2.2 Objectives of financial reporting
The International Accounting Standards Board (IASB) has a conceptual framework that aims to set out publicly which qualities should be in the forefront of the standard-setters' minds when making accounting rules. The IASB explains that ‘the objective of financial statements is to provide information about the financial position, performance and changes in the financial position of an entity that is useful to a wide range of users in making economic decisions’ (IASC, 1989, paragraph 12). (This quote originally appeared in the IASC's Framework for the Preparation and Presentation of Financial Statements in 1989. The Framework was later adopted by the IASB in 2001.) Not all regulators have an overt set of objectives like this, and even when they do, there are usually other factors that come into play. This is one of the reasons that accounting rules differ from one jurisdiction to another: what are the objectives of financial reporting that over time have played the most significant role in shaping the accounting rules?
We need to be wary of over simplification here. Standard-setters face complex choices, and though they may express them one way, very often decisions are made in a way that tries to strike a balance between different objectives. All standard-setters wish the economy to be enhanced not damaged by their rules, all want those entitled to information about the company to have good quality information, all want the application of the rules not to be too onerous, all want the information to be comparable and consistent, none can ignore that accounting rules will influence tax rules in any jurisdiction, and so on. So the issue when you look at a particular jurisdiction is how they interpret these objectives and which seem to get the most emphasis.
If we take Switzerland as an example, the financial reporting regime is changing. (That is another rule of financial reporting: the rules are always changing, but they change more quickly in some jurisdictions than others. One of the reasons that some European countries find it difficult to accept IFRS is that they are used to an environment where the rule changes occur once every 20 years, not one like the US, where several rules are changed each year.) Traditionally, the Swiss rules have been almost exclusively concerned about taxation and a stable economy. The Swiss regulator believes (and it is explicit in the commercial code) that undervaluing the company by creating hidden reserves, gives a positive economic benefit because it means companies have reserves that can be used during a downturn in the economic cycle. The tax rules go along with this, so, in the Canton of Geneva, one third of year-end stock can be written off, as of right, irrespective of its condition. This reduces the value of stock shown in the balance sheet and reduces profit by a corresponding amount. The legislator believes that this is good for the health of the economy, and that users of financial statements are getting good information, precisely because it does not reflect the economic state of the company – they are protected by undervaluation.
The Swiss Commercial Code (code des obligations) in the 1990s addressed its rules to the financial statements of individual companies. There was only one line on groups of companies, saying that they should prepare consolidated accounts. Listed companies now have to follow standards for consolidated accounts that are loosely based on International Financial Reporting Standards (IFRS), but the regulation remains extremely light. In practice, listed companies do not necessarily like this because, as we discussed at the start, the markets want reliable information and this comes from following the rules of a high quality comprehensive basis of accounting. Consequently, a number of Swiss companies either use IFRS (famously Nestlé, amongst others) or claim compliance with EU directives.
The absence of detail in the code suggests that, for the Swiss legislator, the preparation of financial statements as an essential input to capital markets is just not an important factor in framing rules for financial reporting.
At the other extreme, US Generally Accepted Accounting Principles (usually referred to as US GAAP), the main financial reporting rules for the USA, are directed entirely at the capital markets. The rules are under the ultimate authority of the Securities and Exchange Commission (SEC), and the announced objective of the standard-setter (the Financial Accounting Standards Board (FASB)) is to create rules that provide information for investors on which to make investment decisions. The standard-setters believe that the economy is protected by transparent information, so that the investor can make economic judgments. There are no mandatory rules for private companies.
By contrast, a member of the Comité de réglementation comptable (Accounting Regulatory Committee), which is the committee that decides if standards should be given the force of law in France, says in discussing the French system: ‘The composition and functioning of the standard-setting organization is founded on multi-disciplinary cooperation and the representation of the widest possible range of different users of accounting’ (Hoarau, 1995, p. 225). He describes the standards as being a ‘compromise between competing interests’. He adds: ‘French standard setting tries, without always succeeding, to satisfy a number of unspecified or vaguely known needs of users who are never explicitly recognized’.
This issue of different countries perceiving financial reporting as having different objectives is one of the important cultural variables that affect financial reporting. The way in which you represent reality in the financial statements will depend upon what aspects of the company you believe to be most important to convey to the outside world.