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INTERNATIONAL MANAGEMENT INSTITUTE-KOLKATA
2/4 C, Judges Court Road, Alipore, Kolkata-700027
NATIONAL CENTRE FOR CORPORATE GOVERNANCE
(Accredited by National Foundation for Corporate Governance)
Research Report
On
IMPLICATIONS OF IFRS ON DIFFERENT SECTORS (Part –A)
Asish K Bhattacharyya Head, National Centre for Corporate Governance
August 2012
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EXECUTIVE SUMMARY
The movement for the harmonisation of accounting practices through convergence of
local accounting standards with IFRS or through adoption of IFRS has lost steam.
The SEC has decided to defer the decision on the method of endorsement of IFRS and
in deciding the timeline for the endorsement of IFRS. Many experts believe that SEC
will take the route of condorsement. Japan has deferred its decision to make IFRS
mandatory for listed and other companies. China is moving towards convergence of
its accounting standards with IFRS. However, significant gap exists between Chinese
GAAP and IFRS. Moreover the implementation of accounting standards in China is
weak.
Most E.U. countries do not permit preparation of individual financial statements using
IFRS. Canada has adopted IFRs in 2011.
One of the reasons for the slowing down of the movement for harmonisation of
accounting practices through the adoption of IFRS or convergence of local standards
with IFRS is that results of studies around adoption of IFRS by the E.U. countries
could not establish conclusively that adoption of IFRS per se improves the reporting
environment. Moreover, uniformity in implement of IFRS and the cost of
implementing IFRS are concerns expressed at various quarters. In absence of the
uniformity in implementation, the perceived benefits of harmonisation of accounting
practices will not be realised.
Therefore, mandatory adoption of IFRS benefits some and hurts others. There will be
‘winners and losers’. Multinational firms, large size firm, and those which are listed
in stock exchanges abroad are likely to benefit from the adoption of IFRS and those,
which are family controlled and depends on funding from banks and other financial
institutions will be the potential losers.
Recommendations
SEC is going slow in endorsing IFRS, while FASB is working closely with IASB for
bridging the gap between U.S. GAAP and IFRS. Japan has deferred the decision to
make application of IFRS mandatory. The debate on practical benefits of adopting
IFRS has again surfaced. Evidence collected by academicians has failed to establish
that adoption of the IFRS improves the information environment. Although U.S.A.
and Japan has reiterated their commitment to either adopt IFRS or converge local
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accounting standards with IFRS, they articulated that they need more time to evaluate
the impact of IFRS on firms and the society.
In view of the above, India should take a cautious approach. It should study the
impact of IFRs in different sectors of the economy and on the society before
implementing IndAS. Another round of discussion and public debate is required to
ensure that adoption of IFRS does not harm the economy. While developing the
IndAS, NACAS adopted the approach of minimum deviation from IFRS. In
reviewing the IndAS based on inputs from impact study, the government may decide
to make changes, wherever necessary.
In the mean time, the government should strengthen the regulatory measures to ensure
proper implementation of accounting standards. The level of disclosures may be
improved benefit of capital market and to improve the contracting efficiency.
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REPORT
Nature of the project: Research project
Project title: Implications of IFRS on different sectors
Team leader: Prof. Asish K Bhattacharyya, Head of the National Centre
for Corporate Governance, International Management
Institute – Kolkata
This report is divided into five parts. Part I discusses the objective and scope of the
research project and the methodology adopted to achieve the research objective. Part
II discusses the status of IFRS adoption/convergence in few selected countries. Part
III surveys the literature on researches surrounding the adoption of IFRS by different
countries. Part IV summarises the findings under the heading conclusions. The Part V
provides recommendations.
PART I: ABOUT THE RESEARCH PROJECT
1.INTRODUCTION
Harmonisation of accounting practices across the globe is a pre-requisite for the
globalization of capital markets across the world. India needs foreign capital to
achieve its ambitious economic growth targeted by the government. Therefore, it is
imperative that Indian accounting practices match globally acceptable accounting
practices. IFRS has emerged as the globally accepted accounting standards. More than
100 countries have either adopted IFRS or have fully converged national accounting
standards with IFRS. Indian government is committed to implement IFRS in India.
India has adopted the strategy of achieving convergence of Indian accounting
standards with IFRS, rather than adopting IFRS without any modification. The
strategy provides the flexibility of carving out certain accounting principles and
methods from IFRS and carving in certain accounting principles and methods to make
fully converged accounting standards more appropriate for the Indian economic and
institutional environments and Indian culture. The government has notified new set of
accounting standards (IndAS), which are fully converged with IFRS. The date for the
implementation of IndAS is still to be notified. While formulating IndAS, the
National Advisory Committee on Accounting Standards (NACAS) had adopted a
policy of keeping the modifications at the minimum.
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Every one interested in corporate financial reporting agrees that, ideally, there should
be a single set of accounting standards for use across the globe. The benefits from
uniform implementation of a high quality global standard will result in high quality of
financial information, high level of transparency (resulting in less scope for
opportunistic behaviour of managers), and comparability (resulting in lower cost of
for investors and analysts in analysing financial statements).
Convergence of national standards or adoption of IFRS is a major transition in
accounting practices. Accounting practices evolve over a long period and are
influenced by business and regulatory environment, cultural heritage and the
investors’ profile. For example, India has a long history of accounting practices.
Every one does not agree that implementation of IFRS or national standards, which
are fully converged with IFRS, improves the quality of corporate financial reports,
benefits investors, increases investors’ confidence, and reduces the cost of capital.
Therefore, the debate on the benefits and related costs of implementing IFRS
continues. The debate focuses on the pros and cons of fair value accounting because
IFRS uses fair value accounting more extensively than the use of fair value in most of
the national standards. Similarly, disclosure requirements in IFRS are much more
extensive than the disclosures required under the extant Indian Accounting Standards
(AS) and disclosures required under many national accounting standards. Another
issue, which is yet to be settled, is whether uniform accounting standards really lead
to uniform accounting practices. Many believe that uniform accounting standards do
not lead to uniform practices because of implementation difficulties and different
managerial incentives in different economic, regulatory and institutional
environments.
The implementation process is slow. For example, European Union had mandated use
of IFRS for specified companies in 2005. A recent research (2011), based on 2009
data, concludes that 17 percent of those companies, which are required to use IFRS,
have not fully implemented IFRS. Similarly, although Japan had made it optional for
specified companies to use IFRS from 2010, it is yet debating whether use of IFRS
should be made mandatory. It has decided that it cannot make application of IFRS
mandatory before 2016. However, it is reported that more and more large companies
are adopting IFRS. U.S.A is still debating on the methods and timing for the
implementation of IFRS for companies domiciled in that country.
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It is observed that companies that have complex business structures and who present
consolidated financial statements adopt IFRS faster than other companies.
There is no structured study on the socio-economic impact of the implementation of
IFRS.
The increasing uneasiness among preparers, users, and regulators of financial
statements and national governments is quite palpable.
2. SCOPE OF THE PROJECT
The objective of the research project is to analyse the trends/practices being followed
by major developed and developing countries in the implementation of IFRS. The
expected outcome of the research project will be a background note encompassing
primary areas of focus or concern for India in the implementation of IFRS. The
background note will be a prelude a detailed study of the impact of implementing
IFRS or Indian Accounting Standards fully converged with IFRS (IndAS) on major
sectors of the economy, including cost of implementation, cost to investors in
analysing financial statements, socio-economic impact and implications for the global
presence of Indian companies.
The impact study will be taken in the second phase as a separate project.
3. METHODOLOGY
Secondary data/information will be used to understand the status of the
convergence/adoption of IFRS in different territories. It will be primarily a library
research based on documents available in the public space.
In the second project surveys and field study will be carried out to understand the
impact of IFRS implementation.
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PART-II: STATUS OF IFRS IMPLEMENTATION IN SELECTED
COUNTRIES
We have studied the current status of IFRS implementation in U.K, Italy, Germany,
U.S.A., Canada, China, Japan, and Australia.
4. IFRS IMPLEMENTATION IN THE EUROPEAN UNION
4.1 General Observations
In March 2002, the European Parliament passed a resolution requiring all firms listed
on stock exchanges of European member states to apply IFRS when preparing their
financial statements for fiscal years beginning on or after January 1, 2005. This
requirement affected approximately 7,000 firms. The adoption of IFRS in Europe
reflects a EU goal of achieving capital market integration; it is a necessary step
towards convergence of financial reporting not only across Europe, but also between
Europe and the rest of the world.
EU adopted all the IAS without any change except, IAS-39, Recognition and
measurement of financial instruments. The European Commission (EU) endorsed
IAS-39 with certain carve outs, which relate to hedge accounting.
The European IAS regulation applies not only to the 27 EU Member States but also to
the three members of the European Economic Area (EEA) - Iceland, Liechtenstein,
and Norway.
Effective from 1st January 2005, all listed companies, including banks and insurance
companies, started preparing their consolidated financial statements in accordance
with IFRS.
The application of IFRS to unlisted companies and to Individual Financial Statements
differs from country to country.
The IFRS adopted in the EU countries is called ‘IFRS – EU’. This contains all the
IFRS standards, which have been adopted by the European Union. We analysed the
financial statements of 20 listed companies of Germany, United Kingdom, France and
Italy. All the companies provide unreserved statements regarding the adoption of
IFRS –EU.
Some countries have permitted/ required IFRS for Individual Financial Statements
also.
4.2 United Kingdom
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GAAP requirements to individual financial statements
In regard to their individual financial statements, listed companies are given an option
to prepare it either in accordance with IFRs or National GAAP.
Fiscal regulations
The tax requirements of United Kingdom were amended so that financial statements
prepared in accordance with IFRS may be adopted for taxation purposes. The tax
treatments of fair value gains and losses are regulated by the ‘Disregard Rule’.
The Finance Act ("FA") of 2004 and the two Finance Acts of 2005 have contained
legislation aimed at ensuring that companies choosing to adopt International
Accounting Standards (IAS) to prepare their financial statements receive broadly
equivalent tax treatment to companies that continue to use UK GAAP (UK Generally
Accepted Accounting Practice).
http://www.hmrc.gov.uk/practitioners/clause50.htmSection 50 of the Finance
Act 2004 redefines "generally accepted accounting practice" to include both the
European Commission (EC) adopted IAS and UK GAAP (as it may be) for periods
beginning on or after 1 January 2005 (the date in the EC Regulation). The main thrust
of the section is to make IAS as acceptable for tax purposes as UK GAAP – wherever
a provision (such as section 42 Finance Act 1998) refers to GAAP it will include a
reference to IAS.
Whether fair value gains and losses under IFRS shall be considered for taxation
purpose is decided by the ‘Disregard Regulations - Loan Relationships and Derivative
Contracts (Disregard and Bringing into Account of Profits and Losses) Regulations
2004.
4.3 Italy
GAAP requirements to individual financial statements
Through the Legislative decree 28th February 2005, No.38, Italy used extensively the
options in Article 5 of the E.U. Regulation 1606/2002. In particular, listed companies,
banks and other financial institutions are required to adopt IFRS, both for
consolidated and individual accounts. However, insurance companies are not
permitted to prepare individual accounts based on IFRS, except for listed insurance
companies, which do not present consolidated financial statements.
Unlisted companies are required to present consolidated accounts in accordance with
IFRS and all subsidiaries within an IFRS group are permitted to use them for the
preparation of their individual accounts. Although the mandatory adoption of IFRS
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for the individual accounts started from 2006, an earlier adoption was permitted from
2005.
In practice, the majority of companies permitted (but not required) to prepare their
individual accounts according to IFRS, still continues to use the operationally easier
(and more tax oriented) Italian GAAP.
On 26 February 2011, the Legislative Decree no. 225/2010, converted into Law no.
10/2011, introduced modifications to article 4 of Decree 38/2005, stating that new
IFRSs issued by the IASB and adopted by the EU after 1 January 2011 need to be
endorsed by the Italian Ministry of Justice before they can be applied in the separate
financial statements of Italian listed companies.
The endorsement process is designed to verify the compatibility of each newly
published IFRS with the Italian accounting principles.
Fiscal regulation
IFRS was not initially recognised as relevant for fiscal purposes. Therefore, there was
a full disconnection between reported profit and taxable income. This proved to be
very costly for the taxpayers. In order to convert IFRS income to tax base an
intermediate step through Italian GAAP principles was, de facto, required, which
duplicated compliance efforts. Then, since IFRS were not governed in detail by tax
law, many uncertainties emerged, originating an abnormal increase in interpretation
queries to the fiscal agency. The Finance Act 2008 allowed the use, for fiscal
purposes, of IFRS qualification, time imputation and classification criteria. However,
some IFRS aspects, such as the valuation criteria, have not been recognised. Since
2005, the evolution of tax law has also affected companies reporting under Italian
GAAP. “Extra-accounting” adjustments, used in order to convert accounting profits
into taxable profits, were disallowed, strengthening the linkage between fiscal and
Italian GAAP figures.
4.4 Germany
Several ‘global players’ (e.g. Bayer, Heidelberger, Zement and Schering) adopted
IFRS or U.S. GAAP, as early as in 1993. Since these firms were required to continue
reporting under national GAAP (HGB), costly ‘parallel’ and ‘dual’ accounting
resulted. In response to the ensuing ‘demand pull’ for international accounting, the
1998 Capital Raising Facilitation Act allowed publicly traded parent companies to
substitute consolidated IFRS or U.S. GAAP accounts for HGB group accounts. Many
of Germany’s public firms were preparing consolidated IFRS accounts before 2005.
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The IAS Regulation (2002) required that all listed companies should mandatorily
prepare their consolidated financial statements under IFRS by 2005 (2007 in some
cases). However, by 2002, the year of the IAS-Regulation, about 36 per cent of all
group companies required to prepare IFRS consolidated financial statements by
article 4 of that regulation, were already applying IFRS in the preparation and
presentation of consolidated financial statements. By 2003, 19 out of the 30 DAX1
companies were using IFRS and 9 of them were using U.S. GAAP.
Companies and other entities are required to prepare individual financial statements in
accordance with the HGB (German GAAP). German GAAP and IFRS are based on
different principles. While IFRS Financial Statements are primarily designed for
better information to the investors, German GAAP is based on a creditor-protection
approach. German GAAP allows firms to create hidden reserve, for example, through
accelerated depreciation allowed under the tax law and non-recognition of deferred
tax assets.
Fiscal regulation
Individual financial statements prepared in accordance with the HGB (German
GAAP) form the basis for computation of taxable profits of the company.
5. U.S.A
5.1 Approach
The IASB and the US Financial Accounting Standards Board (FASB) have been
working together since 2002 to achieve convergence of IFRSs and US generally
accepted accounting principles (GAAP). In September 2002 the IASB and the FASB
agreed to work together, in consultation with other national and regional bodies, to
remove the differences between international standards and US GAAP. This decision
was embodied in a Memorandum of Understanding (MoU) between the boards known
as the Norwalk Agreement. In 2006 the IASB and FASB set specific milestones to be
reached by 2008. In the light of the progress achieved by the boards and other factors,
the US Securities and Exchange Commission (SEC) removed in 2007 the requirement
for non-US companies registered in the United States to reconcile their financial
reports with US GAAP if their accounts complied with IFRSs as issued by the IASB.
At the same time, the SEC also published a roadmap on adoption of IFRSs for
domestic US companies.
1 The DAX (German stock index)) is a blue chip stock market index consisting of the 30 major German
companies trading on the Frankfurt Stock Exchange.
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SEC’s planned the following seven milestones to achieve full adoption:
i. Improvements to accounting standards
ii. Funding of the International Accounting Standards Committee Foundation
iii. Improved ability to use interactive data for IFRS reporting
iv. Improved education and training in the US
v. Limited use in a narrow group of companies (i.e. December 31, 2009)
vi. SEC to determine in 2011 whether mandatory adoption of IFRS is feasible
based on the progress in the first five milestones
vii. Mandatory use – If decided to go full steam ahead (as discussed in milestone
vi above) then large accelerated, accelerated and non-accelerated filers would
be required to adopt IFRS beginning with their years ending on or after
December 15, 2014, 2015 and 2016, respectively.
5.2 Progresses Reported in April 2012
In April 2012, IASB and FASB announced that the boards were close to completing
the MoU programme. They reported that most of the short-term projects, which were
identified for action, had been completed or were close to completion. Of the longer-
term projects, several had been completed and there were three of the originally
identified projects for which the boards were yet to finalise the technical decisions—
leases, revenue recognition and financial instruments. The boards expect to issue final
standards on these projects by mid- 2013.
5.3 SEC Delays Decision on IFRS
Earlier SEC had announced that it would announce its decision on endorsement of
IFRS in 2011. However, it is yet to announce the same.
In his Remarks Before the AICPA National Conference on Current SEC and PCAOB
Developments on December 5, 2011, James L. Kroeker, who is the Chief Accountant
in�U.S. Securities and Exchange Commission, announced the delay in releasing the
Commission’s final report on the IFRS Work Plan for U.S. markets. The decision will
depend on the completion of all the projects covered under the MOU between FASB
and IASB and the results of the study on the impact of the implementation of IFRS.
Kroeker emphasized the importance of establishing a “strong and lasting” framework
for IFRS incorporation into U.S. GAAP. He believes the framework should:
• “Demonstrate a high level of support for U.S. commitment to continued
development and use of global consistent high quality accounting standards;
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• Provide both in fact and in substantive operation clear U.S. authority over
standards applicable in the U.S. capital markets;
• Provide for and facilitate a strong U.S. voice in the process of establishing
global accounting standards;
• Be responsive to the economic and other impacts of change;
• Consider whether to retain “U.S. GAAP” as the basis for U.S. financial
reporting, thereby mitigating the costs and complexity of introducing a new
set of standards under regulatory regimes, contractual documents, and U.S.
laws under which compliance with U.S. GAAP is often specifically
contemplated.”
5.4 Condorsement
Although the SEC has not yet made a decision regarding whether and, if so, the
manner in which IFRS adoption should be accomplished, some experts believe that it
will take the Condorsement approach. The term ‘condorsement’ was mentioned for
the first time by SEC Deputy Chief Accountant Paul Beswick at the AICPA National
Conference on ‘Current SEC and PCAOB Developments’ held in December 2010.
The Condorsement idea resulted from combining the most common IFRS adoption
approaches used in other jurisdictions, namely Convergence and Endorsement. The
approach is explained in the SEC Staff paper entitled ‘Work plan for the consideration
of incorporating IFRS into the financial reporting system for U.S Issuers’. The
following is the extract from the paper:
“This approach to incorporation is in essence an Endorsement Approach that would
share characteristics of the incorporation approaches with other jurisdictions that have
incorporated or are incorporating IFRS into their financial reporting systems.
However, during the transitional period, the framework would employ aspects of the
Convergence Approach to address existing differences between IFRS and U.S.
GAAP. Importantly, the framework would retain a U.S. standard setter17 and would
facilitate the transition process by incorporating IFRSs into U.S. GAAP over some
defined period of time (e.g., five to seven years). At the end of this period, the
objective would be that a U.S. issuer compliant with U.S. GAAP should also be able
to represent that it is compliant with IFRS as issued by the IASB. Incorporation of
IFRS through the framework would have the objective of achieving the goal of having
a single set of high-quality, globally accepted accounting standards, while doing so in
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a practical manner that could minimize both the cost and effort needed to incorporate
IFRS into the financial reporting system for U.S. issuers. It also would align the
United States with other jurisdictions by retaining the national standard setter’s
authority to establish accounting standards in the United States”. (Source:
http://www.sec.gov/spotlight/globalaccountingstandards/ifrs-work-plan-paper-
052611.pdf)
5.5 SEC Work Plan – Final Staff Report – July 2012
On July 13, 2012 SEC has issued Final Staff Report on the ‘Work plan for the
consideration of incorporating IFRS into the financial reporting system for U.S
Issuers’. The following introductory remarks signals the SEC is yet to finalise the
road amp and the method for incorporation of IFRS in the US GAAP:
“The Commission believes it is important to make clear that publication of the Staff
Report at this time does not imply—and should not be construed to imply—that the
Commission has made any policy decision as to whether International Financial
Reporting Standards should be incorporated into the financial reporting system for
U.S. issuers, or how any such incorporation, if it were to occur, should be
implemented.
Although the Staff Report is constructive and an important contribution, the Work
Plan did not set out to answer the fundamental question of whether transitioning to
IFRS is in the best interests of the U.S. securities markets generally and U.S. investors
specifically. Additional analysis and consideration of this threshold policy question is
necessary before any decision by the Commission concerning the incorporation of
IFRS into the financial reporting system for U.S. issuers can occur.”
5.6 Time Frame
SEC has not stipulated any time frame for implementing IFRS. It appears that the
earlier announcement to implement IFRS in stages starting from 2015 will be missed.
However, if the SEC adopts the condorsement approach it will take five to seven
years to incorporate IFRS into US GAAP.
6. JAPAN
6.1 Voluntary Application
In 2009, the government announced that Japanese companies whose financial or
operational activities are conducted internationally are permitted to prepare their
consolidated financial statements, starting from the consolidated fiscal years ending
on or after March 31, 2010, in accordance with “Designated IFRSs”, provided that
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they meet the following requirements (1) and (2) (“Specified Companies”).
(1) All of the following requirements shall be met.
(a) Shares issued by the companies are listed on a Securities Exchange in Japan.
(b) The companies disclose in their Annual Securities Reports information
regarding specific efforts to ensure appropriateness of their consolidated
financial statements.
(c) The companies allocate executives or employees with ample knowledge
about Designated IFRSs and have in place a structure that enables them to
properly prepare consolidated financial statements in accordance with
Designated IFRSs.
(2) The companies, parent companies of the companies, other related companies
(associate companies) or parent companies of the other related companies shall either:
(a) Disclose under laws and regulations of foreign jurisdiction periodically as
required thereby, documents on their business conditions prepared in
accordance with IFRSs;
(b) Disclose under rules set by foreign security exchange markets periodically
as required thereby, documents on their business conditions prepared in
accordance with IFRSs; or
(c) Own a foreign subsidiary whose capital is equal to or exceeds the equivalent
of two billion Japanese yen.
On December 11, 2009, the Commissioner of the FSA designated in their entirety,
IFRSs and International Financial Reporting Interpretations Committee (IFRIC)
interpretations approved and issued by the IASB, on or before June 30, 2009, as
financial reporting standards to be applied to Specified Companies, without any
curve-outs.
Specified Companies, which do not prepare consolidated financial statements, may
prepare their financial statements under Designated IFRSs, in addition to those under
Japanese Generally Accepted Accounting Standards.
Number of companies
It is reported that only a few Japanese companies have adopted IFRS voluntarily.
6.2 Decision on Mandatory Application Delayed
Interview by the Minister of Financial Services
The Minister for Financial Services of Japan in an interview on June 19, 2012 stated
“The Business Accounting Council held a meeting. Mandatory application of IFRS
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has not been decided by the council. Regarding the application of IFRS, an interim
report summarizing the points of debate was written. I understand that a certain
consensus has been reached on such points as: the separate treatment of consolidated
and non-consolidated financial statements, which refers to limiting the application of
IFRS to consolidated financial statements; the exemption of small and medium-size
enterprises from IFRS; and the expansion of voluntary application.
However, regarding other points of debate, including whether or not to introduce
mandatory application, a conclusion has not been reached, so further debate should be
conducted to delve deeper into those points.
Therefore, as further deliberation will be conducted regarding the future application
of IFRS, it has not been decided to introduce mandatory application”.
(Ref: http://www.fsa.go.jp/en/conference/minister/2012/20120619.html; Extracted on
August 5, 2012)
BAC discussion summary
The 13-page paper, built upon discussions by BAC members on IFRS since 2011,
provides the following general summary of discussions, as well as broad direction on
seven specific topics was issued by FSA of Japan on July 2, 2012.
General summary:
The paper admits that:
1) There are divergent views on a few issues,
2) No final conclusion has been made, both of which would require further
deliberation to deepen discussions.
In addition, key message in this section of the report is:
The effort toward international harmonisation of accounting standards should be
continued, building upon already high-quality and internationally recognised state of
Japanese GAAP. In doing the above, the best approach of using IFRS is to be
developed, based upon the following, by sufficiently considering its objective and
impact on the economy and systems in Japan:
• It should be permitted that accounting standards used for consolidated
financial statements could be different from Japanese GAAP used in separate
financial statements
• IFRSs should not impact accounting by non-public small-medium sized
entities.
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• Meanwhile, 1) continued measures are to be taken for convergence if
appropriate in light of Japanese accounting standards, and 2) voluntary early
adopters of IFRS are to be accumulated further
• It is important to contribute to the development of IFRSs and to communicate
Japan's view as appropriate.
Topic-specific summary:
The report reflects the diverse views expressed by BAC members at past BAC
meetings and includes the following broad directions formed on each of seven topics:
• International harmonisation of accounting standards: Positive measures are to
be taken for convergence to ensure that Japanese GAAP is of high quality and
internationally recognised. In doing this, importance should be placed on
matters identified in responding to the Agenda Consultation 2011 by Japanese
constituents (the “response to AC”), including the concept of net income and
the scope of fair valuation.
• Use of IFRS in Japan: The most appropriate approach of incorporating IFRS
should be explored, reflecting the institutions and economy of Japan, also
taking into account the international environment. In addition, it is necessary
to identify acceptable and unacceptable requirements in IFRSs, using
comments shown in the response to AC, which is to be further considered at
practical level. It is important that the BAC refer to such in its future
deliberations. There are also requests asking stock exchanges to segregate
markets into one where IFRS is used and another with Japanese GAAP.
• Communicating views from Japan: It is important to continue contributing to
IFRS Foundation/IASB in terms of human resources and funding. It is also
appropriate for constituents in Japan to continue concerted efforts toward
communicating views, with international coordination. It is imperative for the
satellite office of the IASB to be opened in Tokyo to be fully utilised in this
regard. A coordinated effort through a forum such as the one formed on the
response to AC should continue to be effective.
• Separate financial statements: It is realistic to permit that accounting
standards for consolidated financial statements be different from Japanese
GAAP used for separate financial statements that are more closely tied to
Company Laws, tax laws and other regulations. In addition, it is appropriate to
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consider measures to ease the burden of disclosure in separate financial
statements, by utilising requirements under the Company Laws.
• Non-public small-medium sized entities: IFRS should not impact accounting
by non-public small-medium sized entities, consistent with existing policy.
• Voluntary application of IFRS: Although deliberation of the use of IFRS
continues, voluntary use of IFRS is to be accumulated further. Such voluntary
use would highlight practical merits and issues of using IFRS and initiatives to
deal with them should be considered and implemented. It is also important to
actively publicise internationally that the use of full IFRS is already permitted
in Japan.
• Approach toward principle-based IFRS: Practical measures by preparers,
auditors, and regulators need to be further considered, with an appropriate
coordination among them.
The full report is available at the website of the Financial Service Agency of Japan (in
Japanese only).
(Source: http://www.iasplus.com/en/news/2012/july/interim-discussion-paper-on-ifrs-
is-finalised-by-the-business-accounting-council-of-japan; Extracted on August
5,2012)
7. CANADA
7.1 Classification of Enterprises
The following definitions have been adopted for the purposes of determining which
part of the Canadian Institute of Chartered Accountants (CICA) Handbook applies to
a reporting entity:
Publicly accountable enterprise
A publicly accountable enterprise is an entity, other than a not-for-profit organization,
or a government or other entity in the public sector, that:
i. Has issued, or is in the process of issuing, debt or equity instruments that are,
or will be, outstanding and traded in a public market (a domestic or foreign
stock exchange or an over-the-counter market, including local and regional
markets); or
ii. Holds assets in a fiduciary capacity for a broad group of outsiders as one of its
primary businesses. �
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Banks, credit unions, insurance companies, securities brokers / dealers, mutual
funds and investment banks typically meet the second criterion above.
Other entities may also hold assets in a fiduciary capacity for a broad group of
outsiders because they hold and manage financial resources entrusted to them by
clients, customers or members not involved in the management of the entity.
However, if they do so, for reasons incidental to a primary business (as, for
example, may be the case for travel or real estate agents, co-operative enterprises
requiring a nominal membership deposit, or sellers that receive payment in
advance of delivery of the goods or services, such as utility companies), which
does not make them publicly accountable.
Private enterprise
A private enterprise is a profit-oriented entity that is neither a publicly accountable
enterprise nor an entity in the public sector.
Not-for-profit organisation
A not-for-profit organization is an entity, normally without transferable ownership
interests, organized and operated exclusively for social, educational, professional,
religious, health, charitable or any other not-for-profit purpose. A not-for-profit
organization's members, contributors and other resource providers do not, in such
capacity, receive any financial return directly from the organization.
Pension Plan
A pension plan is any arrangement (contractual or otherwise) by which a program is
established to provide retirement income to employees.
7.2 Applicability of IFRS
Publicly accountable entities
The Accounting Standards Board (AcSB) adopted International Financial Reporting
Standards (IFRSs) as Canadian GAAP for Publicly Accountable Enterprises (PAE)
for fiscal years beginning on or after January 1, 2011.
Entities with rate-regulated activities
The AcSB decided at its March 20-21, 2012 meeting to extend the deferral of the
mandatory IFRS changeover date for entities with qualifying rate-regulated activities
by one more year from 2012 to 2013. Such entities now have the option to defer their
changeover to IFRSs to January 1, 2013.
Investment companies
19
For investment companies and segregated accounts of life insurance enterprises, the
AcSB agreed to extend the option to defer their changeover to January 1, 2014
because of the timing of the related IASB project.
Government business enterprises
The Public Sector Accounting Board (PSAB) requires government business
enterprises (GBEs) to adopt IFRSs for fiscal years beginning on or after January 1,
2011.
Private enterprises
Private enterprises were given the option to adopt IFRSs or Canadian accounting
standards for private enterprises for fiscal years beginning on or after January 1, 2011.
Private sector not-for-profit organizations
Private sector not-for-profit organizations may also choose to adopt IFRSs or
Canadian accounting standards for not-for profit organisations for fiscal years
beginning on or after January 1, 2012.
7.3 Fiscal Regulations
Canada’s taxation system is quasi independent i.e. the taxable income is based on the
net profit reported for statutory filling purposes after certain adjustments given in the
Income Tax Act.
The Canadian revenue Agency (CRA) has released guidance to tax payers that have
adopted IFRS. In the Income tax Technical News No 42 released on May 31, 2010,
the CRA acknowledged that IFRS is an acceptable starting point for determining
taxable profit.
Canadian tax legislation and jurisprudence provide rules for virtually all transactions
other than routine purchases and sales on income account. For instance, there is a
regime for capital transactions (gains/losses and amortization), for inventory valuation
and for most accruals. Courts have determined that leases are to be accounted for
based on the legal rights of the parties. Given the extent of the rules that override
accounting treatment, it is not expected that taxable income will be significantly
affected by the adoption of IFRS.
8. CHINA
China is moving its standards closer to IFRS without incorporating IFRS fully into its
national financial reporting framework. China has indicated that it intends to
eliminate the existing differences between its Accounting Standards for Business
Enterprises and IFRS. The implementation of IFRS in China is weak (Parker, 2012).
20
An article published by the Hong Kong Institute of Certified Public Accountants in
September 2011, which discusses the accounting quality in China, mentions that the
accounting practices in the country is not of high standards due to the lack of
accounting tradition and capabilities available in that country. An expert commented
“CAS has been so embedded in China’s commercial culture that main- land
accountants, as well as financial managers, have unsurprisingly been unable to throw
off their old clothes immediately.”
(Source: http://app1.hkicpa.org.hk/APLUS/2011/09/pdf/34-36-china-ifrs.pdf)
9. AUSTRALIA
The Australian Accounting Standards Board (the Board) is responsible for developing
and issuing Accounting Standards applicable to Australian entities and the “care and
maintenance” of the body of Standards. The Board's functions and powers are set out
in the Australian Securities and Investments Commission Act 2001.
9.1 Standards Applying from 2005
In 2002 the Financial Reporting Council provided a strategic direction to the Board to
work towards adopting Standards that are the same as those issued by the
International Accounting Standards Board (IASB), for application under the
Corporations Act 2001 for accounting periods beginning on or after 1 January 2005.
In July 2004, the Board issued the initial Australian equivalents to International
Financial Reporting Standards (IFRSs) that applied from 2005.
Entities reporting under the Corporations Act 2001 for annual reporting periods
beginning on or after 1 January 2005 are required to apply IFRS for the preparation
and presentation of financial statements. This is to ensure that general purpose
financial statements prepared by for-profit entities in accordance with AASB
standards will also be in accordance with IFRS. The AASB has a transaction
neutrality policy, which means similar transactions and events should be accounted
for in a similar manner by all types of entities, whether in the for-profit sector, the
not-for-profit private sector, or the public sector – unless there is a sound reason to be
different in particular circumstances. The AASB considers the specific needs of not-
for-profit entities in the private and public sectors when preparing new and revised
IFRSs for adoption in Australia.
The Australian equivalents to IFRSs comprise:
• AASB Accounting Standards that are equivalent to IASB Standards, being
AASBs 1 – 99 corresponding to the IFRS series and AASBs 101 – 199
21
corresponding to the IAS series; and
• Interpretations issued by the AASB corresponding to the Interpretations
adopted by the IASB, as listed in AASB 1048 Interpretation of Standards.
For periods beginning on or after 1 January 2005, these Australian equivalents to
IFRSs supersede their pre-2005 Australian counterparts, if any. Furthermore, some of
the existing domestic AASB and AAS Accounting Standards were retained where
there was no IASB equivalent, such as ancillary Standards like AASB 1031 and
AASB 1039, industry Standards like AASB 1023 and AASB 1038, and public sector
Standards such as AAS 27, AAS 29 and AAS 31. These pre-2005 AASB and AAS
Standards remained in force beyond 1 January 2005, but all have now been revised or
superseded.
From 30 June 2010, the directors declaration accompanying the financial statements
of companies and other entities regulated by the Corporations Act 2001 is required to
include an additional statement referring to the explicit and unreserved statement of
compliance with International Financial Reporting Standards in the notes to the
financial statements (where such a statement is made).
Under a new differential reporting regime released by the Australian Accounting
Standards Board (AASB) in July 2010, eligible entities (unlisted public companies
and large proprietary companies) can elect to adopt the 'Reduced Disclosure
Requirements' (RDR). Entities with public accountability cannot adopt the RDR, but
must comply with Australian Accounting Standards in full (and state compliance with
IFRS).
The RDR requires entities to follow the recognition and measurement requirements of
all Australian Accounting Standards (which are equivalent to IFRSs), but with
reduced disclosure requirements.
The new requirements apply to annual reporting periods beginning on or after 1 July
2013, but may be early adopted for annual financial reporting periods beginning on or
after 1 July 2009.
9.2 Pre-2005 Standards
Until December 1999, the former Australian Accounting Standards Board and the
former Public Sector Accounting Standards Board (PSASB) developed AASB
Standards that applied to entities regulated under the Corporations Law and AAS
Standards that applied to all other types of entities. �AASB Standards issued from
22
2000 onwards applied to all types of entities, and the AAS series has nearly been fully
phased out, with only AAS 25 (superannuation plans) not yet superseded.
9.3 Fiscal Regulation
There are a number of provisions in Australian income tax law that either directly or
indirectly relies on accounting standards and accounting principles for the purposes of
determining a taxpayers’ income tax liability. While there is no systematic connection
between Australian income tax law and Australian accounting standards and practice,
as a practical matter most businesses determine their taxable income or loss for a year
of income by reconciling from a profit and loss account.
The Taxation Office had issued a ‘Blue Print’, which is a conceptual design of the
change in the system-in-place due to adoption of IFRS in Australia.
SUMMARY
Country
/Territory
Listed companies Un-listed
companies
Remarks
Consolidated
financial
statements
Individual
financial
statements
Consolidate
d and
individual
financial
statements
European Union Mandatory; Effective from January 1,2005
Varies from country to country
Varies from country to country
United Kingdom Mandatory;
Effective from January 1,2005
Voluntary; Effective from January 1,2005
No
Italy Mandatory; Effective from January 1,2005
Mandatory; Effective from January 1,2005
Voluntary for subsidiaries in a IFRS group
New IFRSSs to be issued after January 1, 2011 to be vetted by Ministry of Justice
Germany Voluntary until 2005; Mandatory; Effective from January 1,2005
Not permitted
Not permitted
U.S.A. Not Not Not Earlier plan was to
23
permitted permitted permitted announce the decision on endorsement of IFRS in 2011. Decision is delayed. No time lime is announced.
Japan Voluntary for ‘global companies’ effective from fiscal years ending on or after March 31, 2010. Other companies are not permitted.
Not permitted
Not permitted
Earlier plan was to announce the decision on mandatory application of IFRS in 2012. Decision is delayed. No time lime is announced.
Canada Mandatory for ‘publicly accountable entities’ from January 1, 2011
Mandatory for ‘publicly accountable entities’ from January 1, 2011
Voluntary from January 1, 2011
For rate-regulated entities effective from January 1, 2013; For investment and life insurance companies effective from January 1, 2014
China Mandatory for ‘publicly accountable entities’ from 2006.
Mandatory for ‘publicly accountable entities’ from 2006.
Mandatory for ‘publicly accountable entities’ from 2006.
There are differences between fully converged Chinese accounting standards and IFRS; Weak implementation
Australia Mandatory; Effective from January 1,2005
Mandatory; Effective from January 1,2005
Mandatory; Effective from January 1,2005
Unlisted companies can elect to adopt the 'Reduced Disclosure Requirements' (RDR) effective from July1 2013.
24
PART III: LITERATURE SURVEY
The introduction of international accounting standards2 (IFRS) is premised on the
belief that the application of a single high quality accounting standards by countries
across the globe will contribute to better functioning of capital markets. This will
benefit both the countries and investors across the globe. It is argued that the
harmonisation of accounting practices could decrease information costs, thereby
increasing the liquidity, competition and efficiency in the markets (Ball, 2006).
Proponents of IFRS also argue that firms might also benefit from reduced information
asymmetry, which will enable them to make more efficient investment decisions
resulting in lowering their cost of capital. The benefits will be derived only if, the
adoption of IFRS results in high quality accounting, it is applied uniformly across the
globe and the cost of transition is not prohibitive.
Both practitioners and academicians are concerned about the high costs of transition
from national accounting standards to IFRS and other compliance costs. The costs and
benefits will not be uniform for all the firms. It will depend upon the internationality,
size and strategies of the firm. Voluntary disclosure research has consistently found
that larger firms provide stakeholders with more disclosures (e.g. Cuijpers et al.
2005). Similarly, multinational firms are likely to benefit more than domestic firms as
the cost of consolidating financial statements of subsidiaries in different geographic
locations will be reduced and adoption of IFRS will signal the investors, customers
and vendors that the firm is committed to transparency.
Quality of financial information does not depend solely on the quality of accounting
standards. It also depends on the institutional environment, including economic and
political environment. Therefore, the same set of accounting standards might be
implemented differently in different countries. Consequently, potential benefits from
implementing a single set of high quality accounting standards across the globe may
not be realised unless the implementation of the same is monitored effectively. It may
not be easy to establish an effective monitoring mechanism.
We have discussed the research findings under three headings: accounting quality,
implementation diversity and implementation cost. We did not aim for the greatest
2 The IFRS Foundation aims “to develop a single set of high quality, understandable, enforceable and globally accepted international financial reporting standards (IFRSs) through its standard-setting body, the IASB.” (http://www.ifrs.org/The+organisation/IASCF+and+IASB.htm).
25
comprehensiveness. Rather we have tried to select the most influential studies.
10. ACCOUNTING QUALITY
Accounting quality is not well defined. Researchers have looked into it from different
perspectives. Taking them together, we can develop a general understanding of the
concept of accounting quality. High accounting quality reduces the scope for earnings
management, results in more timely loss recognition, and leads to the disclosure of
financial information that is of higher value-relevance to investors (Barth, 2007;
Christensen, 2008). It results in more timely recognition of economic income3 in
accounting income (Ball et al. 2003). It is related to the concept of ‘‘transparency,’’
defined as the ability of users to ‘‘see through’ the financial statements to comprehend
the underlying accounting events and transactions in the firm (Ball et al. 2003). It
lowers information asymmetry between the firm and investors and information risk
and, thus, cost of capital (Armstrong et al. 2009) and it improves the accuracy of
analysts’’ forecast (Ernstberger et al. 2008). It requires accurate depiction of
economic reality, lowering the capacity for managerial manipulation, timeliness in
providing financial information and timelier incorporation of bad news, relative to
good news, in financial statements (Ball, 2006).
The literature on accounting quality mostly focuses on value relevance. However,
value relevance cannot be the sole criteria in evaluating accounting quality.
Accounting quality should also be evaluated in contexts where noise matters,
including debt and compensation contracts (Holthausen 2001; Ball, 2006). Noise
arising from intensive use of fair value in IFRS might result in higher noise in
financial information and might reduce contracting efficiency. However, The
increased transparency promised by IFRS also could cause a similar increase in the
efficiency of contracting between firms and lenders. In particular, timelier loss
recognition in the financial statements triggers debt covenants violations more quickly
after firms experience economic losses that decrease the value of outstanding debt
(Ball, 2006).
10.1 Voluntary Adoption
From early 1990s, firms in European countries, particularly in Germany, started
applying IFRS or US GAAP in presenting financial statements. Many of the firms
listed their securities in U.S. stock exchanges. This resulted in the availability of
3 Economic income here is defined as change in the market value of equity, adjusted for dividends and capital transactions with shareholders.
26
significant volume of data for analysing to collect evidence on whether perceived
benefits from use of IFRS accrued to firms that voluntarily adopted IFRs or U.S.
GAAP. Studies of firms that adopted IFRS voluntarily have self-selection bias. For
example, Cuijpers et al. (2005) observes that firms adopting non-local GAAP
(IAS/US GAAP) are more likely to be listed on a U.S. exchange, the EASDAQ
exchange in Brussels, and have more geographically dispersed operations. Also, these
firms are more likely to be domiciled in a country with lower quality financial
reporting and where IAS is explicitly allowed as an alternative to local GAAP.
Moreover, some structural changes might have occurred within the firm leading to the
decision to adopt IFRS. In spite of this limitation, the results of such studies could
provide valuable insights about the accounting quality of companies that adopted
IFRS or U.S. GAAP. But unfortunately the results could not lead to any definitive
conclusion.
A study (Amir et al., 1993) of the value relevance of information provided in
reconciliation statements (20 F) filed by non-U.S. companies that were listed in a
primary U.S. exchange suggests that overall U.S. GAAP measures appear to be
relatively more value-relevant. The study provides evidence that investors view both
capitalised goodwill and asset revaluations as value-relevant. It implies that 20-F
reconciliations themselves are not required because a careful investor may be able to
reconstruct the value-relevant data from the reports presented in the home country.
This study indicates that national accounting standards are not as inferior as it is made
out to be. The result of the study is consistent with the observations of earlier
researchers that accounting policy does not affect the valuation if investors understand
the accounting policy and can reconstruct financial statements according to their own
preference.
Ashbugh et al. (2001), who studied 80 non-U.S. companies that voluntarily adopted
IFRS during 1990-93, reports that the adoption of IFRS is positively associated with
the reduction in analyst forecast error. They observe that adoption of IFRS leads to
increased disclosure and/or a restricted set of measurement methods. This result
suggests that IFRS is superior to national accounting standards.
Daske (Daske, 2004) analysed a sample of about 13,000 HGB, 4,500 IAS/IFRS and
3,000 US-GAAP firm-month observations in the period 1993-2002 related to German
firms to understand whether application of IFRS or US GAAP reduces the cost of
27
capital. The results failed to support the conjecture that application of IFRS or US-
GAAP reduces information asymmetry and thus, reduces the cost of capital. This does
not necessarily leads to the conclusion that IFRS and US-GAAP are not superior to
the German GAAP because the accounting quality depends on the quality of
accounting standards and also on other exogenous factors such as the institutional set
up in the country. However, the result suggests that in a given institutional set up,
application of IFRS would not necessarily improve the accounting quality.
Cuijpers et al. (Cuijpers et al. 2005) reported that the evidence collected by them does
not suggest lower cost of equity capital for adopters, but shows that financial analysts
follow non-local GAAP users more heavily. They studied 133 listed non-financial EU
firms that voluntarily used non-local GAAP (92 IAS and 41 U.S. GAAP users) for the
financial year 1999. The results show a higher dispersion of analyst earnings forecasts
for firms that have adopted non-local GAAP late. This finding suggests that analyst
need time to learn to interpret a firm’s financial statements drawn up under IFRS or
U.S. GAAP or that firms that recently switched are not yet perfectly complying with
non-local GAAP. This study shows that the benefits of adopting IFRS or US GAAP
are small.
The results of analyses of a large sample of German listed companies by Tendeloo et
al. (Tendeloo et al., 2005) relating to the period 1999–2001 suggest that that IFRS
does not impose a significant constraint on earnings management, as measured by
discretionary accruals. On the contrary, adopting IFRS seems to increase the
magnitude of discretionary accruals. The results indicate that voluntary adopters of
IFRS in Germany cannot be associated with lower earnings management. These
results question the superiority of IFRS over the German GAAP.
A study based on a sample of firms from 34 countries that adopted IFRS voluntarily
over the seven-year period of 1998 through 2004 provides evidence that enhanced
disclosures via voluntary IFRS adoption improve the quality of accounting
information but also facilitate the capital market process of incorporating firm-
specific information into stock prices in a timely and accurate manner, particularly in
an information environment with low analyst following, high accounting opacity, and
poor institutional infrastructure (Kim and Sui, 2010).
Christensen (Christensen, 2012) argues that although research on voluntary adoption
of IFRS documents the large improvements to firms’ information environment appear
inconsistent with the low frequency of voluntary IFRS adoption globally. Assuming
28
that managers are rational, the benefits of IFRS adoption must be substantially smaller
than what academics generally have estimated them to be. He shows that endogeneity
bias likely explains some of the capital market changes around voluntary IFRS
adoption.
Christensen et al. (Christensen, 2008) from the study of German companies, some of
which had adopted IFRS voluntarily before the application of the same was made
mandatory in 2005, demonstrated that voluntary adoption of IFRS is associated with
decreased earnings management and more timely loss recognition, while there is no
such accounting quality improvements for firms that are forced to adopt IFRS. The
results suggest that adoption of IFRS does not necessarily lead to higher quality
accounting, at least not when the preparers have no incentives to adopt. The observed
accounting quality improvements for voluntary adopters could be driven by changes
in incentives of these firms around the time of their adoption. Christensen et al
observes that IFRS per se does not increase the accounting quality even when firms’
prior accounting standards are generally viewed as lower quality. Another interesting
finding of the study is that firms, which have closer relationships with banks, less
demand for information from capital markets, and more concentrated ownership resist
adoption of IFRS. Those firms have no incentives to engage in less earnings
management and more timely loss recognition subsequent to IFRS adoption. These
results suggest that the accounting quality cannot be improved for all firms by
mandating higher quality accounting standards, because the imposition of higher
quality standards will have limited effect for firms without incentives to comply.
Wu and Zhang evaluated the quality of IFRS financial statement from stewardship
and contracting perspective. They used a sample consists of firms from Continental
Europe that voluntarily adopted IFRS or U.S. GAAP from 1988 to 2004. They (Wu
and Zhang, 2008) examined whether the voluntary adoption of international
accounting standards is associated with changes in the internal performance
evaluation process; in particular, whether it is associated with increases in the
sensitivities of CEO turnover and employee layoffs to accounting earnings The
findings suggest that the greater reporting transparency through international
accounting standards likely plays an important role in improving firms’ internal
performance evaluations and governance. They (Wu and Zhang, 2009) also collected
evidence that suggests that firms with low labor productivity and high dividend
29
payouts are more likely to adopt IAS/U.S. GAAP; firms adopting IAS/U.S. GAAP
and with low labor productivity (or high dividend payouts) are more likely to report
lower earnings than before the adoption and the change in earnings is more negative
than for similar non-adopting firms; and firms adopting IAS/U.S. GAAP and with low
labor productivity (or high dividend payouts) are more likely to reduce labor forces
(reduce dividends) than before the adoption and the reduction in labor forces
(dividends) are more pronounced than for similar non-adopting firms. The results
suggest that accounting profit reported using IAS/U.S. GAAP incorporates economic
losses faster after IAS adoption economic losses and thus, facilitates strategic changes
in its labor and dividend policies. These results confirm the findings from other
studies that IFRS/U.S.GAAP accounting profit/loss reflect economic realities better
than profit/loss reported under a local GAAP.
Andre et al. (Andre et al., 2012) studied the accounting practice of unlisted U.K. firms
for the year 2009. The findings suggest that strong reporting incentives play a major
role in the decision to choose IFRS voluntarily. The evidence suggests that
internationality, leverage, firm size, and auditor’s reputation are primary determinants
of firms’ choice for IFRS.
Conclusion
Large volume of literature developed around the voluntary adoption of IFRS by
European companies before its use was made mandatory effective from 2005/2007
(many of which have not been cited here) support the hypothesis that adoption of
IFRS leads to higher quality accounting. However, some results suggest the opposite.
Some reported that IFRS per se does not lead to higher accounting quality. The
managerial incentive plays more dominant role in determining the accounting quality.
Therefore, sweeping mandatory adoptions at the country level without firm-level
incentives, might not bring any fundamental changes in financial reporting quality
across companies.
10.2 Mandatory Adoption
There are number of studies on impact of the adoption of IFRS by European
companies after the use of the same was made mandatory in the preparation of
consolidated financial statements by listed companies. The results do not lead to any
definitive conclusion. One of the important reasons is the absence of sufficient data
for the time series analysis. Another reason is that it is too early to understand the
complete impact of transition from the national GAAP to IFRS.
30
An analysis of the reconciliations of equity presented as part of the transition from
UK Generally Accepted Accounting Principles (UK GAAP) to International Financial
Reporting Standards (IFRS) by the largest UK companies (FT 100 companies as at
January 1, 2005) shows that the effect of change to IFRS on the final net assets figure
is not significant. However, the effect of the change in on individual line items (due to
the application of some accounting standards) could have important consequences for
financial analysis and contractual obligations (Aisbitt, 2006). Thus, the results are
inconclusive. But, They indicate that IFRS financial statements are more informative
when line items are analysed in detail.
A study of IBEX-35 companies with a focus on the effects of the new standards
(IFRS) on comparability and the relevance of financial reporting in Spain shows that
local comparability had worsened (Callo et al., 2007). Callo et al. observe that there
had been no improvement in the relevance of financial reporting to local stock market
operators.
Before the mandatory adoption of IFRS in 2005, U.K firms were not allowed to use
IFRS voluntarily and subsequent to the adoption of IFRS, U.K. firms has no choice
but to present consolidated financial statements using IFRS. Christensen et al.
(Christensen et al., 2007) by using a proxy, grouped U.K. firms into two categories:
one that would have adopted IFRS had there been a choice and the other that have no
incentive to adopt IFRS. Christensen et al. studied the market response to understand
the economic consequence of the adoption of IFRS. The evidence collected by them
shows that the costs and benefits of IFRS adoption vary systematically across firms.
They observe, “IFRS adoption has resulted in winners and losers.” Some firms gain
and some firms lose from complex, mandatory-accounting changes such as IFRS.
Daske et al. (Daske et al., 2008) found similar results. They examined the economic
consequences of mandatory IFRS reporting around the world. They analysed the
effects on market liquidity, cost of capital and Tobin’s q in 26 countries. They used a
sample of over 3,100 firms that were mandated to adopt IFRS. The results show that,
on average, market liquidity increases around the time of the introduction of IFRS,
firms’ cost of capital decreases and there is an increase in equity valuations. Daske et
al. found that the capital market effects are most pronounced for firms that voluntarily
switch to IFRS, both in the year when they switch and again later, when IFRS become
mandatory. This result suggests that the capital-market effects for mandatory adopters
31
cannot be attributed solely or even primarily to the IFRS mandate.
The results of a study by Daske et.al. (Daske et.al., 2011) support the above the
finding of Christensen et al that reporting incentives drive accounting quality
(Christensen et al. 2008). They examined the economic consequences associated with
voluntary and mandatory IFRS adoptions around the world. They focused on the firm-
level heterogeneity in the consequences, recognizing that firms can differ in their
motivations and ways to adopt IFRS. They could not find evidence to support the
hypothesis that voluntary IAS adoptions are, on average, associated with an increase
in market liquidity or a decline in the cost of capital. They concluded that the notion
that IAS reporting per se constitutes a commitment to increased transparency is not
appropriate. The capital market effects reflect, amongst others, underlying changes in
firms’ reporting incentives. They argue that as IFRS is principle based accounting
standards, it provides enough opportunity to interpret and apply the same in
accordance with reporting strategy. Christensen et al. (Christensen et al., 2007) has
put forward similar argument while concluding the managerial incentives drive
accounting quality rather than accounting standards.
Armstrong et al. (2008) examined European stock market reactions to 16 events
leading to the adoption of International Financial Reporting Standards (IFRS) in
Europe. The research objective was to gain an insight into investors’ expectations
regarding the net cost or benefit of IFRS adoption in Europe. They studied 3,265
firms from 19 countries. The research findings suggest that investors perceived net
benefits to IFRS adoption in Europe associated with increases in information quality,
decreases in information asymmetry, more rigorous enforcement of the standards, and
convergence. Armstrong et al. observed that an incrementally positive reaction for
European firms with lower pre-adoption information quality and higher pre-adoption
information asymmetry. It implies that investors were expecting IFRS to improve the
information environment for these firms. The reaction for banks with lower pre-
adoption information quality was more positive. Regarding expected convergence
benefits, the study found a positive reaction to IFRS adoption events even for firms
with high quality pre-adoption information environments. Although investors
expected IFRS adoption to affect only minimally the information environments of
these firms, this finding signals that investors were expecting net benefits associated
with convergence from IFRS adoption.
32
Gjerde et al. (2008) analysed to financial statements of Norwegian companies, listed
at Oslo Stock Ex- change (OSE) for the year 2004 prepared under NGAAP and those
restated as per IFRS to test whether the IFRS accounting figures correlate more
strongly with stock market values than the corresponding NGAAP figures. The
evidence suggests that the difference between IFRS and NGAAP is not large in
practice except that IFRS allows for more intensive use of fair value. Gjerde et al.
observes that the value-relevance of key accounting figures prepared according to
IFRS is not superior to the corresponding figures prepared according to NGAAP. The
result shows that the benefits of adopting IFRS for countries such as Norway with an
advanced accounting regulation prior to IFRS adoption is not significant.
Jeanjean et al. (2008) studied whether the mandatory introduction of IFRS standards
had an impact on earnings quality, and more precisely on earnings management. They
analysed firms in countries in which early adoption of IFRS was not possible before
the transition date, namely Australia, France, and the UK. The findings suggest that
after the transition to IFRS, the pervasiveness of earnings management increased in
France and remained stable in the UK and in Australia. France has the continental
code law tradition. U.K. has the Anglo-American common law tradition and Australia
is a “common law” country. The importance of equity markets is high in Australia and
the UK but less pronounced in France. Taken together, these findings suggest that the
switch to IFRS does not necessarily lead to improvement in terms of earnings quality.
These findings support the idea that management incentives and national institutional
factors play an important role in shaping financial reporting characteristics, probably
more important than accounting standards alone.
Ball (2006) discussed pros and cons of the convergence of local standards with IFRS
or adoption of IFRS by large number of countries. He expressed his reservation about
fair value accounting. Use of fair value in measuring assets and liabilities more
intensively, promises to incorporate more information in the financial statements.
However, it does not necessarily make investors better off and its usefulness in other
contexts has not been clearly demonstrated. He observes: “It could make investors
and other users worse off, for a variety of reasons. The jury is still out on this issue.”
Conclusion
It is not possible to assess the accounting quality of IFRS financial statements
directly. Researchers have used many market related measures to evaluate the
accounting quality of firms and countries that have adopted IFRS. The results are
33
mixed and in some cases conflicting. One most common finding is that adoption of
IFRS per se does not improve the accounting quality. More dominant factors are
reporting incentives and political and institutional environment. Ray Ball, who is the
Sidney Davidson Professor of Accounting at the University of Chicago, questioned
the benefits of fair value accounting (Ball, 2006).
11. IMPLEMENTATION DIVERSITY
Proponents of IFRS argue that harmonisation of accounting practices across the world
reduces the investor’s cost of acquiring expertise about the accounting practices in
different countries. Therefore, the cost of monitoring by investors and analysts is reduced.
The comparison of the performance and financial position of companies domiciled in
different countries becomes easy and the cost is reduced. Therefore, harmonisation of
accounting practices facilitates cross-border investment and the integration of capital
markets. However, whether these benefits will be realised or not depends significantly on
the uniform application of IFRS across countries.
Ball (Ball, 2006) observes:
“Despite the undoubted integration that has occurred, notably in the capital
and product markets, most market and political forces are local, and will
remain so for the foreseeable future. Consequently, it is unclear how much
convergence in actual financial reporting practice will (or should) occur.”
The American Accounting Association (American Accounting Association, 2008) has
expressed similar concerns:
“Even while standard setters and regulators strive to achieve convergence,
there is reason to question the feasibility of achieving any given set of uniform,
global accounting standards. Institutional differences across countries might
well create a need for differences in financial-reporting practices even within
an otherwise uniform set of standards. This is consistent with the country-
specific versions of IFRS that we observe in practice. There is also the concern
that given the differences in institutional structures, forced uniformity in
accounting standards might result in differences in implementation, which could
mislead investors into thinking that financial reporting is uniform when it is
not.”
The American Accounting Association further observed:
34
“Cross-country institutional differences will likely result in differences in the
implementation of any single set of standards. Thus, IFRS may be a high-quality
set of reporting standards (pre-implementation) but the resulting, published
financial-statement information could be of low quality given inconsistent cross-
border implementation practices”.
The above observations of Ball and the American Accounting Association are
consistent with the early research findings (e.g. Ali, 2000) that country-specific
factors are more dominant in determining the accounting quality. Recent studies have
also corroborated early findings.
The results of a study (Tendeloo et al., 2005) show that companies that have adopted
IFRS engage more in earnings smoothing, but this increase in earnings smoothing
(with the adoption of IFRS) is significantly reduced when the company has a Big 4
auditor. This finding suggests that the adoption of high quality standards is not a
sufficient condition for providing high quality information in code-law countries with
low investor protection rights.
Daske et al (Daske et al. 2008) collected evidence that suggests that the capital-
market benefits occur only in countries where firms have incentives to be transparent
and where legal enforcement is strong. This result suggests that firms’ reporting
incentives and countries’ enforcement regimes are of paramount importance for the
quality of financial reporting.
Armstrong et al. (2008), who studied 16 events leading to the adoption of IFRS in
EU, found an incrementally negative reaction for firms domiciled in code law
countries, which are likely to have weaker enforcement of accounting standards. This
signals that even within Europe, investors are concerned about implementation
weakness in certain countries.
The Institute of chartered Accountants of Scotland (ICAS, 2008) studied the
implementation of IFRS in UK, Italy and Ireland. IFRS was implemented in all the
three jurisdictions in the year 2005. They used the content analysis and interviewed
preparers and users of financial statements. It reported different results for the three
countries. While, the results for U.K. and Ireland are similar, the same is different for
Italy. The plausible reason for those differences is that the UK and Ireland are
common law countries and their accounting standards focus primarily on the needs of
shareholders, while Italy has a legal system based on civil law and its accounting
35
standards traditionally focus on creditors. Therefore, a significant cultural change is
required for the effective implementation of IFRS in Italy.
Chen and Zhang (2010) studied the regulatory enforcement and audit upon IFRS
compliance with reference to China. They collected evidence to suggest that the
convergence of accounting practices may be affected by not only the lack of
insufficient understanding of IFRS by local accounting professionals, but also the
management opportunistic behaviour during the application of different standards.
They argue that corporate governance may affect the convergence of accounting
practice.
Parker (2011) observes that pre-2006 Chinese accounting standards (CAS) has been
so embedded in China’s commercial culture that main- land accountants, as well as
financial managers, have unsurprisingly been unable to throw off their old clothes
immediately. It implies that local culture and business practices have significant
impact on the effective implementation of anew set of accounting standards.
SEC work plan (2012) reports inconsistent application of IFRS, which impairs the
comparability. The following observation of the report indicates that use of IFRS may
not improve the comparability of financial statements across countries unless
consistency in application of IFRS is achieved at the global level:
“The diversity arising from the standards themselves was, at times, mitigated
by guidance from local standard setters or regulatory bodies that narrowed
the range of acceptable alternatives already permitted by IFRS or provided
additional guidance or interpretations. This diversity also was mitigated by a
tendency by some companies to carry over their previous home country
practices in their IFRS financial statements. While country guidance and
carryover tendencies may promote comparability within a country, they may
diminish comparability on a global level.”
Conclusions
Benefits of harmonisation of accounting practices will be achieved unless the uniform set
of accounting standards is applied uniformly across countries. That appears to be difficult
because the application of accounting standards involves considerable judgment and the
use of private information. As a result, IFRS (like any other set of accounting standards)
provide firms with substantial discretion. How far this discretion is used depends on firm-
specific characteristics (reporting incentives and operating characteristics), and country-
specific factors.
36
12. IMPLEMENTATION COST
Studies surrounding IFRS have primarily focused on the benefits and not on the costs
of implementation. However, both practitioners and academicians have expressed
concerned about the cost of transition from local standards to IFRS.
Christensen (Christensen, 2012) observes:
“One of the central questions that remain largely unanswered is: what are the costs
of adopting IFRS? Most research has focused on estimating benefits of IFRS
adoption. Given that firms’ revealed preferences suggest that most resist IFRS
adoption, it follows that the costs must be significant or that the benefits are small.”
The Institute of Chartered Accountants of Scotland (The Institute of Chartered
Accountants of Scotland, 2008) reported that most preparers and users in U.K.,
Ireland and Italy had felt that benefits of implementing IFRS were far more nebulous
and that overall the costs outweighed the benefits. The costs were mainly attributable
to the adaptation of information systems, training costs, consultation costs or the
employment of individuals with specific IFRS knowledge who proved to be ‘thin on
the ground’ and audit costs.
13.CONCLUSIONS
The movement for the harmonisation of accounting practices through convergence of
local accounting standards with IFRS or through adoption of IFRS has lost steam.
The SEC has decided to defer the decision on the method of endorsement of IFRS and
in deciding the timeline for the endorsement of IFRS. Many experts believe that SEC
will take the route of condorsement, an idea floated by SEC staff in 2010. The
Condorsement idea resulted from combining the most common IFRS adoption
approaches used in other jurisdictions, namely Convergence and Endorsement.
Japan has deferred its decision to make IFRS mandatory for listed and other
companies. Initially they announced that a decision would be taken in 2012. At
present, international companies has been given a choice to present their consolidated
financial statements either using local accounting standards or IFRS.
China is moving towards convergence of its accounting standards with IFRS.
However, significant gap exists between Chinese GAAP and IFRS. Moreover the
implementation of accounting standards in China is weak.
Most E.U. countries do not permit preparation of individual financial statements using
IFRS.
37
Canada has adopted IFRs in 2011. It requires publicly accountable entities and state-
owned enterprises to prepare both consolidated financial statements and individual
financial statements using IFRS. It allows closely held companies to prepare their
financial statements using IFRS, if they so desire.
One of the reasons for the slowing down of the movement for harmonisation of
accounting practices through the adoption of IFRS or convergence of local standards
with IFRS is that results of studies around adoption of IFRS by the E.U. countries
could not establish conclusively that adoption of IFRS per se improves the reporting
environment. Moreover, available literature shows that reporting incentives and the
country-specific factors (e.g. local political and institutional environment)
significantly influence the accounting quality. Therefore, doubt is expressed on
whether IFRS will be implemented uniformly across countries. In absence of the
same, the perceived benefits of harmonisation of accounting practices will not be
realised. Moreover, weak implementation of IFRS will mislead the investors in the
sense that they will start believing that the information environment has improved
after the adoption of IFRS.
Research findings signals that reporting incentives and reporting strategy are different
for different firms. Therefore, mandatory adoption of IFRS benefits some and hurts
others. There will be ‘winners and losers’. Multinational firms, large size firm, and
those which are listed in stock exchanges abroad are likely to benefit from the
adoption of IFRS and those, which are family controlled and depends on funding
from banks and other financial institutions will be the potential losers.
Cost of implementation is also a concern. Large companies will enjoy the economy of
scale and in their case the benefits will outweigh the implementation cost. Others will
not enjoy the economy of scale and the implicit cost (e.g. loss of competitive
advantage) of higher level of disclosures will outweigh the benefits.
14. RECOMMENDATIONS
SEC is going slow in endorsing IFRS, while FASB is working closely with IASB for
bridging the gap between U.S. GAAP and IFRS. Japan has deferred the decision to
make application of IFRS mandatory. The debate on practical benefits of adopting
IFRS has again surfaced. Evidence collected by academicians has failed to establish
that adoption of the IFRS improves the information environment. Although U.S.A.
and Japan has reiterated their commitment to either adopt IFRS or converge local
38
accounting standards with IFRS, they articulated that they need more time to evaluate
the impact of IFRS on firms and the society.
In view of the above, India should take a cautious approach. It should study the
impact of IFRs in different sectors of the economy and on the society before
implementing IndAS. Another round of discussion and public debate is required to
ensure that adoption of IFRS does not harm the economy. While developing the
IndAS, NACAS adopted the approach of minimum deviation from IFRS. In
reviewing the IndAS based on inputs from impact study, the government may decide
to make changes, wherever necessary.
In the mean time, the government should strengthen the regulatory measures to ensure
proper implementation of accounting standards. The level of disclosures may be
improved benefit of capital market and to improve the contracting efficiency.
39
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