The Effects of New Accounting Standards on the Value of the Firm - Coursework Example

The Effects of New Accounting Standards on the Value of the Firm (Student’s Name) (Institution’s Name) (Instructor’s Name) (Course Code) (Date of Submission) Table of Contents Introduction………………………………………………………………………………………..3 1.1IAS adoption effects on firms’ management and decision making processes………………....4 1.2 IAS adoption effects on financial statements………………………………………………….5 1.2.1Impacts on Balance Sheet……………………………………………………………………6 1.2.2 Impacts on the Income Statement…………………………………………………………...8 Conclusion………………………………………………………………………………………...8 Bibliography………………………………………………………………………………………9 Introduction There are very many challenges which different investors face when trying to get true picture of the financial performance of their firms. The introduction of accounting standards in the company has very many impacts which affect the investors and the company itself. It has been determined that it has an impact on the company profits and sometimes it affects the overall value of the firm (Barth M et al, 2005). The introduction of accounting standards creates a universal language that is used to define, interpreted and publishes financial information that can even be understood with users of financial statements with no accounting knowledge. The purpose of the use of accounting standards is to generate standardized and logical sight of the company performance to investors (Rudhede and Wahlberg, 2003). It is proven that it also improves the financial performance as it is able to eliminate some operation costs of the business which can significantly increase the efficiency of market control and also that used for analyzing financial statements. In the case of this paper, the effect of accounting standards is discussed in two perspectives namely on the value of the firm and on the company efficiency. 1.1 IAS adoption effects on firms’ management and decision making processes The main purpose of the use of accounting standards is to portray a correct and a true picture of the business organization. The use of IAS has more impacts on the business organization beyond mere showing correct financial information about the company. The use of IAS is also important in ensuring that the firm is viewed to have higher value (Wilson, 2001). Through this the company will be able to build its goodwill which is important in improving brand name of the company (Houston and Reinstein, 2001). The use of accounting standards is also responsible in ensuring that the management becomes more accountable and responsible in the manner in which they use financial assets. Through this there is more accountability in management which in general reduces the operating cost. The use of new accounting standards is also essential in ensuring that the company makes correct and reasonable decision. This is because the use of accounting standards makes the company to have relevant, correct and accurate financial information which reflects true status of the business (Rudhede and Wahlberg, 2003). This helps to develop correct forecast and estimates which are important in decision making process. The understanding and adherence to accounting standards makes the company to be more understandable, comparable to users which help them to have valid and correct information for analyzing the potential of the business organization (Hung and Subramanyan, 2004). This is important in supporting the investor’s decisions which can increase the value of the firm by investing more cash in the business project. 1.2 IAS adoption effects on financial statements The effect of accounting standards has both effect on the income statement and the balance sheet. It is effective to examine the implication of the accounting standards on the financial statement because it may have indirect economic influences on the company (Wilson, 2001). The introduction of accounting standards in the financial statement ensures that the company is able to provide clear information to the users of financial statement. This ensures that different accounting methods are used when preparing financial statements (Rudhede and Wahlberg, 2003). Through this the company or business organization is able to report high returns which is important in building the company’s goodwill. The use of IAS is important in ensuring that the company is able to make comparison with its competitors. This helps investors to understand the business environment which is important in decision making. 1.2.1Impacts on Balance Sheet The introduction of new accounting standards improves the value of the firm as it cause a reduction in the net asset. It causes a change in the figure which is indicated in the last balance sheet. This results from the creation on internally generated goodwill on the brand name of the company which cannot be realized by the investors (Saint-Gobain Group, 2005). The effect of new accounting standards is recognized in the value of the firm when there is switching of to IFRS on the opening balance sheet. The main changes which can be observed include reduction in the shareholder’s equity, increase in debt, and increase in gearing ratio. The decrease in goodwill is also realized because there is re- measuring of the foreign operations in relation to IAS-21 and also as a result of cancellation of goodwill (Rudhede and Wahlberg, 2003). The introduction of new accounting standards has the potential to show an increase in the net book value of property, plant and equipment. This is possible when IAS -16 is used where it results into a bigger figure as compared to past accounting principles. This is because it is shown as a retrospective improvement in the usefulness of these assets which can also influence the writing back of depreciation. This change in accounting standard can cause the use of cost method of depreciation which is explained clearly in IAS-16 which indicates an increase in the book value of assets (Dumontier and Raffouriner, 1998). The introduction of new accounting standards is also able to make the intangible assets and goodwill to be realized as indefinite live assets. The reduction in the net value of assets is contributed by the fulfillment of the requirement of the principle to provide an opportunity for the differed tax liability which is determined by the difference between carrying value of assets and their cost (Karamanou and Nishiotis, 2005). The reduction in Goodwill reduces the value of the net assets since it is subject to annual impairment test which involves the removal of amortization expenses (IASB, 2002). This generally increases the reported net profit for the year. The use of new accounting standards cause an increase in differed tax in section IAS-12 which changes due to introduction of a further differed tax that originates from acquired company brands which underwent a reduction in tax rates (Easly and O’Hara, 2004). The introduction of accounting standards has caused significant impact on this company’s balance sheet. In the initial use of IFRS, in the acquisition, the property, plants and equipment had an increase in value due to change in depreciation method reducing balance to cost based method (Combarros, 2001). There is also an impact of new accounting principles on the debt which ensure that the company is able to increase its debt. This is because the value of debt of the company depends on the ability of the firm to borrow more (Karamanou and Nishiotis, 2005). The use of new accounting standards ensures that the company indicates high profitability. This is important in showing a positive picture about the company which is therefore able to convince creditors to grant more credit to the company. 1.2.2 Impacts on the Income Statement New accounting standards also have an impact on the income statement. IAS causes an increase in sales and other operating income (Blanc, 2003). The result of this influences the increase in profit margin. This increase is reflected by the introduction of IAS-19 and IAS -16. IAS-19 is caused by the reclassification which is done in financial income in general and IAS -16 because an increase through decrease in depreciation expenses due to adoption of cost based method. The above results comes a bout because of the above explanation (Gebhardt and Swaminathan, 2001). The increase in value of this firm also resulted from the removal of goodwill amortization which is proven by Barth et al (2005) who suggested that under IAS net income experiences considerable fluctuations. Conclusion There are a number of conclusions which can be made on the effect of new accounting standards on the value of the firm. From the above argument, it is important to conclude that there are a number of effects of IAS on the financial statements. This can be observed directly than any other impact of IAS. To determine more impacts, it is important to conduct further analysis of other accounting standards on the financial statement. This will help in ensuring that every company is it private or limited company adopts different accounting standards. The accounting standards are also important in ensuring that the company published its correct, accurate and reliable financial information to the public. This can help in making effective decision for the company and the investors. In summary the use of new accounting standards has a multiple, positive and direct impacts on the firm’s value. It increases accountability and transparency on how the company uses its finances so that it can meet both company and shareholders goals. Bibliography Barth, M.E., Landsman, W. and Lang, M. (2005) International Accounting Standards and Accounting Quality, Journal of Accounting, p.1-41. Available in the library Blanc, L. (2003) International Accounting Standards - The impact on your Business Systems. Financias, [on line]. Available from: www.oracle.com/lang/fr/applications/newsletter/WP_NormesIAS_Mars03.pdf [Accessed Date 01/12/2005] Combarros, J. L. L. (2001). Accounting and finance audit harmonization in the European Union. European Accounting Review, 9(4), p.643-654. EBSCO host [Accessed Date 30/11/2005] Dumontier, P. and Raffouriner, B. (1998) Why Firms Comply with IAS: an Empirical Analysis with Swiss Data. Journal of International Financial Management and Accounting, 9(3), p.216-242. EBSCO host [Accessed Date 29/11/2005] Easly, D. and O’Hara, M. (2004) Information and the Cost of Capital. Cited in: Karamanou, I. and Nishiotis, G. (2005) The Valuation of Firm Voluntary Adoption of International Accounting Standards. Working Paper, University of Cyprus, p.1- 34. Available in the library Gebhardt, W., Lee, C. and Swaminathan, B. (2001) Toward an Implied Cost of Capital. Journal of Accounting Research, 39(1), p.135-176. EBSCO host [Accessed Date 29/11/2005] Houston, M. and Reinstein, A. (2001) International Accounting Standards and their Implications for Accountants and US Financial Statement Users. Review of Business, 22(1/2), p.75-80. EBSCO host [Accessed Date 29/11/2005] Hung, M. and Subramanyan, K.R. (2004) Financial Statement Effects of Adopting International Accounting Standards: The Case of Germany. Working Paper, University of Southern California, p.1-37. EBSCO host [Accessed Date 29/11/2005] International Accounting Standard Board (2002) Exposure Draft: Improvements to International Accounting Standards. [on line]. Available from: http://www.iasc.org.uk [Accessed Date 01/12/2005]10 Karamanou, I. and Nishiotis, G. (2005) The Valuation of Firm Voluntary Adoption of International Accounting Standards. Working Paper, University of Cyprus, p.1-34. Available in the library Rudhede, P. and Wahlberg, J. (2003) Implementation of IAS in SKF. Unpublished MSc, dissertation, Graduate Business School – Göteborg, [on line]. Available from: http://www.handels.gu.se/epc/archive/00002756/01/gbs%5Fthesis%5F2002%5F47 pdf [Accessed Date 01/12/2005] Saint-Gobain Group (2005) Main impacts of the Switch to IFRS on the Group’s 2004 Financial Statements. Annual Report – 2004, [on line]. Available from: http://www.saint-gobain.com/en/html/investisseurs/rapport/RA04GB-as.pdf [Accessed Date 04/12/2005] Wilson, A. (2001). IAS: the challenge for management. Cited in: Rudhede, P. and Wahlberg, J. (2003) Implementation of IAS in SKF. Unpublished MSc, dissertation, Graduate Business School – Göteborg, [on line]. Available from: http://www.handels.gu.se/epc/archive/00002756/01/gbs%5Fthesis%5F2002%5F47 .pdf [Accessed Date 01/12/2005] Read More