Accounting Coursework Sample Paper on IFRS

IFRS

Outline

  1. Introduction
  2. Analysis; Impact of IFRS on the quality of financial reporting
  3. Comparability  
  4. Transparency
  5. Convergence
  6. Conclusion


Introduction

Financial reporting is an essential aspect in promoting the establishment of efficient business operations in the modern business environment. Barth (2015) posits that financial accounting forms the foundation of a prosperous society. The process of financial reporting has undergone remarkable evolution over the past two decades. The evolution has been stimulated by the high rate of globalisation. Subsequently, the world is increasingly becoming integrated (Cole, Branson & Breesch 2010).

Due to the high rate of globalisation, the need for a harmonised financial reporting has increased substantially. This has culminated in the formulation of universal financial reporting standards commonly referred to the International Financial Reporting Standards (IFRS).  Tschopp and Huefner (2015) define the IFRS as ‘a set of high quality transparent, and comparable global accounting standards’ (p.118). The IFRS were developed by the International Accounting Standards Board (IASB).

The application of IFRS has gained significant acknowledgement across the globe. Despite the existence of divergent opinion on the application of IFRS by some jurisdictions such as the United States, Japan and China, over 100 countries have accepted the IFRS. Nevertheless, public listed companies across different countries are progressively adopting the IFRS as a requirement in their financial reporting process (Barth 2015). This indicates the recognition of the IFRS as a valuable component in companies’ financial reporting processes. This paper seeks to critically appraise the impact of IFRS adoption on the quality of financial reporting and disclosure.

Analysis: Impact of IFRS on the quality of financial reporting

Comparability  

One of essential aspects in organisation’s financial reporting process entails comparability. Zeff (2007) simply defines comparability to include ‘ensuring that things looks alike and unlike things look different’ (p.290). This means that comparability does not constitute uniformity.  Alternatively, Wang (2015) argues that comparability refers to the degree of correlation between measurement procedures and processes adopting by an organisation in measuring accounting earnings.  Zeff (2007) argues that comparability is a difficult aspect to achieve in the financial reporting process.

Some of the notable hindrances that have been identified in the attainment of comparability in the financial reporting process entail existence of varying cultures with reference to various accounting practices such as auditing, regulation and accounting. Due to the divergence of these cultures, achieving comparability might be difficult (Cole, Branson & Breesch 2010). Nevertheless, the formulation of the IFRS has considerably improved comparability in cross border business operation.  This arises from the fact that the concept of comparability requires organisations to disclose the accounting procedures and policies adopted (Cole, Branson & Breesch 2010).

Jeanjean and Stolowy (2008) argue that the IFRS improves comparability and reliability of financial reports.  This aspect arises from the fact that the IFRS aids in the elimination of information externalities that emanate due to lack of comparability. Currently, investors are progressively venturing into the international market in the quest to maximise wealth. However, to effectively make cross border investment decisions, the need for timely, reliable, comparable and timely financial information is fundamental.  

The increased application of the IFRS has contributed to significant reduction in the cost incurred by investors in making cross border investment decisions. One of the factors that have led to the cost reduction aspect entails the requirement for companies to ensure that the financial reports adhere to standardised reporting formats a hence improving the ease of making comparison. The ease of comparison is not only achieved through adherence to format but also by ensuring that the key quality requirements in the reporting process are complied with (Barth 2015).Through application of the IFRS, investors can easily compare financial data across different historical periods (Akgun 2016). Thus, investors in the domestic and foreign market can rely on the financial information provided in the process of making investment decisions.

Transparency

            The application of the IFRS has also contributed to improvement in the quality of financial reporting and disclosure by promoting transparency in the financial reports. Forssbaeck and Oxelheim (2015) identify transparency as one of the core objectives of the IFRS. The motivation to formulate the IFRS arose from increase in cases of agency cost. According to Shen and Chih (2005), agency costs constitute one of the greatest problems that shareholders encounter in their quest for wealth maximisation.

 One of the aspects that investors evaluate in determining the reliability of financial statements entails earnings management (Rudra & Bhattacharjee 2012). According to Xu (2014) affirms that:

‘earnings management occurs when managers use their own judgement in

financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company, or to influence contractual outcomes that depend on reported accounting numbers’ (p.5).

 The application of the IFRS has contributed to reduction in the preference of earnings management, which is one of the major factors increasing the prevalence of accounting fraud (). German firms have in the recent past increased their application of IFRS. Subsequently, the country has experienced a signifcaint reduction in cases of smoothing or earnings management in the financial reporting process. This achievement has arisen from the fact that countries are increasingly making it mandatory for firms to adopt the IFRS hence eliminating the voluntary application of the IFRS.

Financial engineering has been cited as one of the drivers of agency costs (Eng, Sun & Vichitsarwong 2014). Cases of earnings management were prevalent in the global business environment prior to the 2005 implementation of the IFRS as a mandatory aspect in organisations financial reporting process (Eng, Sun & Vichitsarwong 2014). The Enron scandal effectively illustrates the adverse effect on financial engineering on a company’s long term existence. Enron officials established institutional and transaction structures that promoted manipulation of financial reports. The motive of this approach was to avoid financial regulations and to eliminate constraints that might have hindered the firm’s capacity to access credit services from financial institutions. The company engaged in extensive use of derivative to achieve its motive. Thus, the level of transparency in Enron’s financial reporting process was reduced significantly. The revelation of the company’s financial malpractices led to collapse of its stock price and hence its subsequent declaration of bankruptcy (Dembinski, Lager, Cornford & Bonvin 2005).

According to Zaidi and Paz (2014), that firms that have adopted IFRS are less likely to experience fluctuation in their share price. Moreover, their earnings are more predictable due to the low rate of information asymmetry. Therefore, adoption of the IFRS reduces the bid-ask spread and minimises the volatility associated with stock price fluctuations.

A review of literature shows that most of the Indian banks that were characterised by low profitability performance prior to global adoption of the IFRS arose from prevalence in cases of earnings management. The banks understated their non-performing assets with the objective of improving their reporting on capital adequacy and earnings (Rudra 2012). Another study on earnings management in banks involving 48 banks showed that over 75% of the banks engaged in earnings management. However, the implementation of the IFRS has substantially improved the level of transparency and effective disclosure hence protecting the investors.

The Enron case illustrates the effect of lack of transparency in organisation’s financial reporting process on a firm’s long term survival.  According to Rudra (2012), increase in the level of transparency in the financial reporting process culminates in significant elimination of agency costs. The ultimate effect is that the investors benefit substantially from their investment. These views are supported by findings of a study conducted in Belgium and the European Union in 2004 on the effect of IFRS on the quality of financial report. The study affirmed that IFRS has led to improvement in the transparency of financial statements issued to the public and hence their reliability (Zaidi & Paz 2014).

Zeff (2007) identifies the practice of adjusting earning measures as one of the major hindrances in promoting convergence. Ernst and Young identify the practices of earnings adjustment as a practice that is prevalent amongst the European companies. In a study involving 65 companies, Ernst and Young revealed that 25% of the firms had reported alternative earnings per share (Zeff 2007). The motive of adjusting earning measures is to smooth a firm’s year-to-year trend. Such an adjustment of a company’s bottom line is prohibited under the IFRS requirements (Zeff 2007).

Through the implementation of the IFRS, the quality of financial reporting and disclosure has been fostered through improvement in the quality of corporate governance amongst organisations. For example, the IFRS requires organisations to establish independent board of directors. This requirement has played an essential role in deterring cases of earnings management. In spite of establishing independent Board of Directors, it is imperative for organisations to ensure that the elected members of the Board of Directors are diligent. This will improve the effectiveness with which the stipulated IFRS are applied (Rudra 2012).

Convergence

            The adoption of the IFRS also culminates in improvement of the quality financial reporting and disclosure due to the harmonisation characteristic associated with the IFRS. According to Goncharov, Zimmermann (2007), harmonisation or convergence entails the process of ensuring a high level of compatibility between the various financial accounting standards. The rational of convergence is to promote the quality of financial reporting and disclosure. To achieve this goal, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are increasingly adopting a collaborative approach in setting standards.  This collaboration has been spurred by the recognition of the value of IFRS in promoting a country’s economic growth (Zeff 2015).

IFRS advocates for convergence of the internal and external reporting process across firms. Therefore, the effectiveness with which an organisation undertakes consolidated financial reporting is improved. Thus, the quality of the financial information generated on the basis of the IFRS is high. The concept of convergence not only improves the value of the financial information to shareholders but also enhances organisation’s management team capacity to make effective managerial decisions. Past studies conducted on the application of IFRS indicate considerable improvement in the quality of accounting.  Barth (2015) affirms that the available empirical evidence shows that the application IFRS improves the quality of accounting across the world through diverse aspects such as minimising cases of earnings smoothing and management and timely recognition of loss.

Conclusion

            Effective financial reporting and disclosure is a fundamental aspect in a country’s economic growth. Its effective implementation influences the investment decisions across different sectors. Numerous efforts have been put in an effort to promote financial reporting and disclosure. The formulation of the IFRS is one such notable effort. Over the past one decade, IFRS has gained extensive application by different companies. However, some countries such as the United States have not fully accepted IFRS as a requirement in companies financial reporting. Nevertheless, individual companies are progressively accepting the IFRS as a fundamental approach in their financial reporting process. This indicates the relevance of the IFRS in the contemporary business environment.

This paper reviews the role of IFRS is promoting the quality of financial reporting and disclosure. The study’s findings illustrate that IFRS plays a critical role in promoting comparability and transparency, which constitute critical elements in the quality of financial reporting and disclosure. The review identifies existence of unethical practices as one of the major aspects that have increased cases financial scandal in different countries. Some of the accounting malpractices that have been identified relate to earnings management and financial engineering. The prevalence of these practices in the financial reporting and disclosure process significantly reduces the value of the financial statements and reports in making investment and managerial decisions. The formulation of the IFRS has led to remarkable decline in unethical accounting practices such as earnings management. The promotion of the application of the IFRS is further indicated by the high rate at which the accounting bodies are pursuing convergence in formulating setting accounting standards.

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