Arguments For and Against the International Financial Reporting Standards - Research Paper Example

TABLE OF CONTENTS TABLE OF CONTENTS INTRODUCTION 2 METHODOLOGY 2 LITERATURE REVIEW 3 RESULTS AND DISCUSSION 8 CONCLUSION 10 Works Cited 12 Arguments for and Against the IFRS INTRODUCTION This paper aims at examining the case for and against the International Financial Reporting Standards adoption as the global accounting standards. The need for the information reporting harmonization across the world became increasingly important after the World War II when the global capital markets were integrated. To achieve this goal, the accounting standards are being harmonized across the world where various countries are adopting the International Financial Reporting Standards (IFRSs), In addition to their national accounting standards. A notable country that is embracing the IFRSs after being cautious towards the use of foreign standards is the United States. The Financial Accounting Standards Board and the International Accounting Standards Board have been working on the need for the convergence of the US Generally Accepted Accounting Principles (GAAPs) and the IFRSs (Kaya and Pillhofer). Various views have been put across regarding the adoption of the IFRSs as the global financial reporting standards after the analysis of the policy and economic factors surrounding their adoption (Selling). The supporters of IFRSs adoption argue that it enhances the disclosure and comparability of financial information and operations across various firms in the world, a case advocated for by Sunder as a desirable quality for a single set of financial reporting standards that are of high quality. On the other hand, the detractors of IFRSs’ adoption argue that it is unlikely to improve the financial reporting quality. METHODOLOGY A descriptive research design was preferred to facilitate proper understanding of the research objective through an in-depth analysis of the thesis statement. Secondary sources were the primary data sources used in this study as the study was not practically conducted in the field. These secondary sources were those scholarly works that have been done by scholars in the area of the effects of the International Financial Reporting Standards adoption across the globe in general and in various economies in particular. Among the consulted sources were refereed journal articles, credible reports from different agencies, textbooks, and reliable academic websites. LITERATURE REVIEW From the existing literature, there is a vastly scholarly work about the effects or consequences of adopting the International Financial Reporting Standards, and which have been conducted in various fields and disciplines. According to Kaya and Pillhofer, there are instances where the economic effects of IFRSs are dependent on whether the adoption is voluntary or mandatory. Past researchers studied this by focusing mainly on the quality of the reporting, market liquidity, and the cost of capital. Further studies have been carried out about the effects of the International Financial Reporting Standards adoption on the investment efficient. Reporting on the Bath et al. 2008s study on the accounting quality after the adoption of IFRSs, Kaya and Pillhofer state that this study involving companies in 21 countries that had voluntarily adopted the International Accounting Standards established more timely loss recognition, fewer earnings management and more value relevance of the reported financial information. In their study on the reported earnings under the Germany Generally Accepted Accounting Principles and under the IAS by comparing financial information of a sample of 417 Germany companies, Bartov and others found that, under IAS the earnings reported were more value relevant. This implies that the financial information prepared using the shareholder model such as the IFRSs are more informative than those developed under the stakeholders model (Sun, Cahan and Emanuel). However, their similar study where they compared the value relevance of earnings under the IAS and the US GAAPs, these authors did not find any differences. A study by Bath and others in the year 2012 examining the comparability of accounting information between the US firms applying GAAPs and non-US firms applying the IFRSs showed that accounting system comparability, as well as the value relevance comparability with the US entities, increased after the use of IFRSs by non-US entities. Also, they further established that comparability is greater for entities that have mandatorily adopted IFRSs. Reporting on the effects of IFRSs mandatory adoption on the market liquidity, Kaya and Pillhofer reports that the market liquidity increases after the adoption of IFRSs. However, a study by Daske and others established that the market liquidity effects were larger for firms that voluntarily switched to IFRS. These effects are, however, significantly dependent on the respective countrys strict enforcement regimes as well as strong incentives to be transparent. Also, the impact of the market liquidity are greater where there is a substantial difference between the respective countries national GAAPs and the IFRSs (Kaya and Pillhofer). However, no significant differences were noted for firms using the US GAAPs or the IAS. Further, existing studies established that the adoption of IFRSs has effects on the stocks price. The price of the stock is, however, influenced by the information available. According to Biddle, Callahan and Hong the IFRSs is of high quality relative to the past accounting standards for their adoption is significantly reducing the information asymmetries. The authors note that the information asymmetries are reduced through the enhanced cross-border comparability of financial information using common standards, and through the increased disclosure of financial information. A study by Landman and others in 2012 using the information content on earnings in terms of abnormal trading volume and the abnormal return volatility over a three-day period after the announcement of earnings found that firms in the countries that make IFRS be mandatory adopted have a greater increase in the earnings’ information content compared to those firms that do not use the IFRS. Kaya and Pillhofer state that firms that voluntarily adopt IFRSs is associated with a dip in stock synchronicity. These findings deduce that firms that voluntarily adopt the IFRSs add more firm-specific information into their stock prices and improve their information environment. A study by Bath and others in 2012 on the US firms’ accounting information exhibited higher value relevance compared to those using IFRSs. Other studies indicate that the adoption of IFRS has an effect on the cost of capital. According to Li, and Daske, firms that voluntarily adopt the IFRS have their cost of capital reduced. Li has cited the various reasons for this reduction in the cost of capital as majorly falling under two cases. First, the requirement by the IFRSs that the financial disclosure be increased, which most national accounting standards fail to do, reduces the cost of equity capital. The second reason is attributed to the uniformity of accounting standards that lead to improved information comparability across entities. A study by Li on the effects of mandatory adoption of IFRSs by 6,456 entities in 18 European Union countries for the cost of equity capital found that mandatory adopters faced a reduction in their cost of equity capital by 48 basis points. Li also compared firms that voluntarily adopted IFRSs and the compulsory adoption and established that voluntary adopters experience a significantly lower cost of equity capital than the mandatory adopters. The existing literature on the effect of IFRSs adoption of the audit work shows that the audit fees move in the opposite direction after the adoption of IFRSs. Even though, the audit fees are expected to go down because of the increased reporting quality, which lower the risks of financial misstatements, this has not been the case (Risheh and Al-Saeeda; Sun, Cahan and Emanuel; and Selling). Instead, the IFRSs call upon auditors to be extra vigilant and ensure that managers abide by its requirements (De George, Ferguson and Spear). The extra disclosure required by the IFRS in the form of footnotes requires auditors to certify previous information that is of a different nature (Chen and Zhuang). The increased audit complexity has made audit fees to increase. In addition, Chen and Zhuang note that the greater flexibility in the financial reporting process of the management allowed under the IFRS to increase the audit risk, which in turn make audit fees to increase. Another cause for the increase in the audit fees after the IFRS adoption is due to the increased adoption costs, especially with auditors whole has less expertise in auditing and knowledge of IFRS in their pursuit of getting knowledge on this new area (Risheh and Al-Saeeda; De George, Ferguson and Spear). A greater increase in the audit fee is expected where a significant gap exists between the requirements of IFRS and the requirements of national GAAPs and vice versa. Through the exploration of the existing literature, this paper established that the adoption of IFRS as a single financial reporting standard has both positive attributes and negative ones. This paper first highlights the positive effects of adopting IFRS in financial reporting. First, the results of the study by this paper established that the adoption of the IFRSs leads to a reduction in the financing cost. Through the use of IFRSs as the global accounting standards that call for a higher degree of disclosure has enabled the providers of capital to compare the value creating investment projects more effectively with the value-destroying investment projects. Through the increased disclosure by the use of IFRSs, the information asymmetries are reduced for both voluntary and mandatory adopters. By increasing the disclosure requirements by the IFRSs, the investment policies of the managers become more invisible to investors. From the increased disclosure and comparability level of financial information by the use of IFRSs reduces the agency problems that stem from the information asymmetry with the outside lenders of capital. Second, the IFRSs also led to an increased financial reporting quality, which facilitate the identification of viable investment projects by the capital providers leading to reduced adverse selection problems that entities face when issuing securities to finance their positive NPV projects. The use of IFRSs has also enhanced external monitoring through the increased accounting transparency leading to a reduction in the insiders’ dysfunctional behavior (Biddle, Callahan and Hong). Third, further results showed that the adoption of IFRSs has resulted in an increase in the investment efficiency. The increased investment efficiency is linked the increased financial disclosures and comparability that are facilitated through the use of IFRSs. The requirements of IFRSs are: a more comprehensive financial information and a higher level of disclosure. Firms using the IFRSs have thus increased their financial information disclosure and have better accounting quality. The investors ability to extract the needed information from the financial statements for investment purposes is enhanced through the higher degree of financial disclosure. To corroborate this notion, this paper established that forms are voluntarily adopting IFRSs with an aim of satisfying investors’ demand for financial information that is of a high quality. Indeed, investors’ demand is highly enhanced by the IFRS where local accounting standards are opaque, but where the adoption of IFRSs is compulsory, fewer effects are experienced since these economies already have high reporting quality (Biddle, Callahan and Hong). The cross-border comparability between the entities financial reporting has made the adoption of IFRSs to increase the investment efficiency. Through a single set of accounting standards, IFRSs standards, the investors are not required to translate the financial reporting of firms from local accounting standards to another reporting using different accounting standard. Through the enhanced comparability as a result of adopting IFRSs, there is a reduction in local bias and investors can invest in the cross-border entities that have mandatorily adopted IFRSs and have more transparent informational environments. RESULTS AND DISCUSSION The first adverse effects of IFRS adoption as per the results of this study indicated that the adoption of IFRSs affects the stock price of the adopting entity. The IFRSs enhances disclosures that affect the incentive for all market participants to collect, process, as well as trade on firm-specific information leading to a flow of this information in the market. The amount of firm-specific information that is added to the stocks price is higher for entities using the IFRS than non-adopters Kim and Shi. The effect on the stock price is, however, further influenced by the contribution of analysts where it is more pronounced if fewer analysts follow it compared to those followed by more. Despite the contribution of the IFRSs in regard to the extent of disclosure, this paper established that the amount of information incorporated into the price of the stock is influenced by the strength of a countrys institutions and the effects of adopting IFRSs is less for entities in countries with weak institutional infrastructures (Kim and Shi). This implies that the country- level institutional factors and the voluntary IFRS adoption act as substitutes. Second, further results of the study by this paper established that the required adoption of IFRSs by the reporting entities across the world is associated with some adoption costs such as the audit costs. Since the adoption of IFRSs is expected to improve potentially the financial reporting quality, there is an argument that this should lead to a reduction in the audit risk and consequently the audit fees. However, this paper established that this is not the case because the IFRSs are comprehensive, principles-based, and fair-value added. Therefore, their use requires that auditors and accountants are required to make complex estimates, besides the use of the considerable professional judgment. In their study, Kim and Shi state that the audit fee is either defined by the quality of the financial reporting, the strength of a countrys legal framework or the complexity of the audit tasks. This paper found that the adoption of IFRSs leads to increases in audit complexity. The complex arises because the auditors’ are mandated with the assessment of managers’ compliance with these new accounting standards. However, the degree of complexity will vary depending on the level of expertise of the auditors. The more experienced auditors in the IFRS based financial reports have more knowledge on IFRSs than other auditors, and the audit fee may be reflected based on the auditors effort (Chen and Zhuang). Further concerns about the adoption of IFRS is the likelihood of monopoly problems and standard setting inefficiency. However, this monopoly in standard setting will not necessarily be similar to the monopolistic setting in the traditional product markets. Given the cross-country variations in legal, political and enforcement environments, a single set of global accounting standards is unlikely to generate global conformity in accounting practice. Therefore, the adoption of IFRS may not adequately reflect the feature and the needs of the various IFRS-applying countries. The political interference in the setting of the standards will continue with the worldwide IFRS adoption, giving rise to standards adapted to local political conditions. In addition, the adoption of a global set of accounting standards will lead to a loss of diversity in accounting standards, which may negatively affect the reporting quality since a monopolistic standard setter, IASB, will have fewer incentives to satisfy its clients. Therefore, if the accounting standards are established by several bodies, a competition would be cultivated that would countervail the monopoly challenges and lead to a balanced situation in the arena of accounting standards. The supporters of the presence of several accounting standards setters argue that there will be an increased quality since they will continuously review their standards. This will ensure that there are consistent and high-quality accounting standards that are capable of adequately reflecting the changing economic environment as well capable of reacting quickly to changes in this environment. The adoption of IFRS as an international single accounting standard raises concern because of the organizational problems with the IASB. Given that the IASB lacks the political legitimacy, thereby monopoly of IFRS would make it suffer more from the problems arising from its organisational structure. Among the challenges in the IASB are its integrity and utility as it pertains to its funding situation. The IASB also faces problems regarding its ability to raise funds through mandatory payments (Kaya and Pillhofer). CONCLUSION This paper aimed at critically assessing the effects of IFRS adoption. The results of this study indicated that the adoption of IFRS has varied implications for the reporting entity, both negative and positive. These differences are contributed to whether the adoption is voluntary or mandatory. The fundamental underlying contributions of the IRFS financial reporting are its improved disclosure and comparability. The first positive contribution of IFRS is its ability to reduce information asymmetry thereby enhancing cross-border comparability of financial information. This gives rise to the next advantage of the IFRS adoption. The cross-border comparability between the entities’ financial reporting has made the adoption of IFRSs to increase the investment efficiency. Through a single set of accounting standards, IFRSs standards, the investors are not required to translate the financial reporting of firms from local accounting standards to another reporting using different accounting standard. Third, IFRS enhances increased financial reporting quality, which facilitates the identification of viable investment projects by the capital providers leading to reduced cost of capital. On the negative side of the use of IFRS, the results showed that there is increasing audit cost because of the increased audit complexity and the need to clearly certify the footnotes given by the management. In addition, the audit cost depended on the experience of the auditors with respect to the IFRS reporting and its knowledge. The experienced ones are likely to charge lower audit fees, unlike the inexperienced ones who incur other costs such as training costs on the IRFS requirements. Further studies established that there is a decrease in the reporting entitys stock price because the firms specific information is added to the stock price. Works Cited Biddle, Gary C., et al. Does Mandatory Adoption of International Financial Reporting Standards Increase Investment Efficiency? Research paper. Texas: Texas State University, 2011. Chen, Chen and Zili Zhuang. "How does mandatory IFRS adoption affect the audit service market?" School of Accounting Seminar Series. Wales: the University of South Wales, 2014. 1-45. Daske, Holger. "Economic Benefits of Adopting IFRS or US-GAAP- Have the Expected Cost of Equity." Journal of Business Finance & Accounting 33 (3-4) (2006): 329-373. De George, Emmanuel T., Colin B. Ferguson and Nasser A. Spear. "How Much Does IFRS Cost? IFRS Adoption and Audit Fees 88 (2)." The Accounting Review (2013): 429-462. Kaya, Devrimi and Julian A. Pillhofer. "Potential Adoption of IFRS by the United States: A Critical View." Accounting Horizons (2013): 271-299. Kim, Jeong-Bon and Haina Shi. IFRS reporting, Firm-specific Information Flows, and Institutional Environments: International Evidence. Research newsletter. Hong Kong: Department of Accountancy, Hong Kong University, 2013. Li, Siqi. Does Mandatory Adoption of International Accounting Standards Reduce the Cost of Equity Capital? Dissertation. Los Angeles: the University of Southern California, 2008. Risheh, Khaled E. Abu and Motaz Amin Al-Saeeda. "The Impact of IFRS Adoption on Audit Fees: Evidence from Jordan." Accounting and Management Information Systems 13 (3) (2014): 520-536. Selling, Thomas I. "Bumps in the Road to IFRS Adoption: Is a U-turn Possible?" Accounting Horizons 27 (1) (2013): 155-167. Sun, Jerry, Steven F. Cahan and David Emanuel. "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 (2011): 837-860. Sunder, Shyam. "IFRS and the Accounting Consensus." JEL (2008): 1-20. Read More