The effect of International Financial Reporting Standards on the quality of financial statements

Abstract

Investors depend on data provided for their investment and other decision-making requires through annual financial reports. Quality financial reports create efficiency in the allocation of resources in the capital market. This study examined the quality of financial reporting practices by foreign investment companies in Buea Municipality following the adoption of IFRS. It assessed their implementation, amendments, revisions, improvements and adoption of new IFRS. It also examined the impact of factors internal to the business environment including company size, leverage, return on equity and liquidity on the quality of financial reporting of listed foreign investment companies in Buea Municipality. Data was obtained for 10 firms. It was analyzed using mean scores, standard deviation, correlation matrix and analysis of variance. The results of the study indicate the quality of financial reporting mean for the period was 3.14 confirming a marginal improvement in the quality of financial reporting. This confirms that adoption of new IFRS, amendments; revisions and improvements do improve the quality of financial reporting though the improvement was not significant.

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

The International Financial Reporting Standards (IFRS) set common rules so that financial statements can be consistent, transparent and comparable around the world. IFRS are issued by the International Accounting Standards Board (IASB). They specify how companies must maintain and report their accounts, defining types of transactions and other events with financial impact. IFRS were established to create a common accounting language, so that businesses and their financial statements can be consistent and reliable from company to company and country to country.

The IFRS are sometimes confused with International Accounting Standards (IAS), which are the older standards that IFRS replaced. IAS were issued from 1973 to 2000, and the IASB replaced the International Accounting Standards Committee (IASC) in 2001. The IFRS covers a wide range of accounting activities. There are certain aspects of business practices for which IFRS set mandatory rules: Statement of Financial Position, Statement of Comprehensive Income, Statement of Changes in Equity and the Statement of Cash flow.

IFRS originated in the European Union (EU) with the intention of making business affairs and accounts accessible across the continent. The idea quickly spread globally, as a common language allowed greater communication worldwide. Although the U.S and some other countries don’t use IFRS, most do, and they are spread all over the world, making IFRS the most common global set of standards. They are a consequence of growing international shareholding and trade and are particularly important for companies that have dealings in several countries. They are progressively replacing the many different national accounting standards. They are the rules to be followed by accountants to maintain books of accounts which are comparable, understandable, reliable and relevant as per the users, internal or external.

IFRS with the exception of IAS 29 Financial Reporting in hyper inflationary economies and IFRIC 7 applying the Restatement Approach under IAS 29, are authorized in terms of the historical cost paradigm. IAS 2 is related to inventories; in this standard we talk about the stock, its production process and many more. IFRS began as an attempt to harmonize accounting across the EU but the value of harmonization quickly made the concept attractive around the world. However, it has been debated whether or not de facto harmonization has occurred. Standards that were issued by the IASC (the predecessor of the IASB) are still within use today and go by the name IAS, while standards issued by IASB are called IFRS.

IAS were issued between 1973 and 2001 by the board of the IASC. On April 1, the new IASB took over from the IASC the responsibility for setting International Accounting Standards. During its first meeting, the new board adopted existing IAS and Standing Interpretations Committee standards (SICs). The IASB has continued to develop standards calling the new standards ‘’International Financial Reporting Standards’’.

In 2012, the United States Securities and Exchange Commission Staff issued a 127-page report of potential issues with IFRS that would need to be addressed before adoption by the U.S. The staff of the IFRS Foundation provided a detailed answer on the main criticisms in the SEC staff report. A number of criticisms were voiced in the beginning of 2013 in French media to which the IASB Board member Philippe Danjou responded in his document ‘An update on International Financial Reporting Standards (IFRS).

It is widely acknowledged that IAS 29 Financial Reporting in Hyper Inflationary Economies had no positive effect during the six years it was implemented during hyperinflation in Zimbabwe. This led people to ask the purpose of IAS 29. As of March 2014, IAS 29 was been implemented in its original ineffective form in Venezuela and Belarus. It was suggested to the IASB in 2012 that IAS 29 should be corrected to require daily indexation which would result in effective constant purchasing power accounting and would stabilize the non-monetary economy during hyperinflation. The IASB has offered no response to date (March 2014) to this criticism and has not yet altered IAS 29 to require daily indexation.

IFRS are used in many parts of the world, including the South Korea, Brazil, the European Union, India, Hong Kong, Australia, Malaysia, Pakistan, GCC Countries, Russia, Chile, Philippines, South Africa, Singapore, Turkey, but not in the US. It is generally expected that IFRS adoption world-wide will be beneficial to investors and other users of financial statements, by reducing the costs of comparing alternative investments and increasing the quality of information. Companies are also expected to benefit, as investors will be more willing to provide financing. Companies that have high levels of international activities are among the group that would benefit from a switch to IFRS. Companies that are involved in foreign activities and investing benefit from the switch due to the increased comparability of a set accounting standards.

However, Ray J. Bill has expressed some skepticism of the overall cost of the international standard; he argues that the enforcement of the standards could be lax, and the regional difference in accounting could become obscured behind a label. He also expressed concerns about the fair value emphasis of IFRS and the influence of accountants from non-common law regions, where losses have been recognized in a less timely manner.

To assess progress towards the goal of a single set global accounting standards, the IFRS Foundation has developed and posted profiles about the use of IFRS in individual jurisdictions. These were based on information from various sources. The starting point was the responses provided by standard-setting and other relevant bodies to a survey that the IFRS Foundation conducted. Currently, profiles are completed for 124 jurisdictions, including all of the G20 jurisdictions plus 104 others. Eventually, the plan is to have a profile for every jurisdiction that has adopted IFRS, or is on a program toward adoption of IFRS.

1.2 Problem Statement

The IFRS are the rules to be followed by companies, in the process of preparing their financial statements in order to produce quality statements. The IFRS constitutes globally recognized set of standards for the preparation of financial statements that prescribe: the items that should be recognized as assets, liabilities, equity, income and expenses; how to measure these items; how to present these items in a set of financial statements; and the related disclosures required for each of these items. Thus the IFRS standards bring transparency by enhancing the international comparability and quality of financial information, enabling investors and other market participants to make informed economic decisions. More to this, the IFRS strengthen accountability by reducing the information gap between the providers of capital and the people to whom they have entrusted their money.

As a source of globally comparable information, IFRS are also of vital importance to regulators around the world. The IFRS contribute to economic efficiency by helping investors to identify opportunities and risks across the world, thus improving capital allocation. Use of a single, trusted accounting language lowers the cost of capital and reduces international reporting costs for businesses. The IFRS have therefore been developed to address the challenge regarding the presentation and interpretation of financial information into today´s world of borderless financial markets. Applying one set of high quality standards by companies throughout the world improves the comparability and transparency of financial information and reduces financial statement preparation costs. When these standards are applied rigorously and consistently, capital market participants receive higher quality information for decision making.

Despite all these, some companies still do not comply with the rules set by the International Financial Reporting Standards. This has a negative impact on them in that non-compliance with the IFRS prevents financial statements from faithfully representing the company’s results as they ought to, thus not achieving their purpose of providing useful information that enables the users to make informed judgments. Furthermore, non-compliance with the standards leads to low quality of financial information, because it hinders transparency and international comparability. More to that, non-compliance with the international financial reporting standards reduces the possibilities of investors to identify opportunities and risks across the world. Nonetheless, costs of capital and international reporting costs for businesses are increased. Though other researchers have enquired about this, in this study, the researcher seeks more knowledge of other aspects of it.

Research Questions

• What is the effect of International Financial Reporting Standards on the quality of financial statements?

From this main research question, the following specific questions arise:

• Is there a relationship between International Financial Reporting Standards and the quality of financial statements?
• How does the quality of financial statements affect the decisions of users of the financial statements?

1.3 Objectives Of The Study

Based on the main research question, we derive the main research objective;

• To understand how the International Financial Reporting Standards affect the quality of financial statements.

The following specific objectives will facilitate the research;

• To understand the relationship between the International Financial Reporting Standards and the quality of financial statements.
• To determine how the decisions of users of the financial statements are affected by the quality of financial statements.

1.4 Hypothesis

H0: IFRS have no significant effect on the quality of financial statements.

H1: IFRS has a significant effect on the quality of financial statements.