The Big Switch: U.S. GAAP to IFRS Kendra Huff CBA Summer Grant Project
Introduction The International Accounting Standards Board (IASB), along with numerous international bodies, has spent many years working on a set of International Financial Reporting Standards (IFRS) that are acceptable worldwide. 2005 all EU companies required to use IFRS to prepare financials. Prior to 2007, foreign firms trading in US markets were required to prepare a reconciliation to US GAAP. After 2007, foreign firms were allowed to use IFRS without reconciliation. Also in 2007, SEC proposed timeline for US corps to switch to IFRS by 2014. This has not happened and there is no set date for implementation. This part of the study reviews the some of the issues surrounding IFRS adoption and provides information regarding the current use of IFRS in the US.
International Financial Reporting Standards 138 jurisdictions across Europe, Africa, the Middle East, Asia-Oceania and the Americas 94% committed to the use of IFRS as global accounting standards 83% require the use of IFRS for reporting by public corporations Mission of IASB: To develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world s capital markets and other users make economic decisions.
Increase of foreign investment in capital markets worldwide, investors need assurance that the information they are relying on for decisions is relevant, reliable and comparable. Purported benefits of IFRS: Allows for increased comparability and transparency of financial information. Consistent and rigorous application leads to higher quality information resulting in more efficient markets and ultimately lower cost of capital. The U.S. and FASB have not completely jumped on board with the conversion.
IFRS Adoption SEC - key elements required for adoption of IFRS: core set of high quality accounting standards that form a comprehensive, accepted basis of accounting, with comparability, transparency and full disclosure. Standards must be rigorously interpreted and applied. Hard to ensure as IASB does not have the power to regulate capital markets. Must find ways to convince market regulators that enforcement of standards is necessary for the successful implementation of IFRS.
Nolke (2005): noted that national accounting standards are detrimental to the growth of foreign investment in capital markets - lack of transparency affects the analysis of financial statements. Irvine & Lucas (2006) With increasing globalization, IFRS lead to the increase of global companies as well increased activity by regulatory agencies. Kothari and Borone (2006) concur - investors encounter difficulties interpreting financial information prepared according to national accounting standards which may be alleviated by the implementation of IFRS. Main benefits of IFRS adoption - increased foreign investment, ease of financial statement comparison and reduced statement preparation costs as one set of financial statements can be used in multiple markets (Akgun, 2013).
Hope, Jin & Kang sampled 38 countries to try to determine the characteristics leading to the decision to adopt IFRS (as of 2004). Countries with weak shareholder protection are more likely to adopt IFRS, a finding which is in direct contrast to one of the main purposes of IFRS institutionalization. Florou & Pope (2012) found that mandatory adoption of IFRS did lead to an increase in investment. In countries with strong enforcement and reporting incentives. Also found a high degree of difference between the local GAAP and IFRS.
Accounting Quality & Comparability Barth et al. (2007) studied the effect of IFRS on accounting quality. Sample 327 companies (1,896 firm years), 21 countries, adopted IFRS between 1994 and 2003. Found these companies generally applied less earnings management, more timely loss recognition and more value relevant accounting amounts than a matched sample of non-u.s. GAAP companies. Results indicated that accounting numbers for IFRS firms are associated share prices and returns. Atwood (2011) reported that no significant difference in earnings between IFRS and US GAAP was found but that IFRS losses are more persistent. Findings also showed that IFRS earnings are less predictive regarding future cash flows than are US GAAP earnings. Wang (2012) showed a significant increase in income smoothing, an aggressive use of accruals and decrease in the timeliness of loss recognition with IFRS use. (Contrary to Barth)
Barth, et al. (2012) studied a matched sample of IFRS companies from 27 countries, between 1995-2006, and US companies matched by size and industry. Purpose - to determine whether IFRS accounting numbers were comparable to US GAAP accounting numbers. Comparability was the highest for companies from countries with mandatory adoption, common law countries, and strong enforcement of standards. IFRS application was found to have a significant effect on stock price, return and cash flow comparability before/after the adoption of IFRS. Repeated study over 2007-2009 - accounting comparability was even greater, supporting the IASB efforts towards accounting convergence. Findings support that the value relevance of earnings and book value as stock price was found to increase with IFRS adoption - investors can interpret the amounts and their relationship when numerous firms apply IFRS.
Stock Price and IFRS Armstrong et al. (2010) studied the effect on stock price of 16 events leading up to the mandatory conversion. Firms that had lower quality pre-adoption accounting information - effect of IFRS was positive. Also found a positive reaction to IFRS events even for companies from countries with high quality pre-adoption information. Findings are consistent with the idea that investors expect net convergence benefits from IFRS adoption. Hail (2010) - argued that regarding the U.S. stock market for non-us companies, evidence of the benefits often associated with IFRS adoption is not present. Loureiro & Taboada (2012) attempt to determine the effect of mandatory and voluntary IFRS adoption of stock price informativeness. Sample of 3,994 firm years, 30 countries, 1999-2010 Mandatory adopters actually experience a significant decrease in stock price informativeness after IFRS adoption while voluntary adopters do not
U.S. Adoption of IFRS Only a few major countries have yet to officially adopt IFRS: the US, Japan, India and China. 2007 - foreign companies allowed to prepare financials using IFRS. Hoped that elimination of the US GAAP reconciliation would result in an increase of foreign company listings, and In the use of IFRS for financial statement preparation. 2012 - SEC issued a report evaluating the full adoption of IFRS by the US but the report did not include any recommendations for adoption. Kaya (2013) reviewed the annual reports of US-listed foreign companies, 2009-2010 19% in 2009 and 23% in 2010 of foreign filers used IFRS
Barth (2008), Daske (2008) and Armstrong (2010) Performed studies which provided evidence showing positive effects of European adoption of IFRS on the quality of financial reporting. US GAAP already consists of high quality standards and it isn t clear that the same positive effect would be found if the US switches to IFRS. Joos & Leung (2013) attempted to determine US reaction to potential IFRS adoption. Studied investor reaction to several public events related to IRFS adoption. Should investors believe that IFRS adoption is beneficial, a positive market reaction should be observed if events indicate IFRS adoption. Sample - all domestic US firms, 2007-2009 Studied stock market reaction to a number of events surrounding the adoption of IFRS. In cases where adoption was expected to positively impact conversion benefits, investors also reacted positively.
Data & Analysis Identified foreign firms trading in the U.S. 2013 Reviewed annual reports to determine accounting standards being applied. Non-U.S. firms allowed to use IFRS after 2007 should expect to see an increase in number of firms trading in US. Used EDGAR to find annual reports
23% decrease in # firms from 2005-2013 11% decrease from 2007-2013
Non-US Companies trading on NYSE Country # Companies US GAAP IFRS Other Unknown % IFRS Argentina 10 5 2 3 50% Australia 3 1 2 67% Belgium 1 1 100% Bermuda 18 8 7 2 39% Brazil 26 21 2 3 81% British Virgin Islands 5 2 3 60% Canada 145 31 105 2 7 72% Cayman Islands 54 44 8 2 15% Chile 12 6 6 50% China 11 10 1 91% Columbia 2 2 0% Denmark 1 1 100% Finland 1 1 100% France 7 7 100% Germany 5 1 4 80% Greece 1 1 0% Guernsey 1 1 0% Hong Kong 3 3 100% India 10 2 6 1 1 60% Ireland 5 3 1 1 20% Isle of Man 1 1 100% Israel 8 2 6 75% Country # Companies US GAAP IFRS Other Unknown % IFRS Italy 5 1 3 1 60% Japan 15 14 1 7% Jersey 1 1 100% Korea 8 8 100% Liberia 1 1 0% Luxembourg 6 2 4 67% Marshall Islands 23 21 2 9% Mexico 15 5 10 33% Netherlands 13 5 7 1 54% Norway 2 2 100% Panama 3 2 1 67% Peru 3 1 2 33% Philippines 1 1 100% Portugal 1 2 0% Russia 2 2 0% South Africa 7 1 6 86% Spain 4 4 100% Switzerlland 7 3 3 1 43% Taiwan 5 5 100% Turkey 1 1 100% United Kingdom 25 24 1 96% 478 148 278 10 42 58%
96% of firms from the United Kingdom used IFRS - EU countries have been required IFRS since 2005. 91% of firms from China used IFRS. China currently requires the use of their own national standards for local listings. 81% of Brazilian firms used IFRS. Brazil requires IFRS for local markets and for US filings as well. Countries with a smaller number of firms comprise a large percent of those using IFRS, many of these firms are from EU countries. Canada adopted IFRS in 2011. Argentina, Chile, Mexico, and the Netherlands all require the use of IFRS. Bermuda, the Cayman Islands, and Japan permit the use of IFRS. A brief review of the annual reports of firms choosing US GAAP revealed that the choice was often made because the firm only listed on US markets.
What is next? Is IFRS based financial information valued? Following working equation will be used to determine the relevance of accounting information: sp i,t = β 1 IFRS i,t + β 2 BVPS i,t + β 3 EPS i,t + ε i,t where: sp i,t = stock price of firm i at the end of the reporting period; IFRS is a dummy variable (0 year before conversion, 1 year after); BVPS i,t = book value per share of firm i at time t; EPS i,t = earnings per share of firm i and time t (Ricciardi & Kufstein, 2012). Equation will be applied the year before and the year after conversion to IFRS to see if IFRS made a difference. Working on data collection using Capital IQ.