The Institutional and Cultural Influences on Accounting - Essay Example

1. Introduction Accounting practices in different countries have been found to be different as a result of either cultural or al factors.This paper is aimed at examining the institutional and cultural influences on accounting by using relevant examples and research from different countries. Having said this we now turn to the institutional influences on accounting which are discussed in section 2 and section 3 will later discuss the cultural influences. 2. Institutional Influences on Accounting. According to Roberts et al (2005), there are no two countries with identical accounting practices although a few cases such as those of the UK and Ireland, or the US and Canada where differences are relatively few and relatively minor. Countries such as France and the UK, or the US and Mexico exhibit significant differences in their accounting systems. (Roberts et al, 2005). These differences arise as a result of the adoption of different methods of valuation ranging from strict historical costs to full current cost systems, the adoption of quite different definitions of an asset, that is, using either legal ownership or economic control-based definitions. (Roberts et al, 2005). Differences also arise as a result of differences in the relative importance attached to different accounting principles-in particular the matching or accruals principle and the prudence or conservatism principle. (Roberts et al, 2005). Nobes (1992) and Roberts et al (2005), identify six main factors which can be seen as important causes of international differences between financial reporting systems including the following: The legal system; Business organisation and ownership; Stock exchanges; Taxation; The profession; and Other influences. i. The Legal System Roberts et al (2005) stipulate that there are two types of legal systems in liberal democratic counties, including Romano-Germanic or code law and Common law legal systems. Code law legal systems are common in continental Europe, Latin America and much of Asia. (Roberts et al, 2005). In these countries, laws are generally codified (often using a similar framework to that of the French Napoleonic codes of 1804-11). (Roberts et al, 2005). Commercial organisation as well as accounting regulation is governed by commercial codes. Common law on the other hand adopts a philosophy where the role of law is to prohibit undesirable behaviour rather than to prescribe or codify desirable behaviour. Commercial law stems from England where it was exported to the United states and the Common Wealth. (Roberts et al, 2005). The legal/judicial institutions can influence incentives to produce conservative accounting numbers through a series of channels. (Bushman and Piotrosky, 2006). ii. Business Organisation and Ownership. There is also a considerable difference in ownership structure and business organisation across countries. (Nobes, 1992). For example, capital contributed by the government and banks in france is very significant as are small businesses. (Nobes, 1992). Companies in Germany are owned by banks and a majority of shares in public companies are owned and controlled by banks, especially the Deutsche, Dresdner and Commerz Banks. (Nobes, 1992). One would therefore expect accounting methods in Germany to be influenced by these banks since most of the information produced will be done in accordance to their needs. On the other hand, shares in the UK and the USA are owned by institutional investors. There is therefore an increase in the importance of the investor in these countries which is reinforced by the following hypothesis: “in countries with widespread ownership of companies by shareholders who do not have access to internal information there will pressure for disclosure, audit and ‘fair’ information”. (Nobes, 1992). As institutional investors hold larger blocks of shares and may be better organised than private shareholders, their desire for information and their command of resources should increase this pressure as well as succeed in pressing for insider information. (Nobes, 1992). iii. Tax regimes To the extent that financial and tax reporting are linked, the demand for conservative reporting to minimize the present value of tax payments will be increasing in the firm’s expected tax burden. (Bushman and Piotrosky, 2006). Similarly, taxation can be viewed as an alternative mechanism for the state to extract wealth from corporations and shareholders, thus giving rise to political costs that can influence observed reporting practices. (Bushman and Piotrosky, 2006). iv. Stock Exchanges In a similar manner as the importance of the government as user of accounting information exerts a greater influence of taxation or accounting rules, so too is the importance of shareholders connected with the activities of the stock exchange. (Nobes, 1992). Where the importance of the shareholder is at the heart of the stock exchange, there will be some stock exchange regulations on disclosure and vice versa. (Nobes, 1992). v. The Accounting Profession. The nature of the accounting profession also feeds back into the type of accounting that is practiced and could be practiced. For example the 1975 decree in Italy requiring all listed companies to have extended audits similar to those operated in Anglo-Saxon countries could only be implemented initially because of the substantial presence of Anglo-Saxon accounting firms. (Nobes, 1992). vi. Other influences Accounting has been influenced by many other factors, which are not indirect and subtle like the type of ownership of companies, but indirect and external to accounting like the enactment of new laws. (Nobes, 1992). The economic crises in the USA in the late 1920s and early 1930s led to a enactment of Securities Acts, which have diverted accounting from its previous course by introducing extensive disclosure requirements and control of accounting standards. (Nobes, 1992). 3. Cultural Influences on Accounting. Hofstede (1991: pp 5) as restated by Swaiden and Hayes (2005: pp 10) and Roberts et al (2005: pp 171), defined culture as “the collective programming of the mind which distinguishes the members of one group or category of people from another.” This does not imply that humans are programmed the same way computers are. (Swaiden and Hayes, 2005). A number of cultural dimensions were identified by Hofstede in 1984. (Roberts, et al, 2005). They include the following: Individualism Versus collectivism Individualism on the one hand stands for a preference for a loosely knit social framework in society wherein individuals are supposed to take care of themselves and their immediate families only. Collectivism on the other hand refers to a preference for a tightly knit social framework in which individuals can expect their relatives, clan, or other in-group to look after them in exchange for unquestioning loyalty. (Roberts et al, 2005). The main theme behind this dimension is the degree of interdependence a society maintains among individuals. (Roberts et al, 2005). Large versus small power distance Power distance refers to the extent to which members of a society accept that power in institutions is distributed unequally. This affects the behaviour of both more powerful and less powerful members of the society. (Roberts et al, 2005). In large-power distance societies on the one hand, people accept a hierarchical order in which every body has a place, which needs no further jurisdiction. (Roberts et al, 2005). On the other hand, people in small power distance societies strive for power equalization and demand justification for power inequalities. (Roberts et al, 2005). Hofstede (1984) as cited by Roberts et al (2005) also discussed strong versus week uncertainty avoidance as well as masculinity versus femininity (low versus high nurturing). (Roberts et al, 2005). However, Geert Hofstede’s work has been subject to criticisms. McSweeney (2002) asserts that Hostede’s research relies on fundamentally flawed assumptions. McSweeney examines four crucial assumptions upon which Hofstede’s measurements are based as follows: 1. Every Micro-location is typical of the national McSweeney (2002), criticizes this assumption on the grounds that Hofstede’s generalization of the entire population in each country is based on the analysis of a few questionnaire responses. He emphasizes that Hofstede made use of only a certain category of employees of a single company, that is, IBM. 2. Respondents were already permanently ‘mentally programmed’ with three non-interacting cultures. Under this assumption, Hofstede’s claim of identification of national culture in IBM is questioned by McSweeney (2002). He asserts that Hofstede aught to have made a number of other and equally implausible assumptions in order to be able to that he could describe and indeed measure, these cultures. 3. The main dimensions of a national culture can be identified by questionnaire response difference analysis Despite the criticisms above, even if it is assumed that Hofstede managed to isolate unique aspects of national cultures, it takes another non-evidence-based leap of faith to conclude that he was able to construct adequate depictions of national cultures or national cultural differences. (McSweeney, 2002). 4. That ‘identified’ in the workplace is unaffected by location   Hofstede assumes that what he identified within a workplace is situationally nonspecific. It is the same in the courtroom, on the sports field, in the bedroom, everywhere. (McSweeney, 2002). But we all know managers who are ‘rotweilers’ at work and ‘pussycats’ at home, and the converse. (McSweeney, 2002). (McSweeney, 2002). We may often be individualistic within office politics, but usually act in a collectivist way on behalf of our organisations. (McSweeney, 2002). Having defined culture and Hofstede’s work as well as McSweeney’s criticisms, we now turn to the effects of culture on accounting. The financial accounting system is set up and run by or for various groups of people, in particular auditors, management accountants or other statement preparers, accounting regulators (who may or may not be accountants) and statement users. (Roberts et al, 2005: pp 183). Each of these groups is regarded as a distinct group with its own subculture. (Roberts et al, 2005). Roberts et al (2005) assert that the most relevant dimension of Hofstede’s four cultural dimensions to accounting is “uncertainty avoidance” and “individualism”. Institutions tend to be organised in a way that avoids uncertainty in countries with a high degree of uncertainty avoidance. (Roberts et al, 2005). Under such circumstances, rules and regulations are explicit, prescriptive, more detailed, all-embracing, and rigid. (Roberts et al, 2005). On the other hand low-uncertainty avoidance countries have less rules and rely more on general principles and existing rules tend to have options. (Roberts et al, 2005). Individualism affects motivation and as such should affect preferences for particular earnings measurement rules and disclosure practices. (Roberts et al, 2005). BIBLIOGRAPHY Bushman R. M., Piotroski J.D. (2006). Financial reporting incentives for conservative accounting: The influence of legal and political institutions Journal of Accounting and Economics, Vol. 42, Issues 1-2, Pp 107-148. McSweeney B. (2002). Hofstede’s Model of National Cultural Differences and their Consequences: A triumph of faith-A failure of Analysis. Human Relations, Vol. 55, No. 1, Pp 89-118. Nobes. (1992). International Classification of Financial Reporting. Second Edition. Routledge 11 New Fletter Lane London, EC4P 4EE. Roberts C., Weetman P., Paul G. (2005). International Financial Reporting. A comparative Approach. Prentice Hall. Swaiden Z., Hayes L.A. (2005). Hofstede Theory and Cross Cultural Ethics Conceptualization, Review, and Research Agenda The Journal of American Academy of Business, Cambridge Number 2. Read More