Quality of Accounting and the IFRS

The Effectiveness of International Financial Reporting Standards (IFRS) on Accounting Quality

The worldwide adoption of International Financial Reporting Standards (IFRS) has led researchers to investigate their effectiveness in improving financial reporting accuracy. Although IFRS is known as a high-quality collection of accounting standards, the economic implications of implementing IFRS are still a source of contention among administrators, investors, and regulators. Because of the increased interest of companies looking to invest in developing markets, many developed nations tend to have already incorporated IFRS into their financial reporting system. Furthermore, the framework has been adopted by the majority of African developed countries. And despite, the unfriendly economic and political conditions of some nations such as Palestine, their authorities have managed to establish financial institutions which are providing essential services. Even further, they have integrated IFRS into their financial reporting system because of its high financial reporting principles. Worthy to note is the fact that accounting quality is essential for users who use the reports for the purpose of decision making and investment. Therefore, an appropriate adoption of high-quality standards of accounting can provide consistent, comparable, relevant and reliable financial data. In this case, the global implementation of IRFS increases transparency, enhances the quality of financial statement and in the long run improves accounting quality.

Accounting Quality and its Dimensions

Accounting quality means the level at which the information of a financial statement replicates the fundamental economic state (Indrawati, 2015). According to global accounting writings, accounting quality is recounted as a comprehensive model which has multiple dimensions. In this paper, the discussion looks into different magnitudes of accounting quality particularly returns engagement, prompt cost acknowledgement and quality applicability to portray the effects of IFRS on accounting value (Paglietti, 2010).

Earnings Management

Earnings management involves a practice by executives to misinform some shareholders about the financial record of a business or to sway the result of agreements that might have an impact on their returns (Paglietti, 2010). In the long run, it leads to managers manipulating financial information to attain a pre-specified level of returns. Earnings management is mostly exhibited through income smoothing and managing towards positive returns. In this case, the former refers to the practice of influencing the time plan of income to make the revenue pipeline less adjustable whereas at the same time not aggregating the incomes in the long run. The latter is a practice where corporations use accounting discretion to announce small proceeds and avoid minor losses, in the long run, they misrepresent the actual economic performance of a company (Rudra & Bhattacharjee, 2012). In case of a reduced earnings management, it shows that there is improvement in accounting quality.

For instance, Sellami & Slimi (2016), state that mandatory implementation of IFRS by businesses supports the reduction of earnings management (EM) in emerging nations. Based on the studies carried out in South Africa and Nigeria, the results indicate that companies in these nations have experienced a reduction in the extent of discretionary accruals and improved quality accruals as a result of transitioning to IFRS. This is because, IRFS upholds high-quality standards of accounting which allow it to limit opportunistic discretion in management and advance the value of financial data (Chan et al., 2015).

In developed nations, particularly the European Union, evidence gathered from 21 nations portray that the adoption of IFRS reduces EM (Tort, 2013). Despite the general assumption that institutional dynamics and law enforcement are a significant determining factor for the quality of accounting and a potent tool for restricting unscrupulous behaviors. EM occurs because managers have (buried) incentives to misinform financial evidence in order to meet particular earnings inceptions. Nations that have robust equity markets and high investor fortification limit insiders’ capacity to obtain private control remunerations, which decreases their incentives to disguise company performance. Tort (2013) states that IRFS has clear standards of reducing earnings management by curtailing the incentives and in the end having a positive effect on accounting quality.

Earnings control is one aspect of financial reporting that is considered receptive to incentives of accounting quality. In most cases, these concepts rely on policies of management and therefore, they have high chances of being influenced by characteristics and incentives of the principal organization financial reports. Earnings management recognizes progressive incomes as a collective target of incomes control. A sign of progressive earnings management is a better occurrence of lesser progressive incomes. The model fundamental to this target is that management portrays an advancement in accounting value. Studies show that the acceptance of accounting principles which hinder the discretion of controlling leads to a high difference in accounting return. As a result, the convergence of IFRS lowers earnings management which is a sign of high accounting quality.

Timely Loss Recognition

On the other hand, Paglietti (2010) argues that besides IFRS causing a decrease in earnings management, it increases prompt loss acknowledgment and is also a significant player in improving accounting quality. For instance, studies focusing on timely loss recognition in connection with improving accounting quality indicate that voluntary embracing of IFRS has resulted in increased timeliness in the manner of recognizing large losses. The findings exhibit that the voluntary acceptance of IFRS by businesses has advanced a contemporary timeliness in the manner of acknowledging economic losses which are related to the gains in the reported income. Hu et al. (2014) further states that timely loss recognition does not just facilitate the flow of a company’s private information to outsiders but enhances the efficacy of corporate governance and disciplines managerial opportunism.

Fontes et al. (2005), argues that the prompt acknowledgment of losses and gains which are consistent with the quality of increased returns tends to enhance the unpredictability of earnings in line with the flow of cash. Companies which have voluntarily adopted IFRS show prompt loss recognition. Normally, a high quality of earnings portrays a high occurrence of huge losses. This is dependable on the findings of different studies which established that one feature that is connected to increased income quality is the fact that huge losses are acknowledged as suffered rather than differed to a later date. This aspect is strictly connected to returns smoothing which shows that when salaries are smoothed and huge losses become comparatively rare. Though the opposite can happen when the projected outcomes of high accounting value experience advanced rates of large losses. A higher rate of large losses can take place because of errors when estimating accruals. Therefore, when there is extraordinary accounting value, it can lead to a lower occurrence of big losses. For that reason, the adoption of IRFS enhances prompt loss recognition which is an indication of high value of accounting.

However, it is also vital to note that based on the findings of some studies, accounting quality does not necessarily improve when companies adopt IFRS (Chan et al., 2015). These results indicate that the implementation of IFRS also requires incentives to improve accounting quality for companies. The second implication states that even when publicly registered firms function in the same institutional structure, incentives for managerial financial reporting dictate the standards of accounting in defining the quality of accounting (Chan et al., 2015). The findings further suggest that the existing emphasis of auditors on the principles of accounting quality might not at all times produce greater accounting quality. Therefore, improving accounting quality based on the adoption of IFRS relies on the reporting spurs of those making the books, rather than the values themselves (Vardia et al., n.d.)

Value Relevance

Besides contentious results based on the influence of IFRS on prompt loss recognition, different studies point out that the implementation of IFRS positively and meaningfully increases the significance of financial reporting in the area of value relevance (Vardia et al., n.d). In this case, Value relevance refers to the capacity of data revealed by financial statements to capture and summarize the worth of a business. Value relevance can be assessed via the statistical associations amid the evidence offered by the values of the stock market and financial statements (Sellami & Slimi, 2016). Several empirical studies have utilized value relevance in assessing the effects of adopting IRFS on the quality of accounting data and this is because it focusses on investors as the fundamental user of financial reporting (Vardia et al., n.d). Also, this methodology provides the opportunity to assess how the IFRS compliant data is in line with the events that are incorporated in market value.

It is always projected that a firm with high accounting excellence has a high connection concerning earnings, prices of stock and book value of impartiality because higher quality returns are in a better position of explaining the financial side of a firm (Sellami & Slimi, 2016). First, because high quality of accounting requires the use of accounting principles to acknowledge the amount that represents the fundamental financial representation of a firm. Second, exceptional accounting excellence is not prone to unscrupulous managerial policies (Fontes et al., 2005). These two aspects of high accounting quality portray accounting principles which restrict opportunistic behaviors in strategies of accounting that have advanced relevance value. Furthermore, extraordinary accounting value which supports non-opportunistic events has fewer inaccuracies when assessing accruals. In line with these three aspects of high quality of accounting, preceding research indicate that there is advanced quality of returns over the value applicability (Fontes et al., 2005). As a result, it is probable that when a company applies IFRS, it will show a higher value applicability of book quality and net revenue of the company which is a sign high accounting value.

In conclusion, while earnings management, prompt loss acknowledgment and value applicability are essential for determining the influence of IFRS on accounting value, accounting standards such as political, incentive and legal systems also have an impact on accounting value. Therefore, outcomes attained from experimental studies concerning the influence of IFRS acceptance on the value of accounting ought to be construed in connection with particular nation and company factors. Furthermore, assessing the influence of IFRS on the quality of accounting is essential but then again not sufficient. It is also important to evaluate the impact of the increased information quality accessible in the financial reports.

References

Chan, A. L. C., Hsu, A. W. H., & Lee, E. (2015). Mandatory adoption of IFRS and timely loss recognition across Europe: The effect of corporate finance incentives. International Review of Financial Analysis, 38, 70-82.

Fontes, A., Rodrigues, L. L., & Craig, R. (2005, December). Measuring convergence of national accounting standards with international financial reporting standards. In accounting Forum (Vol. 29, No. 4, pp. 415-436). Elsevier.

Hu, J., Kim, J. B., & Lin, Z. J. (2014). Does Timely Loss Recognition Improve the Board’s Ability to Learn from Market Prices? Evidence from Worldwide CEO Turnovers. Journal of International Accounting Research, 14(1), 1-24.

Indrawati, N. (2015). The Impact of Convergence with International Financial Reporting Standards (IFRS) on Accounting Quality in Indonesia. Research Journal of Finance and Accounting 6 (4), 162-170.

Paglietti, P. (2010). Earnings management, timely loss recognition and value relevance in Europe following the IFRS mandatory adoption: evidence from Italian listed companies. Economia aziendale online, 1(4), 97-117.

Rudra, T., & Bhattacharjee, C. D. (2012). Does IFRS influence earnings management? Evidence from India. Journal of Management Research, 4(1), 1.

Sellami, Y. M., & Slimi, I. (2016). The effect of the mandatory adoption of IAS/IFRS on earnings management: Empirical evidence from South Africa. International Journal of Accounting and Economics Studies, 4(2), 87-95.

Tort, L. P. (2013). Earnings Management under IFRS and PGC. Revista de Contabilidad y Dirección, 16, 161-185.

Vardia, S., Kalra, N., & Soral, G. an impact of IFRS on the value relevance of financial statements: a study of selected Indian listed company. Indian Journal of Accounting, 7.