3 Internationa cassification of financia reporting Christopher Nobes CONTENTS 3.1 Introduction 3.2 The nature of cassification 3.3 Cassifications by socia scientists 3.4 Cassifications in accounting 3.5 Extrinsic cassifications 3.5.1 Mueer s cassifications 3.5.2 Morphoogies 3.5.3 Spheres of infuence 3.5.4 Cutura cassification 3.5.5 Cassification of accounting by reguatory stye 3.5.6 Competencies of auditors 3.6 Intrinsic cassifications: 1970s and 1980s 3.6.1 Introduction 3.6.2 Cassifications using custering 3.6.3 Cassification using a mode and new data 3.7 Deveopments reated to the Nobes cassification 3.7.1 Cassification by degree of standardization 3.7.2 Tests 3.7.3 Improvements 3.8 Further intrinsic cassification 3.8.1 New data, new cassifications 3.8.2 New data, od probems 3.9 Is there an Ango-Saxon group? 3.10 A taxonomy of accounting cassifications Summary References Questions 51
Part I Setting the scene OBJECTIVES After reading this chapter, you shoud be abe to: expain why cassification can be usefu in the natura and poitica sciences and in the study of accounting; outine the cassifications of nationa accounting systems that have been deveoped, distinguishing between those based on infuences and those based on actua practices; show why it is important to be cear what is being cassified: practices or reguations, reguations or reguatory systems, practices of a companies or ony of isted companies, measurement practices or discosure practices, countries or sets of financia statements; outine which countries can be cassified with which others, depending on what is being cassified; criticay appraise the cassifications in the iterature. 3.1 Introduction Chapter 2 discussed the causes and nature of internationa differences in financia accounting practices. Aready it has been usefu to note simiarities between groups of countries, and to divide countries into two main casses for some purposes. This chapter is devoted to a more detaied examination of whether it is possibe to cassify countries by their accounting simiarities and differences. First, it is usefu to discuss the nature of cassification in natura sciences and socia sciences. This is done in Sections 3.2 and 3.3, which are foowed by an examination of the purpose of cassification in accounting. It is possibe to divide cassifications into those based on externa factors (Section 3.5) and those based on accounting practices (Sections 3.6 to 3.8). Section 3.10 presents a cassification of the cassifications. A major introductory point is that many countries now exhibit at east two systems of financia reporting, in addition to accounting that may be done for tax or other private purposes. For exampe, in France, the consoidated statements of isted companies use Internationa Financia Reporting Standards (IFRS) whereas individua French companies, whether members of a group or not, use French nationa rues. The majority of the research work on cassification was done in a period before this deveopment, which reates particuary to 2005 onwards. Therefore, for readers ony interested in the consoidated statements of isted companies, those cassification studies are primariy of historica interest. Nevertheess, the buk of financia reporting (i.e. a unconsoidated statements and some consoidated statements) in many countries sti foows domestic rues. So, internationa differences are sti important. Even so, the domestic rues of some countries are themseves being harmonized with IFRS or US rues so the differences are becoming ess dramatic. It is important to distinguish between this process of convergence and the adoption of IFRS for certain purposes within a country. More subty, internationa differences may survive in the form of different interpretations of IFRS or different choices of options. This is taken further in Chapters 4 and 7. 52
Chapter 3 Internationa cassification of financia reporting Studying cassification is a usefu preude to the study of harmonization (Chapter 4) and to the study of domestic rues (Chapter 15). 3.2 The nature of cassification Cassification is one of the basic toos of a scientist. The Mendeeev tabe of eements and the Linnaean system of cassification are fundamenta to chemistry and bioogy respectivey. Cassification shoud sharpen description and anaysis; it shoud revea underying structures and enabe prediction of the properties of an eement based on its pace in a cassification. Cassification may aso provide an insight into what eements once existed, might exist in the future, or do exist and wait to be discovered. It has been said that there are four properties necessary in a cassification (AAA, 1977, pages 77 8). First, the characteristics of cassification shoud be adhered to consistenty. That is, throughout any cassification the characteristics used as the means of differentiating one eement from another shoud be the same. Different purposes for a cassification wi ead to the use of different characteristics. Second, a good cassification wi potentiay contain sufficient subsets to exhaust a given universe. Third, a subsets wi be mutuay excusive in such a way that no eement may fa into more than one of them. Last, hierarchica integrity shoud be observed; for exampe, in the Linnaean bioogica cassification, any specific species of pant or anima is aways in the bottom tier of the cassification, aways beongs to a genus, which aways beongs to a famiy, and so on. Roberts (1995, pages 653 5) examines and criticizes these properties. Different types of cassification are possibe, from the simpest form of dichotomous grouping (e.g. things back versus things white) or rank ordering (e.g. by height of students in a cass) to more compex dimensioning (such as the periodic tabe) or systematizing (such as the Linnaean system). Two ways of grouping eements used in socia science are mutidimensiona scaing and morphoogica structuring. The first uses two or more characteristics on different axes to try to find custers of eements dispaying simiar characteristics. The second seeks to compose a morphoogy that ists eements by important differentiating factors. It shoud then be cearer which eements are simiar to each other (see, for exampe, Figure 3.1, overeaf). 3.3 Cassifications by socia scientists Having briefy ooked at the nature of cassification and the techniques used to achieve it, it may be usefu to examine traditiona methods of cassification in areas cose to accounting. There have been cassifications of poitica, economic and ega systems. For exampe, poitica systems have been grouped into poitica democracies, tuteary democracies, modernizing oigarchies, totaitarian oigarchies and traditiona oigarchies (Shis, 1966). Economic systems have been divided into capitaism, sociaism, communism and fascism. Another cassification is: traditiona 53
Part I Setting the scene Figure 3.1 The AAA s morphoogy for comparative accounting systems Source: Adapted from American Accounting Association (1977) Accounting Review, Suppement to Vo. 52, p. 99. Copyright 1977 American Accounting Association. Reproduced with permission. economies, market economies and panned economies (Neuberger and Duffy, 1976). Lega systems have aso been cassified (Kagan, 1955; Derrett, 1968; David and Brierey, 1985). One set of authors, whie cassifying ega systems, has suppied practica criteria for determining whether two systems are in the same group: systems are said to be in the same group if someone educated in... one aw wi then be capabe, without much difficuty, of handing [the other] (David and Brierey, 1985, page 21). Aso, the two systems must not be founded on opposed phiosophica, poitica or economic principes. The second criterion ensures that systems in the same group not ony have simiar superficia characteristics, but aso have simiar fundamenta structures and are ikey to react to new circumstances in simiar ways. Using these criteria a four-group cassification was obtained by David and Brierey: Romano Germanic, Common Law, Sociaist and Phiosophica Reigious. In a the above exampes, the type of cassification used was rudimentary, invoving no more than spitting systems into a few groups. The groups within the cassifications were sometimes not precisey defined or exhaustive. Aso, the method used to determine and fi the groups was itte more than subjective cassification based on persona knowedge or descriptive iterature. These shortcomings are very difficut to avoid because of the compexity and greyness in the socia sciences. 54
Chapter 3 Internationa cassification of financia reporting 3.4 Cassifications in accounting It was suggested in Chapter 2 that the expression accounting system woud be used to mean the financia reporting practices used by a company. Systems coud be cassified into groups by simiarities and differences. If a or most of the enterprises in a country use very simiar accounting practices, this might suggest that countries can be cassified on the basis of accounting practices. Even then, the system used in the country might change from year to year. In the discussion that foows, it becomes cear that various researchers have been trying to cassify various objects, not necessariy accounting systems in the above sense. The reasons for wanting to cassify financia reporting systems into groups incude the genera reasons for cassification in any science, as outined above. Cassification shoud be an efficient way of describing and comparing different systems. It shoud hep to chart the progress of a country as it moves from use of one system to another, and the progress of ideas of a dominant country s system by noting the other nationa systems grouped around it. The activity invoved in preparing a cassification (e.g. mutidimensiona scaing or morphoogica structuring, as referred to above) shoud encourage precision. Moreover, in the socia sciences, cassification may be used to hep shape deveopment rather than merey to describe how and why things are. For exampe, cassification shoud faciitate a study of the ogic of and the difficuties facing harmonization. This shoud be vauabe both for academics and for those organizing harmonization, or measuring it (Doupnik, 1987). Cassification shoud aso assist in the training of accountants and auditors who operate internationay. Further, a deveoping country might be better abe to understand the avaiabe types of financia reporting, and which one woud be most appropriate for it, by studying a morphoogy and seeing which other countries use particuar systems. Aso, it shoud be possibe for a country to predict the probems that it is about to face and the soutions that might work by ooking at other countries in its group. It has aso been suggested that a way for a country to change from one accounting system to another may be to adjust the economic and poitica parameters to those more conducive to the desired system (AAA, 1977, page 100). However, this might seem ike trying to wag a tai by moving the dog. The next section contains a summary of some cassification attempts which were based on observing characteristics other than accounting practices. Such cassifications may be caed extrinsic ; for exampe, a cassification may be based on factors infuencing the deveopment of accounting. Of course, different concusions about which of these factors are important (see Chapter 2) wi ead to different cassifications. Whether a cassification is propery described as extrinsic depends on what is being cassified. For exampe, one of the cassifications described as extrinsic in the next section concerns reguatory systems. This is because the centra subject matter here is the accounting practices of companies and the content of the rues that contro them. These are infuenced by economic and other factors, and they operate within reguatory systems. By contrast, in the context of a chapter focused on reguatory systems, a cassification based directy on the nature of those systems woud be intrinsic. 55
Part I Setting the scene The so-caed intrinsic studies of Sections 3.6 to 3.8 are aso mosty at one remove from financia reporting practices because they are mosty based on the content of the rues of reporting rather than on the practices. Again, it is hepfu to focus on what is being cassified. In many cases, the objects of cassification are countries, and they are cassified by the nature of financia reporting rues/practices of a set of companies. As expained ater, it woud be better to cassify financia reporting systems themseves, and to do so by their key characteristics. 3.5 Extrinsic cassifications 3.5.1 Mueer s cassifications In the ate 1960s, Professor Gerhard Mueer broke new ground by preparing internationa cassifications of accounting (Mueer, 1967) and of business environments (Mueer, 1968). His cassification of accounting systems into four patterns of deveopment is a simpe grouping that is not accompanied by an expanation of the method used to obtain it. However, the range of four is considered sufficient to embrace accounting as it is presenty known and practised in various parts of the gobe (Mueer, 1967, page 2). Each group is iustrated by one or two exampes. Perhaps it is not reasonabe to expect a more sophisticated cassification in a pioneering work, and perhaps Mueer s informed judgement was one of the best methods of cassification avaiabe. Mueer stresses that the types of accounting rues that exist in a country are a product of economic, poitica and other environments, which have determined the nature of the system. This aso suggests that other countries rues woud not be appropriate to that country and that rues must be chosen to fit a country s needs. Consequenty, doubt is cast on the possibiity and usefuness of harmonization. Mueer s four groups, which are usefuy summarized in a ater work (Choi and Meek, 2005, Chapter 2) are as foows: 1 Accounting within a macroeconomic framework. In this group, accounting has deveoped as an adjunct of nationa economic poicies. We might expect such financia accounting to stress vaue added statements, to encourage income smoothing, to be equivaent to tax accounting and to incude socia responsibiity accounting. Sweden was said to be an exampe. 2 The microeconomic approach. This approach can prosper in a market-oriented economy that has individua private businesses at the core of its economic affairs. The infuence of microeconomics has ed accounting to try to refect economic reaity in its measurements and vauations. This means that accounting rues must be sophisticated but fexibe. Deveopments such as repacement cost accounting wi be accepted most readiy in such systems. The Netherands was suggested as an exampe. 3 Accounting as an independent discipine. Systems of this sort have deveoped independenty of governments or economic theories. Accounting has deveoped in business, has faced probems when they arrived and has adopted soutions which 56
Chapter 3 Internationa cassification of financia reporting worked. Theory is hed in itte regard and turned to ony in emergencies or used ex post in an attempt to justify practica concusions. Expressions such as generay accepted accounting principes are typica. Mueer recognized the accounting systems of the United Kingdom and the United States as exampes. 4 Uniform accounting. Such systems have deveoped where governments have used accounting as a part of the administrative contro of business. Accounting can be used to measure performance, aocate funds, assess the size of industries and resources, contro prices, coect taxation, manipuate sectors of business, and so on. It invoves standardization of definitions, measurements and presentation. France was cited as an exampe. Mueer was not cassifying financia reporting systems directy, on the basis of differences in practices, but indirecty, on the basis of differences in the importance of economic, governmenta and business factors in the deveopment of particuar systems. However, one might expect that systems that have deveoped in a simiar way woud have simiar accounting practices. To an extent, this is true. Chapter 2 of this book has suggested that the United Kingdom and United States have simiar accounting practices; Mueer s deveopmenta cassification aso puts them together. Nevertheess, there are a few probems with Mueer s cassification. The fact that there are ony four excusive groups and no hierarchy reduces the usefuness of the cassification. The Netherands is the ony country in one of the groups and the cassification does not show whether Dutch accounting is coser to Ango-Saxon accounting than it is to Swedish accounting. Simiary, the cassification cannot incude such facts as that German accounting exhibits features that remind one of macroeconomic accounting as we as uniform accounting. Communist accounting was eft out entirey, but this may, of course, be sensibe if the cassification is deaing with pubished financia reporting, because there was none. Another probem has deveoped over time, which is that the cassification is now out of date. For exampe, Sweden moved towards Ango-American accounting, particuary in the 1990s; and the Netherands argey abandoned its repacement cost accounting. However, Mueer s cassification remains of historica importance. Mueer s second cassification (1968) is of business environments. He makes the point that different business environments need different accounting systems and that this shoud be considered when trying to change or standardize accounting. Using estimates of economic deveopment, business compexity, poitica and socia cimate, and ega system, Mueer identifies 10 groupings. This is not a cassification of financia reporting and is perhaps too genera to be of hep in such a cassification. For exampe, one group the deveoping nations of the Near and Far East might be argued by some to need simiar accounting systems, but it certainy did not have them. 3.5.2 Morphoogies It has been mentioned that one way to obtain a cassification is to draw up a morphoogy and to use empirica data with this to obtain custering. Morphoogies of accounting practice have been drawn up by Buckey and Buckey (1974) and by the AAA (1977, page 99). The atter s is reproduced as Figure 3.1. Athough such 57
Part I Setting the scene parameters as the first two (poitica and economic systems) may seem ess reevant than actua characteristics of accounting practice, it may we be important to incude them in order to avoid miscassification based on temporary superficia simiarities. As the AAA s Committee on Internationa Accounting notes, Parameters...P 1 and P 2 are viewed as being pivota to the type of accounting system which does (or can) emerge (page 97). Unfortunatey, these morphoogies have not yet been taken further by combining them with empirica data. 3.5.3 Spheres of infuence There have been some subjective cassifications based on zones of infuence. Seider (1967) suggested three groups: British, American and continenta European. Aso, the AAA s committee produced a subjective cassification of five zones of infuence on accounting systems (AAA, 1977, pages 105 and 129 30). These are as foows: 1 British; 2 French Spanish Portuguese; 3 German Dutch; 4 US; 5 Communist. This cassification is perhaps most usefu in the context of deveoping countries, where cutura infuences from esewhere may be overwheming, as discussed in Chapter 2. It seems ess appropriate as a third genera method of cassifying financia reporting, after the direct (practices) and indirect (environment) approaches mentioned above. This is because it has no hierarchy and thus does not take account, for exampe, of the inks between British and US accounting. Further, to ca a group German Dutch seems inappropriate as a way of cassifying deveoped financia reporting systems when examined in the ight of the materia in Chapters 2 and 11. 3.5.4 Cutura cassification As noted in Chapter 2, Gray (1988) uses Hofstede s (1980) cutura cassification in order to propose expanations for internationa differences in accounting practices. Ceary, a cutura cassification coud then be used to propose an accounting cassification, and Gray (1988, pages 12 and 13) makes preiminary suggestions aong those ines. Others (e.g. Doupnik and Sater, 1995) aso make use of Hofstede s factors in the context of accounting cassification. It was suggested in Chapter 2 that it may be more usefu to see cuture as a background infuence on the causes of internationa accounting differences. This idea is taken up ater in this chapter. 3.5.5 Cassification of accounting by reguatory stye Puxty et a. (1987) use the work of Streeck and Schmitter (1985) to suggest that there are three imiting and idea cases of reguation: through the market, the state and 58
Chapter 3 Internationa cassification of financia reporting Figure 3.2 Reguation of financia reporting Source: Adapted from Puxty et a. (1987), Modes of reguation in advanced capitaism: ocating accountancy in four countries, Accounting Organizations and Society, Vo.12, p. 283. Copyright 1987 Esevier Science. Reproduced with permission. the community. If the process is eft entirey to market forces, each company chooses its own rues, infuenced ony by pressures from, in particuar, the capita market. To some extent this was the position in the unreguated economy of nineteenthcentury Britain, and in the United States before the estabishment of the SEC, where some companies vountariy pubished accounting information and subjected themseves to audit (Watts and Zimmerman, 1983). At another extreme the whoe process can be in the hands of the state, an organ of which decrees which practices are to be foowed and provides an enforcement mechanism. As we sha see ater, this can be accompished in a number of different ways. The third idea case is the emergence of rues through the spontaneous soidarity of the community. Within these three extremes, Puxty et a. usefuy distinguish what they and others term iberaism, associationism, corporatism and egaism. As Figure 3.2 shows, in accounting reguation, the market and the state have predominated over the community. The four modes of Puxty et a. form a continuum: at one extreme is iberaism, whereby reguation is provided excusivey by the discipine of the market, whie companies provide information ony if it is demanded commerciay; at the other is egaism, which reies upon the unreserved appication of state principes. Accounting practice is expected to foow the etter of the aw, which is enforced by the state s monopoy of the means of coercion. Within these two extremes are associationism and corporatism, both of which combine iberaism and egaism with a sma dose of community infuence. In associationism, reguation is accompished through the deveopment of organizations that are formed to represent and advance the interests of their members. These members form, of course, part of the community but do not represent it as a whoe. Corporatism invoves a greater reiance upon the state principe of hierarchica contro. The state does not simpy icense the existence of organized interest groups but incorporates them into its own centraized, hierarchica system of reguation. The basic difference between corporatism and associationism is the extent to which the 59
Part I Setting the scene state eans on interest groupings to achieve pubic (i.e. state), as contrasted with private (i.e. market), purposes. Puxty et a. appy this framework to the United States, the United Kingdom, Germany and Sweden, as foows: United States: eements of egaism and associationism, with the atter subordinated to the former; United Kingdom: principay associationist; Germany: egaism predominant; Sweden: corporatism. Chapters 9 and 14 of this book examine the reguatory systems in three of these (and other) countries. Internationa differences in reguatory systems have argey survived the harmonization of accounting. A cassification by reguatory stye is suggested by Nobes (1992a, pages 99 103). 3.5.6 Competencies of auditors Shoentha (1989) purports to show that the skis of newy quaified auditors in the United Kingdom and the United States coud be used as a cassifying variabe. However, there must be doubt whether this variabe picks up anything reevant; and a two-country study can te us nothing about cassification except that the two countries are different (Nobes, 1992b; Shoentha, 1992). 3.6 Intrinsic cassifications: 1970s and 1980s 3.6.1 Introduction Some researchers have tried to cassify by measuring accounting directy, either using the data coected by others or by generating their own. In most of these cases, the data reates to accounting rues (or to a mixture of rues and practices) rather than to accounting practices aone. An eary attempt at cassification and some more recent descriptions of different nationa systems form the background to modern intrinsic cassifications. There is evidence for a three-group cassification (United Kingdom, United States and Continenta) being used from the beginning of the twentieth century (Hatfied, of 1911 but pubished in 1966). Other descriptions and anayses, such as those by Zeff (1972), Price Waterhouse (1973, 1975 and 1979), AICPA (1964 and 1975), Coopers & Lybrand (1993), Aexander and Archer (2001) and Ordeheide and KPMG (1995 and 2001), provide the raw materia for intrinsic cassification. 3.6.2 Cassifications using custering Da Costa, Bourgeois and Lawson (1978) produced a cassification directy based on accounting practices, using the Price Waterhouse (1973; hereafter PW) Survey in 60
Chapter 3 Internationa cassification of financia reporting Tabe 3.1 Cassification based on 1973 measurement practices British Latin American Continenta United States Commonweath mode mode European mode mode Austraia Argentina Begium Canada Bahamas Boivia France Japan Eire Brazi Germany Mexico Fiji Chie Itay Panama Jamaica Coombia Spain Phiippines Kenya Ethiopia Sweden United States Netherands India Switzerand New Zeaand Paraguay Venezuea Pakistan Peru Rhodesia Uruguay Singapore South Africa Trinidad and Tobago United Kingdom Source: Nair, R.D. and Frank, W.G. (1980) The impact of discosure and measurement practices on internationa accounting cassifications, Accounting Review, Vo. 55, No. 3, p. 429. Reproduced with permission of the American Accounting Association. 38 Countries. Custering produced two groups: one contained the United Kingdom and nine former members of the British Empire; the other contained the United States, France, Germany, South American countries, and a others except for the Netherands and Canada which were said to be uncassifiabe. Another researcher (Frank, 1979) used the same data and simiar (though more eaborate) anaysis, but produced what seems to be a much more reasonabe cassification. This work was extended by Nair and Frank (1980). Here the 1973 and the 1975 PW Surveys are used, and the financia reporting characteristics are divided into those reating to measurement and those reating to discosure. This is a usefu differentiation, particuary because of the effect it has on the cassification of countries such as Germany that had advanced discosure requirements. Frank (1979) cassified Germany in a US group but, by using measurement characteristics ony, Nair and Frank (1980) cassify Germany in the continenta European group. Tabe 3.1 represents the cassification using 1973 measurement characteristics. As yet there is no hierarchy, but the overa resuts do seem pausibe and fit we with the anaysis in previous chapters of this book. However, there are two major types of probem with these cassifications that must now be deat with, reating to the data and the methodoogy. The data Doubts have been expressed about the use of the PW data for the purpose of cassification (Nobes, 1981). Four types of probem with the 1973 data were noted: (a) straightforward mistakes; (b) miseading answers; (c) swamping of important questions by trivia ones; and (d) exaggeration of the differences between the 61
Part I Setting the scene United States and the United Kingdom because of the famiiarity of these countries (and thus their differences) to the compiers of the survey questions. The exampes from the 1973 survey wi not be repeated here, but an error in the 1979 survey wi be mentioned. Taking consoidation practices as an exampe, the survey reported that for practice 209 ( consoidated statements... are prepared for the sharehoders ) the answer was required in France. The reason given for this was that the Commission des Opérations de Bourse (COB) requires consoidation. However, as the Annua Reports of the COB showed, ony 305 isted companies pubished consoidated baance sheets and income statements in 1979 (289 in 1978). This is ess than haf of the isted companies, and a very much smaer proportion of enterprises which issue their statements to the genera pubic, about which the survey was said to be constructed (PW, 1979, page 5). These exampes coud be repicated many times over. They suggest that, at some points, the surveys reported not on actua practices but on what practices might have been if non-mandatory rues had been obeyed, or on what PW partners might have iked practices to have been. The genera probem is that the pubications mix rues and practices together. This and the other types of error suggest that the data were unsatisfactory for the purposes of cassification. At the east, substantia caution is caed for when interpreting the resuts. The methodoogy A the researchers cited above use custer anaysis based on the PW data and appear to consider that this may be superior to previous subjective cassifications. Nair and Frank state (1980) that their research is... aimed at empiricay assessing the vaidity of internationa cassifications proposed repeatedy in the accounting iterature (page 449). This version of empiricism must be chaenged. It does not directy test a particuar hypothetica cassification. It cassifies a mass of data that was not coected with the purpose of cassification in mind. The use of this approach eads one of the sets of researchers referred to above (Da Costa et a., 1978, page 79) to concude that the country east ike the UK group is the United States; in other words, accounting in Uruguay or Ethiopia was considered more ike accounting in the United Kingdom than accounting in the United States was. Whie this may have been a statisticay sound resut from the PW data, it was ceary a very inaccurate representation of the rea word (see Section 3.9). By itsef such a resut is of interest, but the researchers, who were generating a hypothesis from doubtfu data rather than testing one, fe into the trap of taking their resuts seriousy. This ed them to concude that a group of countries containing France, Germany, Begium and Itay, among others, foows the ead of the United States in dissociating itsef from practice common to the British mode. However, it seems highy unikey that the makers of the company and tax aws that govern accounting in such countries bore in mind either that they shoud foow the United States or that they shoud dissociate themseves from the United Kingdom when egisating. The differences between the United States and continenta European countries are known to have been great, and aso suggest that there was no accidenta or subconscious foowing of the former by the atter (Chapter 15). 62
Chapter 3 Internationa cassification of financia reporting The probem that these exampes iustrate stems from the use of data that contained errors and that were not designed for the purpose in hand. Turning to the Linnaean bioogica system for an anaogy, to the extent that judgement and empiricism can be counterposed, the ife scientists use a arge measure of the former. Exacty which criteria to use for a cassification of iving things, and what weight to give them, is a matter of judgement. Judgement is needed to avoid such cassifications as Pato s of man as a featheress biped. In fact, man is not now seen to be cose to birds but to be much more cosey reated to most quadrupeds, and to dophins which appear to have no feet at a. Aristote saw this atter distinction. He referred to homoogues, where objects simiar in structure pay different roes (e.g. human feet and dophins fippers), and to anaogues, where simiar functions are performed by quite different objects (e.g. birds wings and bees wings, which have entirey different structures, the former being arms ). It is the homoogues that indicate nearness in reationship. Looking in more detai at the Linnaean bioogica cassification we can note that, when cassifying animas, bioogists argey ignore the most obvious characteristics; that is, they do not carry out factor anaysis on animas by weight, coour, number of egs, nature of body covering, ength of ife, etc. This woud merey ead to a cassification of those data. It woud put men with ostriches, dophins with sharks, bats with ows, and so on. In fact, by concentrating on a subjective mode that invoves underying (but ess obvious) characteristics, bioogists cassify men, dophins and bats more cosey with each other than with any of the other three types of anima. It is then found that behaviour, inteigence, reproduction and ancestry begin to fit within the cassification. The bioogica scientists, then, use a cassification which is evoutionary and concentrates on underying fundamenta variabes. It shoud aso be noted that botanists have had greater difficuties than zooogists. This perhaps is party due to the ack of skeetons and comparative ack of fossi remains to ook at. The modern approach to bioogica cassification incudes an anaysis of the degree of simiarity of the DNA of various organisms. The anaogy with cassification in accounting seems cear. The danger with empirica cassifications is that one merey cassifies data that concentrate on differences that may be ephemera and superficia (and that may not be correcty recorded). The need is apparent for a mode based on the evoution of accounting practices and upon variabes that have caused differences in them. This woud then have to be checked against carefuy measured structura practices; and one woud have to be cear about the purpose of the cassification. 3.6.3 Cassification using a mode and new data Thus, it woud be possibe to criticize previous cassifications for (a) ack of precision in the definition of what is to be cassified; (b) ack of a mode with which to compare the statistica resuts; (c) ack of a hierarchy that woud add more subtety to the portraya of the size of differences between countries; and (d) ack of judgement in the choice of important discriminating features. Can these probems be remedied? The author attempted to sove them in his own researches (Nobes, 1983), as expained beow. 63
Part I Setting the scene Definition The purpose of the research was defined as the cassification of countries by the financia reporting practices of their pubic companies. The countries chosen were those of the deveoped Western word; the reporting practices were those concerned with measurement and vauation. The date of the cassification was 1980, before the impementation in EU countries of the Fourth Directive on Company Law (see Chapter 11). It is pubic companies whose financia statements are generay avaiabe and whose practices can be most easiy discovered. It is the internationa differences in reporting between such companies that are of interest to sharehoders, creditors, auditing firms, taxation authorities, managements and harmonizing agencies (such as the Internationa Accounting Standards Board or the European Commission) (Mason, 1978, Chapter 5). It was reay ony in deveoped countries that pubic companies existed in arge numbers. However, it woud be possibe to incude more countries by widening the definition of accounting. To some extent this has been tried (Nobes, 1992a, Appendices V and VI). Measurement and vauation practices were chosen because these determine the size of the figures for profit, capita, tota assets, iquidity and so on. Nair and Frank (1980, pages 426 and 428) point out that it is usefu to separate measurement from discosure practices. A mode with a hierarchy The hypothetica cassification simiar to that shown in Figure 3.3 was based on some expanatory variabes for differences in measurement practices; for exampe, the importance of the infuence of aw, or of economics. Some descriptions are incuded at the branching points in Figure 3.3. The number of countries is kept to 14. A these are deveoped nations for reasons noted above; they are a incuded in the PW surveys and thus in the resuts of the researchers referred to earier; and they incude a the countries identified as vita by Mason (1978) for the purposes of internationa harmonization (i.e. France, Japan, Netherands, the United Kingdom, the United States and Germany). Previous cassifications contained separate groups (e.g. Tabe 3.1) but no hierarchy that woud indicate the comparative distances between the groups. It may be reasonabe to cassify the United Kingdom and the United States in different groups, but it might be usefu to demonstrate that these two groups are cosey inked compared with, say, continenta European countries. Discriminating features An attempt was made to isoate those features of a country s financia reporting practices that may constitute ong-run fundamenta differences between countries. The resut was a seection of nine factors that, unike the factors of most of the researchers above, are overt and thus avaiabe for inspection, criticism and amendment (see Tabe 3.2). These factors were designed to be reevant for deveoped countries which share certain economic features. If one wished to incude deveoping countries, it woud 64
Chapter 3 Internationa cassification of financia reporting Figure 3.3 A suggested cassification of accounting systems in some deveoped Western countries in 1980 Notes: 1 This is an abbreviated term for corporate financia reporting. 2 These terms, borrowed from bioogy, shoud be interpreted merey as oose abes. 3 The terms at these and other branching points are merey abes to be used as shorthand to try to capture some of the attributes of the members of the accounting systems beow them. This cassification has been prepared by a UK researcher and may contain usage of terms that wi misead those from other cutures. Tabe 3.2 Factors for differentiation 1 Type of users of the pubished accounts of isted companies. 2 Degree to which aw or standards prescribe in detai and excude judgement. 3 Importance of tax rues in measurement. 4 Conservatism/prudence (e.g. vauation of buidings, stocks, debtors). 5 Strictness of appication of historica cost (in the main accounts). 6 Susceptibiity to repacement cost adjustments in main or suppementary accounts. 7 Consoidation practices. 8 Abiity to be generous with provisions (as opposed to reserves) and to smooth income. 9 Uniformity between companies in appication of rues. be necessary to incude other discriminating factors, such as the degree of deveopment of economy or nature of economic systems. But such a process might not be sensibe because there are few or no pubic companies in some of these other countries, so that one woud have to cassify something other than pubished financia reporting. 65
Part I Setting the scene It was not a straightforward matter to separate measurement practices from expanatory variabes. However, it was cear that at east the first two factors in Tabe 3.2 were exampes of expanatory variabes. Other factors were ess cear. For exampe, the taxation factor coud have been taken as a factor expaining differences or, by asking whether particuar vauations were affected by tax rues, it coud have been seen as a measurement practice. A the factors except the first two were taken in this atter sense. The 14 countries were scored on these nine factors, and then a arge number of aternative arithmetica and computer-based tests were used to produce custers. Very strong support was found for the micro/macro spit in Figure 3.3; and considerabe support for the more detaied groupings (Nobes, 1983). 3.7 Deveopments reated to the Nobes cassification 3.7.1 Cassification by degree of standardization Further cassification work has been carried out by A Najjar (1986), using a simiar approach to Nobes (1983) but appying it to a cassification of countries by degree of standardization of accounting. 3.7.2 Tests Doupnik and Sater (1993) tested the Nobes cassification using their own measurements of accounting practices. One of the probems with this is that the data used to test the 1980 cassification reate to 10 years after it. Later, Doupnik and Sater (1995) suggest a genera mode about the causes of accounting differences, proposing 10 variabes. However, some of the variabes seem misspecified, and some seem to overap with others. For exampe, Doupnik and Sater use a tax variabe, measured on the basis of margina tax rates, as a proposed cause of accounting differences. Chapter 2 of this book suggests that the internationa variation in the reationship between tax and accounting is more of a resut of accounting differences than a cause (see Nobes 1998a for more detai). Further, the use of margina rates seems an inappropriate measure because of the foowing: Tax rates change dramaticay over time without any obvious effect on accounting. For exampe, the top US tax rate fe from 46 per cent to 34 per cent in 1987; and the main rate in the UK rose in 1973 from 40 per cent to 52 per cent, and has now faen to 28 per cent. Many systems have more than one tax rate (e.g. in Germany in 2000, 45 per cent for retained profit but 30 per cent for distributed profit; and, in the UK in that year, 30 per cent for arge companies but 20 per cent for sma). The tax burden depends greaty on the definition of taxabe income, not just on the tax rate. More importanty, in countries with a sma connection between tax and accounting the tax rate wi have itte effect on accounting; and in countries 66
Chapter 3 Internationa cassification of financia reporting with a cose connection, the effect of tax on accounting wi be in the same direction and probaby amost as strong, whether the rate is 30 per cent or 50 per cent. Despite these difficuties, Doupnik and Sater s papers provide a arge degree of support for the cassification in Figure 3.3, particuary for the initia two-cass spit. 3.7.3 Improvements The cassification in Figure 3.3 contains a hierarchy that borrows its abes from bioogy. This can be criticized (see beow), as can the confation of Mueer s abes macro and uniform (Feige, 1997a; Nobes and Mueer, 1997; Feige, 1997b). Part of the probem here is that Nobes s cassification, ike Mueer s, is now historica, athough eements of it might survive an update. Roberts (1995) makes a number of criticisms and carifications reating to accounting cassifications. He points out that the cassification in Figure 3.3 is not reay evoutionary, athough its anaogies with bioogy and use of abes such as species suggest this. Aso, the objects being cassified appear to be countries, which seems miseading. In order to improve upon Figure 3.3, we might make it cearer that the cassification concerns accounting systems, i.e. the financia reporting practices of a particuar company in an annua report. It is possibe for a companies in a country at a particuar date to be using the same system, or for severa different systems to be in use. The most contentious abes (e.g. species ) wi be abandoned and we wi admit that the cassification is not evoutionary as indeed the Linnaean system was not originay. Figure 3.4 shows the cassification of some financia reporting systems, as adapted from Nobes (1998a). Some expanation of certain features may be usefu. For exampe, the system US GAAP means the we-defined set of practices required by US reguators to be used by certain US companies (see Chapter 8). Of course, the system changes somewhat over time. Exampes of users of the system are SEC-registered US companies, and certain arge Japanese companies for their group statements (see Chapter 12). The figure suggests that US GAAP bears a famiy resembance to UK and IFRS rues (see Chapters 2 and 6), and is in a cass of systems suited to strong equity markets. 3.8 Further intrinsic cassification 3.8.1 New data, new cassifications D Arcy (2001) used the data drawn from Ordeheide and KPMG (1995; hereafter OKPMG) to produce cassifications incuding a dendrogram based on custer anaysis in which an Ango-American custer, incuding the UK and the US cannot be found (page 341). D Arcy aso prepared a two-dimensiona diagram derived from mutidimensiona scaing which shows that Switzerand and UK are very cose 67
Part I Setting the scene Figure 3.4 Proposed scheme for cassification (page 343), but that Austraia is far removed from the UK: the Austraian system enforces its outsider position by certain requirements and prohibitions (page 345). Having arrived at this counter-intuitive resut concerning Austraia, d Arcy does not question the data but accepts the resut and seeks to expain it. Athough d Arcy uses superior methods, this reminds one of previous cassifications based on data that had not been prepared for the purpose of cassification. For exampe, it was noted above that Da Costa et a. (1978) attempt to justify, rather than question, why Germany was in the same group as the US but Canada was not, and why UK accounting was apparenty ess ike US accounting than any other in the word. 68 3.8.2 New data, od probems The OKPMG data are much more recent than those of Price Waterhouse. They cover fewer countries and are more reiabe. Further, they do not mix rues and practices, but are ceary based on rues aone. Nevertheess, there are probems with the data. First, as with the PW data, the OKPMG data were not coected or designed for the purposes of cassification. Therefore, important questions may be missing or may
Chapter 3 Internationa cassification of financia reporting be swamped by ess important ones. The second probem is that, unike PW, the OKPMG data were not aready in codabe form. D Arcy (2001) uses carefu methods to code them but, according to Nobes (2004), introduces a series of errors in the process. Nobes shows that adjusted data woud not ead to a cassification with Austraia as an outier and woud probaby produce an Ango-Saxon group. 3.9 Is there an Ango-Saxon group? As noted above, d Arcy (2001) did not find an Ango-American custer, perhaps due to imperfect data. Cairns (1997) and Aexander and Archer (2000) aso cast doubt on the two-group cassification of Figures 3.3 and 3.4. Cairns argues, for exampe, that:... the distinction between Ango-American accounting and Continenta European accounting is becoming ess and ess reevant and more and more confused....there are now probaby far more simiarities between American and German accounting than there are between American and British accounting. Nobes (1998b) agreed that the distinction between the two groups was becoming ess stark, party because of some success by the EU and the IASC, particuary in harmonizing consoidated accounting. He nevertheess proposed that the two-group system sti has descriptive power and recent empirica support (see Section 3.7.2 and beow). The fact that arge German groups are using IFRS or US rues for consoidated statements does not directy affect the German accounting rues themseves. Aexander and Archer (2000) suggested that it is a myth that there is a coherent group of countries that was using Ango-Saxon accounting. However, much of their discussion concerned not accounting practices but reguatory systems, which are indeed different in the UK and the US (see Section 3.5.5). The introductory chapters of this book have argued that there is a ceary definabe Ango-Saxon grouping in terms of purposes and practices. Nobes (2003) suggests that the Ango-Saxon hypothesis heps to expain the internationa accounting deveopments of the ast few years. There is another type of empirica support for the two-group cassification. Guenther and Young (2000) find that accounting earnings in the UK and the US are more cosey reated to underying economic activity than are accounting earnings in France and Germany. Hung (2000) finds a difference between the two pairs of countries with respect to the usefuness of aspects of accrua accounting. Ai and Hwang (2000) aso find that the ink between share prices and financia reporting information is ess for countries with bank-oriented rather than market-oriented financia systems. 3.10 A taxonomy of accounting cassifications In order to practise what we preach, we have prepared a cassification of severa of this chapter s accounting cassifications. This is done in order to sharpen description and anaysis, and to give order to a arge number of facts. The cassification in 69
Part I Setting the scene Figure 3.5 A taxonomy of some accounting cassifications Figure 3.5 first divides the cassifications into extrinsic and intrinsic on the basis of whether or not their direct subject matter is financia reporting practice or the content of the rues that contro it. The extrinsic studies are then grouped by their main topic: cuture, economic and reated environments, coonia spheres of infuence, or reguatory stye. The intrinsic studies are grouped by the source of data. It woud aso have been reevant to group by whether the data concerned rues or practices, but in severa cases there is a mixture. SUMMARY 70 Cassification is of fundamenta importance to natura scientists, and has aso been used in many socia sciences. It seems reasonabe that we might gain from a cassification exercise in comparative internationa accounting, and that simiar rues of cassification to those used by scientists might be appropriate. In accounting, such cassification may aid understanding and training, and may hep to chart the need for, and progress of, harmonization. There have been many attempts at cassification in internationa accounting, and there has been much description and data gathering. Mueer s four-group cassification of practices and ater cassification of environments were usefu preiminary works. However, the cassification of practices woud benefit from a hierarchy. Other attempts have been made to construct morphoogies and to identify zones of infuence or the effects of cuture. Other cassification studies have used the Price Waterhouse survey data of 1973 9. The resuts seem to vary in their pausibiity, and there are doubts about the suitabiity of the data. A cassification was aso proposed by the author. This had a hierarchy and has been tested in a number of ways. Cassification studies have been continued in the 1980s and 1990s, benefiting from a number of critiques.