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INTERNATIONAL MANAGEMENT INSTITUTE-KOLKATA

2/4 C, Judges Court Road, Alipore, Kolkata-700027

NATIONAL CENTRE FOR CORPORATE GOVERNANCE

(Accredited by National Foundation for Corporate Governance)

Research Report

On

IMPLICATIONS OF IFRS ON DIFFERENT SECTORS (Part –A)

Asish K Bhattacharyya Head, National Centre for Corporate Governance

August 2012

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EXECUTIVE SUMMARY

The movement for the harmonisation of accounting practices through convergence of

local accounting standards with IFRS or through adoption of IFRS has lost steam.

The SEC has decided to defer the decision on the method of endorsement of IFRS and

in deciding the timeline for the endorsement of IFRS. Many experts believe that SEC

will take the route of condorsement. Japan has deferred its decision to make IFRS

mandatory for listed and other companies. China is moving towards convergence of

its accounting standards with IFRS. However, significant gap exists between Chinese

GAAP and IFRS. Moreover the implementation of accounting standards in China is

weak.

Most E.U. countries do not permit preparation of individual financial statements using

IFRS. Canada has adopted IFRs in 2011.

One of the reasons for the slowing down of the movement for harmonisation of

accounting practices through the adoption of IFRS or convergence of local standards

with IFRS is that results of studies around adoption of IFRS by the E.U. countries

could not establish conclusively that adoption of IFRS per se improves the reporting

environment. Moreover, uniformity in implement of IFRS and the cost of

implementing IFRS are concerns expressed at various quarters. In absence of the

uniformity in implementation, the perceived benefits of harmonisation of accounting

practices will not be realised.

Therefore, mandatory adoption of IFRS benefits some and hurts others. There will be

‘winners and losers’. Multinational firms, large size firm, and those which are listed

in stock exchanges abroad are likely to benefit from the adoption of IFRS and those,

which are family controlled and depends on funding from banks and other financial

institutions will be the potential losers.

Recommendations

SEC is going slow in endorsing IFRS, while FASB is working closely with IASB for

bridging the gap between U.S. GAAP and IFRS. Japan has deferred the decision to

make application of IFRS mandatory. The debate on practical benefits of adopting

IFRS has again surfaced. Evidence collected by academicians has failed to establish

that adoption of the IFRS improves the information environment. Although U.S.A.

and Japan has reiterated their commitment to either adopt IFRS or converge local

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accounting standards with IFRS, they articulated that they need more time to evaluate

the impact of IFRS on firms and the society.

In view of the above, India should take a cautious approach. It should study the

impact of IFRs in different sectors of the economy and on the society before

implementing IndAS. Another round of discussion and public debate is required to

ensure that adoption of IFRS does not harm the economy. While developing the

IndAS, NACAS adopted the approach of minimum deviation from IFRS. In

reviewing the IndAS based on inputs from impact study, the government may decide

to make changes, wherever necessary.

In the mean time, the government should strengthen the regulatory measures to ensure

proper implementation of accounting standards. The level of disclosures may be

improved benefit of capital market and to improve the contracting efficiency.

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REPORT

Nature of the project: Research project

Project title: Implications of IFRS on different sectors

Team leader: Prof. Asish K Bhattacharyya, Head of the National Centre

for Corporate Governance, International Management

Institute – Kolkata

This report is divided into five parts. Part I discusses the objective and scope of the

research project and the methodology adopted to achieve the research objective. Part

II discusses the status of IFRS adoption/convergence in few selected countries. Part

III surveys the literature on researches surrounding the adoption of IFRS by different

countries. Part IV summarises the findings under the heading conclusions. The Part V

provides recommendations.

PART I: ABOUT THE RESEARCH PROJECT

1.INTRODUCTION

Harmonisation of accounting practices across the globe is a pre-requisite for the

globalization of capital markets across the world. India needs foreign capital to

achieve its ambitious economic growth targeted by the government. Therefore, it is

imperative that Indian accounting practices match globally acceptable accounting

practices. IFRS has emerged as the globally accepted accounting standards. More than

100 countries have either adopted IFRS or have fully converged national accounting

standards with IFRS. Indian government is committed to implement IFRS in India.

India has adopted the strategy of achieving convergence of Indian accounting

standards with IFRS, rather than adopting IFRS without any modification. The

strategy provides the flexibility of carving out certain accounting principles and

methods from IFRS and carving in certain accounting principles and methods to make

fully converged accounting standards more appropriate for the Indian economic and

institutional environments and Indian culture. The government has notified new set of

accounting standards (IndAS), which are fully converged with IFRS. The date for the

implementation of IndAS is still to be notified. While formulating IndAS, the

National Advisory Committee on Accounting Standards (NACAS) had adopted a

policy of keeping the modifications at the minimum.

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Every one interested in corporate financial reporting agrees that, ideally, there should

be a single set of accounting standards for use across the globe. The benefits from

uniform implementation of a high quality global standard will result in high quality of

financial information, high level of transparency (resulting in less scope for

opportunistic behaviour of managers), and comparability (resulting in lower cost of

for investors and analysts in analysing financial statements).

Convergence of national standards or adoption of IFRS is a major transition in

accounting practices. Accounting practices evolve over a long period and are

influenced by business and regulatory environment, cultural heritage and the

investors’ profile. For example, India has a long history of accounting practices.

Every one does not agree that implementation of IFRS or national standards, which

are fully converged with IFRS, improves the quality of corporate financial reports,

benefits investors, increases investors’ confidence, and reduces the cost of capital.

Therefore, the debate on the benefits and related costs of implementing IFRS

continues. The debate focuses on the pros and cons of fair value accounting because

IFRS uses fair value accounting more extensively than the use of fair value in most of

the national standards. Similarly, disclosure requirements in IFRS are much more

extensive than the disclosures required under the extant Indian Accounting Standards

(AS) and disclosures required under many national accounting standards. Another

issue, which is yet to be settled, is whether uniform accounting standards really lead

to uniform accounting practices. Many believe that uniform accounting standards do

not lead to uniform practices because of implementation difficulties and different

managerial incentives in different economic, regulatory and institutional

environments.

The implementation process is slow. For example, European Union had mandated use

of IFRS for specified companies in 2005. A recent research (2011), based on 2009

data, concludes that 17 percent of those companies, which are required to use IFRS,

have not fully implemented IFRS. Similarly, although Japan had made it optional for

specified companies to use IFRS from 2010, it is yet debating whether use of IFRS

should be made mandatory. It has decided that it cannot make application of IFRS

mandatory before 2016. However, it is reported that more and more large companies

are adopting IFRS. U.S.A is still debating on the methods and timing for the

implementation of IFRS for companies domiciled in that country.

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It is observed that companies that have complex business structures and who present

consolidated financial statements adopt IFRS faster than other companies.

There is no structured study on the socio-economic impact of the implementation of

IFRS.

The increasing uneasiness among preparers, users, and regulators of financial

statements and national governments is quite palpable.

2. SCOPE OF THE PROJECT

The objective of the research project is to analyse the trends/practices being followed

by major developed and developing countries in the implementation of IFRS. The

expected outcome of the research project will be a background note encompassing

primary areas of focus or concern for India in the implementation of IFRS. The

background note will be a prelude a detailed study of the impact of implementing

IFRS or Indian Accounting Standards fully converged with IFRS (IndAS) on major

sectors of the economy, including cost of implementation, cost to investors in

analysing financial statements, socio-economic impact and implications for the global

presence of Indian companies.

The impact study will be taken in the second phase as a separate project.

3. METHODOLOGY

Secondary data/information will be used to understand the status of the

convergence/adoption of IFRS in different territories. It will be primarily a library

research based on documents available in the public space.

In the second project surveys and field study will be carried out to understand the

impact of IFRS implementation.

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PART-II: STATUS OF IFRS IMPLEMENTATION IN SELECTED

COUNTRIES

We have studied the current status of IFRS implementation in U.K, Italy, Germany,

U.S.A., Canada, China, Japan, and Australia.

4. IFRS IMPLEMENTATION IN THE EUROPEAN UNION

4.1 General Observations

In March 2002, the European Parliament passed a resolution requiring all firms listed

on stock exchanges of European member states to apply IFRS when preparing their

financial statements for fiscal years beginning on or after January 1, 2005. This

requirement affected approximately 7,000 firms. The adoption of IFRS in Europe

reflects a EU goal of achieving capital market integration; it is a necessary step

towards convergence of financial reporting not only across Europe, but also between

Europe and the rest of the world.

EU adopted all the IAS without any change except, IAS-39, Recognition and

measurement of financial instruments. The European Commission (EU) endorsed

IAS-39 with certain carve outs, which relate to hedge accounting.

The European IAS regulation applies not only to the 27 EU Member States but also to

the three members of the European Economic Area (EEA) - Iceland, Liechtenstein,

and Norway.

Effective from 1st January 2005, all listed companies, including banks and insurance

companies, started preparing their consolidated financial statements in accordance

with IFRS.

The application of IFRS to unlisted companies and to Individual Financial Statements

differs from country to country.

The IFRS adopted in the EU countries is called ‘IFRS – EU’. This contains all the

IFRS standards, which have been adopted by the European Union. We analysed the

financial statements of 20 listed companies of Germany, United Kingdom, France and

Italy. All the companies provide unreserved statements regarding the adoption of

IFRS –EU.

Some countries have permitted/ required IFRS for Individual Financial Statements

also.

4.2 United Kingdom

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GAAP requirements to individual financial statements

In regard to their individual financial statements, listed companies are given an option

to prepare it either in accordance with IFRs or National GAAP.

Fiscal regulations

The tax requirements of United Kingdom were amended so that financial statements

prepared in accordance with IFRS may be adopted for taxation purposes. The tax

treatments of fair value gains and losses are regulated by the ‘Disregard Rule’.

The Finance Act ("FA") of 2004 and the two Finance Acts of 2005 have contained

legislation aimed at ensuring that companies choosing to adopt International

Accounting Standards (IAS) to prepare their financial statements receive broadly

equivalent tax treatment to companies that continue to use UK GAAP (UK Generally

Accepted Accounting Practice).

http://www.hmrc.gov.uk/practitioners/clause50.htmSection 50 of the Finance

Act 2004 redefines "generally accepted accounting practice" to include both the

European Commission (EC) adopted IAS and UK GAAP (as it may be) for periods

beginning on or after 1 January 2005 (the date in the EC Regulation). The main thrust

of the section is to make IAS as acceptable for tax purposes as UK GAAP – wherever

a provision (such as section 42 Finance Act 1998) refers to GAAP it will include a

reference to IAS.

Whether fair value gains and losses under IFRS shall be considered for taxation

purpose is decided by the ‘Disregard Regulations - Loan Relationships and Derivative

Contracts (Disregard and Bringing into Account of Profits and Losses) Regulations

2004.

4.3 Italy

GAAP requirements to individual financial statements

Through the Legislative decree 28th February 2005, No.38, Italy used extensively the

options in Article 5 of the E.U. Regulation 1606/2002. In particular, listed companies,

banks and other financial institutions are required to adopt IFRS, both for

consolidated and individual accounts. However, insurance companies are not

permitted to prepare individual accounts based on IFRS, except for listed insurance

companies, which do not present consolidated financial statements.

Unlisted companies are required to present consolidated accounts in accordance with

IFRS and all subsidiaries within an IFRS group are permitted to use them for the

preparation of their individual accounts. Although the mandatory adoption of IFRS

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for the individual accounts started from 2006, an earlier adoption was permitted from

2005.

In practice, the majority of companies permitted (but not required) to prepare their

individual accounts according to IFRS, still continues to use the operationally easier

(and more tax oriented) Italian GAAP.

On 26 February 2011, the Legislative Decree no. 225/2010, converted into Law no.

10/2011, introduced modifications to article 4 of Decree 38/2005, stating that new

IFRSs issued by the IASB and adopted by the EU after 1 January 2011 need to be

endorsed by the Italian Ministry of Justice before they can be applied in the separate

financial statements of Italian listed companies.

The endorsement process is designed to verify the compatibility of each newly

published IFRS with the Italian accounting principles.

Fiscal regulation

IFRS was not initially recognised as relevant for fiscal purposes. Therefore, there was

a full disconnection between reported profit and taxable income. This proved to be

very costly for the taxpayers. In order to convert IFRS income to tax base an

intermediate step through Italian GAAP principles was, de facto, required, which

duplicated compliance efforts. Then, since IFRS were not governed in detail by tax

law, many uncertainties emerged, originating an abnormal increase in interpretation

queries to the fiscal agency. The Finance Act 2008 allowed the use, for fiscal

purposes, of IFRS qualification, time imputation and classification criteria. However,

some IFRS aspects, such as the valuation criteria, have not been recognised. Since

2005, the evolution of tax law has also affected companies reporting under Italian

GAAP. “Extra-accounting” adjustments, used in order to convert accounting profits

into taxable profits, were disallowed, strengthening the linkage between fiscal and

Italian GAAP figures.

4.4 Germany

Several ‘global players’ (e.g. Bayer, Heidelberger, Zement and Schering) adopted

IFRS or U.S. GAAP, as early as in 1993. Since these firms were required to continue

reporting under national GAAP (HGB), costly ‘parallel’ and ‘dual’ accounting

resulted. In response to the ensuing ‘demand pull’ for international accounting, the

1998 Capital Raising Facilitation Act allowed publicly traded parent companies to

substitute consolidated IFRS or U.S. GAAP accounts for HGB group accounts. Many

of Germany’s public firms were preparing consolidated IFRS accounts before 2005.

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The IAS Regulation (2002) required that all listed companies should mandatorily

prepare their consolidated financial statements under IFRS by 2005 (2007 in some

cases). However, by 2002, the year of the IAS-Regulation, about 36 per cent of all

group companies required to prepare IFRS consolidated financial statements by

article 4 of that regulation, were already applying IFRS in the preparation and

presentation of consolidated financial statements. By 2003, 19 out of the 30 DAX1

companies were using IFRS and 9 of them were using U.S. GAAP.

Companies and other entities are required to prepare individual financial statements in

accordance with the HGB (German GAAP). German GAAP and IFRS are based on

different principles. While IFRS Financial Statements are primarily designed for

better information to the investors, German GAAP is based on a creditor-protection

approach. German GAAP allows firms to create hidden reserve, for example, through

accelerated depreciation allowed under the tax law and non-recognition of deferred

tax assets.

Fiscal regulation

Individual financial statements prepared in accordance with the HGB (German

GAAP) form the basis for computation of taxable profits of the company.

5. U.S.A

5.1 Approach

The IASB and the US Financial Accounting Standards Board (FASB) have been

working together since 2002 to achieve convergence of IFRSs and US generally

accepted accounting principles (GAAP). In September 2002 the IASB and the FASB

agreed to work together, in consultation with other national and regional bodies, to

remove the differences between international standards and US GAAP. This decision

was embodied in a Memorandum of Understanding (MoU) between the boards known

as the Norwalk Agreement. In 2006 the IASB and FASB set specific milestones to be

reached by 2008. In the light of the progress achieved by the boards and other factors,

the US Securities and Exchange Commission (SEC) removed in 2007 the requirement

for non-US companies registered in the United States to reconcile their financial

reports with US GAAP if their accounts complied with IFRSs as issued by the IASB.

At the same time, the SEC also published a roadmap on adoption of IFRSs for

domestic US companies.

1 The DAX (German stock index)) is a blue chip stock market index consisting of the 30 major German

companies trading on the Frankfurt Stock Exchange.

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SEC’s planned the following seven milestones to achieve full adoption:

i. Improvements to accounting standards

ii. Funding of the International Accounting Standards Committee Foundation

iii. Improved ability to use interactive data for IFRS reporting

iv. Improved education and training in the US

v. Limited use in a narrow group of companies (i.e. December 31, 2009)

vi. SEC to determine in 2011 whether mandatory adoption of IFRS is feasible

based on the progress in the first five milestones

vii. Mandatory use – If decided to go full steam ahead (as discussed in milestone

vi above) then large accelerated, accelerated and non-accelerated filers would

be required to adopt IFRS beginning with their years ending on or after

December 15, 2014, 2015 and 2016, respectively.

5.2 Progresses Reported in April 2012

In April 2012, IASB and FASB announced that the boards were close to completing

the MoU programme. They reported that most of the short-term projects, which were

identified for action, had been completed or were close to completion. Of the longer-

term projects, several had been completed and there were three of the originally

identified projects for which the boards were yet to finalise the technical decisions—

leases, revenue recognition and financial instruments. The boards expect to issue final

standards on these projects by mid- 2013.

5.3 SEC Delays Decision on IFRS

Earlier SEC had announced that it would announce its decision on endorsement of

IFRS in 2011. However, it is yet to announce the same.

In his Remarks Before the AICPA National Conference on Current SEC and PCAOB

Developments on December 5, 2011, James L. Kroeker, who is the Chief Accountant

in�U.S. Securities and Exchange Commission, announced the delay in releasing the

Commission’s final report on the IFRS Work Plan for U.S. markets. The decision will

depend on the completion of all the projects covered under the MOU between FASB

and IASB and the results of the study on the impact of the implementation of IFRS.

Kroeker emphasized the importance of establishing a “strong and lasting” framework

for IFRS incorporation into U.S. GAAP. He believes the framework should:

• “Demonstrate a high level of support for U.S. commitment to continued

development and use of global consistent high quality accounting standards;

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• Provide both in fact and in substantive operation clear U.S. authority over

standards applicable in the U.S. capital markets;

• Provide for and facilitate a strong U.S. voice in the process of establishing

global accounting standards;

• Be responsive to the economic and other impacts of change;

• Consider whether to retain “U.S. GAAP” as the basis for U.S. financial

reporting, thereby mitigating the costs and complexity of introducing a new

set of standards under regulatory regimes, contractual documents, and U.S.

laws under which compliance with U.S. GAAP is often specifically

contemplated.”

5.4 Condorsement

Although the SEC has not yet made a decision regarding whether and, if so, the

manner in which IFRS adoption should be accomplished, some experts believe that it

will take the Condorsement approach. The term ‘condorsement’ was mentioned for

the first time by SEC Deputy Chief Accountant Paul Beswick at the AICPA National

Conference on ‘Current SEC and PCAOB Developments’ held in December 2010.

The Condorsement idea resulted from combining the most common IFRS adoption

approaches used in other jurisdictions, namely Convergence and Endorsement. The

approach is explained in the SEC Staff paper entitled ‘Work plan for the consideration

of incorporating IFRS into the financial reporting system for U.S Issuers’. The

following is the extract from the paper:

“This approach to incorporation is in essence an Endorsement Approach that would

share characteristics of the incorporation approaches with other jurisdictions that have

incorporated or are incorporating IFRS into their financial reporting systems.

However, during the transitional period, the framework would employ aspects of the

Convergence Approach to address existing differences between IFRS and U.S.

GAAP. Importantly, the framework would retain a U.S. standard setter17 and would

facilitate the transition process by incorporating IFRSs into U.S. GAAP over some

defined period of time (e.g., five to seven years). At the end of this period, the

objective would be that a U.S. issuer compliant with U.S. GAAP should also be able

to represent that it is compliant with IFRS as issued by the IASB. Incorporation of

IFRS through the framework would have the objective of achieving the goal of having

a single set of high-quality, globally accepted accounting standards, while doing so in

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a practical manner that could minimize both the cost and effort needed to incorporate

IFRS into the financial reporting system for U.S. issuers. It also would align the

United States with other jurisdictions by retaining the national standard setter’s

authority to establish accounting standards in the United States”. (Source:

http://www.sec.gov/spotlight/globalaccountingstandards/ifrs-work-plan-paper-

052611.pdf)

5.5 SEC Work Plan – Final Staff Report – July 2012

On July 13, 2012 SEC has issued Final Staff Report on the ‘Work plan for the

consideration of incorporating IFRS into the financial reporting system for U.S

Issuers’. The following introductory remarks signals the SEC is yet to finalise the

road amp and the method for incorporation of IFRS in the US GAAP:

“The Commission believes it is important to make clear that publication of the Staff

Report at this time does not imply—and should not be construed to imply—that the

Commission has made any policy decision as to whether International Financial

Reporting Standards should be incorporated into the financial reporting system for

U.S. issuers, or how any such incorporation, if it were to occur, should be

implemented.

Although the Staff Report is constructive and an important contribution, the Work

Plan did not set out to answer the fundamental question of whether transitioning to

IFRS is in the best interests of the U.S. securities markets generally and U.S. investors

specifically. Additional analysis and consideration of this threshold policy question is

necessary before any decision by the Commission concerning the incorporation of

IFRS into the financial reporting system for U.S. issuers can occur.”

5.6 Time Frame

SEC has not stipulated any time frame for implementing IFRS. It appears that the

earlier announcement to implement IFRS in stages starting from 2015 will be missed.

However, if the SEC adopts the condorsement approach it will take five to seven

years to incorporate IFRS into US GAAP.

6. JAPAN

6.1 Voluntary Application

In 2009, the government announced that Japanese companies whose financial or

operational activities are conducted internationally are permitted to prepare their

consolidated financial statements, starting from the consolidated fiscal years ending

on or after March 31, 2010, in accordance with “Designated IFRSs”, provided that

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they meet the following requirements (1) and (2) (“Specified Companies”).

(1) All of the following requirements shall be met.

(a) Shares issued by the companies are listed on a Securities Exchange in Japan.

(b) The companies disclose in their Annual Securities Reports information

regarding specific efforts to ensure appropriateness of their consolidated

financial statements.

(c) The companies allocate executives or employees with ample knowledge

about Designated IFRSs and have in place a structure that enables them to

properly prepare consolidated financial statements in accordance with

Designated IFRSs.

(2) The companies, parent companies of the companies, other related companies

(associate companies) or parent companies of the other related companies shall either:

(a) Disclose under laws and regulations of foreign jurisdiction periodically as

required thereby, documents on their business conditions prepared in

accordance with IFRSs;

(b) Disclose under rules set by foreign security exchange markets periodically

as required thereby, documents on their business conditions prepared in

accordance with IFRSs; or

(c) Own a foreign subsidiary whose capital is equal to or exceeds the equivalent

of two billion Japanese yen.

On December 11, 2009, the Commissioner of the FSA designated in their entirety,

IFRSs and International Financial Reporting Interpretations Committee (IFRIC)

interpretations approved and issued by the IASB, on or before June 30, 2009, as

financial reporting standards to be applied to Specified Companies, without any

curve-outs.

Specified Companies, which do not prepare consolidated financial statements, may

prepare their financial statements under Designated IFRSs, in addition to those under

Japanese Generally Accepted Accounting Standards.

Number of companies

It is reported that only a few Japanese companies have adopted IFRS voluntarily.

6.2 Decision on Mandatory Application Delayed

Interview by the Minister of Financial Services

The Minister for Financial Services of Japan in an interview on June 19, 2012 stated

“The Business Accounting Council held a meeting. Mandatory application of IFRS

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has not been decided by the council. Regarding the application of IFRS, an interim

report summarizing the points of debate was written. I understand that a certain

consensus has been reached on such points as: the separate treatment of consolidated

and non-consolidated financial statements, which refers to limiting the application of

IFRS to consolidated financial statements; the exemption of small and medium-size

enterprises from IFRS; and the expansion of voluntary application.

However, regarding other points of debate, including whether or not to introduce

mandatory application, a conclusion has not been reached, so further debate should be

conducted to delve deeper into those points.

Therefore, as further deliberation will be conducted regarding the future application

of IFRS, it has not been decided to introduce mandatory application”.

(Ref: http://www.fsa.go.jp/en/conference/minister/2012/20120619.html; Extracted on

August 5, 2012)

BAC discussion summary

The 13-page paper, built upon discussions by BAC members on IFRS since 2011,

provides the following general summary of discussions, as well as broad direction on

seven specific topics was issued by FSA of Japan on July 2, 2012.

General summary:

The paper admits that:

1) There are divergent views on a few issues,

2) No final conclusion has been made, both of which would require further

deliberation to deepen discussions.

In addition, key message in this section of the report is:

The effort toward international harmonisation of accounting standards should be

continued, building upon already high-quality and internationally recognised state of

Japanese GAAP. In doing the above, the best approach of using IFRS is to be

developed, based upon the following, by sufficiently considering its objective and

impact on the economy and systems in Japan:

• It should be permitted that accounting standards used for consolidated

financial statements could be different from Japanese GAAP used in separate

financial statements

• IFRSs should not impact accounting by non-public small-medium sized

entities.

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• Meanwhile, 1) continued measures are to be taken for convergence if

appropriate in light of Japanese accounting standards, and 2) voluntary early

adopters of IFRS are to be accumulated further

• It is important to contribute to the development of IFRSs and to communicate

Japan's view as appropriate.

Topic-specific summary:

The report reflects the diverse views expressed by BAC members at past BAC

meetings and includes the following broad directions formed on each of seven topics:

• International harmonisation of accounting standards: Positive measures are to

be taken for convergence to ensure that Japanese GAAP is of high quality and

internationally recognised. In doing this, importance should be placed on

matters identified in responding to the Agenda Consultation 2011 by Japanese

constituents (the “response to AC”), including the concept of net income and

the scope of fair valuation.

• Use of IFRS in Japan: The most appropriate approach of incorporating IFRS

should be explored, reflecting the institutions and economy of Japan, also

taking into account the international environment. In addition, it is necessary

to identify acceptable and unacceptable requirements in IFRSs, using

comments shown in the response to AC, which is to be further considered at

practical level. It is important that the BAC refer to such in its future

deliberations. There are also requests asking stock exchanges to segregate

markets into one where IFRS is used and another with Japanese GAAP.

• Communicating views from Japan: It is important to continue contributing to

IFRS Foundation/IASB in terms of human resources and funding. It is also

appropriate for constituents in Japan to continue concerted efforts toward

communicating views, with international coordination. It is imperative for the

satellite office of the IASB to be opened in Tokyo to be fully utilised in this

regard. A coordinated effort through a forum such as the one formed on the

response to AC should continue to be effective.

• Separate financial statements: It is realistic to permit that accounting

standards for consolidated financial statements be different from Japanese

GAAP used for separate financial statements that are more closely tied to

Company Laws, tax laws and other regulations. In addition, it is appropriate to

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consider measures to ease the burden of disclosure in separate financial

statements, by utilising requirements under the Company Laws.

• Non-public small-medium sized entities: IFRS should not impact accounting

by non-public small-medium sized entities, consistent with existing policy.

• Voluntary application of IFRS: Although deliberation of the use of IFRS

continues, voluntary use of IFRS is to be accumulated further. Such voluntary

use would highlight practical merits and issues of using IFRS and initiatives to

deal with them should be considered and implemented. It is also important to

actively publicise internationally that the use of full IFRS is already permitted

in Japan.

• Approach toward principle-based IFRS: Practical measures by preparers,

auditors, and regulators need to be further considered, with an appropriate

coordination among them.

The full report is available at the website of the Financial Service Agency of Japan (in

Japanese only).

(Source: http://www.iasplus.com/en/news/2012/july/interim-discussion-paper-on-ifrs-

is-finalised-by-the-business-accounting-council-of-japan; Extracted on August

5,2012)

7. CANADA

7.1 Classification of Enterprises

The following definitions have been adopted for the purposes of determining which

part of the Canadian Institute of Chartered Accountants (CICA) Handbook applies to

a reporting entity:

Publicly accountable enterprise

A publicly accountable enterprise is an entity, other than a not-for-profit organization,

or a government or other entity in the public sector, that:

i. Has issued, or is in the process of issuing, debt or equity instruments that are,

or will be, outstanding and traded in a public market (a domestic or foreign

stock exchange or an over-the-counter market, including local and regional

markets); or

ii. Holds assets in a fiduciary capacity for a broad group of outsiders as one of its

primary businesses. �

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Banks, credit unions, insurance companies, securities brokers / dealers, mutual

funds and investment banks typically meet the second criterion above.

Other entities may also hold assets in a fiduciary capacity for a broad group of

outsiders because they hold and manage financial resources entrusted to them by

clients, customers or members not involved in the management of the entity.

However, if they do so, for reasons incidental to a primary business (as, for

example, may be the case for travel or real estate agents, co-operative enterprises

requiring a nominal membership deposit, or sellers that receive payment in

advance of delivery of the goods or services, such as utility companies), which

does not make them publicly accountable.

Private enterprise

A private enterprise is a profit-oriented entity that is neither a publicly accountable

enterprise nor an entity in the public sector.

Not-for-profit organisation

A not-for-profit organization is an entity, normally without transferable ownership

interests, organized and operated exclusively for social, educational, professional,

religious, health, charitable or any other not-for-profit purpose. A not-for-profit

organization's members, contributors and other resource providers do not, in such

capacity, receive any financial return directly from the organization.

Pension Plan

A pension plan is any arrangement (contractual or otherwise) by which a program is

established to provide retirement income to employees.

7.2 Applicability of IFRS

Publicly accountable entities

The Accounting Standards Board (AcSB) adopted International Financial Reporting

Standards (IFRSs) as Canadian GAAP for Publicly Accountable Enterprises (PAE)

for fiscal years beginning on or after January 1, 2011.

Entities with rate-regulated activities

The AcSB decided at its March 20-21, 2012 meeting to extend the deferral of the

mandatory IFRS changeover date for entities with qualifying rate-regulated activities

by one more year from 2012 to 2013. Such entities now have the option to defer their

changeover to IFRSs to January 1, 2013.

Investment companies

19

For investment companies and segregated accounts of life insurance enterprises, the

AcSB agreed to extend the option to defer their changeover to January 1, 2014

because of the timing of the related IASB project.

Government business enterprises

The Public Sector Accounting Board (PSAB) requires government business

enterprises (GBEs) to adopt IFRSs for fiscal years beginning on or after January 1,

2011.

Private enterprises

Private enterprises were given the option to adopt IFRSs or Canadian accounting

standards for private enterprises for fiscal years beginning on or after January 1, 2011.

Private sector not-for-profit organizations

Private sector not-for-profit organizations may also choose to adopt IFRSs or

Canadian accounting standards for not-for profit organisations for fiscal years

beginning on or after January 1, 2012.

7.3 Fiscal Regulations

Canada’s taxation system is quasi independent i.e. the taxable income is based on the

net profit reported for statutory filling purposes after certain adjustments given in the

Income Tax Act.

The Canadian revenue Agency (CRA) has released guidance to tax payers that have

adopted IFRS. In the Income tax Technical News No 42 released on May 31, 2010,

the CRA acknowledged that IFRS is an acceptable starting point for determining

taxable profit.

Canadian tax legislation and jurisprudence provide rules for virtually all transactions

other than routine purchases and sales on income account. For instance, there is a

regime for capital transactions (gains/losses and amortization), for inventory valuation

and for most accruals. Courts have determined that leases are to be accounted for

based on the legal rights of the parties. Given the extent of the rules that override

accounting treatment, it is not expected that taxable income will be significantly

affected by the adoption of IFRS.

8. CHINA

China is moving its standards closer to IFRS without incorporating IFRS fully into its

national financial reporting framework. China has indicated that it intends to

eliminate the existing differences between its Accounting Standards for Business

Enterprises and IFRS. The implementation of IFRS in China is weak (Parker, 2012).

20

An article published by the Hong Kong Institute of Certified Public Accountants in

September 2011, which discusses the accounting quality in China, mentions that the

accounting practices in the country is not of high standards due to the lack of

accounting tradition and capabilities available in that country. An expert commented

“CAS has been so embedded in China’s commercial culture that main- land

accountants, as well as financial managers, have unsurprisingly been unable to throw

off their old clothes immediately.”

(Source: http://app1.hkicpa.org.hk/APLUS/2011/09/pdf/34-36-china-ifrs.pdf)

9. AUSTRALIA

The Australian Accounting Standards Board (the Board) is responsible for developing

and issuing Accounting Standards applicable to Australian entities and the “care and

maintenance” of the body of Standards. The Board's functions and powers are set out

in the Australian Securities and Investments Commission Act 2001.

9.1 Standards Applying from 2005

In 2002 the Financial Reporting Council provided a strategic direction to the Board to

work towards adopting Standards that are the same as those issued by the

International Accounting Standards Board (IASB), for application under the

Corporations Act 2001 for accounting periods beginning on or after 1 January 2005.

In July 2004, the Board issued the initial Australian equivalents to International

Financial Reporting Standards (IFRSs) that applied from 2005.

Entities reporting under the Corporations Act 2001 for annual reporting periods

beginning on or after 1 January 2005 are required to apply IFRS for the preparation

and presentation of financial statements. This is to ensure that general purpose

financial statements prepared by for-profit entities in accordance with AASB

standards will also be in accordance with IFRS. The AASB has a transaction

neutrality policy, which means similar transactions and events should be accounted

for in a similar manner by all types of entities, whether in the for-profit sector, the

not-for-profit private sector, or the public sector – unless there is a sound reason to be

different in particular circumstances. The AASB considers the specific needs of not-

for-profit entities in the private and public sectors when preparing new and revised

IFRSs for adoption in Australia.

The Australian equivalents to IFRSs comprise:

• AASB Accounting Standards that are equivalent to IASB Standards, being

AASBs 1 – 99 corresponding to the IFRS series and AASBs 101 – 199

21

corresponding to the IAS series; and

• Interpretations issued by the AASB corresponding to the Interpretations

adopted by the IASB, as listed in AASB 1048 Interpretation of Standards.

For periods beginning on or after 1 January 2005, these Australian equivalents to

IFRSs supersede their pre-2005 Australian counterparts, if any. Furthermore, some of

the existing domestic AASB and AAS Accounting Standards were retained where

there was no IASB equivalent, such as ancillary Standards like AASB 1031 and

AASB 1039, industry Standards like AASB 1023 and AASB 1038, and public sector

Standards such as AAS 27, AAS 29 and AAS 31. These pre-2005 AASB and AAS

Standards remained in force beyond 1 January 2005, but all have now been revised or

superseded.

From 30 June 2010, the directors declaration accompanying the financial statements

of companies and other entities regulated by the Corporations Act 2001 is required to

include an additional statement referring to the explicit and unreserved statement of

compliance with International Financial Reporting Standards in the notes to the

financial statements (where such a statement is made).

Under a new differential reporting regime released by the Australian Accounting

Standards Board (AASB) in July 2010, eligible entities (unlisted public companies

and large proprietary companies) can elect to adopt the 'Reduced Disclosure

Requirements' (RDR). Entities with public accountability cannot adopt the RDR, but

must comply with Australian Accounting Standards in full (and state compliance with

IFRS).

The RDR requires entities to follow the recognition and measurement requirements of

all Australian Accounting Standards (which are equivalent to IFRSs), but with

reduced disclosure requirements.

The new requirements apply to annual reporting periods beginning on or after 1 July

2013, but may be early adopted for annual financial reporting periods beginning on or

after 1 July 2009.

9.2 Pre-2005 Standards

Until December 1999, the former Australian Accounting Standards Board and the

former Public Sector Accounting Standards Board (PSASB) developed AASB

Standards that applied to entities regulated under the Corporations Law and AAS

Standards that applied to all other types of entities. �AASB Standards issued from

22

2000 onwards applied to all types of entities, and the AAS series has nearly been fully

phased out, with only AAS 25 (superannuation plans) not yet superseded.

9.3 Fiscal Regulation

There are a number of provisions in Australian income tax law that either directly or

indirectly relies on accounting standards and accounting principles for the purposes of

determining a taxpayers’ income tax liability. While there is no systematic connection

between Australian income tax law and Australian accounting standards and practice,

as a practical matter most businesses determine their taxable income or loss for a year

of income by reconciling from a profit and loss account.

The Taxation Office had issued a ‘Blue Print’, which is a conceptual design of the

change in the system-in-place due to adoption of IFRS in Australia.

SUMMARY

Country

/Territory

Listed companies Un-listed

companies

Remarks

Consolidated

financial

statements

Individual

financial

statements

Consolidate

d and

individual

financial

statements

European Union Mandatory; Effective from January 1,2005

Varies from country to country

Varies from country to country

United Kingdom Mandatory;

Effective from January 1,2005

Voluntary; Effective from January 1,2005

No

Italy Mandatory; Effective from January 1,2005

Mandatory; Effective from January 1,2005

Voluntary for subsidiaries in a IFRS group

New IFRSSs to be issued after January 1, 2011 to be vetted by Ministry of Justice

Germany Voluntary until 2005; Mandatory; Effective from January 1,2005

Not permitted

Not permitted

U.S.A. Not Not Not Earlier plan was to

23

permitted permitted permitted announce the decision on endorsement of IFRS in 2011. Decision is delayed. No time lime is announced.

Japan Voluntary for ‘global companies’ effective from fiscal years ending on or after March 31, 2010. Other companies are not permitted.

Not permitted

Not permitted

Earlier plan was to announce the decision on mandatory application of IFRS in 2012. Decision is delayed. No time lime is announced.

Canada Mandatory for ‘publicly accountable entities’ from January 1, 2011

Mandatory for ‘publicly accountable entities’ from January 1, 2011

Voluntary from January 1, 2011

For rate-regulated entities effective from January 1, 2013; For investment and life insurance companies effective from January 1, 2014

China Mandatory for ‘publicly accountable entities’ from 2006.

Mandatory for ‘publicly accountable entities’ from 2006.

Mandatory for ‘publicly accountable entities’ from 2006.

There are differences between fully converged Chinese accounting standards and IFRS; Weak implementation

Australia Mandatory; Effective from January 1,2005

Mandatory; Effective from January 1,2005

Mandatory; Effective from January 1,2005

Unlisted companies can elect to adopt the 'Reduced Disclosure Requirements' (RDR) effective from July1 2013.

24

PART III: LITERATURE SURVEY

The introduction of international accounting standards2 (IFRS) is premised on the

belief that the application of a single high quality accounting standards by countries

across the globe will contribute to better functioning of capital markets. This will

benefit both the countries and investors across the globe. It is argued that the

harmonisation of accounting practices could decrease information costs, thereby

increasing the liquidity, competition and efficiency in the markets (Ball, 2006).

Proponents of IFRS also argue that firms might also benefit from reduced information

asymmetry, which will enable them to make more efficient investment decisions

resulting in lowering their cost of capital. The benefits will be derived only if, the

adoption of IFRS results in high quality accounting, it is applied uniformly across the

globe and the cost of transition is not prohibitive.

Both practitioners and academicians are concerned about the high costs of transition

from national accounting standards to IFRS and other compliance costs. The costs and

benefits will not be uniform for all the firms. It will depend upon the internationality,

size and strategies of the firm. Voluntary disclosure research has consistently found

that larger firms provide stakeholders with more disclosures (e.g. Cuijpers et al.

2005). Similarly, multinational firms are likely to benefit more than domestic firms as

the cost of consolidating financial statements of subsidiaries in different geographic

locations will be reduced and adoption of IFRS will signal the investors, customers

and vendors that the firm is committed to transparency.

Quality of financial information does not depend solely on the quality of accounting

standards. It also depends on the institutional environment, including economic and

political environment. Therefore, the same set of accounting standards might be

implemented differently in different countries. Consequently, potential benefits from

implementing a single set of high quality accounting standards across the globe may

not be realised unless the implementation of the same is monitored effectively. It may

not be easy to establish an effective monitoring mechanism.

We have discussed the research findings under three headings: accounting quality,

implementation diversity and implementation cost. We did not aim for the greatest

2 The IFRS Foundation aims “to develop a single set of high quality, understandable, enforceable and globally accepted international financial reporting standards (IFRSs) through its standard-setting body, the IASB.” (http://www.ifrs.org/The+organisation/IASCF+and+IASB.htm).

25

comprehensiveness. Rather we have tried to select the most influential studies.

10. ACCOUNTING QUALITY

Accounting quality is not well defined. Researchers have looked into it from different

perspectives. Taking them together, we can develop a general understanding of the

concept of accounting quality. High accounting quality reduces the scope for earnings

management, results in more timely loss recognition, and leads to the disclosure of

financial information that is of higher value-relevance to investors (Barth, 2007;

Christensen, 2008). It results in more timely recognition of economic income3 in

accounting income (Ball et al. 2003). It is related to the concept of ‘‘transparency,’’

defined as the ability of users to ‘‘see through’ the financial statements to comprehend

the underlying accounting events and transactions in the firm (Ball et al. 2003). It

lowers information asymmetry between the firm and investors and information risk

and, thus, cost of capital (Armstrong et al. 2009) and it improves the accuracy of

analysts’’ forecast (Ernstberger et al. 2008). It requires accurate depiction of

economic reality, lowering the capacity for managerial manipulation, timeliness in

providing financial information and timelier incorporation of bad news, relative to

good news, in financial statements (Ball, 2006).

The literature on accounting quality mostly focuses on value relevance. However,

value relevance cannot be the sole criteria in evaluating accounting quality.

Accounting quality should also be evaluated in contexts where noise matters,

including debt and compensation contracts (Holthausen 2001; Ball, 2006). Noise

arising from intensive use of fair value in IFRS might result in higher noise in

financial information and might reduce contracting efficiency. However, The

increased transparency promised by IFRS also could cause a similar increase in the

efficiency of contracting between firms and lenders. In particular, timelier loss

recognition in the financial statements triggers debt covenants violations more quickly

after firms experience economic losses that decrease the value of outstanding debt

(Ball, 2006).

10.1 Voluntary Adoption

From early 1990s, firms in European countries, particularly in Germany, started

applying IFRS or US GAAP in presenting financial statements. Many of the firms

listed their securities in U.S. stock exchanges. This resulted in the availability of

3 Economic income here is defined as change in the market value of equity, adjusted for dividends and capital transactions with shareholders.

26

significant volume of data for analysing to collect evidence on whether perceived

benefits from use of IFRS accrued to firms that voluntarily adopted IFRs or U.S.

GAAP. Studies of firms that adopted IFRS voluntarily have self-selection bias. For

example, Cuijpers et al. (2005) observes that firms adopting non-local GAAP

(IAS/US GAAP) are more likely to be listed on a U.S. exchange, the EASDAQ

exchange in Brussels, and have more geographically dispersed operations. Also, these

firms are more likely to be domiciled in a country with lower quality financial

reporting and where IAS is explicitly allowed as an alternative to local GAAP.

Moreover, some structural changes might have occurred within the firm leading to the

decision to adopt IFRS. In spite of this limitation, the results of such studies could

provide valuable insights about the accounting quality of companies that adopted

IFRS or U.S. GAAP. But unfortunately the results could not lead to any definitive

conclusion.

A study (Amir et al., 1993) of the value relevance of information provided in

reconciliation statements (20 F) filed by non-U.S. companies that were listed in a

primary U.S. exchange suggests that overall U.S. GAAP measures appear to be

relatively more value-relevant. The study provides evidence that investors view both

capitalised goodwill and asset revaluations as value-relevant. It implies that 20-F

reconciliations themselves are not required because a careful investor may be able to

reconstruct the value-relevant data from the reports presented in the home country.

This study indicates that national accounting standards are not as inferior as it is made

out to be. The result of the study is consistent with the observations of earlier

researchers that accounting policy does not affect the valuation if investors understand

the accounting policy and can reconstruct financial statements according to their own

preference.

Ashbugh et al. (2001), who studied 80 non-U.S. companies that voluntarily adopted

IFRS during 1990-93, reports that the adoption of IFRS is positively associated with

the reduction in analyst forecast error. They observe that adoption of IFRS leads to

increased disclosure and/or a restricted set of measurement methods. This result

suggests that IFRS is superior to national accounting standards.

Daske (Daske, 2004) analysed a sample of about 13,000 HGB, 4,500 IAS/IFRS and

3,000 US-GAAP firm-month observations in the period 1993-2002 related to German

firms to understand whether application of IFRS or US GAAP reduces the cost of

27

capital. The results failed to support the conjecture that application of IFRS or US-

GAAP reduces information asymmetry and thus, reduces the cost of capital. This does

not necessarily leads to the conclusion that IFRS and US-GAAP are not superior to

the German GAAP because the accounting quality depends on the quality of

accounting standards and also on other exogenous factors such as the institutional set

up in the country. However, the result suggests that in a given institutional set up,

application of IFRS would not necessarily improve the accounting quality.

Cuijpers et al. (Cuijpers et al. 2005) reported that the evidence collected by them does

not suggest lower cost of equity capital for adopters, but shows that financial analysts

follow non-local GAAP users more heavily. They studied 133 listed non-financial EU

firms that voluntarily used non-local GAAP (92 IAS and 41 U.S. GAAP users) for the

financial year 1999. The results show a higher dispersion of analyst earnings forecasts

for firms that have adopted non-local GAAP late. This finding suggests that analyst

need time to learn to interpret a firm’s financial statements drawn up under IFRS or

U.S. GAAP or that firms that recently switched are not yet perfectly complying with

non-local GAAP. This study shows that the benefits of adopting IFRS or US GAAP

are small.

The results of analyses of a large sample of German listed companies by Tendeloo et

al. (Tendeloo et al., 2005) relating to the period 1999–2001 suggest that that IFRS

does not impose a significant constraint on earnings management, as measured by

discretionary accruals. On the contrary, adopting IFRS seems to increase the

magnitude of discretionary accruals. The results indicate that voluntary adopters of

IFRS in Germany cannot be associated with lower earnings management. These

results question the superiority of IFRS over the German GAAP.

A study based on a sample of firms from 34 countries that adopted IFRS voluntarily

over the seven-year period of 1998 through 2004 provides evidence that enhanced

disclosures via voluntary IFRS adoption improve the quality of accounting

information but also facilitate the capital market process of incorporating firm-

specific information into stock prices in a timely and accurate manner, particularly in

an information environment with low analyst following, high accounting opacity, and

poor institutional infrastructure (Kim and Sui, 2010).

Christensen (Christensen, 2012) argues that although research on voluntary adoption

of IFRS documents the large improvements to firms’ information environment appear

inconsistent with the low frequency of voluntary IFRS adoption globally. Assuming

28

that managers are rational, the benefits of IFRS adoption must be substantially smaller

than what academics generally have estimated them to be. He shows that endogeneity

bias likely explains some of the capital market changes around voluntary IFRS

adoption.

Christensen et al. (Christensen, 2008) from the study of German companies, some of

which had adopted IFRS voluntarily before the application of the same was made

mandatory in 2005, demonstrated that voluntary adoption of IFRS is associated with

decreased earnings management and more timely loss recognition, while there is no

such accounting quality improvements for firms that are forced to adopt IFRS. The

results suggest that adoption of IFRS does not necessarily lead to higher quality

accounting, at least not when the preparers have no incentives to adopt. The observed

accounting quality improvements for voluntary adopters could be driven by changes

in incentives of these firms around the time of their adoption. Christensen et al

observes that IFRS per se does not increase the accounting quality even when firms’

prior accounting standards are generally viewed as lower quality. Another interesting

finding of the study is that firms, which have closer relationships with banks, less

demand for information from capital markets, and more concentrated ownership resist

adoption of IFRS. Those firms have no incentives to engage in less earnings

management and more timely loss recognition subsequent to IFRS adoption. These

results suggest that the accounting quality cannot be improved for all firms by

mandating higher quality accounting standards, because the imposition of higher

quality standards will have limited effect for firms without incentives to comply.

Wu and Zhang evaluated the quality of IFRS financial statement from stewardship

and contracting perspective. They used a sample consists of firms from Continental

Europe that voluntarily adopted IFRS or U.S. GAAP from 1988 to 2004. They (Wu

and Zhang, 2008) examined whether the voluntary adoption of international

accounting standards is associated with changes in the internal performance

evaluation process; in particular, whether it is associated with increases in the

sensitivities of CEO turnover and employee layoffs to accounting earnings The

findings suggest that the greater reporting transparency through international

accounting standards likely plays an important role in improving firms’ internal

performance evaluations and governance. They (Wu and Zhang, 2009) also collected

evidence that suggests that firms with low labor productivity and high dividend

29

payouts are more likely to adopt IAS/U.S. GAAP; firms adopting IAS/U.S. GAAP

and with low labor productivity (or high dividend payouts) are more likely to report

lower earnings than before the adoption and the change in earnings is more negative

than for similar non-adopting firms; and firms adopting IAS/U.S. GAAP and with low

labor productivity (or high dividend payouts) are more likely to reduce labor forces

(reduce dividends) than before the adoption and the reduction in labor forces

(dividends) are more pronounced than for similar non-adopting firms. The results

suggest that accounting profit reported using IAS/U.S. GAAP incorporates economic

losses faster after IAS adoption economic losses and thus, facilitates strategic changes

in its labor and dividend policies. These results confirm the findings from other

studies that IFRS/U.S.GAAP accounting profit/loss reflect economic realities better

than profit/loss reported under a local GAAP.

Andre et al. (Andre et al., 2012) studied the accounting practice of unlisted U.K. firms

for the year 2009. The findings suggest that strong reporting incentives play a major

role in the decision to choose IFRS voluntarily. The evidence suggests that

internationality, leverage, firm size, and auditor’s reputation are primary determinants

of firms’ choice for IFRS.

Conclusion

Large volume of literature developed around the voluntary adoption of IFRS by

European companies before its use was made mandatory effective from 2005/2007

(many of which have not been cited here) support the hypothesis that adoption of

IFRS leads to higher quality accounting. However, some results suggest the opposite.

Some reported that IFRS per se does not lead to higher accounting quality. The

managerial incentive plays more dominant role in determining the accounting quality.

Therefore, sweeping mandatory adoptions at the country level without firm-level

incentives, might not bring any fundamental changes in financial reporting quality

across companies.

10.2 Mandatory Adoption

There are number of studies on impact of the adoption of IFRS by European

companies after the use of the same was made mandatory in the preparation of

consolidated financial statements by listed companies. The results do not lead to any

definitive conclusion. One of the important reasons is the absence of sufficient data

for the time series analysis. Another reason is that it is too early to understand the

complete impact of transition from the national GAAP to IFRS.

30

An analysis of the reconciliations of equity presented as part of the transition from

UK Generally Accepted Accounting Principles (UK GAAP) to International Financial

Reporting Standards (IFRS) by the largest UK companies (FT 100 companies as at

January 1, 2005) shows that the effect of change to IFRS on the final net assets figure

is not significant. However, the effect of the change in on individual line items (due to

the application of some accounting standards) could have important consequences for

financial analysis and contractual obligations (Aisbitt, 2006). Thus, the results are

inconclusive. But, They indicate that IFRS financial statements are more informative

when line items are analysed in detail.

A study of IBEX-35 companies with a focus on the effects of the new standards

(IFRS) on comparability and the relevance of financial reporting in Spain shows that

local comparability had worsened (Callo et al., 2007). Callo et al. observe that there

had been no improvement in the relevance of financial reporting to local stock market

operators.

Before the mandatory adoption of IFRS in 2005, U.K firms were not allowed to use

IFRS voluntarily and subsequent to the adoption of IFRS, U.K. firms has no choice

but to present consolidated financial statements using IFRS. Christensen et al.

(Christensen et al., 2007) by using a proxy, grouped U.K. firms into two categories:

one that would have adopted IFRS had there been a choice and the other that have no

incentive to adopt IFRS. Christensen et al. studied the market response to understand

the economic consequence of the adoption of IFRS. The evidence collected by them

shows that the costs and benefits of IFRS adoption vary systematically across firms.

They observe, “IFRS adoption has resulted in winners and losers.” Some firms gain

and some firms lose from complex, mandatory-accounting changes such as IFRS.

Daske et al. (Daske et al., 2008) found similar results. They examined the economic

consequences of mandatory IFRS reporting around the world. They analysed the

effects on market liquidity, cost of capital and Tobin’s q in 26 countries. They used a

sample of over 3,100 firms that were mandated to adopt IFRS. The results show that,

on average, market liquidity increases around the time of the introduction of IFRS,

firms’ cost of capital decreases and there is an increase in equity valuations. Daske et

al. found that the capital market effects are most pronounced for firms that voluntarily

switch to IFRS, both in the year when they switch and again later, when IFRS become

mandatory. This result suggests that the capital-market effects for mandatory adopters

31

cannot be attributed solely or even primarily to the IFRS mandate.

The results of a study by Daske et.al. (Daske et.al., 2011) support the above the

finding of Christensen et al that reporting incentives drive accounting quality

(Christensen et al. 2008). They examined the economic consequences associated with

voluntary and mandatory IFRS adoptions around the world. They focused on the firm-

level heterogeneity in the consequences, recognizing that firms can differ in their

motivations and ways to adopt IFRS. They could not find evidence to support the

hypothesis that voluntary IAS adoptions are, on average, associated with an increase

in market liquidity or a decline in the cost of capital. They concluded that the notion

that IAS reporting per se constitutes a commitment to increased transparency is not

appropriate. The capital market effects reflect, amongst others, underlying changes in

firms’ reporting incentives. They argue that as IFRS is principle based accounting

standards, it provides enough opportunity to interpret and apply the same in

accordance with reporting strategy. Christensen et al. (Christensen et al., 2007) has

put forward similar argument while concluding the managerial incentives drive

accounting quality rather than accounting standards.

Armstrong et al. (2008) examined European stock market reactions to 16 events

leading to the adoption of International Financial Reporting Standards (IFRS) in

Europe. The research objective was to gain an insight into investors’ expectations

regarding the net cost or benefit of IFRS adoption in Europe. They studied 3,265

firms from 19 countries. The research findings suggest that investors perceived net

benefits to IFRS adoption in Europe associated with increases in information quality,

decreases in information asymmetry, more rigorous enforcement of the standards, and

convergence. Armstrong et al. observed that an incrementally positive reaction for

European firms with lower pre-adoption information quality and higher pre-adoption

information asymmetry. It implies that investors were expecting IFRS to improve the

information environment for these firms. The reaction for banks with lower pre-

adoption information quality was more positive. Regarding expected convergence

benefits, the study found a positive reaction to IFRS adoption events even for firms

with high quality pre-adoption information environments. Although investors

expected IFRS adoption to affect only minimally the information environments of

these firms, this finding signals that investors were expecting net benefits associated

with convergence from IFRS adoption.

32

Gjerde et al. (2008) analysed to financial statements of Norwegian companies, listed

at Oslo Stock Ex- change (OSE) for the year 2004 prepared under NGAAP and those

restated as per IFRS to test whether the IFRS accounting figures correlate more

strongly with stock market values than the corresponding NGAAP figures. The

evidence suggests that the difference between IFRS and NGAAP is not large in

practice except that IFRS allows for more intensive use of fair value. Gjerde et al.

observes that the value-relevance of key accounting figures prepared according to

IFRS is not superior to the corresponding figures prepared according to NGAAP. The

result shows that the benefits of adopting IFRS for countries such as Norway with an

advanced accounting regulation prior to IFRS adoption is not significant.

Jeanjean et al. (2008) studied whether the mandatory introduction of IFRS standards

had an impact on earnings quality, and more precisely on earnings management. They

analysed firms in countries in which early adoption of IFRS was not possible before

the transition date, namely Australia, France, and the UK. The findings suggest that

after the transition to IFRS, the pervasiveness of earnings management increased in

France and remained stable in the UK and in Australia. France has the continental

code law tradition. U.K. has the Anglo-American common law tradition and Australia

is a “common law” country. The importance of equity markets is high in Australia and

the UK but less pronounced in France. Taken together, these findings suggest that the

switch to IFRS does not necessarily lead to improvement in terms of earnings quality.

These findings support the idea that management incentives and national institutional

factors play an important role in shaping financial reporting characteristics, probably

more important than accounting standards alone.

Ball (2006) discussed pros and cons of the convergence of local standards with IFRS

or adoption of IFRS by large number of countries. He expressed his reservation about

fair value accounting. Use of fair value in measuring assets and liabilities more

intensively, promises to incorporate more information in the financial statements.

However, it does not necessarily make investors better off and its usefulness in other

contexts has not been clearly demonstrated. He observes: “It could make investors

and other users worse off, for a variety of reasons. The jury is still out on this issue.”

Conclusion

It is not possible to assess the accounting quality of IFRS financial statements

directly. Researchers have used many market related measures to evaluate the

accounting quality of firms and countries that have adopted IFRS. The results are

33

mixed and in some cases conflicting. One most common finding is that adoption of

IFRS per se does not improve the accounting quality. More dominant factors are

reporting incentives and political and institutional environment. Ray Ball, who is the

Sidney Davidson Professor of Accounting at the University of Chicago, questioned

the benefits of fair value accounting (Ball, 2006).

11. IMPLEMENTATION DIVERSITY

Proponents of IFRS argue that harmonisation of accounting practices across the world

reduces the investor’s cost of acquiring expertise about the accounting practices in

different countries. Therefore, the cost of monitoring by investors and analysts is reduced.

The comparison of the performance and financial position of companies domiciled in

different countries becomes easy and the cost is reduced. Therefore, harmonisation of

accounting practices facilitates cross-border investment and the integration of capital

markets. However, whether these benefits will be realised or not depends significantly on

the uniform application of IFRS across countries.

Ball (Ball, 2006) observes:

“Despite the undoubted integration that has occurred, notably in the capital

and product markets, most market and political forces are local, and will

remain so for the foreseeable future. Consequently, it is unclear how much

convergence in actual financial reporting practice will (or should) occur.”

The American Accounting Association (American Accounting Association, 2008) has

expressed similar concerns:

“Even while standard setters and regulators strive to achieve convergence,

there is reason to question the feasibility of achieving any given set of uniform,

global accounting standards. Institutional differences across countries might

well create a need for differences in financial-reporting practices even within

an otherwise uniform set of standards. This is consistent with the country-

specific versions of IFRS that we observe in practice. There is also the concern

that given the differences in institutional structures, forced uniformity in

accounting standards might result in differences in implementation, which could

mislead investors into thinking that financial reporting is uniform when it is

not.”

The American Accounting Association further observed:

34

“Cross-country institutional differences will likely result in differences in the

implementation of any single set of standards. Thus, IFRS may be a high-quality

set of reporting standards (pre-implementation) but the resulting, published

financial-statement information could be of low quality given inconsistent cross-

border implementation practices”.

The above observations of Ball and the American Accounting Association are

consistent with the early research findings (e.g. Ali, 2000) that country-specific

factors are more dominant in determining the accounting quality. Recent studies have

also corroborated early findings.

The results of a study (Tendeloo et al., 2005) show that companies that have adopted

IFRS engage more in earnings smoothing, but this increase in earnings smoothing

(with the adoption of IFRS) is significantly reduced when the company has a Big 4

auditor. This finding suggests that the adoption of high quality standards is not a

sufficient condition for providing high quality information in code-law countries with

low investor protection rights.

Daske et al (Daske et al. 2008) collected evidence that suggests that the capital-

market benefits occur only in countries where firms have incentives to be transparent

and where legal enforcement is strong. This result suggests that firms’ reporting

incentives and countries’ enforcement regimes are of paramount importance for the

quality of financial reporting.

Armstrong et al. (2008), who studied 16 events leading to the adoption of IFRS in

EU, found an incrementally negative reaction for firms domiciled in code law

countries, which are likely to have weaker enforcement of accounting standards. This

signals that even within Europe, investors are concerned about implementation

weakness in certain countries.

The Institute of chartered Accountants of Scotland (ICAS, 2008) studied the

implementation of IFRS in UK, Italy and Ireland. IFRS was implemented in all the

three jurisdictions in the year 2005. They used the content analysis and interviewed

preparers and users of financial statements. It reported different results for the three

countries. While, the results for U.K. and Ireland are similar, the same is different for

Italy. The plausible reason for those differences is that the UK and Ireland are

common law countries and their accounting standards focus primarily on the needs of

shareholders, while Italy has a legal system based on civil law and its accounting

35

standards traditionally focus on creditors. Therefore, a significant cultural change is

required for the effective implementation of IFRS in Italy.

Chen and Zhang (2010) studied the regulatory enforcement and audit upon IFRS

compliance with reference to China. They collected evidence to suggest that the

convergence of accounting practices may be affected by not only the lack of

insufficient understanding of IFRS by local accounting professionals, but also the

management opportunistic behaviour during the application of different standards.

They argue that corporate governance may affect the convergence of accounting

practice.

Parker (2011) observes that pre-2006 Chinese accounting standards (CAS) has been

so embedded in China’s commercial culture that main- land accountants, as well as

financial managers, have unsurprisingly been unable to throw off their old clothes

immediately. It implies that local culture and business practices have significant

impact on the effective implementation of anew set of accounting standards.

SEC work plan (2012) reports inconsistent application of IFRS, which impairs the

comparability. The following observation of the report indicates that use of IFRS may

not improve the comparability of financial statements across countries unless

consistency in application of IFRS is achieved at the global level:

“The diversity arising from the standards themselves was, at times, mitigated

by guidance from local standard setters or regulatory bodies that narrowed

the range of acceptable alternatives already permitted by IFRS or provided

additional guidance or interpretations. This diversity also was mitigated by a

tendency by some companies to carry over their previous home country

practices in their IFRS financial statements. While country guidance and

carryover tendencies may promote comparability within a country, they may

diminish comparability on a global level.”

Conclusions

Benefits of harmonisation of accounting practices will be achieved unless the uniform set

of accounting standards is applied uniformly across countries. That appears to be difficult

because the application of accounting standards involves considerable judgment and the

use of private information. As a result, IFRS (like any other set of accounting standards)

provide firms with substantial discretion. How far this discretion is used depends on firm-

specific characteristics (reporting incentives and operating characteristics), and country-

specific factors.

36

12. IMPLEMENTATION COST

Studies surrounding IFRS have primarily focused on the benefits and not on the costs

of implementation. However, both practitioners and academicians have expressed

concerned about the cost of transition from local standards to IFRS.

Christensen (Christensen, 2012) observes:

“One of the central questions that remain largely unanswered is: what are the costs

of adopting IFRS? Most research has focused on estimating benefits of IFRS

adoption. Given that firms’ revealed preferences suggest that most resist IFRS

adoption, it follows that the costs must be significant or that the benefits are small.”

The Institute of Chartered Accountants of Scotland (The Institute of Chartered

Accountants of Scotland, 2008) reported that most preparers and users in U.K.,

Ireland and Italy had felt that benefits of implementing IFRS were far more nebulous

and that overall the costs outweighed the benefits. The costs were mainly attributable

to the adaptation of information systems, training costs, consultation costs or the

employment of individuals with specific IFRS knowledge who proved to be ‘thin on

the ground’ and audit costs.

13.CONCLUSIONS

The movement for the harmonisation of accounting practices through convergence of

local accounting standards with IFRS or through adoption of IFRS has lost steam.

The SEC has decided to defer the decision on the method of endorsement of IFRS and

in deciding the timeline for the endorsement of IFRS. Many experts believe that SEC

will take the route of condorsement, an idea floated by SEC staff in 2010. The

Condorsement idea resulted from combining the most common IFRS adoption

approaches used in other jurisdictions, namely Convergence and Endorsement.

Japan has deferred its decision to make IFRS mandatory for listed and other

companies. Initially they announced that a decision would be taken in 2012. At

present, international companies has been given a choice to present their consolidated

financial statements either using local accounting standards or IFRS.

China is moving towards convergence of its accounting standards with IFRS.

However, significant gap exists between Chinese GAAP and IFRS. Moreover the

implementation of accounting standards in China is weak.

Most E.U. countries do not permit preparation of individual financial statements using

IFRS.

37

Canada has adopted IFRs in 2011. It requires publicly accountable entities and state-

owned enterprises to prepare both consolidated financial statements and individual

financial statements using IFRS. It allows closely held companies to prepare their

financial statements using IFRS, if they so desire.

One of the reasons for the slowing down of the movement for harmonisation of

accounting practices through the adoption of IFRS or convergence of local standards

with IFRS is that results of studies around adoption of IFRS by the E.U. countries

could not establish conclusively that adoption of IFRS per se improves the reporting

environment. Moreover, available literature shows that reporting incentives and the

country-specific factors (e.g. local political and institutional environment)

significantly influence the accounting quality. Therefore, doubt is expressed on

whether IFRS will be implemented uniformly across countries. In absence of the

same, the perceived benefits of harmonisation of accounting practices will not be

realised. Moreover, weak implementation of IFRS will mislead the investors in the

sense that they will start believing that the information environment has improved

after the adoption of IFRS.

Research findings signals that reporting incentives and reporting strategy are different

for different firms. Therefore, mandatory adoption of IFRS benefits some and hurts

others. There will be ‘winners and losers’. Multinational firms, large size firm, and

those which are listed in stock exchanges abroad are likely to benefit from the

adoption of IFRS and those, which are family controlled and depends on funding

from banks and other financial institutions will be the potential losers.

Cost of implementation is also a concern. Large companies will enjoy the economy of

scale and in their case the benefits will outweigh the implementation cost. Others will

not enjoy the economy of scale and the implicit cost (e.g. loss of competitive

advantage) of higher level of disclosures will outweigh the benefits.

14. RECOMMENDATIONS

SEC is going slow in endorsing IFRS, while FASB is working closely with IASB for

bridging the gap between U.S. GAAP and IFRS. Japan has deferred the decision to

make application of IFRS mandatory. The debate on practical benefits of adopting

IFRS has again surfaced. Evidence collected by academicians has failed to establish

that adoption of the IFRS improves the information environment. Although U.S.A.

and Japan has reiterated their commitment to either adopt IFRS or converge local

38

accounting standards with IFRS, they articulated that they need more time to evaluate

the impact of IFRS on firms and the society.

In view of the above, India should take a cautious approach. It should study the

impact of IFRs in different sectors of the economy and on the society before

implementing IndAS. Another round of discussion and public debate is required to

ensure that adoption of IFRS does not harm the economy. While developing the

IndAS, NACAS adopted the approach of minimum deviation from IFRS. In

reviewing the IndAS based on inputs from impact study, the government may decide

to make changes, wherever necessary.

In the mean time, the government should strengthen the regulatory measures to ensure

proper implementation of accounting standards. The level of disclosures may be

improved benefit of capital market and to improve the contracting efficiency.

39

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