Legal system as a reason for international differences in Financial Reporting

Probably there are no any other factor that causes more diversity in accounting than the legal system  a country has, as it does not only shape the behaviour of its citizens, but it also prescribes accounting rules and regulates accounting and financial reporting.

The degree to which government is involved in standard-setting varies from country to country. Countries that practice common law,such as UK and US have their accounting regulation in the hands of professional organisations with fewer regulations while on the other hand, countries that practice Roman or code law e.g. France and Germany rely on detailed rules that are often included in their company legislation. (Table given below illustrates in which some developed countries’ legal systems fall into this two category.) This leads to less flexibility in the preparation of financial reports and are less likely to justify the accounting treatments as used in common law .

Source:  Nobes and Parker (2008)

Many studies have showed that “common law” countries tend to be innovative and open to new business ideas, whereas “code law” countries are more likely to follow the formal, written rules and procedures.

Further, there seems to be some association of common law countries with particular types of accounting practices. For example, companies operating in common law countries have higher levels of disclosures and tend to report losses quickly (Nobes Parker, 2008).

Doupnik and Salter (1995) state that the type of legal system (i.e. code law versus common law) was the main explanation and the basic starting point lied in classifying  accounting practices and financial reporting internationally.

Another issue that closely related to a country’s legal system is judicial corruption. The judicial corruption not only undermines the integrity of a country’s legal system, it destroys the very core values and ethics a society has. The state of affairs has an impact on accounting too, since the behaviour of high institutions will be copied by other all institutions in that country. Therefore, US and other developed western countries has played big role in tackling global bribery and similar steps have been taken in many developing Asian countries. Other countries have been following the suit (Pagiavlas, 2003).

References

Doupnik and Salter (1995) “External Environment, Culture and Accounting Practice: A Preliminary Test of a General Model of International Accounting Development”, International Journal of Accounting, Vol. 30, No 2