CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This study is aimed at describing the impact of cultural factors on the implementation of global accounting standard, IFRS in Nigeria. In order to accomplish this, the study will explain the theoretical framework and conceptual framework within which to address these concerns. The review begins with a background to International Financial Reporting Standard, it then touches on carve-outs on IFRS by most countries, followed by a discussion of the findings of current international research on the impact of culture on aspects of global accounting.
2.2 Theoretical Framework
The eect of culture on international accounting standards cannot be examined without some sort of framework in which accounting and social values can be connected. The formation of this framework begins with the cross-cultural study of Geert Hofstede (1980; 1983). Hofstede’s study attempted to identify important aspects of culture that had an eect on people’s behavior in a professional capacity. This was done through a survey of people’s values across 50 different countries and three regions. Values were analyzed on the collective level, and therefore, were thought to be the best representation of a country’s culture. From this survey Hofstede was able to draw out four dimensions of culture, which included: power distance, uncertainty avoidance, individualism, and masculinity. Power distance was thought to capture the extent to which there was equality in power between members in society. For example, in a society where there is great power distance, many individuals accept the authority and have no say in decisions that are made. Power distances attempts to most closely address, “how a society handles equalities among people when they occur” (Hofstede 1984). Uncertainty avoidance involves the aversion one feels towards the unknown and what actions are taken as a result of that aversion. Those with strong uncertainty avoidance look to plan every detail without any room for flexibility or innovation. If a person has weak uncertainty avoidance then they will be content with letting things happen as they may. Uncertainty avoidance looks at whether a society, “tries to control the future or let it happen” (Hofstede 1984). Individualism is a measure of whether someone feels as though they must fend for themselves or that they are a piece of a greater whole that will take care of them. Simply put, this, “relates to people’s self-concept: ‘I’ or ‘we’” (Hofstede 1984). Finally, masculinity refers to a society’s partiality towards, “achievement, heroism, assertiveness, and material success” (Hofstede 1984). On the opposite end of this spectrum is a society with goals rooted in relationships and quality of life, which Hofstede refers to as feminine. These four values were later validated through a comparison with the Rokeach Value Survey (RVS). The RVS was first used in the United States to measure the importance of a set of 36 values. These values were then divided into two categories, with one labeled “terminal” and the other defined as “instrumental”. In this model, terminal values refer to the desired outcome, whereas instrumental values capture the means to the outcome. While originally designed for use in the United States, the RVS was adopted for use in several Asian Pacific regions, including: Australia; Bangladesh; Hong Kong; India; Malaysia; New Zealand; Papua New Guinea; Japan; and Taiwan. Of the regions where the RVS had been performed, Hofstede had comparable data for all but Malaysia, Bangladesh, and Papua New Guinea.Hofstede and Bond (1984) were able to examine the six areas were the RVS and the cross-cultural study overlapped. They indicated that in these areas there were significant correlations between the RVS variables and Hofstede’s four dimensions. For example, the RVS values of obedient, polite, ambitious, and national security all showed a significant and high positive correlation with power distance. Through this process Hofstede and Bond were able to validate for the four culture dimensions with another measure of values. Hofstede’s crosscultural study provides evidence for the idea that cultural values dier on a measureable level across nations. This allows for a discussion of how individual societies’ values vary and the consequences that holds for implementing rules on an internationally level, such as IFRS. In addition, the establishment of the four cultural dimensions laid the groundwork for incorporating culture into an analysis of the development of international accounting standards. Only a few years later, Sidney Gray (1988) was able to use the four dimensions to create a framework that could be used to analyze the eect of culture on accounting systems. Gray recognized that the four dimensions of culture must somehow be related to the values in the subculture of accounting systems. He, therefore, proposed a link between the two by outlining the important values of accounting subculture while showing each one’s connection to societal values. Gray proposed four main accounting values: professionalism versus statutory control; uniformity versus flexibility; conservatism versus optimism; and secrecy versus transparency. Professionalism versus statutory control is meant to be a measure of the extent to which accountants have control over setting their standards. Accounting systems with a high level of professionalism have private standard setting bodies as opposed to public regulations. Gray proposed that professionalism could be most closely linked with both individualism and uncertainty avoidance. He then hypothesized that, “The higher a country ranks in terms of 8 individualism and the lower it ranks in terms of uncertainty avoidance and power distance then the more likely it is to rank highly in terms of professionalism” (Gray 1988). The second measure of accounting values, uniformity versus flexibility, looks to gauge the degree to which there must be comparability across time, reporting entities, or countries. For instance, a highly flexible system would allow for dierent accounting practices to be used to best suit the situation. Gray posited that uniformity could be linked to high uncertainty avoidance and power distance and low individualism. Conservatism versus optimism addresses the degree of conservatism used in asset measurement and income reporting. This is regarded as an important aspect of accounting systems, and the connection with Hofstede’s dimension of uncertainty avoidance can be seen quite clearly. A high level of uncertainty avoidance results in a desire for smoothing out reported income and asset valuation, thus resulting in a higher level of conservatism. Gray also holds that there is a weak relation between conservatism and higher levels of individualism and masculinity. The fourth and final classification of accounting values, secrecy versus transparency, involves the willingness of reporting entities to disclose information. Secrecy relates to all four of the dimensions in such a way that, “The higher a country ranks in terms of uncertainty avoidance and power distance and the lower it ranks in terms of individualism and masculinity then the more likely it is to rank highly in terms of secrecy” (Gray 1988). Aer outlining the four accounting values that are linked to cultural dimensions, Gray continued by examining how the country classifications made by Hofstede would be grouped based on their accounting systems. In order to do this, the four accounting values were grouped into authority and its enforcement and measurement and disclosure. Authority consisted of professionalism and uniformity, while measurement and disclosure contained conservatism and secrecy. In both cases, Gray placed one value on a vertical axis and the other on a horizontal access and then plotted the country classifications on to that four part grid. When analyzing the groupings that occur on the grid representing authority and its enforcement, there is no strong collection of countries in any one quadrant. The grid representing measurement and disclosure, however, shows all country classifications in either the quadrant for conservatism and secrecy or transparency and optimism with Anglo, Nordic, and Asian colonial falling in the latter category and the rest residing in the former. This is logically sound, as philosophies on measurement and disclosure would naturally go hand and hand. Aer theorizing the framework for analyzing the impact of culture on the development of accounting systems, Gray called for an expansion on his work. The accounting values needed to be operationalized and empirical studies performed on their relationship with Hofstede’s cultural dimensions. While his work in 1988 did not include an empirical study, Gray provided and explanation for how culture and accounting are connected. This in turn allows one to explore not only dierences in culture, but also to consider the eect of those dierences on accounting. The empirical studies that Gray called for have occurred, including a study performed by Sudarawan and Fogarty (1996). In their study, Sudarawan and Fogarty used Indonesia as a study of the hypothesized connection between Hofstede’s cultural dimensions and Gray’s accounting values. The two researches first began by operationalizing the accounting values in order to statistically compare them to Hofstede’s suggested predictors for his cultural dimensions. This study chose to ignore Hofstede’s fih dimension of long-term orientation, which was added in 1991. The rationale for this exclusion was that Indonesian society did not necessarily consider the future more important than the present, and therefore made the fih dimension irrelevant for the study. The authors believed that professionalism could be adequately represented as the number of methods used in financial reporting that were not allowed by Indonesian accounting standards as well as the number of standards issued by the Association of Indonesian Accountants. As a proxy for uniformity they used the number of alternate methods sanctioned by Indonesian accounting standards and the number of accounting changes. The third value of conservatism was measured simply as the number of permitted accounting methods. Finally, secrecy was shown by the number of disclosures required in the income statement and balance sheet under Indonesian standards. The conclusion of the study showed that the proxies used for all four accounting variables proved to be related to those used for the four cultural levels on a statistically significant level. While relationships existed in the data, some did not match what was theorized by Gray. In response to this, the authors cite the influence of managerial discretion as a serious complication to evaluating the eect of culture on accounting systems. Managerial discretion can have an eect on many measureable accounting decisions, but is company specific. Therefore, this discretion may not have been representative of the environmental influences that the authors were trying to measure. While there were some anomalies in a few coeicients, a majority of the results validated Gray’s theory about accounting values, at least in the context of Indonesia. For example, the hypothesis testing showed statistically significant positive relationships between uncertainty avoidance and uniformity and between individualism and professionalism. The authors hold that the work of Gray can only be validated by the continued replication of studies like theirs onto dierent cultures and nations around the world. While this is true, their study does help to provide support for the idea that this framework can be used to analyze the impact of culture on a multinational level. With the partial validation of Gray’s work with empirical evidence, one can study dierences in culture and confidently apply them to variances in accounting systems such as IFRS.
2.3 Conceptual Framework of IFRS
The origins of IFRS reside in the attempt to address the need for a common language in accounting. The first attempt to meet this demand can be seen in the creation of the Accountants International Study Group in 1967. This group was composed of members of the American Institute of Certified Public Accountants, the Canadian Institute of Chartered Accountants, and the Institute of Chartered Accountants of England and Wales. Members of this group worked together to study common topics in accounting that were relevant internationally, such as the study on inventory accounting practices in 1968 (ICAEW 2011). In 1972, Sir Henry Benson proposed the creation of the IASC. The next year the IASC was formed and Benson was named its first Chairman. The Committee was a response to increasing reliance on capital from foreign jurisdictions. The absence of a single set of comparable standards created inefficiencies in capital markets worldwide. Therefore, the IASC’s goal was international accounting harmonization. The Committee was composed of representatives from Australia, France, Canada, Germany, Japan, Mexico, Netherlands, UK, and the United States. The IASC Board responsible for creating standards originally began with nine members, on from each of the founding members. In 1975, the IASC issued its first International Accounting Standard (IAS). In 1977, the International Federation of Accountants (IFAC) was created in attempt to continue work on creating accounting standards and promoting cooperation between many regulatory and accounting organizations. The IFAC and IASC issued several statements of their commitment to work together. In 1982, the IFAC discontinued its role as a standard setter and recognized the IASC as the international standard-setting body. At this time, the IFAC also took responsibility for appointing 13 of the then 17 board members of the IASC (IFAC 2011). Throughout its existence, the IASC worked with many organizations and nations in its attempt to create useable IAS. Two examples include: a project that involved working with bank governors to examine financial reporting for banks; and a project in 1981 which worked with the Netherlands, UK, and US to study accounting for income taxes. The IASC also wanted its IAS to be of the highest quality. Therefore, in 1987, they launched a project aimed at improving standards and enhancing their comparability. This involved the revision of many IAS and making them more prescriptive. The project was complete in 1993 (IAS Plus 2011). In an eort to gain legitimacy as the preeminent creator of high quality comparable international standards, the IASC sought the endorsement of the International Organization of Securities Commissions (IOSCO). The move towards endorsement was solidified through an agreement between the IOSCO and IASC in which the two organizations agreed on a set of “core standards” necessary for cross-border listings. The IOSCO agreed to endorse IAS as long as the “core standards” were completed. The agreed-upon standards were completed in 1998, and the IOSCO endorsed IAS as the appropriate standards to use in cross-border dealings (IAS Plus 2011). The endorsement of IOSCO carried with it an increase in responsibility for the IASC that the organization could not handle in its current state. Therefore, the IASC began making plans to reorganize. The reorganization of the IASC into the IASB began with a strategy review performed by the IASC from 1997 to 1999. In 1997, the IASC created the Strategy Working Party (SWP) to explore possible options for the future of the IASC aer they finished their “core standards”. Their first step was release a discussion paper titled “Shaping the IASC for the Future”. Aer issuing the paper, a joint meeting was held between the IASC and the SWP in which the new structure of the IASC was discussed. The two parties came to the conclusion that the best structure for the IASC moving forward consisted of a single standard-setting board. The board would be made up of some fulltime members and some part-time members. This was a change from the part-time members that had previously made up the IASC. In 1999, a proposed structure for the new IASC consisted of reorganizing the IASC as an independent foundation with a board that set standards and a group of trustees that was responsible for appointing board members, fundraising, and oversight. In 2000, a new constitution was approved which was based upon the proposed structure and called for 19 trustees and 14 board members. On March 8, 2001, the IASB was oicially put into operation and began issuing new standards known as IFRS. Despite the wish to be an independent body, the creation and direction of the IASB was heavily influenced by outside forces at this time. One of these forces was the European Union. At the time, the EU had no common set of accounting standards across its member nations. This generally created many smaller and fragmented capital markets spread throughout the EU. As a result, many looked to the United States, a much larger capital market, for investment. In order to address this problem, the European Commission sought to introduce a common set of accounting standards to the EU. Naturally the EU would want to have some sort of control or influence over the creation of the accounting standards it adopted. Therefore, in 2000 during the development of the IASB, the European Commission made it clear that it intended to use IAS in the near future. This statement put an enormous amount of pressure on the IASC to become an independent body capable of producing high quality accounting standards. In 2002, the European Parliament and Council made the move to existing IAS and future IFRS oicial by forcing the use of said standards in 2005. This prompted the revision of many previous IAS to be at an acceptable quality for use in the EU. The adoption also highlighted the ability of the EU to influence the direction of standard making by the IASB. Shortly before adoption, members of the EU were unhappy with IAS 32 and 39. The opposition to IAS 32 and 39 centered on the use of fair value for financial instruments and hedge accounting. Many nations in the EU, led by France, looked to pressure the IASB into getting rid of the standards. The pressure came when the Accounting Regulatory Committee (ARC) recommended endorsement of all IAS except 32 and 39. IAS 32 was quickly revised and accepted, however, IAS 39 met more resistance. Following a revision of IAS 39, members of the EU were still unhappy. In response to this displeasure, the EC “carved-out” the pieces of IAS 39 that were the cause of most of the opposition (Brackney and Witmer 2005). Outside influence at the time was not limited to only the adoption process for IFRS, but also the composition of the IASB. In 2005, 10 of the 19 trustees and 10 out of the 14 board members were from either the EU or the United States (Brackney and Witmer 2005). This convincing majority reflects the overwhelming “western” cultural influence present in the creation of IFRS. In addition to the large influence the EU has over IFRS, its system for endorsement does little to promote a truly uniform set of international accounting standards. The European Union does not simply accept all new IFRSs that the IASB issues. Each addition to IFRS must make it through an endorsement process before it is put into practice in the EU. The process begins with the IASB issuing a new standard. Aer the standard is issued, the European Financial Reporting Advisory Group (EFRAG) begins to gather opinions from members of the private sector, including accounting professionals and other interest groups. The EFRAG will then use this information to advise the European Commission on endorsement of the standard. The advice oered is then evaluated for objectiveness and completeness by the Standards Advice Review Group (SARG). If the SARG gives its approval, the European Commission will then prepare a dra proposal. The Accounting Regulatory Committee (ARC) will then vote on the proposal. Once the proposal has passed, the European Parliament and Council of the European Union have three months to oppose the dra. The approval of the Parliament and Council or the passage of three months’ time results in the endorsement of the standard issued by the IASB. The entire process takes an average of seven months for completion (European Commission 2011). The process of endorsement in by the EC can best be described as a screening process. The necessity of endorsement allows the EC to pick and choose which standards are best for them to use. This increases the potential for lobbying from members of the EU to try and avoid endorsing standards that do not fit their culture. This manipulation of the “single” set of standards is not limited to the EU. The eect of culture on international accounting can be seen throughout the present condition of IFRS. Currently, IFRS has been adopted or is permitted in about 120 dierent jurisdictions. A list of nations and their status with respect to IFRS can be found in Figure 1. The IFRS foundation is composed of 22 trustees that are responsible for funding, oversight, and appointing the independent board members of the IASB, the Advisory Council, and the Interpretations Committee. The IASB is an independent 15-member board of preeminent accounting professionals from around the world. These members approve new IFRSs, exposure dras, and interpretations. Funding for the board is generated by all jurisdictions that use IFRS currently or will in the future, and contributions are based on national GDP. The composition of the board is intended to be geographically diverse; however, expertise is the most important qualification for choosing board members. In an attempt to cement this intended diversity and to better represent worldwide interests, the board will be expanded to 16 members by 2012. The members will be divided as follows: four members from Asia/Oceanic; four from Europe; four from North America; one from Africa; one from South America; and two from any region. The IFRS created by the IASB are a principle-based set of accounting standards. This allows for more flexible application of the standards and an increased use of professional judgment. It is also worth noting that there is no single body to enforce IFRS. Instead, each jurisdiction that uses IFRS enforces adherence to the standards which can be seen as a significant hindrance to the goals of the IASB. According to the IFRS Constitution, the IASB’s goals are: (1) to work to create a single set of accounting standards that are high quality, comparable, and relevant; (2) promote the use of those standards; and (3) bring about the convergence of international standards while maintaining high quality (IAS Plus 2011). One way in which the IASB aims to achieve these goals is through joint meetings with other accounting bodies such as the Financial Accounting Standards Board (FASB) in the United States and the Accounting Standards Board of Japan (ASBJ). While these meetings are designed to work towards harmonization of global accounting standards, they also present an opportunity for jurisdictions to push their own agenda onto the IASB. The FASB first announced its commitment to convergence with the IASB through the Norwalk Agreement in 2002. Since then, joint-meetings have been occurring between the FASB and IASB. Similar meetings have also been taking place between the IASB and the ASBJ. During these meetings, projects are proposed to bring about high quality solutions to dierences in accounting standards. The relationship between the outside accounting bodies and the IASB allows for pressure to be applied in an attempt to make standards more compatible with one’s own jurisdiction. Both the history and the current state of IFRS have clearly been heavily aected by both the United States and the EU. Whether it be through funding, the adoption of IFRS in the EU, or the current convergence with US GAAP, the influence of these nations have significant implications for the compatibility of IFRS for jurisdictions around the world. As it pertains to culture, this influence implies a stronger pull towards the values of “western” societies. According to Hofstede, these cultural values of “western” societies can be expressed through his cultural dimensions. For example, the United States and UK score highest in the dimension of individuality. The influence of strong individuality on IFRS can be seen through the creation of the IASB as an independent board comprised of professional accountants. This classification of IFRS immediately presents a problem for the implementation of a single set of high-quality and internationally comparable standards. The cultural values that IFRS can be associated with are not present everywhere around the world. Therefore, IFRS will meet resistance in these jurisdictions with dissimilar cultural values. The author holds that the jurisdictions that do not quite align with IFRS express that difference in two ways. The first is through increased pressure on the IASB to change standards. This occurs through joint meetings and convergence between IFRS and other accounting systems. The second way is through carve-outs. Carve-outs illustrate that the adopting jurisdiction’s accounting subculture does not match up with that of IFRS. The areas in which the carve-outs are placed can be used to see where values between the adopting jurisdiction and IFRS do not match. In addition to the marginal differences in accounting values, there also exist cultural differences so vast between regions of the world that IFRS is cannot be truly comparable across all jurisdictions. For instance, cultural values in North America can dier greatly from those in nations in South America, and both dire from those values present in the Middle East. Both types of differences, marginal and vast, will be examined in the following chapters
