Accounting can also be classified by a nation’s legal system.21 This view has dominated accounting thinking for the last 25 years or so.Accounting in common law countries is characterized as oriented toward “fair presentation,” transparency and full disclosure, and a separation between financial and tax accounting. Stock markets dominate as a source of finance, and financial reporting is aimed at the information needs of outside investors. Setting accounting standards tends to be a private sector activity, and the accounting profession plays an important role. Common law accounting is often called “Anglo-Saxon,” “British-American,” or “micro-based.” Common law accounting originated in Britain and was exported to such countries as Australia, Canada, Hong Kong,
India, Malaysia, Pakistan, and the United States. Accounting in code law countries is characterized as legalistic in orientation, opaque with low disclosure, and an alignment between financial and tax accounting. Banks or governments (“insiders”) dominate as a source of finance, and financial reporting is aimed at creditor protection. Setting accounting standards tends to be a public sector activity, with relatively less influence by the accounting profession. Code law accounting is often called “continental,” “legalistic,” or “macro-uniform.” It is found in most of the countries of continental
Europe and their former colonies in Africa, Asia, and the Americas. This characterization of accounting parallels the so-called stockholder and stakeholder models of corporate governance in common and code law countries, respectively. As noted earlier in this chapter, a nation’s legal system and its system of finance may be linked in a cause-and-effect way.22 A common law legal system emphasizes shareholder rights and offers stronger investor protection than a code law system.
Laws protect outside investors and are generally well enforced. The outcome is that strong capital markets develop in common law countries and weak ones develop in code law countries. Relative to code law countries, firms in common law countries raise substantial amounts of capital through public offerings to numerous outside investors. Because investors are at arm’s length to the firm, there is a demand for accounting information that accurately reflects the firm’s operating performance and financial position. Public disclosure resolves the information asymmetry between the firm and investors.
By contrast, ownership of firms in code law countries tends to be concentrated in the hands of families, other corporations, and large commercial banks. Firms satisfy substantial fractions of their capital needs from the government or through bank borrowing. Debt as a source of finance is relatively more important in code law countries than in common law countries. Conservative accounting measurements provide a cushion to lenders in the event of default. Major lenders and significant equity investors may occupy seats on boards of directors, along with other stakeholders, such as labor and important suppliers and customers. Because information demands are satisfied by private communication, there is less demand for public disclosure. Accounting income is the basis for income taxes owed and often, as well, for dividends and employee bonuses, resulting in pressures for smooth income amounts from year to year.
See Also:
The Pension Protection Act of 2006
Audit recommendations on reviewing legal expenditures
Fair Presentation vs. Legal Compliance Accounting
See Also:
The Pension Protection Act of 2006
Audit recommendations on reviewing legal expenditures
Fair Presentation vs. Legal Compliance Accounting
