Case 2-1 Are Classifications of Accounting Outmoded? Consider the following statements by David Cairns, former secretary general of the International Accounting Standards Committee.26 When we look at the way that countries or companies account for particular trans. actions and events, it is increasingly diffi- cult to distinguish in a systematic way so- called Anglo-American accounting from Continental European accounting or American accounting from, say, German accounting I am increasingly persuaded ... that the distinction between Anglo-American accounting and Continental European accounting is becoming less and less rele- vant and more and more confused. In reaching this conclusion. I do not dispute that different economic, social and legal considerations have influenced the devel- opment of accounting in different coun- tries. I also do not dispute the fact that there have been, and still are, differences in the means by which different countries determine accounting requirements and the form of the resulting requirements. I do believe, however, that those who continue to lavour these classifications are ignoring what happening in the world and how companies actually account for transac- tions and events It is increasingly apparent that the dif- ferent economic, social and legal consid- erations which have influenced national accounting do not necessarily result in different accounting and that countries are reaching the same answers irrespec- tive of their different cultural back- grounds (or reaching different answers in spite of the similar cultural back- grounds). In fact, there are now probably far more similarities between American and German accounting than there are between American and British account- ing. There are many reasons for this not least the increasing practice of standard setting bodies and other regulators to share ideas and learn from one another They do this in the IASC, the UN, the OECD, the EU, and such groupings as G4. This cross-fertilization of ideas is not surprising because standard setting bod- ies in all countries are having to address the same accounting problems 52 CHAPTER 2 Development and Classification REQUIRED 1. Do you agree with Cairns's assertion that classifications of accounting are simplistic and of little relevance in today's world? Are attempts to classify accounting futile and outmoded? Why or why not? 2. Some observers contend that financial reporting is becoming more and more alike among "world-class" companies the world's largest multinational corpo- rations and especially those listed on the major stock exchanges, such as London, New York, and Tokyo. What is the relevance of this contention for classifications of accounting, and what are the factors that would cause this to happen? Styles .4:.. . 5 6 case 4 Standing on Principles Recent US accounting scandals such as Perhap. But probably not. It cer- Enron and Worldcom, have caused me to tainly seems true that the highly question whether current US, generally detailed American Standards have accepted accounting principles (GAAP) tended to invite legalistie interpreta are really protecting investor Critic tions and loopholing, whereas the UK. including the US Securities and Exchange paramount requirement to presenta Commission (SEC), charge that the rules true and fair view has helped to remind based approach to US GAAP encourages us that accounting is more than a com a check-the-on mentality that inhibits pliance activity. However, it is much transparency in financial reporting. Some to glib to characterise their account observers express preference for princi ing standards as lacking in principle ples based standards, such as International compared to our in terms of their Financial Reportin Standards or those intellectual rigour, American account found in the Kingdom. Both the ing standards compare favorably with Financial Accounting Standards Board any others in the world CEASB) and the SEC have released reports How is it that the UK and on the feasibility of principles-based ac International Accounting Standards counting standards in the United States Boards appear to have found reliable The following appeared in a leading principles on which to base their own British professional accounting journal standards, principles that have eluded FASR? After all, both dies have them Ever since the Enron debacle first hit the new mug UK accountants have found selves adopted conceptual frameworks that are largely copies of the FASBEE a new excuse for feeling superior to their sion and claim to follow them. The transatlantic Cousins. The US. Financial answer is that they haven't. Our stan. Accounting Standards Board's massive oeuvre have been coffed al as being dards aren't really more principled than the American ons, they are simply less merely a whole bunch of rules that don't detailed. And even that is changing hang together. Toth British and in both the UK and IASB rulehooks have ternational standards, by way of contrast, swollen very considerably in recent are asserted to the based on principles year, often inspired (if that is the word) This essential difference, it is argued. by the content of the equivalent helps to explain why the US, profession has got itself into such deep trouble American standard REQUIRED 1. What is the difference between rules based and principles-based accounting standards, and what are the advantages and disadvantages of each? 2. Why has US GAAP evolved into a rules-based approach? Would princi- ples-based standards be effective in the United States? Why or why not? 3. What needs to change in the United States to make principles-based stan- dards effective? 4. Are investors and analysts better served by rules-based or principles based accounting standards? Why do you say NO Case 4-2 Casino Capital What conditions are necessary to develop an efficient stock market with fair trading? What role does accounting and financial reporting play in stock market develop- ment? Consider the case of China: Those Chinese who think of themselves as street-smart tell a joke about three fools. The first is the boss who plays around with his secretary and ends up her husband. The second is the investor who plays the property market and ends up a homeowner. And the third is the punter who plays the stock market and finds himself a shareholder. 1 up the culture of China's fledgling capi. tal markets. "Trading, not ownership is the approach of China's investors says Anthony Neoh, a former head of Hong Kong's Securities and Futures Commission who is now the chief out- side adviser to Chinas' regulatory body. "That's what we need to change. This marks a shift in China's capital market reforms. So far, Beijing has focused almost entirely on the supply side of the securities market. This has included listing more, and better, com- panies, and forcing them to adopt better standards of corporate governance and disclosure. Such efforts have a long way to go. However, the government now real- izes that it also needs to work on the "demand side." At present. China's stock market. Asia's second-largest by capitalization, consists of 60m mainly clueless retail investors, driven to trade almost entirely on rumor. [T]he balance sheets of Chinese companies are, by common consent, a joke. In January (2001) the government's official auditing body admitted that more than two-thirds of the 1,300 biggest state- owned enterprises cook their books Johnny Chen, the Beijing head of PricewaterhouseCoopers, says that even this is an understatement. Quite simply. the SOES' numbers are whatever the key man wants them to be. And without gen- uinely independent directors to chair an audit committee, that will not change. Even China's mostly hapless stock market investor (66m of them, offi- cially) had something to cheer about this month, after the country's highest court said that shareholders could file individual or class action lawsuits against companies that lie about their accounts. There appear to be a lot of liars about. Around 900 shareholder suits are pending, in a country with 1,200 listed companies It remains to be seen whether these steps amount to mere tinkering, or her. ald the new and bolder approach to financial reform that China badly needs. Its markets for labor. goods and services are nowadays more liberal than those in some capitalist economies. Its capital markets by contrast, have changed only cosmetically since the days of central planning. In effect, all capital in China is allocated, one way or the other, by the government, which wastes much of it. The decade-old stock market is dominated by state-owned enterprises that were listed for political rather than economic reasons. Some two-thirds of the market's capitalization is not traded, so the state retains total con- trol. There is no corporate bond mar- ket to speak of. 2 (All is not what it seems in China's capital markets. For a start, growth in the domestic stock market has out- stripped the efforts game as they are of the regulators and the legal sys- tem to police it. The authorities say that computer matching of share transac tions has allowed them pretty much to stop powerful syndicates ramping up share prices. They have even sent the biggest manipulators to jail, yet insider trading is still rife on a heroic scale. Stock exchange executives reckon that the real number of investors is around half the official number investors use multiple accounts for dodgy share deal ings The real issue is the quality of the listed companies themselves, says one financial official. Even some of the bet ter-regarded ones indulge in all sorts of market abuses, such as lending money raised on the stock market to the parent company rather than investing it, or speculating in the stock market on their own account. Almost all companies allowed a listing are the beneficiaries of government favoritism. Their profitabil ity is usually abysmal, their levels of dis. closure poor, and with the state hold- ing roughly two-thirds of the shares of companies listed in Shanghai and Shenzhen their treatment of minority shareholders appalling. 63 the biggest problem is the poor quality of the listed companies. All but a handful are state enterprises, which are approved for an IPO by a political com mittee rather than by independent underwriters A 2002 survey by the China Securities Regulatory Commission (CSRC), the top regulator, found that one in ten listed companies had doctored its books and the finance ministry reported in January [2004] 152 firms it had surveyed had misstated their profits by a combined 2.9 billion yuan. The stock market has been used to support national industrial policy, to subsidize SOE restructuring, not to allow private companies to raise capital." says Stephen Green of the Royal Institute of International Affairs REQUIRED 1. Describe the conditions necessary to develop a stock market in an emerging economy. 2. How do these conditions compare to the situation in China? 3. How likely is China to develop a stock market with fair trading? Why do you say so? 4. Outline a plan of reforms necessary to achieve stock market development in China Case 5-2 Seeing Is Believing Greg Benson is a stock picker responsible for recommending Mexican securities for his brokerage firm's clients. He is often frus- trated about the lack of credible informa- tion on companies in Mexico "Everything is always so top secret," he says. "Any time I try to learn about a company's activities, all I hear is 'I wouldn't know what to tell you In Mexico, its information is power Trivial or not, information seems to be off limits to anyone who is not an insider. Greg knows that this secretiveness goes way back in Mexico's history. The Aztec rulers kept their subjects amazed by powerful deities who were both unpre- dictable and hard to understand. The Spanish followed many detailed bureau. cratie rules but hardly ever shared them with ordinary Mexicans. After indepen. dence, the ruling political parties made sure that compromising information never got in the wrong hands 195 196 CHAPTER 5 Reporting and Disclosure Historian and novelist Hector Aguilar Camin has written, "In Mexico, powerful people have traditionally kidnapped infor mation. Part of the process of democratiza tion is freeing it. But there is still a tendency to want to hold it hostage for some kind of benefit. Most economists believe that govern ment secrecy made the 1994 currency col- lapse more severe because the Mexican government withheld vital macroeconomic statistics from the international banking community. Many worry now that secrecy will limit Mexico's economic growth. Yet pressure for transparency has grown along with an influx of foreign investors doing business in Mexico. The rise of opposition political parties and the growth of a free press have fueled a new debate over access to information. "What good are all of these trends to me?" complains Greg. "I need better infor mation now. REQUIRED 1 Discuss at least five characteristics that predict relatively low disclosure levels in Mexico. Your response should be based on a review of the material pre- sented in Chapter 2 and 4 and this chapter, in addition to the case infor 2. Discuss characteristics or features that predict relatively high levels of disco sure in Mexico 3. Accounting measurement and disclo sure practices are improving from an investor protection viewpoint) in many emerging market economies. What are some of the recent improvements in these areas in Mexico Discuss the underlying factors that help explain why the improvements are occurring Again, refer to the material presented in Chapters 2 and 4 in addition to the case information above Case 2-1 Are Classifications of Accounting Outmoded? Consider the following statements by David Cairns, former secretary general of the International Accounting Standards Committee.26 When we look at the way that countries or companies account for particular trans. actions and events, it is increasingly diffi- cult to distinguish in a systematic way so- called Anglo-American accounting from Continental European accounting or American accounting from, say, German accounting I am increasingly persuaded ... that the distinction between Anglo-American accounting and Continental European accounting is becoming less and less rele- vant and more and more confused. In reaching this conclusion. I do not dispute that different economic, social and legal considerations have influenced the devel- opment of accounting in different coun- tries. I also do not dispute the fact that there have been, and still are, differences in the means by which different countries determine accounting requirements and the form of the resulting requirements. I do believe, however, that those who continue to lavour these classifications are ignoring what happening in the world and how companies actually account for transac- tions and events It is increasingly apparent that the dif- ferent economic, social and legal consid- erations which have influenced national accounting do not necessarily result in different accounting and that countries are reaching the same answers irrespec- tive of their different cultural back- grounds (or reaching different answers in spite of the similar cultural back- grounds). In fact, there are now probably far more similarities between American and German accounting than there are between American and British account- ing. There are many reasons for this not least the increasing practice of standard setting bodies and other regulators to share ideas and learn from one another They do this in the IASC, the UN, the OECD, the EU, and such groupings as G4. This cross-fertilization of ideas is not surprising because standard setting bod- ies in all countries are having to address the same accounting problems 52 CHAPTER 2 Development and Classification REQUIRED 1. Do you agree with Cairns's assertion that classifications of accounting are simplistic and of little relevance in today's world? Are attempts to classify accounting futile and outmoded? Why or why not? 2. Some observers contend that financial reporting is becoming more and more alike among "world-class" companies the world's largest multinational corpo- rations and especially those listed on the major stock exchanges, such as London, New York, and Tokyo. What is the relevance of this contention for classifications of accounting, and what are the factors that would cause this to happen? Styles .4:.. . 5 6 case 4 Standing on Principles Recent US accounting scandals such as Perhap. But probably not. It cer- Enron and Worldcom, have caused me to tainly seems true that the highly question whether current US, generally detailed American Standards have accepted accounting principles (GAAP) tended to invite legalistie interpreta are really protecting investor Critic tions and loopholing, whereas the UK. including the US Securities and Exchange paramount requirement to presenta Commission (SEC), charge that the rules true and fair view has helped to remind based approach to US GAAP encourages us that accounting is more than a com a check-the-on mentality that inhibits pliance activity. However, it is much transparency in financial reporting. Some to glib to characterise their account observers express preference for princi ing standards as lacking in principle ples based standards, such as International compared to our in terms of their Financial Reportin Standards or those intellectual rigour, American account found in the Kingdom. Both the ing standards compare favorably with Financial Accounting Standards Board any others in the world CEASB) and the SEC have released reports How is it that the UK and on the feasibility of principles-based ac International Accounting Standards counting standards in the United States Boards appear to have found reliable The following appeared in a leading principles on which to base their own British professional accounting journal standards, principles that have eluded FASR? After all, both dies have them Ever since the Enron debacle first hit the new mug UK accountants have found selves adopted conceptual frameworks that are largely copies of the FASBEE a new excuse for feeling superior to their sion and claim to follow them. The transatlantic Cousins. The US. Financial answer is that they haven't. Our stan. Accounting Standards Board's massive oeuvre have been coffed al as being dards aren't really more principled than the American ons, they are simply less merely a whole bunch of rules that don't detailed. And even that is changing hang together. Toth British and in both the UK and IASB rulehooks have ternational standards, by way of contrast, swollen very considerably in recent are asserted to the based on principles year, often inspired (if that is the word) This essential difference, it is argued. by the content of the equivalent helps to explain why the US, profession has got itself into such deep trouble American standard REQUIRED 1. What is the difference between rules based and principles-based accounting standards, and what are the advantages and disadvantages of each? 2. Why has US GAAP evolved into a rules-based approach? Would princi- ples-based standards be effective in the United States? Why or why not? 3. What needs to change in the United States to make principles-based stan- dards effective? 4. Are investors and analysts better served by rules-based or principles based accounting standards? Why do you say NO Case 4-2 Casino Capital What conditions are necessary to develop an efficient stock market with fair trading? What role does accounting and financial reporting play in stock market develop- ment? Consider the case of China: Those Chinese who think of themselves as street-smart tell a joke about three fools. The first is the boss who plays around with his secretary and ends up her husband. The second is the investor who plays the property market and ends up a homeowner. And the third is the punter who plays the stock market and finds himself a shareholder. 1 up the culture of China's fledgling capi. tal markets. "Trading, not ownership is the approach of China's investors says Anthony Neoh, a former head of Hong Kong's Securities and Futures Commission who is now the chief out- side adviser to Chinas' regulatory body. "That's what we need to change. This marks a shift in China's capital market reforms. So far, Beijing has focused almost entirely on the supply side of the securities market. This has included listing more, and better, com- panies, and forcing them to adopt better standards of corporate governance and disclosure. Such efforts have a long way to go. However, the government now real- izes that it also needs to work on the "demand side." At present. China's stock market. Asia's second-largest by capitalization, consists of 60m mainly clueless retail investors, driven to trade almost entirely on rumor. [T]he balance sheets of Chinese companies are, by common consent, a joke. In January (2001) the government's official auditing body admitted that more than two-thirds of the 1,300 biggest state- owned enterprises cook their books Johnny Chen, the Beijing head of PricewaterhouseCoopers, says that even this is an understatement. Quite simply. the SOES' numbers are whatever the key man wants them to be. And without gen- uinely independent directors to chair an audit committee, that will not change. Even China's mostly hapless stock market investor (66m of them, offi- cially) had something to cheer about this month, after the country's highest court said that shareholders could file individual or class action lawsuits against companies that lie about their accounts. There appear to be a lot of liars about. Around 900 shareholder suits are pending, in a country with 1,200 listed companies It remains to be seen whether these steps amount to mere tinkering, or her. ald the new and bolder approach to financial reform that China badly needs. Its markets for labor. goods and services are nowadays more liberal than those in some capitalist economies. Its capital markets by contrast, have changed only cosmetically since the days of central planning. In effect, all capital in China is allocated, one way or the other, by the government, which wastes much of it. The decade-old stock market is dominated by state-owned enterprises that were listed for political rather than economic reasons. Some two-thirds of the market's capitalization is not traded, so the state retains total con- trol. There is no corporate bond mar- ket to speak of. 2 (All is not what it seems in China's capital markets. For a start, growth in the domestic stock market has out- stripped the efforts game as they are of the regulators and the legal sys- tem to police it. The authorities say that computer matching of share transac tions has allowed them pretty much to stop powerful syndicates ramping up share prices. They have even sent the biggest manipulators to jail, yet insider trading is still rife on a heroic scale. Stock exchange executives reckon that the real number of investors is around half the official number investors use multiple accounts for dodgy share deal ings The real issue is the quality of the listed companies themselves, says one financial official. Even some of the bet ter-regarded ones indulge in all sorts of market abuses, such as lending money raised on the stock market to the parent company rather than investing it, or speculating in the stock market on their own account. Almost all companies allowed a listing are the beneficiaries of government favoritism. Their profitabil ity is usually abysmal, their levels of dis. closure poor, and with the state hold- ing roughly two-thirds of the shares of companies listed in Shanghai and Shenzhen their treatment of minority shareholders appalling. 63 the biggest problem is the poor quality of the listed companies. All but a handful are state enterprises, which are approved for an IPO by a political com mittee rather than by independent underwriters A 2002 survey by the China Securities Regulatory Commission (CSRC), the top regulator, found that one in ten listed companies had doctored its books and the finance ministry reported in January [2004] 152 firms it had surveyed had misstated their profits by a combined 2.9 billion yuan. The stock market has been used to support national industrial policy, to subsidize SOE restructuring, not to allow private companies to raise capital." says Stephen Green of the Royal Institute of International Affairs REQUIRED 1. Describe the conditions necessary to develop a stock market in an emerging economy. 2. How do these conditions compare to the situation in China? 3. How likely is China to develop a stock market with fair trading? Why do you say so? 4. Outline a plan of reforms necessary to achieve stock market development in China Case 5-2 Seeing Is Believing Greg Benson is a stock picker responsible for recommending Mexican securities for his brokerage firm's clients. He is often frus- trated about the lack of credible informa- tion on companies in Mexico "Everything is always so top secret," he says. "Any time I try to learn about a company's activities, all I hear is 'I wouldn't know what to tell you In Mexico, its information is power Trivial or not, information seems to be off limits to anyone who is not an insider. Greg knows that this secretiveness goes way back in Mexico's history. The Aztec rulers kept their subjects amazed by powerful deities who were both unpre- dictable and hard to understand. The Spanish followed many detailed bureau. cratie rules but hardly ever shared them with ordinary Mexicans. After indepen. dence, the ruling political parties made sure that compromising information never got in the wrong hands 195 196 CHAPTER 5 Reporting and Disclosure Historian and novelist Hector Aguilar Camin has written, "In Mexico, powerful people have traditionally kidnapped infor mation. Part of the process of democratiza tion is freeing it. But there is still a tendency to want to hold it hostage for some kind of benefit. Most economists believe that govern ment secrecy made the 1994 currency col- lapse more severe because the Mexican government withheld vital macroeconomic statistics from the international banking community. Many worry now that secrecy will limit Mexico's economic growth. Yet pressure for transparency has grown along with an influx of foreign investors doing business in Mexico. The rise of opposition political parties and the growth of a free press have fueled a new debate over access to information. "What good are all of these trends to me?" complains Greg. "I need better infor mation now. REQUIRED 1 Discuss at least five characteristics that predict relatively low disclosure levels in Mexico. Your response should be based on a review of the material pre- sented in Chapter 2 and 4 and this chapter, in addition to the case infor 2. Discuss characteristics or features that predict relatively high levels of disco sure in Mexico 3. Accounting measurement and disclo sure practices are improving from an investor protection viewpoint) in many emerging market economies. What are some of the recent improvements in these areas in Mexico Discuss the underlying factors that help explain why the improvements are occurring Again, refer to the material presented in Chapters 2 and 4 in addition to the case information above