ifrs on australian firms
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The Effects of International Financial Reporting
Standards on the Accounts and Accounting
Quality of Australian Firms:
A Retrospective Study
John G o o d w i n * ,
Kamran
A h m e d b *
and
Richard H e a n e y c *
TheHong
Kong
Polytechnic University
bLaTrobe University
'RMIT University
Received September 2007; Accepted June 2008
Abstract
We exam ine the effect of Australian equivalents to International Financial Reporting Standards
(IFRS)
on the accounts and accounting quality of
1,065
listed firms, relying on retrospective
reconciliations between Australian Generally Accepted Accounting Principles (AGAAP) and
IFRS. We find that IFRS increases total liabilities, decreases equity and more firms have earnings
decreases than increases. IFRS earnings and equity are not more value relevant than AGAAP
earnings and equity and while adjustm ents for changes in accounting fo r provisions and intangibles
other than goodwill are value relevant, they weaken associations with market value. Goodwill
adjustments improve associations with market value. We also find that the reconciliation note for
the earnings adjustments contained no new information.
JE L C lassi3cations:
M40
41
Keywords: LFRS, accounting quality
*We hank participants at research w orkshops at The H ong K ong Polytec hnic University,
RMIT
University,
The University
of
Technology Sydney, the AAA
2007
annual meeting, the AFAANZ 2007 annual meeting and
the JCAE/AJPT
2008
annual symposium for their valuable input. We also thank Eli Bartov, Kim Sawyer, Katherine
Schipper, the editors and the anonymou s reviewer
for
their valuable input. Any errors remain the authors'.
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No 2 (December
2008
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1.
Introduction
In 2002 the Financial Reporting Council (FRC) claimed that the implementation
of Australian equivalents to International Financial Reporting Standards (IFRS) would
enhance the overall quality of financial reporting in Australia FRC,002). This view
was supported by the Australian Accounting Standards Board (AASB) in suggesting that
complying with IFRS would not impose significant burdens and costs on entities when
compared with the benefits of more relevant and reliable information for users of financial
reports (Fenton-Jones, 2003,53). There was general agreement among commentators, the
firms, analysts and the wider community that the introduction of
IFRS
from 2005 would
materially affect Australian firms financial performance and accounts quality (Buffini,
2005; Clarke and Dean, 2005, Deegan, 2005,32-35). A study based on interviews of 60
senior financial executives from Australias top 200 firms reported that the introduction
of IFRS would have a significant impact on financial position and earnings. The majority
of executives expected earnings to be negatively affected while less than half expected a
positive effect on the financial position of their firms (Jones and Higgins, 2006). However, no
substantial empirical study has been undertaken to assess the claim that financial statements
prepared under IFRS will enhance the quality of financial reporting in Australia or to
examine the effects of IFRS on financial performance. In this paper we use a representative
sample of listed firms in attempting to fill this gap in the literature.
Our study contributes to the current debate on whether IFRS based accounting numbers
are of a different quality to those produced under domestic GAAP in several important
ways. First, we examine all listed Australian firms that have available data. Second, the
exemptions from applying IFRS to restated earnings and equity are limited to a small
number of standards and all firms are required to restate and provide reconciliations from
Australian Generally Accepted Accounting Principles (AGAAP) to IFRS upon first-time
adoption of IFRS (AASB 1 First-Time Adop tion ofAustralian Equivalents to International
Financial Standards,
para 39): Prior studies use datasets that may not be representative
of
the full effects of
IFRS
due to small sample size (e.g., Hung and Subramanyam, 2007)
or they may use firms that voluntarily adopt IFRS (e.g., Barth et al., 2005; Bartov et al.,
2005), meaning control for self-selection bias is needed. Self-selection bias is not an issue
with our dataset because early adoption is not permitted (AASB
1).
Third, our large sample
size permits an empirical examination
of
the reconciliation adjustments to IFRS, which
has not been reported in the literature. Finally, examining the switch to IFRS for Australia
is useful, as similar studies have focused on code law countries such as Germany. In
Germany, accounting numbers are more conservative and have different value relevance
than accounting numbers produced under common law based countries like Australia (Ali
and Hwang, 2000; Ball et al., 2000).
IFRS is applicable for reporting periods beginning after 31 December 2004 and firms
are required to restate comparatives and provide reconciliations o IFRS in their notes to the
Supporting this contention are the shareholder briefings
held by
som e firms (e.g., Telstra and Alinta)
to
explain the financial impact
of IFRS
on their accounts.
There are some standards exempt from retrospective application, namely the two financial instruments
standards (AASB 132 and AASB 139),AA SB 3
Business
Combinationsand the three insurance standards
(AASB
4 nsurance Con tracts,AASB 1023General Insurance Contractsand AASB 1038
Life
Insurance Contracts) .
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accounts in the first year of adoption. This requirementpermits a research design that directly
compares accounting numbers and their properties prepared under AGAAP with those
under IFRS for the same set of firm-years, as firms provide earnings and equity amounts
measured under two different sets of accounting standards for the same periods.
Our investigation comprises two main parts. First, we document the effect of IFRS on
key accounting numbers and ratios. Using a sample of 1,065listed firms, we find that the
mean (median) of total liabilities has increased and the mean (median) of total equity has
fallen. Total assets and earnings are higher under IFRS but the changes are not significant
apart from the increase in the half-year earnings median. IFRS increases the leverage ratio.
Second, we examine the relative value relevance of
IFRS
earnings and equity and the
incremental value relevance of IFRS over AGAAP. Using models with market prices and
returns as dependent variables, we carry out our tests on annual earnings (net income) and
equity measured at the changeover date to IFRS. We find no evidence that
IFRS
earnings
and equity are more value relevant than AGAAP. We find weak evidence that the aggregate
changes for earnings and equity are incrementally value relevant to AGAAP. About half of
the reconciling adjustments to AGAAP are value relevant but are generally not timely. The
intangibles and provisions adjustments in particular weaken the association with market
value. Goodwill adjustments improve the association with market value.
Because our data is from retrospective reconciliations, the tests are only of the ability
of accounting numbers to capture information used by the market. Therefore a coefficients
significance provides a lower bound on its true significance. We are aware of two other
similar papers, namely Rees and Elgers (1997) and Hung and Subramanyam (2007)
that examine a retrospective dataset. In our final test we examine whether the earnings
adjustments are associated with market values measured over the interval covering
the
release of the IFRS reconciliation note. This test permits inferences about the usefulness
to investors of the reconciliation adjustments, as observing a significant coefficient in
this regression could result from investors using that information. We find that all of the
information in the earnings adjustments was impounded into prices before the release of
the accounts, suggesting that the market was able to obtain the information from sources
other than the reconciliation note.
The remainder of this paper is organised as follows. The literature review is covered
in the next section. Section
3
describes the institutional background and data collection
process. Section 4 describes the accounting differences between AGAAF and
IFRS
for the
major reconciliation adjustments and provides an examination of the effects of IFRS on
the accounts and on financial statement elements and ratios. Section5 covers methodology
and results for relative value relevance tests and incremental value relevanceis covered in
section
6.
Section 7 concludes the paper.
2.
Literature Review
Barth et al. (2005) use data from 24 countries over a 15-year period to 2004 and find that
the transition to IFRS esults in improved accounting quality using a variety of measures.
Specifically, they find that IFRS results in more timely recognition of losses and higher
R2s in regressions of market value on earnings and book value. A study using European
data by Armstrong et al. (2007) report that the stock market reacts positively to the early
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(December 2008)
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adoption of IFRS, which suggests that European equity investors perceive net benefits due
to convergence of accounting standards and improved information quality following IFRS
adoption.While these results may be more representative of the overall effects of IFRS,they
are difficult to interpret for a study examining one country because each set of domestic
GAAP is likely different in a number of respects. For example, the timeliness characteristic
of earnings differs according to the institutional environment between countries (Ball et
al., 2000): The most closely related studies to the present study are those that examine
samples from one country.
An early single-country study by Kinnunen et al. (2000) exploits a unique market
setting in Finland, where foreign investors are restricted in their trading of certain shares.
This permits the authors to examine the relative value relevance of Finnish GAAP and
voluntarily adopted IFRS between two investor groups. They find IFRS improves the
information content for foreign investors but not for domestic investors. Another Finnish
study by Niskanen et al. 2000), examines components of reconciliations to IFRS for
18 Finnish firms voluntarily using IFRS over the period 1984 to 1992. They report the
aggregate earnings difference is value irrelevant for explaining returns but that untaxed
reserves adjustments and consolidation differences are value relevant. Since these papers
examine voluntary adopters the results may be affected by self-selection bias and they use
a dataset of accounting rules that is dated
More recently, Christensen et al. (2007) have examined the economic consequences for
UK firms of the European Unions decision to impose mandatory IFRS. They show that
there are cross-sectionalvariations in both short-run market reactions and long-run changes
in cost of equity associated with the decision, suggesting that mandatory IFRS adoption
does not benefit all firms in a uniform way but results in winners and losers. Using a price
levels regression, Hu (2003) reports that Chinese GAAP is more value relevant than IFRS
using a sample of 252 firm-years. This finding is supported by Eccher and Healey (2003),
who investigated a sample of 83 Chinese firms that were required to provide two sets of
accounts using Chinese GAAP and
IFRS,
and found that earnings under Chinese GAAP
were more closely associated with returns than earnings under IFRS.
Hung and Subramanyam (2007) use a sample of 80 German firms which voluntarily
adopted IFRS over the period 1998-2002 and provided accounts under German GAAP and
IFRS for the same period. Using price levels models, they find that total assets and book
value of equity, as well as variability of book value and net income, are higher under IFRS
than under German Accounting Rules (HGB). They also find that book value of equity
and net income under IFRS are no more value relevant than the amounts under HGB.
Further, they report that earnings and equity under IFRS are incrementally value relevant
With respect to a countrys institutional environm ent, Ball et al. (2000) report that du e to different levels
of conserv atism, earnings of firms in common law based countries are more timely in impounding ec onom ic
information than earnings of firms in co de law countries. They al so find that earnings co efficients are larger for
code law than for common law countries.
Other studie s on the voluntary adoption
of
IFRS investigate the distinguishing eco nom ic characteristics of
firms that switch to IFRS.El-G azza r et al. (1999) report that firms voluntarily adopting IFRS are those seeking
to access foreign capital, improve customer recognition or reduce political costs. Lang et al. (2003) note that
firms electing to adopt IFRS early are more likely to be those firms with fewer reconciling item s.
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to German GAAP. Both coefficients are highly significant but the earnings coefficient sign
is negative which they suggest is consistent with more measurement errors in the
IFRS
earnings than in the German earnings. Their relative value relevance results contrast with
Bartov et al. (2005) who also compare German HGB with
IFRS
(and
US
GAAP). They
find that
IFRS s more value relevant than German HGB in its ability to explain returns (as
opposed to prices used by Hung and Subramanyam,2007). They also find little difference
in the value relevance of US GAAP earnings and IFRS earnings after self-selection bias
is controlled for?
Bartov et al. (2005) examine firms in the cross section rather than the same set of firms
as do Hung and Subramanyam (2007). The present study also examines the same firms with
the added advantage that firms must adopt IFRS rather than voluntarily. Although Hung
and Subramanyam (2007) control for self-selection bias, the possibility remains that the
bias in the
IFRS
accounts due to the effects of early voluntary adoptions may explain the
conflicting results, as Barth et al. (2005) have noted. Different models might be another
reason, which motives us to estimate both a price levels model and a returns model.
In sum, the literature gives conflicting evidence on accounting quality. Our study adds
to the existing literature on the effects of adopting
IFRS
on earnings and equity quality by
using recent
data
rom companies that are required at initial adoption to provide earnings and
equity numbers under both AGAAP and IFRS,and by using price and returns models.
3.
Institutional Background and Data
Australian firms are required to use IFRS for reporting periods beginning on
or
after
1
January 2005. As part of the transition to IFRS,AASB
1
requires retrospective
reconciliations to
IFRS
earnings and equity to be provided in the first half yearly accounts
using IFRS and the first annual accounts using IFRS. or instance, in its annual accounts
ended 30 June 2006, the firm is required to provide a reconciliation of its annual AGAAP
earnings to
IFRS
earnings for the year ended 30 June 2005 and
of
its AGAAP equity to
IFRS
equity at 30 June 2005
6
These data permit an examination of the major differences
between AGAAP and IFRS earnings and equity both in aggregate and for specific
reconciliation adjustments.
Our final sample of 1,065 firms is determined in a series of steps. First, all firms listed
on the Australian Stock Exchange are selected from Aspect Huntley Pty Ltds FinAnaZysis
database as at January 2006 which gives a total of 1,714firms. From these, 180are deleted
because they were listed in 2005 or 2006; 72 because they used non-Australian GAAP
or foreign currency; 73 because they were suspended from trading and their accounts
are
not available; and two because they were delisted prior to account lodgement. This gives
a potential sample of 1,387 firms. We then examine the notes to the annual accounts and
Leuz 2003)
also examines the value relevance of German accounting numbers and reports that neither the
trading spread nor the trading volumes is significantlydifferent for the companies that choose IFRS or US GAAP
voluntarily.
Another requirement is to provide a reconciliation to half-year IFRS earnings (net income) to December
2004 in the half-year accounts ended
3
1 December2005. These dates are different for afirmwith a year-end that
differs from June
30
(see paragraphs
39
and
45
of
AASB
1 for other requirements).
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record details of any reconciliations for annual net income and equity at the last date that
AGAAP
is used.
We delete 280 firms which were unaffected by IFRS and 42 firms with missing data
or identified as outliers in initial regression tests. In the final sample of
1,065
firms
there
are
1,020
firms with earnings changes and 844 firms with equity changes. Table
1
shows
the sample description.
Table
1
Sample Description
Numb er of firms listed on ASX at January 200 6 1,714
Less:
Firms listed in 2005
or
2006
(180)
Accounts not available (73)
Firms delisted in 200 6
2)
F m s
using foreign currency / foreign GAAP
(72)
Potential sample 1,387
Financial 18% 253
Non financial 47% 649
1,387
Mining 35%
85
Less:
Unaffected by IFR S
(280)
Firms with missing data
Final sample 1,065
Financial 18% 193
Non financial 50 530
1,065
Mining 32%
Firms with earnings chang es
1,020
Firms with equity change s 844
4.
Major Accounting Differences and Their Effects on the Accounts
In this section we describe the main accounting differences between AGAAP and IFRS
for major adjustments, discuss the main reasons for each adjustment, and present evidence
of
their effects on the accounts.
4.1
Ma jor accounting differen cesand adjustments
Table 2 shows frequencies and percentages of unsigned
AGAAP
earnings and equity of
the nine most common reconciling adjustments for earnings, and for a catch-all component
Of the
280
unaffected firms,
15
firms changed comparatives only for prior period
errors
and accounting
policy changes unrelated to IFRS .AASB 108Accounting Policies, Cha nges in Accounting Estimates and Errors
requires retrospective adjustment for these types of change (para 19and 42).
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Table2
~
Frequencies and Percentagesof Unsigned Earnings and Equity for Adjustmentsof Earnings and Equity
Earnings Equity
N
Mean Median
N
Mean Median
Share-based payment
Incom e tax
Goodwill
Intangibles
Provisions
Investments
Impairment
FX
translation
Leases
Other
Total
594
456
381
183
165
131
98
98
90
353
1 020
-34
40
9
-3
75
-54
-4
-4
-16
-1
-3
0
9
1
-1
6
0
0
0
- 1
0
83
41
315
194
174
94
120
84
84
361
844
-4
0
3
-11
-1
5
-12
-1
-1
-9
-6
-1
0
1
-1
0
0
-4
0
0
-1
-1
Earnings is annual net income . Equity is net assets. Mean (median % )is the mean (median) of the reconciling
adjustment amount
for
earnings or equity divided by the absolute value of AGAA P earnings or AGAA P equity
for each firm. ther is a catch-all comp onent.
-
other? A summary of accounting policy differences between AGAAP and
IFRS
is
shown in Appendix A.
Share-basedPayment:
Under
IFRS ,
AASB 2
Share-based Payment
requires expensing
of the fair value of equity granted. The prevalence and effect of this adjustment is due
to the popularity of equity schemes and the almost complete lack of equity payment
expensing prior to
IFRS.
The recognition of the expense for some small
firms
is highly
material (untabulated), thus the mean of -34 percent is much larger than the median of -3
percent. Because the accounting is equity neutral, the number of adjustments to equity is
much smaller than for earnings. The negative adjustments to equity are mainly caused by
derecognition of loans to employees to acquire shares and derecognition of the entitys own
shares held in trust for employees (treasury shares) under AASB
132
Financial Instruments:
Disclosure and Presentation.
We classify these types
of
treasury share adjustments here
because it presents a clearer picture on the effects of employee share scheme accounting.
Other adjustments for treasury shares are included in financial instruments below.
Income
Tax:
The balance sheet method of income tax accounting is used under
AASB
112 Income Taxes
compared with the income statement method under AGAAP.
The principal difference is that the tax effects of items that bypass the income statement
are not recognised under AGAAP. Consequently, common adjustments relate to asset
revaluations, which give rise to deferred tax liabilities (DTLs), and share issue costs in
share capital, which give rise to deferred tax assets (DTAs). Raising DTAs for the
tax
effects of share-based payments expenses is common since these expenses were usually
unrecognised under AGAAP, hence the positive mean. DTLs recognised for intangibles
* T h e
irms
disclosures are used to guide classifying the adjustments.
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Ahmedand Richard Heaney
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V o l 4 ,N o 2
(December 2008)
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that have indefinite lives are also quite common.
Goodwill:
Amortisation over a period not exceeding 20 years under AGAAP is
replaced by an annual impairment test under AASB 3 Business Combinations.The result
is that firms have an increase in earnings and in equity on transition to IFRS. Hence the
means and medians are positive for earnings and equity in Table 2. Several firms wrote
off the balance of goodwill at transition due to impairment and these are classified under
impairment below. As with share-based payments, small firms are the cause of the large
mean of 40 percent relative to the median.
Intangibles: Under AGAAP, acquired and internally generated intangibles can be
capitalised and revalued provided that the value is reliably estimable9. Under AASB
138 Intangible Assets only acquired assets and development costs can be capitalised and
revaluation is only available for assets with an active market, with the result that most
intangibles are carried at cost. Assets are amortised under both AGAAP and IFRS although
amortisation can be avoided under
IFRS
if the asset has an indefinite useful life.
Except for development costs, it is clearly more difficult to capitalise intangibles and
measure them at fair value under IFRS than under AGAAP. Under IFRS development
costs can be capitalised provided the benefits are probable
lo
Under AGAAP, research and
development (R&D) costs can be capitalised provided the benefits are beyond reasonable
doubt, which represents a higher hurdle than probable. However, there are specific
criteria to be met for capitalisation under IFRS, meaning the change in reporting bias is
ambiguous for these assets.
As
a
result of applying AASB 138 retrospectively, some firms have derecognised
their R&D asset and reversed its associated amortisation; and other firms have capitalised
development costs, which they had immediately expensed under AGAAP. In the first case,
at transition to IFRS the firm has a negative equity effect and typically a positive earnings
effect, and in the second case those firms have positive earnings and equity effects. Most
adjustmentske of the first kind, thus Table2 shows positive median adjustmentstoearnings
and negative median adjustments to equity, most of which relate to R&D. Derecognition
of other intangible assets occurs because those assets are not measured by reference to
an
active market. Examples include brand names, trademarks and publishing rights and titles,
which can be very large, hence the mean of -11 percent.
Provisions:
This adjustment includes initial recognition of costs restoration provisions
for leasehold improvements and assets under operating leases under AASB 137Provisions,
Contingent Liabilities and Contingent Assets. Previously, these costs were recognised on a
cash basis except for mining firms, but under AASB 116Property, Plant and Equipment,
the cost of an asset includes the cost of restoration. The re-measurement of AGAAP
provisions for mining firms on a discounted basis gives positive equity adjustments for
these firms, although the fair valuing of provisions under
IFRS
generally leads to negative
adjustments. Other positive adjustments are reversals of general provisions disallowed
under AASB 137, such as doubtful debts and restructuring provisions typically recognised
in a business combination, and reversals of provisions for dividends.
Recognition
of
internally generated goodwill was prohibited under
AGAAP.
Mining firms measured the provision on an undiscounted hasis however.
o Probable is generally accepted to be more than 50 percent likely.
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91
Investments: Revaluations of property are recognised in the income statement under
AASB 140 Investment Property, but under AGAAP such revaluations were recognised
directly in equity. This is the underlying reason for the large difference between the
percentage adjustment to earnings
( 7 5 )
and equity
( 5 ) .
Also included in this adjustment
are re-measurement of investments in associates due to the collective effect of
IFRS,
and
equity investments classified as available for sale. Most adjustments are positive, but the
few negative adjustments are due to initial depreciation on investments reclassified to
property, plant and equipment, because those investments do not meet the definition of
investment under AASB 140.
Impairment: Under AASB 136 Impairment
of
Assets, firms are required to assess
non-current assets to determine whether the carrying amount exceeds the recoverable
amount, measured at present value. Under AGAAP, firms could choose to measure the
recoverable amount using undiscounted or discounted cashflows. More firms and firms
with large write-downs recognised impairments against opening equity at transition, as the
median of
-4
ercent for equity versus a median of
0
percent for earnings suggest.
FX
Translation:Under AGAAP, firms used either the current rate or temporal methods
to translate foreign operations accounts. Under AASB 121 The Effects
of
Changes in
Foreign Exchange Rates , firms are required to determine their functional and presentational
currencies and translate into Australian dollars at the rate current at balance date. The
result is that foreign exchange gains and losses on translation are now recognised directly
in equity until the investment is sold when the net of those gains and losses is recognised
in earnings. Non-monetary items are now translated at the current rate.
Leases: The main change under
IFRS
is the requirement to measure on a straight line
basis the expense for operating leases that contain payment escalation clauses. Previously
under AGAAP, lessees and lessors measured the expense on a cash basis. Lessees generally
have negative adjustments o earnings and equity indicating underexpensing in prior years.
Both lessees and lessors are classified here,
so
some adjustments to earnings are positive,
but most are negative.
Other: Other is a plug component necessary to complete the reconciliation from
AGAAP to
IFRS.
Included here are adjustments for financial instruments, prior period
errors and financial effects of changed accounting policies unrelated to
IFRS.
The bottom row of Table
2
shows the overall mean (median) decrease to earnings
is 7 0)percent and to equity it
is
6(1) percent, consistent with a more conservative bias
under
IFRS.
4.2
Effect of changes on jn an cia l statement elements and ratios
We
next examine the effect
of IFRS
on financial statement elements, retained profits,
cash flow and ratios. The top three rows of Table 3 shows that assets, liabilities and equity
differ under IFRS, but
only
the liabilities and equity differences are significant at the 10
percent level. The mean of total assets has risen yet the median is unchanged, due to some
very large asset increases for a small number of firms. These increases are mainly due
to first time consolidation of mortgage trusts by financial industry firms, which has also
increased liabilities with a zero or small net equity effect. By contrast, the effect is clearly
upward (downward) with liabilities (equity) due to recognition of new liabilities, such
as deferred tax liabilities for asset revaluations and restoration provisions; remeasuring
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Journal of Contemporary Accounting Economics V o l4 ,No 2 (December 2008)
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Table
3
Effect of IFRS on Financial Statement Numbers and R atios
Median
ean
N AGAAP IFRS t-test AGAAP IFRS Wilcoxon
Total assets
Total liabilities
Total equity
Retained profits
Earnings
Earnings - half year
Net cashflow
Operating cashflow
ROE
ROA
TL TA
Price earnings
Market to book
1 065
1 065
1 065
1 065
1 065
1 064
1 065
1 065
1 033
1 065
1 065
496
1 033
517.60
296.40
22 1.20
23.70
22.90
12.50
6.50
30.40
-0.24
0.38
21.70
2.76
-0.15
529.30
342.30
187
OO
13.60
24.40
1
3.20
6.10
3
1.40
-0.23
-0.16
0.41
21.56
3.23
0.49 30.30
30.30
0.02 7.80 8.20
0
oo
19.50 18.50
0.01
-3.90
-4.90
0.11 0.10
0.12
0.21 -0 o I
0
oo
0.27
0.25 0.25
0.21 -0.07
-0.07
0.73 0.01 0.02
0.19 0
oo
0.01
0.oo
0.31 0.33
0.97 10.95
10.51
0.12 1.71
1.84
0.34
0
oo
0
oo
0 oo
0.62
0.01
0.35
0.14
0.56
0.00
0
oo
0 oo
0.00
All balance sheet numbers are measured at the end of the last financial year reported under AGAA P. All
financial statement numbers are expressed in millions. RO E is earn ings divided by equity at year-end. RO A
is annual earnings divided by total assets a t financial year-end. TL is total liabilities. TA is total assets. Price
earnings ratio is calculated only for positive earnings for both AG AA P and IFRS. OE nd market to book ratio
are calculated on smaller samples because some firms (unincorporated trusts) report zero equity under IFRS.
P-values are for two-tailed tests
existing liabilities more conservatively, such as defined benefit superannuation plans; and
restoration provisions and reclassifications, such as equity to debt for trusts.I2
Both yearly and half yearly earnings have increased under IFRS,but the differences are
insignificant except for the half-year medians. Despite these trends more firms experience
an earnings decrease than an increase. This occurs because the dollar amount of the change
to earnings is about four times larger when it is positive. The main reasons for this are
unrealised gains
on investments recognised in earnings under IFRS whereas those gains
were recognised directly in equity under AGAAP, and the reversal of goodwill amortisation.
The differences between operating and net cash flows are not significantly different.
With respect to the ratios the differences in means are insignificant with the exception
of leverage
(TL/TA).
The leverage median difference is also significant and indicates higher
accounting risk under
IFRS.
he ROA median is higher underIFRS, nd the price earnings
ratio, which is measured only for positive earnings, is lower. The median difference of the
market to book ratio is higher reflecting much lower equity values. The results shown in
Tables 2 and 3 indicate that
IFRS
presents a weaker balance sheet for the average firm.
l 2 This latter reason is not expected to impact fu ture reporting periods becau se trusts are presently amending
their deed s to circumvent the accounting requirement for trusts with limited lives to report ze ro equity.
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5.
Relative Value Relevance
5.1
Methodology
Our second main objective is to examine the quality of IFRS-measured earnings and
equity. We adopt a value relevance perspective for accounting quality recognising that it is
but one of several perspectives (Schipper and Vincent,2003 .13Following similar studies
(e.g., Hung and Subramanyam,
2007),
a price levels model based on Ohlson
(1995),
and
a returns model (e.g., Bartov et
al.,
2005) are used. In this section we compare in the cross
section the value relevance of earnings and equity measured using AGAAP and IFRS for
firms that report a net change from IFRS. These tests determine the relative abilities of
AGAAP and
IFRS
earnings and equity to capture information used by the market.
The price levels modelI4 s:
where MV is the market value of the firms equity at the end of the last year that AGAAP
is used scaled by the number of shares at that time; E is the firms earnings for the last year
that AGAAP is used measured under AGAAP (denoted EA) or
IFRS
(denoted
EI)
scaled
by the number of shares at the end of that year; BVi, is the firms equity at the end of the
last year that AGAAP is used measured under AGAAP (denoted BVA) or
IFRS
(denoted
BVI) scaled by the number of shares at that time; and
E
is the error term.
We are also interested in examining the timeliness of the information contained in
AGAAP and IFRS-measured earnings. Our second model is:
where
R
is the annual raw return adjusted for capitalisation changes and dividends
measured to the end of the last year that AGAAP is used; E is the firms earnings for the
last year that AGAAP is used measured under AGAAP (denoted EA) or IFRS (denoted
EI)
scaled by the market value of equity at the start of that period; and E is the error term.
A
more common model includes earnings change as an additional independent variable
but data limitationsprevent us from using that model in the cross sectional comparison.We
do estimate that model in robustness tests in a longitudinal comparison (discussed below)
and inferences are unchanged.
Ball (2006)notes there is little settled theory or empirical evidence on which to build an assessment of
the advantages and disadvantages of
IFRS
despite the fact that almost
100
countries have adopted
them.
I
Som e studies (e.g., Easton, 1998;Easton et al., 2003) criticise scaling by the number of shares, arguing
that it may lead to spurious results due to the effects of scale. Barth and Clinch (2001) investigate the relative
efficiency of deflating methods in m itigating a scale effects model and find that
the
number
of
the firms outstanding
shares, as used in o ur study, is more efficient in m itigating sca le effects.
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conomics V o l 4 ,
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Because earnings releases contain information (Ball and Brown, 1968),value relevance
researchers often measure market value after the release of the accounts (e.g., three months
after fiscal year-end). However, in the present study this would bias the tests in favour of
AGAAP since the last AGAAP accounts are released before the measurement of market
value, and the IFRS reconciliation data are not released until the first IFRS accounts, which
is some months thereafter. Therefore, to place the two regressions on a more equal footing,
returns (and price) are measured at the end of the last year that AGAAP is used. Further,
as AGAAP half yearly earnings are released during the return interval used in Model ( 2 ) ,
which may introduce a bias favouring AGAAP, we also compare half yearly earnings using
model
( 2 )
and use 6-month returns. Results (untabulated) from this regression, discussed
in the robustness tests section below, leave inferences unaffected.
We assess accounting quality by comparing the explanatory power of the models
measured by the adjusted R2,using the test proposed in Vuong
(1
989). AGAAP regression
results are presented firstsoVuongs (1989) Z-statistic ispositive when the IFRS regression
is favoured over the AGAAP regression.
Table 4
Descriptive S tatistics for Regression V ariables
Panel A:
Price levels regression (Model
1 )
Code N Mean Median Std De v Min Max 70Pos
MV
MV
1,065
1.18
0.42
1.71
0.01
8.86
100
AGAAPequity BVA
1,065 0.73
0.23
1.14 -0.56
8.65 98
IFRS equity
BVI
1,065 0.66 0.20 1.04 -0.62 8.65 98
AGAAPeamings EA
1,065 0.05 0.00 0.19 -1.42 3.01 51
IFRS earnings EI
1,065 0.06 0.00 0.19 -1.02 3.01 51
Panel B:
Returns regression (M odel
2)
Returns R
922
0.22 0.05
0.92
-0.95 7.84 55
AGAAP earnings EA
922 -0.07 0.01
0.45
-8.82 1.68 52
IFRS earnings El
922 -0.06
0.02
0.37 -4.68
2.06 52
I n Panel A, all variables are scaled by number of shares outstanding at the end of the last year that AGAAP is
used.
In Panel B , returns are measured over the 12-month period ending on the last day that AGAAP is used and
all independent variables are scaled by market value
of
equity at the start of the last year that AGAAP is used.
Detination of variables are described as in the text.
5.2 Desc riptive statistics
Table4 shows descriptive statistics for the regression variables. As we estimate models
with different scalers, namely number of shares and market value of equity, two sets of
variables are shown in Panel A and B respectively. The second and third top rows of
Panel A show the mean (median) AGAAP earnings is 0.05 ( 0)per share and for equity
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it is 0.73 ( 0.23) per share. The mean and median
IFRS
earnings are similar to AGAAP
earnings but the equity mean and median are lower as Tables 2 and 3 suggest. The number
of
observations reported
in
Panel
B
is lower than in Panel
A
since valid 12-month returns
are needed, thereby excluding recently listed and thinly traded stocks. The sample size
reduces
to
922 from
1,065
for the returns model.
5.3Results
Panel
A
of Table
5
shows the price levels model results.
In
the cross sectional comparison
for the
AGAAP
regression, the coefficients for earnings and book value of equity are
Table 5
Relative Value Relevance
of AGAAP
and
IFRS
Earnings and Equity
Panel A : Price levels model
W a , , + a , E t ,+a , BV, , + E,,
Constant t-stat
E t-stat BV
t-stat
F-stat
Vuong Z-stat
(p-value)
Cross sectional comparison
N=
1,065)
IFRS
0.39 10.13** 1.95 9.01** 1.04 26.24** 0.62 878.15 (0.15)
AGAAP 0.34 9.52** 2.04 10.62** 1.01 31.82** 0.68 1,118.64 -1.44
Longitudinal comparison
(N =
972)
IFRS
0.39 7.51** 2.10 9.31** 1.19 24.63** 0.60 730.65 (0.01)
Panel B: Returns model
AGAAP 0.31 9.21** 2.44 11.44** 1.06 32.92** 0.73 1,336.35 -2.52
4 = a,, a J , ,
&,,
(2)
~ ~~
Constant t-stat E t-stat BV t-stat R2 F-stat VuongZ-stat
(p-value)
~~~~ ~
Cross sectional comparison
(N =
922)
AGAAP 0.24 7.84** 0.28 4.24**
IFRS 0.24 7.84** 0.34 4.28**
Longitudinal comparison (N
=
744)
AGAAP 0.21 7.24** 0.21 3.01**
0.02
17.94 0.03
0.02 18.28 (0.98)
0.01 9.03 0.30
IFRS
0.27 9.74** 0.18 3.55** 0.02 12.59 (0.62)
E
is annual AGAAPeamings,BV is book value of AGAAP equity at the end of the year. All independentvariables
are scaled by the number
of
shares at the end of the year in Panel A and by the market value
of
equity at the start
of the year in Panel B . Price is measured at the end of the last year that AGAAP
is
used in the cross sectional
comparison.Price is measured at the end of the respective financial year in the longitudinal comparison.Returns
are measured for the 12-month interval ending at the end of the last financial year that AGAAP is used in the
cross sectional comparison. Returns are measured for the 12-month interval ending at the end of the respective
financial year in the longitudinal comparison.**= significant at the 0.05 level (two-tailed test), * = significant
at the
0.10
level (two-tailed test)
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2.04 and 1.01 respectively. For the IFRS regression the coefficients are 1.95 and 1.04
respectively. Both models are significant (p
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