted in Italy, the book–tax link is not expected to be severed in the near term. For a detailed discussion of this issue and further references, see Pellens and Sellhorn (2006).

⁵⁰See, for example, Herzig (2004) and Fülbier (2006).

⁵¹Examples of unlisted German firms that can be considered publicly accountable under this definition include the grocery retail chains Aldi and Lidl, the technology firm Bosch, and the food conglomerate Oetker.

⁵²See, for example, Evans et al. (2005).

⁵³Directive 2001/65 as of 27 September 2001, OJ [2001] L 283/28.

⁵⁴Directive 2003/51 as of 18 June 2003, OJ [2003] L 178/16.

⁵⁵See, for example, Haller and Eierle (2004).

⁵⁶See Pownall and Schipper (1999, p. 296), who summarize earlier empirical work pertaining to this issue.

⁵⁷The problem of distinguishing the relative effects of incentives and standards on accounting practice is discussed, for example, by Pownall and Schipper (1999). See also Ball et al. (2003) and the discussion of that paper by Holthausen (2003).

⁵⁸See Deloitte (2005, p. 14). According to the World Federation of Exchanges (www.world-exchanges.org), 7,053 firms where listed on the EU's stock exchanges as of 2004. See also Delvaille et al. (2005, p. 137).

⁵⁹The earnings management literature has identified and tested a number of attributes that are likely to provide financial reporting incentives. See, for example, Leuz et al. (2003). Schipper (2005, pp. 111–112) provides a brief literature overview of factors, including ownership structure, associated with reporting incentives.

⁶⁰A detailed literature review on this issue is provided by Daske (2005).

⁶¹Refer to Section 3.

⁶²Refer to Haller (2002, pp. 169–170).

⁶³See, for example, Dumontier and Raffournier (1998), El-Gazzar et al. (1999), Murphy (1999), Ashbaugh (2001), Street and Gray (2002), Tarca (2004), and Cuijpers and Buijink (2005).

⁶⁴In a similar vein, Evans et al. (2005, p. 30) argue that the advantages of IFRS are usually less convincing for small and medium-sized, unlisted firms.

⁶⁵Consistent with this assumption, Deutscher Industrie- und Handelskammertag and PricewaterhouseCoopers (2005) provide survey evidence showing that larger firms are more interested in and informed about IFRS than smaller firms with insignificant international exposure.

⁶⁶Many SMEs, especially in Germany, were not traditionally dedicated to transparency and full disclosure (Evans et al., 2005, p. 31).

⁶⁷See Deutscher Industrie- und Handelskammertag and PricewaterhouseCoopers (2005).

⁶⁸Many firms expect improved rating by their banks, although, as the study indicates, most banks do not actually require IFRS financial statements for that purpose.

⁶⁹For the definition and measurement of, as well as findings on, these and other attributes, see Leuz et al. (2003) and Francis et al. (2004, 2005).

⁷⁰The CFOs responsible for adopting IFRS have emphasized that scarcity of trained people is the biggest hurdle facing any company making the change in time for 2005 (Cope and Clarke, 2003).