Accounting Regulatory Environment In The UK and US - Case Study Example

Introduction This paper presents insightful investigation into the differences in international accounting practices with respect to the standards and principles prevailing in different countries. The two countries chosen for this paper are the United States and the United Kingdom. The companies that are investigated in this regard are Tesco plc and Target Corporation; both are reputable and well-known companies from the retail sector. This paper illuminates the differences in accounting regulatory environment of these countries, propounds their relevance with accounting classification models, states distinctions in the accounting policies underlying the preparation of these companies' financial statements, the social reporting and segmental reporting disclosures in their annual reports, and the accounting ratio analysis. Accounting Regulatory Environment In The UK and US The accounting and financial reporting standards in the United Kingdom are the responsibility of Financial Reporting Council (FRC). It is an independent professional entity consisting of three auxiliaries viz. the Accounting Standards Board (ASB), the Urgent Issues Task Force (UITF), and the Financial Reporting Review Panel (FRRP). In the year 2000, the European Commission advised all the European Union listed companies to prepare their financial statements in full compliance with the IFRS for the financial years starting on or after January 2005, so as to enhance the comparability and transparency of financial statements (European Commission, 2000). Ever since then, all the companies in UK are required to prepare the financial statements under the standards issued by International Accounting Standards Board. In the United States, the accounting standards are issued mainly by the Financial Accounting Standards Board (FASB). These standards are known as Generally Accepted Accounting Principles on the basis of which, companies in United States are required to prepare the financial statements (Nobes et al., 1997). The Securities and Exchange Commission is responsible to regulate the financial reporting principles in the United States. Bushman and Smith (2003, p65) illuminate that, "in the United States, the SEC, under the oversight of the U.S. Congress, is responsible for maintaining and regulating the required accounting and disclosure rules that firms must follow. These rules are produced both by the SEC itself and through SEC oversight of private standards-setting bodies such as the Financial Accounting Standards Board and the Emerging Issues Task Force". There happens to be considerable divergence between the US GAAP and International Accounting Standards, however FASB and IASB are collaborating to minimise the discrepancies (Malthus, 2004). The FASB has been continuously working for the improvements in the accounting standards prevalent in the United States. This importance to disclosure and transparency of information has helped on the way of harmonising the US GAAP with the IFRS. In the year 2002, it provided its support to IASB and both the boards signed an agreement to act united in the pursuit of harmonisation of accounting standards and thus the FASB has taken a leadership role second to IASB in the internationalisation of financial reporting standards (Halliday, 2003). Classification Of Accounting Systems Both these countries i.e., the United Kingdom and the United States belong to the Anglo-American model as proposed by Nobes and Parker (1998; 2000) (Wolk et al., 2001). The standards issued by International Accounting Standards Board (IASB) also come into the category of Anglo-American model. The six important factors of international differences with respect to accounting practices as proposed by Nobes and Parker (1998; 2000), both the countries have legal system based on common law, UK and US have strong equity system with greater shareholder influence, greater significance of stock exchange, both the countries have staunch power of accounting profession (Wolk et al., 2001) and both the countries demand extended disclosure of financial information from the companies. However, as we can see the accounting standards followed by these countries are significantly distinct from each other with respect to IAS and US GAAP. Differences In Accounting Policies Tesco plc has presented the company's financial statements in compliance with IFRS as per the requirement of European Commission, whereas Target Corporation has prepared its accounts based on the principles of US GAAP. An analysis of the accounting policies mentioned in both the companies' annual reports, reveals several significant reporting differences reflective of the accounting standards followed by the companies. Two of these distinctions are examined below: Goodwill Tesco plc has reported the company's goodwill as an asset at the date of acquisition while apportioning it to every single cash generating business unit that is expected to benefit from it. The company doesn't record the amortisation on goodwill as per the rules of IAS 36/39 and IFRS 3; rather it reviews the impairment of goodwill on an annual basis at the minimum owing to the recoverable amount of all the cash generating units associated with goodwill. If the company sells off any goodwill associated subsidiary, it records the attributable amount of goodwill as gain or loss on disposal i.e., as the extraordinary gains or losses (Tesco plc, Accounting Policies Note, p48). In order to test the good for any impairment, the company utilises cash flow projection method to estimate the recoverable value of cash generating units while assuming the values for discount rates, growth rates and expected change in margins. Target Corporation has presented goodwill along with the other intangible assets at the value of acquisition cost less amortisation as it is allowed under the US GAAP. The amortisation is recorded on straight-line method. The company also has a policy of not amortising some of its assets and reviews them annually for impairment tests. Target Corporation uses the discounted cash flow models test the goodwill for impairment on the fair value (Target Corporation, Note 15, p31). Deferred Income Taxes The deferred tax policy of Tesco plc accounts for temporary discrepancies between the amounts of assets and liabilities while using the Balance Sheet liability method. The company calculates the deferred tax on the basis of expected rates and is reflected in the income statement. As per the requirement from IAS-12, the company recognises deferred tax assets and liabilities in so far to make it probable that the company will be able to avail the deductible temporary differences out of the taxable profits. On the other hand, the company inspects the carrying amount of deferred tax assets at every balance sheet date in order to dilute it to avoid the probability that all or some of the assets could be recovered enough out of the available taxable profits (Tesco plc, Accounting Policies Note, pp49-50). Target Corporation, as per the requirement of US GAAP, records deferred tax on the basis of asset and liability method. Under this method, the company measures the deferred tax assets and liabilities on the rates issued for the year in which the recovery is expected and the changes in tax rates are also recognised in the same year (Target Corporation, Note 15, p34). Social Reporting Chewning et al. (1990, p207) refers to the concept of social activities performed by corporations as, "to serve a wider range of human values". Tesco plc reports various features of its socially beneficial activities (Tesco plc, Operating and Financial Review, pp12-13) as a part of its "operating and financial review". The company points out several activities such as fundraising for social causes, donations to charitable organisations in specified sums, acting environment friendly, 20% less use of energy as compared to other similar stores, opening energy efficient stores and recycling activities. The Target Corporation has reported the social aspects of its activities in its annual reports by summarising its major contributions to the society and community in a separate head of "Corporate Responsibility". It has mentioned several financial and non-financial angles through which it claims to be a socially beneficial company. It has emphasised considerably on plus points like its contribution to education, children's welfare, culture, financial support to charitable organisations, workforce betterment, safety of environment and society (Target Corporation, Corporate Responsibility, pp14-15). Both the companies have reported significant contributions to society and community. However the social reporting by Target Corporation appears to be much illustrative than that of the Tesco plc. Segmental Reporting Disclosures Target Corporation mentions that its business happens to be a single segment operation (Target Corporation, Accounting Policies, p28). The company operates on national level and thus, has no disclosure for segments in its annual report for the year 2006. Also the company has not reported any disclosures for foreign currency translations in its annual report. Tesco plc operates on international level and has its operations in UK, Europe and Asia. The company has classified its financial information on the basis of segments in the notes to accounts section (p53). This has been done in compliance with the International Accounting Standards (IAS 14), which requires the companies to report their financial information on the basis of geographical and business line segmentation. The company has complied with both the requirements of IAS 14 by showing both the types of segmentation. It has reported the financial information by geographical segmentation viz. the UK, Europe and Asia with all segment revenues, expenses, results, assets and liabilities. It has also attempted to show the segmentation by line of business, however the company reports that it operates on a single line of business. Accounting Ratio Analysis Weetman et al., (1998) propound that the financial results reported by companies in UK and US happen to be significantly distinct from one another. The UK accounting regulatory environment follows the principles and standards of International Accounting Standards Board, while the United States is reluctant to completely converge its accounting standards with that of the IASB. The following is the comparison of financial performance of Tesco plc (www.reuters.com) and Target Corporation (www.morningstar.com) on the basis of accounting ratios: Accounting Ratios Tesco Target Gross Profit Margin 7.68% 33.6% Operating Profit Margin 5.78% 8.2% Net Profit Margin 4.02% 4.58% Return On Assets 7.43% 7.16% Price/Earnings 18.83 17.8 Dividend Yield 2.30% 0.8% The above financial ratios of both the companies have been derived from their financial statements that have been prepared under two different sets of accounting standards and policies concerning goodwill, deferred taxes, leases, non-current assets, impairment of long lived assets and amortisation. However this is to expect that the results from the financial analysis might be misleading because of differences in accounting practices. Gross margin of Tesco plc is 7.68% and Target Corporation is 33.6%, which shows that Tesco is losing about 92% of its total sales revenue in accounting for various production costs. Target Corporation, on the other hand retains 33.6% of its sales revenue after accounting for cost of goods sold. The difference between gross profit margin, operating margin, pre-tax profit margin and net profit margin indicates the amount of expenditures borne by the company from production to distribution, SG&A, operating, interests and taxes etc. The operating profit margin and net margin illuminate that Tesco manages to retail about 4% of its total sales revenue and Target secures 4.5% as net profit, after meeting all the production, distribution and operating expenses. This analysis also reveals that Tesco loses most of its sales revenue (about 93%) on production costs, while Target loses mostly on production costs (about 67%) and operating expenses (about 25%). The return on asset ratio for Tesco plc and Target Corporation is 7.43% and 7.16% respectively, which reveals that both the companies are generating almost the same percentage of return on their assets, but this ratio includes the figure of total assets which also includes goodwill and the recording practice of goodwill is different in the standards followed by these companies. Hence, it is difficult to express that both the companies are generating the same amount of return for their shareholders. The P/E ratio for Tesco and Target is 18.83 and 17.8 respectively. This reveals that the investors' trust and market value of Tesco plc's stock in relation to the company's earnings are higher than that of the Target Corporation. Besides stock prices, this ratio is affected by net income, which in turn is influenced by the accounting practice of these companies. The dividend yield of Tesco is much higher than the Target Corporation showing that the company is providing more returns to its shareholders in the form of dividend in relation to the its stock price. Concluding Comments This study and analysis of research undertaken in this assignment proved to be useful in developing an in depth understanding of: The contrasting elements in the standards prescribed by the International Accounting Standards Board and the US GAAP. The differences in regulatory environment and accounting practices of the two countries i.e., the United States and United Kingdom. Practical problems in analysing the international financial statements with the help of accounting ratios. Application of differences in accounting systems classification models studies. Word Count: 2113 References Bushman R.M. and Smith, A.J. (2003), "Transparency, Financial Accounting Information, And Corporate Governance", FRBNY Economic Policy Review, pp.65-87 Chewning, R.C., Eby, J.W., and Roels, S. J. (1990), "Business Through the Eyes of Faith", Harper & Row, San Francisco European Commission (2000), "The EU's Financial Reporting Strategy: The Way Forward, 9637/00, Brussels: European Commission Halliday, D. (2003), "International Convergence and the Rise of International Standards", International Accountant, 20 Malthus, S. (2004), "International Convergence of Financial Reporting Standards", Working Paper, No. 1/2004, Nelson Marlborough Institute Of Technology: NZ Nobes, C. and Parker, R. (1998), "Comparative International Accounting, 5th edition, London, Prentice Hall Europe Nobes, C. and Parker, R. (2000), "Comparative International Accounting, 6th edition, London, Prentice Hall Europe Nobes, C; Mueller, G; Gernon, H; Meek, G. (1997), "Accounting an International Perspective", (4th edition), Irwin, Inc; Chicago Tesco Plc (2006), Ratios, accessed 19.08.06 from www.reuters.com Target Corporation (2006), Ratios, accessed 19.08.06 from www.morningstar.com Weetman P., Jones E. A. E., Adams C. A. and Gray S. J. (1998). "Profit Measurement and UK Accounting Standards: A Case of Increasing Disharmony in relation to US GAAP and IASs". Accounting and Business Research. 28, 3 (Summer): 189-208 Wolk, H., Tearney, M. and Dodd, J. (2001), "A Conceptual and intestinal Approach: Accounting Theory", 5th edition, South-Western College Publishing Read More