IFRS and accounting quality: legal origin, regional, and disclosure impacts

• Published date: 01 August 2016
• DOI: https://doi.org/10.1108/IJAIM-11-2015-0075
• Pages: 296-316
• Date: 01 August 2016
• Author: Ajit Dayanandan,Han Donker,Mike Ivanof,Gökhan Karahan

IFRS and accounting quality:

legal origin, regional, and

disclosure impacts

Ajit Dayanandan and Han Donker

College of Business and Public Policy, University of Alaska Anchorage,

Anchorage, Alaska, USA

Mike Ivanof

School of Business, University of the Fraser Valley, Abbotsford, Canada, and

Gökhan Karahan

College of Business and Public Policy, University of Alaska Anchorage,

Anchorage, Alaska, USA

Abstract

Purpose – The purpose of this study is to examine whether the quality of nancial reporting has

improved after the adoption of International Financial Reporting Standards (IFRS) in Europe and

across the world. The study investigates the impact of IFRS on income smoothing and earnings

management in different geographic regions under different legal origins and disclosure environments.

Design/methodology/approach – To measure income smoothing in the pre- and post-IFRS periods,

the authors use the coefcient of variation and the panel unit root model proposed by Im et al. (2003) for

testing whether net income is stationary throughout the sample period. The study uses a dynamic panel

estimation framework, as it captures the dynamics of IFRS on discretionary accruals efciently.

Discretionary accruals are used to measure earnings management.

Findings – The results suggest that the adoption of high quality standards, such as IFRS, reduces

income smoothing and earnings management. In addition, the study nds that earnings management

has decreased in the post-IFRS period, in particular, for French and Scandinavian civil law countries,

but not for German civil law countries and common law countries. The latter can be explained by the

fact that common law countries have strong investor protection laws, strict law enforcement and high

disclosure levels of nancial information. The study also nds empirical evidence that the adoption of

IFRS reduces earnings management in countries with high levels of nancial disclosure. Overall, the

study shows that the adoption of IFRS improved the quality of nancial reporting.

Originality/value – This study is useful for accounting standard setters across the world, including

those countries that have not yet decided to adopt IFRS. The study contributes to the literature by

examining the adoption of IFRS in income smoothing and earnings management under different legal

regimes and disclosure environments by using advanced empirical methodologies.

Keywords IFRS, Disclosure, Legal systems, Earnings management, Income smoothing,

Accounting quality

Paper type Research paper

1. Introduction

With globalization of international nancial markets, the process of political integration

exemplied by the European Union (EU) as well as rms’ operations in different

The current issue and full text archive of this journal is available on Emerald Insight at:

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IJAIM

24,3

296

Received 6 November 2015

Revised 7 December 2015

Accepted 7 December 2015

InternationalJournal of

Accountingand Information

Management

Vol.24 No. 3, 2016

pp.296-316

©Emerald Group Publishing Limited

1834-7649

DOI 10.1108/IJAIM-11-2015-0075

jurisdictions are the driving force behind the call for a common language for nancial

reporting (Ball, 2006;Whittington, 2005;Carmona and Trombetta, 2008). The

International Accounting Standards Board developed International Financial Reporting

Standards (IFRS) with the aim of harmonization of nancial accounting standards

across countries (Crawford et al., 2014). This initiative took a new turn when European

Union (2002) mandated (as of 1 January 2005) all companies domiciled in the EU with

shares listed on securities exchanges to prepare their consolidated accounts in

accordance with IFRS. Approximately 140 countries have now permitted IFRS adoption

for domestic listed countries. A distinctive feature of International Accounting

Standards (IAS)/IFRS standards is that they are “principles-based” instead of

“rules-based”, which include specic criteria, bright line thresholds etc. (Nelson, 2003).

The introduction of IFRS was not without controversy, with some welcoming it as a step

towards “fair value accounting”, enhancing the comparability of nancial statements

across countries, thereby generating capital market benets such as improving the

corporate transparency, liquidity and market efciency. Lowering the cost of equity

capital and improving regulatory enforcement and corporate governance were also

mentioned as expected major outcomes (Botosan, 1997;Botosan and Plumlee, 2002;Hail,

2002;Francis et al., 2004;Hail and Leuz, 2006). On the other hand, a survey of EU listed

companies in 2004 found that majority of the rms agreed with the view that IFRS

would lead to increased volatility of earnings (Jermakowicz and Gornik-Tomaszewski,

2006).

The empirical evidence about these presumed benets of IFRS is often conicting

and controversial. Research on IFRS impacts has generally focused on whether the

benets of IFRS depend on the type of adoption – mandatory or voluntary – (Daske et al.,

2008) – IFRS and information asymmetry (Leuz, 2003), whether benets of IFRS occur in

countries whose accounting standards are signicantly different from international

standards (Brochet et al., 2013), how IFRS impacts cost of equity capital (Daske, 2006;

Lambert et al., 2007), analysts’ information environment (Chalmers et al., 2012;Jansson

et al., 2012 Horton et al., 2013), value relevance (Liu et al., 2011;Jermakowicz et al., 2007;

Devalle et al., 2010;Clarkson et al., 2011) and accounting quality (Ashbaugh and Pincus,

2001;Barth et al., 2008a,2008b;Chen et al., 2010;Ahmed et al., 2013), whether IFRS

improves market liquidity (Daske et al., 2008) and IFRS and IFRS impacts in emerging

market economies such as China (Liu et al., 2011;Kim, 2013;Wang et al., 2012;Zhang

et al., 2012) and Peru (Liu et al., 2012). Zeghal and Mhedhbi (2012) demonstrate that the

development of the emerging capital markets is positively and signicantly associated

with the use of IFRS. Chen and Rezaee (2012) examined the role of corporate governance

in an emerging capital market. They show that Chinese listed companies that have a

more effective board of directors tend to be more aligned with IFRS under the Chinese

new accounting standards. Most of the extant literature examines the effect of IFRS on

a group of rms in a single country or a group of countries without consideration of the

institutional landscape of the countries (such as legal system, level of investor

protection, etc.). The impact of IFRS depends not only on the enforcement mechanisms

(Ball et al., 2003;Barth et al., 2008a,2008b;Daske et al., 2008) but also on reporting

incentives of rms, which are shaped by a number of institutional factors such as legal

system, taxation systems and nancing systems of countries (Nobes, 2006,2013;

Jeanjean and Stolowy, 2008;Kvaal and Nobes, 2010). Solsma and Wilder (2015) nd that

US listed foreign rms applying IFRS report pro forma disclosures more frequently

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IFRS and

accounting

quality