Contents

Introduction .............................................................................................................................. 2
Current Harmonization Scenarios ............................................................................................. 3
Bilateral Agreement .............................................................................................................. 4
Regional Agreement.............................................................................................................. 4
International Agreement ...................................................................................................... 5
The Need for International Accounting Standards ................................................................... 6
Why Isn't There Just One GAAP? .......................................................................................... 7
Problems with Having Diversity in GAAP .............................................................................. 9
The Benefits of International Accounting Standards .............................................................. 10
The Influencing Factors of Accounting Harmonization ........................................................... 11
Legal system ........................................................................................................................ 11
Financing methods .............................................................................................................. 13
Taxation system .................................................................................................................. 13
Inflation ............................................................................................................................... 14
Problems Caused By Accounting Diversity.............................................................................. 14
Preparation of consolidated financial statements .............................................................. 14
Asses to foreign capital markets ..................................................................................... 15
Comparability of financial statements ............................................................................ 15
Lack of high-quality accounting information .................................................................. 16
Impediments to the Successful Implementation of International Standards......................... 16
Ethiopia in the process of harmonization ............................................................................... 17
Statutory Framework .............................................................................................................. 17
Setting Accounting and Auditing Standards ........................................................................... 20
References............................................................................................................................... 21

1
Introduction

With increasing globalization of the marketplace, international investors need access

to financial information based on harmonized accounting systems and procedures.
Investors constantly face economic choices that require a comparison of financial
information. Without harmonization in the underlying methodology of financial
reports, real economic differences cannot be separated from alternative accounting
systems and procedures. Harmonization is used as a reconciliation of different points
of view, which is more practical than uniformity, which may impose one country’s
accounting point of view on all others. With the growth of international business
transactions by private and public entities, the need to coordinate different investment
decisions has increased. This would also lead to the reduction of the information
diversity between managers and investors. The information diversity is a costly and
can be blamed for the decrease of the managers’ bonus, the increase of the equity’s
cost and the inaccuracy of the economical and the financial forecasts
Historically, harmonization of the international accounting information systems has
tended to follow the integration of the markets served by the accounts. Comparable,
transparent, and reliable financial information is fundamental for the smooth
functioning of capital markets. In the global arena, the need for comparable standards
of financial reporting has become paramount because of the dramatic growth in the
number, reach, and size of multinational corporations, foreign direct investments,
cross-border purchases and sales of securities, as well as the number of foreign
securities listings on the stock exchanges. However, because of the social, economic,
legal, and cultural differences among countries, the accounting standards and
practices in different countries vary widely. The credibility of financial reports
becomes questionable if similar transactions are accounted for differently in different
countries.
The primary reason for accounting’s existence is that it satisfies a need for
information. Accounting is generally defined as the language of business but what
happens when there is more than one accounting language? And what if each

2
language has its own eccentricities and nuances? Such is the case with international
accounting. Each country has its own set of acceptable accounting regulations
(Generally Accepted Accounting Principles or GAAP) in the domestic business
community. While there may be significant commonalities between and among
countries' GAAPs, each nation has the ability to impose its own set of rules on
companies doing business within its borders. This is fine in a purely domestic
setting. After all, the investors and creditors of a country will be able to understand
their own accounting and reporting practices and will be able to use domestic
financial statements to make sound business decisions. However, when these same
investors or creditors wish to invest or lend internationally or when businesses seek
capital from other countries, the differences in national generally accepted accounting
principles (GAAP) can make these efforts nearly impossible. Access to cross-border
capital providers is closed on the simple basis of ignorance.

Current Harmonization Scenarios

The most important driving force in the development of international accounting

standards is the International Accounting Standards Committee (IASC), an
independent private-sector body formed in 1973. The broad objective of the IASC is
to further harmonization of accounting practices through the formulation of
accounting standards and to promote their worldwide acceptance.

To improve the comparability of financial statements, harmonization of accounting

standards is advocated. Harmonization strives to increase comparability between
accounting principles by setting limits on the alternatives allowed for similar
transactions. Harmonization differs from standardization in the way that the latter
allows no room for alternatives even in cases where economic realities differ.

The international accounting standards resulting from harmonization efforts create

important benefits. Investors and analysts benefit from enhanced comparability of
financial statements. Multinational corporations benefit from not having to prepare
different reports for different countries in which they operate. Stock exchanges

3
benefit from the growth in the listings and volume of securities transactions. The
international standards also benefit developing or other countries that do not have a
national standard-setting body or do not want to spend scarce resources to undertake
the full process of preparing accounting standards.

The harmonization of accounting, auditing, and financial reporting is multi-

dimensional. The current harmonization schemes are varied. However, three major
harmonization trends have emerged.

Bilateral Agreement
When two countries have similar accounting systems, the regulators of the countries
may try to work on a bilateral level to gain mutual recognition. The market
regulators of the different countries engage in negotiations seeking mutual
recognition of each other’s accounting standards to facilitate multinational offerings.
The multi-jurisdictional disclosure system between the US and Canada is an example
of this system. Bilateral agreements only work for countries with similar accounting
systems and reporting standards. Otherwise, the investment of both time and money
to reconcile a set of financial statements may prove cost prohibitive (i.e., Japan and
the US have incompatible accounting systems). Although a bilateral arrangement
makes life easier for securities regulators with its reciprocal acceptance of
domestically prepared financial statements (Wyatt & Yospe, 1993), it does not help
investors and creditors, who still must decipher the regulations of another country’s
accounting system.

Regional Agreement
Increased economic cooperation and regional trade barrier reductions drive regional
cooperation. The objectives of a regional level of cooperation include: increasing
free movement of goods, labor, and capital; eliminating or reducing trade barriers;
and harmonizing accounting reporting requirements on the respective countries' stock
exchanges (Hora & Tondkar, 1997). The North American Free Trade Agreement
(NAFTA), the Association of Southeast Asian Nations (ASEAN), and the European
Union (EU) are all examples of regional level responses to accounting diversity. The
accounting standards setting committees of countries involved in regional co-

4
operations attempt to create accounting standards that will be accepted in all member
states. Some regional areas, such as ASEAN, have decided to de-emphasize their
focus of accounting harmonization, leaving that difficult task to the IASC. Instead,
ASEAN is promoting regional cooperation on issues of accounting education and the
development of training and professional standards for accountants in its member
nations. This concept of a regional cooperation or mutual recognition emphasizes the
political clout of regional economies while de-emphasizing the roles of professional
accountants and their organizations.

International Agreement
The third scenario places the responsibility of international harmonization with
private international accounting standard setting bodies such as the International
Accounting Standards Committee (IASC) and the International Federation of
Accountants (IFAC). However, there is some question as to who should lead and who
should follow - the standard-setters or the accountants. Wyatt & Yospe (1993) claim
that “many believe a quality body of international accounting standards, having
relatively few acceptable alternatives and requiring disclosure of information
investors and creditors reasonably need to make investment decisions, should be
developed through a collaborative effort of many countries’ accounting professions.”
Under this view, the professional groups would make the internal agreements on key
issues and then negotiate acceptance with regulators and other political bodies.
These approaches: bilateral, regional, international; are not necessarily
intermediate and sequential steps on the way to a single set of worldwide accounting
standards. Indeed, they might actually be counter-productive to such a movement.
Often, bilateral and regional approaches may prove more feasible than a set of IAS.
As a result, the potential exists for a competitive rather than a complementary effect
on global harmonization. As J.H. Denman observes, cooperation among national
standard setters and governments on a regional basis “may be threatening progress
towards internationalization and, specifically, threatening the existence of the IASC
and delaying the internationalization of financial reporting” (Horthe a & Tondkar,
1997).

5
The Need for International Accounting Standards

There is an obvious need to resolve the diversity in accounting and financial

accounting practices. Corporate executive officers (CEOs) and corporate financial
officers (CFOs) in multinational enterprises (MNEs) conduct business in a global
environment. These executives are faced daily with the varying rules governing
accounting in the countries in which their businesses operate. A uniform way of
maintaining financial information and reporting would resolve many of the
interpretation issues they currently face.
Companies around the world are looking to expand their capital in foreign
countries. However, to effectively raise capital in a foreign market, a MNE's financial
statements must be understandable to foreign investors. One solution is to prepare
more than one set of financial statements (so-called "secondary financial
statements"), using the language, currency, and accounting principles that are
generally accepted in those foreign markets. Yet, the costs of such a solution are
prohibitively high. A more effective solution would be to create and use a commonly
acceptable set of reporting practices, enabling MNEs to cross-list their securities on
various stock exchanges throughout the world, engage in trans-border financing
activities, and satisfy the potential information needs of creditors and investors
wherever they are located. Indeed, the “linkage of worldwide capital markets is one
of the driving forces behind the movement toward a single set of accounting rules”
(Wyatt & Yospe, 1993).
The International Accounting Standards Committee (IASC), the organization
in the lead in establishing international accounting standards (IAS), believes that
having such standards will:
1) Lower cost by requiring business to have only one set of financial statements,
2) Lower the confusion in interpreting different countries’ reports,
3) Increase credibility of accounting and financial statements in general, and
4) Help developing countries create a national standard that is useful in today’s
international world. (IASC, 1999a)

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Why Isn't There Just One GAAP?
Given the obvious benefits of having a uniform set of reporting standards, the
potential savings from not having to keep records in accordance with multiple sets of
accounting rules, access to more capital markets, information creditability and
understandability, and lowered capital costs (Pacter, 1998) - why do accounting and
financial reporting differ almost everywhere? Are these differences merely
idiosyncratic, or is there a reason for this diversity?
Quite clearly, countries do not adopt particular accounting standards just to be
different. Rather, a country's (or region's or cluster's) reporting standards represent
reactions to and reflections of several major environmental variables. These
environmental factors are what cause the diversity in international accounting, and
these variables present obstacles to the adoption of a single set of international
accounting standards.
A first environmental factor that impacts the type of accounting that is required
under "home country GAAP" is the relationship that has developed between
businesses and the providers of capital. Mueller, et al., (1997) suggest that
countries fit into three different relationship patterns. If the investor and creditor
group in a country has become large and diverse, financial statements tend to be
oriented towards the information needs of this group. The widespread ownership
is usually uninvolved in the day-to-day running of the business. Therefore, the
objective of the financial statements is to describe the financial position of a
business and the results of its recent operations. This user orientation assists
investors and creditors in making sound investment decisions. The United States
and the United Kingdom are excellent examples of this relationship pattern.
Another relationship scenario occurs where most of the capital needs of domestic
businesses are satisfied by a small number of very large banks. Personal contact is
the critical component in establishing a banking relationship in this environment.
Hence, financial statements are designed to protect the creditors. Some countries
in this situation include Switzerland, Germany, and Japan.
A third relationship pattern, where the nation’s government largely controls
natural resources, can be found in France and Sweden. Financial accounting rules

7
are compliance oriented, with accounting focused on decision-making by
government planners. The uniformity of accounting and reporting practices act as
the facilitators for better governmental decisions. Accounting standards exists to
help the government make clear decisions about future resource allocation. With
national standards centered on three different foci (investor and creditors, tax
collection and creditor protection, or macroeconomic policies), it seems natural for
diversity to occur.
Another environmental factor impacting the development of reporting standards is
the level of inflation a country has experienced. If a country has not experienced
significant inflation, the historical cost principle forms the unit of measurement for
accounting. The historical cost principle assumes that the dollar (for U.S.
companies) does not change in value. It is as stable a unit of measurement as is a
gallon or an inch for accounting purposes. In economies experiencing spiral
inflationary rates, such as most of the countries in Latin America, this standard is
replaced with principles that deal with the changing value of the nation’s currency.
When examining a country’s business environment, one must also consider the
size and complexity of domestic business enterprises, the sophistication of the
management and financial community, and the overall general levels of education.
Countries with larger businesses require more highly educated accountants to deal
with the more sophisticated business operations on the financial statements. In
addition, if the country’s general education level is low, users of accounting
information will not demand a more sophisticated set of financial statements.
A final environmental variable that effects accounting development is culture.
Although research is sparse and inconclusive, most analysts believe there is a
direct correlation between culture and accounting. Recent accounting research has
attempted to link culture to components of accounting concepts, standards, and
practices. Intuitively, diversity in accounting practices are understandable since
national accounting standards develop around what a country finds important,
which differs based on the cultures of individual countries, races, religions,
geographic areas, and other unique features.

8
Problems with Having Diversity in GAAP
The differences in national standards can be seen worldwide. This diversity
in GAAP effects corporate managements of multinational corporations (MNCs).
Different sets of financial statements must be prepared in accordance with each
country’s standards, which is a costly proposition. MNCs also sense that accounting
diversity affects competitiveness. MNCs are required to issue financial statements in
compliance with national GAAP and Securities regulations, limiting the possibilities
for raising capital. The significant differences in worldwide GAAP can create
significant inequalities in acquiring, disposing, or operating a company. The current
atmosphere of accounting diversification creates an “unlevel playing field”, creating
barriers and possible retaliation.
Investors are adversely affected because accounting diversification limits
international investment opportunity. Global investing is difficult when investors
cannot understand the financial statements of a foreign company. Investment
analysts experience interpretation issues due to worldwide differences in accounting.
If investors, analysts, and underwriters experience difficulty with GAAP diversity,
financial markets are operating inefficiently with investors receiving less than optimal
returns on their investments.
Stock markets feel the effect when looking for foreign companies to list on
their exchanges. Accounting and disclosure requirements vary extensively for listing
a company on a foreign stock exchange. Most companies will not make the plethora
of changes necessary to list on a foreign stock exchange because of the increased
costs to prepare the new financial statements. As a result, domestic stock exchanges
do not represent all global investment opportunities.
Accounting professionals are perceived as seeing a positive effect of diversity;
the complexity and confusion surrounding competing and conflicting GAAP
produces an increased need for accountants, and, therefore, higher fees. Because
GAAP diversity complicates cross-border auditing, a cynical view would see
accountants as welcoming these differences inasmuch as they would generate
increased audit fees. However, seemingly against their own best interests, accounting
professionals are pushing for the acceptance of a set of uniform accounting

9
standards_ specifically, of the International Accounting Standards (IAS).
The Benefits of International Accounting Standards

International and global firms desire an international set of accounting

standards. A study conducted by Barniv & Fetyko (1997) indicates that there is an
increase in demand for harmonization by global business entities, practitioners, and
financial statement users. Even with a potential increase in compliance costs due to
harmonization of accounting standards, the respondent group believed the benefits
outweighed any potential increase in costs. Some large businesses have already
switched their accounting principles to follow IAS even though they are not yet
widely accepted. Bayer AG stated that IAS “provides investors and the financial
world with a reliable basis for evaluating our company and its performance” (Pacter,
1998). The Union Bank of Switzerland also switched to IAS and stated that “by so
doing, we bring greater transparency, furnish additional information, and simplify
international comparisons.”
Despite the objections of some key “holdout” nations, the process of
internationalization seems irreversible. There are several key factors that support an
optimistic future for international harmonization. According to Oliverio and Newman
(1997), “the current technological power to transmit information and the giant shift in
the business community within the last 10 years are possibly the combination that is
most significant.” As accountability becomes globally more significant, the
internationalization of accounting standards become more pressing.
The efforts of both the IASC and the IOSCO have been significant. In recent
years, the collaborative efforts of these organizations have focused on allowing
companies to list their securities on any foreign stock exchange with one set of
financial statements that conform to an IOSCO approved set of international
accounting standards. The IASC recently reported that over 2,000 companies,
primarily multinational companies and international financial institutions, are
preparing their financial statements in accordance with IAS. In addition, many
countries endorse the IASC’s standards with little to no change and accept their
international standards for cross-border listing purposes (Oliverio & Newman, 1997).
An intrinsic benefit of harmonization is that it does not force the elimination

10
of national standards, which could be met with significant nationalistic opposition.
Harmonization through the use of global standards will enhance the comparability of
financial statements across borders; thus providing a better quality of information for
investors and creditors. However, some developing countries are hesitant to embrace
harmonization for fear that accounting standards will be dominated by standards from
developed countries specifically U.S. GAAP(Nobes 2006).
The Influencing Factors of Accounting Harmonization

In order to standardize the different kinds of financial statements, the International

Accounting Standards Board is working on creating accounting principles which can
be used in the whole world (Epstein and Mirza, 2007). Although the aim seems to be
easy, the execution might be problematic due to the diversity of the current
principles. The accounting harmonization establishes a system where the financial
statements are standardized therefore they are transparent. However it does not mean
that the use of standards would result in an operating consistent accounting system,
because there are other factors which have influence on the harmonization process,
for instance the national legislation system, the regulations by auditors or by the
courts.
The reason for differences in accounting principles between certain nations could be
that they vary in the level of economic development, in the legal system, in the
taxation system, in the intensity of capital market, so as in the level of inflation, in the
typical methods of financing an enterprise, in the shareholder background, finally in
the political and cultural traits. These are all determining the regulatory aims and
philosophy behind them.

Legal system
The legal system of a country mainly influences the accounting principles. There are
two main clusters: the ‘civil law system’, based on codification (typical in almost all
European countries except for United Kingdom and in Japan) and the so called
‘common law system’ which is precedent based (typical in the United Kingdom, in
the USA). According to certain researches (e.g. Sodestrom and Sun, 2006) the
principles of the financial reporting system and the accounting standards (especially

11
regarding the principle of being careful or the discrete evaluation) differ very much
from each other.
In the ‘civil law system’ the accounting standards are laid down in laws by the
elected deputies. It is not common that companies in these countries (continental
Europe and the historical colonies of Belgium, France, Germany, Italy, Portugal and
Spain) are registered on stock exchange therefore the publication of financial
statements is not a priority.
This system derives from the Roman Law (jus civile) the first description of which
was the CodexJustinianeus in 529. The codification is done in accounting regulation
as well (e.g.: the Hungarian Law of Accounting 100/2000.) however the company
law contains the most important rules for the operation of a company such as the
publication of the financial statement and its formal requirements. In such countries
the accountant professionals motivate the introduction of the international accounting
standards. In the ‘common law system’ only the frameworks are determined in the
company law and the special regulation is done by the independent committee of
accounting. Doing so, the committee focuses on the experience based solutions
elaborating in details the accounting rules for profit oriented and non profit oriented
companies.
In the ‘civil law system’ the Accounting Law is rather general, it does not contain
special regulations, therefore if the companies face with special problems, they ask
for help of auditors or search for other laws e.g. tax laws.
The ‘common law system’ develops much more detailed regulation. For the special
cases common
general rules are applied (in the USA, Canada, Australia or New Zealand). These
countries are very market oriented and the investors trust much more in financial
statements than in other states. The publication of this information is crucial. The
regulation is clear and much more supporting the information needs of the
shareholders, of stakeholders and of analysts. This is the best environment for
international accounting standards.

12
Financing methods
The legal forms of companies and the proprietors are different. In Germany, in
France, in Italy, the banks give the financial background. However in the United
Kingdom or in the USA the companies are financed mainly by shareholders.
Generally speaking, in the latter countries the capital markets are quite strong and
there is a sounder defence of the shareholders. The company structure could be
influenced by the political interests as well.
It is worthwhile to analyze the proprietors and the financing companies in the EU. In
Germany it is common that banks own shares of the national companies and they are
financing them at the same time.
There are several national public limited companies in which Deutsche Bank has a
significant portion of shares. The situation is similar in France and in Italy where the
banks take part in decision making and in the execution of them too due to their
significant amount of shares. In the United Kingdom and in the USA the main
proprietors of national companies are rather the institutions than private shareholders.
In the continental EU countries there are not many foreign shareholders, so for them
it is not crucial to regulate the prompt publication of the financial statements there is
no need for as much audit and the tax laws overwrite the accounting requirements.
On the contrary the private financing system induce need for adequate accounting
information, therefore the accounting rules are more separated from the taxation
regulations and they are not in a hierarchical context. There is a strong need for more
auditors.

Taxation system
In France and Germany the taxation laws function influenced the accounting rules.
Belgium, Italy and Japan apply similar principles and the taxation laws have strong
influence on the financial statements. In the USA and in the United Kingdom the
accounting regulation totally differs from taxation regulations and they handle it by
deferrals, calculating the difference between the tax payable according to accounting
regulation and taxation regulation. This also applies to Holland. There are examples
also in Hungary for deferrals of tax payable when it is about consolidation.

13
Inflation
The effect of inflation can be measured in connection with the evaluation of assets or
when calculating theprofit. The historical accounting principle of evaluation can
cause problems in periods when there is a highinflation rate. The main problems
come when a multinational company wants to make a consolidation incountries
where there is a high inflation rate. The effects of inflation can be seen when
evaluating the fixedassets or most directly when converting foreign currency.
Measuring profitability can be done in thecurrency of the parent company or of the
affiliate company. For instance, if there is an acquisition, theaccounting of the
goodwill is a crucial issue. According to the US GAAP after goodwill no
amortizationcan be accounted; they calculate it through the net present value of the
capability of producing income.
Problems Caused By Accounting Diversity

Preparation of consolidated financial statements

The diversity in accounting practice across countries causes problems that can be
quite serious for someparties. One problem relates to the preparation of consolidated
financial statements by companies withforeign operations. Consider General Motors
Corporation, which has subsidiaries in more than 50 countriesaround the world. Each
subsidiary incorporated in the country in which it is located is required to
preparefinancial statements in accordance with local regulations. These regulations
usually require companies tokeep books in local currency using local accounting
principles. Thus, General Motors de Mexico preparesfinancial statements in Mexican
pesos using Mexican accounting rules and General Motors Japan Ltd.prepares
financial statements in Japanese yen using Japanese standards. To prepare
consolidated financialstatements into U.S. dollars, the parent company must also
convert the financial statements into U.S. dollarsand the parent company must also
convert the financial statements of its foreign operations into U.S. GAAP.
Each foreign operation must either maintain two sets of books prepared in accordance
with both local andU.S. GAAP or, as is more common, reconciliations case,
considerable effort and cost are involved companypersonnel must develop an
expertise than one country’s accounting standards.

14
Asses to foreign capital markets
A second problem caused by accounting diversity relates to companies gaining access
to foreign capitalmarkets. If a company desires to obtain capital by selling stock or
borrowing money in a foreign country, itmight be required to present a set of
financial statements prepared in accordance with the accountingstandards in the
country which the capital is being obtained. Consider the case of the Swedish
appliancemanufacturer AB Electrolux. The equity market in Sweden is so small
(there are fewer than 9 millionSwedes) and Elektrolux’s capital needs are so great
that the company has found it necessary to have its common shares listed on stock
exchanges in London and on the NASDAQ in the US, in addition to its home
exchange in Stockholm. To have stock traded in the US, foreign companies must
either prepare financial statements using U.S. accounting standards or provide a
reconciliation of local GAAP net income and stockholders’ equity to US GAAP. This
can be quite costly. In preparing for a New York Stock Exchange (NYSE) listing in
2008, the German automaker Daimler-Benz estimated it spent $ 120 million to
initially prepare U.S. GAAP financial statements, it expected to spend $30 to $40
million each year thereafter.

Comparability of financial statements

A third problem relates to the lack of comparability of financial statements between
companies from different countries. A lack of comparability of financial statements
can have an adverse effect on corporations when making foreign acquisition
decisions. There was a very good reason why accounting in the communist countries
of Eastern Europe and the Soviet Union was so much different from accounting in
capitalist countries. Financial statements were not prepared for the benefit of
investors and creditors to be used in making investment and lending decisions.
Instead, financial statements were prepared to provide the government with
information to determine whether the central economic plan was being fulfilled.
Financial statements prepared for central planning purposes have limited value in
making investment decisions.

15
 Lack of high-quality accounting information
A fourth problem associated with accounting diversity is the lack of high-quality
accounting standards in some parts of the world. There is general agreement that the
failure of many banks in East Asian financial crisis was due to three factors:
- a highly leveraged corporate sector,
- the private sector’s reliance on foreign currency debt, and
- lack of accounting transparency.
International investors and creditors were unable to adequately assess risk because
financial statements did not reflect the extent of risk exposure due to the following
disclosure deficiencies:
- the actual magnitude of debt was hidden by undisclosed related-party transactions
and off-balance-sheet financing,
- high levels of exposure to foreign exchange risk were not evident,
- information on the extent to which investments and loans were made in highly
speculative assets was not available,
- contingent liabilities for guaranteeing loans, often foreign currency loans, were not
reported, and appropriate disclosures regarding loan loss provisions were not made.

Impediments to the Successful Implementation of International

Standards

a. Misunderstandings as to the nature of international standards

b. Lack of appropriate mechanisms for granting national authority to international
standards
c. Inconsistencies between international standards and the legal framework
d. Lack of appropriate linkages between general-purpose financial reporting and regulatory
reporting
e. Inappropriate scope of application of international standards
f. Non-observability of compliance e.g. Areas for improvement in the standards themselves
h. Mismatch between accounting and auditing requirements and market demands
i. Mismatch between accounting and auditing requirements and the capacity to comply

16
j. Mismatch between accounting and auditing requirements and domestic enforcement
capacity
k.The special role of the international audit firm networks
Ethiopia in the process of harmonization

Statutory Framework

The accounting and auditing provisions in the Commercial Code 1960 need to be
brought up to date with good international practice. The Commercial Code makes
directors of companies responsible for preparation of financial statements, including
consolidated financial statements for group companies, and for ensuring that an audit
of the financial statements is conducted. However, the provisions for both preparation
and audit of financial statements require improvement. In provisions for preparing
financial statements, there is no requirement to comply with accounting standards,
and the financial statements required to be produced are only balance sheet and profit
and loss account. In provisions for audit, there is no requirement to comply with
auditing standards, no specified qualification of auditors, and no audit requirement
for private limited companies with 20 or less shareholders; and companies are
required to appoint more than one auditor at a time. Another area which needs to be
reviewed in the Commercial Code is the issuance of shares to the public. Share
companies are allowed to issue shares to the public, but there is no regulation for the
issuance of these shares. There is a draft revised Commercial Code but this still
requires improvements.

Public Enterprises Proclamation 25/1992 requires state-owned enterprises to

keep books of accounts following generally accepted accounting principles (GAAP).
However, within the Public Enterprises Proclamation, there is no requirement for
state-owned enterprises to prepare financial statements in compliance with any
defined accounting standards or for their auditors to comply with any defined
auditing standards. Without definition, interpretations ofGAAP can vary widely. As
to audits, the Proclamation states that the provisions on powers, duties, and liability

17
of auditors in the Commercial Code shall apply. The Commercial Code does not
require auditors to comply with any defined auditing standards.

The financial reporting requirements of NGOs are contained in the General

Guidelines for the Implementation of the National Policy on Disaster Prevention and
Management. There is no guidance for NGOs on the standards to be used in
preparation and auditing of their financial statements in the General Guidelines. The
regulations require NGOs to prepare financial statements; have the financial
statements audited by chartered accountants; and file annual audited financial
statements with their supervising agency, the Disaster Preparedness and Prevention
Agency. However the regulations do not provide the NGOs with guidance on
standards to be used in preparation and auditing of the financial statements.

There are no extra requirements for banks and insurance companies for preparation of
their annual financial statements. Banks and insurance companies are subjectto
regulatory laws and directives issued by the National Bank of Ethiopia, but there are
no extra requirements in these laws or directives for preparation of annual financial
statements. The applicable requirements for preparation of annual financial
statements for banks and insurance companies are those provided in the Commercial
Code. The Commercial Code has no requirement for compliance with any defined
accounting standards. Banks and insurance companies are public interest entities
which should be subjected to high standards of financial reporting.

Auditors for banks are required to be approved by the National Bank of Ethiopia. On
an annual basis, banks are required to send selected auditor’s name to the National
Bank of Ethiopia for the approval of the appointment of bank auditor. This is a legal
requirement under Proclamation for Licensing and Supervision of Banking Business
No. 84/1994. When approving auditors, the National Bank of Ethiopia ensures that
only those auditors licensed by OFAG are approved.

18
Auditors for insurance companies are not subjected to any additional requirements
other than the provisions of the Commercial Code. The Proclamation for Licensing
and Supervision of Insurance Businesses No.86/1994 states that the auditors for
insurance companies shall have powers, functions, and duties; and be subject to
liabilities and penalties under the Commercial Code. There are no other regulations
for auditors of insurance companies.

The Income Tax Law requires taxable income of businesses to be determined on the
basis of financial statements prepared according to generally accepted accounting
standards. The Income Tax Proclamation No. 286/2002 states that taxable business
income shall be determined per tax period on the basis of the profit and loss account,
or income statement, which shall be drawn in compliance with generally accepted
accounting standards. The problem in this case is that ‘generally accepted accounting
standards’ is not defined, and there are no accounting standards set or adopted in the
country.

The Office of the Federal Auditor General and the Ethiopian Civil Service College
has been given some legislative authority for regulating the accountancy profession.
OFAG was established by Proclamation No.68/1997 by which it was set up “to make
efforts, in co-operation with concerned organs, to promote and strengthen accounting
and auditing professions.” OFAG has other broader responsibilities as provided for in
the country’s Constitution. Article 101 (2) of the Constitution states that “The
Auditor General shall audit and inspect the accounts of ministries and other agencies
of the Federal Government to ensure that expenditures are properly made for
activities carried out during the fiscal year and in accordance with approved
allocations and submit his reports thereon to the House of Peoples Representatives.”
The ECSC was re-established through Council of Ministers Regulations
No.121/2006. One of its objectives, as set out in these regulations, is “to formulate
standards and certify professionals.” The ECSC is also given powers and duties, “to
formulate standards and based on such standards confer professional certification in
auditing and accountancy.” For these purposes, the ECSC has established an Institute

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for Certifying Accountants and Auditors (ICAA). The ECSC already has broader
responsibilities of responding to capacity building needs of the civil service.

Setting Accounting and Auditing Standards

There is no accounting and auditing standards set in Ethiopia. For accounting

standards, there is no law or regulation that has set or requires accounting standards
in preparation of financial statements. Some laws require GAAP to be applied.
However, in all cases, GAAP is not defined. For auditing standards, in the year 2003,
OFAG directed all auditors to conduct audits in compliance with ISA. However, the
directive met resistance from auditors. One of the arguments for resistance by the
auditors was that it is impossible to apply ISA in the absence of accounting standards.
The directive was subsequently withdrawn.

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References

John Hegarty, F. 2004, world bank’s accounting and auditing ROSC program ‘
implementation of international accounting and auditing standards’ accessed January 20,
2012

http://media.wiley.com/product_data/excerpt/22/EHEP0005/EHEP000522-2.pdf

SEC Concept Release, 2000 ‘international accounting standards’ accessed 18

January, 2012

www.sec.gov

Robert W.1998 ‘harmonizing international accounting standards’

Report on the observance of standards and codes 2007, ‘accounting and auditing’
accessed 17, January 19, 2012 http://www.worldbank.org/ifa/rosc_aa_eth.pdf

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