Effects of International Financial Reporting Standards on the Accounts and Accounting Quality of Australian Firms

1、effects of international financial reporting standards on the accounts and accounting quality of australian firmskamran ahmeda, john goodwinb*a department of accounting, la trobe university, melbourne, vic, 3083, australiab school of accounting and law, rmit university, melbourne, vic, 3000, austral

2、iaabstractthis study examines the effect of australian equivalents to international financial reporting standards (aifrs) for 1,387 listed firms over 2004 and 2005. we document and analyse the effects of the most significant changes from aifrs on earnings and equity and the changes to various financ

3、ial statement numbers and ratios. we find that aifrs earnings is higher and equity is lower than agaap, and more firms have earnings decreases than increases. the effect on ratios is most significant for leverage where the aifrs ratio is higher. we find little evidence that aifrs earnings and book v

4、alue are more value relevant than agaap earnings and book value and this result holds for partitions of industry sector, firm size and profit and loss-making firms. there is weak evidence of incremental value relevance of aifrs accounting information.key words: ifrs adoption, accounting quality, acc

5、ount effects* corresponding author.email addresses: .au (k. ahmed), .au (j. goodwin)1. introductionthis study examines the effects of australian equivalents to international financial reporting standards (aifrs) on the accounts of 1,387 listed entities, which is

6、 over 80 percent of the listed firm population at january 2006. aifrs are applicable for reporting periods beginning after 31 december 2004, and entities are required to restate comparatives and provide reconciliations to australian generally accepted accounting principles (agaap) upon first-time ad

7、option. the time of initial adoption is an appropriate time for assessing the impact of this major change in reporting rules since firms provide earnings and equity amounts measured under two different gaap for the same periods. we compare the aifrs numbers with those under agaap for the period imme

8、diately prior to aifrs adoption, there are some standards exempt from retrospective application, namely the two financial instruments standards (aasb 132 and aasb 139), aasb 3 business combinations and the three insurance standards (aasb 4 insurance contracts, aasb 1023 general insurance contracts a

9、nd aasb 1038 life insurance contracts). focussing on earnings and the balance sheet. there seems to be general agreement among commentators, the firms, analysts and the wider community that the introduction of aifrs will materially affect some australian entities. consistent with this are the shareh

10、older briefings held by some firms (e.g. telstra and alinta), to explain the financial impact of aifrs on the firms accounts. for example, the head of the australasian investor relations association, mr ian matheson, said in june 2005; in some cases, the ifrs changes will have a material bearing on

11、the companies reported results” (buffini, 2005, 6). there is no empirical evidence on this issue.there are also different opinions on the economic consequences of aifrs. in particular, public opinion differs on accounting quality, cost of capital, capital raising ability and the costs of implementat

12、ion. we also examine in this paper the differences in accounting quality of aifrs applying a relative value relevance approach and we examine incremental value relevance. perhaps the loudest voice for improved quality from aifrs is the financial reporting council (frc) who, in 2002, claimed that the

13、 standards will enhance “the overall quality of financial reporting in australia” (frc, 2002). this view is supported by the australian accounting standards board (aasb) in a 2003 press release: “complying with these requirements is unlikely to impose significant burdens and costs on entities when c

14、ompared with the benefits of relevant and reliable information to users of financial reports.” (fenton-jones, 2003, 53). in contrast to the frcs view, professors frank clarke and graeme dean of the university of sydney suggested in march 2005, that aifrs will mislead investors because of the parliam

15、entary joint committee on corporations and financial services conclusion in february 2005, that aifrs are corporations act compliant. specifically, they argue that investors can not rely on a firms accounts under agaap as being true and fair, since aifrs compliant accounts are consistent with a true

16、 and fair view (clarke and dean, 2005). there is no australian evidence on the impact of aifrs that can shed light on the abovementioned debate on the effect of aifrs and its consequences for accounting quality. one objective of this study is to investigate the effect of aifrs on earnings and equity

17、 for the average australian listed firm. this is important since better predictions can be made for the effects of aifrs on the majority of australian firms. using a large sample of listed entities that restate their earnings and equity, this paper presents the first empirical evidence on the effect

18、s of aifrs on the accounts and the consequences of aifrs for financial statement quality. the second objective is to examine the accounting quality of aifrs earnings and book values compared with earnings and book values prepared under agaap. jubb (2005) used the notes to the firms accounts in 2004

19、to infer the future effect of aifrs. the present study uses the reconciliations provided in the notes to measure the future effect of aifrs. absent any deliberate manipulation at first-time adoption and the few standards that are exempt from restatement, we expect this comparison to provide an accur

20、ate guide of the future effects of aifrs on the accounts. prior studies exploiting similar requirements use a data set that may not be representative of the full effects of ifrs due to small sample size (hung and subramanyam, 2006), or firms that voluntarily adopt aifrs which introduces the possibil

21、ity of self-selection bias (barth et al. 2005). the present study does not suffer from either of these potential problems because we examine all listed firms that have available data, the exemptions from restatement are limited to a smaller number of standards and all firms are required to restate c

22、omparatives and provide reconciliations to agaap upon first-time adoption of aifrs in australia (aasb 1, para 39). our sample is over 90 percent of those currently listed firms that were listed in 2004.we find that the two most common adjustments to earnings are for share based payments and income t

23、ax respectively and the two most common adjustments to equity are for income tax and goodwill. mean annual earnings has risen from about $38m to about $40m under aifrs and mean equity fallen from about $309m to about $275m under aifrs. medians have the same trend. liabilities and mean assets have in

24、creased significantly but the assets median has fallen as has total equity. retained earnings has also fallen although not as significantly. operating cash flows are unaffected. the leverage ratio shows a weaker financial position under aifrs. our results do not support aifrs earnings and book value

25、 as being more value relevant than those of agaap. we find weak evidence that aifrs information in earnings adds additional information to information captured by agaap earnings and book value, but only when predicting future operating cashflows two periods ahead. it should be noted that our main an

26、alyses use earnings that are not always fully aifrs compliant because some standards such as aasb 139 financial instruments, compulsory from 1 january 2005, do not have to be retrospectively applied. nevertheless, supplementary tests on earnings that are fully-aifrs-compliant provide consistent evid

27、ence for market value relevance. the results have several implications. first, aifrs generally shows a weaker balance sheet suggesting that debt covenants and lending criteria may need to be addressed by account preparers and lenders. second, the large decline in retained earnings implies dividend-p

28、aying capability may be reduced for some firms. finally, if accounting numbers are an input into the markets cost of capital estimations, our results suggest that cost of capital may not be lower due to aifrs. the paper proceeds as follows. the literature review is covered in the next section follow

29、ed by data in section 3. in section 4 we measure the effects on earnings and equity of the most common changes from aifrs, and report and examine differences between accounting numbers and ratios under agaap and aifrs. section 5 covers the methodology. empirical tests of financial reporting quality

30、are presented in section 6 and in section 7 we investigate the robustness of the main results for various partitions of the data. section 8 concludes the paper with a summary of the major findings.2. literature reviewcountries in the european union moved to ifrs for reporting periods beginning after

31、 december 31 2004, as did australia. as a result, much of the existing research uses firms with distinguishing economic characteristics that voluntarily adopt ifrs. for example, firms voluntarily adopting ifrs are those seeking to access foreign capital, to improve customer recognition or reduce pol

32、itical costs (el-gazzar et al. 1999). as noted by lang et al. (2003), firms electing to adopt ifrs early, are more likely to be those firms with fewer reconciling items. how these data sets affect accounting quality comparisons is unknown. an important difference between existing studies and this st

33、udy is our data set comprises firms that must adopt aifrs, meaning the possible effects of self selection bias are redundant. consequently, the formulation of hypotheses is somewhat problematic by drawing on this literature. further, conflicting results in prior literature limit our ability to form

34、confident predictions.the most closely related studies to the present study are those that examine samples from one country. an early paper by kinnunen et al. (2000) exploit a unique market setting in which foreign investors are restricted in their trading of certain shares. this permits the authors

35、 to examine the relative value relevance of finnish gaap and voluntarily-adopted ias between two investor groups. they find ias improves the information content for foreign investors but not for domestic investors. niskanen et al. (2000) also examine finnish gaap finding that ias does not have incre

36、mental value relevance. using a price levels regression, dan hu (2004) reports that chinese gaap is more value relevant than ias using a sample of 252 firm years. this finding is supported by eccher and healey (2003), who investigate a sample of 83 chinese firms that are required to provide two sets

37、 of accounts using chinese gaap and ifrs; finding that earnings under chinese gaap are more closely associated with returns than earnings under ifrs. they also find little difference in predictive ability of chinese gaap and ifrs for future operating cash flows. hung and subramanyam (2006) use a sam

38、ple of 80 german firms voluntarily adopting ifrs over the period 1998-2002 that provide accounts under german and ifrs gaap for the same period. using several levels models they find that ifrs earnings are less persistent than german gaap earnings, and ifrs earnings and book values explain less of t

39、he variation in market price than does german gaap. their results contrast with bartov et al. (2004) who also compare german gaap with ifrs (and u.s. gaap), and find that ifrs is more value relevant than german gaap, but less value relevant than u.s. gaap, using different measures of value relevance

40、. they also find little difference in the value relevance of u.s. gaap earnings and ifrs earnings. however, bartov et al. (2004) examine firms in the cross section rather than the same set of firms as do hung and subramanyam (2006). this study also examines the same firms with the added advantage th

41、at firms must adopt aifrs rather than voluntarily. although hung and subramanyam (2006) attempt to control for self selection bias, the possibility remains that the bias in the ifrs accounts due to the effects of early voluntary adoptions may explain the conflicting results, as barth et al. (2005) h

42、ave noted. different methodology might be another reason. barth et al. (2005) use data from 24 countries over a 15-year period to 2004 and find that the transition to aifrs results in improved accounting quality using a variety of measures. specifically, they find that aifrs results in more timely r

43、ecognition of losses and higher r2s in regressions of market value on earnings and book value. while their results may be more representative of the overall effects of aifrs, they are also difficult to interpret for a study examining one country, because each set of domestic gaap is likely different

44、 in a number of respects. for example, the timeliness characteristic of earnings differs according to the institutional environment between countries (ball et al. 2000). with respect to a countrys institutional environment, ball et al. (2000) report that due to different levels of conservatism, earn

45、ings of firms in common law-based countries are more timely in impounding economic information than earnings for firms in code law countries. they also find that earnings coefficients are larger for code law than for common law countries. since australia is a common law country and germany a code la

46、w country, the results in hung and subramanyan (2006) imply higher associations of agaap earnings with market value than aifrs and perhaps lower earnings coefficients under agaap ceteris paribus. predictability of cash flows may also be higher under agaap since the strength of associations of earnin

47、gs with market value and of earnings with future operating cash flows are generally positively correlated (see aboody et al. 1999, for example). alternatively, because bartov et al. (2004) report the opposite results to that of hung and subramanyam (2006) using tests that are more closely aligned wi

48、th some of our tests, earnings value relevance may be lower under agaap than aifrs ceteris paribus.the literature gives conflicting evidence on accounting quality. our study adds to the existing literature on the effects of adopting ifrs on earnings and equity quality, using recent data from compani

49、es that are required at initial adoption, to provide earnings and equity numbers under both agaap and aifrs. our evidence contributes to the ongoing debate on the alleged superiority of ifrs.3. dataall firms listed on the australian stock exchange were selected from aspect huntley pty ltds finanlays

50、is database at january 2006 that gave a total of 1,714 firms. from these, 180 were deleted because they were listed in 2005 or 2006, 72 because they use non-australian gaap or foreign currency, 73 because their accounts were not available and two because they were delisted in 2006 and did not lodge

51、accounts prior to delisting. table 1, panel a shows the sample description. the notes to the half yearly accounts contain the restated earnings and equity that is compared with the corresponding numbers from the accounts lodged in the prior year, and the reconciliations to agaap required by aasb 1.

52、an example reconciliation note for buderim ginger ltd is shown in appendix 1. the final sample comprises 1,387 firms and the industry group breakdown is shown in table 1, panel b. 4. financial statement effects of aifrswe examine in this section the disclosures under accounting standard aasb 1, wher

53、e firms are required to reconcile agaap earnings and equity to aifrs earnings and equity, and disclose the amounts of significant changes. agaap differs from aifrs in a number of respects. nobes et al. (2001) reports six recognition and measurement areas where there is no australian standard and thr

54、ee for disclosure. additionally, agaap is inconsistent with ifrs in 13 areas (nobes et al. 2001). nobes et al. (2001) study does not cover the pervasiveness of these differences or their materiality however. one indicator of pervasiveness of the changeover is the firms disclosures of expected effect

55、s which can be obtained from the pre-transition disclosures. in her summary of the most disclosed significant effects of aifrs jubb (2005) reports income tax is the most cited followed by share based payments. intangibles are likely larger and potentially their effects more material but they are als

56、o likely to be less pervasive with about 30 percent of australian firms capitalising intangibles (goodwin and ahmed, 2006). of course the amounts and types of significant changes and pervasiveness can only be determined once ex-post data is available. 4.1 reconciliations of earnings and equitytable

57、2 shows the aggregated reconciliations for the last year of agaap earnings and for equity at the most recent balance date that agaap was used. for example, for a december 31 annual balance date firm, earnings is for the year to 31 december 2004 and equity is at 31 december 2004. we select the ten mo

58、st common reasons for earnings and rank from most to least common for earnings and for equity. equity at the most recent date is used since that is the earliest date that the majority of aifrs will be applied and is the most recent of the three reconciliation dates. specifically, aasb 139 financial

59、instruments is not required to be retrospectively applied by must be applied for reporting periods beginning on or after 1 january 2005, but some firms apply the standard at the date of their last agaap balance sheet. the left half of panel a shows the means, medians and standard deviations for those items that have non-zero amounts, and the right half of panel a shows that informa