IMPACT ON ECONOMIC ACTIVITIES BY ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS BY INDIAN COMPANIES

Transcription

1 IMPACT ON ECONOMIC ACTIVITIES BY ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS BY INDIAN COMPANIES A thesis submitted to Christ University for the Degree of DOCTOR OF PHILOSOPHY IN COMMERCE RAM KESH GUPTA Research Scholar UNDER THE GUIDANCE OF Dr D. N. S. KUMAR Professor and Associate Director Centre for Research-Projects Christ University Bangalore - 29 Centre for Research Christ University, Bangalore March 2012

2 IMPACT ON ECONOMIC ACTIVITIES BY ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS BY INDIAN COMPANIES A thesis submitted to Christ University for the Degree of DOCTOR OF PHILOSOPHY IN COMMERCE RAM KESH GUPTA Research Scholar UNDER THE GUIDANCE OF Dr D. N. S. KUMAR Professor and Associate Director Centre for Research-Projects Christ University Bangalore - 29 Centre for Research Christ University, Bangalore March 2012

3 CERTIFICATE This is to certify that, the thesis entitled IMPACT ON ECONOMIC ACTIVITIES BY ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS BY INDIAN COMPANIES submitted by Ram Kesh Gupta to Christ University, Bangalore for the award of the degree of Doctor of Philosophy is an original research work carried out by Ram Kesh Gupta under my supervision. The contents of this thesis, in full or part(s) have not been submitted to any other University for the award of any degree or diploma. Place: Bangalore Date: Dr D. N. S. Kumar Professor and Associate Director Centre for Research-Projects Christ University Bangalore - 29 i

4 DECLARATION I hereby declare that Ph.D. thesis on titled IMPACT ON ECONOMIC ACTIVITIES BY ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS BY INDIAN COMPANIES is an original research work done by me under the guidance and supervision of Dr D. N. S. Kumar, Associate Director, Centre for Research-Projects, Christ University. This thesis is submitted to Christ University, Bangalore, for the award of the degree of DOCTOR OF PHILOSOPHY IN COMMERCE. I also declare that, this thesis or any part(s) of it have not been submitted to any other University for the award of any degree or diploma. Place: Bangalore Date: Ram Kesh Gupta Research Scholar ii

5 ACKNOWLEDGEMENT The Ph.D. research study has been a treasure in my life. I wish to take this opportunity to acknowledge the valuable help provided by many people in this journey. First of all, I wish to express my sincere gratitude to my supervisor and guide, Professor Dr D. N. S. Kumar for his insightful suggestions that have shaped the necessary progress of this research. His boundless energy combined with his patience and support has enabled me to complete this work. I would also like to thank the Vice Chancellor Dr (Fr) Thomas C. Mathew and the Pro-Vice Chancellor Dr (Fr) Abraham V. M., Christ University for the opportunity to do this research. Further, I would also like to thank Prof. (CA) J. Subramanian, Registrar and Dean of Commerce and Management, Fr Thomas T.V., C. K. T. Chandrashekara and T. S. Ramchandran, Institute of Management, Christ University for their constant encouragement. My special thanks to Dr Srikanta Swamy, Additional Director, Centre for Research, Christ University, who has been equally enthusiastic and provided valuable insights into my work. I would also like to thank my professional friends in KPMG India, Deloitte India and executives of Infosys Ltd., Dabur India Ltd., Noida Toll Bridge Co. Ltd and Rolta India Ltd. for their suggestions and guidance in my research. Thanks are also due to Prof. R. Narayanaswamy and Prof. M. Jayadev of Indian Institute of Management, Bangalore for their valuable suggestions and guidance that have helped me in my research. iii

6 I extend my thanks to Sreekumar Nair, Librarian, Christ University Library for his help and support in enabling me to use valuable resources. I would also like to thank Prof. Anil Pinto, Christ University and Saurabh Pandya, Indian Institute of Management, Bangalore for providing valuable contributions. I wish to thank my parents and most of all; I deeply thank my wife Deepika for her patience, love and positive support. Deepika, I adore you for your continued encouragement and appreciation of what I do. Finally, I humbly acknowledge the glory of The Supreme God, the true essence and strength of life who provides perseverance during all tasks. Ram Kesh Gupta iv

7 TABLE OF CONTENTS Certificate i Declaration ii Acknowledgement iii Table of Contents v List of Tables ix List of Graphs xi List of Acronyms and Abbreviations xii Chapter I INTRODUCTION 1 I.0 Introduction 2 I.1 Brief History of International Financial Reporting Standards 5 I.2 Related Literature 9 I.3 Statement of Problem 13 I.4 Research Question 14 I.5 Scope and Significance of the Study 15 I.6 Objectives of the Study 16 I.7 Hypotheses of the Study 17 I.8 Operational Definitions 17 I.9 Major Findings 19 I.10 Limitations of the Study 21 I.11 Chapter Scheme 21 v

8 Chapter II LITERATURE REVIEW 23 II.0 Introduction 24 II.1 Brief History of the International Accounting Standards Committee 24 II.2 Origin of International Accounting Standards Board 26 II.2.i International Accounting Standards Board 26 II.2.ii International Financial Reporting Interpretations Committee 27 II.3 Popularity and Acceptance of International Financial Reporting Standards Worldwide 28 II.4 Literature Review 30 II.5 Description of International Financial Reporting Standards 38 II.6 Description of International Accounting Standards 40 II.7 II.8 Indian Accounting Standards with relevant International Accounting Standards/International Financial Reporting Standards 44 Overview of International Financial Reporting Standards in Summarized Form 46 II.9 Summarization of Indian Accounting Standards 65 II.10 Major Differences between Indian Generally Accepted Accounting Principles and International Financial Reporting Standards/International Accounting Standards 148 Chapter III RESEARCH DESIGN AND METHODOLOGY 168 III.0 Purpose of the Study 169 III.1 Research Methodology 169 III.1.i Study Design 169 III.1.ii Data Collection 170 III.1.iii Companies under Study 171 vi

9 III.1.iv Tools for Collecting Data and Information 171 III.1.v Financial Matrix for Data analysis and Inference 171 III.1.vi. Graphical Presentation 172 Chapter IV COMPANIES UNDER STUDY 173 IV.0 Accounting Regulations and International Financial Reporting Standards in India 174 IV.1 Legal Recognition for Accounting Standards 176 IV.1.i Presentation of Financial Statements 177 IV.2 Convergence with International Financial Reporting Standards 179 IV.2.i Applicability of International Financial Reporting Standards to Small and Medium Size Entities 181 IV.3 Companies under Study 182 IV.3.i Dabur India Ltd 182 IV.3.ii Infosys Ltd 186 IV.3.iii Noida Toll Bridge Company Ltd 189 IV.3.iv Rolta India Ltd 191 Chapter V ANALYSIS AND INTERPRETATION 194 V.0 Data Analysis and Measurement 195 V.1 Measurement of Variables 195 V.2 Data Analysis 196 V.2.i Hypothesis 1-Financial Risk and International Financial Reporting Standards 196 V.2.i.a Financial Matrix-Hypothesis V.2.i.b Testing of Hypothesis vii

10 V.2.ii Hypothesis 2-Investment activities and International Financial Reporting Standards 204 V.2.ii.a Financial Matrix-Hypothesis V.2.ii.b Testing of Hypothesis V.2.iii Hypothesis 3-Mergers and Acquisitions activities and International Financial Reporting Standards 212 V.2.iii.a Financial Matrix-Hypothesis V.2.iii.b Testing of Hypothesis V.2.iv Hypothesis 4-Diversification activities and International Financial Reporting Standards 221 V.2.iv.a Financial Matrix-Hypothesis V.2.iv.b Testing of Hypothesis V.3 Interpretation of Results 229 Chapter VI CONCLUSION, SUGGESTIONS, AND SCOPE FOR FURTHER RESEARCH 233 VI.0 Conclusion 234 VI.1 Contributions 235 VI.2 Suggestions 238 VI.3 Scope for Further Research 241 REFERENCES 244 viii

11 LIST OF TABLES Sl. No. Table No. Title Page No. 1. I.8.i Operationalisation of Variables II.5.i Comparative position of International Financial Reporting Standards with Indian Generally Accepted Accounting Principles II.6.i Comparative position of International Accounting Standards and Indian Generally Accepted Accounting Principles II.7.i Indian Accounting Standards with Relevant International Accounting Standards/International Financial Reporting Standards II.10.i Differences between Indian Generally Accepted Accounting Principles and International Financial Reporting Standards/International Accounting Standards IV.3.i Information about the Indian Companies selected for study V.2.i.a Hypothesis 1 Variables V.2.i.a.ai Financial Matrix under IFRS-Hypothesis V.2.i.a.aii Financial Matrix under IGAAP-Hypothesis V.2.i.a.aiii Financial Matrix of difference between IFRS and IGAAP for Hypothesis V.2.i.a.aiv Descriptive Statistics of Financial Ratios (Hypothesis 1) V.2.i.a.av Descriptive Statistics of Financial Risks (Hypothesis 1) V.2.ii.a Hypothesis 2 Variables V.2.ii.a.ai Financial Matrix under IFRS-Hypothesis V.2.ii.a.aii Financial Matrix under IGAAP-Hypothesis ix

12 16. V.2.ii.a.aiii Financial Matrix of Difference between IFRS and IGAAP for Hypothesis V.2.ii.a.aiv Descriptive Statistics of Financial Ratios (Hypothesis 2) V.2.ii.a.av Descriptive Statistics of Investment Activities (Hypothesis 2) V.2.iii.a Hypothesis 3 Variables V.2.iii.a.ai Financial Matrix under IFRS-Hypothesis V.2.iii.a.aii Financial Matrix under IGAAP-Hypothesis V.2.iii.a.aiii Financial Matrix of Difference between IFRS and IGAAP for Hypothesis V.2.iii.a.aiv Descriptive Statistics of Financial Ratios (Hypothesis 3) V.2.iii.a.av Descriptive Statistics of Mergers and Acquisitions Activities (Hypothesis 3) V.2.iv.a Hypothesis 4 Variables V.2.iv.a.ai Financial Matrix under IFRS-Hypothesis V.2.iv.a.aii Financial Matrix under IGAAP-Hypothesis V.2.iv.a.aiii Financial Matrix of Difference between IFRS and IGAAP for Hypothesis V.2.iv.a.aiv Descriptive Statistics of Financial Ratios (Hypothesis 4) V.2.iv.a.av Descriptive Statistics of Diversification Activities (Hypothesis 4) V.3.i Hypotheses Testing with t-test Results 230 x

13 LIST OF GRAPHS Sl. No. Graph No. Title Page No. 1. V.2.i.b.bi Hypothesis 1 testing-left tail with critical region V.2.ii.b.bi Hypothesis 2 testing-right tail with critical region V.2.iii.b.bi Hypothesis 3 testing-right tail with critical region V.2.iv.b.bi Hypothesis 4 testing-right tail with critical region 227 xi

14 ACRONYMS and ABBREVIATIONS (In alphabetical order) AS : Accounting Standards of India ASB : Accounting Standards Board of India CRISIL : Credit Rating and Information Services of India Ltd. DEPS : Diluted Earnings per Share DIL : Dabur India Limited ER : Equity Ratio FAT : Fixed Asset Turnover Ratio FMCG : Fast Moving Consumer Goods IAS : International Accounting Standards IASB : International Accounting Standards Board IASC : International Accounting Standards Committee ICAI : Institute of Chartered Accountants of India IFAC : International Federation of Accountants IFRIC : International Financial Reporting Interpretations Committee IFRS : International Financial Reporting Standards IGAAP : Indian Generally Accepted Accounting Principles xii

15 ILFS : Infrastructure Leasing and Financial Services Ltd. InvCF : Investing Cash Flows InvFA : Investments in Fixed Assets IRDA : Insurance Regulatory and Development Authority EPS : Earnings per Share EU : European Union FASB : Financial Accounting Standards Board GAAPs : Generally Accepted Accounting Principles GDR : Global Depository Receipt GR : Gearing Ratio MCA : Ministry of Corporate Affairs of India NACAS : National Advisory Committee on Accounting Standards NASDAQ : National Association of Securities Dealers Automated Quotations NSE : National Stock Exchange of India NTBCL : Noida Toll Bridge Company Limited NZGAAP : New Zealand Generally Accepted Accounting Principles OpCF : Operating Cash Flows PE : Price Earnings Ratio QR : Quick Ratio xiii

16 RBI : Reserve Bank of India ROA : Return on Assets ROE : Return on Equity SAGR : Sales Growth SEBI : Securities and Exchange Board of India SEC : Securities Exchange Commission SICs : Standing Interpretations Committee Standards SMC : Small and Medium sized Companies USA : United States of America USSEC : United States Securities Exchange Commission USGAAP : United States Generally Accepted Accounting Principles xiv

17 CHAPTER I INTRODUCTION 1

18 I.0 INTRODUCTION The importance of international accounting practice studies has grown over the past few years in order to meet economic agent demands and to facilitate international business practices. It is essential to understand that international accounting convergence is an important topic for capital market regulators, investors, markets, governments and all others who deal with financial information of public companies. This brings out the importance of accounting as being an essential fiscal tool for various economic agents. The merit of international accounting convergence lies in its ability to minimize negative effects resulting from diversity of accounting practices in different countries (Cordeiro et al. 2007). In such a scenario, the introduction of International Financial Reporting Standards (IFRS) for listed companies in many countries around the world is viewed as one of the most significant regulatory changes in accounting history (Daske et al. 2008). IFRS issued by the International Accounting Standards Board (IASB) are now being recognized as the premier global reporting standards of accounting information world over. Today, more than hundred nations demand or permit the use of IFRS in their countries. Many countries have already announced their willingness to adopt IFRS in their countries. This is becoming the most popular and commonly accepted financial reporting model around the world, such as, European Union, Australia, New Zealand and Russia. The legal frameworks currently permit the use of IFRS in their countries. The importance of IFRS grew as they provide greater comparability of financial information for investors and also encourage them to invest across borders. Studies show that, IFRS adoption help in lowering the cost of capital for the companies and benefits more efficient allocation of capital. 2

19 Levitt (1998) in his paper on the importance of high quality accounting standards emphasized the need for harmonization of accounting standards to deliver credible information grounded in transparent financial reporting. The author lists out three key objectives for international standards to gain acceptance, as under: 1) The standards should include a core set of accounting pronouncements that constitute a comprehensive, generally accepted basis of accounting. 2) The standards must be of high quality -they must result is comparability and transparency and provide for full disclosure. Investors must be able to meaningfully analyse performance across time periods and among companies. 3) The standards must be rigorously interpreted and applied. If the accounting standards are to satisfy the objective of having similar transactions and events accounted for in similar ways-whenever and wherever they are encountered, auditors and regulators around the world must insist on rigorous interpretation and application of those standards. Otherwise, the comparability and transparency that is the objective of common standards will get eroded. The Securities Exchange Commission (SEC) of United States of America (USA) has allowed usage of IFRS without reconciliation of United States Generally Accepted Accounting Principles (USGAAP) in the financial reports filed by foreign private issuers, thereby, giving foreign private issuers a choice between IFRS and USGAAP. SEC has proposed that the USA issuers should begin reporting under IFRS from 2014 with full conversion to occur by 2016 depending on size of the entity, this will bring almost the entire world on one single, uniform accounting platform, that is, IFRS. With the economy growing and increasing integration among the global economies, Indian companies are also raising their capital globally due to 3

20 diversification, cross-border mergers, investments or divestments. Under these circumstances, it is imperative for Indian corporate world to adopt IFRS for their financial reporting. The Core Group of Ministry of Corporate Affairs of India (MCA) has recommended convergence to IFRS in a phased manner from April 1, Till then, an Indian corporate having global aspirations should consider voluntary adoption of IFRS. The convergence with IFRS standards is set to change the landscape for financial reporting in India. Indian companies currently follow the local accounting standards known as Indian Generally Accepted Accounting Principles (IGAAP) issued by Institute of Chartered Accountants of India (ICAI) on behalf of MCA, Government of India. The proponents of IFRS argue that accounting standards harmonization via IFRS enhances the quality and comparability of corporate financial disclosures, and accounting disclosure qualities have been the major focus of investors and also regulators. The only positive and direct method of reducing agency cost and risk due to information asymmetry is through better accounting disclosure policies. The accounting quality pertains to better information disclosure quality. Various accounting standards and GAAPs (Generally Accepted Accounting Practices) around the world lay down different set of norms for accounting disclosures hence the quality of accounting information also differ across nations. The basic feature of IFRS is that it is a principle-based standard rather than being a rule-based one. Since IFRS is still in its infancy, researches across the globe are interested to study the importance and impact on the financials of the companies. It is argued that the use of IFRS enhances the comparability of financial statements, improves corporate transparency, increases quality of financial reporting and thus benefits investors. Daske et al. (2008) in their study on economic consequences due to 4

21 mandatory IFRS reporting around the world, argue that, from an economic perspective, there are reasons to be skeptical about the above expectations because the economic consequences of mandating IFRS reporting are not obvious. Arguing on the same basis, this research aims to study the impact on economic activities of Indian companies by adopting IFRS. Even though there are several similarities between IGAAP and IFRS, still there exist differences that can have significant economic impacts. The research aims to understand these impacts due to IFRS adoption by Indian companies. I.1 BRIEF HISTORY OF INTERNATIONAL FINANCIAL REPORTING STANDARDS With the rampant rise of globalization, it is really difficult to disagree with Thomas L. Friedman, author of the world-renowned book, The World is Flat, who said around the year 2000 that we have entered a new stage of globalization, a whole new era that he referred to as Globalization 3.0. According to him, the size of the world is shrinking from small to tiny. Some people believe that this magical phenomenon of globalization has led to the emergence of a global village that we live in. If we believe in the old adage, Accounting is the language of business, then business enterprises around the world should not be speaking in different languages to each other while exchanging and sharing financial results of their international business activities and also reporting the results of business and trade to their international stakeholders. One school of thought believes that since business enterprises around the world are so highly globalized now and need to refer to each other in a common language of business, there is real need for single, universal set of 5

22 accounting standards that would unify the accounting world and, more importantly, solve the problem of diversity of accounting practices across borders. Historically, countries around the world have had their own national accounting standards. However, with such a compulsion to be part of the globalization movement, wherein business across national boundaries are realizing that it is an astute business strategy to embrace the world as their workplace and marketplace, having different rules or standards of accounting for the purposes of reporting financial results would not help them at all; rather, it would serve as an impediment to the smooth flow of information. Businesses, therefore, have realized that they need to talk to each other in a common language. IFRS are clearly emerging as a global financial reporting benchmark and most countries have already started using them as their benchmark standard for listed companies. With the recent issuance of IFRS for Small and Medium Enterprises, a stand-alone set of standards for private entities that do not have public accountability, the global reach of the IASB is further enhanced. However, if these international standards are not applied uniformly across the world, due to interpretational differences, then their effectiveness as a common medium of international financial reporting will be in question. If the different entities within the region apply them differently based on their interpretation of the standards, it would make global comparison of published financial statements of entities using IFRS difficult. Debate still rages amongst accountants and auditors globally on many burning and contentious accounting issues that need a common stand based on proper interpretation of these standards. According to one school of thought, IFRS are emerging as the much-awaited answer to the billion-dollar question on the minds of accountants, financial 6

23 professionals, financial institutions, and regulators, that is, Which set of accounting standards would solve the conundrum of diversity in accounting practices worldwide by qualifying as a single or a common set of standards for the world of accounting to follow and rely upon? Undoubtedly, for years, USGAAP was leading this much-talked about international race to qualify as the most acceptable set of accounting standards worldwide. Due to several reasons, including the highly publicized corporate debacles such as Enron in the United States, the global preference of most countries has now been clearly in favour of IFRS as the most acceptable set of international accounting and financial reporting standards worldwide. With the current acceptance of IFRS in more than hundred countries and with several more expected to adopt IFRS in the coming years, one can argue that IFRS could possibly qualify as an Esperanto of international accounting. However, there is a strong possibility of the USSEC s accepting IFRS ultimately. Judging from the amazing change in attitude of the USSEC, which has already allowed use of IFRS by foreign issuers for filings on USA stock exchanges, one may expect-that is, if the SEC s road map to convergence with IFRS goes through successfully without any glitches, that by 2014, the world of accounting may be rejoicing and celebrating under a strong common banner of a global set of accounting and financial reporting standards, namely the IFRS. The history of IFRS can be traced back to 1973 when representatives of the professional accounting bodies from major developed economies-australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom, Ireland and the US-reached an agreement to establish the International Accounting Standards Committee (IASC) with no statutory mandates given by political jurisdictions. In 7

24 1975, the IASC pronounced its first International Accounting Standard (IAS). Since then the IASC issued a total of 41 IAS until it was restructured into the International Accounting Standard Board (IASB) in The IASB has pronounced a total of eight International Financial Reporting Standards (IFRS) as on A major task of the IASB is to cooperate with national accounting standard setting bodies to achieve harmonization in accounting standards around the world. Nowadays, the IAS and IFRS are widely accepted and have become one of the most prevalent accounting standards around the world. In 2002, the IASB and the Financial Accounting Standards Board (FASB) embarked on a joint programme to make USGAAP and IFRS converge to the maximum possible extent (Schipper, 2005). Also, the IFRS has been widely adopted in the Asia-Pacific region. For example, Bangladesh requires companies listed on local stock exchanges to adopt IFRS. Some countries-australia, Hong Kong and New Zealand-have changed their local standards into new standards that are virtually similar to IFRS. Other countries, for example, Singapore, India, Malaysia, Thailand, and others, have changed most parts of local standards that are equivalent to IFRS. Economic activities such as investments, mergers and acquisitions, and diversifications are key activities of development, survival and sustainability. Companies are in competition at global level, hence the pertinent research is undertaken to study the impact of IFRS on such of the economic activities. Interestingly it is found that the financial risks have not improved and investments, mergers and acquisitions and diversification do not impact statistically on economic activities even though differences are seen in absolute numbers. An important step towards accounting standards harmonization through IFRS was made in March 2002, when the European Parliament broadly endorsed the 8

25 proposal that all European Union companies listed on organized stock exchanges (about 9,000 companies in total) should, from 2005 onwards at the latest, prepare and publish their consolidated accounts in accordance with IFRS. Implementation of IFRS practices in the European Union turned out to be a historic event. It was the most significant revolution concerning accounting standards and accounting practices ever (Cordeiro et al. 2007). The countries in European Union that required domestic listed firms to follow IFRS from 2005 were Austria, Belgium, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, the Netherlands, Norway, Poland, Portugal, Slovakia, Spain, Sweden and the United Kingdom. I.2 RELATED LITERATURE There are different streams of IFRS literature. One stream investigates the impact of IFRS adoption on earnings quality and finds mixed results (Cuijpers & Buijink, 2005; Gassen & Sellhorn, 2006; Barth et al. 2008; Tendeloo & Vanstraelen, 2005). Another stream of research examines the value relevance of IFRS in comparison with local GAAP (Hung & Subramanyan, 2007; Bartov et al. 2005; Goodwin et al. 2008). The third stream of research examines the impact of IFRS adoption on cost of capital (Leuz & Verrecchia, 2000; Daske, 2006). There are also other streams of IFRS literature that examine factors influencing disclosure on transition to IFRS (Kent & Stewart, 2008; Palmer, 2008), relevance of accounting classification in the IFRS era (Nobes, 2008), impact of particular IFRS on harmonization (Morais & Fialho, 2008) and value relevance (Chalmers et al. 2008). Regulators and investors have commonly expressed the view that more the transparency and higher the quality in accounting, lower is the cost of capital for adopting companies (Levitt, 1998; IASB, 2002). Proponents of IFRS often claim that 9

26 IFRS adoption leads to greater and higher-quality disclosures. When compared with local accounting standards in most countries, IFRS is considered as being more fairvalue-oriented, reducing accounting flexibility allowed for the issuers of financial statements, incorporating the effects of economic events on firm performance into financial statements in a timelier manner (Coopers & Lybrand 1993; Dumontier & Raffounier 1998; GAAP 2000). In one of the major work on studying economic consequences due to mandatory IFRS reporting Daske et al. (2008) with a sample of 26 countries for a period from 2001 to 2005 found that, on an average, market liquidity increased around the time of introduction of IFRS. Capital market benefits occur only in countries where firms have incentives to be transparent and where legal enforcement is strong. Capital market also affects most of the firms that voluntarily switch to IFRS, both in the year they switch and again later, when IFRS become mandatory. Many adopting countries make concurrent efforts to improve enforcement and governance regimes. Moreover, several studies provide empirical evidence suggesting that IFRS is of higher quality than local GAAP. Bartov et al. (2005) assess the value relevance of earnings produced under USA and German GAAP relative to that under IFRS, and finds that USGAAP-based and IFRS-based earnings are of higher value relevance than German GAAP-based earnings. Armstrong et al. (2008) examine the European stock market reaction to adoption of IFRS through an event study approach and find that, market perceives net benefits associated with either convergence of accounting standards or improved information quality by IFRS. While these studies focus on the impact of IFRS adoption on the disclosure quality, the other stream of research focuses on the association between the disclosure 10

27 quantity or level and a firm s voluntary adoption of IFRS. Ding et al. (2005) report that IFRS require more comprehensive disclosures than the domestic standards of most countries. Lantto and Sahlstrom (2009) in their study examine the impact of IFRS adoption on key financial ratios using Finland as a sample country. The results clearly show that, the adoption of IFRS changes the magnitude of the key accounting ratios. Moreover, it also found that, adoption of fair value accounting rules and stricter requirements on certain accounting issues are the reasons for the changes observed in accounting figures and financial ratios. In this regard, the results of the study indicate that, the adoption of IFRS changes the magnitudes of the key accounting ratios of Finnish companies by considerably increasing the profitability ratios and gearing ratio moderately, and considerably decreasing the PE ratio and equity and quick ratios marginally. The results indicate that the increases in the profitability ratios and the decrease in the PE ratio can be explained by increases in the income statement profits. In another study using financial ratios based on profitability, activity, liquidity and solvency, Padrtova and Vochozka (2011) compare the informative value of financial statements of CEZ Inc drawn up under IFRS and Czech accounting standards for 2004 and The financial analysis results proved the impact of IFRS implementation on financial performance of the company. Financial statements prepared under Czech accounting standards showed the company healthier than financial statements drawn under IFRS. Similarly, Beuren et al. (2008) in their study developed on economic-financial indicators of 37 English companies suggested divergence between IFRS and USGAAP, indicated significant correlation between differences of these indicators. However, in contrast, Ferrer et al. (2011) investigate how liquidity and 11

28 leverage ratios exert significant effect on the degree of compliance with IFRS disclosures as measured by disclosure indexes constructed from Balance Sheets and Income Statements of 100 publicly listed companies in Philippines. Multiple regression analysis based findings suggest that none of the indices exert a significant effect on the financial variables based on computed t-statistics. The study accepts null hypotheses that liquidity and financial leverage have no effect with IFRS when expressed in terms of Balance Sheet and Income Statement indices. Zhou et al. (2009) undertake a study in China, an emerging economy as sample country, investigated whether firms adopting IFRS have higher earning quality as compared to non-adopting firms in an emerging market. The results suggest some improvement in the quality of accounting information associated with the adoption of IFRS. The findings point to the need for a stricter enforcement mechanism of accounting standards in emerging markets. Enforcing the same sentiment, Liu et al. (2011) examine the impact of IFRS on accounting quality in China, a regulated market using a sample of 870 firms that were mandated to follow the new standards. Results of the data from 2005 to 2008 show that changes are less likely to result from changes in economic conditions but from changes in the market. This study is important because it provides direct evidence on the question whether IFRS can be relevant to markets that are still disciplined mainly by regulators than by market mechanisms. In one of the only descriptive study using Indian banking industry, Firoz et al. (2011) critically analyse financial statements like business per employee, capital and reserves, investments and advances, net non-performing assets ratios and the impact thereon on relevant provisions of IFRS. The authors conclude that certain issues need 12

29 clarity from tax authorities as well as from Reserve Bank of India to ensure successful IFRS implementation by banking industry. The idea that IFRS adoption enhances disclosure level and/or quality of corporate disclosures forms the basis of arguments in this thesis. The intuition is that a firm s voluntary adoption of IFRS can be viewed as commitment to better disclosure, which may have various economic impacts on the firm. I.3 STATEMENT OF PROBLEM The statement of problem is to test what are the impacts on economic activities, that is, on financial risks, investments, diversifications, mergers and acquisitions and other key functions of finance after adoption of International Financial Reporting Standards by Indian companies and to study whether disclosures under IFRS really have an impact on economic activities of the Indian companies or not. As the necessity demands, the researcher has planned to study how IFRS has impacted key economic activities such as: 1) What is the impact on financial risk after voluntary adoption of IFRS by Indian companies? 2) What is the impact on investment activities after voluntary adoption of IFRS by Indian companies? 3) What is the impact on merger and acquisition activities after voluntary adoption of IFRS by Indian companies? 4) What is the impact on diversification activities after voluntary adoption of IFRS by Indian companies? 13

30 I.4 RESEARCH QUESTION The main purpose of this thesis is to examine the impact of firms voluntary IFRS adoption on economic activities. In order to empirically address the issue, the researcher employs four types of economic activities-financial risks, investment activities, merger and acquisition activities and diversification activities. In the first study, given that, impact on financial risks measures the amount of firm-specific information being impounded into liquidity, profitability, leverage and market based ratio, the researcher investigates whether IFRS adoption has an impact on financial risks. A detailed look at how IFRS adoption impacts economic activityfinancial risk is included in this research. The researcher hypothesizes that financial risks improved after adoption of IFRS voluntarily. In the second study, given that, impact on investment activities measures the amount of firm-specific information being impounded into investments in fixed assets, investing cash flow and return on assets, the researcher investigates whether IFRS adoption has an impact on investment activities. A detailed look at how IFRS adoption impacts economic activity-investment activities is included in this research. The researcher hypothesizes that investment activities increased after the adoption of IFRS voluntarily. In the third study, given that, impact on mergers and acquisitions activities measure the amount of firm-specific information being impounded into diluted earnings per share (EPS), equity ratio and operating risk, the researcher investigates whether IFRS adoption has an impact on mergers and acquisitions activities. A detailed look at how IFRS adoption impacts economic activity-mergers and acquisitions activities is included in this research. The researcher hypothesizes that mergers and acquisitions activities improved after the adoption of IFRS voluntarily. 14

31 In the fourth study, given that, impact on diversification activities measures the amount of firm-specific information being impounded into growth and operating cash flow, the researcher investigates whether IFRS adoption has an impact on diversification activities. A detailed look at how IFRS adoption impacts economic activity-diversification activities is included in this research. The researcher hypothesizes that diversification activities increased after the adoption of IFRS voluntarily. I.5 SCOPE AND SIGNIFICANCE OF THE STUDY This study is significant because Indian companies have started going abroad to raise money and therefore they have to comply with the international accounting standards. This gives importance to the use of IFRS being a single accounting standard across the globe. The scope of this research is restricted to listed Indian companies on National Stock Exchange (NSE). NSE listed companies have to publish their financial annual reports in the mandatory accounting principles as required in India. In addition to this, some of these companies also publish their financial annual reports in IFRS voluntarily in India. The foreign companies that have obligations to publish their results in IFRS due to their multiple listing are excluded from this analysis. This research will significantly contribute to accounting and finance knowledge from the perspective of users of such information. The research also tries to uncover factors influencing the economic activities like financial risk management, investments, diversification and mergers and acquisitions in Indian companies and see how these activities are affected by better disclosures through IFRS. 15

32 I.6 OBJECTIVES OF THE STUDY The overall objective of the research is to study the impact on economic activities due to voluntary adoption of IFRS by Indian companies. The specific objectives are as follows: i. To study the existing accounting and disclosing norms; ii. iii. iv. To know what made the companies under study to adopt IFRS voluntarily; To measure the impact on economic activities by adoption of IFRS; and To make suitable suggestions for better disclosures that would enhance the value with such economic activities. The adoption of accounting standards that requires high-quality, transparent, and comparable information is welcomed by investors, creditors, financial analysts, and other users of financial statements. It is difficult to compare worldwide information without a common set of accounting and financial reporting standards. The use of a single set of high quality accounting standards would facilitate investment and other economic decisions across borders, increase market efficiency, and reduce the cost of raising capital. The motivation for this research is to evaluate the impact on economic activities of Indian companies by disclosing their accounting information under IFRS. As a matter of fact, better disclosures reduce the estimation risk of future earnings, thereby reducing the cost of information asymmetry that occurs due to adverse selection and risk premium which in turn reduces the financial risks faced by the companies and increases the economic activities like investment activities, diversifications, mergers and acquisitions and other key functions of finance. 16

33 I.7 HYPOTHESES OF THE STUDY Based on the objectives of the study, the researcher hypothesizes the following: Hypothesis 1: H o : H 1 : Financial risk did not improve after the adoption of IFRS voluntarily. Financial risk improved after the adoption of IFRS voluntarily. Hypothesis 2: H o : Investment activities did not increase after the adoption of IFRS voluntarily. H 1 : Investment activities increased after the adoption of IFRS voluntarily. Hypothesis 3: H o : Merger and acquisitions activities did not improve after the adoption of IFRS voluntarily. H 1 : Mergers and acquisitions activities improved after the adoption of IFRS voluntarily. Hypothesis 4: H o : Diversification activities did not increase after the adoption of IFRS voluntarily. H 1 : Diversification activities increased after the adoption of IFRS voluntarily. I.8 OPERATIONAL DEFINITIONS In order to test the hypotheses, the researcher needs to identify the different variables. For this, the researcher analysed the important terms in the above hypotheses. Since each hypothesis is aimed to test specific economic activity due to IFRS 17

34 adoption, it is important to go deeper into each economic aspect of the above hypotheses to operationalize these variables. The definitions for variables operationalization are supported from the extensive literature review done in Chapter II. These variables are discussed in greater details in Chapter V. These variables are tabulated as under: Table I.8.i: Operationalization of Variables Hypothesis Economic Ratios Definition Related literature activity Hypothesis 1 Financial risk Liquidity Quick ratio Lantto & Shalstrom (2009), Padrtova & Vochozka (2011) Profitability Return on equity Lantto & Shalstrom (2009), Padrtova & Vochozka (2011) Leverage Gearing ratio Lantto & Shalstrom (2009), Padrtova & Vochozka (2011) Market based ratio Price earnings ratio Lantto & Shalstrom (2009) Hypothesis 2 Investment activities Investment in fixed assets Gross value to be used Aubert & Grudnitski (2011) Investing cash flow As originally reported in Aubert & Grudnitski (2011) cash flow statements Return on assets Ratio between total assets and net income Kabir et al. (2010), Padrtova & Vochozka (2011) 18

35 Hypothesis Hypothesis 3 Hypothesis 4 Economic activity Mergers and acquisitions activities Diversification activities Ratios Definition Related literature Diluted EPS As reported Aubert & Grudnitski (2011) Equity ratio Equity ratio Lantto & Shalstrom (2009), Padrtova & Vochozka (2011) Operating Fixed asset Aubert & risk turnover ratio Grudnitski (2011), Padrtova & Vochozka (2011) Growth Sales variation Byard et al. (2010) over previous year Operating As originally Aubert & cash flow reported in Grudnitski (2011) cash flow statements I.9 MAJOR FINDINGS The findings of this research are very interesting in relation to the impact on economic activities of Indian companies due to voluntary IFRS adoption. There are positive and negative differences, some greater, some lesser, in each financial indicator of economic activity. These changes in financial ratios exist in absolute numbers (magnitude) calculated based on IFRS and IGAAP financial statements. This suggests that the adoption of stricter accounting rules under IFRS could be the reasons for the changes observed in accounting figures and financial ratios. However, there was no statistical evidence at 5% level of significance to prove that any of the 19

36 economic activities improved/increased under voluntary adoption of IFRS by Indian companies. The main findings of this research, therefore, do not lend support to proponents of IFRS. In the first study, the researcher finds no empirical evidence at 5% level of significance to suggest that there is improvement in financial risks under IFRS voluntary adoption. In the second study, the researcher finds no empirical evidence at 5% level of significance to suggest that there is improvement in investment activities under IFRS voluntary adoption. In the third study, the researcher finds no empirical evidence at 5% level of significance to suggest that there is improvement in mergers and acquisitions activities under IFRS voluntary adoption. In the fourth study, the researcher finds no empirical evidence at 5% level of significance to suggest that there is improvement in diversification activities under IFRS voluntary adoption. It is, therefore, interesting to know that none of the economic activities showed improvement statistically with IFRS voluntary adoption by Indian companies, though differences were observed in absolute financial ratios. These results find support in various studies as in (a) Auer (1996) where the empirical results suggested no statistically significant differences in the information between IFRS-based and Swiss GAAP-based statements; (b) Tendeloo & Vanstralen (2005) where there was no significant differences in earnings management between companies using adopted IFRS and others using German GAAP; (c) Daske (2006) where risk for IFRS companies was found to have increased; (d) Kabir et al. (2010) where there was no statistical support for information based on IFRS and New Zealand GAAP. 20

37 I.10 LIMITATIONS OF THE STUDY This research is subject to some limitations. The sample size is relatively very small and hence the research design has been adapted to this condition. The sample periods of the four companies in this research cover only, the reason being reporting in both IFRS as well as IGGAP is done only by these companies, Because of this, the sample size is small as IFRS adoption in India is still voluntary. Therefore, selecting the sample size itself was difficult given data availability constraints. The measures used in the research may also suffer from measurement errors because some indicators are included in the financial matrix used, the research may not be able to control all reporting indicators. This research encompasses an empirical investigation of impact of voluntary IFRS adoption and economic activities in the emerging market of India. As a countryspecific study (Zhou et al. 2009), the conclusions from this research are probably difficult to extrapolate to other countries exhibiting different socio-economic and socio-political characteristics. This constitutes another limitation of this research. I.11 CHAPTER SCHEME The thesis is divided into six chapters, organized as follows: Chapter 1: Introduction This chapter deals with a brief history of Indian Generally Accepted Accounting Principles, International Financial Reporting Standards, International Accounting Board, and Financial Accounting Standard Board. The chapter also provides information on the objectives, statement of problem, research question, scope and significance, hypotheses and operational definitions of the study. It also provides findings and limitations and presents an overview of the thesis chapter organization. 21

38 Chapter 2: Literature Review This chapter covers literature across various nations including studies in India. It also discusses the origin of International Accounting Standards. Further, it covers literature on various IAS, IFRS and their major differences with IGAAP. Chapter 3: Research Design and Methodology This chapter covers the purpose of study, design, data collection, methods and tools and financial matrices used for analysis. Chapter 4: Companies under study This chapter covers accounting regulations and IFRS reporting and convergence in India. It includes discussion about the companies considered for study (1) Dabur India Ltd (2) Infosys Ltd (3) Noida Toll Bridge Co. Ltd and (4) Rolta India Ltd. Brief description in terms of history and background, products, investment activities, diversification and mergers and acquisitions and other activities about each company are covered. Chapter 5: Analysis and Interpretation This chapter covers data analysis and measurement of variables from the annual reports of the companies through the financial matrices. Data analysis is done by testing of the hypotheses through the statistical tools. Chapter 6: Conclusion, Suggestions, and Scope for Further Research This chapter summarizes the results presented in the thesis, suggestions and, how stage-wise IFRS can be implemented, benefits of usage and various training required for different types of management teams. It also highlights potential areas for future research studies. 22

39 CHAPTER II LITERATURE REVIEW 23

40 II.0 INTRODUCTION IFRS are a set of standards promulgated by the IASB, an international standard-setting body based in London. The IASB places emphasis on developing standards based on sound, clearly stated principles, from which interpretation is necessary. IFRS are also referred to as principles-based standards. These contrast with sets of standards, like Indian/USGAAP as well as standards of other countries, which contain significantly more application guidance. Such standards are referred to as rules-based standards. According to one school of thought, since IFRS are primarily principles-based standards, the IFRS approach focuses more on business or the economic purpose of a transaction and the underlying rights and obligations, instead of providing prescriptive rules (or guidance). IFRS provides guidance in the form of principles. II.1 BRIEF HISTORY OF THE INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE The International Accounting Standards Committee (IASC), the predecessor of the IASB, was established in 1973 and came into being through an agreement by professional accountancy bodies from Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom, Ireland, and the United States. The objective behind setting up the IASC was to develop, in the public interest, accounting standards that would be acceptable around the world in order to improve financial reporting internationally. Over the years, IASC saw several changes to its structure and functioning. For example, by the year 2000, IASC s sponsorship grew from the original nine sponsors to 152 accounting bodies from 112 countries, that is, all professional accounting bodies that were members of the International Federation of Accountants (IFAC). Such fundamental changes to the IASC have helped it to 24