The Reasons for Adopting a Single Set of International Financial Accounting Standards - Essay Example

The Reasons for Adopting a Single Set of International Financial Accounting Standards Introduction The widespread adoption of the International Financial Reporting Standards (IFRS) by different countries has elicited debate over underlying reasons for the global convergence towards the system. According to Kargin (2013), the benefits that stem from using single set of international accounting standards (IAS) are highly compelling to both states and organisations. In light of this development, IFRS has emerged as the single most preferred International Accounting Standard by the developed and developing economies. The present essay mainly aims to evaluate critically the reasons for the adoption of the single set of IAS. In doing so, the preceding arguments will employ IFRS as a proxy to IAS. The structure of the paper will comprise of the discussion and the conclusion. The discussion section will critically evaluate presented reasons for the adoption of IFRS. The Key highlight of the reasons will include: IRFS advancement of timely information for investors, better quality accounting, comparability, improved earning and management, political incentives and the capital market benefits. The essay will conclude with a summary of the identified driving factors for the implementation of IAS. Provision of Timely Information for Investors According to Chua and Taylor (2008), IAS highly promotes timely access to information by investors. The adoption of a single set of IAS enhances the evaluation of companies across regions by investors based on a single standardized accounting framework. IAS underpin timeliness through the standardization of accounting procedures and reporting formats thereby eliminating time lag that has traditionally emanated from the analytical adjustment of the financial statements for the purposes of international comparison. Apart from time aspect, the existences of IAS also leads to cost reduction that could have been incurred in the processing of the financial information in a manner that will allow comparison to be conducted. In light of the globalization effect, it is further imperative that the multinationals adopt a single accounting standard that reconcile financial statements globally across their entire branch network. The provision of financial statement on single IAS further underpins the significance of the value relevance for investors. According to Edwards (2009), value relevance refers to the ability of the financial information documented in the financial statement to adequately expound on the predominant parameters in the stock market. Chua and Taylor (2008) noted that periodic financial statements have increasingly gained relevance by facilitating supervision and settling of contractual arrangements. Through IAS, the value relevance clearly depicts a wholesome picture for organisations operating at a regional level (Kargin, 2013). Chua and Taylor (2008) further added that the adoption of IAS provided an explicit link between managerial performance and financial reporting. Extensive evidence indicated that firms that had implemented IFRS had a direct correlation between CEO turnover and the companies’ earnings. Comparability Immense literatures in support of a single set of IAS have termed comparability of information as the hallmark of the accounting models. Li (2010) noted that economic integration across nations had dramatically increased because of globalization thereby the need for an international-based accounting information system. Advocates of IAS argue that comparable information facilitates international transactions and hence lowering exchange costs. Li (2010) added that the adoption of IAS leads to similarity of value relevance, extent of earning management and conservatism. On the other hand, information comparability gains should be examined in terms of similarity facet and difference facet. Chua and Taylor (2008) stated that similarity facet of information comparability demonstrates whether organisations undertaking similar economic ventures announces similar results. On the contrary, difference facet shows whether companies undertaking varying economic activities post dissimilar financial figures. While there exist paucity of knowledge on whether IAS improves on both facets of the information comparability, studies by Kim et al., (2007) showed that IFRS was more inclined towards the improvement of the similarity facet. In their studies, Barth et al. (2011) noted that IAS in non-American firm resulted in a more effective comparison of value relevance of earnings and equity book value than when they applied local standards of accounting. The existence of comparable accounting earnings from firms is subject to the nature of the accounting standard utilized by a given firm (Li, 2010). The prevalence of IFRS profoundly promotes comparable financial reporting that in turn lead to information transfer. Apparently, firms have been compelled to adopt IAS based on the knowledge that non-comparable information highly undermines the prediction of the value of other firms based on financial announcements. On the contrary, Jeanjean and Stolowy (2008) discredited comparability as one of the core drivers of IAS. In their argument, Jeanjean and Stolowy (2008) noted that financial accounting literature on comparability failed to provide comprehensive definition of the term. Similarly, scholarly writing in support of information comparability has suffered from non-existence of an empirical measurement system for comparability of financial reporting. Vis a vis, Chua and Taylor (2008) concluded that information comparability does not exhibit empirical importance. Better Quality Accounting International convergence of firms and states towards IAS has been intricately associated with better quality accounting. In deconstructing the impact of IAS on accounting quality, recent studies have focused on either of the following constructs of quality; emergent computational procedures and integration of accounting information with capital markets (Jaweher and Mounira, 2014). Studies by Chua and Taylor (2008) found out that implementation of IAS resulted in a significant reduction of forecast errors and forecast dispersion by financial analysts. On one hand, Jeanjean and Stolowy (2008) wrote that the adoption of an IAS was being driven by the need for an enhanced quality accounting. As a consequent of IFRS, improved information disclosure, advancement in the quality of earnings, and positive investors’ relationship with firms have equally contributed to improved analytical accuracy and performance (Robinson and Cope, 2015). Subsequently, critical analysis of empirical research on the relationship between IFRS implementation and improved accounting quality indicate mixed reaction. It emerged that the mandatory adoption of IFRS had insignificant impact on the quality of accounting. On the contrary, voluntary IFRS implementation positively correlated with improved quality of accounting. Studies by Daske et al (2007) highlighted on improved accounting quality among 26 countries that was further dependent on the regulatory framework and reporting incentives inherent in the individual countries. Chua and Taylor (2008) noted that IAS only contributed to improved accounting quality when firms were presented with incentives to adopt. Firms subsequently are enticed to adopt IFRS to experience reduced earnings management and advance their time loss recognition. Therefore, improvement of accounting quality is contingent on the adoption of IAF on a voluntary basis. Improved Earning Quality and reduced Earning Management Voluntary IAS has also been linked with reduced financial losses by firms through improved earnings quality and deterrent of earning management. Based on a study by Jeanjean and Stolowy (2008) that assessed the distribution of earnings of firms in three states, the transition to IFRS relatively resulted in improved earning quality. The findings highlighted on the increased distribution of earnings in France while UK and Australia remained stable. Although in their conclusion Chua and Taylor (2008) stated that IAS had insignificant impact on the quality of earning quality, subsequent studies by Chand and Patel (2011) offered contradictory results. Chand and Patel (2011) noted that at the international level, multinational firms opted to adopt IAS on a voluntary basis to attract investors through their reduced earning management. As a set of quality accounting standards, IAS such as IFRS faithfully underpin earning quality through the facilitation of effective monitoring framework and advancement of comparability of financial reports. It suffices to note that stringent accounting standards that characterize IAS enforce quality earnings and further tame the pervasiveness of earnings management. Additionally, studies by Sun et al., (2011) added that the adoption of a single IAS has been driven by the ability of firms to reduce target beating and increase earning persistence as a means of improving earning quality. The study mainly examined five indicators of earning quality which include:, target beating, earnings perspective, discretionary accruals, loss recognition and earnings response coefficient. In the long run, the culmination of improved earning quality and reduction of earnings management has resulted to the earning convergence in firms that adopted IAS. Political Incentives The characterization of political incentives in terms of trade alliances and associated benefits also underline the reasons for the adoption of IAS by states and firms. In their arguments, Tsamenyi and Uddin (2010) examined the political value of single IAS in terms of the international political power games and culture politics. In relation to political power struggle, less powerful states readily traded off the control of local accounting standards with the prospective of forging cross-country relationship with international bodies such as EU. Vis a vis, developing economies are enticed to either incorporate their local accounting standards with international ones or completely overhaul local standards. Similarly, in terms of cultural politics, the perception of IAS with global economic leaders highly promotes its adoption. Anglo American firms may be inclined to adopt accounting standards such as IFRS due to its relationship with EU. Furthermore, regional economic blocks such as COMESA and EU advocates for the adoption of a single IAS with the objective of advancing economic gains by instituting uniform accountings frameworks such as the IFRS. Subsequently, in scenarios where the adoption of the IAS is voluntary, trade partners are likely to pressure each other to adopt a common IAS to smoothen inter-state trade. Increased Capital Market Benefits According to findings by Yip and Young (2012), the adoption of IAS presented firms with increased benefits from capital market. The study noted that the ease of comparability of financial information between firms that had adopted IFRS compared to those that had not and accrued capital market benefits was a core determinant factor in the adoption of IAS. In addition, the study showed that firms that had voluntarily adopted IFRS enjoyed heightened capital market benefits that related to share turnover, and liquidity. However, the accrued benefits of capital markets were further subjected to the level of comparability of the financial information in the market and prevalence of IAS adoption in a given country (Edwards, 2009). Subsequently, the dependence of capital market benefits on the comparability of information stresses the need for the convergence of firms towards the adoption of single IAS. Camfferman and Zeff (2007) further reiterated that the net gains of the IAS underpinned effectiveness of the capital market. By use of IFRS as a IAS, Jeanjean and Stolowy (2008) stated that improved reporting transparency, regional comparability, and reduction of information costs had a resultant effect of improved liquidity, share turnover, competitiveness and market efficiency. Vis a vis, it suffices to note that emergent firms have had dramatic interest in the institutionalisation of IAS in order to benefit from the mentioned gains. Conclusion Globally, the adoption of IAS has gained prominence over the employment of the Generally Acceptable Accounting Principles (GAAP). The analysis was aimed at critically evaluating the underlying reasons for the adoption of IAS. Critical analysis on the status of IAS adoption showed academic reviews of the factors driving the global popularity of the standards. Nevertheless, the dramatic increase in the adoption of IAS has been attributed to myriad factors that cumulatively advanced the economic interest of countries and firms. The implementation of a single IAS was shown to facilitate timely information access to investors through standardization of reporting procedures and formats. Similarly, firms have been attracted by the ease in which IAS enhances information comparability thereby saving on costs. Subsequently, the international attributes of standards such as IFRS were noted to lead to quality accounting and improved earning quality through the deterrent earning management. In addition, increased capital market benefits and the associated political incentives that originate from instituting IAS have also played significant role in the adoption of common/ single set of IAS. It is thus evident that the perverse adoption of IAS has been founded on the pre-conceived benefits that firms and states prospect to enjoy after implementing the international accounting standards. References Barth, M, Landsman, R., Lang, H. and Williams, D. 2011. Are IFRS-based and US GAAP-based accounting amounts comparable? Rock Center for Corporate Governance of Stanford University Working Paper No. 78. Camfferman, K., & Zeff, S. A. 2007. Financial reporting and global capital markets: a history of the International Accounting Standards Committee, 1973-2000. Oxford, Oxford University Press. Chand, P., & Patel, C. 2011. Achieving global convergence of financial reporting standards implications from the South Pacific region. Bingley, U.K., Emerald. Retrieved from: http://public.eblib.com/choice/publicfullrecord.aspx?p=834889. Accessed on [12.04.2015] Chua, W. and Taylor, S. (2008). The rise and rise of IFRS: An examination of IFRS diffusion. Journal of Accounting and Public Policy, 27(6), pp.462-473. Edwards J.R. 2009. Accounting Theory and Regulation. In: ICSA Publishing The ICSA Study Text In Financial Accounting. (6th edition). London: ICSA Information and Training Ltd Jaweher, B. and Mounira, B. 2014. 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New Yory, U.S: Wiley Publishers. Sun, J., Cahan, S. and Emanuel, D. 2011. How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? Evidence from Cross-Listed Firms in the U.S. Accounting Horizons, 25(4), pp.837-860. Tsamenyi, M., & Uddin, S. 2010. Research in accounting in emerging economies. Vol. 10 Bingley, Emerald. Yip, R. and Young, D. 2012. Does Mandatory IFRS Adoption Improve. The Accounting Review, Vol. 87, No. 5, pp. 1767-1789.   Read More