The Impact of Adopting International Accounting Standards - Essay Example

? The Impact of Adopting International Accounting Standards on Capital Markets and Financial ments Users [Instructor’s Name] [Date] The Impact of Adopting International Accounting Standards on Capital Markets and Financial Statements Users Introduction Apart from the fact that the trend of globalisation has been triggered during the last few decades, different countries still consider it appropriate to follow their national standards for financial reporting. On the contrary, there are some countries in which international accounting standards are considered as an appropriate means for carrying out financial reporting. This difference in their financial reporting is based on varying prejudices and preconceived concerns, the basis of which has often been questioned by experts and proponents of adopting national and international accounting standards. Notwithstanding the concerns and prejudices, there has been noted an increasing trend towards adoption of international accounting standards as a preferred financial reporting framework. Among the concerns stated by the stakeholders to adopting international accounting standards, many are related to the impact of adopting them on capital markets operations and efficiency and on the users of financial statements. The International Financial Reporting Standards are different from the national standards developed by countries for financial reporting within their respective jurisdictions. These differences result in significant shifts in their financial reporting practices for business entities, when they decide on their own or due to mandatory requirements to adopt International Financial Reporting Standards as their financial reporting framework. Due to the differences in the respective requirements of different financial reporting frameworks, there are varying impacts of each on capital markets and users of financial information. This paper attempts to provide a critical review of how adoption of international accounting standards can influence the capital markets and users of financial statements. In this regard, the paper includes critical discussion of the impact of adopting international accounting standards on capital markets and users of financial statements in separate sections. Impact of Adopting International Accounting Standards on Capital Markets The impact of adopting international accounting standards as a financial reporting framework can be determined by understanding the impact of adopting the international accounting standards on the efficiency of capital markets. Keeping in view the significant difference in reporting requirements under International Financial Reporting Standards and other national accounting standards, such as U.S. GAAP or other accounting frameworks, a general expectation can be developed that with the adopting of International Financial Reporting Standards, there will be a significant impact on the efficiency of capital markets. Researchers have investigated whether the impact caused by adopting International Financial Reporting Standards on efficiency in capital markets is positive or negative. Some researchers have noted that the impact of adoption of International Financial Reporting Standards on market can be measured through variations in the market liquidity and the cost of capital for business entities. In this regard, Daske et al (2008) have noted that with the adoption of international accounting standards, market liquidity is influenced positively, that is it increases. Similarly, another major finding of their research work is that by adopting international accounting standards the cost of capital for firms are decreased, whereas the value of their equity increases (Daske et al., 2008). Daske et al. (2011) have also noted that those firms which are committed to provide highly transparent financial reporting and thus adopt International Financial Reporting Standards as their financial reporting framework, such firms experience a significant improvement in their respective liquidity and cost associated with raising capital from the market (Daske et al., 2011). Although empirical findings are suggestive of improvements in the efficiency of capital market operations, it is pertinent to understand that why does such improvements take place. In this regard, the study conducted by Li (2010) reveals that due to increased requirements for disclosure by firms adopting International Financial Reporting Standards and the fact that they are required to present information in a manner which is more comparable, the resulting benefits are reduction in the cost of capital (Li, 2010). But, it has also been noted side by side that such benefits are more likely to exist in countries where there exist effective legal and regulatory systems. In a research by Palea (2007), she noted that those business entities in the European Union region which were using International Financial Reporting Standards, their cost of capital decreased in comparison with the business entities which followed other local financial reporting standards (Palea, 2007). Moreover, share prices have often been used to determine the extent to which financial information is useful. In this regard, studies conducted by Ball and Brown (1968) and by Beaver (1968) are important to consider. The research works in this context have revealed that by adopting International Financial Reporting Standards as the financial reporting framework, business entities are able to share information which is specifically related to their particular businesses and operating conditions and as a consequence the uncertainty and the element of surprise is avoided (Ball & Brown, 1968; Beaver, 1968). Considering these benefits, it can also be stated further that the abnormalities in stock returns are also minimized as more information is able in the market for a particular stock, and the same has also been noted by Landsman et al. (2011). Apart from these assertions and empirical evidences being put forward as a justification for international accounting standards being beneficial for the capital markets, contrary arguments can also be made, which are obviously supported by prior research work. As for instance, the fact that some researchers have actually preached that with the adoption of international accounting standards comparability of information is enhanced which results in further benefits; however, these assertions have been challenged by other researchers, such as Kvaal and Nobes (2010; 2011). Apart from these studies, in a recent research work, an investigation between changes in the earnings of firms operating in different parts of the world and comparability of their accounting information has been measured by Lang et al. (2010). The changes in earnings were actually considered by researchers as the variation in firms’ earnings, whereas comparability was regarded as a relationship between earnings of the firms and their returns. Lang et al. (2010) found that changes in the earnings of those firms which adopted International Financial Reporting Standards as their financial reporting framework existed but no evidence of improvement in comparability were observed. In addition to this, the researchers related the increase in changes in earnings to lack of efficiency in information environment (Lang et al., 2010). These empirical findings provide a convincing basis to understand that there is a favourable impact of adopting International Financial Reporting Standards on the capital markets. In addition to the impact of adopting International Financial Reporting Standards on capital market, the effects of International Financial Reporting Standards on the users of financial statements have been discussed in the following section. Impact of Adopting International Accounting Standards on Financial Statements Users Talking about the users of financial statements and information presented therein and the impact of International Financial Reporting Standards on their decision making and ability to interpret the underlying information, there are both internal and external users. The internal users of financial statements primarily include management and board members. The external users of financial information from the statements prepared as per financial reporting framework include stakeholders like investors, shareholders, lenders, regulatory bodies, capital market players, analysts, governmental institutions, etc. In addition to the exploratory research works concerning impact of International Financial Reporting Standards on capital markets, researchers have also investigated the impact of adopting the International Financial Reporting Standards on participants in the capital market. There are numerous research works in which the impact of International Financial Reporting Standards’ mandatory adoption has been evaluated with reference to the capital market users of financial statements. The reason behind this is that users of financial statements in capital are considered important as they are the ones who input information on the basis of which investment decisions are made. In this regard, Hope et al, (2006) suggests that when financial reporting frameworks enable high quality financial reporting and disclosures, the analysts in the capital market are directly and positively influenced by such quality practices. The International Financial Reporting Standards are said to uphold transparent financial reporting, present of relevant financial information and enhance the comparability of information. As far as investors are concerned, Bruggemann et al. (2009) carried out a study for evaluating the impact of adopting International Financial Reporting Standards on the trading activity in Frankfurt Stock Exchange. The researchers noted in their study that with the adoption international accounting standards, trading activity in the stock market increased considerably owing to the use of better quality and comparable financial reporting standards by the business entities. It is pertinent to mention here that the study included trading of stocks related to firms listed on the Frankfurt Stock Exchange from different countries, which implies that adopting International Financial Reporting Standards result enhancing investments in foreign equity investments (Bruggemann et al., 2009). Apart from investors, the adoption of International Financial Reporting Standards has also considered as beneficial for financial and securities analysts. It has been noted that those analysts, who have based their analysis on the information prepared and presented on the basis of International Financial Reporting Standards, have produced more accurate financial analysis and evaluation in comparison with those analysts who make use of financial information prepared on the basis of financial reporting standards other than International Financial Reporting Standards. These findings have been reported by Horton et al. (2012) in their research work, which involved comparison of financial analysts’ work on the basis of financial information prepared under International Financial Reporting Standards and under other accounting standards. The researchers also concluded that the International Financial Reporting Standards resulted in improvement in the quality and comparability of financial information presented in financial statements by firms (Horton et al., 2012). Apart from Horton et al. (2012) research work, there are others also who have noted that there is an improvement noted in the accuracy of forecasting presented by financial and security analysts. As for instance, Jiao et al. (2012) have found that forecasting for business entities in European Union by analysts, which used International Financial Reporting Standards as the preferred financial reporting framework, was more accurate in comparison with other non-IFRS firms (Jiao et al., 2012). Similar results were also reported by studies conducted by Panaretou et al. (2009), Cotter et al. (2012) and others. Another area which can be focused on in relation to adopting the International Financial Reporting Standards is its impact on incorporating the information with stock market and influencing the decisions of stakeholders. In this regard, Beuselinck et al. (2010) found in their study that International Financial Reporting Standards enhanced the abilities of financial and security analysts to relate financial and stock market information with prices of stocks traded in the market, which ultimately resulted in the reduction of advantage of institutional owners due to the undisclosed information made available to them only (Beuselinck et al., 2010). According to Byard et al. (2011), the business entities operating in the European Union region and which have adopted International Financial Reporting Standards as their financial reporting framework have benefited significantly from them by ensuring more information provision for investors, analysts and other users of financial statements. As a result of this, analysts in the European Union region have also been able to predict the variations and other developments in the capital market more efficiently and accurately (Byard et al., 2011). It is also pertinent to note here that where the difference between the national financial reporting standards and International Financial Reporting Standards have been greatest, more benefits were observed for analysts, as there was a remarkable difference noted in the accuracy brought in their forecasting in the post International Financial Reporting Standards adoption period. Similar observations have also been made in cases where regulatory frameworks and legal situation prior to the adoption of International Financial Reporting Standards was sound. As per the findings of research work conducted by Tan et al, (2011), countries where adoption of International Financial Reporting Standards was made mandatory, the financial analysts showed more interest and confidence due to the fact that financial information presented as per the guidelines of International Financial Reporting Standards provided more accuracy as compared to the financial information presented in accordance with the national accounting standards (Tan et al., 2011). However, it is noteworthy that the positive influence of adoption of International Financial Reporting Standards on the experiences of individual analysts as the users of financial statements was largely influenced by the degree to which national standards were different from the International Financial Reporting Standards. Conclusion The discussion included in this report related to the impact of adopting International Financial Reporting Standards on capital markets and users of financial statements. In the first portion, the impact of adopting International Financial Reporting Standards on capital markets has been discussed. From the discussion and taking into consideration the empirical evidences regarding the impact, it has been concluded that capital markets have experienced a positive impact due to the adoption of International Financial Reporting Standards by firms. In particular, it has been concluded that International Financial Reporting Standards enable integration of financial and market information, which in turn influences the liquidity and cost of capital in the capital markets for firms. In addition, it has been concluded that by adopting International Financial Reporting Standards as the financial reporting framework, business entities are able to share information which is specifically related to their particular businesses and operating conditions and as a consequence the uncertainty and the element of surprise is avoided. Moreover, keeping in view these benefits, it can also be stated further that the abnormalities in stock returns are also minimized as more information is able in the market for a particular stock. Apart from this, discussion on the impact of International Financial Reporting Standards on the users of financial statements has also been included in the report. By reviewing empirical evidences in this regard, it has been concluded that with the adoption of International Financial Reporting Standards, users of financial statements benefit a lot. As for instance, apart from a few empirical evidences stating otherwise that changes in the earnings of those firms which adopted International Financial Reporting Standards as their financial reporting framework existed but no evidence of improvement in comparability were observed, it has been however concluded by many researchers that the comparability of information increases thus enhancing the ability of analysts to accurately present their forecasts. Moreover, it has also been concluded that those analysts, who have based their analysis on the information prepared and presented on the basis of International Financial Reporting Standards, have produced more accurate financial analysis and evaluation in comparison with those analysts who make use of financial information prepared on the basis of financial reporting standards other than International Financial Reporting Standards. This leads to a common consensus that users of financial information benefit from the adoption of International Financial Reporting Standards. List of References Ball, R. & Brown, P., 1968. An empirical evaluation of accounting income numbers. Journal of Accounting Research, 6(2), p.159. Beaver, W.H., 1968. The information content of annual earnings announcements. Journal of Accounting Research, 6, pp.67-92. Beuselinck, C., Joos, P., Khurana, I. & Meulen, S.V., 2010. Mandatory adoption of IFRS and analysts' forecasts information properties. SSRNeLibrary. Bruggemann, U., Daske, H., Homburg, C. & Pope, P.F., 2009. How do individual investors react to global IFRS adoption? SSRNeLibrary. Byard, D., Li, Y. & Yu, Y., 2011. The Effect of Mandatory IFRS Adoption on Financial Analysts’ information Environment. Journal of Accounting Research, 49(1), pp.69-96. Cotter, J., Tarca, A. & Wee, M., 2012. IFRS adoption and analysts' earnings forecasts: Australian evidence. 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Analyst following and forecast accuracy after mandated IFRS adoptions. Journal of Accounting Research, 49(5), pp.1307-57. Read More