 Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at reasons for international like accounting diversity in this course is covered. Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at reasons for accounting diversity across the group across the globe. This topic is covered an international accounting course also covered on the CPA exam. If you are listening to me, please connect with me on LinkedIn. If you don't have a LinkedIn account, you should create one LinkedIn is very important for your professional image. Please subscribe to my YouTube. I have over 1500 lectures of accounting, tax and auditing. If you like my YouTube, please like them, share them, let the world know about them. If you're benefiting from my YouTube, other people might benefit as well. So please share the wealth. This is my Instagram account. Please follow me on Instagram as I'm trying to grow my Instagram account. This is my Facebook. If you're a Facebook user on Gumroad, you can find my CPA premium material and I do have a website in case you need to get in touch with me. So before we look at the reasons for accounting diversity, let's take a look at an actual diversity to see what it looks like. So let's take a look just at face value and spec Vodafone, which is a UK company versus Verizon, which is a US company. We're looking at their balance sheet. In the US, when we prepare the balance sheet, we prepare the balance sheet in order of liquidity cash comes first short-term investments account receivable. In the UK, notice cash is on the bottom of the asset section, then we have other investments then trade receivable. So notice the liquidity is in reverse. So that's the first thing that face value in the US after assets comes liabilities, then equity in the UK. So first we list equity, we list the equity section. Then after equity, we list liabilities. Notice the format is different. There could be some terminology differences. For example, in the US, we use the term common stock for the money that the investors can contribute to the company. In the UK, we called it called up shared capital. In the UK, we use the term provisions for estimated liability. In the US, we use the term estimated liabilities if it's material enough to be listed separately, or it could be part of our liability. In the US, we use the term treasury stock, common stock and treasury stock. In the UK, we might call it own shares held. So we might have an account called own shares held and that will be considered treasury stock. We also retained earnings, which is that's called sometimes reinvested and reinvested earning or retained earning. In the UK, they might call it profit and loss account. So there are some differences in terminology, some differences in format, but there's also differences in recognition rules. Recognitions means when do we record an entry? And there are differences in measurement rules. Measurement is how do we measure a transaction? What dollar amount or what currency amount do we put on that currency? But those are the recognition and the measurement will deal with those topics a little bit more in detail in future session. But the most important thing is to take a look at why do we have accounting diversity to understand to appreciate that diversity. There are six relevant reasons for accounting diversity. The one is legal system, basis of taxation, providers of financing, inflation, political and economic ties. There's a six factor, kind of considered the six factor, which is the cultural factor. And the cultural factor, I'm going to have its own recording. I believe it's worth it. And we're going to discuss half step and Gary's framework, cultural framework. So every time I have a list, if you listen to my recording, I'll go over the list separately explaining each component of the list. So the first thing we're going to look at is the legal system. We're going to break down the globe into two type of legal system, common and code law. Are these the only two legal system? Obviously not. But those are the one that are used mainly for the largest economy. That's why we covered the common law and the code law. So first the common law, fewer statues. It's basically it's a court interpretation. So if you're in the US, the UK, or an Australia English speaking countries, they use common law and common law basically the court determine the law. There's not a lot of statues, the court, the court, the judge decide the law. So laws, the creation of precedence or case law. So once a judge decide on a case, that case becomes the law until a new judge comes and changes the law. So first this is basically the law. And again, that's an English speaking country, the US, the UK, Australia, Canada. Code law is a little bit different. Code law, you have more statues. Basically the laws is written down. And usually it's a non English speaking countries. And it's what they do with accounting rule, they legislate basically a political body legislate the accounting rules. In the US, the sources of the accounting rules are non legislative organization. What does that mean? It means private organization, something like pass me. Okay, accounting law is detailed and specific. So the accounting law is so much detailed. It's sometimes it's confusing and very specific accounting law and code law countries is very general to give you the general rule, then you have to follow it. In other words, other guidance is required because the law is a general, it's a general law. On the other hand, FASB in the US provides substantial amount of guidance. So in common law, they do give you a lot of guidance. Sometimes it's overload. Okay, sometimes it's overload. For example, the German accounting law is only 47 pages passed in 1985. I could assure you if you look at the revenue recognition and FASB, it's over 200 pages. Only the revenue recognition. So just to give you a sense what we're looking at here. For example, the German common law does not mention leases for incurrency translation or statement of cash flow. What they do is they let you interpret, they let you interpret it basically. Okay, you look for other guidance. So what would you look for? You would look for tax law and you're going to see why we look for tax law. Opinion of audit professions, accounting, academician, basically professors, people who are experts in the industry, they rely on them. Now basis of taxation is another reason why tax law changes. Accounting rules differ from country to country because of taxes. Different countries are taxed differently. And to illustrate the point I'm going to be using the US and Germany since we are already talking about Germany. In the US, we have two sets of books. We have one set of books for the IRS and another set of books for GAP generally accepted accounting principle. So when we prepare two sets of financial statements, one follow GAP financial reporting and one follow IRS, which is this is the tax and this is for financial reporting. They are different, not 100% different, but they differ. They differ substantially in certain rules. So in the US, we have different taxable income and book income. And because of this, that gives the rise to deferred income taxes. So in the US, we learn about something deferred income taxes. It's the least favorite subject for students, but nevertheless, we do have deferred income taxes. And the reason is because we do have two sets of books, we have to prepare our financial statements following GAP and we have to prepare IRS taxable income. Because those two differ, what we have to do for GAP, we have to create deferred income taxes to show the differences between the two. On the other hand, in Germany, published financial statements are the same whether it's the taxable income or book income. So in Germany, they only have basically one sets of record and that's the tax record or extremely, if you want to illustrate, to make the point, they don't have that much difference between financial accounting and tax accounting. US companies use different depreciation method for tax and financial statement purposes. Up to 2009, the German company had to use the same depreciation method for both tax and financial statement. Then they started to change. Then the law did give them a little bit of flexibility. So now they could use slightly different depreciation method, but nevertheless, not the flexibility of the US companies. Another source of difference between accounting rules is providers of financing. Who are the provider of financing? The people that or the parties doesn't have to be people. The parties that provide financing to the companies. That matters. Who provides financing to you matters from an accounting perspective? Because if you remember when you learn about the conceptual framework under GAP, what we said, we said when we issue financial statements, we issue financial statements for investors and creditors. Those are the main groups. Who are these? Those are providers of financing. So we're going to again look at the US just to compare it to other than the US and specifically Europe and Japan. It doesn't have to be only Europe and Japan just to make the point. In Europe and Japan, most large companies, they are owned by families, bank, state and other shareholders. In the US, most companies are owned by shareholders rather than families, banks and state. It doesn't mean families and banks are not involved, state to a lesser degree, but much, much lower rate than Europe and Japan. So the owners of each or the capital providers for the companies have a different identity, US versus other than the US. So what does that mean? It means if you are a Japanese or European company and you are one of these families, guess what? You are going to try to secure yourself a seat on the board of directors. Why? Because you have money invested. Your family have money invested and what you do is you try to get a seat. You vote yourself. Or if you're a bank, you also represent yourself. And if you're a state, you also could represent yourself. So as long as you represent yourself, guess what? You have less pressure for disclosure. What do you mean by less pressure for disclosure? If I'm there, if I'm monitoring what's going on, if I'm on the board of directors, I'm not going to be asking the company for all these disclosures because I'm there. It's no need to. In the US, because most of the capital providers are public shareholders, then guess what? You cannot, for every 300 individual elected representative, what you do then, you're going to demand greater transparency because these shareholders, they need to know what's going on. They cannot be represented on the board of directors. Therefore, more disclosure and transparency is required. You have more diversity in terms of ownership. What I mean by diversity means you have many, many people versus countries other than the US. Again, Japan and Europe to a great degree, most large corporations are still owned by families, banks, and the state. Also, the way we do accounting all depends on who are the capital providers. For example, if the capital providers are banks and state, they are interested more in solvency and liquidity. Also, families as well because they want to make sure they're going to keep that wealth. In the US, since the shareholders are looking for profit, the accounting is more profit oriented, so we're looking to make profit. So the way we provide accounting, we want to make sure we provide accounting to help users judge the profitability of the company. Versus when we provide information to families, banks, and state, they're interested in their solvency and their liquidity, they're more conservative. A fourth reason is inflation, and in the US, inflation is non-existent, and this is basically seriously an issue in the US because the Federal Reserve Bank don't know why we don't have any inflation. It's a problem, but something might be solved down the road. So because we have no inflation, there is no need to adjust financial statement. Other countries, other than the US, for example, in Latin America, they might have high inflation, or they used to be at least have high inflation in the 80s and the 90s. Now it's more or less under controlled, but it could pop out again. For example, in Venezuela now, inflation is hyperinflation is very, very high, but again, that's a special case. What does it mean if we have inflation? If we have inflation, we have to adjust our accounting record. This is what means with inflation. So we have to write up our non-monetary asset and inventory and tangible property planning equipment. As a result, what's going to happen, cost of goods, salt, amortization and depreciation expense will have to be written up as well. Also, our tax is affected. Once you have inflation, the way you file your taxes, it's going to have effect on your bottom line. And if you're in countries where taxes is the main record, then inflation will play an important role in your accounting standard. Other reasons for diversity in accounting is political and economic ties. Accounting just like any other thing, it's a technology that can be relatively and easily transferred or imposed on others. What does that mean? It means colonial powers such as England and France have transferred their accounting framework to a variety of countries, to their colonies. And accounting English speaking, accounting English influence can be found as far as Australia and as deep as Zimbabwe. And also accounting French influence can be found in Francophonic countries. So as they were colonizing those countries, they were also using or they were imposing or they were teaching, they were spreading the accounting system that they brought with them, the French and the English. And political and economic ties also affect how accounting rules are conveyed. For example, right now, all of the EU, all 27 countries, well, it might change down the road, they all use the IFRS and the reason is because they have political and economic ties. Therefore, they want to be uniform. Therefore, they use one set of rules. So political and economic ties also influence why we have uniformity in this situation. But uniformity in Europe across versus the US. In the US, we don't follow IFRS as of yet. We follow US gap. So those are the five reasons. There is the sixth reason. Again, I prefer to have one whole lecture about the sixth reason. I believe it's worth it. It's important to emphasize what's in the cultural factor. We also have to understand that all these factors, they cannot be taken as a single factor. There's a lot of correlation of factors. For example, common law countries have domestic listed companies relying on equity for capital. Common law, again, think of the US. They have many listed companies. Listed companies are publicly traded and rely mostly on equity. Let's take a look at some common law countries. The US is not listed here. UK, Australia, and Canada. All of these, they have a common law countries. Notice they have the number of companies listed, and this is the number of companies listed per million of population, which is much larger than Germany, France, and Japan, who their legal system is a code system. Notice they don't have tax conformity. It means they use different sets of tax records than their financial accounting. They don't have to use the same type of financial record accounting and taxes. If we look at Germany, France, and Japan, which they follow the legal, the code system, the domestic companies as per million of population is much less. So they have less publicly traded companies, less companies that are owned by the public, and notice there is tax conformity. What is tax conformity? It means the way they recognize and they measure their financial statements, it has to be the same for tax as well as for financial accounting. So they don't have a lot of flexibility. They cannot use different measurement for the same transaction, tax versus financial accounting. So code law countries tend to link taxation to accounting statement and rely less on financing provided by shareholders. So who provide the financing? Once again, large families, banks, and the state, the government. If you have any questions, any comments about this topic, please email me. If you happen to visit my website for additional lectures, please consider donating. Good luck.