How arbitrary are international accounting classifications? Lessons from centuries of classifying in many disciplines, and experiments with IFRS data

Abstract

The process of classification is central to the daily task of doctors and librarians; and it is the foundation of study and research in chemistry and biology. Double-entry bookkeeping and the preparation of financial statements are classification activities of accounting practice. Classifying national accounting systems has long been an aspect of accounting research. This paper seeks to extract lessons for accounting researchers from anthropology, biology, chemistry, cosmology and medicine. In particular, we examine how the classifiers themselves and the characteristics that they choose can affect classification. We observe that objectivity is neither possible nor desirable in classification. Despite the arbitrariness, some classifications can be more reasonable or more useful than others. For previous accounting classifications, we analyze the classifiers, the scope, the characteristics used, the data and the classification techniques. We report various problems. We then empirically investigate the sensitivity of classifications to such issues as the characteristics chosen, and the countries and sectors included. For this, we hand pick data on the practices of large listed companies from 12 jurisdictions relating to 14 accounting topics under International Financial Reporting Standards. We show how different researchers could produce different classifications, particularly depending on which accounting topics are used to represent the countries.

Introduction

Classification is a fundamental part of many disciplines. The classifications of diseases and books are vital in the daily tasks of medical practitioners and librarians, respectively. The Linnaean and Mendeleev classifications are central to learning and research in biology and chemistry. Classifications have also been made in many other fields; for example, languages (Ruhlen, 1991), economies (Neuberger & Duffy, 1976), political systems (Shils, 1966), and legal systems (David & Brierley, 1985). Members of society are also put into classes, e.g. recently in the UK (Savage et al., 2013). In all cases, the fundamental purpose of the classification is to simplify (Rudner, 1966).

The everyday work of accountants involves recording transactions in the classification system that is double-entry bookkeeping. The financial statements which result are also classifications: for example, assets are classed as non-current or current; the former are then sub-classed as tangible, intangible or financial (Gröjer, 2001). The classifications are debatable: in the income statement, should expenses be classified by nature or by function? Some classifications are metaphysical: the split of equity financial assets into trading or available-for-sale rests² not on any observable characteristic, nor even on the real intentions of managers, but on the declared intentions of managers.

Classification has also been applied in the field of international accounting. Just as in other fields, classification has been used to assist understanding of how the many different objects (in this case, accounting systems) are related. We explain in more detail below how classification of accounting systems can be relevant to accounting practice and research. We use the term ‘accounting system’ to refer to a set of accounting practices, i.e. policies on recognition, measurement and presentation as used in a company’s published financial statements. For example, each individual listed company in the USA has its own accounting practices. However, the accounting of all the companies has many shared characteristics, imposed and enforced by the Securities and Exchange Commission. The individual examples of US accounting share so much in common that they could be said to comprise a ‘system’: the US GAAP accounting system. Another precise, but quite different, system is French GAAP as used for unconsolidated financial statements in France. A country can exhibit more than one system. For example, although a national GAAP (such as French GAAP) is still used for unconsolidated financial statements in most EU countries, the consolidated statements of listed companies are now prepared using International Financial Reporting Standards (IFRS).

The US and French ‘systems’ contain few overt³ options. However, partly because of international political negotiations (Camfferman & Zeff, 2007, chap. 5), many options were included in IFRS; although these are gradually being removed. Therefore, transition from French (or German etc.) GAAP to IFRS has increased the variation in accounting practices within a country. Even so, when considering the options, national factors (including such matters as tax and legal systems) can still affect a company’s choice. Ball (2006, p. 15) explains how, even if all entities are complying with IFRS, the incentives of preparers and enforcers remain ‘primarily local’. As a result, one can discern national patterns of IFRS practice (Kvaal & Nobes, 2010). These could be seen as different ‘systems’ of generic IFRS. We classify such systems in the empirical part of this paper.

Many international classifications of accounting systems have been proposed, beginning more than a century ago. An examination of other fields (see below) suggests that a classification might reflect its classifier, and that the process of classification is awash with judgements of various kinds. Few accounting classifiers have even discussed, let alone investigated, the sensitivity of classifications to changes in the nature of the classifiers, the number of objects being classified (countries or accounting systems), the nature and number of characteristics used to measure the objects, or the type of companies (e.g. corporate sectors) included. This paper discusses and empirically investigates these issues.

Our first objective is to investigate the ways in which classifications in fields other than accounting (i.e. anthropology, biology, chemistry, cosmology and medicine) have been affected by issues analogous to those in the previous paragraph and how classifications have changed dramatically over time. We seek lessons for assessing the robustness of accounting classifications.

Our second objective is to apply these lessons. We examine previous accounting classifications, especially to record the number of countries classified, the number and type of characteristics used to classify them, and whether industry sectors were discussed or excluded. We find that the early classifications reflect the classifiers; in particular, they vary by the national backgrounds of the classifiers. We then find that some classifiers apparently used no data, and most of the rest used data collected by others for other purposes. Few classifiers specified the date or the scope of their classifications (e.g. was it limited to listed companies or to non-financial companies?), and few specified a clear purpose.

Our final objective is to investigate empirically whether accounting classifications are anything other than arbitrary; whether they can easily be manipulated to back up particular arguments. To do this, we hand pick data on the practices in 2011, under International Financial Reporting Standards (IFRS), of a large sample of listed companies from 12 jurisdictions. For these companies, we examine the observable accounting policy choices on 14 topics, including presentation issues (e.g. choice of format for the income statement) and measurement issues (e.g. use of cost or fair value for investment property). Our analyses are based on a total of 5689 choices of 514 companies. We find that our classifications are highly sensitive to changes in the set of characteristics measured (i.e. the IFRS policy topics, in our case), and this is a feature common to classifications in other fields such as biology. However, certain aspects of the classifications are remarkably stable, e.g. Italy and Spain are always in the same group, and never with the UK. Furthermore, with minor exceptions, the classifications are much more robust to the exclusion of individual countries or sectors. We therefore conclude that our classifications based on IFRS choices are not essentially arbitrary. Nevertheless, our classifications could be used to support or refute the influence on accounting of the code/common legal dichotomy.

The advantage of using the above policy topics is that IFRS specifically allows management to choose among the options.⁴ There is therefore scope for country and industry influences to lead to varied practice, unlike the setting of previous studies of pre-IFRS accounting where management is constrained by national rules, which can also vary by industry. Our experiments deal with the accounting policy choices of actual companies but, for the purposes of other accounting research, different objects should be classified. For example, in an analysis of corporate reporting regulation, Leuz (2010) classifies countries on the basis of facts and impressions about legal systems and securities laws. The purpose of a study should guide the choice of characteristics measured (Roberts, 1995); different accounting classifications are suitable for different purposes.

The paper contributes by drawing together relevant lessons on classification from fields other than accounting; by conducting the first meta-analysis of accounting classifications; by applying the lessons from other fields when analyzing the accounting classification literature with a new focus on the nature of the classifiers and of the characteristics, sectors and countries included; and by assessing the reliability of previous classifications through empirical investigation of the sensitivity of classification to variations in such factors, thereby revealing the dramatic effect of inclusions/exclusions on classifications. Our purpose is not to present a classification but, as a by-product of our work, we provide data on IFRS practices for the first time for several jurisdictions (i.e. China, Hong Kong, South Africa, South Korea and Switzerland), and we provide classifications which include these countries (and Canada) for the first time.

Our findings on the reliability of classifications are important because hundreds⁵ of academic papers refer to the classifications as part of motivating research (Ball et al., 2000, Gray, 1988, O’Donnell and Prather-Kinsey, 2010, Saudagaran and Biddle, 1995) or to justify an independent variable (type of accounting system) which is expected to influence issues such as value relevance (e.g. Ali & Hwang, 2000). Then, there are new uses for classifications, as explanations of which companies volunteer to adopt IFRS (Tarca, Morris, & Moy, 2013), how jurisdictions respond to IFRS (Sellhorn and Gornik-Tomaszewski, 2006, Tyrrall et al., 2007), how countries change from one class to another (Xiao, Weetman, & Sun, 2004), how practices on major topics vary over time (Ding, Richard, & Stolowy, 2008), how companies respond to the choices available in IFRS (Nobes, 2011), why the amount of lobbying on IFRS varies by country (Orens, Jorissen, Lybaert, & van der Tas, 2011), by how much various countries’ domestic accounting requirements vary from IFRS (Ding, Hope, Jeanjean, & Stolowy, 2007), or how to identify countries with similar backgrounds when selecting countries for study (Delvaille, Ebbers, & Saccon, 2005). If the classifications are inappropriate, the research setting or the variables will be questionable.

For financial analysts, students and policy makers, the classifications are a convenient way of simplifying and summarizing. So, again, inappropriate classifications are likely to be misleading. For instance, much of the argumentation on the development of new standards is political (Harrison & McKinnon, 1986), and is now often expressed in terms of resisting ‘Anglo-American’ accounting. As an example, German writers have seen the international standard-setters as a Trojan horse which conceals Anglo-American accounting (Kleekämper, 2000) or as ‘the unknown enemy from London’⁶ (Hennes & Metzger, 2010). Botzem and Quack (2009) believe that the history of the International Accounting Standards Committee has been wrongly reported as ‘an Anglo-American success story’ (p. 991). However, as will be shown, some classifiers deny the existence of Anglo-American accounting.

Power (2009) warns researchers not to exaggerate the international differences (p. 325) and to be wary of resorting to cultural variables to explain them (p. 331). On the first point, Power notes that we can only talk of different arrangements of balance sheets because all companies present balance sheets and show very similar things in them. This paper reinforces those warnings by showing that some findings about international differences are unreliable and that classification could be used to prove or disprove the importance of one commonly used cultural variable: the legal system. Further, although classifications do identify countries which are different, their main purpose is to group together countries on the basis of their similarities.

The paper proceeds as follows. The next section shows how classification in various fields can depend on who is doing the classifying. Then we examine the degree to which classification depends upon the characteristics chosen to measure the objects being classified, and upon the definition of the characteristics. After that, we perform a meta-analysis of previous accounting classifications, and we analyze them in order to reveal the apparent effects on classifications of the classifiers and the potential effects of various other factors, such as the countries/systems included and the characteristics chosen to represent them. The next four sections report on our empirical investigations: the data, the findings on policy choice, the analysis of sensitivity of classification to the manipulation of various factors, and the presentation of some new classifications. Then, there are conclusions.