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EFFECT OF INTERNATIONAL FINANCIAL REPORTING STANDARDS ADOPTION ON EARNINGS QUALITY OF LISTED CONGLOMERATE FIRMS
Chapter
One
Introduction
1.1
Background to the Study
The International Accounting Standards
Board’s (IASB) has equally acknowledged the need to improve reporting quality
globally. Consequently, the IASB promotes the application of a common set of
financial reporting standards as a solution. Further, extant literature
suggests that applying diverse accounting standards around the world often
results in the use of different criteria for resources accounting (IASB, 2009;
Lorchir, 2015). Analysts view that this creates inconsistencies in the
investment information employed by global investors; a gap that is expected to
be narrowed by global application of IFRS. In this regard, complying with IFRS
is expected to facilitate informed trading and reduce adverse selection in the
market. Information asymmetry puts small investors, who are less likely than
their sophisticated counterparts to generate financial information from
alternative sources at a disadvantage in the market (Ball, 2006). The notion
behind the promotion of a common set of high-quality standards globally is that
the risk and cost of processing financial information to investors is reduced. Hassan
(2015) opined that in Nigeria, the information disclosure requirements in the
financial statements under Nigerian generally accepted accounting principles
(NGAAP) were grossly inadequate to effectively bridge the information asymmetry
between companies and the users of the financial statements. Shehu (2011) posit
that financial information quality in Nigeria remains weak compared too many
advanced jurisdictions. This resulted in the hampering of the growth of
efficient equity markets. A common complaint among investors in Nigeria is that
financial information on company performance is either unavailable or, if
provided, lacks reliability. Hence, he conceived that companies will disclose
more of their financial information with the transition to IFRS. The adoption
of IFRS definitely affects many aspects of accounting. For instance, the
introduction of fair value principle, which is regarded as the most important
implication of IFRS, motivates more debate on the adoption of the standards.
More clearly, IFRS required the use of fair value contrary to the book value as
used by Nigerian GAAP. It is believed that fair value provides up-to-date
information about assets as it reflects their real value. However, impairment
test is carried out on goodwill under IFRS, while it expected to be amortized
under NGAAP. Adeyemi (2016) is of the opinion that managers have more
flexibility under IFRS and may intend to use their accounting decisions to
manipulate impairment test of goodwill which could affect the quality of
reported earnings. Likewise, NGAAP allows convertible debt to be recorded as
long-term debt, while the IFRS records convertible bonds separately into the
equity component and the debt components. IFRS which is a principle-based
accounting method give managers significant flexibility and discretion and
leave more room for earnings manipulation than rule-based accounting standards
NGAAP (Adeyemi, 2016).
Application of the IFRS is expected to
produce higher quality financial information because the International
standards are characterised by features that facilitate reporting of quality
accounting information (Barth et al, 2008). Earning quality is defined in SFAC
No.1 (2008) as earning of higher quality that provides more information about
the feature of a firm‟s financial performance that is relevant to a specific
decision made by a specific decision maker. The quality of accounting
information is often determined by the quality of the reported earnings
(Schipper, 2003). Researchers use different methods in determining the quality
of reported earnings, and so, there is no universal approach on how to
determine quality of the reported earnings. Schipper and Vincent (2003)
consider three earnings quality constructs: persistence, predictive ability,
and the time-series variance of earnings as measures of earnings quality. These
constructs are consistent with the Conceptual Framework which suggests that
earnings quality might be assessed by some combination of persistence,
predictive ability, and variability of earnings. Earnings being one of the most
significant economic variables in financial statements serve as a decision base
for different users of financial information. The IASB‟s campaign on the global
adoption of IFRS has recorded considerable achievements and over 120 countries
have adopted or officially allowed IFRS (PWC, 2014). Other countries are
establishing timelines to adopt the IFRS. However, the perception that adoption
of IFRS is likely to increase quality in reporting earnings and usefulness of
financial statements globally has generated considerable debate. Studies
(Lorchir, 2015; Barth, & Schipper, 2008; Atwood, Drake, Myers, &
Myers,2011; Agostino, Drago, & Silipo,2011) have analysed the impact of
IFRS adoption on earnings quality. Different perspectives are followed,
targeting various countries and continents. There are two conflicting views
regarding the influence of IFRS adoption on accounting quality. Some studies
show that IFRS implementation improves earnings‟ quality. In particular,
proponents such as Agostino et al, (2011); Lorchir (2015) argued that firms
reporting under IFRS provide more decision-useful accounting numbers, for
investment and lending purposes relative to firms reporting under domestic
accounting standards. The decision usefulness of IFRS compliant accounting
numbers from a theoretical standpoint has also been established. Furthermore,
others such as Carmone and Trombetta (2008) and Barth and Schipper (2008)
argued that the principles‟ orientation underpinning the conceptual framework
of IFRS is likely to discourage fraud.
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