The effect of new international accounting standards on firms from India and US.

Etnyre, Vance ; Singhal, Parakh

INTRODUCTION AND BACKGROUND

Accounting systems deal with the monetary structures of countries, which are derived from local laws, socio-economic conditions, cultural standards and traditions. Accommodations to cultural, legal, and socio-economic factors give accounting systems unique structures. In spite of the common framework of principles, countries integrate specific aspects of culture, socioeconomic framework and legal structure into unique sets of Generally Accepted Accounting Principles or GAAPs.

Accounting standards and practices reflect the influence of legal, cultural, political and economic factors. Because these factors vary by country, the underlying goals and philosophy of national accounting systems vary dramatically (Griffin, 2009).

In common law countries like the United States and United Kingdom, accounting procedures evolve from decisions of independent standard-setting boards. Accountants in common law countries follow generally accepted accounting principles (GAAP) that provide a "true and fair" value of a firm's performance based on standards promulgated by standard-setting boards. Operating within the boundaries of GAAP, accountants can exercise professional discretion in reporting a "true and fair" depiction of a firm's performance (Griffin, 2009).

In countries which rely on code law, national accounting practices are likely to be codified rather than based on the collective wisdom of professional accounting groups. In France, for example, firms must adhere to a national chart of accounts. This accounting system dates back to the seventeenth century and reflects a long tradition of strong government control over the economy (Griffin, 2009).

In countries where accounting practices are determined by national laws, the government plays the major role in monitoring accounting practices. Common law countries rely to a greater extent on private litigation to enforce the accuracy and honesty of accounting practices.

A country's accounting system may also reflect its cultural background. Large companies in France must publish a "social balance sheet" detailing compensation of their workforces. Strong anti-inflation biases are embedded in German accounting practices as a reaction to the hyperinflation of the early 1920s (Griffin, 2009).

Accounting system structure is heavily influenced by economic and political systems also. In centrally planned economies, accounting systems are designed to provide information which shows how state funds are used and whether state-mandated production quotas are being met.

EFFECT OF ECONOMIC GLOBALIZATION

Companies that participate in the "Global Economy" must develop accounting systems that provide the internal information required by managers to run the organization and external information needed by lenders, shareholders, and government officials in all countries in which the companies operate.

Economic globalization highlights the need for common bases of understanding of financial structure. As different countries try to open up their industries and their capital markets to foreign investment, multiple GAAPs create problems of consistent reporting to potential investors. To reduce the negative effects of these differences, organizations like the International Financial Reporting Standards Board has proposed a set of common financial reporting standards (IFRS). Supporters of this effort hope that widespread adoption of these common reporting standards will increase investors' confidence and reduce barriers to the flow of investment capital. "Converging" to a common set of reporting standards will cause short-term problems which, hopefully, will lead to long-term net benefits.

Currencies, dates and other units of measure differ significantly from one country to the next. In the U.S., the last day of 2009 would be written as December 31, 2009 and a million currency units would be written as $1,000,000.00. In India, the last day of 2009 might be written as 31 December 2009, and a million currency units might be Rs 10,00,000.00. Because of the differences in currencies and languages, companies have to make choices as to how their statements will be presented.

METHODS FOR COMPANIES TO DEAL WITH GLOBAL ACCOUNTING ISSUES

Companies whose operations or financing become globalized may not be able to ignore differences between reporting requirements at home and different reporting practices in countries where they have significant numbers of customers or investors. According to Sorensen (2007), methods for dealing with different reporting requirements include:

* Do nothing extra for foreign countries

* Convenience Translations

* Convenience Statements

* Limited Restatements

* Reconciliation to foreign country's GAAP

* Secondary Statements

Many companies provide the same reports to foreign users that they provide to domestic users. This "Do Nothing Extra" approach is reasonable for companies that are not particularly interested in attracting foreign investors. Such companies do not see enough additional benefits to justify the cost of taking any additional action to attract foreign investors.

Convenience translations represent the minimal effort on the part of companies to respond to foreign users. In a convenience translation, the preparer translates the language of the financial statements to the language of the foreign country, but the accounting principles and currency are still those of the preparer's country. In international accounting literature, the term Convenience Statement means that reports are prepared in a foreign user's language and currency, but the accounting principles remain those of the home country.

In addition to translating language and currency, Limited Restatements provide supplementary disclosures to reconcile financial statements to the user's GAAP. Reconciliation to Foreign GAAP is similar to limited restatement, but includes more complete restatements of financial information to accommodate regulations of the countries where securities are listed. Preparation of Secondary Statements means translating the home country annual report into a foreign country's language, currency, and accounting principles.

Translating home country annual report into a foreign country's language, currency, and accounting principles can be very expensive. Companies wishing to list stock on several different exchanges worldwide can use Universal Secondary Statements rather than Country-Specific Secondary Statements. In universal secondary statements, a company could use its own currency or a major international currency such as the euro or the U.S. dollar. The language of such statements would be English and the format would be in accordance with International Financial Reporting Standards.

TOOLS FOR TEACHING ACCOUNTING SYSTEMS IN A GLOBAL ENVIRONMENT

Most business schools in the United States teach accounting courses with the assistance of one or more accounting packages. Peachtree Accounting and Microsoft Dynamics (formerly Microsoft Accounting) are examples of accounting systems frequently used to teach accounting. Enterprise Resource Planning (ERP) systems have tools for selecting appropriate currencies and formats, but ERP systems introduce many new sets of problems including high license fees, complicated installations and very high maintenance costs. Some schools have added a third option for teaching accounting in a global environment. The third option is software specifically designed to demonstrate differences between different accounting systems.

At the University of Houston--Clear Lake, a software package called Clear Lake Accounting is being developed to help in teaching various accounting classes. One feature of Clear Lake Accounting is the ability to integrate data from different sources and present that data in different formats.

[FIGURE 1 OMITTED]

The package Clear Lake Accounting allows the user to combine different methods for converting currencies with different templates for display financial reports. Figure 1 above shows a portion of the Clear Lake Accounting which allows the user to select data for the Indian software company Infosys. Before reaching this screen, the user would have selected the mode of data entry as Text file, spreadsheet, XML file or Database.

Clear Lake Accounting can access data from text files, spreadsheets, XML files, or databases. In displaying financial reports, the user of this system can translate currencies and present reports in various languages and formats. Translation of currencies can be done in a very simple manner, using one exchange rate for all values to be translated, or it can be done using program scripting to translate different accounts with rates from different time periods. Program scripts are also used to combine sub-accounts into aggregate accounts. Templates are used to determine the output formats of various reports. Portions of this program were specifically designed to be used to compare features of different accounting systems throughout the world.

Figure 2, below, shows the result of combining the selected data with a template for an income statement under Indian GAAP. In this example, the language is English and the currency units are rupees.

[FIGURE 2 OMITTED]

The Clear Lake Accounting Package includes provisions for simple currency conversions where one conversion rate is applied to all currency data. Figure 3, shows the process of converting rupees into U.S. dollars using a single conversion rate.

Figure 4, shows a "convenience statement", a version of the Infosys income statement in English, after converting the currency to U.S. dollars. . This simple conversion process can be used to prepare "Convenience" statements, but may not serve the T"u needs of foreign investors because the GAAP of the home country is maintained.

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Simply converting language and currency units will not be sufficient to attract investment funds from the U.S. capital markets. Any company hoping to attract U.S. capital should provide audited statements showing compliance with U.S. GAAP. This could be very expensive. While a large company such as Infosys can afford to provide such a restatement of its financial position, most companies cannot afford such luxuries.

Even for large companies such as Infosys, there are limits to the expense which can be justified in order to provide secondary financial statements. Capital markets in Japan, China and the European Union offer excellent opportunities for companies which can afford to provide financial information in an effective manner, but providing secondary financial statements in multiple languages to satisfy the requirements of multiple GAAPs would be prohibitive for even large firms.

As an added difficulty, companies which have a major portion of their operations in a country which uses a different currency would have to account for gains and losses due to fluctuations in the value of that currency relative to the home currency of the company. This means that foreign exchange transaction risks and foreign currency translation risks would have to be considered in preparing financial statements (Sorensen, 2007).

According to the rules proposed by the International Financial Standards Board, transaction risks would be accounted for on consolidated income statements and translation risks would not be accounted for on the current income statement, but would be recognized as an adjustment to owners' equity. The difference would occur because different items would be translated using exchange rates from different time periods.

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For instance, sales of merchandise, operating expenses and current liabilities would be converted at the current (reporting) date while long-term investments and long-term liabilities would be converted at historic rates. Converting items at different rates (due to different time periods) introduces translation adjustments.

These adjustments are reported as part of the "Other Comprehensive Income" category which is added to increases in retained earnings in determining Stockholder Equity. Figure 5, shows a complex process of converting rupees into U.S. dollars for several different categories of accounts.

Figure 6, shows the results of calculating Stockholder Equity which includes Currency Translation Adjustment as part of Other Comprehensive Income.

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CONCLUSIONS

Utilizing an almost universally accepted set of international standards, even small companies could reach capital markets which previously had been unavailable to them. It is extremely important that companies act in a timely manner to take advantage of new opportunities as they become available. This means that companies which want to take advantage of newly emerging global opportunities must be ready and able to use international standards as soon as they become accepted.

Effective and wide-spread use of international standards will not occur unless educators begin immediately to provide materials which demonstrate the effects of international financial reporting standards. Upgraded accounting packages and ERP software will provide some of the tools needed to train tomorrow's business leaders. Other tools must be developed by those who are teaching accounting and finance courses today.

The tools used to teach accounting and finance courses must specifically include devices which show the effects of foreign exchange transaction risk, foreign currency translation risk, and specific effects to financial statements of currency translations made over different time periods.

REFERENCES

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Vance Etnyre, University of Houston--Clear Lake

Parakh Singhal, University of Houston--Clear Lake