IFRS adoption or convergence goes beyond just being another regulatory mandate
A lot has already been spoken about IFRS. For one reason being that, currently, there are 117 countries that have either adopted or committed to adopt IFRS. But, last month the US SEC announced that companies could start using IFRS no sooner than 2015 - a year after from the earlier timeline of 2014. However, according to a recent survey conducted by KPMG, 49% US executives said they would like the option to adopt IFRS before 2015.
Reasons such as cost of switching accounting systems, maintaining liquidity during financial crisis, increased reliance on auditor and management judgment under IFRS etc. are being cited for driving the SECs decision.
Hence, a question arises “Why in the first place consider adopting or converging to IFRS?” A preliminary internet search did not reveal any convincing findings. To my dismay, the Big 4 have not dwelled into why a company should consider a voluntary adoption and seem to have adopted a retroactive approach driven by the regulatory environment. One is, thus, led to believe that the adoption/convergence to IFRS starts and ends as a mandate.
On researching further, I was able to list down some of the most interesting findings from various articles and quantitative research carried out especially around the time of adoption of IFRS in EU. Majority of these empirical studies, on the effects of IFRS adoption, have been carried out on the market/investor related information (such as bid-ask spreads, market returns etc.) from various countries around the dates of IAS related announcements or the time post its adoption. (The points below are in not in any particular order)
1. Investors benefit from a common reporting regime – In a recent paper published in Science Direct, authors by comparing two companies reporting in both IFRS and US GAAP demonstrated that different sets of reporting standards can lead to different decisions. For e.g., while under US GAAP one of the companies turned out to be an attractive investment, the other company seemed more appealing under IFRS. Thus, moving to a single international accounting standard will benefit the decision making of investors2. Increased Access to capital – As this point roots from the preceding one, I would only cite the benefit to cross-border investments from increased comparability of financial reporting. Recent empirical evidence (Leuz et al. 2008 etc.) suggests that comparable reporting across firms from different countries facilitates cross border investment and integration of capital markets thus resulting in higher FII flow, lower cost of capital and improved risk sharing
3. Reduced Information Asymmetry – According to accounting theory, financial reporting reduces information asymmetry by disclosing relevant and timely information. Researchers Horton et al. (‘08) and Wang et al. (‘08) found direct evidence linking improvement of the information environment with the mandatory adoption of IFRS. They used analyst forecast properties like forecast accuracy and forecast dispersion, alongside the relative information content of earnings announcements, as measures of information asymmetry
4. Future Cost Savings – Investors can benefit from the time saved on reconciliation of multiple accounting standards, thus amounting to substantial cost savings. Multinationals having global operations in IFRS driven countries (of majority in the time to come) will also find cost savings by having all their business units/investments on a common accounting platform
5. Overhauling the IT strategy – While there is no factual research supporting this, but it is widely believed that the adoption of IFRS can help firms overhaul their existing financial systems, i.e. re-evaluate and re-design using clean sheet of paper, thus leading to better auditing, transparency and higher cost savings from automating manual activities
6. Rules Based (US GAAP) to Principles based (IFRS) – According to a ‘08 survey by Grant Thornton of 200 CFOs across US, 70% believed that the financial statements are too complex for the average investor and around 60% preferred principles based over rules based accounting principles
The benefits of IFRS adoption cannot be generalized for all companies (or countries) as they completely depend on the reporting incentives available to firms and the local regulatory enforcement practices. Between 2003 and 2005, multiple empirical researches were carried out comparing IFRS versus US GAAP and German GAAP. The results suggested that the market participants do not perceive differences in quality of financial reports prepared under US GAAP and IFRS, but however, the firms reporting as per German GAAP had a weaker relation between their earnings and market returns. The benefits, hence, would be higher for firms that move to IFRS from a standard perceived to be of lower accounting quality, that is, the one which currently scores low on (a.) relevance of financial information to the investor and creditor, (b.) ability of financial information to reliably measure a company’s economic position and performance, and, (c.) extent of investor protection provided by the local regulator.
To summarize, from a macro-perspective the regulator of a country currently under a high quality accounting standard regime might not see huge benefits from transitioning or converging with IFRS, but nevertheless, would follow/converge with the global trends. But, from a micro-perspective, a firm having global aspirations, and presence, in terms of business operations or funding requirements can attain competitive advantage, atleast in the short term, with IFRS.